Business context and reporting period
Arch Capital Group Ltd. (Arch) provides insurance, reinsurance and mortgage insurance globally. This unaudited Form 10-Q covers the three months ended March 31, 2021; comparisons are with the first quarter of 2020 unless otherwise noted. PricewaterhouseCoopers reviewed, but did not audit, the interim statements.
Financial performance and condition
| Metric | Q1 2021 | Q1 2020 / comparison |
|---|---|---|
| Total revenue | $2.266 billion | $1.525 billion |
| Net income (loss) | $475.7 million | $(88.7) million |
| Net income available to Arch common shareholders | $427.8 million; diluted EPS $1.05 | $133.7 million; diluted EPS $0.32 |
| Net premiums earned | $1.948 billion | $1.744 billion |
| Consolidated underwriting income | $185.9 million | $154.1 million |
| Consolidated combined ratio | 90.7% | 91.5% |
| Net investment income | $98.9 million | $145.2 million |
| Operating income available to Arch common shareholders (non-GAAP) | $239.8 million; operating ROAE 7.8% | $189.8 million; operating ROAE 7.1% |
Reported earnings included $142.5 million of net realized investment gains, $71.7 million of equity-method investment fund income and a $74.5 million one-time gain from the Coface investment. Net investment income declined, primarily reflecting lower market yields; the annualized pre-tax investment income yield was 1.31%, versus 2.20% a year earlier. The investment portfolio’s pre-tax total return was negative 0.18%, compared with negative 0.86% in Q1 2020.
Operating cash flow was $762.8 million, investing cash flow was $(493.2) million and financing cash flow was $(186.6) million. Cash and restricted cash ended the quarter at $1.368 billion. The investing outflow included $546.3 million for the Coface stake; financing included $179.3 million of share repurchases and $10.4 million of preferred dividends.
At March 31, total assets were $44.204 billion, total liabilities $30.173 billion and total shareholders’ equity $13.973 billion. Arch’s capital, excluding Watford, was $15.820 billion, including $2.724 billion of senior notes; debt to total capital was 17.2%, and debt plus preferred shares to total capital was 22.1%. Common book value per share was $30.54, up from $30.31 at year-end 2020. Arch held $26.3 billion of investable assets, excluding Watford; its average portfolio duration was 2.71 years and embedded book yield 1.59%.
Material changes and segment results
- Insurance net premiums written rose 20.0%; underwriting income improved to $18.4 million from a $28.2 million loss, and the combined ratio improved to 97.7% from 103.9%.
- Reinsurance net premiums written rose 25.3%; the segment recorded a $19.7 million underwriting loss versus a $9.4 million loss, with a 102.9% combined ratio versus 102.0%. Growth reflected rate increases and new business; the prior-year comparison included an $88 million loss portfolio transfer contract.
- Mortgage underwriting income increased 1.4% to $200.3 million, while net premiums earned declined 2.5%. Its combined ratio improved to 42.4% from 44.1%. U.S. mortgage new insurance written was $27.0 billion, about 60% higher year over year.
- Net favorable prior-year reserve development was $41.7 million, compared with $19.0 million. Q1 2021 included winter storm losses, notably in reinsurance; catastrophe activity contributed 24.7 loss-ratio points in that segment and 5.1 points in insurance.
- Accumulated other comprehensive income declined to $205.8 million from $488.9 million at year-end, primarily reflecting unrealized declines in available-for-sale investments and currency translation. Management cited rising interest rates as a drag on fixed-income values.
Outlook, risks and contingencies
Management’s 2021 priorities are to grow where pricing supports returns above the cost of capital, manage mortgage insurance through recovery, and actively manage investments and capital. It expects underwriting margins to improve over coming quarters, citing rate increases, mix changes and continued market discipline; insurance first-quarter rate increases averaged over 11%, and estimated reinsurance effective rate change was about 8%. These are expectations, not formal quantified earnings guidance.
COVID-19 uncertainty remains. Management made no significant change to COVID-19-related loss reserves in Q1. U.S. mortgage delinquencies were 3.86% at quarter-end, down from 4.19% at December 31, 2020, but remain elevated; forbearance programs and economic conditions may affect ultimate claims. Refinancing reduced U.S. mortgage persistency to 54.1% from 58.7% at year-end. Catastrophe exposure, reserve estimation uncertainty, inflation, market and credit volatility, foreign exchange, reinsurer recoverability and investment liquidity are material risks. Management’s modeled peak catastrophe and severe economic loss measures are not maximum exposures and actual losses may differ materially.
Arch expected its liquidity needs for the next 12 months to be met through underwriting and investment cash flows, cash and short-term investments, investment maturities or sales, and credit facilities. Arch MI U.S. reported estimated PMIER sufficiency of 190%, versus 173% at year-end. The Watford acquisition, at $35 per share for shares not already owned, was expected to close in Q2 2021 subject to customary conditions and ongoing regulatory approvals. Arch also announced an agreement to acquire Westpac’s Australian lenders mortgage insurance business. No litigation or arbitration was identified as expected by management to have a material adverse effect; the filing reported no material change to previously disclosed risk factors.
Important facts for investors to verify
- Separate recurring underwriting performance from the Coface gain, investment gains and equity-method fund income that contributed to reported earnings.
- Track catastrophe losses, reserve development and whether favorable prior-year reserve releases continue.
- Monitor mortgage delinquencies, forbearance outcomes, persistency and the effects of refinancing on premiums earned.
- Assess investment portfolio sensitivity to interest rates and credit spreads, including the impact on book value and reported comprehensive income.
- Confirm regulatory approvals and closing terms for the Watford and Westpac transactions, and review associated capital and liquidity effects.
- Distinguish Arch’s capital and debt measures excluding Watford from consolidated balance-sheet figures that include Watford.