================================================================================

                                  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, 2001
                                       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                               (I.R.S. Employer
 incorporation or organization)                              Identification No.)

          20 Horseneck Lane
        Greenwich, Connecticut                                     06830
(Address of principal executive offices)                         (Zip Code)

Registrant's telephone number, including area code:  (203) 862-4300

              ----------------------------------------------------
              (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 the number of shares outstanding of each of the issuer's classes of
common shares.

            CLASS                              OUTSTANDING AT SEPTEMBER 30, 2001
            -----                              ---------------------------------
Common Shares, $0.01 par value                            12,868,158

================================================================================


                             ARCH CAPITAL GROUP LTD.

                                      INDEX

                                                                        Page No.
                                                                        --------

PART I.  FINANCIAL INFORMATION

ITEM 1 -- CONSOLIDATED FINANCIAL STATEMENTS

Review Report of Independent Accountants                                     1

Consolidated Balance Sheet                                                   2
  September 30, 2001 and December 31, 2000

Consolidated Statement of Income                                             3
  For the three and nine month periods ended September 30, 2001 and 2000

Consolidated Statement of Shareholders' Equity and Comprehensive Income      4
  For the nine month periods ended September 30, 2001 and 2000

Consolidated Statement of Cash Flows                                         5
  For the nine month periods ended September 30, 2001 and 2000

Notes to Consolidated Financial Statements                                   6

ITEM 2 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS                                                   25

ITEM 3 -- QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK        30

PART II.  OTHER INFORMATION

ITEM 1 -- LEGAL PROCEEDINGS                                                 31

ITEM 6 -- EXHIBITS AND REPORTS ON FORM 8-K                                  31


                        REPORT OF INDEPENDENT ACCOUNTANTS

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, 2001, and the related
consolidated statements of income, of changes in shareholders' equity and
comprehensive income and of cash flows for each of the nine-month periods ended
September 30, 2001 and 2000. These financial statements are the responsibility
of the Company's management.

We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with generally accepted auditing standards, 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 information for it to
be in conformity with accounting principles generally accepted in the United
States of America.

We previously audited in accordance with auditing standards generally accepted
in the United States of America, the consolidated balance sheet as of December
31, 2000, and the related consolidated statements of income and comprehensive
income, of changes in shareholders' equity, and of cash flows for the year then
ended (not presented herein), and in our report dated February 6, 2001 except as
to the matters described in Note 2 to the consolidated financial statements
which is as of August 6, 2001, 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, 2000,
is fairly stated in all material respects in relation to the consolidated
balance sheet from which it has been derived.


/s/ PricewaterhouseCoopers
PricewaterhouseCoopers
Hamilton, Bermuda
November 13, 2001


                                        1


                    ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEET
                        (IN THOUSANDS, EXCEPT SHARE DATA)



                                                                            (UNAUDITED)
                                                                            SEPTEMBER 30,   DECEMBER 31,
                                                                                2001            2000
                                                                            ------------    ------------
                                                                                             (RESTATED)
                                                                                      
ASSETS
Investments:
Fixed maturities (amortized cost: 2001, $125,074; 2000, $37,849)                $128,700         $38,475
Publicly traded equity securities (cost: 2001, $2,656; 2000, $24,987)              3,506          51,322
Privately held securities (cost: 2001, $35,873; 2000, $57,913)                    35,925          56,418
Securities held in escrow (amortized cost: 2001, $22,073; 2000, $20,887)          22,093          20,970
Short-term investments                                                            85,928          97,387
                                                                            ------------    ------------
Total investments                                                                276,152         264,572
                                                                            ------------    ------------

Cash                                                                              14,671          11,481
Accrued investment income                                                          2,228           1,432
Premiums receivable                                                               64,791
Unpaid claims and claims expenses recoverable                                     87,695
Paid claims and claims expenses recoverable                                        8,927
Prepaid reinsurance premiums                                                      59,895
Reinsurance balances receivable                                                    3,610
Goodwill                                                                          26,587           6,111
Deferred income tax asset                                                          7,345           8,192
Deferred policy acquisition costs                                                  5,320
Other assets                                                                       8,334           4,119
                                                                            ------------    ------------
TOTAL ASSETS                                                                    $565,555        $295,907
                                                                            ============    ============

LIABILITIES
Claims and claims expenses                                                      $112,104
Unearned premiums                                                                 89,183
Reinsurance balances payable                                                      50,037
Reserve for contingent loss of escrowed assets                                    15,382         $15,000
Other liabilities                                                                 22,491           8,608
                                                                            ------------    ------------
TOTAL LIABILITIES                                                                289,197          23,608
                                                                            ------------    ------------

COMMITMENTS AND CONTINGENCIES

SHAREHOLDERS' EQUITY
Preferred shares, $0.01 par value:
50,000,000 shares authorized (none issued)
Common shares, $0.01 par value:
200,000,000 shares authorized
(issued:  2001, 12,868,158; 2000, 12,708,818)                                        129             127
Additional paid-in capital                                                       290,464         288,016
Deferred compensation under share award plan                                      (1,204)           (341)
Retained earnings (deficit)                                                      (16,341)        (33,626)
Accumulated other comprehensive income consisting of unrealized
appreciation (depreciation) of investments, net of income tax                      3,310          18,123
                                                                            ------------    ------------
TOTAL SHAREHOLDERS' EQUITY                                                       276,358         272,299
                                                                            ------------    ------------
Total Liabilities & Shareholders' Equity                                        $565,555        $295,907
                                                                            ============    ============


                 See Notes to Consolidated Financial Statements


                                        2


                    ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
                        CONSOLIDATED STATEMENT OF INCOME
                        (IN THOUSANDS, EXCEPT SHARE DATA)



                                                                  (UNAUDITED)                    (UNAUDITED)
                                                              THREE MONTHS ENDED             NINE MONTHS ENDED
                                                                 SEPTEMBER 30,                  SEPTEMBER 30,
                                                             2001            2000           2001            2000
                                                         ------------    ------------   ------------    ------------
                                                                          (RESTATED)                     (RESTATED)
                                                                                            
REVENUES
Net premiums written                                          $14,448                        $24,005        ($10,604)
(Increase) decrease in unearned premiums                       (2,649)                        (5,008)         98,134
                                                         ------------    ------------   ------------    ------------
Net premiums earned                                            11,799                         18,997          87,530
Net investment income                                           2,509          $3,359          8,747          12,906
Net investment gains (losses)                                    (190)            728         18,419          32,834
Fee income                                                      3,524                          8,950
Net commission income                                                                          1,344
Equity in net income of investees                                 966             878          1,887           1,511
Gain on sale of reinsurance operations                                                                         2,191
                                                         ------------    ------------   ------------    ------------
TOTAL REVENUES                                                 18,608           4,965         58,344         136,972

EXPENSES
Claims and claims expenses                                      9,196                         16,267          76,263
Net commissions and brokerage                                     337                                         26,756
Other operating expenses                                        7,674           1,502         16,748           5,748
Foreign exchange loss                                                                                          1,159
                                                         ------------    ------------   ------------    ------------
TOTAL EXPENSES                                                 17,207           1,502         33,015         109,926

INCOME BEFORE INCOME TAXES                                      1,401           3,463         25,329          27,046

Income taxes:
Current                                                           627                            878
Deferred                                                         (118)          1,177          7,166          19,670
                                                         ------------    ------------   ------------    ------------
Income tax expense                                                509           1,177          8,044          19,670
                                                         ------------    ------------   ------------    ------------

NET INCOME                                                       $892          $2,286        $17,285          $7,376
                                                         ============    ============   ============    ============

AVERAGE SHARES OUTSTANDING
Basic                                                      12,864,790      12,402,693     12,828,180      13,429,315
Diluted                                                    12,897,846      12,405,101     12,842,765      13,430,612

Basic and diluted net income
per share                                                       $0.07           $0.18          $1.35           $0.55


                 See Notes to Consolidated Financial Statements


                                        3


                    ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
     CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME
                                 (IN THOUSANDS)



                                                                                                             (UNAUDITED)
                                                                                                          NINE MONTHS ENDED,
                                                                                                            SEPTEMBER 30,
                                                                                                         2001          2000
                                                                                                      ----------    ----------
                                                                                                                    (RESTATED)
                                                                                                              
COMMON SHARES
Balance at beginning of year                                                                                $127          $171
Common shares issued                                                                                           2             1
                                                                                                      ----------    ----------
Balance at end of period                                                                                     129           172
                                                                                                      ----------    ----------

ADDITIONAL PAID-IN CAPITAL
Balance at beginning of year                                                                             288,016       342,034
Common shares issued                                                                                       2,496         1,341
Common shares retired                                                                                        (48)
                                                                                                      ----------    ----------
Balance at end of period                                                                                 290,464       343,375
                                                                                                      ----------    ----------

DEFERRED COMPENSATION UNDER SHARE AWARD PLAN
Balance at beginning of year                                                                                (341)         (317)
Restricted common shares issued                                                                           (1,772)       (1,122)
Compensation expense recognized                                                                              909           797
                                                                                                      ----------    ----------
Balance at end of period                                                                                  (1,204)         (642)
                                                                                                      ----------    ----------

RETAINED EARNINGS (DEFICIT)
Balance at beginning of year, as previously reported                                                     (30,916)      (22,175)
Adjustment to retroactively adopt the equity method of accounting for the original
  investment in ART Services                                                                              (2,710)       (3,439)
                                                                                                      ----------    ----------
Balance at beginning of year, as adjusted                                                                (33,626)      (25,614)
Net income                                                                                                17,285         7,376
                                                                                                      ----------    ----------
Balance at end of period                                                                                 (16,341)      (18,238)
                                                                                                      ----------    ----------

TREASURY SHARES, AT COST
Balance at beginning of year                                                                                              (387)
Purchase of treasury shares                                                                                  (48)      (59,415)
Retirement of treasury shares                                                                                 48
                                                                                                      ----------    ----------
Balance at end of period                                                                                               (59,802)
                                                                                                      ----------    ----------

ACCUMULATED OTHER COMPREHENSIVE INCOME
UNREALIZED APPRECIATION (DEPRECIATION) OF INVESTMENTS, NET OF INCOME TAX
Balance at beginning of year                                                                              18,432        27,188
Adjustment to retroactively adopt the equity method of accounting for the original
  investment in ART Services                                                                                (309)         (745)
                                                                                                      ----------    ----------
Balance at beginning of year, as adjusted                                                                 18,123        26,443
Change in unrealized appreciation (depreciation)                                                         (14,813)      (25,205)
                                                                                                      ----------    ----------
Balance at end of period                                                                                   3,310         1,238
                                                                                                      ----------    ----------

TOTAL SHAREHOLDERS' EQUITY                                                                              $276,358      $266,103
                                                                                                      ==========    ==========
COMPREHENSIVE INCOME (LOSS)
  Net income                                                                                             $17,285        $7,376
  Other comprehensive income (loss), net of tax
    Unrealized appreciation (depreciation) of investments:
      Unrealized holding gains (losses) arising during period                                             (3,275)       (3,862)
      Less: reclassification adjustment for net realized gains included in net income                    (11,538)      (21,343)
                                                                                                      ----------    ----------
  Other comprehensive income (loss)                                                                      (14,813)      (25,205)
                                                                                                      ----------    ----------
Comprehensive Income (Loss)                                                                               $2,472      ($17,829)
                                                                                                      ==========    ==========


                 See Notes to Consolidated Financial Statements


                                        4


                    ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENT OF CASH FLOWS
                                 (IN THOUSANDS)



                                                                                                            (UNAUDITED)
                                                                                                         NINE MONTHS ENDED,
                                                                                                            SEPTEMBER 30,
                                                                                                         2001          2000
                                                                                                      ----------    ----------
                                                                                                                    (RESTATED)
                                                                                                              
OPERATING ACTIVITIES
Net income                                                                                               $17,285        $7,376
  Adjustments to reconcile net income
  to net cash provided by operating activities:
   Liability for claims and claims expenses                                                                6,905         7,069
   Unearned premiums                                                                                       9,202        (5,226)
   Premiums receivable                                                                                   (14,027)       10,733
   Accrued investment income                                                                                 162           664
   Reinsurance recoverables                                                                               (9,875)      (11,093)
   Reinsurance balances payable                                                                            3,569        (5,121)
   Deferred policy acquisition costs                                                                        (984)          344
   Net investment gains                                                                                  (18,419)      (24,331)
   Deferred income tax asset                                                                               7,337         5,386
   Other liabilities                                                                                      (3,160)        7,718
   Other items, net                                                                                        5,709         8,541
                                                                                                      ----------    ----------
NET CASH PROVIDED BY (USED FOR) OPERATING ACTIVITIES                                                       3,704         2,060
                                                                                                      ----------    ----------

INVESTING ACTIVITIES
Purchases of fixed maturity investments                                                                  (90,334)      (96,915)
Sales of fixed maturity investments                                                                       85,084       221,323
Purchases of equity securities                                                                                         (18,233)
Sales of equity securities                                                                                43,504        77,853
Net purchases of short-term investments                                                                   (3,039)     (120,997)
Sales or disposal (purchases) of furniture and equipment                                                    (912)            6
Proceeds from sale of reinsurance operations                                                                               517
Acquisition of American Independent Insurance Holding Company, net of cash                                  (225)
Acquisition of ART Services, net of cash                                                                 (34,211)
                                                                                                      ----------    ----------
NET CASH PROVIDED BY (USED FOR) INVESTING ACTIVITIES                                                        (133)       63,554
                                                                                                      ----------    ----------

FINANCING ACTIVITIES
Common shares issued                                                                                          90           100
Purchase of treasury shares                                                                                  (48)      (59,415)
Debt retirement                                                                                             (423)
                                                                                                      ----------    ----------
NET CASH PROVIDED BY (USED FOR) FINANCING ACTIVITIES                                                        (381)      (59,315)
                                                                                                      ----------    ----------

Increase in cash                                                                                           3,190         6,299
Cash beginning of year                                                                                    11,481         9,457
                                                                                                      ----------    ----------
CASH END OF PERIOD                                                                                       $14,671       $15,756
                                                                                                      ==========    ==========


                 See Notes to Consolidated Financial Statements


                                        5


                    ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. ORGANIZATION

      Arch Capital Group Ltd. ("ACGL") is a Bermuda-based insurance and
financial services company. In October 2001, ACGL announced the launch of an
underwriting initiative to meet current and future demand in the global
insurance marketplace and a related $763.15 million financing transaction to
support this initiative. The financing will raise ACGL's total invested capital
to over $1 billion and is subject to customary closing conditions. See Note 15.

      ACGL was formed in September 2000 and became the sole shareholder of Arch
Capital Group (U.S.) Inc. ("Arch-U.S.") pursuant to an internal reorganization
transaction completed in November 2000, as described below. Arch-U.S. is a
Delaware company formed in March 1995 under the original name of "Risk Capital
Holdings, Inc." Arch-U.S. commenced operations in September 1995 following the
completion of its initial public offering. Prior to May 5, 2000, Arch-U.S.
provided reinsurance and other forms of capital for insurance companies through
its wholly owned subsidiary, Arch Reinsurance Company ("Arch Re"), a Nebraska
corporation formed in 1995 under the original name of "Risk Capital Reinsurance
Company." On May 5, 2000, Arch-U.S. sold the reinsurance operations of Arch Re
to Folksamerica Reinsurance Company ("Folksamerica").

      On November 8, 2000, following the approval of Arch-U.S.'s shareholders,
Arch-U.S. completed an internal reorganization that resulted in Arch-U.S.
becoming a wholly owned subsidiary of ACGL. ACGL performs the holding company
functions previously conducted by Arch-U.S., and the shareholders of Arch-U.S.
have become the shareholders of ACGL. Prior to the reorganization, ACGL had no
significant assets or capitalization and had not engaged in any business or
prior activities other than in connection with the reorganization. Arch-U.S.
remains the holding company for certain United States subsidiaries.

      As used below, the "Company" means ACGL and its subsidiaries, except when
referring to periods prior to November 8, 2000, when it means Arch-U.S. and its
subsidiaries. Similarly, "Common Shares" means the common shares, par value
$0.01, of ACGL, except when referring to periods prior to November 8, 2000, when
it means the common stock of Arch-U.S.

      The Common Shares of ACGL are traded on the Nasdaq National Market under
the symbol "ACGL." Class A warrants to purchase an aggregate of 2,531,079 Common
Shares and Class B warrants to purchase an aggregate of 1,920,601 Common Shares
were issued in connection with the Company's initial public offering in
September 1995. Class A warrants are immediately exercisable at $20 per share
and expire September 19, 2002. Class B warrants will become exercisable at $20
per share after the Common Shares have traded at or above $30 per share for 20
out of 30 consecutive trading days or a change of control (as defined in the
Class B warrants) has occurred. The Class B warrants expire on September 19,
2005. See Note 15.

2. GENERAL

      The interim consolidated financial statements have been prepared in
conformity with generally accepted accounting principles ("GAAP") in the United
States and include the accounts of ACGL, Arch Reinsurance Ltd. ("Arch Re
Bermuda"), Arch-U.S., Hales & Company Inc. ("Hales"), American Independent
Insurance Holding Company ("AIHC"), Arch Risk Transfer Services Ltd., formerly
known as Altus Holdings, Ltd. ("ART Services"), Arch Re and Cross River
Insurance Company ("Cross River"). All 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


                                       6


                    ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

2. GENERAL (CONT'D.)

estimates. In the opinion of management, the accompanying interim consolidated
financial statements reflect all adjustments necessary (consisting of normal
recurring accruals) for a fair presentation 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.

3. RECLASSIFICATIONS

      Certain amounts in the 2000 consolidated financial statements have been
reclassified to conform to the 2001 presentation. Such reclassifications had no
effect on the Company's net income, shareholders' equity or cash flows.

4. RESTATEMENT

      The Company filed with the Securities and Exchange Commission ("SEC") an
amended Form 10-K for the year ended December 31, 2000 and an amended Form 10-Q
for the quarter ended March 31, 2001 to restate the financial statements
included in such filings, as described below. The accompanying consolidated
financial statements include the effects of the required restatement for the
quarterly and year-to-date periods ended September 30, 2000, and should be read
in conjunction with the restated financial statements contained in such amended
SEC filings.

      On June 22, 2001, the Company completed its acquisition of all of the
remaining ownership interests in one of its investee companies, ART Services.
After the Company's acquisition of its initial 27.9% ownership interest in ART
Services in March 1998, the investment was carried at its estimated fair value
from the initial purchase through March 31, 2001 in accordance with generally
accepted accounting principles. The Company accounted for its initial interest
in ART Services under "fair value" because the Company did not have the ability
to exercise significant influence over this investment due to the Company's
limited voting and consent rights. Upon the closing of the Company's acquisition
of ART Services, the Company was required under generally accepted accounting
principles governing a "step acquisition" of an investee company to
retroactively adopt the equity method of accounting for its original 27.9%
ownership interest in ART Services for the periods prior to the acquisition and
to restate its historical financial results. The required change to the equity
method of accounting for this investment resulted in a reduction in the
Company's book value at September 30, 2001 in the amount of $3.5 million, or
$0.27 per share, and decreased net income by $475,000, or $0.04 per share, for
the nine months ended September 30, 2001. Restating net income previously
reported resulted in an increase in net income of $27,000 and $1.9 million, or
$0.14 per share, for the 2000 third quarter and the nine months ended September
30, 2000, respectively. See also Note 9 and Note 11.

      The principal effects of these changes on the September 30, 2000 financial
statements are presented below and in the 2000 financial statements as follows
(in thousands, except per share data):



                                                       THREE MONTHS ENDED                   NINE MONTHS ENDED
                                                       SEPTEMBER 30, 2000                  SEPTEMBER 30, 2000
                                                ----------------------------------  ----------------------------------
                                                      AS           AS PREVIOUSLY          AS           AS PREVIOUSLY
                                                   RESTATED          REPORTED          RESTATED          REPORTED
                                                ---------------   ----------------  ----------------  ----------------
                                                                                              
Net investment gains (losses)                           $728              $728           $32,834           $29,661
Equity in net income of investees                        878               837             1,511             1,820
Income before income taxes                             3,463             3,422            27,046            24,182
Income tax expense                                     1,177             1,163            19,670            18,667
Net income (loss)                                     $2,286            $2,259            $7,376            $5,515

Basic and diluted net income (loss) per share          $0.18             $0.18             $0.55             $0.41



                                       7


                    ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

4. RESTATEMENT (CONT'D.)



CONSOLIDATED BALANCE SHEET:                                                     DECEMBER 31, 2000
(IN THOUSANDS, EXCEPT SHARE DATA)                                        -----------------------------
                                                                             AS          AS PREVIOUSLY
                                                                           RESTATED         REPORTED
                                                                         ------------    -------------
                                                                                   
ASSETS
Investments:
Fixed maturities (amortized cost: $37,849)                                    $38,475          $38,475
Publicly traded equity securities (cost: $24,987)                              51,322           51,322
Privately held securities (cost: restated, $57,913; original, $60,623)         56,418           59,437
Securities held in escrow (amortized cost: $20,887)                            20,970           20,970
Short-term investments                                                         97,387           97,387
                                                                         ------------    -------------
Total investments                                                             264,572          267,591
                                                                         ------------    -------------

Cash                                                                           11,481           11,481
Accrued investment income                                                       1,432            1,432
Premiums receivable
Unpaid claims and claims expenses recoverable
Paid claims and claims expenses recoverable
Prepaid reinsurance premiums
Reinsurance balances receivable
Goodwill                                                                        6,111            6,111
Deferred income tax asset                                                       8,192            8,192
Deferred policy acquisition costs
Other assets                                                                    4,119            4,119
                                                                         ------------    -------------
TOTAL ASSETS                                                                 $295,907         $298,926
                                                                         ============    =============

LIABILITIES
Claims and claims expenses
Unearned premiums
Reinsurance balances payable
Reserve for contingent loss of escrowed assets                                $15,000          $15,000
Other liabilities                                                               8,608            8,608
                                                                         ------------    -------------
TOTAL LIABILITIES                                                              23,608           23,608
                                                                         ------------    -------------

COMMITMENTS AND CONTINGENCIES

SHAREHOLDERS' EQUITY
Preferred shares, $.01 par value:
50,000,000 shares authorized (none issued)
Common shares, $.01 par value:
200,000,000 shares authorized
(issued: 12,708,818)                                                              127              127
Additional paid-in capital                                                    288,016          288,016
Deferred compensation under share award plan                                     (341)            (341)
Retained earnings (deficit)                                                   (33,626)         (30,916)
Less treasury shares, at cost
Accumulated other comprehensive income consisting of unrealized
Appreciation of investments, net of income tax                                 18,123           18,432
                                                                         ------------    -------------
TOTAL SHAREHOLDERS' EQUITY                                                    272,299          275,318
                                                                         ------------    -------------
Total Liabilities & Shareholders' Equity                                     $295,907         $298,926
                                                                         ============    =============



                                       8


                    ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

4. RESTATEMENT (CONT'D.)

CONSOLIDATED STATEMENT OF INCOME
(IN THOUSANDS, EXCEPT SHARE DATA)



                                                  THREE MONTHS ENDED                NINE MONTHS ENDED
                                                  SEPTEMBER 30, 2000                SEPTEMBER 30, 2000
                                           -------------------------------   --------------------------------
                                                 AS         AS PREVIOUSLY          AS          AS PREVIOUSLY
                                              RESTATED         REPORTED         RESTATED          REPORTED
                                           --------------   --------------   --------------    --------------
                                                                                       
REVENUES
Net premiums written                                                               ($10,604)         ($10,604)
(Increase) decrease in unearned premiums                                             98,134            98,134
                                           --------------   --------------   --------------    --------------
Net premiums earned                                                                  87,530            87,530
Net investment income                              $3,359           $3,359           12,906            12,906
Net investment gains                                  728              728           32,834            29,661
Fee income
Net commission income
Equity in net income of investees                     878              837            1,511             1,820
Gain on sale of reinsurance operations                                                2,191             2,191
                                           --------------   --------------   --------------    --------------
TOTAL REVENUES                                      4,965            4,924          136,972           134,108

EXPENSES
Claims and claims expenses                                                           76,263            76,263
Net commissions and brokerage                                                        26,756            26,756
Other operating expenses                            1,502            1,502            5,748             5,748
Foreign exchange loss                                                                 1,159             1,159
                                           --------------   --------------   --------------    --------------
TOTAL EXPENSES                                      1,502            1,502          109,926           109,926

INCOME BEFORE INCOME TAXES                          3,463            3,422           27,046            24,182

Income taxes:
Current
Deferred                                            1,177            1,163           19,670            18,667
                                           --------------   --------------   --------------    --------------
Income tax expense                                  1,177            1,163           19,670            18,667
                                           --------------   --------------   --------------    --------------

NET INCOME                                         $2,286           $2,259           $7,376            $5,515
                                           ==============   ==============   ==============    ==============

AVERAGE SHARES OUTSTANDING
Basic                                          12,402,693       12,402,693       13,429,315        13,429,315
Diluted                                        12,405,101       12,405,101       13,430,612        13,430,612

Basic and diluted net income per share              $0.18            $0.18            $0.55             $0.41


5. ACCOUNTING PRONOUNCEMENTS

      In July 2001, the Financial and Accounting Standards Board issued
Statement of Financial Accounting Standard ("SFAS") No. 141 "Business
Combinations" and SFAS No. 142 "Goodwill and Other Intangible Assets." SFAS No.
141 establishes accounting and reporting standards for business combinations and
requires that the purchase method of accounting be used for all business
combinations initiated after June 30, 2001. Use of the pooling-of-interests
method will be prohibited. The Company has accounted for its recently completed
acquisitions using the purchase method of accounting and does not anticipate any
material impact from the adoption of SFAS No. 141.


                                       9


                    ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

5. ACCOUNTING PRONOUNCEMENTS (CONT'D.)

      SFAS No. 142 changes the accounting for goodwill and other intangible
assets in business combinations from an amortization method to an
impairment-only approach. This change provides investors with greater
transparency regarding the economic value of goodwill and its impact on
earnings. The adoption of SFAS No. 142 will result in the Company's
discontinuation of amortization of its goodwill beginning in 2002. The Company
will continue to be required to test goodwill for impairment under the new
standard, which could have an adverse effect on future results of operations to
the extent an impairment exists. Under SFAS No. 142, goodwill recorded after
June 30, 2001 will not be amortized. Goodwill recorded prior to July 1, 2001
will continue to be amortized until the Company adopts SFAS No. 142 on January
1, 2002. The Company is currently in the process of assessing the effect of the
adoption of SFAS 142 on its results of operations, financial condition and
liquidity.

6. GOODWILL

      Goodwill of acquired businesses represents the difference between purchase
cost and the fair value of the net assets of the acquired businesses and is
amortized on a straight-line basis over the expected life of the related
operations acquired, which generally does not exceed 15 years. See Note 5. The
Company recorded goodwill relating to its acquisitions of Hales, AIHC and ART
Services and has not allocated any amounts to other intangible assets relating
to such acquisitions. The Company evaluates the recoverability of the carrying
value of goodwill relating to acquired businesses on an undiscounted basis to
ensure it is properly valued. If it is determined that an impairment exists, the
excess of the unamortized balance will be charged to earnings at that time. The
carrying amount of goodwill at September 30, 2001 was $26.6 million, consisting
of $5.8 million, $14.0 million and $6.8 million, respectively, relating to the
acquisitions of Hales, AIHC and ART Services. At December 31, 2000, goodwill
consisted of $6.1 million relating to the acquisition of Hales. Amortization of
goodwill for the nine months ended September 30, 2001 was $979,000, or $0.08 per
share.

7. RELATED PARTY TRANSACTION

      In June 2001, Arch Re Bermuda entered into a retroactive loss portfolio
transfer agreement with American Independent Insurance Company ("American
Independent"), a wholly owned subsidiary of AIHC, pursuant to which Arch Re
Bermuda reinsured 100% of all unpaid losses and loss adjustment expenses on the
transferred policies in excess of a $4.0 million retention. Pursuant to the
agreement, American Independent transferred approximately $14.7 million to Arch
Re Bermuda, which is equal to the amount reserved by American Independent for
such liabilities, less $4.0 million. The impact of this transaction is
eliminated in the Company's consolidated financial statements. See Note 9.

8. CONTINGENCIES RELATING TO SALE OF REINSURANCE OPERATIONS

      Under the terms of the agreement relating to the sale of the Company's
reinsurance operations to Folksamerica on May 5, 2000, the Company placed $20.0
million of the purchase price in escrow for a period of five years. Such amounts
represent restricted funds that appear under a separate caption entitled
"Securities held in escrow" on the Company's consolidated balance sheet at
September 30, 2001. These funds will be used to reimburse Folksamerica if the
loss reserves (which were $32.3 million at the closing of the asset sale)
transferred to it in the asset sale relating to business produced on behalf of
Arch Re by a certain managing underwriting agency are deficient as measured at
the end of such five-year period or to satisfy certain indemnity claims
Folksamerica may have during such period. In connection with the escrow
arrangement, the Company will record a loss in an amount equal to any probable
deficiency in the related reserve that may become known during or at the end of
the five-year period, plus accrued interest income on the amount of any such
deficiency. If such loss reserves are redundant at the end of the five year
period, all of the escrowed funds will be released from escrow to the Company
and Folksamerica will pay the Company an amount equal to such redundancy.


                                       10


                    ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

8. CONTINGENCIES RELATING TO SALE OF REINSURANCE OPERATIONS (CONT'D.)

      As required under the agreement, Folksamerica reported to the Company that
adverse development had occurred in the loss reserves subject to the
Folksamerica escrow agreement for the period from May 5, 2000 to December 31,
2000. Based on such information and an independent actuarial analysis, the
Company recorded in the 2000 fourth quarter a loss contingency of $15.0 million,
on a pre-tax basis, to recognize a probable deficiency in such reserves. The
actuarial analysis was based on estimates of claims and claims expenses incurred
as of December 31, 2000 and, therefore, the amount ultimately paid may be more
or less than such estimate. As of September 30, 2001, there have been no changes
to the Company's reserve for contingent loss of the escrowed assets based on
information reported to the Company by Folksamerica through such date, except
for an increase equal to accrued interest income on the loss contingency amount.

      Under the terms of the agreement, the Company has also purchased
reinsurance protection covering the Company's aviation business to reduce the
net financial loss to Folksamerica on any large commercial airline catastrophe
to $5.4 million, net of reinstatement premiums. Although the Company believes
that any such net financial loss will not exceed $5.4 million, the Company has
agreed to reimburse Folksamerica for a net financial loss it may incur that is
in excess of $5.4 million for aviation losses under certain circumstances prior
to May 5, 2003.

      The Company also made representations and warranties to Folksamerica about
the Company and the business transferred to Folksamerica for which the Company
retains exposure for certain periods. Although Folksamerica has not asserted
that any amount is currently due under any of the indemnities provided by the
Company under the asset purchase agreement, Folksamerica has indicated a
potential indemnity claim under the agreement in the event of the occurrence of
certain future events. Based on all available information, the Company denies
the validity of any such potential claim.

      At the closing of the asset sale, Arch Re and Folksamerica entered into a
transfer and assumption agreement, under which Folksamerica assumed Arch Re's
rights and obligations under the reinsurance agreements transferred in the asset
sale. The reinsureds under such agreements that were in-force were notified that
Folksamerica had assumed Arch Re's obligations and that, unless the reinsureds
objected to the assumption, Arch Re would be released from its obligations to
those reinsureds. None of such reinsureds objected to the assumption and,
accordingly, the gross liabilities for such business have been removed from the
accounts of Arch Re for statutory and GAAP accounting purposes. However, Arch Re
will continue to be liable under those reinsurance agreements if the notice is
found not to be an effective release by the reinsureds. Folksamerica has agreed
to indemnify the Company for any losses arising out of the reinsurance
agreements transferred to Folksamerica Reinsurance Company in the asset sale.
However, in the event that Folksamerica refuses or is unable to perform its
obligations to the Company, Arch Re may incur losses relating to the reinsurance
agreements transferred in the asset sale.


                                       11


                    ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

9. ACQUISITIONS

      ARCH RISK TRANSFER SERVICES LTD.

      On June 22, 2001, the Company completed the acquisition of all of the
remaining ownership interests in one of its investee companies, ART Services,
for a purchase price of approximately $38.8 million. The purchase price
consisted of approximately $38.4 million in cash and 24,200 ACGL Common Shares.
Upon the closing of the acquisition, the Company was required under generally
accepted accounting principles governing a "step acquisition" of an investee
company to retroactively adopt the equity method of accounting for its original
minority ownership interest in ART Services for the periods prior to the
acquisition and to restate its historical financial results. See Note 4 and Note
11.

      Through its wholly owned subsidiaries, including First American Insurance
Company ("First American"), an admitted insurer with licenses in 49 states and
an A.M. Best rating "A- (Excellent)", ART Services provides insurance and
alternative risk transfer services through rent-a-captive and other facilities.

      AMERICAN INDEPENDENT INSURANCE HOLDING COMPANY

      On February 28, 2001, the Company completed a reorganization transaction
pursuant to which the Company acquired all of the common stock of AIHC, one of
its investee companies. See Note 11. AIHC is a specialty property and casualty
insurance holding company that, through its subsidiaries, markets and
underwrites nonstandard personal automobile liability and physical damage lines
of insurance, primarily in Pennsylvania, as well as in Maryland and Delaware.

      The Company purchased a portion of the outstanding shares of AIHC for
$1.25 million. The remaining outstanding shares of AIHC were redeemed by AIHC in
exchange for the right to receive a portion of the proceeds resulting from the
final adjudication or settlement of certain lawsuits that AIHC, as plaintiff,
has previously filed against certain defendants. A third party also forgave the
obligations owing to it under certain notes previously issued by AIHC in the
aggregate principal amount of $4 million and returned certain warrants to
purchase shares of AIHC in exchange for the right to receive a portion of the
proceeds resulting from the final adjudication or settlement of such lawsuits.
Immediately after the Company's purchase of AIHC, the Company contributed to the
capital of AIHC notes in the aggregate principal amount of $8.5 million that
were issued to the Company in connection with loans it had previously made to
AIHC and also returned certain warrants to purchase shares of AIHC. Following
the purchase, the Company also made a capital contribution to AIHC in the amount
of $11.0 million.

      In connection with the loans the Company had previously made to AIHC, the
Company had obtained rights to provide reinsurance to AIHC's subsidiary,
American Independent, for specified periods, which rights had been transferred
to Folksamerica in the asset sale on May 5, 2000. In connection with the
Company's acquisition of AIHC, Folksamerica released American Independent from
these reinsurance commitments at a cost to American Independent of $1.5 million.
See Note 7 regarding a retroactive loss portfolio transfer agreement entered
into by American Independent and Arch Re Bermuda in June 2001.


                                       12


                    ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

9. ACQUISITIONS (CONT'D.)

      PRO FORMA FINANCIAL INFORMATION

      The following unaudited pro forma financial information for the nine
months ended September 30, 2001 includes the unaudited financial information for
ART Services and AIHC for the nine months ended September 30, 2001 as if the
acquisitions of ART Services and AIHC had occurred on January 1, 2001. The
unaudited pro forma financial information for the year ended December 31, 2000
includes the audited financial information for ART Services and AIHC for the
year ended December 31, 2000 as if the acquisitions occurred on January 1, 2000.

      The pro forma financial information is based upon information currently
available and certain assumptions that the Company's management believes are
reasonable. The pro forma financial information does not purport to be
indicative of the Company's results of operations or financial condition that
would have occurred or resulted had the transactions been completed on such
dates, nor is the information intended to be a projection of the Company's
results of operations or financial condition for any future periods.



                                            (IN THOUSANDS, EXCEPT SHARE DATA)
                                                    PRO FORMA RESULTS
                                              NINE MONTHS      TWELVE MONTHS
                                                 ENDED             ENDED
                                              SEPTEMBER 30,     DECEMBER 31,
                                                  2001              2000
                                             --------------    --------------
                                                                 (Restated)
                                                            
      Total Revenues                             $83,762          $174,139

      Net Income (Loss)                          $20,145          ($20,854)

      Basic earnings (loss) per share              $1.57            ($1.58)
      Diluted earnings (loss) per share            $1.57            ($1.58)


10. EARNINGS PER SHARE DATA

      Earnings per share are computed in accordance with SFAS No. 128 "Earnings
Per Share." Basic earnings per share exclude dilution and is computed by
dividing income available to common shareholders by the weighted average number
of Common Shares outstanding for the periods. Diluted earnings per share reflect
the potential dilution that could occur if Class A and B warrants and employee
stock options were exercised or converted into Common Shares. See Note 15. When
a loss occurs, diluted per share amounts are computed using basic average shares
outstanding because including dilutive securities would decrease the loss per
share and would therefore be anti-dilutive.


                                       13


                    ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

10. EARNINGS PER SHARE DATA (CONT'D.)

      The following table sets forth the computation of basic and diluted
      earnings per share:



                                                        (IN THOUSANDS, EXCEPT SHARE DATA)
                                                  THREE MONTHS ENDED           NINE MONTHS ENDED
                                                     SEPTEMBER 30,               SEPTEMBER 30,
                                                  2001          2000          2001          2000
                                              ------------  ------------  ------------  ------------
                                                             (Restated)                  (Restated)
                                                                              
NET INCOME
BASIC EARNINGS PER SHARE:
Net income                                            $892        $2,286       $17,285        $7,376
Divided by:
Weighted average shares outstanding for the
period                                          12,864,790    12,402,693    12,828,180    13,429,315
Basic earnings per share                             $0.07         $0.18         $1.35         $0.55

DILUTED EARNINGS PER SHARE:
Net income                                            $892        $2,286       $17,285        $7,376
Divided by:
Weighted average shares outstanding for the
period                                          12,864,790    12,402,693    12,828,180    13,429,315
Effect of dilutive securities:
     Warrants
     Employee stock options                         33,056         2,408        14,585         1,297
                                              ------------  ------------  ------------  ------------
Total shares                                    12,897,846    12,405,101    12,842,765    13,430,612
                                              ============  ============  ============  ============
Diluted earnings per share                           $0.07         $0.18         $1.35         $0.55


11. INVESTMENT INFORMATION

      Realized investment gains (losses) for the three and nine month periods
ended September 30, 2001 consisted of the following:



                                                                 (IN THOUSANDS)
                                        THREE MONTHS ENDED                           NINE MONTHS ENDED
                                        SEPTEMBER 30, 2001                           SEPTEMBER 30, 2001
                            ------------------------------------------    -------------------------------------------
                                                               NET                                           NET
                                GROSS          GROSS        REALIZED          GROSS          GROSS         REALIZED
                              REALIZED       REALIZED         GAINS         REALIZED       REALIZED         GAINS
                                GAINS         LOSSES        (LOSSES)          GAINS         LOSSES         (LOSSES)
                            ------------   ------------   ------------    ------------   ------------    ------------
                                                                                            
Fixed maturity securities           $502           $692          ($190)           $755         $3,052         ($2,297)
Publicly traded equity
Securities                                                                      20,966                         20,966
Privately held securities                                                                         250            (250)
                            ------------   ------------   ------------    ------------   ------------    ------------
Total                               $502           $692          ($190)        $21,721         $3,302         $18,419
                            ============   ============   ============    ============   ============    ============



                                       14


                    ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

11. INVESTMENT INFORMATION (CONT'D.)

      The following table reconciles estimated fair value and carrying value to
the amortized cost of fixed maturities and equity securities:



                                                             (IN THOUSANDS)
                                                           SEPTEMBER 30, 2001
                                    -----------------------------------------------------------------
                                      ESTIMATED
                                      FAIR VALUE          GROSS           GROSS
                                     AND CARRYING       UNREALIZED      UNREALIZED        AMORTIZED
                                        VALUE             GAINS          (LOSSES)            COST
                                    --------------   --------------   --------------   --------------
                                                                                 
Fixed maturities                          $128,700           $3,750            ($124)        $125,074
Publicly traded equity securities            3,506            1,914           (1,064)           2,656
Privately held securities                   35,925               52                            35,873
Securities held in escrow                   22,093               20                            22,073
                                    --------------   --------------   --------------   --------------
Total                                     $190,224           $5,736          ($1,188)        $185,676
                                    ==============   ==============   ==============   ==============


      The Company classifies all of its publicly traded fixed maturities and
equity securities as "available for sale" and, accordingly, such securities are
carried at estimated fair value. The fair values of publicly traded fixed
maturities and publicly traded equity securities are estimated using quoted
market prices or dealer quotes. Short-term investments, which have a maturity of
one year or less at the date of acquisition, are carried at cost, which
approximates fair value.

      At September 30, 2001, the Company's publicly traded equity securities and
privately held securities were issued by insurance and reinsurance companies or
companies providing services to the insurance industry. At such date, the
publicly traded equity portfolio consisted of the following:



                                                        (IN THOUSANDS)
                                                      SEPTEMBER 30, 2001
                              ------------------------------------------------------------------
                                 ESTIMATED
                                FAIR VALUE         GROSS            GROSS
                               AND CARRYING      UNREALIZED       UNREALIZED
                                   VALUE           GAINS           (LOSSES)            COST
                              --------------   --------------   --------------    --------------
                                                                              
COMMON STOCK:
Meadowbrook Insurance Group             $394                           ($1,064)           $1,458
Renaissance Re                         3,112           $1,914                              1,198
                              --------------   --------------   --------------    --------------
         Total                        $3,506           $1,914          ($1,064)           $2,656
                              ==============   ==============   ==============    ==============



                                       15


                    ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

11. INVESTMENT INFORMATION (CONT'D.)

      Investments in privately held securities may include both equity
securities and securities convertible into, or exercisable for, equity
securities (some of which may have fixed maturities). Privately held securities
are subject to trading restrictions or are otherwise illiquid and do not have
readily ascertainable market values. The risk of investing in such securities is
generally greater than the risk of investing in securities of widely held,
publicly traded companies. Lack of a secondary market and resale restrictions
may result in the Company's inability to sell a security at a price that would
otherwise be obtainable if such restrictions did not exist and may substantially
delay the sale of a security which the Company seeks to sell. Such investments
are classified as "available for sale" and carried at estimated fair value,
except for investments in which the Company believes it has the ability to
exercise significant influence (generally defined as investments in which the
Company owns 20% or more of the outstanding voting common stock of the issuer),
which are carried under the equity method of accounting. Under this method, the
Company records its proportionate share of income or loss for such investments
in results of operations.

      Goodwill for privately held equity securities carried under the equity
method of accounting was $7.7 million at September 30, 2001, compared to $8.0
million at December 31, 2000.

      The estimated fair value of investments in privately held securities,
other than those carried under the equity method or those with quoted market
values, is initially equal to the cost of such investments until the investments
are revalued based principally on substantive events or other factors which
could indicate a diminution or appreciation in value, such as an arm's-length
third party transaction justifying an increased valuation or adverse development
of a significant nature requiring a write-down. The Company periodically reviews
the valuation of investments in privately held securities with MMC Capital, Inc.
("MMC Capital"), its equity investment advisor with respect to certain of the
Company's privately held securities.

      Privately held securities consisted of the following:



                                                         (IN THOUSANDS)
                                                   SEPTEMBER 30,  DECEMBER 31,
                                                       2001           2000
                                                   ------------   ------------
                                                                   (Restated)
                                                                 
CARRIED UNDER THE EQUITY METHOD:
Arch Risk Transfer Services Ltd. (formerly Altus
  Holdings, Ltd.)                                                      $12,981
The ARC Group, LLC                                       $8,042          8,468
Arx Holding Corp.                                         3,712          3,514
Island Heritage Insurance Company, Ltd.                   4,853          4,534
New Europe Insurance Ventures                               647            642
Sunshine State Holding Corporation                        1,889          1,766
                                                   ------------   ------------
Sub-total                                                19,143         31,905
                                                   ------------   ------------

CARRIED AT FAIR VALUE:
American Independent Insurance Holding Company                           7,350
Distribution Investors, LLC                                 293            100
GuideStar Health Systems, Inc.                                0            250
Stockton Holdings Limited                                10,000         10,000
Trident II, L.P.                                          6,489          6,813
                                                   ------------   ------------
Sub-total                                                16,782         24,513
                                                   ------------   ------------
Total                                                   $35,925        $56,418
                                                   ============   ============



                                       16


                    ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

11. INVESTMENT INFORMATION (CONT'D.)

      At September 30, 2001, the Company had investment commitments relating to
its privately held securities totaling approximately $21.9 million. The
outstanding commitments at September 30, 2001 included $17.5 million committed
to Trident II, L.P. ("Trident II"), an investment fund established by MMC
Capital dedicated to making private equity and equity related investments in the
global insurance, reinsurance and related industries, and $1.2 million to
Distribution Investors, LLC, the general partner of Distribution Partners
Investment Capital, L.P., a private equity fund investing in insurance
distribution entities which is affiliated with Hales. The Company was released
from its obligations to make any further capital contributions to Trident II,
other than with respect to outstanding capital calls for which the Company
funded approximately $6.5 million in November 2001. See Note 15.

      Set forth below is certain information related to the Company's private
investment activity for the nine month period ended September 30, 2001:

      AMERICAN INDEPENDENT INSURANCE HOLDING COMPANY

      On February 28, 2001, the Company completed a reorganization transaction
pursuant to which the Company acquired all of the common stock of one of its
investee companies, AIHC. Immediately after the Company's purchase of AIHC, the
Company contributed to the capital of AIHC notes in the aggregate principal
amount of $8.5 million that were issued to the Company in connection with loans
it had previously made to AIHC. At that date, the Company restored the estimated
market value discount on the loans in the amount of $1.1 million, which had been
previously recorded in the Company's financial statements. The Company also
returned certain warrants to purchase shares of AIHC. See Note 9.

      THE ARC GROUP, LLC

      During the nine-month period ended September 30, 2001, the Company
received distributions from The ARC Group, LLC totaling $2.0 million.

      ARCH RISK TRANSFER SERVICES LTD.

      On June 22, 2001, the Company completed the acquisition of all of the
remaining ownership interests in ART Services for a purchase price of
approximately $38.8 million. The purchase price consisted of approximately $38.4
million in cash and 24,200 ACGL Common Shares. After the Company's acquisition
of its initial 27.9% ownership interest in ART Services in March 1998, the
investment was carried at its estimated fair value from the initial purchase
through March 31, 2001 in accordance with generally accepted accounting
principles. The Company accounted for its initial interest in ART Services under
"fair value" because the Company did not have the ability to exercise
significant influence over this investment due to the Company's limited voting
and consent rights. Upon acquiring the remaining ownership interests in ART
Services, the Company was required under generally accepted accounting
principles governing a "step acquisition" of an investee company to
retroactively adopt the equity method of accounting for its original 27.9%
ownership interest in ART Services for the periods prior to the acquisition and
to restate its historical financial results. Such restatement resulted in a
reduction of $3.0 million to the carrying value of this investment at December
31, 2000, as reflected in the above table. See Note 4 and Note 9.

      DISTRIBUTION INVESTORS, LLC

      During May 2001, the Company funded a capital call of Distribution
Investors, LLC in the amount of $192,500. At September 30, 2001, the Company had
funded a total of $293,000 of its $1.5 million capital commitment to
Distribution Investors.

      GUIDESTAR HEALTH SYSTEMS, INC.

      After consulting with its investment advisor, the Company reduced the
carrying value of its investment in GuideStar Health Systems, Inc. from $250,000
at March 31, 2001 to zero during the 2001 second quarter.


                                       17


                    ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

12. REINSURANCE

      In the normal course of business, the Company's insurance subsidiaries
cede a substantial portion of their premium through quota share, surplus, excess
of loss and facultative reinsurance agreements. 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.

      With respect to 2000 results reflected below, the following table sets
forth the effects of reinsurance on the Company's prior reinsurance operations,
which were sold on May 5, 2000 to Folksamerica. See Note 8. With respect to 2001
results reflected below, the following table sets forth the effects of
reinsurance on the Company's insurance subsidiaries, which were acquired during
2001.



                                                   (IN THOUSANDS)
                                  THREE MONTHS ENDED             NINE MONTHS ENDED
                                     SEPTEMBER 30,                  SEPTEMBER 30,
                             ----------------------------   ----------------------------
                                 2001            2000           2001            2000
                             ------------    ------------   ------------    ------------
                                                                    
PREMIUMS WRITTEN:
Direct                            $48,969                        $80,300
Assumed                               (78)                           (78)       $102,034
Ceded                             (34,443)                       (56,217)        (19,731)
Unearned premium portfolio
transfer and assumption                                                          (92,907)
                             ------------    ------------   ------------    ------------
Net                               $14,448              --        $24,005        ($10,604)
                             ============    ============   ============    ============

PREMIUMS EARNED:
Direct                            $44,829                        $70,998
Assumed                                22                             22        $107,404
Ceded                             (33,052)                       (52,023)        (19,874)
                             ------------    ------------   ------------    ------------
Net                               $11,799              --        $18,997         $87,530
                             ============    ============   ============    ============

CLAIMS AND CLAIMS EXPENSES
INCURRED:
Direct                            $42,033                        $63,277
Assumed                               758                            758         $88,676
Ceded                             (33,595)                       (47,768)        (12,413)
                             ------------    ------------   ------------    ------------
Net                                $9,196              --        $16,267         $76,263
                             ============    ============   ============    ============


13. INCOME TAXES

      ACGL is incorporated under the laws of Bermuda and, under current Bermuda
law, is not obligated to pay any taxes in Bermuda based upon income or capital
gains. The Company has received a written undertaking from the Minister of
Finance in Bermuda under the Exempted Undertakings Tax Protection Act 1966 that,
in the event that any legislation is enacted in Bermuda imposing any tax
computed on profits, income, gain or appreciation on any capital asset, or any
tax in the nature of estate duty or inheritance tax, such tax will not be
applicable to ACGL or any of its operations until March 28, 2016. This
undertaking does not, however, prevent the imposition of taxes on any person
ordinarily resident in Bermuda or any company in respect of its ownership of
real property or leasehold interests in Bermuda.


                                       18


                    ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

13. INCOME TAXES (CONT'D.)

      ACGL will be subject to U.S. federal income tax only to the extent that it
derives U.S. source income that is subject to U.S. withholding tax or income
that is effectively connected with the conduct of a trade or business within the
U.S. and is not exempt from U.S. tax under an applicable income tax treaty with
the United States. ACGL will be subject to a withholding tax on dividends from
U.S. investments and interest from certain U.S. payors. ACGL's U.S. subsidiaries
will continue to be subject to U.S. income taxes on their worldwide income.

      Arch-U.S., Hales, Arch Re and Cross River file a U.S. consolidated federal
income tax return, with Arch-U.S. serving as the common parent, and have a tax
sharing agreement (the "Tax Sharing Agreement"), allocating the consolidated
income tax liability on a separate return basis. Pursuant to the Tax Sharing
Agreement, Hales, Arch Re and Cross River make tax sharing payments to Arch-U.S.
based on such allocation. In addition, AIHC and its subsidiaries, and the U.S.
subsidiaries of ART Services, file separate U.S. consolidated returns.

      An analysis of the Company's effective tax rate for the nine months ended
September 30, 2001 and 2000 follows:



                                                           (IN THOUSANDS)
                                                          NINE MONTHS ENDED
                                                             SEPTEMBER 30,
                                                         2001            2000
                                                     ------------    ------------
                                                                       (Restated)
                                                                    
Income tax computed on pre-tax income                      $8,865          $9,466
Addition (reduction) in income tax resulting from:
      Valuation allowance                                  (1,096)         10,205
      Write-off deferred tax asset                            251
      Tax-exempt investment income                                           (304)
      Foreign income, not subject to income tax              (323)
      Dividend received deduction                             (13)           (240)
      Limitation on executive compensation                                    405
      Other                                                   360             138
                                                     ------------    ------------
Income tax expense on pre-tax income                       $8,044         $19,670
                                                     ============    ============



                                       19


                    ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

13. INCOME TAXES (CONT'D.)

      Deferred income taxes reflect the tax effect of temporary differences
between the value of assets and liabilities for financial reporting purposes and
such values as measured by U.S. tax laws and regulations. The net deferred
income tax asset is net of a valuation allowance for the portion of the deferred
tax asset that management believes may not be realized. Significant components
of the Company's deferred income tax assets and liabilities as of September 30,
2001 and December 31, 2000 were as follows:



                                                             (IN THOUSANDS)
                                                      SEPTEMBER 30,   DECEMBER 31,
                                                          2001            2000
                                                      ------------    ------------
                                                                     
Deferred income tax assets:
     Net operating loss                                    $15,561         $12,465
     Reserve for contingent loss of escrowed assets          5,250
     AMT credit carryforward                                   965             651
     Net claim reserve discount                                360
     Net unearned premium reserve                            2,052
     Unrealized loss on private equity securities              350             262
     Unrealized loss on marketable securities                  548             606
     Compensation liabilities                                   10             250
     Other, net                                              1,659              48
                                                      ------------    ------------
Total deferred tax assets                                   26,755          14,282
                                                      ------------    ------------
Deferred income tax liabilities:
     Equity in net income on investees, net                   (569)           (379)
     Deferred policy acquisition cost                       (1,862)
     Net unrealized appreciation of investments               (608)            (61)
                                                      ------------    ------------
Total deferred tax liabilities                              (3,039)           (440)
                                                      ------------    ------------
Valuation allowance                                        (16,371)         (5,650)
                                                      ------------    ------------
Net deferred income tax asset                               $7,345          $8,192
                                                      ============    ============


      As of September 30, 2001, the Company has a deferred income tax valuation
allowance of $16.4 million that adjusts the net deferred income tax asset to its
estimated realizable value of approximately $7.3 million.

      The Company's U.S. subsidiaries have total net operating loss
carryforwards of $44.5 million. Approximately $9.1 million of such loss
carryforwards will expire beginning in 2011, and substantially all of the
balance of these carryforwards will expire between 2019 and 2020. To the extent
a change in control under Section 382 of the Internal Revenue Code of 1986, as
amended, results from the financing and related transactions described in Note
15, the Company may be limited in its annual utilization of such net operating
loss carryforwards.


                                       20


                    ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

14. SEGMENT INFORMATION

      SFAS No. 131 requires certain disclosures about operating segments in a
manner that is consistent with how management evaluates the performance of the
segment. At September 30, 2001, the Company's two operating segments included
insurance and merchant banking:



BUSINESS IDENTITY        BUSINESS ACTIVITY
---------------------    -------------------------------------------------------
                      
ART Services             Provides insurance and alternative risk transfer
                         services through rent-a-captive and other facilities

AIHC                     Markets and underwrites nonstandard personal automobile
                         liability and physical damage lines of insurance,
                         primarily in Pennsylvania

Arch Re Bermuda          Underwrites business produced by intermediaries,
                         underwriting agencies and insurance companies

Hales                    A merchant banking firm specializing in the insurance
                         industry


      At September 30, 2001, the Company's insurance operating segment, which
consisted of ART Services, AIHC, and Arch Re Bermuda, included total assets of
$436.2 million. For the nine months ended September 30, 2001, the insurance
operating segment generated revenues of $42.8 million and net income of $4.2
million.

      The results of Hales did not meet any of the thresholds for segment
reporting. The contribution of Hales to the Company's net income was not
material for the nine months ended September 30, 2001. The remaining portion of
the Company's net income was generated through the Company's investment
activities, offset by other operating expenses.

15. SUBSEQUENT EVENTS

      On October 24, 2001, the Company entered into a subscription agreement
(the "Subscription Agreement") with investment funds affiliated with Warburg
Pincus LLC (collectively, "Warburg Pincus") and an investment fund affiliated
with Hellman & Friedman LLC ("H&F" and, together with Warburg Pincus, the
"Investors"). The transaction was unanimously approved by the Company's Board of
Directors.

      Pursuant to the Subscription Agreement, Warburg Pincus agreed to purchase,
for cash, an aggregate of $500.0 million of Series A Convertible Preference
Shares of the Company (the "Preference Shares") and Class A Warrants of the
Company (the "Warrants" and, together with the Preference Shares, the
"Securities"), and H&F agreed to purchase, for cash, an aggregate of $250.0
million of the Securities.

      Subject to the limitation described below, each Preference Share will be
convertible into one Common Share of the Company. This conversion ratio is
subject to customary anti-dilution protection. The Preference Shares will vote,
together with the Common Shares, on an as-converted basis. The purchase price of
each Preference Share is intended to be equal to the Company's book value per
share on June 30, 2001, adjusted for transaction-related expenses and to reflect
a mark-to-market on marketable securities in the Company's investment portfolio
as of the closing date of the financing (the "Closing").

      The purchase price may be subject to a post-closing adjustment based on an
audit of the Company's balance sheet as of June 30, 2001. In addition, if the
Company's outstanding Class B Warrants become exercisable, the purchase price
under the Subscription Agreement will be adjusted downward by $1.50 per


                                       21


                    ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

15. SUBSEQUENT EVENTS (CONT'D.)

Preferred Share purchased. The Class B Warrants become exercisable if (1) the
closing price of the Company's Common Shares is at least $30.00 per share for at
least 20 out of 30 consecutive trading days or (2) a change of control, as
defined in the Class B Warrants, occurs. The purchase price under the
Subscription Agreement will also be adjusted based on actual loss experience on
the Company's pre-Closing insurance operations and certain other balance sheet
developments during the period from July 1, 2001 through the second anniversary
of Closing (or such earlier date as is agreed upon by the Investors and the
Company), with the possibility of a limited further adjustment thereafter based
on specified tax and other matters. Any purchase price adjustment in favor of
the Investors will be made through the issuance of additional Preferred Shares.

      Each Warrant purchased by the Investors will be exercisable for one Common
Share at an exercise price equal to $20.00 per share. This exercise price and
exercise ratio are subject to anti-dilution protection on substantially the same
terms as the Company's existing Class A Warrants. The Warrants will expire on
September 15, 2002 if not exercised before that time.

      Pursuant to the Company's bye-laws (unless and until otherwise amended by
the shareholders), each Investor's voting rights will be limited to 9.9% of the
total voting power of all outstanding voting shares. In addition, prior to
shareholder approval, conversion of the Preference Shares will be limited so
that the amount of Common Shares issued does not exceed the amount permitted to
be issued under Nasdaq rules without shareholder approval. Finally, prior to
regulatory approval, conversion of the Preference Shares will be limited so that
the amount of Common Shares issued does not exceed the amount permitted to be
issued without regulatory approval. If the shareholder or regulatory approvals
are not obtained, or if the ultimate purchase price adjustment exceeds $250.0
million, at the Investors' option, the Preference Shares will become convertible
into a pro rata portion (assuming that all issued Preference Shares are
convertible) of the shares of a newly formed subsidiary of the Company that will
hold all of the Company's core insurance and reinsurance operations.

      As a condition to the obligations of the Investors to purchase the
Securities, the Company has agreed to enter into a shareholders agreement with
the Investors (the "Shareholders Agreement"). Pursuant to the Shareholders
Agreement, after the Closing and prior to the shareholders meeting, Warburg
Pincus will have the right to designate one director for appointment to the
Company's Board and H&F will have the right to designate one director for
appointment to the Company's Board. In addition, after receipt of the
shareholder and regulatory approvals described above, Warburg Pincus and H&F
will have the right to designate additional directors. After giving effect to
the resignations and appointments contemplated, designees of Warburg Pincus and
H&F collectively will constitute a majority of the Board of Directors. The
Shareholders Agreement will also provide the Investors with certain registration
rights. The closing of the financing transaction is subject to other customary
conditions.

      On November 8, 2001, the Company entered into an agreement (the "Letter
Agreement") with the Investors, The Trident Partnership, L.P. ("Trident I"),
Trident II, Marsh & McLennan Risk Capital Holdings, Ltd. ("Marsh"), Marsh &
McLennan Capital Professionals Fund, L.P. and Marsh & McLennan Employees'
Securities Company, L.P. (collectively, the "Co-Investment Funds").

      Pursuant to the Letter Agreement, Warburg Pincus assigned to Trident II
and the Co-Investment Funds its right to purchase an aggregate of $35.0 million
of the Securities under the Subscription Agreement. The assignees will purchase
the Securities on the same economic terms as the Investors. In addition, the
parties


                                       22


                    ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

15. SUBSEQUENT EVENTS (CONT'D.)

confirmed that Marsh's right to have an observer attend meetings of the Board of
Directors of the Company has been terminated, and that the right of Trident I to
designate a director for election to the Board of Directors has been terminated.
The Company was released from its obligation to make any further capital
contributions to Trident II, other than with respect to outstanding capital
calls for which the Company funded approximately $6.5 million through November
2001. At the Closing, all of Marsh's 905,397 Class A Warrants will be canceled
in exchange for the issuance by the Company of 140,380 Common Shares, and all of
Marsh's 1,770,601 Class B Warrants will be canceled in exchange for a cash
payment by the Company of $7.50 per Class B Warrant (approximately $13.3 million
in the aggregate).

      Also on October 24, 2001, Arch Re Bermuda (as defined above), the
Company's Bermuda-based reinsurance subsidiary, appointed a new management team,
consisting of Paul Ingrey, as Chief Executive Officer; Dwight Evans, as
President; and Marc Grandisson, as Senior Vice President and Chief Actuary.

      Mr. Clements will continue as Chairman of the Company's Board of
Directors, and Peter Appel will continue as the Company's President and Chief
Executive Officer. Two new directors were appointed to the Board of Directors on
October 23, 2001: John Pasquesi, who was appointed Vice Chairman, and Mr.
Ingrey. Mr. Pasquesi, a former Managing Director of Hellman & Friedman, is a
private investor based in San Francisco. He was formerly a director of Mid Ocean
Reinsurance and chairman of its finance committee.

      The new and ongoing management team received certain restricted share and
option awards as follows: Mr. Clements was granted 1,668,157 restricted shares;
Mr. Pasquesi was granted options to purchase 1,126,419 Common Shares; Mr. Appel
was granted options to purchase 422,407 Common Shares (of which 200,000 become
exercisable only if the Company's Class B Warrants become exercisable); Mr.
Ingrey was granted 422,407 restricted shares and options to purchase 422,407
Common Shares; Mr. Evans was granted 50,000 restricted shares and options to
purchase 100,000 Common Shares; and Mr. Grandisson was granted 12,500 restricted
shares and options to purchase 37,500 Common Shares. The options are exercisable
at $20.00 per share. The restricted share awards and option grants are subject
to certain terms and conditions. It is contemplated that Mr. Clements will be
granted an additional 21,472 restricted shares.

      In addition, certain members of management (or entities affiliated with
them) entered into a management subscription agreement with the Company (the
"Management Subscription Agreement") to purchase an aggregate of $13.15 million
of the Securities on the same economic terms as the Investors under the
Subscription Agreement. An entity affiliated with Mr. Clements will purchase
$2.0 million of Securities; an entity affiliated with Mr. Pasquesi will purchase
$7.5 million of Securities; Mr. Appel will purchase $1.0 million of Securities;
Mr. Ingrey will purchase $2.0 million of Securities; Mr. Evans will purchase
$400,000 of Securities; and Mr. Grandisson will purchase $250,000 of Securities.

      It is currently estimated that the Preference Shares issuable under the
Subscription Agreement and the Management Subscription Agreement will be
convertible into an aggregate of approximately 36,134,000


                                       23


                    ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

15. SUBSEQUENT EVENTS (CONT'D.)

Common Shares, and the Class A Warrants issuable under the Subscription
Agreement and the Management Subscription Agreement will be exercisable for an
aggregate of approximately 3,827,000 Common Shares. Together, they would
represent approximately 65.8% of the Common Shares on a fully-diluted basis at
Closing. It is currently estimated that, at Closing, there will be outstanding
approximately 13,009,000 Common Shares, approximately 2,175,000 restricted
shares, options to purchase approximately 3,795,000 Common Shares and warrants
(excluding the new Class A Warrants) to purchase approximately 1,776,000 Common
Shares.

      Pursuant to the Subscription Agreement, the Company has agreed to hold a
special meeting of its shareholders, after the Closing, (1) to approve the
issuance of such number of Common Shares issuable upon conversion of the
Preference Shares, that together with the number of Common Shares issuable upon
exercise of the Warrants, is in excess of the amount that may be issued without
shareholder approval under the Nasdaq Stock Market rules, (2) to approve the
adoption of amendments to the Company's bye-laws that restrict voting rights of
shareholders and that require directors of certain subsidiaries of the Company
to be elected directly by shareholders of the Company and (3) to elect Mr.
Ingrey as a director of Arch Re Bermuda.


                                       24


         MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
                              RESULTS OF OPERATIONS

                                     GENERAL

      THE COMPANY

      Arch Capital Group Ltd. ("ACGL") is a Bermuda-based insurance and
financial services company. At September 30, 2001, our consolidated
shareholders' equity was $276.4 million. Our common shares are traded on the
Nasdaq National Market under the symbol "ACGL." Our principal offices are
located at Clarendon House, 2 Church Street, Hamilton HM 11 Bermuda (phone
number: (441) 295-1422), and our executive offices are located at 20 Horseneck
Lane, Greenwich, Connecticut 06830 (phone number: (203) 862-4300).

      FINANCING TRANSACTION AND ADDITION OF NEW EXECUTIVES

      In October 2001, we announced the launch of an underwriting initiative to
meet current and future demand in the global insurance marketplace. As part of
this initiative, Arch Reinsurance Ltd., our Bermuda-based reinsurance subsidiary
("Arch Re Bermuda"), appointed a new management team, consisting of Paul Ingrey,
formerly Chairman of F&G Re; Dwight Evans, formerly Executive Vice President,
North American Property for St. Paul Re and F&G Re; and Marc Grandisson,
formerly Vice President and Actuary of the reinsurance division of Berkshire
Hathaway.

      Simultaneously, we also announced that investment funds affiliated with
Warburg Pincus LLC ("Warburg Pincus") and Hellman & Friedman LLC ("H&F")
together would invest $750 million in the company to support the underwriting
initiative. Warburg Pincus agreed to purchase $500 million, and H&F agreed to
purchase $250 million, of Series A Convertible Preference Shares and Class A
Warrants of the company. Warburg Pincus has assigned its right to purchase $35
million of the company's securities to Trident II, L.P., an insurance industry
investment fund managed by Marsh & McLennan Risk Capital Holdings, Ltd., and
related co-investment funds. In addition, certain members of management (or
entities affiliated with them) agreed to purchase an aggregate of $13.15 million
of the company's securities on the same economic terms as the investors. The
financing will raise our total invested capital to over $1 billion and is
subject to customary closing conditions. See note 15 of the notes accompanying
our consolidated financial statements.

      AGREEMENT TO ACQUIRE ROCK RIVER INSURANCE COMPANY

      On September 24, 2001, we announced that the company has entered into a
definitive agreement to acquire Rock River Insurance Company, an approved excess
and surplus lines insurer in 45 states and the District of Columbia and an
admitted insurer in two other states. Under the terms of the agreement, the
existing policies and other liabilities of Rock River are reinsured or otherwise
assumed by the seller, Sentry Insurance a Mutual Company, which has an A.M. Best
rating of A+. The transaction is contingent on obtaining applicable regulatory
approvals and other customary closing conditions.

                         LIQUIDITY AND CAPITAL RESOURCES

      We are a holding company whose assets primarily consist of the stock of
our subsidiaries and our invested assets. Generally, we depend on our available
cash resources, liquid investments and dividends or other distributions from our
subsidiaries to make payments, including the payment of operating expenses we
may incur and for any dividends our board of directors may determine, and we may
need to utilize funds from such sources in connection with acquisitions. Our
board does not currently intend to declare any dividends or make any other
distributions.

      The above financing transaction and the addition of new executives is
designed to position the company to address current and anticipated future needs
for capacity in the global insurance marketplace. The company is expanding
underwriting activities during the 2001 fourth quarter, initially with a primary
focus on reinsurance. See "--General" and note 15 of the notes accompanying our
consolidated financial statements.


                                       25


      As of September 30, 2001, our readily available cash, short-term
investments and marketable securities, excluding amounts held by our regulated
insurance subsidiaries and prior to the completion of the above financing
transaction and the acquisition of Rock River, totaled $43.9 million. Such
amount consisted of $21.4 million of cash and short-term investments, $19.4
million of fixed maturity investments, and $3.1 million of publicly traded
equity securities. As of that date, investments that are restricted or generally
unavailable for liquidity purposes (other than our ownership interests in our
subsidiaries and the invested assets of our regulated insurance subsidiaries)
included $29.7 million of privately held securities and $22.1 million of fixed
maturity investments held in escrow in connection with the sale of our
reinsurance operations in May 2000. Our agreement to acquire Rock River requires
the payment of approximately $20.0 million for the insurer, which has statutory
surplus of approximately $17.5 million. In addition, at September 30, 2001, we
had investment commitments relating to our privately held investments in Trident
II and Distribution Investors, LLC of approximately $17.5 million and $1.2
million, respectively. The company was released from its obligations to make any
further capital contributions to Trident II, other than with respect to
outstanding capital calls for which the company funded approximately $6.5
million in November 2001. See note 11 and note 15 under the captions "Investment
Information" and "Subsequent Events," respectively, of the notes accompanying
our consolidated financial statements.

      The ability of our regulated insurance subsidiaries to pay dividends or
make distributions is dependent on their ability to meet applicable regulatory
standards. Prior approval of the Bermuda Minister of Finance is required if any
dividend payments or other distributions of Arch Re Bermuda would reduce its
total statutory capital by 15% or more. Based on 2000 results, American
Independent and First American Insurance Company (a subsidiary of Arch Risk
Transfer Services Ltd.) may not pay any significant dividends or distributions
during 2001 without prior regulatory approval. Due to the distributions made by
Arch Reinsurance Company, our Nebraska-domiciled subsidiary, in connection with
the XL Capital share repurchase and our redomestication to Bermuda in 2000, Arch
Re may not make any distributions without prior regulatory approval until
December 2001.

      Consolidated cash flows used for operating activities for the nine months
ended September 30, 2001 and 2000 were approximately $3.7 million and $2.1
million, respectively. Cash flows are provided by premiums collected, fee
income, investment income (excluding net realized investment gains) and
collected reinsurance receivable balances, offset by reinsurance premiums
payable, claim payments and operating costs.

      Our expanded underwriting activities will be supported by the proceeds
from the financing transaction (see "--General" above and note 15 of the notes
accompanying our consolidated financial statements), and we expect that our
other operational needs for the foreseeable future will be met by our balance of
cash and short-term investments, as well as by funds generated from investment
income and proceeds on the sale or maturity of our investments.

      We are subject to certain contingencies relating to the sale of our
reinsurance operations on May 5, 2000, as described in note 8 under the caption
"Contingencies Relating to Sale of Reinsurance Operations" of the notes
accompanying our consolidated financial statements. Based on all information
available to the company to date, we believe that the company's insurance and
reinsurance subsidiaries do not have any material exposures to the events of
September 11, 2001.

                              RESULTS OF OPERATIONS

      NET INCOME

      The following net income amounts have been restated for all periods prior
to the 2001 second quarter as a result of our acquisition of the remaining
ownership interests in ART Services on June 22, 2001. See note 4, note 9 and
note 11 of the notes accompanying our consolidated financial statements.
Comparisons of our 2001 results of operations to prior year periods are not
meaningful due to the changes in our business during 2000 and 2001, including
(1) the sale of our reinsurance operations in May 2000, (2) the reorganization
transaction completed in November 2000, (3) our acquisition activity, and (4)
the establishment of Arch Re Bermuda.


                                       26


      For the 2001 third quarter, we reported after-tax operating income, which
excludes net realized investment gains and losses and equity in net income of
investees, of $465,000, or $0.04 per share, compared to operating income of $1.2
million, or $0.10 per share, in the 2000 third quarter. For the nine months
ended September 30, 2001, after-tax operating income was $4.6 million, or $0.36
per share, compared to an operating loss for the comparable 2000 period of $13.0
million, or $0.97 per share.

      For the 2001 third quarter, we reported net income of $892,000, or $0.07
per share, which included after-tax net realized investment losses of $247,000,
or $0.02 per share, and after-tax equity in net income of investees of $674,000,
or $0.05 per share. These amounts compare with net income for the 2000 third
quarter of $2.3 million, or $0.18 per share, which included after-tax net
realized investment gains of $473,000, or $0.04 per share, and after-tax equity
in net income of investees of $572,000, or $0.04 per share.

      For the nine months ended September 30, 2001, we reported net income of
$17.3 million, or $1.35 per share, which included after-tax net realized gains
of $11.5 million, or $0.90 per share, and after-tax equity in net income of
investees of $1.2 million, or $0.09 per share. These amounts compare with net
income for the comparable period in 2000 of $7.4 million, or $0.55 per share,
which included after-tax net realized investment gains of $21.3 million, or
$1.59 per share, after-tax equity in net income of investees of $982,000, or
$0.07 per share, and an after-tax loss on the sale of the Company's reinsurance
operations of $1.9 million, or $0.14 per share.

      SEGMENT DATA

      Statement of Financial Accounting Standard No. 131 requires certain
disclosures about operating segments in a manner that is consistent with how
management evaluates the performance of the segment. At September 30, 2001, our
two operating segments included insurance and merchant banking. See note 14
under the caption "Segment Information" of the notes accompanying our
consolidated financial statements; see also note 12 and note 15 under the
captions "Reinsurance" and "Subsequent Events," respectively, of the notes
accompanying our consolidated financial statements.

      BOOK VALUE PER SHARE

      At September 30, 2001, our consolidated shareholders' equity was $276.4
million, or $21.48 per share, compared with $272.3 million, or $21.43 per share,
at December 31, 2000. The change in consolidated shareholders' equity included a
$3.3 million, or $0.25 per share, decline in book value resulting from a
decrease in the company's investment portfolio for the nine months ended
September 30, 2001. On a diluted basis, book value per share was $21.43 at
September 30, 2001, compared with $21.42 at December 31, 2000, as restated.

      NET INVESTMENT INCOME

      After-tax net investment income for the 2001 third quarter was $2.1
million, compared with $2.3 million for the 2000 third quarter. For the first
nine months of 2001, after-tax net investment income was $7.8 million, compared
with $8.9 million for the comparable prior year period. The decrease in net
investment income in 2001 compared with 2000 primarily reflected the decline in
our average invested asset base resulting from the sale of Arch Re's reinsurance
operations in May 2000 and a declining interest rate environment, partially
offset by a decrease in investment expenses.

      For the three and nine month periods ended September 30, 2001 and 2000,
our sources of net realized investment gains (losses) were as follows (in
thousands):



                                       THREE MONTHS ENDED           NINE MONTHS ENDED
                                          SEPTEMBER 30,               SEPTEMBER 30,
                                       2001          2000          2001          2000
                                    ----------    ----------    ----------    ----------
                                                                              (Restated)
                                                                     
Fixed maturities                         ($190)        ($294)      ($2,297)      ($3,235)
Publicly traded equity securities                        358        20,966        35,892
Privately held securities                                664          (250)          177
                                    ----------    ----------    ----------    ----------
Total                                    ($190)         $728       $18,419       $32,834
                                    ==========    ==========    ==========    ==========



                                       27


      During the nine months ended September 30, 2001, we disposed of, or
reduced our position in, several publicly traded equity security investments,
producing a net realized gain of $21.0 million. We also realized losses in our
high yield portfolio of $3.0 million.

      For the first nine months of 2001, the decline in after-tax net unrealized
depreciation of investments of $14.8 million reflects the sales described above,
coupled with a decline in market prices in the insurance sector of the public
equity markets and our high yield fixed maturity investments.

      INVESTMENTS

      At September 30, 2001, consolidated cash and invested assets totaled
approximately $290.8 million, consisting of $100.6 million of cash and
short-term investments, $128.7 million of publicly traded fixed maturity
investments, $22.1 million of fixed maturities held in escrow, $3.5 million of
publicly traded equity securities, and $35.9 million of privately held
securities.

      At September 30, 2001, approximately 100% of our fixed maturity and
short-term investments were rated investment grade by Moody's or Standard &
Poor's and had an average quality rating of A+ and an average duration of
approximately three years.

      As of July 31, 2001, we completed the liquidation of our high yield
portfolio and the related sale proceeds of approximately $32 million were
reinvested in short duration securities. From January 1, 2001 through July 31,
2001, cumulative realized losses from the high yield portfolio amounted to
approximately $3.0 million.

      During the first six months in 2001, we liquidated substantially all of
our publicly traded equity portfolio. The proceeds from the sales, which
amounted to approximately $43 million, were reinvested in short duration
securities. The liquidation was completed in order to (1) reduce our
concentration risk in a limited number of issuers in the insurance sector, (2)
make additional funds available for future acquisitions, and (3) reduce
volatility in our financial results. These sales generated realized gains of
approximately $21.0 million through September 30, 2001.

      Investments included in our private portfolio include securities issued by
privately held companies that are generally restricted as to resale or are
otherwise illiquid and do not have readily ascertainable market values. The risk
of investing in such securities is generally greater than the risk of investing
in securities of widely held, publicly traded companies. Lack of a secondary
market and resale restrictions may result in an inability by us to sell a
security at a price that would otherwise be obtainable if such restrictions did
not exist and may substantially delay the sale of a security we seek to sell.
Variability and declines in our results of operations could be exacerbated by
certain private equity investments that are accounted for under the equity
method.

      At September 30, 2001, our private equity portfolio consisted of eight
investments. See note 11 under the caption "Investment Information" of the notes
accompanying our consolidated financial statements for certain information
regarding our publicly traded and privately held securities and their carrying
values, and commitments made by us relating to our privately held securities,
and note 15 under the caption "Subsequent Events" of the notes accompanying our
consolidated financial statements.

      On February 28, 2001, we completed a reorganization transaction pursuant
to which we acquired all of the common stock of American Independent Insurance
Holding Company, one of our investee companies. On June 22, 2001, we completed
the acquisition of the remaining ownership interests in ART Services, another of
our investee companies. See note 4, note 9 and note 11 of the notes accompanying
our consolidated financial statements.

      We have not invested in derivative financial instruments such as futures,
forward contracts, swaps, or options or other financial instruments with similar
characteristics such as interest rate caps or floors and fixed-rate loan
commitments. Our portfolio includes market sensitive instruments, such as
mortgage-backed securities, which are subject to prepayment risk and changes in
market value in connection with changes in interest rates.


                                       28


      MARKET SENSITIVE INSTRUMENTS AND RISK MANAGEMENT

      In accordance with the SEC's Financial Reporting Release No. 48, we
performed a sensitivity analysis to determine the effects that market risk
exposures could have on the future earnings, fair values or cash flows of our
financial instruments as of December 31, 2000. (See "Management's Discussion and
Analysis of Financial Condition and Results of Operations" included in our 2000
Annual Report on Form 10-K/A.) Market risk represents the risk of changes in the
fair value of a financial instrument and is comprised of several components,
including liquidity, basis and price risks. At September 30, 2001, there have
been no material changes in market risk exposures that affect the quantitative
and qualitative disclosures presented as of December 31, 2000.

      INCOME TAXES

      Upon our redomestication to Bermuda, Arch Capital Group (U.S.) Inc.
("Arch-U.S.") distributed substantially all of its public equity portfolio to
its Bermuda parent, ACGL, at the current market values and realized gains for
tax purposes of $21.0 million. The associated income tax expense of $7.4 million
reduced Arch-U.S.'s net operating loss carryforwards by such amount. However,
for financial reporting purposes, since the securities have not been sold to an
unrelated third party, the realized gain has been deferred and was reported as
unrealized appreciation in our consolidated financial statements. Accordingly,
the income tax expense was also deferred and reduced unrealized appreciation in
our consolidated financial statements.

      Income tax expense for the nine months ended September 30, 2001 was $8.0
million, which included recognizing $6.9 million of the deferred taxes described
above relating to the investment gains realized during the period. This compares
to income tax expense for the nine months ended September 30, 2000 of $19.7
million, of which $10.2 million related to the establishment of a valuation
allowance against the deferred tax asset during that period.

      As of September 30, 2001, we have a deferred income tax asset valuation
allowance of $16.4 million that adjusts our deferred income tax asset to its
estimated realizable value of approximately $7.3 million.

      See note 13 under the caption "Income Taxes" of the notes accompanying our
consolidated financial statements.

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

      The Private Securities Litigation Reform Act of 1995 provides a "safe
harbor" for forward-looking statements. This report or any other written or oral
statements made by or on behalf of the company may include forward-looking
statements which reflect our current views with respect to future events and
financial performance. All statements other than statements of historical fact
included in this report are forward-looking statements. Forward-looking
statements can generally be identified by the use of forward-looking terminology
such as "may," "will," "expect," "intend," "estimate," "anticipate," "believe"
or "continue" or their negative or variations or similar terminology.

      Forward-looking statements involve our current assessment of risks and
uncertainties. Actual events and results may differ materially from those
expressed or implied in these statements. Important factors that could cause
actual events or results to differ materially from those indicated in such
statements are discussed below and elsewhere in this report and include:

      o     our future business operations and strategy;

      o     acceptance of our products and services;


                                       29


      o     general economic and market conditions and conditions specific to
            the reinsurance and insurance markets in which we operate;

      o     competition, including increased competition, on the basis of
            pricing, capacity, coverage terms or other factors;

      o     competition for acquisition opportunities and in the businesses of
            the operating companies we have acquired or may acquire or form;

      o     integration of new management personnel into our existing structure;

      o     the integration of businesses we have acquired or may acquire into
            our existing operations;

      o     greater than expected loss ratios on insurance written by our
            insurance subsidiaries and adverse development of claim and/or claim
            expense liabilities related to business written by our insurance
            subsidiaries in prior years;

      o     losses relating to aviation business and business produced by a
            certain managing underwriting agency for which we may be liable to
            the purchaser of our prior reinsurance business or to others in
            connection with the May 5, 2000 asset sale;

      o     the failure of reinsurers or others to meet their obligations to our
            reinsurance and insurance subsidiaries in connection with losses
            relating to their insurance businesses;

      o     changes in interest rates;

      o     regulatory changes and conditions;

      o     rating agency policies and practices; and

      o     loss of key personnel.

      In addition, the proposed $763.15 million financing is subject to various
risks and uncertainties, including, but not limited to, the risk that the
conditions to closing will not be satisfied.

      All subsequent written and oral forward-looking statements attributable to
us or persons acting on our behalf are expressly qualified in their entirety by
these cautionary statements. The foregoing review of important factors should
not be construed as exhaustive and should be read in conjunction with other
cautionary statements that are included herein or elsewhere. We undertake no
obligation to publicly update or revise any forward-looking statement, whether
as a result of new information, future events or otherwise.

           QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

      Reference is made to the information appearing above under the subheading
"Market Sensitive Instruments and Risk Management" under the caption
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," which information is hereby incorporated by reference.


                                       30


PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

      The Company's insurance and reinsurance subsidiaries are involved in
ordinary routine litigation and arbitration proceedings incidental to their
businesses. The Company does not believe that there are any material pending
legal proceedings to which the Company or any of its subsidiaries is a party or
of which any of their property is subject.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) EXHIBITS.

EXHIBIT NO.       DESCRIPTION
-----------       -----------

10.1.1            Subscription Agreement, dated as of October 24, 2001, between
                  Arch Capital Group Ltd. ("ACGL") and Warburg Pincus Private
                  Equity VIII, L.P., Warburg Pincus International Partners,
                  L.P., Warburg Pincus Netherlands International Partners I,
                  C.V., Warburg Pincus Netherlands International, Partners II,
                  C.V., and HFCP IV (Bermuda), L.P. (collectively, the
                  "Investors").

10.1.2            Form of Certificate of Designations for Preference Shares.

10.1.3            Form of Series A Warrant Certificate.

10.1.4            Form of Bye-Law Amendment.

10.1.5            Form of Shareholders Agreement.

10.2              Agreement, dated as of November 8, 2001, among ACGL, the
                  Investors, The Trident Partnership, L.P., Trident II, L.P.,
                  Marsh & McLennan Risk Capital Holdings, Ltd., Marsh & McLennan
                  Capital Professionals Fund, L.P. and Marsh & McLennan
                  Employees' Securities Company, L.P.

10.3              Management Subscription Agreement, dated as of October 24,
                  2001, between ACGL and certain members of management.

10.4              Employment Agreement, dated as of October 23, 2001, among
                  ACGL, Arch Reinsurance Ltd. ("Arch Re Bermuda") and Paul
                  Ingrey.

10.5              Employment Agreement, dated as of October 23, 2001, among
                  ACGL, Arch Re Bermuda and Dwight Evans.

10.6              Employment Agreement, dated as of October 23, 2001, among
                  ACGL, Arch Re Bermuda and Marc Grandisson.

10.7              Restricted Share Agreements, dated as of January 30, 2001 and
                  October 23, 2001, between ACGL and Robert Clements.

10.8              Restricted Share Agreement, dated as of January 30, 2001,
                  between ACGL and Peter Appel.

10.9              Restricted Share Agreement, dated as of October 23, 2001,
                  between ACGL and Paul Ingrey.

10.10             Restricted Share Agreement, dated as of October 23, 2001,
                  between ACGL and Dwight Evans.


                                       31


EXHIBIT NO.       DESCRIPTION
-----------       -----------

10.11             Restricted Share Agreement, dated as of October 23, 2001,
                  between ACGL and Marc Grandisson.

10.12             Restricted Share Agreement, dated as of January 30, 2001,
                  between ACGL and Louis Petrillo.

10.13             Stock Option Agreement, dated as of October 23, 2001, between
                  ACGL and Paul Ingrey.

10.14             Stock Option Agreement, dated as of October 23, 2001, between
                  ACGL and Dwight Evans.

10.15             Stock Option Agreement, dated as of October 23, 2001, between
                  ACGL and Marc Grandisson.

10.16             Stock Option Agreements, dated as of January 30, 2001 and
                  October 23, 2001, between ACGL and Debra O'Connor.

10.17             Stock Option Agreements, dated as of January 30, 2001 and
                  October 23, 2001, between ACGL and Louis Petrillo.

15                Accountants' Awareness Letter (regarding unaudited interim
                  financial information)

(b) REPORTS ON FORM 8-K.

      The Company filed reports on Form 8-K during the three-month period ended
September 30, 2001 on (1) July 6, 2001 to report the closing of the Company's
acquisition of Arch Risk Transfer Services Ltd. ("ART Services") and (2) August
7, 2001 to file required financial information relating to such acquisition of
ART Services. The Company also filed a report on Form 8-K on November 9, 2001 to
report its new underwriting initiative and the financing transaction in suport
of such initiative and related transactions.


                                       32


                                   SIGNATURES

================================================================================

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

                                 ARCH CAPITAL GROUP LTD.
                                 -----------------------------------------------
                                 (REGISTRANT)


                                 /s/ Peter A. Appel
                                 -----------------------------------------------
Date: November 14, 2001          Peter A. Appel
                                 President & Chief Executive Officer


                                 /s/ Debra M. O'Connor
                                 -----------------------------------------------
Date: November 14, 2001          Debra M. O'Connor
                                 Senior Vice President, Controller & Treasurer


                                       33


                                  EXHIBIT INDEX

EXHIBIT NO.       DESCRIPTION
-----------       -----------

10.1.1            Subscription Agreement, dated as of October 24, 2001, between
                  Arch Capital Group Ltd. ("ACGL") and Warburg Pincus Private
                  Equity VIII, L.P., Warburg Pincus International Partners,
                  L.P., Warburg Pincus Netherlands International Partners I,
                  C.V., Warburg Pincus Netherlands International, Partners II,
                  C.V., and HFCP IV (Bermuda), L.P. (collectively, the
                  "Investors").

10.1.2            Form of Certificate of Designations for Preference Shares.

10.1.3            Form of Series A Warrant Certificate.

10.1.4            Form of Bye-Law Amendment.

10.1.5            Form of Shareholders Agreement.

10.2              Agreement, dated as of November 8, 2001, among ACGL, the
                  Investors, The Trident Partnership, L.P., Trident II, L.P.,
                  Marsh & McLennan Risk Capital Holdings, Ltd., Marsh & McLennan
                  Capital Professionals Fund, L.P. and Marsh & McLennan
                  Employees' Securities Company, L.P.

10.3              Management Subscription Agreement, dated as of October 24,
                  2001, between ACGL and certain members of management.

10.4              Employment Agreement, dated as of October 23, 2001, among
                  ACGL, Arch Reinsurance Ltd. ("Arch Re Bermuda") and Paul
                  Ingrey.

10.5              Employment Agreement, dated as of October 23, 2001, among
                  ACGL, Arch Re Bermuda and Dwight Evans.

10.6              Employment Agreement, dated as of October 23, 2001, among
                  ACGL, Arch Re Bermuda and Marc Grandisson.

10.7              Restricted Share Agreements, dated as of January 30, 2001 and
                  October 23, 2001, between ACGL and Robert Clements.

10.8              Restricted Share Agreement, dated as of January 30, 2001,
                  between ACGL and Peter Appel.

10.9              Restricted Share Agreement, dated as of October 23, 2001,
                  between ACGL and Paul Ingrey.

10.10             Restricted Share Agreement, dated as of October 23, 2001,
                  between ACGL and Dwight Evans.


                                       34


EXHIBIT NO.       DESCRIPTION
-----------       -----------

10.11             Restricted Share Agreement, dated as of October 23, 2001,
                  between ACGL and Marc Grandisson.

10.12             Restricted Share Agreement, dated as of January 30, 2001,
                  between ACGL and Louis Petrillo.

10.13             Stock Option Agreement, dated as of October 23, 2001, between
                  ACGL and Paul Ingrey.

10.14             Stock Option Agreement, dated as of October 23, 2001, between
                  ACGL and Dwight Evans.

10.15             Stock Option Agreement, dated as of October 23, 2001, between
                  ACGL and Marc Grandisson.

10.16             Stock Option Agreements, dated as of January 30, 2001 and
                  October 23, 2001, between ACGL and Debra O'Connor.

10.17             Stock Option Agreements, dated as of January 30, 2001 and
                  October 23, 2001, between ACGL and Louis Petrillo.

15                Accountants' Awareness Letter (regarding unaudited interim
                  financial information)


                                       35