Arch Capital Group Ltd. — 2020 Form 10-K
Reporting period: Fiscal year ended December 31, 2020; comparisons are primarily with 2019. Arch is a Bermuda-based global specialty insurer and reinsurer, with insurance, reinsurance and mortgage businesses. Amounts below are U.S. dollars unless stated otherwise.
Key financial results
| Metric | 2020 | 2019 | Change / context |
|---|---|---|---|
| Net premiums written | $7.44 billion | $6.04 billion | Up 23.2% |
| Net premiums earned | $6.99 billion | $5.79 billion | Up 20.8% |
| Total revenue | $8.53 billion | $6.93 billion | Up 23.0%; includes investment gains |
| Net income available to common shareholders | $1.36 billion | $1.59 billion | Down 14.5% |
| Diluted earnings per share | $3.32 | $3.87 | Down 14.2% |
| After-tax operating income available to common shareholders | $557 million | $1.16 billion | Down 52.1%; non-GAAP measure |
| Operating return on average common equity | 4.8% | 12.0% | Lower underwriting and investment income |
| Net cash provided by operating activities | $2.89 billion | $2.05 billion | Higher, primarily reflecting premium collections |
GAAP earnings included $823 million of net realized investment gains, versus $363 million in 2019. Net investment income fell to $520 million from $628 million, and net foreign exchange losses increased to $84 million from $21 million. The gap between GAAP and operating earnings chiefly reflects investment-related items excluded from Arch’s non-GAAP operating measure.
Underwriting performance
| Segment | Net premiums earned | Underwriting income (loss) | Combined ratio |
|---|---|---|---|
| Insurance | $2.87 billion, up 19.8% | $(129) million | 104.5%, versus 101.5% |
| Reinsurance | $2.16 billion, up 47.5% | $16 million | 99.5%, versus 94.9% |
| Mortgage | $1.40 billion, up 2.3% | $593 million | 59.0%, versus 24.9% |
Combined ratios worsened in insurance and reinsurance as current-year catastrophe losses rose. Mortgage underwriting income declined 43%, reflecting much higher reported delinquencies and losses. Consolidated underwriting income, including the “other” segment, was $449 million, compared with $1.04 billion in 2019.
Financial position, debt and liquidity
- Total assets were $43.3 billion at year-end, compared with $37.9 billion a year earlier. Total shareholders’ equity was $13.9 billion; equity available to Arch was $13.1 billion.
- Book value per share increased 14.7% to $30.31 from $26.42, reflecting underwriting and investment returns.
- Arch-held investable assets were $26.9 billion, excluding $2.7 billion attributable to Watford. The portfolio’s average credit rating was AA/Aa2 and effective duration was 3.01 years. Net investment income yield declined to 1.78% from 2.52%.
- Common shareholders’ equity plus preferred shares and senior notes represented $15.8 billion of capital available to Arch. Parent-level senior notes were $2.72 billion; debt-to-total-capital was 17.2%, compared with 13.1%. Arch issued $1.0 billion of 3.635% senior notes due 2050 in June 2020. Consolidated debt also includes Watford obligations.
- Cash and restricted cash totaled $1.29 billion. The filing states liquidity was not materially impacted by COVID-19 and that expected near-term needs should be met through operating cash flows, investments and credit facilities. Certain investments are illiquid, and $2.15 billion of investment commitments were unfunded at year-end.
- Arch Re Bermuda could pay approximately $3.8 billion to Arch Capital in 2021 without filing an affidavit with the Bermuda regulator. Subsidiary dividends remain subject to regulatory, solvency and rating constraints.
- Arch MI U.S. met PMIERs requirements, with a reported sufficiency ratio of 173%, versus 161% in 2019.
Material changes and notable items
- Premium growth reflected rate increases, new business and expansion in existing accounts, particularly in reinsurance. Management described market conditions as hardening and said all three underwriting segments had attractive growth opportunities at acceptable returns.
- Arch recorded $272 million of COVID-19 losses in its property-casualty segments and classified them as catastrophe losses. Insurance and reinsurance current-year loss ratios included 4.1 and 7.2 percentage points, respectively, for COVID-19 exposure.
- U.S. primary mortgage delinquencies rose to 4.19% at year-end from 1.54% a year earlier, although they declined from 4.69% at September 30, 2020. Management cautioned that forbearance, unemployment and foreclosure delays made future claims difficult to forecast.
- Net loss reserves, after reinsurance recoverables, increased to $12.2 billion from $9.8 billion. Gross reserves were $16.5 billion. Prior-year reserve development was favorable by $161 million overall, including $134 million in reinsurance; reserving remains highly judgmental and a critical audit matter.
- Arch repurchased $83.5 million of common shares during 2020; $916.5 million remained authorized at year-end. From January 1 through February 24, 2021, it repurchased a further $154.9 million.
Outlook, risks and contingencies
- Management said insurance renewal rate changes increased approximately 12% in fourth-quarter 2020 and expected the trend of higher rates to continue into 2021. It raised $1.0 billion in long-term debt to support underwriting growth.
- Management could not reliably estimate the pandemic’s future impact. It warned that COVID-19 could increase claims, reduce insurable exposures, pressure investment results and affect mortgage delinquencies, capital access and ratings. Many mortgage delinquencies could cure, but timing and ultimate claim rates were uncertain.
- Major risks include catastrophe and climate-related losses, reserve inadequacy, competition and underwriting-cycle shifts, reinsurer and counterparty credit risk, investment-market volatility, cyber incidents, regulatory changes and Brexit-related uncertainty. The modeled 1-in-250-year peak catastrophe loss was $860 million for a Florida Tri-County windstorm; modeled mortgage severe-economic-event losses were 6% of tangible equity. These models are not maximum-loss estimates.
- The Watford merger agreement, entered into in fourth-quarter 2020, contemplated a $35-per-share cash purchase for shares Arch did not own, subject to approvals. Following closing, the acquisition vehicle was to be owned 40% by Arch Re Bermuda and 30% each by Kelso- and Warburg Pincus-managed funds.
- After year-end, Arch completed a 29.5% investment in Coface for approximately €453 million including fees. A February 2021 Texas winter storm had occurred, but losses were too early to estimate. Arch also agreed to transfer approximately $380 million of legacy Syndicate 1955 net liabilities to Premia, effective January 1, 2021.
- Management reported no litigation or arbitration expected to have a material adverse effect. The independent auditor issued an unqualified opinion on the financial statements and found internal control over financial reporting effective.
Important facts for investors to verify
- How COVID-19 claims, business-interruption litigation and the elevated mortgage delinquency inventory develop, including the rate of cures versus claims.
- Whether underwriting rate increases and premium growth translate into improved segment combined ratios, especially in insurance and reinsurance.
- The adequacy and development of reserves, including the contribution of favorable prior-year reserve releases to reported underwriting results.
- The composition and durability of 2020 investment gains, the effect of lower yields on recurring investment income, and the liquidity of alternative investments and unfunded commitments.
- Final terms, ownership, approvals and financial consequences of the Watford transaction, as well as the effect of the Coface investment and Texas storm losses.
- Capital availability at regulated subsidiaries, PMIERs compliance, debt service capacity and any changes in ratings or dividend restrictions.