UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

FORM 10-Q

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
March 31, 2017
Or
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number:  001-16209

ARCH CAPITAL GROUP LTD.

(Exact name of registrant as specified in its charter)

Bermuda	Not applicable
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
Waterloo House, Ground Floor
100 Pitts Bay Road, Pembroke HM 08, Bermuda	(441) 278-9250
(Address of principal executive offices)	(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 þNo 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 þ     Noo

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,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. Large accelerated Filer þAccelerated Filer o Non-accelerated Filer oSmaller reporting

company oEmerging growth company o

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes oNo þ

If an emerging growth company, indicate by check mark if the Registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

As of May 1, 2017, there were 123,069,706 common shares, $0.0033 par value per share, of the registrant outstanding.

ARCH CAPITAL GROUP LTD.

INDEX TO FORM 10-Q

Item		Page No.
	PART I
	Financial Information	2
Item 1.	Consolidated Financial Statements	4
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	40
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	60
Item 4.	Controls and Procedures	60
	PART II
	Other Information	61
Item 1.	Legal Proceedings	61
Item 1A.	Risk Factors	61
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	62
Item 5.	Other Information	62
Item 6.	Exhibits	63
	Signatures	64

ACGL 2017 FIRST QUARTER FORM 10-Q 1

PART I.  FINANCIAL INFORMATION

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 us may include forward-looking statements, which reflect our 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 our 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 our periodic reports filed with the Securities and Exchange Commission (the “SEC”), and include:

• our ability to successfully implement our business strategy during “soft” as well as “hard” markets;

• acceptance of our business strategy, security and financial condition by rating agencies and regulators, as well as by brokers and our insureds and reinsureds;

• the integration of United Guaranty and any other businesses we have acquired or may acquire into our existing operations;

• our ability to maintain or improve our ratings, which may be affected by our 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, 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 we operate;

• competition, including increased competition, on the basis of pricing, capacity (including alternative forms of capital), coverage terms or other factors;

• developments in the world’s financial and capital markets and our access to such markets;

• our ability to successfully enhance, integrate and maintain operating procedures (including information technology) to effectively support our current and new business;

• the loss of key personnel;

• accuracy of those estimates and judgments utilized in the preparation of our 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 our company, are even more difficult to make than those made in a mature company since relatively limited historical information has been reported to us through March 31, 2017;

• greater than expected loss ratios on business written by us and adverse development on claim and/or claim expense liabilities related to business written by our insurance and reinsurance subsidiaries;

• severity and/or frequency of losses;

• claims for natural or man-made catastrophic events in our insurance or reinsurance business could cause large losses and substantial volatility in our results of operations;

• acts of terrorism, political unrest and other hostilities or other unforecasted and unpredictable events;

• availability to us of reinsurance to manage our 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 us;

• the timing of loss payments being faster or the receipt of reinsurance recoverables being slower than anticipated by us;

• our investment performance, including legislative or regulatory developments that may adversely affect the fair value of our investments;

ACGL 2017 FIRST QUARTER FORM 10-Q 2

• 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 our business, financial condition and results of operations;

• the volatility of our shareholders’ equity from foreign currency fluctuations, which could increase due to us not matching portions of our projected liabilities in foreign currencies with investments in the same currencies;

• losses relating to aviation business and business produced by a certain managing underwriting agency for which we may be liable to the purchaser of our prior reinsurance business or to others in connection with the May 5, 2000 asset sale described in our periodic reports filed with the SEC;

• changes in accounting principles or policies or in our application of such accounting principles or policies;

• changes in the political environment of certain countries in which we operate or underwrite business;

• statutory or regulatory developments, including as to tax policy and 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 us, our subsidiaries, brokers or customers; 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 our Annual Report on Form 10-K for the year ended December 31, 2016, as well as the other factors set forth in our 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 us or persons acting on our 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. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise. 

ACGL 2017 FIRST QUARTER FORM 10-Q 3

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

	Page No.
Report of Independent Registered Public Accounting Firm	5
Consolidated Balance Sheets
March 31, 2017 (unaudited) and December 31, 2016	6
Consolidated Statements of Income
For the three month periods ended March 31, 2017 and 2016 (unaudited)	7
Consolidated Statements of Comprehensive Income
For the three month periods ended March 31, 2017 and 2016 (unaudited)	8
Consolidated Statements of Changes in Shareholders’ Equity
For the three month periods ended March 31, 2017 and 2016 (unaudited)	9
Consolidated Statements of Cash Flows
For the three month periods ended March 31, 2017 and 2016 (unaudited)	10
Notes to Consolidated Financial Statements (unaudited)
Note 1 - General	11
Note 2 - Recent Accounting Pronouncements	11
Note 3 - Variable Interest Entities and Noncontrolling Interests	12
Note 4 - Earnings Per Common Share	14
Note 5 - Segment Information	15
Note 6 - Reserves for Losses and Loss Adjustment Expenses	18
Note 7 - Investment Information	20
Note 8 - Fair Value	25
Note 9 - Derivative Instruments	30
Note 10 - Commitments and Contingencies	31
Note 11 - Share Transactions	31
Note 12 - Other Comprehensive Income (Loss)	32
Note 13 - Guarantor Financial Information	33
Note 14 - Income Taxes	39
Note 15 - Legal Proceedings	39
Note 16 - Transactions With Related Parties	39

ACGL 2017 FIRST QUARTER FORM 10-Q 4

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholders of Arch Capital Group Ltd.:

We have reviewed the accompanying consolidated balance sheet of Arch Capital Group Ltd. and its subsidiaries (the “Company”) as of March 31, 2017, and the related consolidated statements of income, comprehensive income, changes in shareholders’ equity and cash flows for the three-month periods ended March 31, 2017 and March 31,2016. 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 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, 2016, 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 1, 2017, 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, 2016, is fairly stated, in all material respects in relation to the consolidated balance sheet from which it has been derived.

/s/ PricewaterhouseCoopers LLP

May 5, 2017

ACGL 2017 FIRST QUARTER FORM 10-Q 5

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (U.S. dollars in thousands, except share data)
	(Unaudited)
	March 31, 2017			December 31, 2016
Assets
Investments:
Fixed maturities available for sale, at fair value (amortized cost: $13,767,375 and $13,522,671)	$	13,745,932		$	13,426,577
Short-term investments available for sale, at fair value (amortized cost: $803,624 and $611,878)	803,619			612,005
Collateral received under securities lending, at fair value (amortized cost: $538,353 and $762,554)	538,361			762,565
Equity securities available for sale, at fair value (cost: $369,189 and $475,085)	428,594			518,041
Other investments available for sale, at fair value (cost: $197,431 and $149,077)	228,437			167,970
Investments accounted for using the fair value option	3,648,120			3,421,220
Investments accounted for using the equity method	861,607			811,273
Total investments	20,254,670			19,719,651
Cash	703,754			842,942
Accrued investment income	104,168			124,483
Securities pledged under securities lending, at fair value (amortized cost: $524,758 and $746,409)	525,569			744,980
Premiums receivable	1,254,048			1,072,435
Reinsurance recoverable on unpaid and paid losses and loss adjustment expenses	2,133,148			2,114,138
Contractholder receivables	1,766,340			1,717,436
Ceded unearned premiums	941,923			859,567
Deferred acquisition costs	487,925			447,560
Receivable for securities sold	239,678			58,284
Goodwill and intangible assets	750,315			781,553
Other assets	930,688			889,080
Total assets	$	30,092,226		$	29,372,109
Liabilities
Reserve for losses and loss adjustment expenses	$	10,296,821		$	10,200,960
Unearned premiums	3,631,259			3,406,870
Reinsurance balances payable	321,285			300,407
Contractholder payables	1,766,340			1,717,436
Collateral held for insured obligations	327,161			301,406
Senior notes	1,732,410			1,732,258
Revolving credit agreement borrowings	734,961			756,650
Securities lending payable	538,353			762,554
Payable for securities purchased	389,649			76,183
Other liabilities	674,313			806,260
Total liabilities	20,412,552			20,060,984
Commitments and Contingencies
Redeemable noncontrolling interests	205,644			205,553
Shareholders' Equity
Non-cumulative preferred shares	772,555			772,555
Convertible non-voting common equivalent preferred shares	1,101,304			1,101,304
Common shares ($0.0033 par, shares issued: 174,935,104 and 174,644,101)	583			582
Additional paid-in capital	548,053			531,687
Retained earnings	8,238,296			7,996,701
Accumulated other comprehensive income (loss), net of deferred income tax	(15,677		)	(114,541		)
Common shares held in treasury, at cost (shares: 51,907,618 and 51,856,584)	(2,039,270		)	(2,034,570		)
Total shareholders' equity available to Arch	8,605,844			8,253,718
Non-redeemable noncontrolling interests	868,186			851,854
Total shareholders' equity	9,474,030			9,105,572
Total liabilities, noncontrolling interests and shareholders' equity	$	30,092,226		$	29,372,109

See Notes to Consolidated Financial Statements

ACGL 2017 FIRST QUARTER FORM 10-Q 6

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (U.S. dollars in thousands, except share data)
	(Unaudited)
	Three Months Ended
	March 31,
	2017			2016
Revenues
Net premiums written	$	1,276,260		$	1,121,235
Change in unearned premiums	(159,243		)	(169,656		)
Net premiums earned	1,117,017			951,579
Net investment income	117,874			93,735
Net realized gains (losses)	34,153			37,324
Other-than-temporary impairment losses	(1,807		)	(7,737		)
Less investment impairments recognized in other comprehensive income, before taxes	—			98
Net impairment losses recognized in earnings	(1,807		)	(7,639		)
Other underwriting income	4,633			5,047
Equity in net income (loss) of investment funds accounted for using the equity method	48,088			6,655
Other income (loss)	(782		)	(25		)
Total revenues	1,319,176			1,086,676
Expenses
Losses and loss adjustment expenses	552,570			522,949
Acquisition expenses	182,289			167,838
Other operating expenses	174,719			150,148
Corporate expenses	27,792			9,383
Amortization of intangible assets	31,294			4,748
Interest expense	28,676			16,107
Net foreign exchange losses (gains)	19,404			23,566
Total expenses	1,016,744			894,739
Income before income taxes	302,432			191,937
Income tax expense	(28,397		)	(16,310		)
Net income	$	274,035		$	175,627
Net (income) loss attributable to noncontrolling interests	(20,908		)	(20,829		)
Net income available to Arch	253,127			154,798
Preferred dividends	(11,218		)	(5,484		)
Net income available to Arch common shareholders	$	241,909		$	149,314
Net income per common share and common share equivalent
Basic	$	1.80		$	1.24
Diluted	$	1.74		$	1.20
Weighted average common shares and common share equivalents outstanding
Basic	134,034,927			120,428,179
Diluted	139,047,672			124,496,496

See Notes to Consolidated Financial Statements

ACGL 2017 FIRST QUARTER FORM 10-Q 7

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (U.S. dollars in thousands)
	(Unaudited)
	Three Months Ended
	March 31,
	2017			2016
Comprehensive Income
Net income	$	274,035		$	175,627
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	100,792			132,981
Portion of other-than-temporary impairment losses recognized in other comprehensive income, net of deferred income tax	—			(98		)
Reclassification of net realized (gains) losses, net of income taxes, included in net income	(5,044		)	(32,223		)
Foreign currency translation adjustments	3,124			17,313
Comprehensive income	372,907			293,600
Net (income) loss attributable to noncontrolling interests	(20,908		)	(20,829		)
Foreign currency translation adjustments attributable to noncontrolling interests	(8		)	158
Comprehensive income available to Arch	$	351,991		$	272,929

See Notes to Consolidated Financial Statements

ACGL 2017 FIRST QUARTER FORM 10-Q 8

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (U.S. dollars in thousands)
	(Unaudited)
	Three Months Ended
	March 31,
	2017			2016
Non-cumulative preferred shares
Balance at beginning and end of period	$	772,555		$	325,000
Convertible non-voting common equivalent preferred shares
Balance at beginning and end of period	1,101,304			—
Common shares
Balance at beginning of year	582			577
Common shares issued, net	1			2
Balance at end of period	583			579
Additional paid-in capital
Balance at beginning of year	531,687			467,339
Common shares issued, net	(1		)	—
Exercise of stock options	710			4,222
Amortization of share-based compensation	15,657			14,265
Other	—			117
Balance at end of period	548,053			485,943
Retained earnings
Balance at beginning of year	7,996,701			7,332,032
Cumulative effect of an accounting change (1)	(314		)	—
Balance at beginning of year, as adjusted	7,996,387			7,332,032
Net income	274,035			175,627
Net (income) loss attributable to noncontrolling interests	(20,908		)	(20,829		)
Preferred share dividends	(11,218		)	(5,484		)
Balance at end of period	8,238,296			7,481,346
Accumulated other comprehensive income (loss), net of deferred income tax
Balance at beginning of year	(114,541		)	(16,502		)
Unrealized appreciation (decline) in value of available-for-sale investments, net of deferred income tax:
Balance at beginning of year	(27,641		)	50,085
Unrealized holding gains (losses) arising during period, net of reclassification adjustment	95,748			100,758
Portion of other-than-temporary impairment losses recognized in other comprehensive income, net of deferred income tax	—			(98		)
Balance at end of period	68,107			150,745
Foreign currency translation adjustments:
Balance at beginning of year	(86,900		)	(66,587		)
Foreign currency translation adjustments	3,124			17,313
Foreign currency translation adjustments attributable to noncontrolling interests	(8		)	158
Balance at end of period	(83,784		)	(49,116		)
Balance at end of period	(15,677		)	101,629
Common shares held in treasury, at cost
Balance at beginning of year	(2,034,570		)	(1,941,904		)
Shares repurchased for treasury	(4,700		)	(77,345		)
Balance at end of period	(2,039,270		)	(2,019,249		)
Total shareholders’ equity available to Arch	8,605,844			6,375,248
Non-redeemable noncontrolling interests	868,186			754,915
Total shareholders’ equity	$	9,474,030		$	7,130,163

(1) See Note 2, “Recent Accounting Pronouncements,” for details.

See Notes to Consolidated Financial Statements

ACGL 2017 FIRST QUARTER FORM 10-Q 9

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (U.S. dollars in thousands)
	(Unaudited)
	Three Months Ended
	March 31,
	2017			2016
Operating Activities
Net income	$	274,035		$	175,627
Adjustments to reconcile net income to net cash provided by operating activities:
Net realized (gains) losses	(40,855		)	(43,034		)
Net impairment losses recognized in earnings	1,807			7,639
Equity in net income or loss of investment funds accounted for using the equity method and other income or loss	(36,141		)	3,243
Amortization of intangible assets	31,294			4,748
Share-based compensation	15,657			14,265
Changes in:
Reserve for losses and loss adjustment expenses, net of unpaid losses and loss adjustment expenses recoverable	53,027			111,255
Unearned premiums, net of ceded unearned premiums	159,243			169,656
Premiums receivable	(176,350		)	(217,348		)
Deferred acquisition costs	(41,728		)	(30,050		)
Reinsurance balances payable	20,114			51,929
Other items, net	(51,985		)	74,613
Net Cash Provided By Operating Activities	208,118			322,543
Investing Activities
Purchases of fixed maturity investments	(10,476,918		)	(8,133,537		)
Purchases of equity securities	(143,833		)	(128,263		)
Purchases of other investments	(427,039		)	(305,198		)
Proceeds from sales of fixed maturity investments	10,386,746			7,827,536
Proceeds from sales of equity securities	253,347			216,012
Proceeds from sales, redemptions and maturities of other investments	317,518			211,125
Proceeds from redemptions and maturities of fixed maturity investments	174,718			163,894
Net settlements of derivative instruments	(3,921		)	21,091
Net (purchases) sales of short-term investments	(397,851		)	(65,594		)
Change in cash collateral related to securities lending	180,946			(43,118		)
Purchases of fixed assets	(5,194		)	(3,952		)
Other	19,603			6,737
Net Cash Provided By (Used For) Investing Activities	(121,878		)	(233,267		)
Financing Activities
Purchases of common shares under share repurchase program	—			(75,256		)
Proceeds from common shares issued, net	(3,990		)	202
Repayments of borrowings	(22,000		)	(74,171		)
Change in cash collateral related to securities lending	(180,946		)	43,118
Dividends paid to redeemable noncontrolling interests	(4,497		)	(4,497		)
Other	(5,018		)	29,115
Preferred dividends paid	(11,218		)	(5,484		)
Net Cash Provided By (Used For) Financing Activities	(227,669		)	(86,973		)
Effects of exchange rate changes on foreign currency cash	2,241			2,332
Increase (decrease) in cash	(139,188		)	4,635
Cash beginning of year	842,942			553,326
Cash end of period	$	703,754		$	557,961
Income taxes paid	$	711		$	2,504
Interest paid	$	5,829		$	3,813

See Notes to Consolidated Financial Statements

ACGL 2017 FIRST QUARTER FORM 10-Q 10

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 wholly-owned subsidiaries. As used herein, the “Company” means ACGL and its subsidiaries. The Company’s consolidated financial statements include the results of Watford Holdings Ltd. and its wholly owned subsidiaries. See Note 3.

On December 31, 2016, the Company completed the acquisition of United Guaranty Corporation, a North Carolina corporation (“UGC”). The acquisition of UGC (“UGC acquisition”) expanded the scale of Arch’s existing mortgage insurance businesses by combining UGC’s position as the market leader in the U.S. private mortgage insurance industry with Arch’s financial strength and history of innovation, further diversifying the Company’s business profile and customer base.

The interim consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”). 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, 2016 (“2016 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, including the presentation of ‘amortization of intangible assets’ on its consolidated statements of income to split out such item (previously reflected in acquisition expenses and/or other operating expenses). 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.    Recent Accounting Pronouncements

Recently Issued Accounting Standards Adopted

The Company adopted Financial Accounting Standards Board (“FASB”) Accounting Standard Update (“ASU”) 2016-09, “Compensation - Stock Compensation (Topic 718) - Improvements to Employee Share-Based Payment Accounting,” effective January 1, 2017. This ASU was issued in the 2016 first quarter to improve and simplify the accounting for employee share-based payment transactions. This ASU provides simplifications with respect to income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows for these types of transactions. With respect to the forfeiture accounting policy election, the Company has elected to account for forfeitures as they occur, which did not result in a material cumulative effect adjustment. With respect to the change in presentation in the statement of cash flows related to excess tax benefits, the Company has applied the guidance prospectively and prior periods have not been adjusted.

Recently Issued Accounting Standards Not Yet Adopted

ASU 2016-18, "Statement of Cash Flows (Topic 230) - Restricted Cash " was issued in the 2016 fourth quarter. The ASU requires that restricted cash and restricted cash equivalents be included with cash and cash equivalents in the reconciliation of beginning and ending cash on the statements of cash flows. As a result, transfers between cash and cash equivalents and restricted cash and restricted cash equivalents will no longer be presented on the statement of cash flows. The ASU also requires a reconciliation of the statement of the cash flows to the balance sheet if the balance sheet includes more than one line item of cash, cash equivalents, and restricted cash. The ASU is effective, with retrospective adoption, for interim and annual periods beginning after December 15, 2017, with early adoption permitted. The Company is currently assessing the impact the implementation of this ASU will have on its consolidated financial statements.

ASU 2017-08, “Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities,” was issued in the 2017 first quarter.The ASU amends the amortization period for certain purchased callable debt securities held at a premium by shortening the amortization period for the premium to the earliest call date. The ASU will be effective for the Company on January 1, 2019 and is required to be applied using a modified retrospective approach through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

which the guidance is effective. The Company is currently assessing the impact the implementation of this ASU will have on its consolidated financial statements.

3. Variable Interest Entities and Noncontrolling Interests

A variable interest entity (“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.

Watford Holdings Ltd.

In March 2014, 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. Watford Holdings Ltd. is the parent of Watford Re Ltd., a multi-line Bermuda reinsurance company (together with Watford Holdings Ltd., “Watford Re”). Watford Re is considered a VIE and the Company concluded that it is the primary beneficiary of Watford Re. As such, the results of Watford Re are included in the Company’s consolidated financial statements.

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.

The following table provides the carrying amount and balance sheet caption in which the assets and liabilities of Watford Re are reported:

	March 31,		December 31,
	2017		2016
Assets
Investments accounted for using the fair value option	$	1,976,466	$	1,857,623
Cash	47,566		74,893
Accrued investment income	14,066		17,017
Premiums receivable	196,866		189,911
Reinsurance recoverable on unpaid and paid losses and LAE	25,673		24,420
Ceded unearned premiums	16,383		12,145
Deferred acquisition costs	93,227		86,379
Receivable for securities sold	19,235		1,326
Goodwill and intangible assets	7,650		7,650
Other assets	116,336		111,386
Total assets of consolidated VIE	$	2,513,468	$	2,382,750
Liabilities
Reserves for losses and loss adjustment expenses	$	566,175	$	510,809
Unearned premiums	319,677		293,480
Reinsurance balances payable	15,171		12,289
Revolving credit agreement borrowings	234,961		256,650
Payable for securities purchased	81,216		42,922
Other liabilities	100,198		88,976
Total liabilities of consolidated VIE	$	1,317,398	$	1,205,126
Redeemable noncontrolling interests	$	220,344	$	220,253

For the three months ended March 31, 2017, Watford Re generated $62.2 million of cash provided by operating activities, $60.5 million of cash used for investing activities and $29.0 million of cash used for financing activities, compared to $65.3 million of cash provided by operating activities, $43.7 million of cash used for investing activities and $51.3 million of cash used for financing activities for the three months ended March 31, 2016.

Non-redeemable noncontrolling interests

The Company accounts for the portion of Watford Re’s common equity attributable to third party investors in the shareholders’ equity section of its consolidated balance sheets. The noncontrolling ownership in Watford Re’s common shares was approximately 89% at March 31, 2017. The portion of Watford Re’s income or loss attributable to third party investors is recorded in the consolidated statements of income in ‘net (income) loss attributable to noncontrolling interests.’

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following table sets forth activity in the non-redeemable noncontrolling interests:

	March 31,
	2017		2016
Three Months Ended
Balance, beginning of period	$	851,854	$	738,831
Amounts attributable to noncontrolling interests	16,324		16,242
Foreign currency translation adjustments attributable to noncontrolling interests	8		(158		)
Balance, end of period	$	868,186	$	754,915

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 relate to the 9,065,200 cumulative redeemable preference shares (“Watford Preference Shares”) issued in March 2014 with a par value of $0.01 per share and a liquidation preference of $25.00 per share. Preferred dividends, including the accretion of the discount and issuance costs, are included in ‘net (income) loss attributable to noncontrolling interests’ in the Company’s consolidated statements of income.

The following table sets forth activity in the redeemable non-controlling interests:

	March 31,
	2017		2016
Three Months Ended
Balance, beginning of period	$	205,553	$	205,182
Accretion of preference share issuance costs	91		92
Balance, end of period	$	205,644	$	205,274

The portion of Watford Re’s income or loss attributable to third party investors, recorded in the Company’s consolidated statements of income in ‘net (income) loss attributable to noncontrolling interests,’ are summarized in the table below:

	March 31,
	2017			2016
Three Months Ended
Amounts attributable to non-redeemable noncontrolling interests	$	(16,324	)	$	(16,242	)
Dividends attributable to redeemable noncontrolling interests	(4,584		)	(4,587		)
Net (income) loss attributable to noncontrolling interests	$	(20,908	)	$	(20,829	)

Bellemeade Re I and II

Upon closing of the UGC acquisition, the Company acquired the rights and obligations related to aggregate excess of loss reinsurance agreements with Bellemeade Re I Ltd. (“Bellemeade I”), entered into in July 2015, and with Bellemeade Re II Ltd. (“Bellemeade II”), entered into in May 2016 (the “Bellemeade Agreements”). Bellemeade I and Bellemeade II are special purpose reinsurance companies domiciled in Bermuda, each of which provided for up to approximately $300 million of aggregate excess of loss reinsurance coverage at inception for new delinquencies on portfolios of in-force policies issued.

As a result of the evaluation of the Bellemeade Agreements, the Company concluded that both Bellemeade I and Bellemeade II are VIEs. However, given that the ceding insurers do not have the unilateral power to direct those activities that are significant to the economic performance of Bellemeade I and Bellemeade II, the Company does not consolidate Bellemeade I and Bellemeade II in its consolidated financial statements. The following table presents total assets of Bellemeade I and Bellemeade II as well as the Company’s maximum exposure to loss associated with these VIEs:

			Maximum Exposure to Loss
	Total VIE Assets		On-Balance Sheet		Off-Balance Sheet		Total
Bellemeade I	$	146,200	$	351	$	1,310	$	1,661
Bellemeade II	283,777		54		1,103		1,157
Total	$	429,977	$	405	$	2,413	$	2,818

Irving Partners Limited Partnership

Upon closing of the UGC acquisition, the Company acquired a limited partnership interest in Irving Partners Limited Partnership (“Irving Partners”), which owns and operates an office building in Greensboro, North Carolina in which the Company is the main tenant. The Company concluded that Irving Partners is a VIE but that it is not the primary beneficiary. The Company’s maximum exposure to loss is approximately $14.5 million at March 31, 2017.

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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

4.    Earnings Per Common Share

The following table sets forth the computation of basic and diluted earnings per common share:

	Three Months Ended
	March 31,
	2017			2016
Numerator:
Net income	$	274,035		$	175,627
Amounts attributable to noncontrolling interests	(20,908		)	(20,829		)
Net income available to Arch	253,127			154,798
Preferred dividends	(11,218		)	(5,484		)
Net income available to Arch common shareholders	$	241,909		$	149,314
Denominator:
Weighted average common shares outstanding	121,272,107			120,428,179
Series D preferred shares (1)	12,762,820			—
Weighted average common shares and common share equivalents outstanding — basic	134,034,927			120,428,179
Effect of dilutive common share equivalents:
Nonvested restricted shares	1,646,555			1,460,654
Stock options (2)	3,366,190			2,607,663
Weighted average common shares and common share equivalents outstanding — diluted	139,047,672			124,496,496
Earnings per common share:
Basic	$	1.80		$	1.24
Diluted	$	1.74		$	1.20

(1) Such shares are convertible non-voting common equivalent preferred shares issued in connection with the UGC acquisition.

(2) 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 2017 first quarter and 2016 first quarter, the number of stock options excluded were 263,475 and 607,208, respectively.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

5.    Segment Information

The Company 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 and Chief Executive Officer, the President and Chief Operating Officer, 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 insurance segment consists of the Company’s insurance underwriting units which offer specialty product lines on a worldwide basis. Product lines include: construction and national accounts; excess and surplus casualty; lenders products; professional lines; programs; property, energy, marine and aviation; travel, accident and health; and other (consisting of alternative markets, excess workers' compensation and surety business).

The reinsurance segment consists of the Company’s reinsurance underwriting units which offer specialty product lines on a worldwide basis. Product lines include: casualty; marine and aviation; other specialty; property catastrophe; property excluding property catastrophe (losses on a single risk, both excess of loss and pro rata); and other (consisting of life reinsurance, casualty clash and other).

The mortgage segment includes the Company’s U.S. and international mortgage insurance and reinsurance operations as well as government sponsored enterprise (“GSE”) credit-risk sharing transactions. Arch Mortgage Insurance Company, United Guaranty Residential Insurance Company and United Guaranty Mortgage Indemnity Company (combined “Arch MI U.S.”) are approved as eligible mortgage insurers by Federal National Mortgage Association (“Fannie Mae”) and Federal Home Loan Mortgage Corporation (“Freddie Mac”), each a GSE.

The corporate (non-underwriting) segment results include net investment income, other income (loss), corporate expenses, UGC transaction costs and other, interest expense, dividends 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.

The ‘other’ segment includes the results of Watford Re (see Note 3). 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.

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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
	March 31, 2017
	Insurance			Reinsurance			Mortgage			Sub-Total			Other			Total
Gross premiums written (1)	$	782,281		$	475,782		$	348,623		$	1,606,686		$	154,120		$	1,657,990
Premiums ceded	(234,095		)	(166,092		)	(73,925		)	(474,112		)	(10,434		)	(381,730		)
Net premiums written	548,186			309,690			274,698			1,132,574			143,686			1,276,260
Change in unearned premiums	(42,540		)	(64,839		)	(30,175		)	(137,554		)	(21,689		)	(159,243		)
Net premiums earned	505,646			244,851			244,523			995,020			121,997			1,117,017
Other underwriting income	—			(306		)	4,123			3,817			816			4,633
Losses and loss adjustment expenses	(332,641		)	(105,454		)	(29,065		)	(467,160		)	(85,410		)	(552,570		)
Acquisition expenses, net	(74,868		)	(46,147		)	(28,766		)	(149,781		)	(32,508		)	(182,289		)
Other operating expenses	(88,126		)	(37,533		)	(41,870		)	(167,529		)	(7,190		)	(174,719		)
Underwriting income (loss)	$	10,011		$	55,411		$	148,945		214,367			(2,295		)	212,072
Net investment income										95,812			22,062			117,874
Net realized gains (losses)										28,512			5,641			34,153
Net impairment losses recognized in earnings										(1,807		)	—			(1,807		)
Equity in net income (loss) of investment funds accounted for using the equity method										48,088			—			48,088
Other income (loss)										(782		)	—			(782		)
Corporate expenses (2)										(12,208		)	—			(12,208		)
UGC transaction costs and other (2)										(15,584		)	—			(15,584		)
Amortization of intangible assets										(31,294		)	—			(31,294		)
Interest expense										(25,756		)	(2,920		)	(28,676		)
Net foreign exchange gains (losses)										(19,845		)	441			(19,404		)
Income (loss) before income taxes										279,503			22,929			302,432
Income tax expense										(28,397		)	—			(28,397		)
Net income (loss)										251,106			22,929			274,035
Dividends attributable to redeemable noncontrolling interests										—			(4,584		)	(4,584		)
Amounts attributable to noncontrolling interests										—			(16,324		)	(16,324		)
Net income (loss) available to Arch										251,106			2,021			253,127
Preferred dividends										(11,218		)	—			(11,218		)
Net income (loss) available to Arch common shareholders										$	239,888		$	2,021		$	241,909
Underwriting Ratios
Loss ratio	65.8		%	43.1		%	11.9		%	46.9		%	70.0		%	49.5		%
Acquisition expense ratio	14.8		%	18.8		%	11.8		%	15.1		%	26.6		%	16.3		%
Other operating expense ratio	17.4		%	15.3		%	17.1		%	16.8		%	5.9		%	15.6		%
Combined ratio	98.0		%	77.2		%	40.8		%	78.8		%	102.5		%	81.4		%
Goodwill and intangible assets	$	24,371		$	773		$	717,521		$	742,665		$	7,650		$	750,315

(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.

(2) Certain expenses have been excluded from ‘corporate expenses’ and reflected in ‘UGC transaction costs and other.’

ACGL 2017 FIRST QUARTER FORM 10-Q 16

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

	Three Months Ended
	March 31, 2016
	Insurance			Reinsurance			Mortgage			Sub-Total			Other			Total
Gross premiums written (1)	$	798,553		$	481,390		$	111,280		$	1,391,061		$	148,606		$	1,437,966
Premiums ceded	(248,789		)	(160,566		)	(4,767		)	(413,960		)	(4,472		)	(316,731		)
Net premiums written	549,764			320,824			106,513			977,101			144,134			1,121,235
Change in unearned premiums	(36,675		)	(59,616		)	(44,748		)	(141,039		)	(28,617		)	(169,656		)
Net premiums earned	513,089			261,208			61,765			836,062			115,517			951,579
Other underwriting income	—			325			3,793			4,118			929			5,047
Losses and loss adjustment expenses	(323,609		)	(111,598		)	(8,629		)	(443,836		)	(79,113		)	(522,949		)
Acquisition expenses, net	(74,348		)	(54,758		)	(5,793		)	(134,899		)	(32,939		)	(167,838		)
Other operating expenses	(85,058		)	(36,258		)	(23,494		)	(144,810		)	(5,338		)	(150,148		)
Underwriting income (loss)	$	30,074		$	58,919		$	27,642		116,635			(944		)	115,691
Net investment income										70,409			23,326			93,735
Net realized gains (losses)										31,862			5,462			37,324
Net impairment losses recognized in earnings										(7,639		)	—			(7,639		)
Equity in net income (loss) of investment funds accounted for using the equity method										6,655			—			6,655
Other income (loss)										(25		)	—			(25		)
Corporate expenses										(9,383		)	—			(9,383		)
Amortization of intangible assets										(4,748		)	—			(4,748		)
Interest expense										(12,627		)	(3,480		)	(16,107		)
Net foreign exchange gains (losses)										(22,041		)	(1,525		)	(23,566		)
Income (loss) before income taxes										169,098			22,839			191,937
Income tax expense										(16,310		)	—			(16,310		)
Net income (loss)										152,788			22,839			175,627
Dividends attributable to redeemable noncontrolling interests										—			(4,587		)	(4,587		)
Amounts attributable to noncontrolling interests										—			(16,242		)	(16,242		)
Net income (loss) available to Arch										152,788			2,010			154,798
Preferred dividends										(5,484		)	—			(5,484		)
Net income (loss) available to Arch common shareholders										$	147,304		$	2,010		$	149,314
Underwriting Ratios
Loss ratio	63.1		%	42.7		%	14.0		%	53.1		%	68.5		%	55.0		%
Acquisition expense ratio	14.5		%	21.0		%	9.4		%	16.1		%	28.5		%	17.6		%
Other operating expense ratio	16.6		%	13.9		%	38.0		%	17.3		%	4.6		%	15.8		%
Combined ratio	94.2		%	77.6		%	61.4		%	86.5		%	101.6		%	88.4		%
Goodwill and intangible assets	$	27,825		$	1,713		$	63,132		$	92,670		$	—		$	92,670

(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.

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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

6.    Reserve for Losses and Loss Adjustment Expenses

The following table represents an analysis of losses and loss adjustment expenses and a reconciliation of the beginning and ending reserve for losses and loss adjustment expenses:

	Three Months Ended March 31,
	2017			2016
Reserve for losses and loss adjustment expenses at beginning of year	$	10,200,960		$	9,125,250
Unpaid losses and loss adjustment expenses recoverable	2,083,575			1,828,837
Net reserve for losses and loss adjustment expenses at beginning of year	8,117,385			7,296,413
Net incurred losses and loss adjustment expenses relating to losses occurring in:
Current year	635,775			578,978
Prior years	(83,205		)	(56,029		)
Total net incurred losses and loss adjustment expenses	552,570			522,949
Net foreign exchange losses (gains)	31,278			33,575
Net paid losses and loss adjustment expenses relating to losses occurring in:
Current year	(34,957		)	(49,079		)
Prior years	(464,585		)	(362,595		)
Total net paid losses and loss adjustment expenses	(499,542		)	(411,674		)
Net reserve for losses and loss adjustment expenses at end of year	8,201,691			7,441,263
Unpaid losses and loss adjustment expenses recoverable	2,095,130			1,937,724
Reserve for losses and loss adjustment expenses at end of period	$	10,296,821		$	9,378,987

2017 Prior Year Development

During the 2017 first quarter, the Company recorded net favorable development on prior year loss reserves of $83.2 million, which consisted of $57.2 million from the reinsurance segment, $2.1 million from the insurance segment, $23.6 million from the mortgage segment and $0.3 million from the ‘other’ segment.

The reinsurance segment’s net favorable development of $57.2 million, or 23.4 points, for the 2017 first quarter consisted of $40.8 million from short-tailed lines and $16.4 million from long-tailed and medium-tailed lines. Favorable development in short-tailed lines included $34.0 million from property catastrophe and property other than property catastrophe reserves, across most underwriting years (i.e., all premiums and losses attributable to contracts having an inception or renewal date within the given twelve-month period), reflecting lower levels of reported and paid claims activity than previously anticipated which led to decreases in certain loss ratio selections during the period. Favorable development in long-tailed and medium-tailed lines reflected reductions in casualty reserves of $5.5 million based on varying levels of reported and paid claims activity, primarily from the 2003 to 2013 underwriting years, and favorable development in marine reserves of $9.9 million across most underwriting years.

The insurance segment’s net favorable development of $2.1 million, or 0.4 points, for the 2017 first quarter consisted of $7.0 million of net favorable development in long-tailed lines and $1.9 million of net favorable development in short-tailed

lines, partially offset by $6.8 million of net adverse development in medium-tailed lines. Net favorable development in long-tailed lines reflected net reductions in executive assurance reserves from the 2008 to 2014 accident years (i.e., the year in which a loss occurred). Net favorable development in short-tailed lines primarily resulted from property (including special risk other than marine) reserves from the 2011 to 2016 accident years. Net adverse development in medium-tailed lines primarily resulted from an increase in programs of $14.2 million stemming in part from development on a small number of programs in the 2013 and 2014 accident years, partially offset by net favorable development of $7.5 million in other medium-tailed lines, primarily in professional liability and surety.

The mortgage segment’s net favorable development was $23.6 million, or 9.6 points, for the 2017 first quarter. The 2017 first quarter development was primarily driven by continued lower than expected claim emergence across most origination years and also reflected $8.2 million related to subrogation recoveries on second lien and other portfolios.

2016 Prior Year Reserve Development

During the 2016 first quarter, the Company recorded net favorable development on prior year loss reserves of $56.0 million, which consisted of $47.4 million from the reinsurance segment, $6.2 million from the insurance segment, $2.7 million from the mortgage segment less adverse development of $0.2 million from the ‘other’ segment.

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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The reinsurance segment’s net favorable development of $47.4 million, or 18.1 points, for the 2016 first quarter consisted of $36.5 million from short-tailed lines and $10.9 million from long-tailed and medium-tailed lines. Favorable development in short-tailed lines included $29.8 million from property catastrophe and property other than property catastrophe reserves, primarily from the 2013 to 2015 underwriting years, reflecting lower levels of reported and paid claims activity than previously anticipated which led to decreases in certain loss ratio selections during the period. Favorable development in long-tailed lines reflected reductions in casualty reserves of $14.2 million based on varying levels of reported and paid claims activity, primarily from the 2002 to 2005 underwriting years and 2009 to 2011 underwriting years. Such amounts were partially offset by net adverse development on marine reserves of $2.0 million, partially offset by favorable development from most other underwriting years.

The insurance segment’s net favorable development of $6.2 million, or 1.2 points, for the 2016 first quarter consisted of $9.9 million of net favorable development in long-tailed lines and $3.7 million of net favorable development in short-tailed lines, partially offset by $7.4 million of net adverse development in medium-tailed lines. Net favorable development in long-tailed lines reflected favorable development in casualty reserves of $6.9 million, primarily from the 2008 and 2012 accident years. Net favorable development in short-tailed lines primarily resulted from reductions in property (including special risk other than marine) reserves from the 2012 to 2014 accident years, primarily due to varying levels of reported claims activity. Net adverse development in medium tailed lines primarily resulted from an increase in programs of $6.1 million with approximately 30% stemming from terminated programs.

The mortgage segment’s net favorable development was $2.7 million, or 4.4 points, for the 2016 first quarter. The 2016 first quarter development was primarily driven by lower than expected claim rates across most origination years.

ACGL 2017 FIRST QUARTER FORM 10-Q 19

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

7.    Investment Information

At March 31, 2017, total investable assets of $20.74 billion included $18.83 billion managed by the Company and $1.90 billion attributable to Watford Re.

Available For Sale Investments

The following table summarizes the fair value and cost or amortized cost of the Company’s investments classified as available for sale:

	Estimated Fair Value		Gross Unrealized Gains		Gross Unrealized Losses			Cost or Amortized Cost		OTTI Unrealized Losses (2)
March 31, 2017
Fixed maturities (1):
Corporate bonds	$	4,546,756	$	31,033	$	(36,615	)	$	4,552,338	$	(1,876	)
Mortgage backed securities	412,023		5,210		(2,712		)	409,525		(3,323		)
Municipal bonds	2,519,112		14,332		(17,411		)	2,522,191		(201		)
Commercial mortgage backed securities	590,521		3,485		(6,040		)	593,076		—
U.S. government and government agencies	3,266,908		7,940		(11,152		)	3,270,120		—
Non-U.S. government securities	1,295,366		26,017		(39,356		)	1,308,705		—
Asset backed securities	1,638,347		8,984		(4,910		)	1,634,273		(22		)
Total	14,269,033		97,001		(118,196		)	14,290,228		(5,422		)
Equity securities	431,062		66,628		(6,660		)	371,094		—
Other investments	228,437		31,844		(838		)	197,431		—
Short-term investments	803,619		120		(125		)	803,624		—
Total	$	15,732,151	$	195,593	$	(125,819	)	$	15,662,377	$	(5,422	)
December 31, 2016
Fixed maturities (1):
Corporate bonds	$	4,392,373	$	27,606	$	(46,905	)	$	4,411,672	$	(2,285	)
Mortgage backed securities	490,093		4,794		(8,357		)	493,656		(3,323		)
Municipal bonds	3,713,434		8,554		(29,154		)	3,734,034		(201		)
Commercial mortgage backed securities	536,051		2,876		(6,508		)	539,683		—
U.S. government and government agencies	2,804,540		9,319		(24,437		)	2,819,658		—
Non-U.S. government securities	1,096,440		19,036		(56,872		)	1,134,276		—
Asset backed securities	1,123,987		6,897		(6,526		)	1,123,616		(22		)
Total	14,156,918		79,082		(178,759		)	14,256,595		(5,831		)
Equity securities	532,680		62,627		(17,517		)	487,570		—
Other investments	167,970		21,358		(2,465		)	149,077		—
Short-term investments	612,005		272		(145		)	611,878		—
Total	$	15,469,573	$	163,339	$	(198,886	)	$	15,505,120	$	(5,831	)

(1) In securities lending transactions, the Company receives collateral in excess of the fair value of the securities pledged. For purposes of this table, the Company has excluded the collateral received under securities lending, at fair value and included the securities pledged under securities lending, at fair value. See “—Securities Lending Agreements.”

(2) Represents the total other-than-temporary impairments (“OTTI”) recognized in accumulated other comprehensive income (“AOCI”). It does not include the change in fair value subsequent to the impairment measurement date. At March 31, 2017, the net unrealized gain related to securities for which a non-credit OTTI was recognized in AOCI was $2.0 million, compared to a net unrealized gain of $2.8 million at December 31, 2016.

ACGL 2017 FIRST QUARTER FORM 10-Q 20

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following table summarizes, for all available for sale securities in an unrealized loss position, the fair value and gross unrealized loss by length of time the security has been in a continual unrealized loss position:

	Less than 12 Months					12 Months or More					Total
	Estimated Fair Value		Gross Unrealized Losses			Estimated Fair Value		Gross Unrealized Losses			Estimated Fair Value		Gross Unrealized Losses
March 31, 2017
Fixed maturities (1):
Corporate bonds	$	1,832,009	$	(34,331	)	$	26,288	$	(2,284	)	$	1,858,297	$	(36,615	)
Mortgage backed securities	137,291		(2,652		)	4,150		(60		)	141,441		(2,712		)
Municipal bonds	1,043,998		(16,890		)	25,004		(521		)	1,069,002		(17,411		)
Commercial mortgage backed securities	304,022		(5,890		)	3,928		(150		)	307,950		(6,040		)
U.S. government and government agencies	1,803,247		(11,152		)	—		—			1,803,247		(11,152		)
Non-U.S. government securities	914,310		(39,153		)	13,924		(203		)	928,234		(39,356		)
Asset backed securities	662,917		(4,257		)	40,477		(653		)	703,394		(4,910		)
Total	6,697,794		(114,325		)	113,771		(3,871		)	6,811,565		(118,196		)
Equity securities	134,646		(6,660		)	—		—			134,646