Arch Capital Group Ltd. — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. Arch is a Bermuda-based global insurer, reinsurer and mortgage insurer. Financial statements are unaudited interim GAAP statements reviewed by PwC, not audited.
Financial results and position
- Third-quarter earnings: Total revenue was $1.404 billion, down 5.1% from $1.480 billion a year earlier. Net income was $248.8 million versus a $45.2 million loss; income available to common shareholders was $217.0 million, or $0.54 per basic share, versus a $52.8 million loss, or $0.13 per share.
- Nine-month results: Revenue was $4.099 billion versus $4.206 billion. Net income increased to $671.5 million from $427.9 million; common earnings rose to $587.5 million from $363.0 million. Diluted EPS was $1.42 versus $0.87.
- Premiums and underwriting: Q3 net premiums written were $1.334 billion, up 0.6%; earned premiums were $1.291 billion, up 2.3%. Nine-month written and earned premiums increased 5.1% and 6.7%, respectively. Q3 underwriting income was $234.6 million versus a $142.2 million loss, and the consolidated combined ratio improved to 82.3% from 111.8%. Nine-month combined ratio was 82.1% versus 93.1%.
- Segment performance: Q3 insurance reported a $26.7 million underwriting loss and a 104.8% combined ratio; reinsurance earned $30.9 million with an 89.9% ratio; mortgage earned $230.6 million with a 24.6% ratio. The mortgage segment was the largest underwriting-income contributor.
- Investment results and returns: Q3 net investment income rose to $144.0 million from $116.5 million, while net realized losses were $51.7 million versus gains of $66.3 million. Nine-month net realized losses were $239.3 million versus gains of $122.2 million. Operating ROAE was 11.4% for both Q3 and the nine-month period, versus (5.3)% and 4.4%, respectively, in 2017. Portfolio total return was 0.31% in Q3 and (0.19)% year to date; the respective benchmarks returned 0.36% and (0.46)%. Rising rates weighed on fixed-income values.
- Cash flow and liquidity: Consolidated nine-month operating cash flow was $1.121 billion, investing cash flow was negative $390.1 million and financing cash flow was negative $736.7 million. Consolidated cash and restricted cash ended at $709.8 million. Excluding Watford, operating cash flow was $947.7 million and cash and restricted cash increased $42.5 million. Management said anticipated liquidity needs for at least the next 12 months are expected to be met by operating and investment cash flows, cash, liquid investments and credit facilities.
- Capital, debt and equity: Arch shareholders’ equity was $9.36 billion. Book value per share was $21.15, up from $20.68 at June 30, 2018; the filing attributes quarterly growth to underwriting results, partly offset by interest-rate-related investment declines. Excluding Watford, total capital available was $11.21 billion and debt was $1.858 billion, including $125 million of revolver borrowings; debt-to-total-capital was 16.6%, down from 18.6% at year-end 2017. Arch MI U.S. reported estimated PMIERs sufficiency of 151%, versus 129% at year-end.
Material changes and management commentary
- Results improved sharply against Q3 2017, when hurricanes Harvey, Irma and Maria drove much higher catastrophe losses. 2018 Q3 underwriting also benefited from $79.6 million of favorable prior-year reserve development, including $38.6 million in mortgage and $34.3 million in reinsurance. Nine-month favorable development was $195.2 million.
- Management cited a competitive property-casualty market and said it is maintaining underwriting discipline, emphasizing smaller and mid-sized accounts, reducing exposure in some commoditized lines and using reinsurance to manage volatility. It seeks an average operating ROAE of 15% or greater over the insurance cycle; this is a target, not quarter-specific guidance. No specific earnings or premium forecast was provided.
- Mortgage market conditions were described as generally favorable, with U.S. pricing appearing to stabilize. U.S. mortgage new insurance written was $21.4 billion in Q3, up from $17.7 billion, and the delinquency rate was 1.60%, down from 1.98% a year earlier.
- After quarter-end, Arch estimated Hurricane Michael would reduce Q4 pretax results by $40–$60 million, net of reinsurance and reinstatement premiums; actual losses may differ materially. Arch also entered a new Bellemeade mortgage risk-transfer agreement and announced a planned acquisition of McNeil & Co. and a U.K. commercial-lines renewal-rights transaction, both subject to completion conditions.
- Key risks include catastrophe severity and frequency, reserve-estimation uncertainty, investment and interest-rate volatility, competitive pricing, mortgage-credit conditions, foreign exchange, and reinsurer counterparty performance. Management reported no litigation expected to materially harm results or liquidity and no material change in previously disclosed risk factors.
Most important facts for investors to verify
- How much of improved underwriting earnings depends on favorable prior-year reserve releases, and whether current-year loss trends remain favorable.
- Actual Hurricane Michael claims, reinsurance recoveries and reinstatement costs compared with the preliminary $40–$60 million estimate.
- Whether investment losses and unrealized fixed-income declines persist if interest rates rise further, and the effect of the new accounting treatment for equity-security fair-value changes.
- Mortgage portfolio performance under weaker housing or employment conditions, including delinquency trends, risk-to-capital and PMIERs sufficiency.
- Completion and financial impact of the announced acquisitions and renewal-rights transaction, and the availability and cost of reinsurance and liquidity.