Arch Capital Group Ltd. — Q3 2020 Form 10-Q
Business and period: Bermuda-based global insurer, reinsurer and mortgage insurer. This unaudited filing covers the quarter and nine months ended September 30, 2020, with comparisons to the corresponding 2019 periods unless noted. The interim statements received a review, not an audit.
Financial results and condition
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Net premiums earned | $1.77bn | $1.44bn | $5.18bn | $4.27bn |
| Total revenue | $2.31bn | $1.68bn | $6.14bn | $5.18bn |
| Net income available to Arch common shareholders | $408.6m | $382.1m | $830.8m | $1.28bn |
| Diluted EPS | $1.00 | $0.92 | $2.02 | $3.11 |
| Consolidated underwriting income | $96.6m | $231.3m | $228.1m | $784.5m |
| Consolidated combined ratio | 94.9% | 84.2% | 96.0% | 82.1% |
| Net investment income | $128.5m | $161.5m | $405.2m | $473.5m |
| Net realized gains | $280.5m | $61.4m | $470.1m | $322.4m |
- Q3 underwriting results weakened despite premium growth: catastrophe losses and higher current-year loss ratios offset favorable prior-year reserve development. The combined ratio remained below 100%, while insurance and “other” segments reported underwriting losses.
- Balance sheet at September 30: total assets were $42.72bn, total liabilities $29.45bn, and shareholders’ equity $13.21bn; equity available to Arch was $12.45bn. Book value per share was $28.75, versus $26.42 at December 31, 2019.
- Cash was $976.4m; cash and restricted cash totaled $1.19bn. Consolidated operating cash flow for the first nine months was $2.33bn. Excluding Watford, operating cash flow was $2.20bn.
- Consolidated senior notes were $2.86bn and revolving-credit borrowings were $210.7m. Separately, Arch’s capital structure excluding Watford showed $2.72bn of senior notes and $15.18bn of total capital; debt-to-total-capital was 17.9%.
- Arch issued $1.0bn of 3.635% senior notes due 2050 in June. The notes supported underwriting operations; higher debt contributed to increased interest expense.
Changes, outlook and risks
- Net premiums written increased 16% in Q3 and 24% for the nine-month period. Management attributed growth mainly to new business, rate increases and expansion in existing accounts, with a decline in travel business amid COVID-19.
- Management cited a hardening market and attractive growth opportunities. Insurance-segment rate increases averaged more than 11% in Q3; management expected the rate trend to continue through 2021. This is commentary, not formal earnings guidance.
- COVID-19 losses across property-casualty segments were $11.9m in Q3 and $271.6m year to date. Management said the pandemic’s future financial impact could not yet be estimated reliably. Catastrophe activity also included major storms and a derecho.
- Mortgage underwriting income fell 50% in Q3 to $130.5m and 47% year to date to $404.6m. U.S. primary mortgage delinquencies were 4.69% at quarter-end, up from 1.48% a year earlier. Management expected full-year mortgage underwriting income to be significantly below 2019 and warned delinquencies could rise as forbearance programs continue.
- Prior-year reserve development was favorable by $48.0m in Q3 and $111.1m year to date, below the respective 2019 nine-month favorable development of $130.5m. Reserve estimates are inherently uncertain.
- Investment income declined as market yields fell. Q3 gains included $126.7m of equity-method investment fund income; the filing notes such results may be reported on a one-to-three-month lag. These items and realized gains can make reported earnings volatile.
- Arch reported no liquidity impact from COVID-19 that was material during Q3 and said expected liquidity needs for the next 12 months should be met through operating cash flows, investments and credit facilities. Mortgage insurer PMIERs sufficiency was 158%, versus 161% at year-end 2019.
- Subsequent to quarter-end, Arch announced a revised agreement to acquire all Watford common shares for $35 per share, approximately $700m, with Warburg Pincus and Kelso. The transaction was expected to close in Q1 2021, subject to customary approvals; Arch expected to own about 40% at closing. Watford remains consolidated in the reported statements despite Arch’s approximately 13% common ownership at quarter-end.
- Risks include COVID-19 claims and economic effects, mortgage forbearance and defaults, catastrophe exposure, investment-market and credit risks, reinsurance recoverability, and possible regulatory action affecting coverage or premiums. Management said no pending litigation was expected to have a material adverse effect. Disclosure controls were considered effective; no material change in internal control over financial reporting was reported.
Investor verification priorities
- Track COVID-19 and catastrophe claims, reserve development, and the sensitivity of loss estimates to future developments.
- Monitor mortgage delinquencies, forbearance cures and claims, and PMIERs capital sufficiency.
- Assess the quality and sustainability of earnings apart from realized investment gains and equity-method fund results, alongside lower recurring investment yields.
- Verify Watford transaction approvals, closing, financing and the resulting ownership, consolidation and noncontrolling-interest effects.
- Review debt maturities, investment commitments of approximately $1.91bn, and exposure to market, credit and liquidity changes.