Arch Capital Group Ltd. — Q1 2011 Form 10-Q
Reporting period: Three months ended March 31, 2011; balance-sheet comparisons are to December 31, 2010. Arch is a Bermuda-based global insurer and reinsurer focused on specialty property and casualty business. Amounts below are U.S. dollars; financial statement amounts are rounded to millions. Interim statements are unaudited and were reviewed, not audited, by PricewaterhouseCoopers.
Key financial results
| Metric | Q1 2011 | Q1 2010 / prior date |
|---|---|---|
| Total revenue | $775.1 million | $844.9 million |
| Net premiums written | $764.3 million | $767.8 million |
| Net premiums earned | $633.7 million | $669.9 million |
| Net income | $25.8 million | $217.0 million |
| Net income available to common shareholders | $19.3 million; diluted EPS $0.41 | $210.5 million; diluted EPS $3.79 |
| Net cash provided by operating activities | $224.6 million | $184.6 million |
| Cash | $406.9 million | $362.7 million at Dec. 31, 2010 |
| Total assets / total liabilities | $17.19 billion / $12.87 billion | $15.77 billion / $11.26 billion at Dec. 31, 2010 |
| Shareholders’ equity | $4.33 billion | $4.51 billion at Dec. 31, 2010 |
| Book value per common share | $91.02 | $89.98 at Dec. 31, 2010 |
Q1 underwriting loss was $63.5 million, versus underwriting income of $23.9 million a year earlier. The consolidated combined ratio was 110.0%, compared with 96.4%; insurance was 106.2% and reinsurance 116.8%. Net investment income was $88.3 million versus $93.0 million. Net realized gains were $20.7 million versus $47.8 million. Net foreign exchange losses were $36.9 million, compared with gains of $38.6 million in Q1 2010.
Material changes and drivers
- Net catastrophe losses, after reinsurance and reinstatement premiums, were $178.7 million, versus $58.1 million in Q1 2010. Q1 2011 included the Japan earthquake and tsunami, New Zealand earthquake, and Australian floods/Cyclone Yasi. Management cautioned that estimates could change materially.
- Reinsurance underwriting swung from $53.9 million of income to a $38.0 million loss; its combined ratio rose to 116.8% from 77.7%, chiefly reflecting catastrophe losses. Insurance remained loss-making, with its combined ratio improving modestly to 106.2% from 106.9%.
- Prior-period reserve development was favorable by $58.8 million overall: $15.4 million in insurance and $43.4 million in reinsurance. Reserve estimates remain inherently uncertain and actual losses may differ substantially.
- Operating ROAE, a company-defined non-GAAP measure, was 0.8%, versus 9.8%. Management attributed the decline primarily to catastrophe activity, market conditions and lower reinvestment yields. Pre-tax investment portfolio total return was 1.50%, versus 1.58%; it exceeded the benchmark’s 0.92% in Q1 2011.
- Operating cash flow increased to $224.6 million from $184.6 million. Investing activities used $68.0 million and financing activities used $117.8 million, including $237.2 million for share repurchases. The company repurchased 2.7 million shares in the quarter and had approximately $992.4 million remaining under its program.
Financial position, outlook and risks
- Debt included $300 million of senior notes, $100 million drawn under the revolving credit agreement, and $322.2 million of TALF borrowings. The $100 million revolving borrowing was variable-rate; the credit agreement was scheduled to expire August 30, 2011. The company said renewal or replacement was anticipated but not assured on satisfactory terms. It reported compliance with facility covenants.
- At March 31, outstanding letters of credit under LOC facilities were $692.2 million, secured by investments with a market value of $780.1 million. Approximately $6.12 billion of assets were restricted for collateral, regulatory deposits and related purposes. Management expected liquidity needs for at least the next 12 months to be met through operations, investments and credit facilities, while noting that claim timing and recoveries can vary.
- Management described a competitive market with excess capacity and slight price declines; primary insurance rates fell approximately 4% in Q1. Reinsurance conditions were generally unchanged except for international catastrophe-exposed property, where post-event submissions and demand increased. Management’s objective is average operating ROAE of at least 15% over the insurance cycle, not a specific quarterly forecast.
- Catastrophe-exposed business is expected to remain a significant part of the portfolio and can increase earnings volatility. Management’s modeled 1-in-250-year net probable maximum loss limit is approximately 25% of shareholders’ equity for a severe event in any geographic zone; modeled April 1 peak exposures were $726 million for a Northeastern U.S. windstorm and $665 million for Florida Tri-County. These are estimates, not maximum-loss limits.
- Other risks include reserve-estimation uncertainty, reinsurer nonperformance, investment and interest-rate volatility, mortgage and credit exposures, foreign-currency movements, and access to financing. The company reported $2.7 million of net investment impairment losses in earnings. It also cited potential adverse effects from leverage in some investment funds.
- Management estimated a $8–$12 million Q2 loss related to its investment in Aeolus LP from Q1 catastrophe events; actual results could differ materially. A three-for-one common share split was approved after quarter-end, with shares to be distributed in May 2011.
- Management reported no litigation or arbitration expected to have a material adverse effect. Disclosure controls were concluded effective; no material change in internal control over financial reporting was reported.
Important facts for investors to verify
- How catastrophe loss estimates develop, particularly for Japan, New Zealand and Australia, and whether reinsurance recoveries are collected as expected.
- Whether reserve development remains favorable and how reserve adequacy compares with subsequent claims emergence.
- Renewal or replacement terms for the credit agreement expiring in August 2011, and ongoing availability of letter-of-credit capacity.
- Drivers of the sharp year-over-year decline in earnings, including underwriting losses, foreign-exchange effects and investment income yields.
- Share repurchase pace and capital impact, along with the treatment of per-share data following the three-for-one split.