Arch Capital Group Ltd. — Q1 2023 Form 10-Q
Reporting period: Three months ended March 31, 2023; comparisons are with Q1 2022 unless otherwise noted. Arch provides insurance, reinsurance and mortgage insurance worldwide. Financial amounts below are in U.S. dollars in millions, except per-share data.
Key financial results
| Metric | Q1 2023 | Q1 2022 / comparison |
|---|---|---|
| Net premiums earned | $2,883 | $2,121; up 36% |
| Total revenues | $3,168 | $1,942 |
| Net income | $717 | $198 |
| Net income available to common shareholders | $705 | $186 |
| Diluted earnings per common share | $1.87 | $0.48 |
| Underwriting income | $570 | $458 |
| Combined ratio | 80.6% | 78.7% |
| Net investment income | $199 | $80 |
| Net realized investment gains (losses) | $17 | $(292) |
| Operating cash flow | $963 | $552 |
| Book value per share | $35.35 | $32.62 at Dec. 31, 2022; up 8.4% in Q1 |
Annualized net income return on average common equity was 22.3%, versus 6.0%; operating return on average common equity, a non-GAAP measure, was 20.7%, versus 13.6%. Investment income rose primarily because market yields were higher. Q1 2022 net realized losses included equity mark-to-market losses, contributing to the year-over-year earnings improvement.
Segments and material changes
- Insurance: Net premiums written rose 19% to $1,437; underwriting income increased to $114 from $63. The combined ratio improved to 90.9% from 93.8%, with a lower loss ratio and lower catastrophe impact.
- Reinsurance: Net premiums written increased 52% to $1,726; underwriting income rose to $213 from $109. The combined ratio improved to 84.3% from 86.6%. Property catastrophe net premiums written were nearly double the prior-year quarter, reflecting stronger pricing and terms and lower retrocession activity.
- Mortgage: Underwriting income was $243, down from $286; net premiums written declined 9% to $261. The combined ratio increased to 20.0% from 3.1%, in part because current-year loss estimates increased. Favorable prior-year reserve development was $71, versus $102 in Q1 2022.
- Consolidated favorable prior-year reserve development was $136, compared with $141. The 2023 amount included $12 from insurance, $53 from reinsurance and $71 from mortgage; mortgage development primarily reflected reduced reserves for pandemic-era delinquencies.
Financial condition, liquidity and capital
- Total assets were $51.1 billion at March 31, 2023, compared with $48.0 billion at year-end; total shareholders’ equity available to Arch was $14.0 billion, up from $12.9 billion.
- Cash was $803; cash and restricted cash totaled $1.215 billion. Operating activities provided $963, investing activities used $996 and financing activities used $30; cash and restricted cash decreased $58 during the quarter.
- Senior notes were $2.726 billion. Debt to total capital was 16.3%, down from 17.4% at year-end. Total capital available to Arch was $16.714 billion.
- Management expects liquidity needs to be met through underwriting cash generation, investment income, cash and short-term investments, investment maturities or sales, and credit facilities. Arch Capital received $55 in dividends from Arch Re Bermuda during Q1; the filing says approximately $3.7 billion could be paid to the parent during the remainder of 2023 without an affidavit to the Bermuda Monetary Authority.
- Arch MI U.S. estimated PMIER sufficiency was 248%, versus 236% at year-end. Mortgage insurance delinquency was 1.65%, down from 1.77% at year-end and 2.09% a year earlier.
Outlook, risks and other notable items
- Management stated its 2023 objective remains long-term shareholder value creation. It described property and casualty markets as attractive, with continued rate improvement in property and disciplined market behavior; it intends to allocate underwriting capital toward areas offering returns above its cost of capital. No specific earnings or revenue guidance was provided.
- Management highlighted inflation as a continuing concern for pricing, reserving and investment values. It incorporates emerging inflation trends into pricing and reserves, but ultimate claim effects remain uncertain.
- Catastrophe and severe economic-event exposures remain significant. Modeled peak-zone pre-tax catastrophe losses included $1.07 billion for a Northeastern U.S. windstorm and $1.07 billion for a Gulf of Mexico windstorm. Modeled U.S. mortgage severe-economic-event loss was about 13% of tangible shareholders’ equity. The company cautions that modeled estimates are not maximum exposures and actual losses could differ materially.
- Available-for-sale fixed maturities had $1.297 billion of gross unrealized losses at quarter-end. The investment portfolio’s average effective duration was 2.89 years and average credit ratings were AA-/Aa3. A hypothetical 100-basis-point rise in rates was estimated to reduce fixed-income fair value by $0.8 billion.
- Investment commitments were approximately $2.9 billion. Reinsurance recoverables were $6.612 billion; 31.5% was due from carriers without an A.M. Best rating, though more than 94% of that amount was collateralized.
- Management reported no litigation or arbitration expected to have a material adverse effect, and no material change to previously disclosed risk factors. Disclosure controls were deemed effective; no material change in internal control over financial reporting was reported. The interim financial statements were reviewed, not audited, by PwC.
- The company made no purchases under its public share-repurchase authorization in Q1. It repurchased 364,454 shares from employees to cover withholding taxes and exercises.
Important facts for investors to verify
- Whether premium growth and improved underwriting results persist, particularly in property catastrophe and other reinsurance lines.
- How much earnings depend on favorable prior-year reserve development, especially mortgage reserve releases, and whether current-year mortgage claims continue to rise.
- The sensitivity of reserves and investment values to inflation, interest rates, credit spreads and catastrophe losses; review the filing’s modeled-loss assumptions and caveats.
- Investment portfolio credit quality, unrealized losses, liquidity restrictions, unfunded commitments and the collectability and collateralization of reinsurance recoverables.
- Mortgage portfolio performance, including delinquency trends, PMIER sufficiency and the effect of housing-market or economic stress.