Arch Capital Group Ltd. Reports 2019 First Quarter Results

PEMBROKE, Bermuda–(BUSINESS WIRE)–Arch Capital Group Ltd. (NASDAQ: ACGL) announces its 2019 first quarter
results. The results included:

“Management’s Discussion and Analysis of Financial Condition and
Results of Operations”

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• Net income available to Arch common shareholders of $438.1 million, or
  $1.07 per share, a 19.5% annualized return on average common equity,
  compared to $137.3 million, or $0.33 per share, for the 2018 first
  quarter;
• After-tax operating income available to Arch common shareholders, a
  non-GAAP measure, of $275.9 million, or $0.67 per share, a 12.3%
  annualized return on average common equity, compared to $235.1
  million, or $0.56 per share, for the 2018 first quarter;
• Book value per common share of $23.12 at March 31, 2019, a 7.4%
  increase in the 2019 first quarter and a 13.3% increase for the
  trailing twelve months;
• Pre-tax current accident year catastrophic losses, net of reinsurance
  and reinstatement premiums⁽¹⁾ of $7.9 million;
• Favorable development in prior year loss reserves, net of related
  adjustments⁽¹⁾ of $36.7 million;
• Combined ratio excluding catastrophic activity and prior year
  development⁽¹⁾ of 81.4%.

All earnings per share amounts discussed in this release are on a
diluted basis. The following table summarizes the Company’s underwriting
results, both (i) on a consolidated basis and (ii) on a consolidated
basis excluding the ‘other’ segment (i.e., results of Watford Re,
as defined below):

Pursuant to GAAP, the Company consolidates the results of Watford
Holdings Ltd. in its financial statements, although it only owns
approximately 11% of Watford Holdings Ltd.’s outstanding common equity.
Watford Holdings Ltd. is the parent of Watford Re Ltd., a multi-line
Bermuda reinsurance company (together with Watford Holdings Ltd.,
“Watford Re”). See ‘Comments on Regulation G’ for further details.

The following table summarizes the Company’s consolidated financial
data, including a reconciliation of net income or loss available to Arch
common shareholders to after-tax operating income or loss available to
Arch common shareholders and related diluted per share results:

Each line item in the table above reflects the impact of the Company’s
approximate 11% ownership of Watford Re’s outstanding common equity. See
‘Comments on Regulation G’ for a discussion of non-GAAP financial
measures.

Segment Information

The following section provides analysis on the Company’s 2019 first
quarter performance by operating segment. For additional details
regarding the Company’s operating segments, please refer to the
Company’s Financial Supplement dated March 31, 2019. The Company’s
segment information includes the use of underwriting income (loss) and a
combined ratio excluding catastrophic activity (if applicable for the
segment) and prior year development. Such items are non-GAAP financial
measures (see ‘Comments on Regulation G’ for further details).

Insurance Segment

Gross premiums written by the insurance segment in the 2019 first
quarter were 14.4% higher than in the 2018 first quarter while net
premiums written were 7.8% higher than in the 2018 first quarter. The
increase in net premiums written primarily reflects the acquisition of a
U.K. commercial lines book of business on January 1, 2019, along with
the growth in most lines of business. The percentage increase in gross
premiums written is higher than the increase in net premiums written due
to a single large national account, for which the premium written in the
quarter was substantially ceded. Net premiums earned by the insurance
segment in the 2019 first quarter were 2.7% higher than in the 2018
first quarter, and reflect changes in net premiums written over the
previous five quarters.

The 2019 first quarter loss ratio reflected minimal current year
catastrophic activity, compared to 0.2 points in the 2018 first quarter.
Estimated net favorable development of prior year loss reserves, before
related adjustments, reduced the loss ratio by 0.8 points in the 2019
first quarter, compared to 0.4 points in the 2018 first quarter. The
balance of the change in the 2019 first quarter loss ratio primarily
resulted from changes in mix of business.

The underwriting expense ratio was 35.5% in the 2019 first quarter,
compared to 32.9% in the 2018 first quarter. The increase in the
underwriting expense ratio reflected a previously announced change in
the timing of our incentive compensation practices, with a large portion
of the expense associated with the share based compensation grants
reflected in the 2019 first quarter. In prior periods, share based
compensation grants occurred in the second quarter. On the U.K.
acquisition noted above, only a small portion of net premiums written
were earned in the 2019 first quarter while the Company incurred a full
quarter of expenses. This resulted in a higher expense ratio in the
period, which is expected to moderate as the business matures. The
Company did not acquire any loss reserves or unearned premiums as part
of the transaction.

Reinsurance Segment

Gross and net premiums written by the reinsurance segment in the 2019
first quarter were 18.2% higher than in the 2018 first quarter. The
increase in net premiums written in the 2019 first quarter primarily
reflected growth from selected new business opportunities in casualty
and property excluding property catastrophe. Net premiums earned by the
reinsurance segment in the 2019 first quarter were 24.1% higher than in
the 2018 first quarter, and reflect changes in net premiums written over
the previous five quarters.

The 2019 first quarter loss ratio included 2.3 points of current year
catastrophic activity, compared to 0.4 points of catastrophic activity
in the 2018 first quarter. Estimated net adverse development of prior
year loss reserves, before related adjustments, increased the loss ratio
by 0.5 points in the 2019 first quarter, compared to 13.1 points of
favorable development in the 2018 first quarter. The estimated net
adverse development in the 2019 first quarter included an increase in
reserves on Typhoon Jebi of $16.0 million, or 4.6 points, based on
receipt of updated information from cedents and additional updated
industry data.

The underwriting expense ratio was 26.0% in the 2019 first quarter,
compared to 30.0% in the 2018 first quarter, primarily as a result of
growth in net premiums earned and changes in mix of business.

Mortgage Segment

Gross premiums written by the mortgage segment in the 2019 first quarter
were 10.9% higher than in the 2018 first quarter, while net premiums
written were 11.7% higher. The growth in net premiums written primarily
reflected an increase in monthly premiums business due to growth in U.S.
insurance in force, partially offset by a lower level of U.S. single
premium business, a decrease in Australian mortgage reinsurance business
and higher ceded premiums related to Bellemeade transactions. The
increase in net premiums earned for the 2019 first quarter primarily
reflected the growth in insurance in force over the last twelve months,
with $390.4 billion of insurance in force at March 31, 2019, compared to
$349.9 billion at March 31, 2018.

Arch MI U.S. generated $11.2 billion of new insurance written (“NIW”) in
the 2019 first quarter, consistent with the $11.4 billion in the 2018
first quarter. Monthly premium policies contributed 91.6% of NIW in the
2019 first quarter, compared to 91.4% in the 2018 first quarter.

The loss ratio for the 2019 first quarter reflected estimated net
favorable development in prior year loss reserves, before related
adjustments, of 11.3 points in the 2019 first quarter, compared to 4.6
points in the 2018 first quarter. The estimated net favorable
development in the 2019 first quarter was primarily driven by lower
expected claim rates on first lien business and subrogation activity on
second lien business. The percentage of loans in default on first lien
business was 1.54% at March 31, 2019, a decrease from 1.60% at
December 31, 2018 and from 1.98% at March 31, 2018.

The mortgage segment’s underwriting expense ratio was 22.1% in the 2019
first quarter, compared to 23.3% in the 2018 first quarter. The lower
ratio in the 2019 first quarter primarily resulted from the higher level
of net premiums earned.

At March 31, 2019, the mortgage segment’s risk-in-force (before
reinsurance) of $77.1 billion consisted of $71.1 billion from Arch MI
U.S. with the remainder from reinsurance and credit-risk sharing
operations.

Corporate and Non-Underwriting

Corporate and non-underwriting results include net investment income,
other income (loss), corporate expenses, transaction costs and other,
amortization of intangible assets, interest expense, items related to
the Company’s non-cumulative preferred shares, net realized gains or
losses, net impairment losses included in earnings, equity in net income
or loss of investment funds accounted for using the equity method, net
foreign exchange gains or losses and income taxes. Such amounts exclude
the results of the ‘other’ segment.

Pre-tax net investment income for the 2019 first quarter was $0.30 per
share, or $121.2 million, compared to $0.24 per share, or $100.2
million, for the 2018 first quarter. The growth in 2019 first quarter
net investment income reflected the reinvestment of fixed income
securities at higher available yields and the shift from municipal bonds
to corporates. The annualized pre-tax investment income yield was 2.67%
for the 2019 first quarter, compared to 2.13% for the 2018 first
quarter. Total return, a non-GAAP measure, was 2.70% for the 2019 first
quarter, primarily reflecting the decline in interest rates during the
period and attendant appreciation in the Company’s fixed income
portfolio. See ‘Comments on Regulation G’ for a discussion of non-GAAP
financial measures.

Interest expense for the 2019 first quarter was $23.5 million, compared
to $25.9 million for the 2018 first quarter, reflecting the paydown of
revolving credit agreement borrowings in the second half of 2018.

On a pre-tax basis, net foreign exchange gains for the 2019 first
quarter were $5.2 million, compared to net foreign exchange losses for
the 2018 first quarter of $15.0 million. For both periods, such amounts
were primarily unrealized and resulted from the effects of revaluing the
Company’s net insurance liabilities required to be settled in foreign
currencies at each balance sheet date. Changes in the value of
available-for-sale investments held in foreign currencies due to foreign
currency rate movements are reflected as a direct increase or decrease
to shareholders’ equity and are not included in the consolidated
statements of income. Although the Company generally attempts to match
the currency of its projected liabilities with investments in the same
currencies, the Company may elect to over or underweight one or more
currencies from time to time, which could increase the Company’s
exposure to foreign currency fluctuations and increase the volatility of
the Company’s shareholders’ equity.

The Company’s effective tax rate on income before income taxes (based on
the Company’s annual effective tax rate) was 9.3% for the 2019 first
quarter, compared to 12.7% for the 2018 first quarter. The Company’s
effective tax rate on pre-tax operating income available to Arch common
shareholders was 13.1% for the 2019 first quarter, compared to 9.9% for
the 2018 first quarter. The effective tax rates for the 2019 first
quarter included a discrete income tax benefit of $1.8 million related
to share-based compensation. This benefit had the effect of reducing the
effective tax rate on operating income available to Arch common
shareholders by 0.5%. The Company’s effective tax rate may fluctuate
from period to period based upon the relative mix of income or loss
reported by jurisdiction, the level of catastrophic loss activity
incurred, and the varying tax rates in each jurisdiction.

Conference Call

The Company will hold a conference call for investors and analysts at
11:00 a.m. Eastern Time on May 1, 2019. A live webcast of this call will
be available via the Investors section of the Company’s website at https://www.archgroup.com.
A telephone replay of the conference call also will be available
beginning on May 1, 2019 at 2:00 p.m. Eastern Time until May 8, 2019 at
midnight Eastern Time. To access the replay, domestic callers should
dial 855-859-2056, and international callers should dial 404-537-3406
(passcode 7196298 for all callers).

Please refer to the Company’s Financial Supplement dated March 31, 2019,
which is available via the Investors section of the Company’s website at https://www.archgroup.com.
The Financial Supplement provides additional detail regarding the
financial performance of the Company. From time to time, the Company
posts additional financial information and presentations to its website,
including information with respect to its subsidiaries. Investors and
other recipients of this information are encouraged to check the
Company’s website regularly for additional information regarding the
Company.

Arch Capital Group Ltd., a Bermuda-based company with approximately
$11.85 billion in capital at March 31, 2019, provides insurance,
reinsurance and mortgage insurance on a worldwide basis through its
wholly owned subsidiaries.

Comments on Regulation G

Throughout this release, the Company presents its operations in the way
it believes will be the most meaningful and useful to investors,
analysts, rating agencies and others who use the Company’s financial
information in evaluating the performance of the Company and that
investors and such other persons benefit from having a consistent basis
for comparison between quarters and for comparison with other companies
within the industry. These measures may not, however, be comparable to
similarly titled measures used by companies outside of the insurance
industry. Investors are cautioned not to place undue reliance on these
non-GAAP financial measures in assessing the Company’s overall financial
performance.

This presentation includes the use of “after-tax operating income or
loss available to Arch common shareholders,” which is defined as net
income available to Arch common shareholders, excluding net realized
gains or losses, net impairment losses recognized in earnings, equity in
net income or loss of investment funds accounted for using the equity
method, net foreign exchange gains or losses, transaction costs and
other and loss on redemption of preferred shares, net of income taxes,
and the use of annualized operating return on average common equity. The
presentation of after-tax operating income available to Arch common
shareholders and annualized operating return on average common equity
are non-GAAP financial measures as defined in Regulation G. The
reconciliation of such measures to net income available to Arch common
shareholders and annualized return on average common equity (the most
directly comparable GAAP financial measures) in accordance with
Regulation G is included on the following page of this release.

The Company believes that net realized gains or losses, net impairment
losses recognized in earnings, equity in net income or loss of
investment funds accounted for using the equity method, net foreign
exchange gains or losses, transaction costs and other and loss on
redemption of preferred shares in any particular period are not
indicative of the performance of, or trends in, the Company’s business
performance. Although net realized gains or losses, net impairment
losses recognized in earnings, equity in net income or loss of
investment funds accounted for using the equity method and net foreign
exchange gains or losses are an integral part of the Company’s
operations, the decision to realize investment gains or losses, the
recognition of the change in the carrying value of investments accounted
for using the fair value option in net realized gains or losses, the
recognition of net impairment losses, the recognition of equity in net
income or loss of investment funds accounted for using the equity method
and the recognition of foreign exchange gains or losses are independent
of the insurance underwriting process and result, in large part, from
general economic and financial market conditions. Furthermore, certain
users of the Company’s financial information believe that, for many
companies, the timing of the realization of investment gains or losses
is largely opportunistic. In addition, net impairment losses recognized
in earnings on the Company’s investments represent other-than-temporary
declines in expected recovery values on securities without actual
realization. The use of the equity method on certain of the Company’s
investments in certain funds that invest in fixed maturity securities is
driven by the ownership structure of such funds (either limited
partnerships or limited liability companies). In applying the equity
method, these investments are initially recorded at cost and are
subsequently adjusted based on the Company’s proportionate share of the
net income or loss of the funds (which include changes in the fair value
of the underlying securities in the funds). This method of accounting is
different from the way the Company accounts for its other fixed maturity
securities and the timing of the recognition of equity in net income or
loss of investment funds accounted for using the equity method may
differ from gains or losses in the future upon sale or maturity of such
investments. Transaction costs and other include advisory, financing,
legal, severance, incentive compensation and other costs related to
acquisitions and Watford Re’s non-recurring listing expenses. The
Company believes that transaction costs and other, due to their
non-recurring nature, are not indicative of the performance of, or
trends in, the Company’s business performance. The loss on redemption of
preferred shares related to the redemption of the Company’s Series C
preferred shares in January 2018 and had no impact on shareholders’
equity or cash flows. Due to these reasons, the Company excludes net
realized gains or losses, net impairment losses recognized in earnings,
equity in net income or loss of investment funds accounted for using the
equity method, net foreign exchange gains or losses, transaction costs
and other and loss on redemption of preferred shares from the
calculation of after-tax operating income or loss available to Arch
common shareholders.

The Company believes that showing net income available to Arch common
shareholders exclusive of the items referred to above reflects the
underlying fundamentals of the Company’s business since the Company
evaluates the performance of and manages its business to produce an
underwriting profit. In addition to presenting net income available to
Arch common shareholders, the Company believes that this presentation
enables investors and other users of the Company’s financial information
to analyze the Company’s performance in a manner similar to how the
Company’s management analyzes performance. The Company also believes
that this measure follows industry practice and, therefore, allows the
users of the Company’s financial information to compare the Company’s
performance with its industry peer group. The Company believes that the
equity analysts and certain rating agencies which follow the Company and
the insurance industry as a whole generally exclude these items from
their analyses for the same reasons.

The Company’s segment information includes the presentation of
consolidated underwriting income or loss and a subtotal of underwriting
income or loss before the contribution from the ‘other’ segment. Such
measures represent the pre-tax profitability of its underwriting
operations and include net premiums earned plus other underwriting
income, less losses and loss adjustment expenses, acquisition expenses
and other operating expenses. Other operating expenses include those
operating expenses that are incremental and/or directly attributable to
the Company’s individual underwriting operations. Underwriting income or
loss does not incorporate items included in the Company’s corporate
(non-underwriting) segment. While these measures are presented in the
Segment Information footnote to the Company’s Consolidated Financial
Statements, they are considered non-GAAP financial measures when
presented elsewhere on a consolidated basis. The reconciliations of
underwriting income or loss to income before income taxes (the most
directly comparable GAAP financial measure) on a consolidated basis and
a subtotal before the contribution from the ‘other’ segment, in
accordance with Regulation G, is shown on the following pages.

Management measures segment performance for its three underwriting
segments based on underwriting income or loss. The Company does not
manage its assets by underwriting segment and, accordingly, investment
income and other non-underwriting related items are not allocated to
each underwriting segment. As noted earlier, the ‘other’ segment
includes the results of Watford Re. Watford Re has its own management
and board of directors that is responsible for the overall profitability
of the ‘other’ segment. For the ‘other’ segment, performance is measured
based on net income or loss. The Company does not guarantee or provide
credit support for Watford Re, and the Company’s financial exposure to
Watford Re is limited to its investment in Watford Re’s common and
preferred shares and counterparty credit risk (mitigated by collateral)
arising from reinsurance transactions.

Along with consolidated underwriting income, the Company provides a
subtotal of underwriting income or loss before the contribution from the
‘other’ segment and believes that this presentation enables investors
and other users of the Company’s financial information to analyze the
Company’s underwriting performance in a manner similar to how the
Company’s management analyzes performance.

In addition, the Company’s segment information includes the use of a
combined ratio excluding catastrophic activity (if applicable for the
segment) and prior year development. These ratios are non-GAAP financial
measures as defined in Regulation G. The reconciliation of such measures
to the combined ratio (the most directly comparable GAAP financial
measure) in accordance with Regulation G are shown on the individual
segment pages. The Company’s management utilizes the adjusted combined
ratio excluding current accident year catastrophic events and favorable
or adverse development in prior year loss reserves in its analysis of
the underwriting performance of each of its underwriting segments.

Total return on investments includes investment income, equity in net
income or loss of investment funds accounted for using the equity
method, net realized gains and losses and the change in unrealized gains
and losses generated by Arch’s investment portfolio. Total return is
calculated on a pre-tax basis and before investment expenses, excludes
amounts reflected in the ‘other’ segment, and reflects the effect of
financial market conditions along with foreign currency fluctuations.
Management uses total return on investments as a key measure of the
return generated to Arch common shareholders on the capital held in its
business, and compares the return generated by the Company’s investment
portfolio against benchmark returns which it measures portfolio returns
against during the periods presented.

The following tables summarize the Company’s results by segment for the
2019 first quarter and 2018 first quarter and a reconciliation of
underwriting income or loss to income or loss before income taxes and
net income or loss available to Arch common shareholders:

Cautionary Note Regarding Forward-Looking Statements

The Private Securities Litigation Reform Act of 1995 (“PSLRA”) provides
a “safe harbor” for forward-looking statements. This release or any
other written or oral statements made by or on behalf of the Company may
include forward-looking statements, which reflect the Company’s current
views with respect to future events and financial performance. All
statements other than statements of historical fact included in or
incorporated by reference in this release are forward-looking
statements. Forward-looking statements, for purposes of the PSLRA or
otherwise, can generally be identified by the use of forward-looking
terminology such as “may,” “will,” “expect,” “intend,” “estimate,”
“anticipate,” “believe” or “continue” and similar statements of a future
or forward-looking nature or their negative or variations or similar
terminology.

Forward-looking statements involve the Company’s current assessment of
risks and uncertainties. Actual events and results may differ materially
from those expressed or implied in these statements. Important factors
that could cause actual events or results to differ materially from
those indicated in such statements are discussed below and elsewhere in
this release and in the Company’s periodic reports filed with the
Securities and Exchange Commission (the “SEC”), and include:

• the Company’s ability to successfully implement its business strategy
  during “soft” as well as “hard” markets;
• acceptance of the Company’s business strategy, security and financial
  condition by rating agencies and regulators, as well as by brokers and
  its insureds and reinsureds;
• the integration of any businesses the Company has acquired or may
  acquire into its existing operations;
• the Company’s ability to maintain or improve its ratings, which may be
  affected by its ability to raise additional equity or debt financings,
  by ratings agencies’ existing or new policies and practices, as well
  as other factors described herein;
• general economic and market conditions (including inflation, interest
  rates, unemployment, housing prices, foreign currency exchange rates,
  prevailing credit terms and the depth and duration of a recession) and
  conditions specific to the reinsurance and insurance markets
  (including the length and magnitude of the current “soft” market) in
  which the Company operates;
• competition, including increased competition, on the basis of pricing,
  capacity (including alternative sources of capital), coverage terms or
  other factors;
• developments in the world’s financial and capital markets and the
  Company’s access to such markets;
• the Company’s ability to successfully enhance, integrate and maintain
  operating procedures (including information technology) to effectively
  support its current and new business;
• the loss of key personnel;
• accuracy of those estimates and judgments utilized in the preparation
  of the Company’s financial statements, including those related to
  revenue recognition, insurance and other reserves, reinsurance
  recoverables, investment valuations, intangible assets, bad debts,
  income taxes, contingencies and litigation, and any determination to
  use the deposit method of accounting, which for a relatively new
  insurance and reinsurance company, like the Company, are even more
  difficult to make than those made in a mature company since relatively
  limited historical information has been reported to the Company
  through March 31, 2019;
• greater than expected loss ratios on business written by the Company
  and adverse development on claim and/or claim expense liabilities
  related to business written by its insurance and reinsurance
  subsidiaries;
• severity and/or frequency of losses;
• claims resulting from natural or man-made catastrophic events or
  severe economic events in the Company’s insurance, reinsurance and
  mortgage businesses could cause large losses and substantial
  volatility in the Company’s results of operations;
• the effect of climate change on the Company’s business;
• acts of terrorism, political unrest and other hostilities or other
  unforecasted and unpredictable events;
• availability to the Company of reinsurance to manage its gross and net
  exposures and the cost of such reinsurance;
• the failure of reinsurers, managing general agents, third party
  administrators or others to meet their obligations to the Company;
• the timing of loss payments being faster or the receipt of reinsurance
  recoverables being slower than anticipated by the Company;
• the Company’s investment performance, including legislative or
  regulatory developments that may adversely affect the fair value of
  the Company’s investments;
• changes in general economic conditions, including new or continued
  sovereign debt concerns in Eurozone countries or downgrades of U.S.
  securities by credit rating agencies, which could affect the Company’s
  business, financial condition and results of operations;
• the volatility of the Company’s shareholders’ equity from foreign
  currency fluctuations, which could increase due to us not matching
  portions of the Company’s projected liabilities in foreign currencies
  with investments in the same currencies;
• changes in accounting principles or policies or in the Company’s
  application of such accounting principles or policies;
• changes in the political environment of certain countries in which the
  Company operates, underwrites business or invests;
• a disruption caused by cyber-attacks or other technology breaches or
  failures on the Company or the Company’s business partners and service
  providers, which could negatively impact the Company’s business and/or
  expose the Company to litigation;
• statutory or regulatory developments, including as to tax policy
  matters and insurance and other regulatory matters such as the
  adoption of proposed legislation that would affect
  Bermuda-headquartered companies and/or Bermuda-based insurers or
  reinsurers and/or changes in regulations or tax laws applicable to the
  Company, its subsidiaries, brokers or customers, including the Tax
  Cuts and Jobs Act of 2017; and
• the other matters set forth under Item 1A “Risk Factors”, Item 7
  “Management’s Discussion and Analysis of Financial Condition and
  Results of Operations” and other sections of the Company’s Annual
  Report on Form 10-K, as well as the other factors set forth in the
  Company’s other documents on file with the SEC, and management’s
  response to any of the aforementioned factors.

All subsequent written and oral forward-looking statements attributable
to the Company or persons acting on its behalf are expressly qualified
in their entirety by these cautionary statements. The foregoing review
of important factors should not be construed as exhaustive and should be
read in conjunction with other cautionary statements that are included
herein or elsewhere. The Company undertakes no obligation to publicly
update or revise any forward-looking statement, whether as a result of
new information, future events or otherwise.