Business context and reporting period
Arch Capital Group Ltd. is a Bermuda-based global insurer, reinsurer and mortgage insurer. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2022; dollar amounts below are in U.S. dollars. PwC conducted an interim review, not an audit, and reported no material modifications were needed for GAAP conformity.
Comparability is affected by the July 2021 transaction under which Somers became owned by Greysbridge, in which Arch holds a 40% interest. Arch stopped consolidating Somers from July 1, 2021, so the 2021 first-half comparison includes Somers’ results while 2022 does not.
Financial results and key metrics
| Metric | Q2 2022 | Q2 2021 | Six months 2022 | Six months 2021 |
|---|---|---|---|---|
| Net premiums earned | $2.326 billion | $2.121 billion | $4.446 billion | $4.069 billion |
| Total revenue | $2.215 billion | $2.570 billion | $4.157 billion | $4.836 billion |
| Net income available to common shareholders | $394.2 million | $663.8 million | $579.8 million | $1.092 billion |
| Diluted EPS | $1.04 | $1.63 | $1.52 | $2.68 |
| After-tax operating income available to common shareholders (non-GAAP) | $506.5 million | $407.2 million | $928.5 million | $647.0 million |
| Operating ROAE (non-GAAP, annualized) | 17.1% | 13.0% | 15.3% | 10.3% |
Premium growth and stronger underwriting were outweighed in GAAP revenue and earnings by investment-market losses. Net realized losses were $266.6 million in Q2 and $559.0 million in the first half, versus gains in the comparable 2021 periods. Net investment income was $106.4 million in Q2 and $186.8 million year to date. Q2 net income also benefited from an $87.8 million foreign-exchange gain; first-half foreign-exchange gains were $91.6 million.
Underwriting income was $535.4 million in Q2. The consolidated combined ratio was 77.1%, compared with 82.0% a year earlier, but the comparison is affected by Somers’ inclusion in 2021. Q2 segment results: insurance underwriting income of $97.6 million and a 91.1% combined ratio; reinsurance income of $139.4 million and an 85.4% ratio; mortgage income of $298.4 million and a negative 1.5% ratio. Mortgage results included substantial favorable reserve development.
For the first six months, operating cash flow was $1.454 billion; investing cash outflow was $815.6 million and financing cash outflow was $682.1 million. Cash and restricted cash decreased $86.5 million to $1.228 billion. At June 30, total assets were $45.719 billion, total liabilities $33.293 billion and shareholders’ equity available to Arch $12.418 billion. Senior notes were $2.725 billion; debt to total capital was 18.0%. Cash was $813.5 million, and available-for-sale short-term investments were $2.228 billion.
Book value per share was $31.37 at June 30, down 2.5% from $32.18 at March 31 and from $33.56 at December 31, 2021. The first-half decline in common equity included a $1.194 billion after-tax reduction in other comprehensive income, primarily from unrealized investment losses. The portfolio’s total return was negative 3.02% for Q2 and negative 6.00% for the first half, while its benchmark returns were negative 5.37% and negative 9.13%, respectively.
Material changes and management outlook
- Net premiums written increased 27.5% in insurance and 25.7% in reinsurance in Q2 year over year; mortgage net premiums written declined 12.5%. Management attributed property and casualty growth to rate increases, new opportunities and growth in existing accounts.
- Management said it remained in a growth phase of the underwriting cycle, deploying capacity where rates support returns above its required thresholds. It described specialty insurance conditions as opportunistic and said it was cautiously optimistic about improving property catastrophe reinsurance renewals, while remaining disciplined on catastrophe exposure. No specific earnings or premium guidance was provided.
- Management highlighted inflation as a pricing and reserving focus. It expects higher future investment returns and prudent reserving to mitigate inflation’s impact, while acknowledging uncertainty around the ultimate effects on claims and investment values.
- Mortgage insurance in force in the U.S. reached $292 billion, which management linked to higher persistency as mortgage refinancing slowed. U.S. portfolio delinquencies were 1.77%, compared with 3.11% a year earlier. First-half mortgage results included $220.2 million of favorable prior-year reserve development, principally from the U.S. first-lien 2020 accident year.
- Across the company, favorable prior-year reserve development was $171.2 million in Q2 and $313.0 million in the first half. Changes in estimates are inherently uncertain; the filing notes that actual claims paid may differ substantially from reserves.
Risks, contingencies and unusual items
- Rising interest rates and equity-market declines drove significant realized and unrealized investment losses. Available-for-sale fixed maturities had $1.258 billion of gross unrealized losses at June 30, versus $171.5 million at year-end 2021. Management’s modeled portfolio VaR rose to 7.0% from 4.8%.
- Catastrophe exposure includes natural disasters, war and other man-made events; the company cited current-year catastrophe activity, including events outside the U.S. and Russia’s invasion of Ukraine. Modeled peak-zone loss estimates are not maximum exposures and may differ materially from actual losses.
- Management identifies inflation, reserve adequacy, investment performance, credit and reinsurance counterparty risk, foreign exchange, cyber events, regulation and severe economic or catastrophic events as risks. It cautions that actual losses may exceed modeled estimates, including if reinsurance is unavailable or counterparties do not perform.
- Liquidity planning relies on underwriting and investment cash flows, liquid investments, subsidiary distributions and credit facilities. The amended five-year facility totals $925 million; $333.4 million of its $425 million secured letter-of-credit capacity was outstanding at quarter-end.
- Investment commitments were approximately $3.5 billion, including $3.0 billion of unfunded commitments to equity-method limited partnerships. The company had $964.7 million of reinsurance recoverables from Somers at June 30.
- Management reported no litigation or arbitration expected to have a material adverse effect and no material changes to previously disclosed risk factors. Disclosure controls were assessed as effective; no material changes in internal control over financial reporting were reported.
Important facts for investors to verify
- How much of reported underwriting strength is sustainable after the unusually large favorable mortgage reserve releases, and how reserve estimates develop in subsequent quarters.
- Whether premium growth and rate increases continue to exceed loss-cost inflation, particularly in long-tail lines and catastrophe-exposed business.
- How investment portfolio values, realized losses, credit-loss allowances and book value respond to interest rates, spreads and equity markets.
- The effect of Somers’ deconsolidation on year-over-year comparisons, including underwriting, cash flows and noncontrolling interests.
- Liquidity, reinsurance recoverable quality and the capacity to meet the company’s investment commitments and insurance obligations.