Arch Capital Group Ltd. — Q2 2020 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2020. Arch writes insurance, reinsurance and mortgage insurance globally. Financial statements are unaudited; PwC performed an interim review, not an audit.
Financial performance
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Net premiums earned | $1.665bn | $1.464bn | $3.410bn | $2.833bn |
| Total revenues | $2.292bn | $1.779bn | $3.826bn | $3.502bn |
| Net income available to Arch common shareholders | $288.4m | $458.6m | $422.1m | $896.7m |
| Diluted EPS | $0.71 | $1.12 | $1.03 | $2.19 |
| Consolidated net income | $466.4m | $485.8m | $377.7m | $981.3m |
- Q2 pretax income was $492.5m, versus $530.3m a year earlier. Higher losses outweighed premium growth; Q2 revenues also benefited from $556.6m of consolidated net realized gains, while equity-method investment funds recorded a $65.1m loss.
- Q2 underwriting results: insurance posted a $56.7m loss (combined ratio 108.3%); reinsurance a $33.1m loss (106.8%); mortgage income of $76.4m (80.9%). Consolidated combined ratio was 101.8% including the “other” segment; underwriting subtotal excluding “other” was 101.2%.
- For the first half, consolidated underwriting income was $131.5m and the combined ratio was 96.5%. Insurance and reinsurance reported underwriting losses of $84.9m and $42.5m; mortgage underwriting income was $274.1m.
- Q2 net investment income was $131.5m, down from $155.0m; first-half income was $276.6m versus $312.0m. Management attributed the decline mainly to lower market yields. Q2 total investment return was 3.72%, below the 6.06% benchmark; first-half return was 2.82%, above the 1.23% benchmark.
- Operating ROAE, a non-GAAP measure, was 0.6% in Q2 and 3.8% for the first half, versus 13.1% and 12.7% in 2019. Book value per share was $27.62 at June 30, up 5.8% from March 31 and 12.1% year over year.
Cash flow, balance sheet and capital
- Six-month consolidated operating cash flow was $1.322bn; investing cash outflow was $1.810bn and financing inflow was $671.3m. Cash and restricted cash ended the period at $1.065bn. Excluding Watford, operating cash flow was $1.234bn and cash/restricted cash increased $155.8m.
- Total assets were $41.20bn and total shareholders’ equity $12.67bn at June 30. Arch-available shareholders’ equity was $11.99bn, versus $11.50bn at year-end 2019. Investments totaled $26.46bn; Arch-reported investable assets excluding Watford were $24.53bn.
- Senior notes were $2.861bn on the consolidated balance sheet; revolving-credit borrowings were $335.6m, both including Watford. Arch’s capital-structure presentation excluding Watford showed $2.723bn of senior notes and debt-to-total-capital of 18.5%, up from 13.1% at year-end.
- On June 30, Arch issued $1.0bn of 3.635% senior notes due 2050; proceeds were contributed to Arch Re Bermuda to support underwriting. The board-authorized repurchase program had $924.5m remaining, but Arch said it did not expect program repurchases for the rest of 2020.
- Arch MI U.S. reported PMIER sufficiency of 161% at June 30, unchanged from year-end. Restricted assets were $8.21bn. The filing says liquidity was not materially affected by COVID-19 during Q2 and expects near-term needs to be met through operating and investment cash flows, existing cash, asset maturities/sales and credit facilities.
Material changes and outlook
- Net premiums written increased 15.5% in Q2 to $1.668bn. Growth reflected rate increases and new business, particularly in reinsurance property lines; travel-related writings weakened amid COVID-19. First-half net premiums written rose 28.1% to $3.806bn.
- Arch recorded $173.1m of COVID-19 losses in Q2 and $259.7m for the first half across property-casualty segments, classified as catastrophe losses. COVID-19 contributed 11.3 points to the Q2 insurance current-year loss ratio and 19.8 points to reinsurance.
- Mortgage delinquencies rose: U.S. primary delinquency was 5.14% at June 30, versus 1.42% at March 31. Management said reported delinquencies were better than its expectations at the start of the pandemic, but expects further increases and elevated incurred losses as forbearance notices emerge. Its current view implies a claim rate slightly above 5%; management expects 2020 mortgage-segment pretax underwriting income to be significantly below 2019. It characterized the pandemic as an earnings event, not a capital event, while noting substantial uncertainty.
- Management cited improving rates and attractive growth opportunities across all three underwriting segments, with a willingness to expand property-casualty writings while maintaining underwriting discipline. It cautioned that catastrophe-exposed business can increase results volatility. No specific consolidated earnings or revenue guidance was provided.
- Prior-year reserves developed favorably by $44.1m in Q2 and $63.1m in the first half, mainly in reinsurance. Favorable development partly offset higher current-year losses.
- Key risks include pandemic-related claims and coverage disputes, possible retroactive mandates for business-interruption or workers’ compensation coverage, mortgage forbearance/defaults and PMIER impacts, investment-market volatility and credit losses, catastrophe exposure, reserve-estimation uncertainty, reinsurer credit risk, and cyber/operational disruption from remote work. Management stated no known litigation was expected to materially harm results, financial condition or liquidity.
Important facts for investors to verify
- How COVID-19 claims develop beyond the $259.7m first-half estimate, including coverage litigation and potential regulatory changes.
- Whether mortgage delinquencies, forbearance cures and ultimate claim rates align with management’s assumptions, and the resulting effect on reserves and PMIER headroom.
- Underlying underwriting performance excluding catastrophe losses and prior-year reserve releases, particularly in insurance and reinsurance.
- Investment returns, credit quality and liquidity under further market stress; Q2 realized gains and equity-method losses were significant and volatile.
- Debt servicing and capital deployment following the $1.0bn 2050 notes issuance, including the stated pause in share repurchases.