10-Q 1 acgl10q93014.htm 10-Q ACGL 10Q 9.30.14
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549
 
FORM 10-Q
 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
For the period ended September 30, 2014
 
Or
 
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
Commission file number:  001-26456
 
ARCH CAPITAL GROUP LTD.
(Exact name of registrant as specified in its charter)
 
Bermuda
(State or other jurisdiction of incorporation or organization)
 
Not Applicable
(I.R.S. Employer Identification No.)
 
Waterloo House, Ground Floor
100 Pitts Bay Road
Pembroke HM 08, Bermuda
(Address of principal executive offices)
 
(441) 278-9250
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x     No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x     No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer x
 
Accelerated filer o
 
 
 
Non-accelerated filer o
 
Smaller reporting company o
 
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o   No x
 
The number of the registrant’s common shares (par value, $0.0033 per share) outstanding as of October 31, 2014 was 129,110,352.



ARCH CAPITAL GROUP LTD.
 
INDEX
 
 
 
Page No.
PART I. Financial Information
 
 
 
 
 
Item 1 — Consolidated Financial Statements
 
 
 
 
 
 
 
 
 
 
 
September 30, 2014 (unaudited) and December 31, 2013
 
 
 
 
 
 
For the three and nine month periods ended September 30, 2014 and 2013 (unaudited)
 
 
 
 
 
 
For the three and nine month periods ended September 30, 2014 and 2013 (unaudited)
 
 
 
 
 
 
For the nine month periods ended September 30, 2014 and 2013 (unaudited)
 
 
 
 
 
 
For the nine month periods ended September 30, 2014 and 2013 (unaudited)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

1


Report of Independent Registered Public Accounting Firm
 
To the Board of Directors and Shareholders of
Arch Capital Group Ltd.:
 
We have reviewed the accompanying condensed consolidated balance sheet of Arch Capital Group Ltd. and its subsidiaries (the “Company”) as of September 30, 2014, and the related condensed consolidated statements of income and comprehensive income for the three-month and nine-month periods ended September 30, 2014 and September 30, 2013, and the condensed consolidated statements of changes in shareholders’ equity and cash flows for the nine-month periods ended September 30, 2014 and September 30, 2013. These interim financial statements are the responsibility of the Company’s management.
 
We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States).  A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters.  It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole.  Accordingly, we do not express such an opinion.
 
Based on our review, we are not aware of any material modifications that should be made to the accompanying condensed consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.
 
We previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet as of December 31, 2013, and the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for the year then ended (not presented herein), and in our report dated March 3, 2014, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet information as of December 31, 2013, is fairly stated in all material respects in relation to the consolidated balance sheet from which it has been derived.
 
/s/ PricewaterhouseCoopers LLP
 
New York, New York
November 7, 2014

2


ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(U.S. dollars in thousands, except share data)
 
(Unaudited)
 
 
 
September 30,
2014
 
December 31,
2013
Assets
 

 
 

Investments:
 

 
 

Fixed maturities available for sale, at fair value (amortized cost: $10,699,615 and $9,564,634)
$
10,733,382

 
$
9,571,776

Short-term investments available for sale, at fair value (amortized cost: $754,641 and $1,477,584)
748,659

 
1,478,367

Investment of funds received under securities lending, at fair value (amortized cost: $100,680 and $97,943)
104,252

 
100,584

Equity securities available for sale, at fair value (cost: $513,196 and $433,275)
582,075

 
496,824

Other investments available for sale, at fair value (cost: $398,719 and $488,687)
431,833

 
498,310

Investments accounted for using the fair value option
2,202,995

 
1,221,534

Investments accounted for using the equity method
307,252

 
244,339

Total investments
15,110,448

 
13,611,734

 
 
 
 
Cash
663,726

 
434,057

Accrued investment income
65,042

 
66,848

Investment in joint venture (cost: $100,000)
97,313

 
104,856

Fixed maturities and short-term investments pledged under securities lending, at fair value
107,547

 
105,081

Premiums receivable
1,027,204

 
753,924

Reinsurance recoverable on unpaid and paid losses and loss adjustment expenses
1,814,190

 
1,804,330

Contractholder receivables
1,286,799

 
1,064,246

Prepaid reinsurance premiums
404,661

 
328,343

Deferred acquisition costs, net
409,174

 
342,314

Receivable for securities sold
672,259

 
50,555

Goodwill and intangible assets
111,528

 
27,319

Other assets
840,794

 
872,487

Total assets
$
22,610,685

 
$
19,566,094

 
 
 
 
Liabilities
 
 
 
Reserve for losses and loss adjustment expenses
$
8,958,734

 
$
8,824,696

Unearned premiums
2,303,247

 
1,896,365

Reinsurance balances payable
244,379

 
196,167

Contractholder payables
1,286,799

 
1,064,246

Deposit accounting liabilities
349,850

 
421,297

Senior notes
800,000

 
800,000

Revolving credit agreement borrowings
100,000

 
100,000

Securities lending payable
110,736

 
107,999

Payable for securities purchased
740,953

 
51,318

Other liabilities
633,502

 
456,510

Total liabilities
15,528,200

 
13,918,598

 
 
 
 
Commitments and Contingencies


 


Redeemable noncontrolling interests (1)
219,419

 

 
 
 
 
Shareholders' Equity
 
 
 
Non-cumulative preferred shares
325,000

 
325,000

Common shares ($0.0033 par, shares issued: 171,380,760 and 169,560,591)
571

 
565

Additional paid-in capital
366,408

 
299,517

Retained earnings
6,644,892

 
6,042,154

Accumulated other comprehensive income, net of deferred income tax
102,186

 
74,964

Common shares held in treasury, at cost (shares: 40,680,141 and 35,885,707)
(1,358,011
)
 
(1,094,704
)
Total shareholders' equity available to Arch
6,081,046

 
5,647,496

Non-redeemable noncontrolling interests (1)
782,020

 

Total shareholders' equity
6,863,066

 
5,647,496

Total liabilities, noncontrolling interests and shareholders' equity
$
22,610,685

 
$
19,566,094


(1)     See Note 4.

See Notes to Consolidated Financial Statements

3


ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(U.S. dollars in thousands, except share data)
 
(Unaudited)
 
(Unaudited)
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Revenues
 

 
 

 
 

 
 

Net premiums written
$
959,539

 
$
839,135

 
$
2,996,457

 
$
2,602,446

Change in unearned premiums
(55,888
)
 
(44,135
)
 
(325,874
)
 
(295,860
)
Net premiums earned
903,651

 
795,000

 
2,670,583

 
2,306,586

Net investment income
80,105

 
66,083

 
220,089

 
200,124

Net realized gains (losses)
18,515

 
(6,022
)
 
92,356

 
64,970

Other-than-temporary impairment losses
(8,593
)
 
(901
)
 
(26,313
)
 
(3,873
)
Less investment impairments recognized in other comprehensive income, before taxes

 
173

 

 
175

Net impairment losses recognized in earnings
(8,593
)
 
(728
)
 
(26,313
)
 
(3,698
)
 
 
 
 
 
 
 
 
Other underwriting income
1,702

 
526

 
5,317

 
1,966

Equity in net income of investment funds accounted for using the equity method
4,966

 
5,665

 
17,459

 
30,429

Other income (loss)
(7,815
)
 
624

 
(5,069
)
 
2,702

Total revenues
992,531

 
861,148

 
2,974,422

 
2,603,079

 
 
 
 
 
 
 
 
Expenses
 
 
 
 
 
 
 
Losses and loss adjustment expenses
501,673

 
427,045

 
1,423,431

 
1,245,101

Acquisition expenses
163,547

 
147,313

 
482,047

 
406,582

Other operating expenses
149,480

 
118,070

 
451,629

 
365,661

Interest expense
4,152

 
5,937

 
32,890

 
17,687

Net foreign exchange (gains) losses
(56,031
)
 
40,562

 
(47,174
)
 
2,487

Total expenses
762,821

 
738,927

 
2,342,823

 
2,037,518

 
 
 
 
 
 
 
 
Income before income taxes
229,710

 
122,221

 
631,599

 
565,561

Income tax expense
(6,446
)
 
(7,396
)
 
(17,473
)
 
(17,320
)
Net income
$
223,264

 
$
114,825

 
$
614,126

 
$
548,241

Amounts attributable to noncontrolling interests (1)
5,411

 

 
5,065

 

Net income available to Arch
228,675

 
114,825

 
619,191

 
548,241

Preferred dividends
(5,484
)
 
(5,484
)
 
(16,453
)
 
(16,453
)
Net income available to Arch common shareholders
$
223,191

 
$
109,341

 
$
602,738

 
$
531,788

 
 
 
 
 
 
 
 
Net income per common share
 

 
 

 
 

 
 

Basic
$
1.69

 
$
0.83

 
$
4.56

 
$
4.05

Diluted
$
1.64

 
$
0.80

 
$
4.42

 
$
3.92

 
 
 
 
 
 
 
 
Weighted average common shares and common share equivalents outstanding
 

 
 

 
 

 
 

Basic
131,945,962

 
131,495,296

 
132,151,824

 
131,262,309

Diluted
135,876,605

 
136,034,413

 
136,354,172

 
135,680,829


(1)     See Note 4.


See Notes to Consolidated Financial Statements

4


ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(U.S. dollars in thousands)
 
(Unaudited)
 
(Unaudited)
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Comprehensive Income
 
 
 
 
 

 
 

Net income
$
223,264

 
$
114,825

 
$
614,126

 
$
548,241

Other comprehensive income (loss), net of deferred income tax
 
 
 
 
 
 
 
Unrealized appreciation (decline) in value of available-for-sale investments:
 
 
 
 
 
 
 
Unrealized holding gains (losses) arising during period
(90,619
)
 
41,226

 
89,162

 
(208,865
)
Portion of other-than-temporary impairment losses recognized in other comprehensive income, net of deferred income tax

 
(173
)
 

 
(175
)
Reclassification of net realized (gains) losses, net of income taxes, included in net income
(17,483
)
 
20,701

 
(47,017
)
 
(31,916
)
Foreign currency translation adjustments
(23,595
)
 
29,523

 
(14,923
)
 
(4,106
)
Comprehensive income
91,567

 
206,102

 
641,348

 
303,179

Amounts attributable to noncontrolling interests (1)
5,411

 

 
5,065

 

Comprehensive income available to Arch
$
96,978

 
$
206,102

 
$
646,413

 
$
303,179


(1)     See Note 4.


See Notes to Consolidated Financial Statements

5


ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(U.S. dollars in thousands)
 
(Unaudited)
 
Nine Months Ended
 
September 30,
 
2014
 
2013
Non-cumulative preferred shares
 

 
 

Balance at beginning and end of period
$
325,000

 
$
325,000

 
 
 
 
Common shares
 
 
 
Balance at beginning of year
565

 
561

Common shares issued, net
6

 
4

Balance at end of period
571

 
565

 
 
 
 
Additional paid-in capital
 

 
 

Balance at beginning of year
299,517

 
227,778

Common shares issued, net
6,401

 
5,583

Exercise of stock options
14,891

 
7,438

Amortization of share-based compensation
45,118

 
40,305

Other
481

 
2,345

Balance at end of period
366,408

 
283,449

 
 
 
 
Retained earnings
 

 
 

Balance at beginning of year
6,042,154

 
5,354,361

Net income
614,126

 
548,241

Amounts attributable to noncontrolling interests (1)
5,065

 

Preferred share dividends
(16,453
)
 
(16,453
)
Balance at end of period
6,644,892

 
5,886,149

 
 
 
 
Accumulated other comprehensive income
 
 
 
Balance at beginning of year
74,964

 
287,017

Unrealized appreciation in value of available-for-sale investments, net of deferred income tax:
 
 
 
Balance at beginning of year
80,692

 
289,956

Unrealized holding gains (losses) arising during period, net of reclassification adjustment
42,145

 
(240,781
)
Portion of other-than-temporary impairment losses recognized in other comprehensive income, net of deferred income tax

 
(175
)
Balance at end of period
122,837

 
49,000

Foreign currency translation adjustments:
 
 
 
Balance at beginning of year
(5,728
)
 
(2,939
)
Foreign currency translation adjustments
(14,923
)
 
(4,106
)
Balance at end of period
(20,651
)
 
(7,045
)
Balance at end of period
102,186

 
41,955

 
 
 
 
Common shares held in treasury, at cost
 
 
 
Balance at beginning of year
(1,094,704
)
 
(1,025,839
)
Shares repurchased for treasury
(263,307
)
 
(67,994
)
Balance at end of period
(1,358,011
)
 
(1,093,833
)
 
 
 
 
Total shareholders’ equity available to Arch
6,081,046

 
5,443,285

Non-redeemable noncontrolling interests (1)
782,020

 

Total shareholders’ equity
$
6,863,066

 
$
5,443,285


(1)     See Note 4.

 

See Notes to Consolidated Financial Statements

6


ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(U.S. dollars in thousands)
 
(Unaudited)
 
Nine Months Ended
 
September 30,
 
2014
 
2013
Operating Activities
 

 
 

Net income
$
614,126

 
$
548,241

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Net realized gains
(113,033
)
 
(66,957
)
Net impairment losses recognized in earnings
26,313

 
3,698

Equity in net income or loss of investment funds accounted for using the equity method and other income or loss
3,784

 
35,634

Share-based compensation
45,118

 
40,305

Changes in:
 
 
 
Reserve for losses and loss adjustment expenses, net of unpaid losses and loss adjustment expenses recoverable
94,255

 
(24,305
)
Unearned premiums, net of prepaid reinsurance premiums
325,874

 
295,860

Premiums receivable
(279,766
)
 
(160,091
)
Deferred acquisition costs, net
(72,120
)
 
(73,793
)
Reinsurance balances payable
49,621

 
2,573

Other liabilities
117,889

 
(15,893
)
Other items
(12,402
)
 
41,776

Net Cash Provided By Operating Activities
799,659

 
627,048

 
 
 
 
Investing Activities
 

 
 

Purchases of:
 

 
 

Fixed maturity investments
(22,030,862
)
 
(12,436,587
)
Equity securities
(366,578
)
 
(438,255
)
Other investments
(1,596,691
)
 
(992,935
)
Proceeds from the sales of:
 
 
 
Fixed maturity investments
20,284,869

 
11,877,419

Equity securities
305,034

 
373,000

Other investments
1,030,901

 
813,596

Proceeds from redemptions and maturities of fixed maturity investments
636,729

 
595,503

Net sales (purchases) of short-term investments
678,388

 
(268,968
)
Change in investment of securities lending collateral
(2,737
)
 
2,508

Purchase of business, net of cash acquired (1)
(235,578
)
 

Purchases of furniture, equipment and other assets
(14,575
)
 
(10,953
)
Net Cash Used For Investing Activities
(1,311,100
)
 
(485,672
)
 
 
 
 
Financing Activities
 

 
 

Purchases of common shares under share repurchase program
(251,919
)
 
(57,796
)
Proceeds from common shares issued, net
3,248

 
(425
)
Change in securities lending collateral
2,737

 
(2,508
)
Third party investment in non-redeemable noncontrolling interests (2)
796,903

 

Third party investment in redeemable noncontrolling interests (2)
219,233

 

Dividends paid to redeemable noncontrolling interests (2)
(9,632
)
 

Other
6,559

 
5,679

Preferred dividends paid
(16,453
)
 
(16,453
)
Net Cash Provided By (Used For) Financing Activities
750,676

 
(71,503
)
 
 
 
 
Effects of exchange rate changes on foreign currency cash
(9,566
)
 
(4,773
)
 
 
 
 
Increase in cash
229,669

 
65,100

Cash beginning of year
434,057

 
371,041

Cash end of period
$
663,726

 
$
436,141


(1)     See Note 2.
(2)     See Note 4.


See Notes to Consolidated Financial Statements

7

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)


1.    General

Arch Capital Group Ltd. (“ACGL”) is a Bermuda public limited liability company which provides insurance and reinsurance on a worldwide basis through its subsidiaries (together with ACGL, the “Company”).

On January 30, 2014, the Company acquired CMG Mortgage Insurance Company and its affiliated mortgage insurance companies (together, “CMG Entities”) and the mortgage insurance platform and related assets from PMI Mortgage Insurance Co. (“PMI”) (see Note 2).

On March 20, 2014, the Company acquired approximately 11% of Watford Holdings Ltd.’s common equity and a warrant to purchase additional common equity for $100 million. Watford Holdings Ltd. is the parent of Watford Re Ltd., a newly-formed multi-line Bermuda reinsurance company (together with Watford Holdings Ltd., “Watford”). Watford is considered a variable interest entity (“VIE”) and the Company concluded that it is the primary beneficiary of Watford. As such, the results of Watford are included in the Company’s consolidated financial statements (see Note 4).

The interim consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”) and include the accounts of the Company and Watford. All significant intercompany transactions and balances have been eliminated in consolidation. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates and assumptions. In the opinion of management, the accompanying unaudited interim consolidated financial statements reflect all adjustments (consisting of normally recurring accruals) necessary for a fair statement of results on an interim basis. The results of any interim period are not necessarily indicative of the results for a full year or any future periods.
 
Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted; however, management believes that the disclosures are adequate to make the information presented not misleading. This report should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2013 (“2013 Form 10-K”), including the Company’s audited consolidated financial statements and related notes.
 
The Company has reclassified the presentation of certain prior year information to conform to the current presentation. Such reclassifications had no effect on the Company’s net income, comprehensive income, shareholders’ equity or cash flows. Tabular amounts are in U.S. Dollars in thousands, except share amounts, unless otherwise noted.
 
2.    Business Acquired

On January 30, 2014, the Company’s U.S.-based subsidiaries completed the acquisition of the CMG Entities through a stock purchase agreement (“SPA”) from its previous owners, PMI, which has been in rehabilitation under the receivership of the Arizona Department of Insurance since 2011, and CMFG Life Insurance Company (“CUNA Mutual”). In addition, the Company entered into a distribution agreement with CUNA Mutual and a reinsurance agreement with an affiliate of CUNA Mutual. CMG Mortgage Insurance Company has been renamed “Arch Mortgage Insurance Company” (“Arch MI U.S.”). As part of the transaction, Arch MI U.S. obtained approval as an eligible mortgage insurer from Federal National Mortgage Association and Federal Home Loan Mortgage Corporation (each a government sponsored enterprise or “GSE”), subject to maintaining certain ongoing requirements.

In addition, through an asset purchase agreement (“APA”) with PMI, the Company acquired the mortgage insurance operating platform of PMI, 100% of the capital stock of PMI Mortgage Assurance Co., a mortgage insurance company licensed in all 50 states (renamed Arch Mortgage Guaranty Company), and entered into a quota share reinsurance agreement pursuant to which Arch Reinsurance Ltd. agreed to provide 100% quota share indemnity reinsurance to PMI for all certificates of insurance that were issued by PMI between and including January 1, 2009 and December 31, 2011 that were not in default as of an agreed upon effective date. Other than this quota share, no PMI legacy exposures were assumed in the transaction. As part of the transaction, the Company entered into a services agreement with PMI to provide certain necessary operational services to administer the run-off of PMI’s legacy business at the direction of PMI. Arch MI U.S. also entered into a quota share

8

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

reinsurance agreement whereby it will cede 20% of all new primary flow mortgage insurance business post-closing (both credit union and non-credit union business) on the first $25 billion in original loan amounts to PMI, on a funds-withheld basis.

The completion of the SPA and APA transactions enabled the Company to enter the U.S. mortgage insurance marketplace and serve all lenders nationwide. The arrangements with CUNA Mutual also provided a seamless transition and enabled the Company to provide uninterrupted access and services to the credit union marketplace.

At closing, the Company paid aggregate consideration of $160.6 million (80% of the actual closing date book value of the CMG Entities) under the SPA and $84.6 million under the APA. Additionally, the SPA contains provisions for contingent consideration payments, subject to an overall maximum payment of 150% of closing book value of the pre-closing portfolio of the CMG Entities as re-calculated over an earn-out period and payable at the third, fifth and sixth anniversaries after closing (subject to a one time extension period of one to three years at the sellers’ discretion). The maximum amount of contingent consideration payments is $136.9 million. To the extent that the adjusted book value of the CMG Entities drops below the cumulative amount paid by the Company, no additional payments would be due. To determine the fair value of the contingent consideration liability, the Company estimated future payments using a weighted average cost of capital approach at a rate of return of 15% which reflects the industry-weighted average rate of return on debt and equity as required by market participants. The fair value of the contingent consideration liability was $41.8 million at closing. The contingent consideration liability, which is included in ‘other liabilities’ in the consolidated balance sheets, is remeasured at fair value at each balance sheet date ($58.7 million at September 30, 2014) until the contingency is resolved with changes in fair value recognized in ‘net realized gains (losses).’

The following table summarizes the fair value of net assets acquired and allocation of purchase price, measured as of the acquisition date:
 
 
Total
 
Useful Life
Purchase price
 
 
 
 
Cash paid
 
$
245,157

 
 
Contingent consideration liability
 
41,762

 
 
Total purchase price (a)
 
$
286,919

 
 
 
 
 
 
 
Assets acquired
 
 
 
 
Cash
 
$
9,579

 
 
Investments, at fair value
 
312,093

 
 
Intangible asset -- acquired insurance contracts
 
46,473

 
5 years
Intangible asset -- operating platform
 
29,900

 
5 years
Intangible asset -- favorable lease contract
 
1,056

 
5 years
Intangible asset -- insurance licenses
 
16,858

 
Indefinite
Other assets acquired
 
21,691

 
 
Total assets acquired
 
437,650

 
 
 
 
 
 
 
Liabilities acquired
 
 
 
 
Reserves for losses and loss adjustment expenses
 
$
121,572

 
 
Unearned premiums
 
26,261

 
 
Intangible liability -- unfavorable service contract
 
9,533

 
9 years
Other liabilities acquired
 
7,217

 
 
Total liabilities acquired
 
164,583

 
 
Net assets acquired (b)
 
$
273,067

 
 
Goodwill (a)-(b)
 
$
13,852

 
 

From the acquisition date to September 30, 2014, the Company recorded amortization expense of $15.0 million related to net intangible assets acquired. The Company recognized goodwill of $13.9 million that is primarily attributed to PMI’s assembled workforce, access to the mortgage insurance market and additional synergies to be realized in the future. Under U.S. tax principles, which differentiate between taxable and non-taxable business combinations, the Company estimates that $48.0 million of goodwill is expected to be deductible for tax purposes.

The Company includes the operations of Arch MI U.S. in its mortgage segment (see Note 6).


9

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

3.    Significant Accounting Policies

As discussed in Note 2, the Company completed its acquisition of the CMG Entities on January 30, 2014. As such, the Company has added relevant sections pertaining to mortgage insurance to its significant accounting policies as described in Note 2, “Significant Accounting Policies,” of its audited consolidated financial statements and related notes of the 2013 Form 10-K.

(b) Premium Revenues and Related Expenses

Insurance. Insurance premiums written are generally recorded at the policy inception and are primarily earned on a pro rata basis over the terms of the policies for all products, usually 12 months. Premiums written include estimates in the Company’s programs, specialty lines, lenders products business and for participation in involuntary pools. Such premium estimates are derived from multiple sources which include the historical experience of the underlying business, similar business and available industry information. Unearned premium reserves represent the portion of premiums written that relates to the unexpired terms of in-force insurance policies.

Reinsurance. Reinsurance premiums written include amounts reported by brokers and ceding companies, supplemented by the Company’s own estimates of premiums where reports have not been received. The determination of premium estimates requires a review of the Company’s experience with the ceding companies, familiarity with each market, the timing of the reported information, an analysis and understanding of the characteristics of each line of business, and management’s judgment of the impact of various factors, including premium or loss trends, on the volume of business written and ceded to the Company. On an ongoing basis, the Company’s underwriters review the amounts reported by these third parties for reasonableness based on their experience and knowledge of the subject class of business, taking into account the Company’s historical experience with the brokers or ceding companies. In addition, reinsurance contracts under which the Company assumes business generally contain specific provisions which allow the Company to perform audits of the ceding company to ensure compliance with the terms and conditions of the contract, including accurate and timely reporting of information. Based on a review of all available information, management establishes premium estimates where reports have not been received. Premium estimates are updated when new information is received and differences between such estimates and actual amounts are recorded in the period in which estimates are changed or the actual amounts are determined.

Reinsurance premiums written are recorded based on the type of contracts the Company writes. Premiums on the Company’s excess of loss and pro rata reinsurance contracts are estimated when the business is underwritten. For excess of loss contracts, premiums are recorded as written based on the terms of the contract. Estimates of premiums written under pro rata contracts are recorded in the period in which the underlying risks are expected to incept and are based on information provided by the brokers and the ceding companies. For multi-year reinsurance treaties which are payable in annual installments, generally, only the initial annual installment is included as premiums written at policy inception due to the ability of the reinsured to commute or cancel coverage during the term of the policy. The remaining annual installments are included as premiums written at each successive anniversary date within the multi-year term.

Reinstatement premiums for the Company’s insurance and reinsurance operations are recognized at the time a loss event occurs, where coverage limits for the remaining life of the contract are reinstated under pre-defined contract terms. Reinstatement premiums, if obligatory, are fully earned when recognized. The accrual of reinstatement premiums is based on an estimate of losses and loss adjustment expenses, which reflects management’s judgment. Premium estimates are reviewed by management at least quarterly. Such review includes a comparison of actual reported premiums to expected ultimate premiums along with a review of the aging and collection of premium estimates. Based on management’s review, the appropriateness of the premium estimates is evaluated, and any adjustment to these estimates is recorded in the period in which it becomes known. Adjustments to premium estimates could be material and such adjustments could directly and significantly impact earnings favorably or unfavorably in the period they are determined because the estimated premium may be fully or substantially earned. A significant portion of amounts included as premiums receivable, which represent estimated premiums written, net of commissions, are not currently due based on the terms of the underlying contracts.

Reinsurance premiums written, irrespective of the class of business, are generally earned on a pro rata basis over the terms of the underlying policies or reinsurance contracts. Contracts and policies written on a “losses occurring” basis cover claims that may occur during the term of the contract or policy, which is typically 12 months. Accordingly, the premium is earned evenly over the term. Contracts which are written on a “risks attaching” basis cover claims which attach to the underlying insurance policies written during the terms of such contracts. Premiums earned on such contracts usually extend beyond the original term of the reinsurance contract, typically resulting in recognition of premiums earned over a 24-month period. Certain

10

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

of the Company’s reinsurance contracts include provisions that adjust premiums or acquisition expenses based upon the experience under the contracts. Premiums written and earned, as well as related acquisition expenses, are recorded based upon the projected experience under such contracts.

The Company also writes certain reinsurance business that is intended to provide insurers with risk management solutions that complement traditional reinsurance. Under these contracts, the Company assumes a measured amount of insurance risk in exchange for an anticipated margin, which is typically lower than on traditional reinsurance contracts. The terms and conditions of these contracts may include additional or return premiums based on loss experience, loss corridors, sublimits and caps. Examples of such business include aggregate stop-loss coverages, financial quota share coverages and multi- year retrospectively rated excess of loss coverages. If these contracts are deemed to transfer risk, they are accounted for as reinsurance.

Mortgage. Mortgage guaranty insurance policies are contracts that are generally non-cancelable by the insurer, are renewable at a fixed price, and provide for payment of premiums on a monthly, annual or single basis. Upon renewal, the Company is not able to re-underwrite or re-price its policies. Consistent with industry accounting practices, premiums written on a monthly basis are earned as coverage is provided. Premiums written on an annual basis are amortized on a monthly pro rata basis over the year of coverage. Primary mortgage insurance premiums written on policies covering more than one year are referred to as single premiums. A portion of the revenue from single premiums is recognized in premiums earned in the current period, and the remaining portion is deferred as unearned premiums and earned over the estimated expiration of risk of the policy. If single premium policies related to insured loans are canceled due to repayment by the borrower and the policy is a non-refundable product, the remaining unearned premium related to each canceled policy is recognized as earned premium upon notification of the cancellation.

Unearned premiums represent the portion of premiums written that is applicable to the estimated unexpired risk of insured loans. A portion of premium payments may be refundable if the insured cancels coverage, which generally occurs when the loan is repaid, the loan amortizes to a sufficiently low amount to trigger a lender permitted or legally required cancellation, or the value of the property has increased sufficiently in accordance with the terms of the contract. Premium refunds reduce premiums earned in the consolidated statements of operations.

Acquisition Costs. Acquisition expenses and other expenses related to the Company’s underwriting operations that vary with, and are directly related to, the successful acquisition or renewal of business are deferred and amortized based on the type of contract. For property and casualty insurance and reinsurance contracts, deferred acquisition costs are amortized over the period in which the related premiums are earned. Consistent with mortgage insurance industry accounting practice, amortization of acquisition costs related to the mortgage insurance contracts for each underwriting year’s book of business is charged against revenue in proportion to estimated gross profits. Estimated gross profits are comprised of earned premiums and losses and loss adjustment expenses. For each underwriting year, the Company estimates the rate of amortization to reflect actual experience and any changes to persistency or loss development.

Acquisition expenses, net of ceding commissions received from reinsurers, consist principally of commissions and premium taxes paid to obtain the Company’s business. Other operating expenses also include expenses that vary with, and are directly related to, the acquisition of business. Deferred acquisition costs are carried at their estimated realizable value and take into account anticipated losses and loss adjustment expenses, based on historical and current experience, and anticipated investment income. A premium deficiency occurs if the sum of anticipated losses and loss adjustment expenses, unamortized acquisition costs and maintenance costs exceed unearned premiums (including expected future premiums) and anticipated investment income. A premium deficiency is recorded by charging any unamortized acquisition costs to expense to the extent required in order to eliminate the deficiency. If the premium deficiency exceeds unamortized acquisition costs then a liability is accrued for the excess deficiency.


11

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(i) Reserves for Losses and Loss Adjustment Expenses

Insurance and Reinsurance. The reserve for losses and loss adjustment expenses consists of estimates of unpaid reported losses and loss adjustment expenses and estimates for losses incurred but not reported. The reserve for unpaid reported losses and loss adjustment expenses, established by management based on reports from ceding companies and claims from insureds, excludes estimates of amounts due from insureds related to losses under high deductible policies, and represents the estimated ultimate cost of events or conditions that have been reported to or specifically identified by the Company. Such reserves are supplemented by management’s estimates of reserves for losses incurred for which reports or claims have not been received. The Company’s reserves are based on a combination of reserving methods, incorporating both Company and industry loss development patterns. The Company selects the initial expected loss and loss adjustment expense ratios based on information derived by its underwriters and actuaries during the initial pricing of the business, supplemented by industry data where appropriate. Such ratios consider, among other things, rate changes and changes in terms and conditions that have been observed in the market. These estimates are reviewed regularly and, as experience develops and new information becomes known, the reserves are adjusted as necessary. Such adjustments, if any, are reflected in income in the period in which they are determined. As actual loss information has been reported, the Company has developed its own loss experience and its reserving methods include other actuarial techniques. Over time, such techniques have been given further weight in its reserving process based on the continuing maturation of the Company’s reserves. Inherent in the estimates of ultimate losses and loss adjustment expenses are expected trends in claims severity and frequency and other factors which may vary significantly as claims are settled. Accordingly, ultimate losses and loss adjustment expenses may differ materially from the amounts recorded in the accompanying consolidated financial statements. Losses and loss adjustment expenses are recorded on an undiscounted basis, except for excess workers’ compensation and employers’ liability business written by the Company’s insurance operations.

Mortgage. The reserves for mortgage guaranty insurance losses and loss adjustment expenses are the estimated claim settlement costs on notices of default that have been received by the Company, as well as loan defaults that have been incurred but have not been reported by the lenders. Consistent with industry accounting practice, the Company does not establish loss reserves for future claims on insured loans that are not currently in default (defined as two consecutive missed payments). The Company establishes loss reserves on a case-by-case basis when insured loans are identified as currently in default using estimated claim rates and average claim sizes for each report year, net of any salvage recoverable. The Company also reserves for defaults that have occurred but have not yet been reported to the Company prior to the close of an accounting period. To determine this reserve, the Company estimates the number of defaults not yet reported using historical information regarding late reported delinquencies and applies estimated claim rates and claim sizes for the estimated defaults not yet reported.

The establishment of reserves across the Company’s segments is an inherently uncertain process, are necessarily based on estimates, and the ultimate net cost may vary from such estimates. The methods for making such estimates and for establishing the resulting liability are reviewed and updated using the most current information available. Any resulting adjustments, which may be material, are reflected in current operations

(p) Recent Accounting Pronouncements

A new accounting standard issued in the 2014 second quarter will change the manner in which most companies recognize revenue. The standard requires that revenue reflect the transfer of goods or services to customers based on the consideration or payment the company expects to be entitled to in exchange for those goods or services; however, the standard does not change the accounting for insurance contracts or financial instruments. The new standard also requires enhanced disclosures about revenue. This accounting guidance is effective in the 2017 first quarter and may be applied on a full retrospective or modified retrospective approach. The Company is currently assessing the impact the implementation of this standard will have on its consolidated financial statements.

(q) Goodwill and Intangible Assets

Goodwill represents the excess of the purchase price of an acquisition over the fair value of the net assets acquired and is assigned to the applicable reporting unit at acquisition. Goodwill is not amortized and is evaluated for impairment on an annual basis. Impairment tests may be performed more frequently if the facts and circumstances indicate a possible impairment. In performing impairment tests, the Company may first assess qualitative factors to determine whether it is more likely than not (that is, more than a 50% probability) that the fair value of a reporting unit exceeds its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in the accounting guidance.


12

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Indefinite-lived intangible assets, such as insurance licenses, are not amortized and are evaluated for impairment similar to goodwill. Finite-lived intangible assets and liabilities include the value of insurance and reinsurance contracts, which are estimated based on the present value of future expected cash flows and amortized in ‘acquisition expenses’ in proportion to the estimated profits expected to be realized. Other finite-lived intangible assets or liabilities, including favorable or unfavorable contracts, are amortized in ‘other operating expenses’ over their useful lives. Finite-lived intangible assets and liabilities are periodically reviewed for indicators of impairment. An impairment is recognized when the carrying amount is not recoverable from its undiscounted cash flows and is measured as the difference between the carrying amount and fair value.

If goodwill or intangible assets are impaired, such assets are written down to their realizable values with the related expense recorded in the Company’s results of operations.

4.     Variable Interest Entity and Noncontrolling Interests

Variable interest entity

A VIE refers to an entity that has characteristics such as (i) insufficient equity at risk to allow the entity to finance its activities without additional financial support or (ii) instances where the equity investors, as a group, do not have characteristics of a controlling financial interest. The primary beneficiary of a VIE is defined as the variable interest holder that is determined to have the controlling financial interest as a result of having both (i) the power to direct the activities of a VIE that most significantly impact the economic performance of the VIE and (ii) the obligation to absorb losses or right to receive benefits from the VIE that could potentially be significant to the VIE. If a company is determined to be the primary beneficiary, it is required to consolidate the VIE in its financial statements.

In March 2014, Watford raised approximately $1.1 billion of capital consisting of $907.3 million in common equity ($895.6 million net of issuance costs) and $226.6 million in preference equity ($219.2 million net of issuance costs and discount). The Company invested $100.0 million and acquired approximately 11% of Watford Holdings Ltd.’s common equity and a warrant to purchase additional common equity. Arch Underwriters Ltd. (“AUL”), a subsidiary of the Company, acts as Watford’s reinsurance manager, and Highbridge Principal Strategies, LLC (“Highbridge”), a subsidiary of JPMorgan Chase & Co., manages Watford’s investment assets, each under separate long term services agreements. John Rathgeber, previously Vice Chairman of Arch Worldwide Reinsurance Group, was named CEO of Watford. In addition, Marc Grandisson, Chairman and CEO of Arch Worldwide Reinsurance and Mortgage Groups, and Nicolas Papadopoulo, CEO Reinsurance Group, were appointed to the board of directors of Watford.

The Company concluded that Watford is a VIE due to both the reinsurance management services agreement with AUL and the investment management agreement with Highbridge. Both of these agreements provide for services for an extended period of time with limited termination rights by Watford. In addition, these agreements allow for both AUL and Highbridge to participate in the favorable results of Watford in the form of performance fees. To determine if the Company is the primary beneficiary of Watford, the Company concluded that the most significant activity of Watford pertains to the insurance activities arising from the reinsurance management services agreement, as these activities will ultimately generate the investable assets required by Highbridge to execute the investment strategy. In addition, the Company factored into its analysis qualitative aspects of the relationship with Watford that are indicative of power to direct the insurance activities. These aspects coupled with the Company’s board seats and a former executive of the Company serving as Watford’s CEO resulted in the Company concluding that it is the primary beneficiary of Watford. As such, the results of Watford are included in the Company’s consolidated financial statements.

The Company concluded that Watford represents a separate operating segment and provides the income statement and total investable assets, total assets and total liabilities of Watford within Note 6. Because Watford is an independent company, the assets of Watford can be used only to settle obligations of Watford and Watford is solely responsible for its own liabilities and commitments. The Company’s financial exposure to Watford is limited to its investment in Watford’s common shares and counterparty credit risk (mitigated by collateral) arising from the reinsurance transactions.


13

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Non-redeemable noncontrolling interests

The Company accounts for the portion of Watford’s common equity attributable to third party investors in the shareholders’ equity section of its consolidated balance sheets. The noncontrolling ownership in Watford’s common shares was approximately 89% at September 30, 2014. The portion of Watford’s income or loss attributable to third party investors is recorded in the consolidated statements of income in ‘amounts attributable to noncontrolling interests.’ The following table sets forth activity in the non-redeemable noncontrolling interests:
 
Three Months Ended September 30, 2014
 
Nine Months Ended September 30, 2014
Balance, beginning of period
$
792,340

 
$

Sale of shares to noncontrolling interests

 
796,903

Amounts attributable to noncontrolling interests
(10,320
)
 
(14,883
)
Balance, end of period
$
782,020

 
$
782,020


Redeemable noncontrolling interests

The Company accounts for redeemable noncontrolling interests in the mezzanine section of its consolidated balance sheets in accordance with applicable accounting guidance. Such redeemable noncontrolling interests represent the 9,065,200 cumulative redeemable preference shares (“Watford Preference Shares”) issued in late March 2014 with a par value of $0.01 per share and a liquidation preference of $25.00 per share. The Watford Preference Shares were issued at a discounted amount of $24.50 per share. Holders of the Watford Preference Shares will be entitled to receive, if declared by Watford’s board, quarterly cash dividends on the last day of March, June, September, and December. Dividends will accrue from the closing date to June 30, 2019 at a fixed rate of 8.5% per annum. From June 30, 2019 and subsequent, dividends will accrue based on a floating rate equal to the 3 month U.S. dollar LIBOR (with a 1% floor) plus a margin based on the difference between the fixed rate and the 5 year mid swap rate to the floating rate as set out on the IRSB18. The Watford Preference Shares may be redeemed by Watford on or after June 30, 2019 or at the option of the preferred shareholders at any time on or after June 30, 2034. Because the redemption features are not solely within the control of Watford, the Company accounts for the redeemable noncontrolling interests in the Watford Preference Shares in the mezzanine section of its consolidated balance sheets. Third party investors own 100% of the Watford Preference Shares at September 30, 2014. Preferred dividends, including the accretion of the discount and issuance costs, are included in ‘amounts attributable to noncontrolling interests’ in the Company’s consolidated statements of income.


14

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

5.    Earnings Per Common Share
 
The following table sets forth the computation of basic and diluted earnings per common share:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
 
 
 
 
 
 
 
 
Numerator:
 

 
 

 
 

 
 

Net income
$
223,264

 
$
114,825

 
$
614,126

 
$
548,241

Amounts attributable to noncontrolling interests
5,411

 

 
5,065

 

Net income available to Arch
228,675

 
114,825

 
619,191

 
548,241

Preferred dividends
(5,484
)
 
(5,484
)
 
(16,453
)
 
(16,453
)
Net income available to Arch common shareholders
$
223,191

 
$
109,341

 
$
602,738

 
$
531,788

 
 
 
 
 
 
 
 
Denominator:
 

 
 

 
 

 
 

Weighted average common shares outstanding — basic
131,945,962

 
131,495,296

 
132,151,824

 
131,262,309

Effect of dilutive common share equivalents:
 
 
 
 
 
 
 
Nonvested restricted shares
1,156,790

 
1,124,644

 
1,134,481

 
1,094,327

Stock options (1)
2,773,853

 
3,414,473

 
3,067,867

 
3,324,193

Weighted average common shares and common share equivalents outstanding — diluted
135,876,605

 
136,034,413

 
136,354,172

 
135,680,829

 
 
 
 
 
 
 
 
Earnings per common share:
 

 
 

 
 

 
 

Basic
$
1.69

 
$
0.83

 
$
4.56

 
$
4.05

Diluted
$
1.64

 
$
0.80

 
$
4.42

 
$
3.92

_________________________________________________
(1)
Certain stock options were not included in the computation of diluted earnings per share where the exercise price of the stock options exceeded the average market price and would have been anti-dilutive or where, when applying the treasury stock method to in-the-money options, the sum of the proceeds, including unrecognized compensation, exceeded the average market price and would have been anti-dilutive. For the 2014 third quarter and 2013 third quarter, the number of stock options excluded were 1,355,087 and 387,249, respectively. For the nine months ended September 30, 2014 and 2013, the number of stock options excluded were 1,378,249 and 1,735,995, respectively.


15

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

6.    Segment Information
 
During the 2014 first quarter, to reflect activity during the period as described below, the Company changed its segment structure and added two new segments (mortgage and ‘other’). The Company now classifies its businesses into three underwriting segments — insurance, reinsurance and mortgage — and two other operating segments — ‘other’ and corporate (non-underwriting). The Company determined its reportable segments using the management approach described in accounting guidance regarding disclosures about segments of an enterprise and related information. The accounting policies of the segments are the same as those used for the preparation of the Company’s consolidated financial statements. Intersegment business is allocated to the segment accountable for the underwriting results.

The Company’s insurance, reinsurance and mortgage segments each have managers who are responsible for the overall profitability of their respective segments and who are directly accountable to the Company’s chief operating decision makers, the Chairman, President and Chief Executive Officer of ACGL and the Chief Financial Officer of ACGL. The chief operating decision makers do not assess performance, measure return on equity or make resource allocation decisions on a line of business basis. 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, with the exception of goodwill and intangible assets, and, accordingly, investment income is not allocated to each underwriting segment.

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

The ‘other’ segment includes the results of Watford (see Note 4). Watford 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.


16

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)


The following tables summarize the Company’s underwriting income or loss by segment, together with a reconciliation of underwriting income or loss to net income available to common shareholders:
 
Three Months Ended
 
September 30, 2014
 
Insurance
 
Reinsurance
 
Mortgage
 
Sub-Total
 
Other
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
Gross premiums written (1)
$
726,683

 
$
345,747

 
$
66,389

 
$
1,138,392

 
$
103,483

 
$
1,159,907

Premiums ceded
(187,689
)
 
(83,502
)
 
(7,904
)
 
(278,668
)
 
(3,668
)
 
(200,368
)
Net premiums written
538,994

 
262,245

 
58,485

 
859,724

 
99,815

 
959,539

Change in unearned premiums
(19,607
)
 
34,303

 
(5,539
)
 
9,157

 
(65,045
)
 
(55,888
)
Net premiums earned
519,387

 
296,548

 
52,946

 
868,881

 
34,770

 
903,651

Other underwriting income
499

 
215

 
988

 
1,702

 

 
1,702

Losses and loss adjustment expenses
(338,319
)
 
(123,784
)
 
(15,987
)
 
(478,090
)
 
(23,583
)
 
(501,673
)
Acquisition expenses, net
(81,775
)
 
(60,205
)
 
(11,958
)
 
(153,938
)
 
(9,609
)
 
(163,547
)
Other operating expenses
(83,138
)
 
(36,337
)
 
(17,913
)
 
(137,388
)
 
(1,658
)
 
(139,046
)
Underwriting income (loss)
$
16,654

 
$
76,437

 
$
8,076

 
101,167

 
(80
)
 
101,087

 
 
 
 
 
 
 
 
 
 
 
 
Net investment income
 
 
 
 
 
 
72,239

 
7,866

 
80,105

Net realized gains (losses)
 
 
 
 
 
 
31,411

 
(12,896
)
 
18,515

Net impairment losses recognized in earnings
 
 
 
 
 
 
(8,593
)
 

 
(8,593
)
Equity in net income of investment funds accounted for using the equity method
 
 
 
 
 
 
4,966

 

 
4,966

Other income (loss)
 
 
 
 
 
 
(7,815
)
 

 
(7,815
)
Other expenses
 
 
 
 
 
 
(10,434
)
 

 
(10,434
)
Interest expense
 
 
 
 
 
 
(4,152
)
 

 
(4,152
)
Net foreign exchange gains (losses)
 
 
 
 
 
 
57,611

 
(1,580
)
 
56,031

Income before income taxes
 
 
 
 
 
 
236,400

 
(6,690
)
 
229,710

Income tax expense
 
 
 
 
 
 
(6,446
)
 

 
(6,446
)
Net income
 
 
 
 
 
 
229,954

 
(6,690
)
 
223,264

Dividends attributable to redeemable noncontrolling interests
 
 
 
 
 
 

 
(4,909
)
 
(4,909
)
Amounts attributable to noncontrolling interests
 
 
 
 
 
 

 
10,320

 
10,320

Net income available to Arch
 
 
 
 
 
 
229,954

 
(1,279
)
 
228,675

Preferred dividends
 
 
 
 
 
 
(5,484
)
 

 
(5,484
)
Net income available to Arch common shareholders
 
 
 
 
 
 
$
224,470

 
$
(1,279
)
 
$
223,191

 
 
 
 
 
 
 
 
 
 
 
 
Underwriting Ratios
 

 
 

 
 

 
 
 
 

 
 

Loss ratio
65.1
%
 
41.7
%
 
30.2
%
 
55.0
%
 
67.8
%
 
55.5
%
Acquisition expense ratio
15.7
%
 
20.3
%
 
22.6
%
 
17.7
%
 
27.6
%
 
18.1
%
Other operating expense ratio
16.0
%
 
12.3
%
 
33.8
%
 
15.8
%
 
4.8
%
 
15.4
%
Combined ratio
96.8
%
 
74.3
%
 
86.6
%
 
88.5
%
 
100.2
%
 
89.0
%
 
 
 
 
 
 
 
 
 
 
 
 
Goodwill and intangible assets
$
24,024

 
$
3,939

 
$
83,565

 
$
111,528

 
$

 
$
111,528

 
 
 
 
 
 
 
 
 
 
 
 
Total investable assets
 
 
 
 
 
 
$
14,584,727

 
$
1,124,048

 
$
15,708,775

Total assets
 
 
 
 
 
 
21,207,667

 
1,403,018

 
22,610,685

Total liabilities
 
 
 
 
 
 
15,223,488

 
304,712

 
15,528,200

_________________________________________________
(1)
Certain amounts included in the gross premiums written of each segment are related to intersegment transactions. Accordingly, the sum of gross premiums written for each segment does not agree to the total gross premiums written as shown in the table above due to the elimination of intersegment transactions in the total.

 

17

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 
Three Months Ended
 
September 30, 2013
 
Insurance
 
Reinsurance
 
Mortgage
 
Sub-Total
 
Other
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
Gross premiums written (1)
$
682,839

 
$
330,458

 
$
24,633

 
$
1,036,987

 
$

 
$
1,036,987

Premiums ceded
(180,868
)
 
(17,927
)
 

 
(197,852
)
 

 
(197,852
)
Net premiums written
501,971

 
312,531

 
24,633

 
839,135

 

 
839,135

Change in unearned premiums
(22,842
)
 
(9,433
)
 
(11,860
)
 
(44,135
)
 

 
(44,135
)
Net premiums earned
479,129

 
303,098

 
12,773

 
795,000

 

 
795,000

Other underwriting income
545

 
(19
)
 

 
526

 

 
526

Losses and loss adjustment expenses
(305,921
)
 
(119,107
)
 
(2,017
)
 
(427,045
)
 

 
(427,045
)
Acquisition expenses, net
(82,799
)
 
(61,063
)
 
(3,451
)
 
(147,313
)
 

 
(147,313
)
Other operating expenses
(75,734
)
 
(32,108
)
 
(2,334
)
 
(110,176
)
 

 
(110,176
)
Underwriting income
$
15,220

 
$
90,801

 
$
4,971

 
110,992

 

 
110,992

 
 
 
 
 
 
 
 
 
 
 
 
Net investment income
 
 
 
 
 
 
66,083

 

 
66,083

Net realized losses
 
 
 
 
 
 
(6,022
)
 

 
(6,022
)
Net impairment losses recognized in earnings
 
 
 
 
 
 
(728
)
 

 
(728
)
Equity in net income of investment funds accounted for using the equity method
 
 
 
 
 
 
5,665

 

 
5,665

Other income (loss)
 
 
 
 
 
 
624

 

 
624

Other expenses
 
 
 
 
 
 
(7,894
)
 

 
(7,894
)
Interest expense
 
 
 
 
 
 
(5,937
)
 

 
(5,937
)
Net foreign exchange losses
 
 
 
 
 
 
(40,562
)
 

 
(40,562
)
Income before income taxes
 
 
 
 
 
 
122,221

 

 
122,221

Income tax expense
 
 
 
 
 
 
(7,396
)
 

 
(7,396
)
Net income
 
 
 
 
 
 
114,825

 

 
114,825

Dividends attributable to redeemable noncontrolling interests
 
 
 
 
 
 

 

 

Amounts attributable to noncontrolling interests
 
 
 
 
 
 

 

 

Net income available to Arch
 
 
 
 
 
 
114,825

 

 
114,825

Preferred dividends
 
 
 
 
 
 
(5,484
)
 

 
(5,484
)
Net income available to Arch common shareholders
 
 
 
 
 
 
$
109,341

 
$

 
$
109,341

 
 
 
 
 
 
 
 
 
 
 
 
Underwriting Ratios
 

 
 

 
 

 
 
 
 

 
 

Loss ratio
63.8
%
 
39.3
%
 
15.8
%
 
53.7
%
 
%
 
53.7
%
Acquisition expense ratio
17.3
%
 
20.1
%
 
27.0
%
 
18.5
%
 
%
 
18.5
%
Other operating expense ratio
15.8
%
 
10.6
%
 
18.3
%
 
13.9
%
 
%
 
13.9
%
Combined ratio
96.9
%
 
70.0
%
 
61.1
%
 
86.1
%
 
%
 
86.1
%
 
 
 
 
 
 
 
 
 
 
 
 
Goodwill and intangible assets
$
20,653

 
$
8,307

 
$

 
$
28,960

 
$

 
$
28,960

 
 
 
 
 
 
 
 
 
 
 
 
Total investable assets
 
 
 
 
 
 
$
13,282,560

 
$

 
$
13,282,560

Total assets
 
 
 
 
 
 
18,930,823

 

 
18,930,823

Total liabilities
 
 
 
 
 
 
13,487,538

 

 
13,487,538

_________________________________________________
(1)
Certain amounts included in the gross premiums written of each segment are related to intersegment transactions. Accordingly, the sum of gross premiums written for each segment does not agree to the total gross premiums written as shown in the table above due to the elimination of intersegment transactions in the total.



18

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 
Nine Months Ended
 
September 30, 2014
 
Insurance
 
Reinsurance
 
Mortgage
 
Sub-Total
 
Other
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
Gross premiums written (1)
$
2,309,560

 
$
1,212,641

 
$
169,772

 
$
3,690,462

 
$
190,239

 
$
3,726,804

Premiums ceded
(646,082
)
 
(215,623
)
 
(17,622
)
 
(877,816
)
 
(6,428
)
 
(730,347
)
Net premiums written
1,663,478

 
997,018

 
152,150

 
2,812,646

 
183,811

 
2,996,457

Change in unearned premiums
(158,878
)
 
(23,495
)
 
(9,606
)
 
(191,979
)
 
(133,895
)
 
(325,874
)
Net premiums earned
1,504,600

 
973,523

 
142,544

 
2,620,667

 
49,916

 
2,670,583

Other underwriting income
1,513

 
834

 
2,970

 
5,317

 

 
5,317

Losses and loss adjustment expenses
(936,615
)
 
(413,745
)
 
(39,938
)
 
(1,390,298
)
 
(33,133
)
 
(1,423,431
)
Acquisition expenses, net
(235,156
)
 
(199,673
)
 
(32,593
)
 
(467,422
)
 
(14,625
)
 
(482,047
)
Other operating expenses
(250,111
)
 
(110,198
)
 
(48,077
)
 
(408,386
)
 
(4,402
)
 
(412,788
)
Underwriting income (loss)
$
84,231

 
$
250,741

 
$
24,906

 
359,878

 
(2,244
)
 
357,634

 
 
 
 
 
 
 
 
 
 
 
 
Net investment income
 
 
 
 
 
 
211,690

 
8,399

 
220,089

Net realized gains (losses)
 
 
 
 
 
 
102,074

 
(9,718
)
 
92,356

Net impairment losses recognized in earnings
 
 
 
 
 
 
(26,313
)
 

 
(26,313
)
Equity in net income of investment funds accounted for using the equity method
 
 
 
 
 
 
17,459

 

 
17,459

Other income (loss)
 
 
 
 
 
 
(5,069
)
 

 
(5,069
)
Other expenses
 
 
 
 
 
 
(36,512
)
 
(2,329
)
 
(38,841
)
Interest expense
 
 
 
 
 
 
(32,890
)
 

 
(32,890
)
Net foreign exchange gains (losses)
 
 
 
 
 
 
48,191

 
(1,017
)
 
47,174

Income before income taxes
 
 
 
 
 
 
638,508

 
(6,909
)
 
631,599

Income tax expense
 
 
 
 
 
 
(17,473
)
 

 
(17,473
)
Net income (loss)
 
 
 
 
 
 
621,035

 
(6,909
)
 
614,126

Dividends attributable to redeemable noncontrolling interests
 
 
 
 
 
 

 
(9,818
)
 
(9,818
)
Amounts attributable to noncontrolling interests
 
 
 
 
 
 

 
14,883

 
14,883

Net income available to Arch
 
 
 
 
 
 
621,035

 
(1,844
)
 
619,191

Preferred dividends
 
 
 
 
 
 
(16,453
)
 

 
(16,453
)
Net income available to Arch common shareholders
 
 
 
 
 
 
$
604,582

 
$
(1,844
)
 
$
602,738

 
 
 
 
 
 
 
 
 
 
 
 
Underwriting Ratios
 
 
 
 
 
 
 
 
 
 
 
Loss ratio
62.3
%
 
42.5
%
 
28.0
%
 
53.1
%
 
66.4
%
 
53.3
%
Acquisition expense ratio
15.6
%
 
20.5
%
 
22.9
%
 
17.8
%
 
29.3
%
 
18.1
%
Other operating expense ratio
16.6
%
 
11.3
%
 
33.7
%
 
15.6
%
 
8.8
%
 
15.5
%
Combined ratio
94.5
%
 
74.3
%
 
84.6
%
 
86.5
%
 
104.5
%
 
86.9
%
_________________________________________________
(1)
Certain amounts included in the gross premiums written of each segment are related to intersegment transactions. Accordingly, the sum of gross premiums written for each segment does not agree to the total gross premiums written as shown in the table above due to the elimination of intersegment transactions in the total.

 

19

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 
Nine Months Ended
 
September 30, 2013
 
Insurance
 
Reinsurance
 
Mortgage
 
Sub-Total
 
Other
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
Gross premiums written (1)
$
2,075,560

 
$
1,099,803

 
$
69,135

 
$
3,241,424

 
$

 
$
3,241,424

Premiums ceded
(567,471
)
 
(74,581
)
 

 
(638,978
)
 

 
(638,978
)
Net premiums written
1,508,089

 
1,025,222

 
69,135

 
2,602,446

 

 
2,602,446

Change in unearned premiums
(125,339
)
 
(138,479
)
 
(32,042
)
 
(295,860
)