Arch Capital Group Ltd. — Q3 2023 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2023; filed November 9, 2023. Arch is a Bermuda-based global insurer, reinsurer and mortgage insurer. Financial amounts below are U.S. dollars unless stated otherwise.
Financial performance
| Metric | Q3 2023 | Q3 2022 | Nine months 2023 | Nine months 2022 |
|---|---|---|---|---|
| Net premiums earned | $3.248 billion | $2.471 billion | $9.096 billion | $6.918 billion |
| Total revenue | $3.329 billion | $2.386 billion | $9.659 billion | $6.542 billion |
| Net income available to Arch common shareholders | $713 million | $7 million | $2.079 billion | $587 million |
| Diluted earnings per common share | $1.88 | $0.02 | $5.50 | $1.55 |
| Underwriting income | $721 million | $68 million | $1.897 billion | $1.062 billion |
| Combined ratio | 77.9% | 97.3% | 79.4% | 84.8% |
| Net investment income | $269 million | $129 million | $710 million | $315 million |
| Net realized investment losses | $248 million | $184 million | $354 million | $743 million |
Q3 net income included a $146 million favorable prior-year reserve development benefit and $59 million of income from equity-method investment funds. The quarter also included $248 million of net realized losses, including investment and derivative valuation effects. Management’s non-GAAP operating income available to common shareholders was $876 million for Q3 and $2.256 billion year to date; these measures exclude specified investment, foreign-exchange and other items.
Segments and material changes
- Insurance: Q3 underwriting income was $129 million versus a $34 million loss; premiums earned rose 19% to $1.412 billion and the combined ratio improved to 90.9% from 102.8%. Lower catastrophe losses contributed to the improvement.
- Reinsurance: Q3 underwriting income was $310 million versus a $197 million loss; premiums earned rose 54% to $1.543 billion and the combined ratio improved to 80.0% from 119.7%. Q3 catastrophe activity contributed 9.7 loss-ratio points, compared with 42.8 points in Q3 2022.
- Mortgage: Q3 underwriting income was $282 million, compared with $299 million. Premiums earned increased 4% to $293 million, while favorable prior-year reserve development was $92 million versus $126 million. Lower mortgage originations weighed on new business; U.S. mortgage persistency was 83.9%, up from 75.4% a year earlier.
For the first nine months, favorable prior-year reserve development totaled $403 million, down from $492 million in 2022. The mortgage segment supplied $243 million of the 2023 release, primarily from U.S. first-lien reserves for 2020–2022 accident years. Insurance and reinsurance had favorable development overall, partly offset by adverse development in professional liability and casualty lines.
Financial condition, cash flow and liquidity
- Total assets were $55.227 billion at September 30, 2023, versus $47.990 billion at year-end 2022. Total investments were $31.380 billion; cash was $859 million.
- Loss reserves were $21.836 billion, unearned premiums $9.074 billion, and total liabilities $39.986 billion. Shareholders’ equity available to Arch was $15.239 billion, including $14.409 billion of common equity. Book value per share was $38.62, up 4.3% in the quarter and from $32.62 at year-end 2022.
- Nine-month operating cash flow was $4.084 billion, compared with $2.834 billion. Investing activities used $3.936 billion; financing activities used $52 million. Cash and restricted cash ended at $1.355 billion.
- Senior notes were $2.726 billion carrying value. Debt was 15.2% of total capital, down from 17.4% at year-end 2022. The filing reports no material liquidity concern and expects needs to be met through underwriting and investment cash flows, liquid assets, investment maturities or sales, and credit facilities.
- The investment portfolio’s average effective duration was 2.97 years and average credit quality AA-/Aa3. Available-for-sale fixed maturities had $1.415 billion of gross unrealized losses at quarter-end, largely associated with market interest rates; these losses are not equivalent to recognized credit losses.
Outlook, risks and notable items
- Management said favorable property and casualty market opportunities remained, with rate increases above loss trends in most sectors, though pricing was declining in some lines and increasing in others. It expects hard property-market conditions to continue through the next renewal cycle. No numerical earnings or premium guidance was provided.
- Management cited underwriting discipline, prudent reserving and cycle-focused capital allocation. It noted higher mortgage rates and lower originations as constraints on mortgage new business, partly offset by higher persistency and international opportunities.
- Modeled peak-zone catastrophe losses as of October 1, 2023 were $1.47 billion for Florida Tri-County windstorm, $1.41 billion for Northeastern U.S. windstorm and $1.35 billion for Gulf of Mexico windstorm. Management cautioned that modeled losses are estimates, not maximum exposures, and actual results could differ materially.
- Inflation may affect claim severity, reserve adequacy and investment values. Other disclosed risks include catastrophe and severe economic events, reserve-estimation uncertainty, reinsurer credit and recoverability, market and interest-rate movements, foreign exchange, competition, regulation and tax changes, and cyber or operational disruptions.
- The company reported no litigation or arbitration expected by management to have a material adverse effect, no material changes to previously disclosed risk factors, and effective disclosure controls. A $1.0 billion repurchase authorization remained available through December 31, 2024; there were no purchases under that program in Q3.
- Subsequent events included an October 2023 mortgage reinsurance agreement providing up to $233 million of coverage and an amended Lloyds letter-of-credit facility increased to $530 million.
Most important facts for investors to verify
- How much of the earnings improvement is sustainable underwriting performance versus lower catastrophe losses and favorable reserve development, particularly in mortgage insurance.
- The adequacy and sensitivity of loss reserves, including adverse development in professional liability and casualty, against continued inflation and changing claims trends.
- Investment portfolio exposure to interest rates, credit spreads and unrealized losses, along with the timing and impact of any realized investment losses.
- Reinsurance recoverability and concentration: $6.821 billion of recoverables were reported, and 33.1% was due from carriers without an A.M. Best rating; the filing says more than 95% of that portion was collateralized.
- Mortgage portfolio performance as originations remain affected by higher rates, including delinquency trends, persistency and the contribution of reserve releases to segment earnings.
- Execution of capital allocation and liquidity plans, including the unused repurchase authorization, investment commitments of approximately $3.1 billion, and the terms and use of credit and letter-of-credit facilities.