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 quarterly period ended March 31, 2009

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.)

Wessex House, 45 Reid Street

Hamilton HM 12, 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 o  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

Indicate the number of shares outstanding of each of the issuer’s classes of common shares as of the latest practicable date.

Class	Outstanding at April 30, 2009
Common Shares, $0.01 par value	60,555,269

ARCH CAPITAL GROUP LTD.

INDEX

	Page No.
PART I. Financial Information
Item 1 — Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm	2
Consolidated Balance Sheets March 31, 2009 (unaudited) and December 31, 2008	3
Consolidated Statements of Income For the three month periods ended March 31, 2009 and 2008 (unaudited)	4
Consolidated Statements of Changes in Shareholders’ Equity For the three month periods ended March 31, 2009 and 2008 (unaudited)	5
Consolidated Statements of Comprehensive Income For the three month periods ended March 31, 2009 and 2008 (unaudited)	6
Consolidated Statements of Cash Flows For the three month periods ended March 31, 2009 and 2008 (unaudited)	7
Notes to Consolidated Financial Statements (unaudited)	8
Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations	33
Item 3 — Quantitative and Qualitative Disclosures About Market Risk	57
Item 4 — Controls and Procedures	57
PART II. Other Information
Item 1 — Legal Proceedings	58
Item 2 — Unregistered Sales of Equity Securities and Use of Proceeds	58
Item 5 — Other Information	58
Item 6 — Exhibits	59

See Notes to Consolidated Financial Statements

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 consolidated balance sheets of Arch Capital Group Ltd. and its subsidiaries (the “Company”) as of March 31, 2009, and the related consolidated statements of income, changes in shareholders’ equity, comprehensive income and cash flows for each of the three-month periods ended March 31, 2009 and March 31, 2008. 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.

As discussed in Note 7 to the consolidated financial statements, the Company changed the manner in which it accounts for other-than-temporary impairment losses in 2009.

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, 2008, and the related consolidated statements of income, changes in shareholders’ equity, comprehensive income and of cash flows for the year then ended (not presented herein), and in our report dated March 2, 2009, 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, 2008, 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

May 11, 2009

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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(U.S. dollars in thousands, except share data)

	(Unaudited)
	March 31,			December 31,
	2009			2008
Assets
Investments:
Fixed maturities available for sale, at market value (amortized cost: 2009, $8,735,769; 2008, $8,314,615)	$	8,540,653		$	8,122,221
Short-term investments available for sale, at market value (amortized cost: 2009, $749,178; 2008, $478,088)	749,708			479,586
Investment of funds received under securities lending agreements, at market value (amortized cost: 2009, $571,102; 2008, $750,330)	550,821			730,194
Other investments (cost: 2009, $114,779; 2008, $125,858)	104,988			109,601
Investment funds accounted for using the equity method	293,452			301,027
Total investments	10,239,622			9,742,629
Cash	244,037			251,739
Accrued investment income	65,365			78,052
Investment in joint venture (cost: $100,000)	101,143			98,341
Fixed maturities and short-term investments pledged under securities lending agreements, at market value	559,691			728,065
Premiums receivable	720,724			628,951
Unpaid losses and loss adjustment expenses recoverable	1,710,781			1,729,135
Paid losses and loss adjustment expenses recoverable	76,312			63,294
Prepaid reinsurance premiums	274,578			303,707
Deferred income tax assets, net	62,210			60,192
Deferred acquisition costs, net	313,973			295,192
Receivable for securities sold	1,191,896			105,073
Other assets	531,955			532,175
Total Assets	$	16,092,287		$	14,616,545
Liabilities
Reserve for losses and loss adjustment expenses	$	7,709,317		$	7,666,957
Unearned premiums	1,617,431			1,526,682
Reinsurance balances payable	146,981			138,509
Senior notes	300,000			300,000
Revolving credit agreement borrowings	100,000			100,000
Securities lending payable	574,337			753,528
Payable for securities purchased	1,433,732			123,309
Other liabilities	580,093			574,595
Total Liabilities	12,461,891			11,183,580
Commitments and Contingencies
Shareholders’ Equity
Non-cumulative preferred shares ($0.01 par value, 50,000,000 shares authorized, issued: 13,000,000)	130			130
Common shares ($0.01 par value, 200,000,000 shares authorized, issued: 2009, 60,532,222; 2008, 60,511,974)	605			605
Additional paid-in capital	996,417			994,585
Retained earnings	2,894,577			2,693,239
Accumulated other comprehensive income (loss), net of deferred income tax	(261,333		)	(255,594		)
Total Shareholders’ Equity	3,630,396			3,432,965
Total Liabilities and Shareholders’ Equity	$	16,092,287		$	14,616,545

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)
	Three Months Ended
	March 31,
	2009			2008
Revenues
Net premiums written	$	822,863		$	811,342
Increase in unearned premiums	(122,299		)	(103,108		)
Net premiums earned	700,564			708,234
Net investment income	95,882			122,193
Net realized gains (losses)	(5,164		)	48,686
Total other-than-temporary impairment losses	(92,989		)	(12,711		)
Portion of loss recognized in other comprehensive income (loss), before taxes	56,855			—
Net impairment losses recognized in earnings	(36,134		)	(12,711		)
Fee income	925			1,068
Equity in net income (loss) of investment funds accounted for using the equity method	(9,581		)	(22,313		)
Other income	3,951			4,036
Total revenues	750,443			849,193
Expenses
Losses and loss adjustment expenses	400,542			404,417
Acquisition expenses	126,458			114,639
Other operating expenses	87,116			97,187
Interest expense	5,712			5,524
Net foreign exchange (gains) losses	(25,205		)	23,587
Total expenses	594,623			645,354
Income before income taxes	155,820			203,839
Income tax expense	9,490			7,956
Net income	146,330			195,883
Preferred dividends	6,461			6,461
Net income available to common shareholders	$	139,869		$	189,422
Net income per common share
Basic	$	2.32		$	2.90
Diluted	$	2.24		$	2.78
Weighted average common shares and common share equivalents outstanding
Basic	60,313,550			65,295,516
Diluted	62,559,969			68,019,413

See Notes to Consolidated Financial Statements

4

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(U.S. dollars in thousands)

	(Unaudited)
	Three Months Ended
	March 31,
	2009			2008
Non-Cumulative Preferred Shares
Balance at beginning and end of period	$	130		$	130
Common Shares
Balance at beginning of year	605			673
Common shares issued, net	0			0
Purchases of common shares under share repurchase program	(0		)	(27		)
Balance at end of period	605			646
Additional Paid-in Capital
Balance at beginning of year	994,585			1,451,667
Common shares issued	0			0
Exercise of stock options	528			3,749
Common shares retired	(3,760		)	(190,278		)
Amortization of share-based compensation	4,318			4,600
Other	746			83
Balance at end of period	996,417			1,269,821
Retained Earnings
Balance at beginning of year	2,693,239			2,428,117
Cumulative effect of change in accounting principle, adoption of FSP FAS 115-2/124-2 (1)	61,469			—
Balance at beginning of year, as adjusted	2,754,708			2,428,117
Dividends declared on preferred shares	(6,461		)	(6,461		)
Net income	146,330			195,883
Balance at end of period	2,894,577			2,617,539
Accumulated Other Comprehensive Income (Loss)
Balance at beginning of year	(255,594		)	155,224
Cumulative effect of change in accounting principle, adoption of FSP FAS 115-2/124-2 (1)	(61,469		)	—
Balance at beginning of year, as adjusted	(317,063		)	155,224
Change in unrealized appreciation (decline) in value of investments, net of deferred income tax	114,844			(37,577		)
Portion of other-than-temporary impairment losses recognized in other comprehensive income, net of deferred income tax	(56,855		)	—
Foreign currency translation adjustments, net of deferred income tax	(2,259		)	(1,239		)
Balance at end of period	(261,333		)	116,408
Total Shareholders’ Equity	$	3,630,396		$	4,004,544

(1)FASB Staff Position No. FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments” (“FSP FAS 115-2/124-2”)

See Notes to Consolidated Financial Statements

5

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(U.S. dollars in thousands)

	(Unaudited)
	Three Months Ended
	March 31,
	2009			2008
Comprehensive Income
Net income	$	146,330		$	195,883
Other comprehensive income (loss), net of deferred income tax
Unrealized appreciation (decline) in value of investments:
Unrealized holding gains (losses) arising during period	58,324			12,707
Portion of other-than-temporary impairment losses recognized in other comprehensive income, net of deferred income tax	(56,855		)	—
Reclassification of net realized (gains) losses, net of income taxes, included in net income	56,520			(50,284		)
Foreign currency translation adjustments	(2,259		)	(1,239		)
Other comprehensive income (loss)	55,730			(38,816		)
Comprehensive Income	$	202,060		$	157,067

See Notes to Consolidated Financial Statements

6

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(U.S. dollars in thousands)

	(Unaudited)
	Three Months Ended
	March 31,
	2009			2008
Operating Activities
Net income	$	146,330		$	195,883
Adjustments to reconcile net income to net cash provided by operating activities:
Net realized (gains) losses	5,620			(46,502		)
Net impairment losses recognized in earnings	36,134			12,711
Equity in net (income) loss of investment funds accounted for using the equity method and other income	10,428			18,277
Share-based compensation	4,318			4,600
Changes in:
Reserve for losses and loss adjustment expenses, net of unpaid losses and loss adjustment expenses recoverable	83,763			182,498
Unearned premiums, net of prepaid reinsurance premiums	120,867			105,497
Premiums receivable	(94,777		)	(148,197		)
Deferred acquisition costs, net	(18,933		)	(21,319		)
Reinsurance balances payable	11,278			19,677
Other liabilities	2,802			40,490
Other items, net	(13,027		)	(29,070		)
Net Cash Provided By Operating Activities	294,803			334,545
Investing Activities
Purchases of fixed maturity investments	(3,632,350		)	(3,772,652		)
Proceeds from sales of fixed maturity investments	3,377,680			3,523,338
Proceeds from redemptions and maturities of fixed maturity investments	168,758			136,932
Purchases of other investments	(22,670		)	(146,815		)
Proceeds from sales of other investments	24,027			65,226
Net (purchases) sales of short-term investments	(204,924		)	74,201
Change in investment of securities lending collateral	179,191			274,855
Purchases of furniture, equipment and other assets	(7,647		)	(3,045		)
Net Cash Provided By (Used For) Investing Activities	(117,935		)	152,040
Financing Activities
Purchases of common shares under share repurchase program	(1,552		)	(189,843		)
Proceeds from common shares issued, net	(1,688		)	2,540
Change in securities lending collateral	(179,191		)	(274,855		)
Excess tax benefits from share-based compensation	742			660
Preferred dividends paid	(6,461		)	(6,461		)
Net Cash Used For Financing Activities	(188,150		)	(467,959		)
Effects of exchange rate changes on foreign currency cash	3,580			139
Increase (decrease) in cash	(7,702		)	18,765
Cash beginning of year	251,739			239,915
Cash end of period	$	244,037		$	258,680
Income taxes paid, net	$	2,231		$	2,510
Interest paid	$	184		—

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 wholly owned subsidiaries.

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 ACGL and its wholly owned subsidiaries (together with ACGL, the “Company”). 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, 2008, including the Company’s audited consolidated financial statements and related notes and the section entitled “Risk Factors.”

To facilitate period-to-period comparisons, certain amounts in the 2008 consolidated financial statements have been reclassified to conform to the 2009 presentation. Such reclassifications had no effect on the Company’s consolidated net income. Additionally, the Company adopted FSP No. FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments,” effective for its interim period ending March 31, 2009. See note 7, “Investment Information—Other-Than-Temporary Impairments” for further details.

2.      Share Transactions

Share Repurchases

The board of directors of ACGL has authorized the investment of up to $1.5 billion in ACGL’s common shares through a share repurchase program. Repurchases under the program may be effected from time to time in open market or privately negotiated transactions through February 2010. In March 2009, ACGL repurchased $1.6 million of common shares through the share repurchase program. Since the inception of the share repurchase program through March 31, 2009, ACGL has repurchased 15.3 million common shares for an aggregate purchase price of $1.05 billion. As a result of the share repurchase transactions to date, weighted average shares outstanding were reduced by 15.3 million for the 2009 first quarter, compared to 9.4 million shares for the 2008 first quarter.

At March 31, 2009, $448.3 million of repurchases were available under the share repurchase program. The timing and amount of the repurchase transactions under this program will depend on a variety of factors, including market conditions and corporate and regulatory considerations. In connection with the share repurchase program, the Warburg Pincus funds waived their rights relating to share repurchases under its shareholders agreement with ACGL for all repurchases of common shares by ACGL under the share repurchase program in open market transactions and certain privately negotiated transactions.

8

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Non-Cumulative Preferred Shares

During 2006, ACGL completed two public offerings of non-cumulative preferred shares (“Preferred Shares”). On February 1, 2006, $200.0 million principal amount of 8.0% series A non-cumulative preferred shares (“Series A Preferred Shares”) were issued with net proceeds of $193.5 million and, on May 24, 2006, $125.0 million principal amount of 7.875% series B non-cumulative preferred shares (“Series B Preferred Shares”) were issued with net proceeds of $120.9 million. The net proceeds of the offerings were used to support the underwriting activities of ACGL’s insurance and reinsurance subsidiaries. ACGL has the right to redeem all or a portion of each series of Preferred Shares at a redemption price of $25.00 per share on or after (1) February 1, 2011 for the Series A Preferred Shares and (2) May 15, 2011 for the Series B Preferred Shares. Dividends on the Preferred Shares are non-cumulative. Consequently, in the event dividends are not declared on the Preferred Shares for any dividend period, holders of Preferred Shares will not be entitled to receive a dividend for such period, and such undeclared dividend will not accrue and will not be payable. Holders of Preferred Shares will be entitled to receive dividend payments only when, as and if declared by ACGL’s board of directors or a duly authorized committee of the board of directors. Any such dividends will be payable from the date of original issue on a non-cumulative basis, quarterly in arrears. To the extent declared, these dividends will accumulate, with respect to each dividend period, in an amount per share equal to 8.0% of the $25.00 liquidation preference per annum for the Series A Preferred Shares and 7.875% of the $25.00 liquidation preference per annum for the Series B Preferred Shares. At March 31, 2009, the Company had declared an aggregate of $3.3 million of dividends to be paid to holders of the Preferred Shares.

3.      Debt and Financing Arrangements

Senior Notes

On May 4, 2004, ACGL completed a public offering of $300 million principal amount of 7.35% senior notes (“Senior Notes”) due May 1, 2034 and received net proceeds of $296.4 million. ACGL used $200 million of the net proceeds to repay all amounts outstanding under a revolving credit agreement. The Senior Notes are ACGL’s senior unsecured obligations and rank equally with all of its existing and future senior unsecured indebtedness. Interest payments on the Senior Notes are due on May 1st and November 1st of each year. ACGL may redeem the Senior Notes at any time and from time to time, in whole or in part, at a “make-whole” redemption price. For the 2009 and 2008 first quarters, interest expense on the Senior Notes was $5.5 million. The market value of the Senior Notes at March 31, 2009 and December 31, 2008 was $193.4 million and $246.1 million, respectively.

Letter of Credit and Revolving Credit Facilities

As of March 31, 2009, the Company had a $300 million unsecured revolving loan and letter of credit facility and a $1.0 billion secured letter of credit facility (the “Credit Agreement”). Under the terms of the agreement, Arch Reinsurance Company (“Arch Re U.S.”) is limited to issuing $100 million of unsecured letters of credit as part of the $300 million unsecured revolving loan. Borrowings of revolving loans may be made by ACGL and Arch Re U.S. at a variable rate based on LIBOR or an alternative base rate at the option of the Company. Secured letters of credit are available for issuance on behalf of the Company’s insurance and reinsurance subsidiaries. Issuance of letters of credit and borrowings under the Credit Agreement are subject to the Company’s compliance with certain covenants and conditions, including absence of a material adverse change. These covenants require, among other things, that the Company maintain a debt to total capital ratio of not greater than 0.35 to 1 and shareholders’ equity in excess of $1.95 billion plus 25% of future aggregate net income for each quarterly period (not including any future net losses) beginning after June 30, 2006 and 25% of future aggregate proceeds from the issuance of common or preferred equity and that the Company’s principal insurance and reinsurance subsidiaries maintain at least a “B++” rating from A.M. Best. In addition, certain of the Company’s subsidiaries which are party to the Credit Agreement are required to maintain minimum

9

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

shareholders’ equity levels. The Company was in compliance with all covenants contained in the Credit Agreement at March 31, 2009. The Credit Agreement expires on August 30, 2011.

Including the secured letter of credit portion of the Credit Agreement and another letter of credit facility (together, the “LOC Facilities”), the Company has access to letter of credit facilities for up to a total of $1.45 billion. The principal purpose of the LOC Facilities is to issue, as required, evergreen standby letters of credit in favor of primary insurance or reinsurance counterparties with which the Company has entered into reinsurance arrangements to ensure that such counterparties are permitted to take credit for reinsurance obtained from the Company’s reinsurance subsidiaries in United States jurisdictions where such subsidiaries are not licensed or otherwise admitted as an insurer, as required under insurance regulations in the United States, and to comply with requirements of Lloyd’s of London in connection with qualifying quota share and other arrangements. The amount of letters of credit issued is driven by, among other things, the timing and payment of catastrophe losses, loss development of existing reserves, the payment pattern of such reserves, the further expansion of the Company’s business and the loss experience of such business. When issued, certain letters of credit are secured by a portion of the Company’s investment portfolio. In addition, the LOC Facilities also require the maintenance of certain covenants, which the Company was in compliance with at March 31, 2009. At such date, the Company had $585.7 million in outstanding letters of credit under the LOC Facilities, which were secured by investments totaling $700.0 million. In May 2008, the Company borrowed $100.0 million under the Credit Agreement at a Company-selected variable interest rate that is based on 1 month, 3 month or 6 month reset option terms and their corresponding term LIBOR rates plus 27.5 basis points. The proceeds from such borrowings, which are repayable in August 2011, were contributed to Arch Reinsurance Ltd. (“Arch Re Bermuda”) and used to fund the investment in Gulf Re (see Note 6).

4.      Segment Information

The Company classifies its businesses into two underwriting segments — insurance and reinsurance — and corporate and other (non-underwriting). The Company’s insurance and reinsurance operating segments each have segment 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 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. The Company determined its reportable operating segments using the management approach described in SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information.”

Management measures segment performance based on underwriting income or loss. The Company does not manage its assets by segment and, accordingly, investment income is not allocated to each underwriting segment. In addition, other revenue and expense items are not evaluated by segment. 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 insurance segment consists of the Company’s insurance underwriting subsidiaries which primarily write on both an admitted and non-admitted basis. The insurance segment consists of eleven product lines: casualty; construction; executive assurance; healthcare; national accounts casualty; professional liability; programs; property, energy marine and aviation; surety; travel and accident; and other (consisting of excess workers’ compensation and employers’ liability business and lender products).

The reinsurance segment consists of the Company’s reinsurance underwriting subsidiaries. The reinsurance segment generally seeks to write significant lines on specialty property and casualty reinsurance treaties. Classes of business 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 non-traditional and casualty clash business).

10

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Corporate and other (non-underwriting) includes net investment income, other fee income, net of related expenses, other income (loss), other expenses incurred by the Company, interest expense, net realized gains or losses, net impairment losses recognized in earnings, equity in net income (loss) of investment funds accounted for using the equity method, net foreign exchange gains or losses and income taxes. In addition, corporate and other results include dividends on the Company’s non-cumulative preferred shares.

The following tables set forth an analysis of the Company’s underwriting income by segment, together with a reconciliation of underwriting income to net income available to common shareholders:

	Three Months Ended
	March 31, 2009
(U.S. dollars in thousands)	Insurance			Reinsurance			Total
Gross premiums written (1)	$	638,409		$	390,129		$	1,024,971
Net premiums written (1)	441,586			381,277			822,863
Net premiums earned (1)	$	401,097		$	299,467		$	700,564
Fee income	870			55			925
Losses and loss adjustment expenses	(270,015		)	(130,527		)	(400,542		)
Acquisition expenses, net	(57,623		)	(68,835		)	(126,458		)
Other operating expenses	(62,908		)	(18,192		)	(81,100		)
Underwriting income	$	11,421		$	81,968		93,389
Net investment income							95,882
Net realized losses							(5,164		)
Net impairment losses recognized in earnings							(36,134		)
Equity in net income (loss) of investment funds accounted for using the equity method							(9,581		)
Other income							3,951
Other expenses							(6,016		)
Interest expense							(5,712		)
Net foreign exchange gains							25,205
Income before income taxes							155,820
Income tax expense							(9,490		)
Net income							146,330
Preferred dividends							(6,461		)
Net income available to common shareholders							$	139,869
Underwriting Ratios
Loss ratio	67.3		%	43.6		%	57.2		%
Acquisition expense ratio (2)	14.1		%	23.0		%	17.9		%
Other operating expense ratio	15.7		%	6.1		%	11.6		%
Combined ratio	97.1		%	72.7		%	86.7		%

(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. The insurance segment and reinsurance segment results include $0.1 million and $3.5 million, respectively, of gross and net premiums written and $0.5 million and $4.7 million, respectively, of net premiums earned assumed through intersegment transactions.

(2)

The acquisition expense ratio is adjusted to include policy-related fee income.

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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

	Three Months Ended
	March 31, 2008
(U.S. dollars in thousands)	Insurance			Reinsurance			Total
Gross premiums written (1)	$	626,348		$	433,827		$	1,053,152
Net premiums written (1)	402,764			408,578			811,342
Net premiums earned (1)	$	419,100		$	289,134		$	708,234
Fee income	882			186			1,068
Losses and loss adjustment expenses	(287,303		)	(117,114		)	(404,417		)
Acquisition expenses, net	(51,889		)	(62,750		)	(114,639		)
Other operating expenses	(73,637		)	(18,238		)	(91,875		)
Underwriting income	$	7,153		$	91,218		98,371
Net investment income							122,193
Net realized gains							48,686
Net impairment losses recognized in earnings							(12,711		)
Equity in net income (loss) of investment funds accounted for using the equity method							(22,313		)
Other income							4,036
Other expenses							(5,312		)
Interest expense							(5,524		)
Net foreign exchange losses							(23,587		)
Income before income taxes							203,839
Income tax expense							(7,956		)
Net income							195,883
Preferred dividends							(6,461		)
Net income available to common shareholders							$	189,422
Underwriting Ratios
Loss ratio	68.6		%	40.5		%	57.1		%
Acquisition expense ratio (2)	12.2		%	21.7		%	16.1		%
Other operating expense ratio	17.6		%	6.3		%	13.0		%
Combined ratio	98.4		%	68.5		%	86.2		%

(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. The insurance segment and reinsurance segment results include nil and $7.0 million, respectively, of gross and net premiums written and $0.1 million and $8.7 million, respectively, of net premiums earned assumed through intersegment transactions.

(2)

The acquisition expense ratio is adjusted to include certain fee income.

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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Set forth below is summary information regarding net premiums written and earned by major line of business and net premiums written by client location for the insurance segment:

	Three Months Ended
	March 31,
	2009			2008
INSURANCE SEGMENT (U.S. dollars in thousands)	Amount		% of Total	Amount		% of Total
Net premiums written (1)
Property, energy, marine and aviation	$	106,029	24.0	$	97,237	24.1
Programs	74,807		16.9	54,583		13.6
Professional liability	52,008		11.8	54,081		13.4
Executive assurance	50,079		11.3	42,169		10.5
Construction	36,571		8.3	39,480		9.8
Casualty	26,539		6.0	28,543		7.1
National accounts casualty	24,227		5.5	13,055		3.2
Travel and accident	17,534		4.0	16,653		4.1
Surety	11,358		2.6	10,867		2.7
Healthcare	11,219		2.5	10,997		2.7
Other (2)	31,215		7.1	35,099		8.8
Total	$	441,586	100.0	$	402,764	100.0
Net premiums earned (1)
Property, energy, marine and aviation	$	73,840	18.4	$	84,458	20.2
Programs	66,669		16.6	56,987		13.6
Professional liability	58,234		14.5	68,810		16.4
Executive assurance	47,816		11.9	44,408		10.6
Construction	40,420		10.1	42,717		10.2
Casualty	32,698		8.2	42,306		10.1
National accounts casualty	14,439		3.6	7,923		1.9
Travel and accident	13,156		3.3	15,485		3.7
Surety	13,391		3.3	13,499		3.2
Healthcare	10,928		2.7	13,445		3.2
Other (2)	29,506		7.4	29,062		6.9
Total	$	401,097	100.0	$	419,100	100.0
Net premiums written by client location (1)
United States	$	317,044	71.8	$	279,255	69.3
Europe	92,396		20.9	86,300		21.4
Other	32,146		7.3	37,209		9.3
Total	$	441,586	100.0	$	402,764	100.0
Net premiums written by underwriting location (1)
United States	$	320,829	72.7	$	287,208	71.3
Europe	105,313		23.8	102,012		25.3
Other	15,444		3.5	13,544		3.4
Total	$	441,586	100.0	$	402,764	100.0

(1)

Insurance segment results include premiums written and earned assumed through intersegment transactions of $0.1 million and $0.5 million, respectively, for the 2009 first quarter and premiums written and earned assumed of nil and $0.1 million, respectively, for the 2008 first quarter. Insurance segment results exclude premiums written and earned ceded through intersegment transactions of $3.5 million and $4.7 million, respectively, for the 2009 first quarter and $7.0 million and $8.7 million, respectively, for the 2008 first quarter.

(2)

Includes excess workers’ compensation and employers’ liability business and lender products.

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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following table sets forth the reinsurance segment’s net premiums written and earned by major line of business and type of business, together with net premiums written by client location:

	Three Months Ended
	March 31,
REINSURANCE SEGMENT	2009			2008
(U.S. dollars in thousands)	Amount		% of Total	Amount		% of Total
Net premiums written (1)
Property excluding property catastrophe (2)	$	119,088	31.2	$	95,922	23.5
Casualty (3)	99,432		26.1	105,987		25.9
Property catastrophe	91,903		24.1	106,224		26.0
Other specialty	40,712		10.7	75,680		18.5
Marine and aviation	28,523		7.5	22,164		5.4
Other	1,619		0.4	2,601		0.7
Total	$	381,277	100.0	$	408,578	100.0
Net premiums earned (1)
Property excluding property catastrophe (2)	$	96,231	32.1	$	63,341	21.9
Casualty (3)	85,946		28.7	107,648		37.2
Property catastrophe	58,601		19.6	50,281		17.4
Other specialty	33,450		11.2	38,484		13.3
Marine and aviation	24,830		8.3	27,431		9.5
Other	409		0.1	1,949		0.7
Total	$	299,467	100.0	$	289,134	100.0
Net premiums written (1)
Pro rata	$	181,222	47.5	$	215,419	52.7
Excess of loss	200,055		52.5	193,159		47.3
Total	$	381,277	100.0	$	408,578	100.0
Net premiums earned (1)
Pro rata	$	194,518	65.0	$	192,076	66.4
Excess of loss	104,949		35.0	97,058		33.6
Total	$	299,467	100.0	$	289,134	100.0
Net premiums written by client location (1)
United States	$	229,968	60.3	$	217,179	53.2
Europe	101,501		26.6	143,920		35.2
Bermuda	37,567		9.9	34,060		8.3
Other	12,241		3.2	13,419		3.3
Total	$	381,277	100.0	$	408,578	100.0
Net premiums written by underwriting location (1)
Bermuda	$	195,600	51.3	$	220,669	54.0
United States	146,193		38.3	154,480		37.8
Other	39,484		10.4	33,429		8.2
Total	$	381,277	100.0	$	408,578	100.0

(1)	Reinsurance segment results include premiums written and earned assumed through intersegment transactions of $3.5 million and $4.7 million, respectively, for the 2009 first quarter and $7.0 million and $8.7 million, respectively, for the 2008 first quarter. Reinsurance segment results exclude premiums written and earned ceded through intersegment transactions of $0.1 million and $0.5 million, respectively, for the 2009 first quarter and premiums written and earned ceded of nil and $0.1 million, respectively, for the 2008 first quarter.
(2)	Includes facultative business.
(3)	Includes professional liability, executive assurance and healthcare business.

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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

5.      Reinsurance

In the normal course of business, the Company’s insurance subsidiaries cede a substantial portion of their premium through pro rata and excess of loss reinsurance agreements on a treaty or facultative basis. The Company’s reinsurance subsidiaries participate in “common account” retrocessional arrangements for certain pro rata treaties. Such arrangements reduce the effect of individual or aggregate losses to all companies participating on such treaties, including the reinsurers, such as the Company’s reinsurance subsidiaries, and the ceding company. In addition, the Company’s reinsurance subsidiaries may purchase retrocessional coverage as part of their risk management program. Reinsurance recoverables are recorded as assets, predicated on the reinsurers’ ability to meet their obligations under the reinsurance agreements. If the reinsurers are unable to satisfy their obligations under the agreements, the Company’s insurance or reinsurance subsidiaries would be liable for such defaulted amounts.

The effects of reinsurance on the Company’s written and earned premiums and losses and loss adjustment expenses with unaffiliated reinsurers were as follows:

	Three Months Ended
	March 31,
(U.S. dollars in thousands)	2009			2008
Premiums Written
Direct	$	620,446		$	619,486
Assumed	404,525			433,666
Ceded	(202,108		)	(241,810		)
Net	$	822,863		$	811,342
Premiums Earned
Direct	$	587,760		$	630,814
Assumed	332,567			365,364
Ceded	(219,763		)	(287,944		)
Net	$	700,564		$	708,234
Losses and Loss Adjustment Expenses
Direct	$	351,493		$	420,971
Assumed	147,145			141,249
Ceded	(98,096		)	(157,803		)
Net	$	400,542		$	404,417

The Company monitors the financial condition of its reinsurers and attempts to place coverages only with substantial, financially sound carriers. At March 31, 2009, approximately 88.9% of the Company’s reinsurance recoverables on paid and unpaid losses (not including prepaid reinsurance premiums) of $1.79 billion were due from carriers which had an A.M. Best rating of “A-” or better and the largest reinsurance recoverables from any one carrier was less than 6.9% of the Company’s total shareholders’ equity. At December 31, 2008, approximately 88.5% of the Company’s reinsurance recoverables on paid and unpaid losses (not including prepaid reinsurance premiums) of $1.79 billion were due from carriers which had an A.M. Best rating of “A-” or better and the largest reinsurance recoverables from any one carrier was less than 7.3% of the Company’s total shareholders’ equity.

On December 29, 2005, Arch Re Bermuda entered into a quota share reinsurance treaty with Flatiron Re Ltd. (“Flatiron”), a Bermuda reinsurance company, pursuant to which Flatiron assumed a 45% quota share (the “Treaty”) of certain lines of property and marine business underwritten by Arch Re Bermuda for unaffiliated third parties for the 2006 and 2007 underwriting years (January 1, 2006 to December 31, 2007). Effective June 28, 2006, the parties amended the Treaty to increase the percentage ceded to Flatiron from 45% to 70% of all covered business bound by Arch Re Bermuda from (and including) June 28, 2006 until (and including) August 

15

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

15, 2006 provided such business did not incept beyond September 30, 2006. The ceding percentage for all business bound outside of this period continued to be 45%. On December 31, 2007, the Treaty expired by its terms. At March 31, 2009, $7.3 million of premiums ceded to Flatiron were unearned.

Flatiron is required to contribute funds into a trust for the benefit of Arch Re Bermuda (the “Trust”). Effective June 28, 2006, the parties amended the Treaty to provide that, through the earning of all written premium, the amount required to be on deposit in the Trust, together with certain other amounts, will be an amount equal to a calculated amount estimated to cover ceded losses arising from in excess of two 1-in-250 year events for the applicable forward twelve-month period (the “Requisite Funded Amount”). If the actual amounts on deposit in the Trust, together with certain other amounts (the “Funded Amount”), do not at least equal the Requisite Funded Amount, Arch Re Bermuda will, among other things, recapture unearned premium reserves and reassume losses that would have been ceded in respect of such unearned premiums. No assurances can be given that actual losses will not exceed the Requisite Funded Amount or that Flatiron will make, or will have the ability to make, the required contributions into the Trust.

Arch Re Bermuda pays to Flatiron a reinsurance premium in the amount of the ceded percentage of the original gross written premium on the business reinsured less a ceding commission, which includes a reimbursement of direct acquisition expenses as well as a commission to Arch Re Bermuda for generating the business. The Treaty also provides for a profit commission to Arch Re Bermuda based on the underwriting results for the 2006 and 2007 underwriting years on a cumulative basis. For the 2009 first quarter, $3.5 million of premiums written, $14.5 million of premiums earned and $3.7 million of losses and loss adjustment expenses were ceded to Flatiron by Arch Re Bermuda, compared to $18.4 million of premiums written, $58.9 million of premiums earned and $11.8 million of losses and loss adjustment expenses for the 2008 first quarter. Reinsurance recoverables from Flatiron, which is not rated by A.M. Best, were $153.5 million at March 31, 2009, compared to $148.7 million at December 31, 2008. As noted above, Flatiron is required to contribute funds into a trust for the benefit of Arch Re Bermuda. The recoverable from Flatiron was fully collateralized through such trust at March 31, 2009 and December 31, 2008.

6.      Investment in Joint Venture

In May 2008, the Company provided $100.0 million of funding to Gulf Reinsurance Limited (“Gulf Re”), a newly formed reinsurer based in the Dubai International Financial Centre, pursuant to the joint venture agreement with Gulf Investment Corporation GSC (“GIC”). Under the agreement, Arch Re Bermuda and GIC each own 50% of Gulf Re, which commenced underwriting activities in June 2008. Gulf Re will initially target the six member states of the Gulf Cooperation Council, which include Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates. The joint venture will write a broad range of property and casualty reinsurance, including aviation, energy, commercial transportation, marine, engineered risks and property, on both a treaty and facultative basis. The initial capital of the joint venture consisted of $200.0 million with an additional $200.0 million commitment to be funded equally by the Company and GIC depending on the joint venture’s business needs. The Company accounts for its investment in Gulf Re, shown as “Investment in joint venture,” using the equity method and records its equity in the operating results of Gulf Re in “Other income” on a quarter lag basis.

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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

7.      Investment Information

The following table summarizes the Company’s invested assets:

	March 31,			December 31,
(U.S. dollars in thousands)	2009			2008
Fixed maturities available for sale, at market value	$	8,540,653		$	8,122,221
Fixed maturities pledged under securities lending agreements, at market value (1)	503,449			626,501
Total fixed maturities	9,044,102			8,748,722
Short-term investments available for sale, at market value	749,708			479,586
Short-term investments pledged under securities lending agreements, at market value (1)	56,242			101,564
Other investments	104,988			109,601
Investment funds accounted for using the equity method	293,452			301,027
Total investments (1)	10,248,492			9,740,500
Securities transactions entered into but not settled at the balance sheet date	(241,836		)	(18,236		)
Total investments, net of securities transactions	$	10,006,656		$	9,722,264

(1) In securities lending transactions, the Company receives collateral in excess of the market value of the fixed maturities and short-term investments pledged under securities lending agreements. For purposes of this table, the Company has excluded the collateral received at March 31, 2009 and December 31, 2008 of $550.8 million and $730.2 million, respectively, which is reflected as “investment of funds received under securities lending agreements, at market value” and included the $559.7 million and $728.1 million, respectively, of “fixed maturities and short-term investments pledged under securities lending agreements, at market value.”

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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Fixed Maturities and Fixed Maturities Pledged Under Securities Lending Agreements

The following table summarizes the Company’s fixed maturities and fixed maturities pledged under securities lending agreements:

			Included in Accumulated Other Comprehensive Income (“AOCI”)
					Gross Unrealized Losses
(U.S. dollars in thousands)	Estimated Market Value		Gross Unrealized Gains		Non-OTTI Unrealized Losses			OTTI Unrealized Losses (1)			Amortized Cost
March 31, 2009:
Corporate bonds	$	2,181,763	$	32,016	$	(99,877	)	$	(23,672	)	$	2,273,296
Mortgage backed securities	1,692,863		31,111		(70,249		)	(67,981		)	1,799,982
U.S. government and government agencies	1,547,416		51,239		(6,940		)	(614		)	1,503,731
Commercial mortgage backed securities	1,209,605		20,153		(42,587		)	(5,689		)	1,237,728
Asset backed securities	922,560		8,388		(29,955		)	(15,833		)	959,960
Municipal bonds	861,954		32,621		(1,959		)	(198		)	831,490
Non-U.S. government securities	627,941		22,550		(23,477		)	(647		)	629,515
Total	$	9,044,102	$	198,078	$	(275,044	)	$	(114,634	)	$	9,235,702
December 31, 2008:
Corporate bonds	$	2,019,373	$	51,131	$	(98,979	)	—			$	2,067,221
Mortgage backed securities	1,581,736		23,306		(125,759		)	—			1,684,189
U.S. government and government agencies	1,463,897		77,762		(14,159		)	—			1,400,294
Commercial mortgage backed securities	1,219,737		16,128		(68,212		)	—			1,271,821
Asset backed securities	970,041		1,121		(70,762		)	—			1,039,682
Municipal bonds	965,966		26,815		(1,730		)	—			940,881
Non-U.S. government securities	527,972		33,690		(31,884		)	—			526,166
Total	$	8,748,722	$	229,953	$	(411,485	)	—			$	8,930,254

(1) Represents the total other-than-temporary impairments (“OTTI”) recognized in accumulated other comprehensive income (“AOCI”) at March 31, 2009.

The contractual maturities of the Company’s fixed maturities and fixed maturities pledged under securities lending agreements are shown below. Expected maturities, which are management’s best estimates, will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

	March 31, 2009				December 31, 2008
(U.S. dollars in thousands) Maturity	Estimated Market Value		Amortized Cost		Estimated Market Value		Amortized Cost
Due in one year or less	$	177,866	$	180,842	$	173,168	$	169,187
Due after one year through five years	2,835,183		2,857,223		2,451,062		2,452,344
Due after five years through 10 years	1,784,817		1,756,034		1,726,742		1,686,575
Due after 10 years	421,208		443,933		626,236		626,456
	5,219,074		5,238,032		4,977,208		4,934,562
Mortgage backed securities	1,692,863		1,799,982		1,581,736		1,684,189
Commercial mortgage backed securities	1,209,605		1,237,728		1,219,737		1,271,821
Asset backed securities	922,560		959,960		970,041		1,039,682
Total	$	9,044,102	$	9,235,702	$	8,748,722	$	8,930,254

18

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following table provides an analysis of the length of time each of those fixed maturities, fixed maturities pledged under securities lending agreements, equity securities and short-term investments with an unrealized loss has been in a continual unrealized loss position:

<

	Less than 12 Months					12 Months or More					Total
(U.S. dollars in thousands)	Estimated Market Value		Gross Unrealized Losses (1)			Estimated Market Value		Gross Unrealized Losses (1)			Estimated Market Value		Gross Unrealized Losses (1)
March 31, 2009:
Corporate bonds	$	874,438	$	(97,914	)	$	92,736	$	(25,635	)	$	967,174	$	(123,549	)
Mortgage backed securities	459,638		(51,091		)	127,043		(87,139		)	586,681		(138,230		)
U.S. government and government agencies	187,544		(7,554		)	—		—			187,544		(7,554		)
Commercial mortgage backed securities	499,768		(31,161		)	80,292		(17,115		)	580,060		(48,276		)
Asset backed securities	385,775		(35,666		)	48,813		(10,122		)	434,588		(45,788		)
Municipal bonds	67,822		(1,818		)	7,562		(339		)	75,384		(2,157		)
Non-U.S. government securities	43,630		(23,908		)	5,741		(216		)	49,371		(24,124		)
Total	2,518,615		(249,112		)	362,187		(140,566		)	2,880,802		(389,678		)
Other investments	28,715		(17,687		)	—		—			28,715		(17,687		)
Short-term investments	88,597		(1,124		)	—		—			88,597		(1,124		)
Total	$	2,635,927	$	(267,923	)	$	362,187	$	(140,566	)	$	2,998,114	$	(408,489	)
December 31, 2008:
Corporate bonds	$	870,093	$	(89,446	)	$	30,608	$	(9,533	)	$	900,701	$	(98,979	)
Mortgage backed securities	417,373		(105,154		)	23,295		(20,605		)	440,668		(125,759		)
U.S. government and government agencies	356,719		(14,159		)	—		—			356,719		(14,159		)
Commercial mortgage backed securities	714,497		(68,210		)	52		(2		)	714,549		(68,212		)
Asset backed securities	888,908		(63,845		)	26,185		(6,917		)	915,093		(70,762		)
Municipal bonds	93,072		(1,730		)	—		—			93,072		(1,730		)