Arch Capital Group Ltd. — Q3 2022 Form 10-Q
Reporting period: Three and nine months ended September 30, 2022. Arch provides insurance, reinsurance and mortgage insurance worldwide. Financial statements are unaudited and were reviewed, but not audited, by PwC.
Financial performance and condition
| Metric | Q3 2022 | Q3 2021 | Nine months 2022 | Nine months 2021 |
|---|---|---|---|---|
| Total revenue | $2.386 billion | $2.101 billion | $6.543 billion | $6.937 billion |
| Net income | $18.3 million | $421.4 million | $619.6 million | $1.616 billion |
| Net income available to common shareholders | $6.9 million | $388.8 million | $586.7 million | $1.480 billion |
| Diluted earnings per common share | $0.02 | $0.98 | $1.55 | $3.66 |
| Net cash from operating activities | Not separately provided for Q3 | $2.834 billion | $2.628 billion |
- Net premiums earned increased 28% in Q3 to $2.471 billion and 15% for the first nine months to $6.917 billion. Underwriting income was $68.8 million in Q3 and $1.062 billion year to date; the consolidated underwriting combined ratio was 97.3% for Q3 and 84.8% year to date.
- Quarterly results reflected $183.7 million of net realized investment losses and $18.9 million of losses from investment funds accounted for under the equity method. Net investment income rose to $128.6 million from $88.2 million. Nine-month realized investment losses were $742.7 million, compared with $320.3 million of gains in 2021.
- Q3 underwriting varied by segment: insurance reported a $33.7 million underwriting loss and 102.8% combined ratio; reinsurance a $196.9 million loss and 119.7% ratio; mortgage $299.4 million income and a negative 5.2% ratio. Mortgage results benefited substantially from prior-year reserve releases.
- Prior-year reserves developed favorably by $180.8 million in Q3 and $493.9 million year to date, including mortgage-segment releases of $126.2 million and $346.4 million, respectively.
- At September 30, total assets were $46.337 billion, total liabilities $34.533 billion, and shareholders’ equity available to Arch $11.795 billion. Common book value per share was $29.69, down from $33.56 at year-end 2021. Accumulated other comprehensive loss reached $1.892 billion, largely reflecting declines in available-for-sale investments.
- Senior notes were $2.725 billion; debt was 18.8% of total capital. Cash was $813.6 million and cash plus restricted cash was $1.258 billion. Operating cash flow was $2.834 billion for nine months; financing cash outflow included $585.8 million of share repurchases.
Changes versus comparable periods
- Q3 common earnings fell sharply from 2021, while premiums earned expanded. The quarter’s results were pressured by catastrophe losses and financial-market-driven investment losses; the 2021 comparison included substantially higher investment-fund and operating-affiliate income.
- Q3 reinsurance incurred a 92.6% loss ratio, versus 80.4% a year earlier, including 42.8 points of current-year catastrophe activity, principally Hurricane Ian and other events. Insurance’s current-year catastrophe losses were 13.4 points of its Q3 loss ratio.
- For the first nine months, insurance and reinsurance premiums written grew, while mortgage net premiums written fell 11.7%. Mortgage U.S. new insurance written was $60.9 billion versus $83.2 billion; the persistency rate improved to 75.4% from 57.7%.
- Comparability is affected by Arch’s July 2021 deconsolidation of Somers following its acquisition by Greysbridge; Somers’ results were included in Arch’s 2021 results through June 30, 2021.
Outlook, risks and other notable items
- Management said it was “cautiously optimistic” about Q4 2022 and 2023, with no quantified earnings or premium guidance. It expects to keep growing where pricing supports returns above its thresholds, and described insurance pricing and terms as disciplined. Reinsurance management emphasized quota-share business and discipline in property-catastrophe exposure.
- Management cited inflation, rising interest rates and catastrophe activity as key concerns, while saying pricing, reserving and exposure management incorporate emerging inflation trends. It noted Hurricane Ian and other Q3 catastrophes had increased pressure on property-catastrophe markets and could affect other property and casualty lines.
- Investment performance was affected by rising rates and weak equity markets: nine-month pre-tax total investment return was negative 8.83%, versus negative 12.78% for its benchmark. The portfolio’s average duration was 2.84 years. The filing reports $1.861 billion of gross unrealized losses on available-for-sale fixed maturities at quarter-end.
- Mortgage insurance in force reached $294.9 billion in U.S. primary insurance. Management said higher rates affected new loan origination volume but that borrower credit quality remained strong. Arch MI U.S. reported a 237% estimated PMIER sufficiency ratio.
- Arch reported $3.1 billion of investment commitments and approximately $3.1 billion of additional dividend capacity from Arch Re Bermuda for the remainder of 2022 without an affidavit to Bermuda’s regulator. The amended revolving and letter-of-credit facility totaled $925 million; $311.8 million of its $425 million secured letter-of-credit capacity was outstanding.
- Management reported no litigation or arbitration expected to have a material adverse effect and no material changes to previously disclosed risk factors. It warned that catastrophe and mortgage stress-model estimates are uncertain and actual losses could materially exceed modeled amounts. Other risks include reserve adequacy, reinsurer performance, inflation, market volatility, foreign exchange, regulation and cyber events.
- The board’s repurchase authorization had $596.4 million remaining at September 30; the program was authorized through December 31, 2022. The Inflation Reduction Act provisions effective in 2023 were not expected by the company to have a material financial-statement effect.
Most important facts for investors to verify
- How much of reported underwriting income and earnings depends on favorable reserve development, particularly the large mortgage reserve releases.
- The ultimate net cost of Hurricane Ian and other catastrophe losses, including effects on Q4 claims, pricing and reinsurance renewals.
- Whether investment losses and accumulated unrealized losses recover, and the effect of further rate, credit-spread and equity-market changes on book value and capital.
- Reserve adequacy, mortgage portfolio performance under weaker housing and employment conditions, and the durability of favorable delinquency trends.
- Liquidity and capital availability after share repurchases, investment commitments, collateral requirements and potential claims; also review related-party reinsurance with Somers and the associated recoverables and payables.