Arch Capital Group Ltd. — Q3 2021 Form 10-Q
Reporting period: Three and nine months ended September 30, 2021. Arch is a Bermuda-based global insurer, reinsurer and mortgage insurer. Interim financial statements were reviewed by PwC, not audited.
Financial results and position
| Metric | Q3 2021 | Q3 2020 | Nine months 2021 | Nine months 2020 |
|---|---|---|---|---|
| Total revenue | $2.10 billion | $2.31 billion | $6.94 billion | $6.13 billion |
| Net income | $421 million | $489 million | $1.62 billion | $866 million |
| Net income available to common shareholders | $389 million | $409 million | $1.48 billion | $831 million |
| Diluted EPS | $0.98 | $1.00 | $3.66 | $2.02 |
| Net premiums earned | $1.93 billion | $1.77 billion | $6.00 billion | $5.18 billion |
| Net investment income | $88 million | $129 million | $299 million | $405 million |
| Net realized investment gains (losses) | $(25) million | $280 million | $320 million | $470 million |
- Underwriting: Consolidated combined ratio was 91.4% in Q3 versus 94.9% a year earlier, and 87.9% for nine months versus 96.0%. Q3 ratios were 102.2% for insurance, 106.2% for reinsurance and 26.2% for mortgage. Favorable prior-year reserve development was $123 million in Q3 and $223 million year to date.
- Operating earnings: Non-GAAP after-tax operating income available to common shareholders was $295 million in Q3 versus $120 million, and $942 million for nine months versus $327 million. Operating ROAE was 9.3% and 10.1%, respectively. These measures exclude specified investment, foreign exchange, tax and other items.
- Cash flow: The consolidated cash flow statement reports $2.63 billion of operating cash flow for nine months, versus $2.33 billion in 2020. Cash and restricted cash ended at $1.55 billion. The MD&A separately presents operating cash flow of $2.58 billion versus $2.20 billion; the difference reflects presentation around Watford’s deconsolidation.
- Balance sheet and capital: Total assets were $44.78 billion and total liabilities $31.39 billion at September 30. Investable assets were $27.28 billion, with a 2.68-year average duration and 1.54% embedded book yield. Senior notes were $2.72 billion; no revolving-credit borrowings were reported at quarter-end. Debt-to-total-capital was 16.9%, and debt plus preferred shares to total capital was 22.1%.
- Equity and liquidity: Arch-attributable shareholders’ equity was $13.39 billion; book value per share was $32.43, up 1.3% in Q3 and 12.8% year over year. Management expects liquidity needs over the next 12 months to be met by underwriting and investment cash flows, cash and short-term investments, investment maturities and sales, and credit facilities. Restricted assets totaled $8.14 billion.
Material changes and unusual items
- Net premiums earned increased 9% in Q3 and 16% for the nine-month period. Growth reflected higher rates and business expansion; Q3 gross written premiums rose across insurance and reinsurance.
- Q3 total revenue and common earnings were lower year over year, principally reflecting much lower realized investment gains and investment income. Nine-month common earnings rose substantially, supported by underwriting and investment-affiliate results.
- Catastrophe losses weighed on Q3 underwriting: current-year catastrophe activity represented 12.2 loss-ratio points in insurance and 34.6 points in reinsurance, primarily from Hurricane Ida, European floods and other events. Reinsurance’s Q3 combined ratio rose to 106.2% from 99.0%.
- Mortgage underwriting income increased to $234 million in Q3 from $131 million, with lower COVID-related loss assumptions and favorable reserve development. U.S. primary mortgage delinquencies declined to 2.67% from 4.19% at year-end 2020.
- Effective July 1, Arch stopped consolidating Watford after its acquisition by Greysbridge, in which Arch holds 40%. The change affects comparability of reported results and balance-sheet amounts. Q3 included a $33 million loss from Watford’s deconsolidation and a $96 million one-time gain from the Greysbridge acquisition.
- Arch acquired Somerset Bridge in August and Westpac’s Australian lenders mortgage insurance business in August. The acquisitions added $337 million to goodwill and intangible assets.
- Arch issued $500 million of Series G preferred shares and redeemed $450 million of Series E preferred shares; the redemption produced a $15 million accounting loss with no effect on total equity or cash flows. Arch repurchased $872 million of common shares during the first nine months.
Outlook, risks and contingencies
- Management expects improved property-casualty underwriting margins over the next several quarters, citing rate increases, rate-on-rate effects and business mix. It reported 2021 rates up about 10% versus 2020 and expects higher premium levels to benefit results into 2022 and beyond, subject to rates supporting target returns.
- Management described mortgage conditions as improving: forbearance was declining, notices of default had returned to pre-pandemic levels, and mortgage returns were in the mid-teens. It noted continued refinancing activity and competition.
- Key risks include catastrophe frequency and severity, inflation and claim-cost trends, COVID-19 effects, reserve-estimation uncertainty, investment-market and interest-rate movements, reinsurance collectability, foreign-exchange exposure, and competition. Modeled peak-zone catastrophe losses and mortgage stress estimates are not maximum exposures and could differ materially from actual outcomes.
- Management reported no litigation or arbitration expected to have a material adverse effect, and no material change in previously disclosed risk factors. Disclosure controls were deemed effective; no material change in internal control over financial reporting was reported.
- After quarter-end, the board increased the share-repurchase authorization to up to $1.5 billion through December 31, 2022. The filing gives no earnings-per-share or revenue guidance.
Important facts for investors to verify
- How much Q3 and year-to-date earnings depended on favorable reserve releases and one-time gains, and whether underwriting performance persists excluding these effects.
- Catastrophe loss development, especially the Q3 reinsurance current-year loss ratio and the concentration of 2021 event losses.
- Comparability of financial results and balance-sheet trends after Watford’s deconsolidation, including the impact of related-party reinsurance with Watford.
- Mortgage delinquency, forbearance, refinancing and housing-market trends, together with the durability of mortgage-segment earnings.
- Investment portfolio sensitivity to rates and credit spreads, investment-fund liquidity and $2.6 billion of investment commitments; also monitor capital deployment, repurchases and preferred dividends.