Arch Capital Group Ltd. — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016; balance-sheet comparisons are with December 31, 2015. Unless stated otherwise, dollar figures are U.S. dollars in millions. The interim statements were reviewed by PwC, not audited.
Business context and performance
Arch is a Bermuda-based global insurer and reinsurer, with insurance, reinsurance and mortgage underwriting businesses. Its consolidated results also include Watford Re, a variable-interest entity in which Arch owns approximately 11% of common equity; third-party interests are reflected as noncontrolling interests.
| Metric | Q1 2016 | Q1 2015 |
|---|---|---|
| Net premiums written | $1,121.2 | $1,067.0 |
| Net premiums earned | $951.6 | $910.3 |
| Total revenues | $1,086.7 | $1,082.3 |
| Income before taxes | $191.9 | $321.4 |
| Net income | $175.6 | $308.8 |
| Net income available to Arch common shareholders | $149.3 | $277.9 |
| Diluted earnings per common share | $1.20 | $2.16 |
| After-tax operating income available to common shareholders (non-GAAP) | $145.7 | $149.8 |
Underwriting and investment results
- Consolidated underwriting income was $110.9 million versus $116.5 million; the combined ratio was 88.9% versus 88.4%.
- Insurance: underwriting income $29.3 million; combined ratio 94.3%. Net premiums written rose 1.4%.
- Reinsurance: underwriting income $58.7 million, down 20.6%; combined ratio increased to 77.7% from 74.0%. Net premiums written fell 8.0%, reflecting reduced property writings, increased retrocessions and market conditions.
- Mortgage: underwriting income rose to $23.9 million from $13.5 million; combined ratio improved to 67.5% from 88.5%. Net premiums written more than doubled, primarily from Australian mortgage reinsurance growth.
- Net investment income increased to $93.7 million from $79.0 million. Net realized gains declined to $37.3 million from $83.3 million. Net foreign-exchange results swung to a $23.6 million loss from a $66.5 million gain.
- Prior-year reserve development was favorable across the insurance, reinsurance and mortgage segments: $6.2 million, $47.4 million and $2.7 million, respectively. Reinsurance’s favorable development was lower than the $58.0 million reported a year earlier.
Financial position, cash flow and capital
- Total assets were $24,541 million, total liabilities $17,168 million, and total shareholders’ equity $7,169 million at March 31, 2016. Equity available to Arch was $6,414 million.
- Book value per common share was $49.87, up 4.0% from $47.95 at year-end 2015. Management attributed the quarterly increase to underwriting and investment returns.
- Consolidated cash was $558 million. Q1 operating cash flow was $322.5 million, investing cash flow was negative $233.3 million, and financing cash flow was negative $87.0 million; cash increased $4.6 million. On management’s non-GAAP “core” basis, operating cash flow was $257.3 million.
- Debt consisted of $791.3 million in senior notes and $457.4 million in consolidated revolving borrowings. The latter included $357.4 million at Watford Re; Arch’s own revolving borrowings were $100.0 million. Arch reported $6.9 million of readily available parent-company cash, short-term investments and marketable securities, excluding regulated subsidiaries.
- Investable assets totaled $16.66 billion, including $14.95 billion managed by Arch and $1.71 billion attributable to Watford Re. Approximately $5.71 billion of assets were restricted or pledged for collateral, guarantees or regulatory deposits.
- Arch repurchased 1.14 million shares under its public program for approximately $75.3 million; $446.5 million remained authorized. Preferred dividends were $5.5 million.
Changes, outlook and risks
- Reported common earnings fell substantially year over year, while total revenue was nearly flat. The comparison was affected by the prior-year foreign-exchange gain and higher realized investment gains; Q1 2016 also had higher net investment income and premiums earned.
- Management described insurance pricing and terms as under modest pressure and reinsurance as under moderate pressure, amid a competitive market and low interest rates. Arch reduced writings in certain property-casualty lines and emphasized underwriting discipline, smaller and medium-sized accounts, and reinsurance protection for large-account exposures.
- Management’s objective is average operating return on average common equity of at least 15% over the insurance cycle; reported Q1 operating ROAE was 9.7%, versus 10.2% a year earlier. No specific near-term earnings or premium guidance was provided.
- Mortgage markets were described as favorable but increasingly competitive. Arch MI U.S. generated $2.91 billion of new insurance written; persistency declined to 74.2% from 75.6% at year-end. It met the PMIERs financial requirements at March 31, 2016, but as a newly approved insurer faced restrictions, including a prohibition on affiliate dividends through January 2017.
- Catastrophe exposure remains a source of volatility. Management’s modeled April 1, 2016 peak-zone net probable maximum pre-tax losses were $494 million for a Northeastern U.S. windstorm, $438 million for the Gulf of Mexico, and $385 million for Florida’s Tri-County region. These are estimates, not maximum-loss limits; actual losses could differ materially.
- Liquidity and investment risks include potentially uneven claim payments, delayed reinsurance recoveries, illiquid or leveraged alternative investments, market and interest-rate movements, and uncalled investment commitments of approximately $1.19 billion. Foreign-currency movements and reserve-estimation uncertainty may also materially affect results.
- Management said it expected liquidity needs over at least the next 12 months to be met through underwriting and investment cash flows, cash and liquid investments, investment maturities or sales, and credit facilities. It also cautioned that market or catastrophe conditions could require asset sales or additional financing.
- No litigation or arbitration was identified as expected to have a material adverse effect; the filing reported no material change to previously disclosed risk factors. Disclosure controls were considered effective, and no material change in internal control over financial reporting was reported.
Important facts for investors to verify
- Whether reserve development remains favorable, especially the extent to which reinsurance results depend on prior-year releases.
- How much of the earnings decline reflects recurring underwriting performance versus foreign-exchange and investment gains or losses.
- Mortgage portfolio growth, delinquency and persistency trends, capital needs under PMIERs, and the effect of affiliate-dividend restrictions.
- Available parent-company liquidity versus consolidated cash, regulated-subsidiary dividend capacity, and Watford Re’s separate borrowing and collateral obligations.
- Actual catastrophe exposure and the sensitivity of investment valuations, reserves and liquidity to adverse market conditions.