Arch Capital Group Ltd. — Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2011. Arch provides worldwide insurance and reinsurance, with underwriting segments in insurance and reinsurance. Financial statements are unaudited; the independent accountant performed a review, not an audit.
Financial results and position
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Net premiums earned | $682.0m | $627.4m | $1,958.6m | $1,920.3m |
| Total revenues | $765.0m | $797.4m | $2,315.6m | $2,418.6m |
| Net income | $169.0m | $148.0m | $293.1m | $608.5m |
| Net income available to common shareholders | $162.5m | $141.6m | $273.7m | $589.1m |
| Diluted EPS | $1.19 | $0.92 | $1.98 | $3.68 |
| Operating cash flow | Not provided separately | Not provided separately | $756.5m | $657.6m |
Amounts in the table are U.S. dollars. For the nine-month periods, revenue declined about 4% and net income about 52% year over year; Q3 net income increased about 14% despite lower revenue. Net investment income was $257.7m for nine months, down from $274.3m; realized gains were $96.1m, down from $178.7m. Q3 included a $60.0m foreign-exchange gain, compared with a $65.2m loss in Q3 2010, helping lift reported quarterly earnings. Nine-month after-tax operating income available to common shareholders, a company-defined non-GAAP measure, was $176.7m versus $361.6m.
Underwriting: The consolidated combined ratio was 94.3% in Q3 versus 90.4% a year earlier, and 101.1% for nine months versus 92.4%. Insurance recorded underwriting losses of $5.8m in Q3 and $64.8m for nine months; its combined ratios were 101.4% and 105.1%. Reinsurance earned $44.7m in Q3 and $42.4m for nine months; its combined ratios were 81.7% and 94.0%. Higher catastrophe losses drove deterioration, partly offset by favorable prior-period reserve development.
Balance sheet and liquidity: At September 30, total assets were $17.43bn, total liabilities $12.96bn, and shareholders’ equity $4.47bn, compared with $15.81bn, $11.30bn, and $4.51bn at year-end 2010. Book value per common share was $31.20, up from $29.99. Cash was $369.9m and total investments $11.97bn. The company reported $12.23bn of investable assets. The holding company itself had $4.4m of readily available cash, short-term investments and marketable securities excluding regulated subsidiaries; it relies on subsidiary distributions and other resources for its obligations.
Debt and financing included $300m of senior notes, $100m drawn under the revolving credit agreement, and $314.1m of TALF borrowings. The company had $621.5m of letters of credit outstanding, secured by investments valued at $644.2m, and reported compliance with facility covenants. Nine-month share repurchases used $287.6m; $942.0m remained available under the program. Restricted assets were $5.68bn.
Material changes and management commentary
- Net premiums written grew 6.6% to $2.16bn for nine months, while premiums earned grew 2.0%. Reinsurance written premiums grew 11.2%; insurance written premiums grew 4.1%.
- Catastrophe losses, net of reinsurance and reinstatement premiums, were $333.3m for the first nine months of 2011 versus $89.3m in 2010. Q3 catastrophe losses were $59.6m versus $24.2m.
- Favorable prior-period reserve development was $180.6m across both segments for nine months, compared with $108.2m in 2010. This benefited reported loss ratios; reserve estimates remain subject to uncertainty.
- Pre-tax portfolio total return was negative 0.23% in Q3, compared with positive 3.61% in Q3 2010; nine-month return was 2.97% versus 7.08%. Investment income yields declined amid lower reinvestment yields and portfolio changes. Equity-method investment funds generated a $30.5m Q3 loss, partly reflecting leveraged funds.
- Management described insurance markets as competitive, although most lines moved to positive rate trends in Q3; it said further increases were needed in many lines. The company emphasized disciplined underwriting and short-tail business and identified catastrophe-exposed business as its most attractive pricing area.
- Management’s objective is average operating return on average common equity of at least 15% over the insurance cycle. Operating ROAE was 10.4% in Q3 and 5.7% for nine months, below the comparable 2010 levels of 12.3% and 11.5%.
Outlook, risks and contingencies
Management expects next-12-month liquidity needs to be met through underwriting and investment cash flows, cash and short-term investments, investment maturities or sales, and credit facilities. No specific earnings or revenue guidance was provided. Management cautioned that catastrophe-exposed business may increase results volatility and that actual catastrophe losses can materially exceed modeled estimates. As of October 1, modeled peak-zone net probable maximum pre-tax losses were $972m for a Gulf of Mexico windstorm and $870m for a Northeastern U.S. windstorm; these are not maximum exposure estimates.
Other stated risks include volatile financial markets and investment valuations, further U.S. or other sovereign downgrades, low interest and reinvestment yields, leveraged or potentially illiquid investments, mortgage credit and prepayment risks, foreign-currency movements, reserve estimation uncertainty, and delayed or unrecovered reinsurance claims. The company noted that insurer and reinsurer dividends are subject to regulatory capital restrictions. It reported no litigation expected by management to have a material adverse effect. Unfunded investment commitments were approximately $229.6m.
Important facts for investors to verify
- How catastrophe claims and subsequent reserve development affect loss reserves and underwriting results, particularly the reinsurance segment.
- Whether investment income, portfolio returns, and leveraged equity-method funds stabilize or worsen after the weak Q3 investment performance.
- The drivers and persistence of the difference between reported net income and operating income, including foreign-exchange gains and realized investment gains.
- Availability of holding-company liquidity and regulated subsidiary dividend capacity, alongside debt, letter-of-credit obligations, and share repurchases.
- Exposure to sovereign and credit-market deterioration, mortgage-related assets, and modeled catastrophe losses; assess actual losses against the stated modeling assumptions.