Arch Capital Group Ltd.
2018 Annual Report
Amounts in millions, except percentages and per share amounts
Book value per common share at year-end
Net income available to common shareholders*
Per share
Net income return on average common equity
After-tax operating income*
Per share
2018
$21.52
$713.6
$ 1.73
8.4%
$909.2
$ 2.20
Operating return on average common equity
10.7%
2017
$20.30
$566.5
$ 1.36
7.2%
$447.2
$ 1.07
5.7%
Change
6.0%
26.0%
27.2%
103.3%
105.6%
Table excludes amounts related to the “other” segment. All per share amounts are on a
diluted basis.
To Our Shareholders:
Arch’s business model is aimed at growing book value per share. The Company’s diversification across three
segments—property casualty insurance, property casualty reinsurance and mortgage insurance and reinsurance—
supports that model by giving us opportunities to invest in the sectors and product lines that offer the best potential
risk-adjusted returns at any given time. At the same time, we are underweight in those sectors and product lines
in which we perceive the risk-adjusted returns to be inadequate. Our allocation of capital across segments is
dynamic—we increase or reduce our allocation among and within segments as opportunities emerge or diminish.
The soundness of our model proved itself again in 2018 as we performed well financially, despite a second
consecutive year of unusually high industry-wide property casualty catastrophe losses. We fared well in 2018
compared to the property casualty industry because we were relatively underweight in property catastrophe
coverages, where we felt pricing was inadequate, while we allocated a significant portion of our capital to mortgage
insurance and other sectors that provided favorable expected returns.
Book Value per Share and Operating Return on Equity
Book value per share is a key measure used to evaluate the Company’s performance, since we believe increases in
this metric over time are what ensure the creation of long-term value for shareholders. The Company’s book value
per share rose to $21.52 at the end of 2018, up 6.0% from year-end 2017, the 10th consecutive annual increase.
Book value per share has now grown at an average annual rate of 14.2% over the past decade.
* Please refer to “Net Income, Operating Income, Underwriting Results and Cash” for a discussion of the components of net income available
to common shareholder and after-tax operating income. After-tax operating income, which is a non-GAAP measure of financial performance,
is defined as net income available to common shareholders, excluding 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, transaction costs
and other and loss on redemption of preferred shares, net of income taxes. The reconciliation of net income available to common shareholders
to after-tax operating income can be found in the Company’s Annual Report on Form 10-K, filed with the SEC on February 28, 2019, under the
caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” A copy of the Form 10-K is available on the
Company’s web site and accompanies this letter.
Operating return on equity (“ROE”) is a key driver of book value growth. The Company’s operating ROE was
10.7% in 2018, up from 5.7% in 2017, and has averaged 10.3% during the past decade. Operating ROE consists
primarily of underwriting income and net investment income and excludes net realized gains and losses, equity in
net income and losses of investment funds accounted for using the equity method, net foreign exchange gains and
losses and other “non-operating” items.
All financial results in this letter are presented on a core basis, which excludes amounts related to the “other”
segment, i.e., Watford Holdings Ltd. (“Watford”). In accordance with GAAP, 100% of the results of Watford are
included in the Company’s consolidated financial statements even though the Company owns only about an 11%
equity interest in Watford. We believe core results offer a more meaningful way for investors, analysts, rating
agencies and others to evaluate the Company’s performance. Results for the “other” segment can be found on pages
110 to 116 of the Company’s Form 10-K for 2018.
Core Principles, Earnings and Underwriting Results
The Company writes specialty lines of insurance and reinsurance in which we seek to employ our knowledge,
skills and strong capital base to competitive advantage. We are deeply committed in all our lines to our operating
principles of innovation, sound risk selection, underwriting discipline, diversification and deploying our capital only
when we believe the risk-adjusted return opportunities available to us meet our objectives.
The Company’s net income reached $713.6 million, or $1.73 per share, in 2018, rising 27.2% from 2017 on a per-share
basis. After-tax operating income increased to $909.2 million, or $2.20 per share, up 105.6% on a per-share basis.
Underwriting income advanced 75.6%, to $897.1 million, as we continued to benefit from our diverse portfolio
of insurance and reinsurance businesses. The Company’s combined ratio—a measure of underwriting profitability—
improved to 81.0% in 2018 from 88.8% in 2017. A combined ratio below 100% indicates an underwriting profit.
All three business segments contributed to the 2018 improvement, led by our mortgage insurance group.
Results for 2018 included $193.3 million of catastrophe losses, down from $385.8 million in 2017. We have
scaled back our participation in the property catastrophe insurance and reinsurance markets over the last several
years, reflecting the lack of attractiveness in the risk-reward characteristics of these markets. Property catastrophe
coverage represented 5.8% of our net reinsurance premiums written in 2018, down from 6.0% in 2017 and 25.9% in
2011. Major natural disasters in 2018 included Hurricane Michael in the southeastern United States and wildfires in
California, amid ongoing public concern about the impact of climate change. It is uncertain whether climate change
will lead to an increased pattern of natural disasters and persistently high catastrophe losses, but we remain alert to
the issue and continue to factor it into our assessment of pricing adequacy.
Net favorable reserve development was $270.5 million in 2018, essentially unchanged from 2017, as earlier-year
reserves proved to be more than adequate, resulting in the release of a portion of these reserves to earnings. While
2018 represented our 16th consecutive year of favorable reserve development, we review the adequacy of our
reserves quarterly and there is no guarantee that favorable reserve development will continue in the future.
2
We continued to generate a healthy level of cash flow. Net cash provided by operating activities was $1.3 billion in
2018, up from $0.8 billion in 2017, reflecting a variety of factors, including the solid performance of our business units.
Investment Results
Total investable assets were $19.6 billion at the end of 2018, down slightly from year-end 2017, as we repaid debt
and returned capital to shareholders through share repurchases. Net investment income was $438.0 million, or $1.06
per share, in 2018, advancing 16.5% from 2017 on a per-share basis.
The year was challenging for investors, as both the fixed income and equity markets provided meager or negative
returns. The benchmark 10-year U.S. Treasury note had a total return of -0.03%, while the U.S. stock market
returned -4.38%, as measured by the S&P 500 Index. We maintained a defensive posture through our investments
in high-quality fixed income securities and the relatively short average duration of our fixed income holdings. At
year-end 2018, approximately 81% of the portfolio was invested in fixed maturity and short-term securities, with an
average credit quality of “AA/Aa2.” The average effective duration of the portfolio was 3.38 years at December 31,
2018, and 2.83 years at the end of 2017. In addition, we allocate a portion of the portfolio to alternative investments
and equities, which provide diversification and offer the potential for higher returns. Such investments accounted
for approximately 16% of the portfolio at the end of 2018.
Our investment approach stresses preservation of capital, market liquidity and diversification of risk. We also
focus on maximizing total return, which contributes to increases in book value per common share but may not be
entirely reflected in operating income or net income. Total return (consisting of net investment income, net realized
gains and losses, changes in unrealized gains and losses and equity in the net income or losses of investment funds
accounted for using the equity method) was 0.33% in 2018 compared to 5.87% in 2017. All components of total
return, except for changes in unrealized gains and losses, are included in the Company’s net income, while only net
investment income is included in operating income.
Market values for many types of fixed income securities declined in 2018 as interest rates rose—hence our low
total return for the year. Even though higher interest rates negatively affected the market value of many of our
fixed income holdings, they provided opportunities to invest new money at higher yields, which could benefit the
Company going forward. The pre-tax investment income yield of the portfolio was 2.36% for 2018 and 2.06% for
2017, while the embedded book yield, before investment expenses, increased to 2.89% at the end of 2018 from
2.32% a year earlier.
As discussed in prior letters, we divide the portfolio for investment purposes into three main categories:
investments generated from our insurance, reinsurance and mortgage operations cash flows; investments supported
by our debt and hybrid securities; and investments supported by common shareholders’ equity. For our insurance,
reinsurance and mortgage liabilities, we generally attempt to match, within a reasonable range, the duration of our
investments to the duration of the underlying claim obligations. We manage the portfolio conservatively to protect
our reserves on an economic basis and ensure our ongoing ability to pay claims. For our debt and hybrid securities
3
and common shareholders’ equity, we vary the duration of the portfolio based on our view of potential returns and
the outlook for investments and the economy in general.
Market Segments
Arch writes property casualty insurance and reinsurance for commercial accounts primarily from operations in
Bermuda, the United States, Canada and Europe. We write mortgage insurance and reinsurance in the United States,
Bermuda, Europe, Australia and Hong Kong. Companywide, net premiums written were $4.7 billion in 2018, a
7.6% increase over 2017.
Technology continues to be an increasingly powerful tool in all our segments, helping us reduce costs, make more
informed underwriting decisions and deliver better service to our customers. Our use of data analytics to assess
risk more accurately and enable risk-based pricing is an example: we pioneered risk-based pricing in the mortgage
insurance business with RateStar, which tailors pricing to a homebuyer’s individual risk characteristics, rather than
using a standardized rate card. RateStar allows us to provide more granular pricing on each loan, based on its risk
characteristics. We continue to expand the use of data analytics in other parts of our business.
Property casualty insurance: Based on premiums written, this is our largest segment, accounting for 47% of
the Company’s premium volume in 2018. Net premiums written were $2.21 billion in 2018, up 4.2% from 2017.
Insurance pricing has been under pressure for several years and competition is especially fierce in the insurance
purchases of the largest corporations. Consequently, our underwriting results have not met our return hurdles for
the past two years, although they improved significantly in 2018.
Over the past several years, we have responded to an extended soft market by carving out positions in those
specialty areas where we see attractive, long-term opportunities. For example, in 2018, we continued to build our
position in travel and accident insurance. This product line accounted for 13.1% of the segment’s net premiums
written in 2018, up from 11.7% in 2017 and 4.2% in 2011. In addition, we continued to migrate toward serving
smaller and mid-sized corporate clients, where insurance is less commoditized and we can get closer to the insured
and provide added value. We announced the acquisition of two companies in 2018 in support of this objective.
McNeil & Co., which provides risk management services and insurance programs to businesses in the United
States, was acquired in December. On January 1, 2019, we completed the acquisition of the commercial lines
business of The Ardonagh Group in the U.K., including commercial property, casualty, motor, professional liability,
personal accident and travel insurance.
Property casualty reinsurance: This segment represented 29% of the Company’s premium volume in 2018 as net
premiums written increased 16.9% to $1.37 billion for the year. In 2018, as in 2017, our growth reflected increased
writings of motor business in Europe and non-catastrophe exposed property coverages.
4
The profitability of our reinsurance segment improved in 2018, despite industry-wide overcapacity in most
product lines and continued weak pricing in many lines. Average rate increases for property catastrophe reinsurance
were positive, but below expectations during the January 2019 renewals. We remain agile in our approach to the
reinsurance market, allowing us to deliver more solutions to our clients, more quickly than our competitors. We
reduced our participation in large, commoditized risks and continue to seek attractive opportunities.
Mortgage insurance and reinsurance: Mortgage insurance and reinsurance was our most profitable segment in
2018 and represented 24% of the Company’s premium volume. Net premiums written were $1.16 billion for the
year, increasing 4.2% from 2017, as we continued to allocate additional capital to this segment. The mortgage
business remains very attractive because of desirable market conditions, the visibility and sustainability of its
earnings and the low historical correlation of returns in mortgage insurance to returns in property casualty
insurance and reinsurance. As a result, we continued to grow our mortgage insurance in force (the aggregate dollar
amount of each insured mortgage loan’s current principal balance) to $384 billion at the end of 2018, from $352
billion a year earlier. Insurance in force represents a source of future income as insurance premiums are typically
paid monthly over the period of coverage.
We are an innovator in mortgage credit risk, as demonstrated by our 2018 launch of Arch Mortgage Risk Transfer.
This unit is engaged in pilot programs to accept mortgage-related risks from both Fannie Mae and Freddie Mac
and arrange the transfer of that risk to a panel of approved reinsurance capital providers. The goal is to attract a
diversified and robust capital base to the U.S. housing market and, in doing so, support market stability through
economic cycles.
Managing Third-Party Capital
We have been intentionally building a third-party management capability—that is, using our underwriting
platform to generate income by managing risk for others. Insurers and reinsurers are evolving from being risk takers
exclusively toward newer models where they manage risk for others or utilize pass-through entities to keep some
risk on their balance sheets and pass along the rest to the capital markets.
We have had great success in our mortgage insurance segment by sharing risk with the capital markets through a
series of mortgage insurance-linked securities transactions issued through the Bellemeade special purpose vehicle,
including three transactions in 2018. Since the inception of the program, these Bellemeade transactions have raised
nearly $2.5 billion of reinsurance protection for loans representing over $220 billion of unpaid principal balance.
Other examples include our ownership position in Premia Holdings Ltd., formed in 2017 to provide runoff
solutions for property casualty insurance and reinsurance companies, and our multi-year agreement in 2018 with a
major European reinsurer to provide mortgage credit assessment and underwriting advisory services related to that
company’s involvement in credit risk transfer programs offered by Fannie Mae and Freddie Mac.
5
Strong Balance Sheet
The Company has a healthy, liquid balance sheet with a 22.5% ratio of debt and hybrids to total capital at the
end of 2018, down from 26.4% a year earlier, as we repaid the remaining balance of our revolving line of credit.
A strong capital position underpins our ability to write insurance, serve clients and quickly adapt to business
opportunities as they arise.
We have consistently maintained that we are stewards of the capital entrusted to us and seek to create value for
shareholders by deploying this capital profitably in the business. Whenever the Company has excess capital not
needed in the business, we look to return the excess to Arch shareholders, its rightful owners. One way we do so
is by repurchasing Arch common shares in the open market. In 2018, we repurchased 10.6 million shares for a
total of $282.8 million, or an average price of $26.78 per share. At year-end, $163.7 million was available for share
repurchases under the Board of Directors’ authorization.
Arch People
Our success in the highly competitive world of insurance and reinsurance depends on an ability to attract
and retain talented people who fit well with our culture of teamwork, accountability and innovation; provide
opportunities for them to develop their skills and advance in their careers; and reward them well for long-term
performance. We pride ourselves on our deep pool of skilled, motivated people and our track record of promoting
from within.
Corporate
In May 2018, François Morin was named Executive Vice President and Chief Financial Officer. François has
nearly 30 years of experience in the insurance industry and joined Arch in 2011, serving most recently as Senior
Vice President, Chief Risk Officer and Chief Actuary.
More recently, Janice Englesbe joined Arch as Senior Vice President, Chief Risk Officer, succeeding François in
that position. She has more than 25 years of experience in risk management in the property casualty industry.
Mortgage Insurance
In March 2019, we announced strategic leadership changes to the Global Mortgage Group. Andrew Rippert
was named Arch’s first Chief Innovation and Strategic Investment Officer. Andrew joined Arch in 2010 and most
recently served as Chief Executive Officer of the Global Mortgage Group. In this newly created role, he will be
responsible for pursuing innovative business models and developing a pipeline of creative products, services and
untapped markets to deliver future revenue streams across all business lines.
David Gansberg succeeds Andrew as Chief Executive Officer, Global Mortgage Group. David joined Arch in
2001 and held several roles in the Reinsurance Group before becoming the President and Chief Executive Officer
of Arch Mortgage Insurance Company (“Arch MI”) in 2014.
6
Michael Schmeiser was named President and Chief Executive Officer of Arch MI, reporting to David Gansberg.
Michael joined Arch in 2017 following Arch’s acquisition of United Guaranty. Most recently, he has served as Chief
Strategy Officer of the Global Mortgage Group, reporting to Andrew Rippert.
Insurance
During the year, we announced several leadership team promotions in our Insurance Group. Matt Shulman
assumed the newly created role of Chief Executive Officer, Arch Insurance North America, heading our property
casualty insurance operations in the United States and Canada. Matt joined Arch in 2009 and had served as
President and Chief Executive Officer of Arch Insurance Europe since 2016.
Additionally, Arch Insurance North America established a new organizational structure with three Chief
Underwriting Officers (“CUOs”) reporting to Matt Shulman. These CUOs provide strategic, dedicated oversight of
their business units, allowing Arch to provide more flexible, comprehensive solutions. The three CUOs are:
Brian First as CUO—Programs, Property and Specialty. This encompasses A&H/Travel, Alternative Markets,
Contract Binding, E&S Casualty, Property & Casualty Programs and Property. Brian joined Arch in 2014 and most
recently served as Executive Vice President, Property & Casualty Programs and Alternative Markets.
John Rafferty as CUO—Financial and Professional Lines. This includes Executive Assurance, Professional
Liability and Healthcare. John joined Arch in 2009 and was previously Executive Vice President, Executive
Assurance and Business Unit Management.
Rich Stock as CUO—Large Account Casualty and Surety. This encompasses Casualty, Construction, High Excess
Workers’ Compensation, Lenders, National Accounts and Surety. Rich joined Arch in 2005 and served as Executive
Vice President, Construction, National Accounts and Excess Workers’ Compensation prior to assuming the CUO role.
Mark Lange was promoted to Executive Vice President, Strategy and Distribution, for Arch Insurance Group’s North
American operations. He joined Arch in 2015 as Senior Vice President of the Property & Casualty Programs business.
Hugh Sturgess was promoted to Chief Executive Officer, Arch Insurance International, leading our property
casualty insurance operations in Europe, Bermuda and Australia. He has been with the Company since 2005,
serving most recently as President and Chief Executive Officer of Arch Insurance Canada Ltd.
John Mentz, President of Arch Insurance North America, took on additional responsibilities as Arch Insurance
Worldwide Chief Operating Officer. He oversees various corporate functions including finance, actuarial, operations
and ceded reinsurance and, in his expanded role, is extending our best practices to our property casualty insurance
operations globally. John has been with Arch since 2002.
7
Board of Directors
We are pleased to note the election of Laurie S. Goodman to the Arch Board of Directors at the Annual Meeting
of Shareholders in May. Laurie is the founder and Co-Director of the nonprofit Housing Finance Policy Center at
the Urban Institute. She brings a wealth of insight and experience to our Board, not only in her current work at the
Urban Institute, which she joined in 2013, but also in three prior decades at Wall Street firms.
Yiorgos Lillikas, a member of our Board since 2010, has elected not to stand for re-election at the 2019 annual
meeting because of new professional responsibilities. We appreciate his involvement as a member of our Board and
thank him for his contributions to the Company.
Summary
Taken together, 2017 and 2018 produced extreme property casualty insured losses. Despite these challenging
market conditions, we grew our book value per share for the 10th consecutive year and generated increased earnings
in 2018 through the diversity of our product lines and our ability to allocate capital to the best opportunities.
Five values help distinguish what Arch is and what it stands for: work hard and smart to serve all of our
stakeholders; embrace the power of teamwork; continually pursue innovation and improvement; exhibit honesty
and integrity in all we do; and strive to make a difference in our communities. With our culture of innovation and
excellence, and our proven history of underwriting discipline across a diverse portfolio of businesses, we remain
confident in the Company’s future.
We thank Arch employees for their dedication to the Company and their indispensable contributions to its
success. We thank our agents and brokers for their ongoing support, and our customers for choosing to do business
with us. We recognize that our customers have other choices and it is incumbent upon us to continue to serve their
needs with the highest quality decisions, products and experiences. And we thank you, our investors, for the trust
you have placed in us through your ownership of our stock.
Constantine “Dinos” Iordanou
Marc Grandisson
Chairman
March 2019
President and Chief Executive Officer
8
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 2018
Commission File No. 001-16209
ARCH CAPITAL GROUP LTD.
(Exact name of registrant as specified in its charter)
Bermuda
(State or other jurisdiction of incorporation or organization)
Waterloo House, Ground Floor
100 Pitts Bay Road, Pembroke HM 08, Bermuda
(Address of principal executive offices)
Not applicable
(I.R.S. Employer Identification No.)
(441) 278-9250
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Exchange Act:
Title of each class
Common Shares, $0.0011 par value per share
5.25% Non-Cumulative Preferred Shares, Series E, $0.01 par value per share
5.45% Non-Cumulative Preferred Shares, Series F, $0.01 par value per share
Name of each exchange on which registered
NASDAQ Stock Market (Common Shares)
NASDAQ Stock Market
NASDAQ Stock Market
Securities registered pursuant to Section 12(g) of the Exchange Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes
No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.
Yes
No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act 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
No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). Yes
No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained
herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any amendment to this Form 10-K.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting
company, or an emerging growth 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
Accelerated Filer
Non-accelerated Filer
Smaller reporting company
Emerging Growth Company
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.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes
No
The aggregate market value of the voting and non-voting common equity held by non-affiliates, computed by reference to the closing price as
reported by the NASDAQ Stock Market as of the last business day of the Registrant’s most recently completed second fiscal quarter, was
approximately $10.3 billion.
As of February 25, 2019, there were 402,529,670 of the registrant’s common shares outstanding.
Portions of Part III and Part IV incorporate by reference our definitive proxy statement for the 2019 annual meeting of shareholders to be
filed with the Securities and Exchange Commission pursuant to Regulation 14A before May 1, 2019.
DOCUMENTS INCORPORATED BY REFERENCE
ARCH CAPITAL GROUP LTD.
TABLE OF CONTENTS
Item
Page
ITEM 1.
BUSINESS
ITEM 1A. RISK FACTORS
ITEM 1B. UNRESOLVED STAFF COMMENTS
ITEM 2.
ITEM 3.
ITEM 4.
PROPERTIES
LEGAL PROCEEDINGS
MINE SAFETY DISCLOSURES
PART I
PART II
ITEM 5.
MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
ITEM 6.
SELECTED FINANCIAL DATA
ITEM 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
ITEM 9A. CONTROLS AND PROCEDURES
ITEM 9B. OTHER INFORMATION
PART III
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
ITEM 11.
EXECUTIVE COMPENSATION
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
AND RELATED STOCKHOLDER MATTERS
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
ITEM 16.
FORM 10-K SUMMARY
PART IV
4
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51
52
52
52
54
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93
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176
177
177
178
178
179
179
179
188
Cautionary Note Regarding Forward-Looking Statements
The Private Securities Litigation Reform Act of 1995 (“PSLRA”) provides a “safe harbor” for forward-looking statements. This
report 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 report 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, elsewhere in this report and in our periodic reports filed
with the Securities and Exchange Commission (“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 any 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, unemployment, housing prices, foreign currency
exchange rates, prevailing credit terms and the depth and duration of a recession) and conditions specific to the reinsurance
and insurance markets (including the length and magnitude of the current “soft” market) in which we operate;
• competition, including increased competition, on the basis of pricing, capacity (including alternative sources of capital),
coverage terms, or other factors;
• developments in the world’s financial and capital markets and 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 December 31, 2018;
• 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 or severe economic events in our insurance, reinsurance and mortgage
businesses could cause large losses and substantial volatility in our results of operations;
•
the effect of climate change on our business;
• 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;
• 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;
• 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;
• a disruption caused by cyber-attacks or other technology breaches or failures on us or our business partners and service providers,
which could negatively impact our business and/or expose us to litigation;
• statutory or regulatory developments, including as to tax 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, including the recently enacted
Tax Cuts and Jobs Act of 2017; and
•
the other matters set forth under Item 1A “Risk Factors,” Item 7 “Management’s Discussion and Analysis of Financial Condition
and Results of Operations” and other sections of this Annual Report on Form 10-K, as well as the other factors set forth in Arch
Capital Group Ltd.’s other documents on file with the SEC, and management’s response to any of the aforementioned factors.
All subsequent written and oral forward-looking statements attributable to 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.
PART I
ITEM 1. BUSINESS
As used in this report, references to “we,” “us,” “our,” “Arch”
or the “Company” refer to the consolidated operations of Arch
Capital Group Ltd. (“Arch Capital”) and its subsidiaries.
Tabular amounts are in U.S. Dollars in thousands, except share
amounts, unless otherwise noted. We refer you to Item 1A “Risk
Factors” for a discussion of risk factors relating to our business.
OUR COMPANY
General
Arch Capital, a Bermuda public limited liability company with
$11.17 billion in capital at December 31, 2018, provides
insurance, reinsurance and mortgage insurance on a worldwide
basis through its wholly owned subsidiaries. While we are
positioned to provide a full range of property, casualty and
mortgage insurance and reinsurance lines, we focus on writing
specialty lines of insurance and reinsurance. For 2018, we wrote
$5.35 billion of net premiums and reported net income available
to Arch common shareholders of $713.6 million. Book value
per share was $21.52 at December 31, 2018, compared to
$20.30 per share at December 31, 2017.
Arch Capital’s registered office is located at Clarendon House,
2 Church Street, Hamilton HM 11, Bermuda (telephone
number: (441) 295-1422), and its principal executive offices
are located at Waterloo House, Ground Floor, 100 Pitts Bay
Road, Pembroke HM 08, Bermuda (telephone number:
(441) 278-9250). Arch Capital makes available free of charge
through its website, located at www.archcapgroup.com, its
annual reports on Form 10-K, quarterly reports on Form 10-Q,
current reports on Form 8-K, and all amendments to those
reports as soon as reasonably practicable after such material is
electronically filed with, or furnished to, the SEC. The SEC
maintains an Internet site that contains reports, proxy and
information statements, and other information regarding issuers
that file electronically with the SEC (such as Arch Capital) and
the address of that site is www.sec.gov.
Our History
Arch Capital was formed in September 2000 and became the
sole shareholder of Arch Capital Group (U.S.) Inc. (“Arch-
U.S.”) pursuant to an internal reorganization transaction
completed in November 2000. In October 2001, Arch Capital
launched an underwriting initiative to meet current and future
demand in the global insurance and reinsurance markets that
included the recruitment of new management teams and an
equity capital infusion of $763.2 million. Since that time, we
have attracted a proven management team with extensive
industry experience and enhanced our existing global
underwriting platform for our insurance and reinsurance
businesses. It is our belief that our underwriting platform, our
experienced management team and our strong capital base that
is unencumbered by significant pre-2002 risks have enabled us
to establish a strong presence in the global insurance and
reinsurance markets.
Prior to the 2001 underwriting initiative, our insurance
underwriting platform consisted of Arch Insurance (Bermuda),
a division of Arch Reinsurance Ltd. (“Arch Re Bermuda”), our
Bermuda-based reinsurer and insurer, and our U.S.-licensed
insurers, Arch Insurance Company (“Arch Insurance”), Arch
Excess & Surplus Insurance Company (“Arch E&S”), Arch
Specialty Insurance Company (“Arch Specialty”) and Arch
Indemnity Insurance Company (“Arch Indemnity”). We
established Arch Insurance Company (Europe) Limited (“Arch
Insurance Company Europe”), our United Kingdom-based
subsidiary, in 2004, and we expanded our North American
presence when Arch Insurance opened a branch office in
Canada in 2005. In 2013, Arch Insurance Canada Ltd. (“Arch
Insurance Canada”), a Canada domestic company, commenced
operations and replaced the branch office. In 2009, we
established a managing agent and syndicate 2012 (“Arch
Syndicate 2012”) at Lloyd’s of London (“Lloyd’s”). In
December 2018, we completed the acquisition of McNeil &
Company, Inc. (“McNeil”), a U.S. nationwide leader in
specialized risk management and program administration
headquartered in Cortland, New York. In addition, we acquired
U.K. commercial lines business from Ardonagh Group in
January 2019. See “Operations—Insurance Operations” for
further details on our insurance operations.
Prior to the 2001 underwriting initiative, our reinsurance
underwriting platform consisted of Arch Re Bermuda and Arch
Reinsurance Company (“Arch Re U.S.”), our U.S.-licensed
reinsurer. Our reinsurance operations in Europe began in 2006
with the formation of a Swiss branch of Arch Re Bermuda, and
the formation of a Danish underwriting agency in 2007. In
addition to the U.S. reinsurance treaty activities of Arch Re
U.S., we launched our property facultative reinsurance
underwriting operations in 2007, which underwrite in the U.S.,
Canada and Europe. In 2008, we formed Arch Reinsurance
Europe Designated Activity Company (“Arch Re Europe”), our
Ireland-based reinsurance company, which replaced the Swiss
branch. We launched treaty operations in Canada in 2011 and
the following year we acquired the credit and surety reinsurance
operations of Ariel Reinsurance Company Ltd. In 2015, we
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obtained complete ownership and effective control of Gulf
Reinsurance Limited (“Gulf Re”), previously a joint venture.
See “Operations—Reinsurance Operations” for further details
on our reinsurance operations.
Our mortgage operations include U.S. and international
mortgage insurance and reinsurance operations as well as
participation in government sponsored enterprise (“GSE”)
credit risk sharing transactions. Our mortgage platform was
built through the acquisition of CMG Mortgage Insurance
Company in 2014 (subsequently renamed Arch Mortgage
Insurance Company) and further expanded through the
acquisition of United Guaranty Corporation
(“UGC”)
(including United Guaranty Residential Insurance Company),
from American International Group, Inc. (“AIG”), which
closed at the end of 2016. In 2017, we completed the acquisition
of AIG United Guaranty Insurance (Asia) Limited (renamed
“Arch MI Asia Limited”) from AIG.
Our U.S. primary mortgage operations provide mortgage
insurance products and services to the U.S. market. These
operations include providers that are also approved as eligible
mortgage insurers by Federal National Mortgage Association
(“Fannie Mae”) and Federal Home Loan Mortgage Corporation
(“Freddie Mac”), each a GSE. Arch Mortgage Insurance
Designated Activity Company (“Arch MI Europe”), provides
mortgage insurance products and services to the European
market. In January 2019, Arch LMI Pty Ltd (“Arch LMI”) was
authorized by the Australian Prudential Regulation Authority
(“APRA”) to write lenders’ mortgage insurance on a direct basis
in Australia.
The mortgage operations also include participation in GSE
credit risk-sharing transactions and direct mortgage insurance
to U.S. mortgage lenders with respect to mortgages that lenders
intend to retain in portfolio or include in non-agency
securitizations along with mortgage reinsurance for the U.S.
and Australian markets. See
“Operations—Mortgage
Operations” for further details on our mortgage operations.
In 2014 we acquired approximately 11% of Watford Holdings
Ltd. Watford Holdings Ltd. is the parent of Watford Re Ltd., a
multi-line Bermuda reinsurance company (together with
Watford Holdings Ltd., “Watford Re”). In 2017, we acquired
approximately 25% of Premia Holdings Ltd. Premia Holdings
Ltd. is the parent of Premia Reinsurance Ltd., a multi-line
Bermuda reinsurance company (together with Premia Holdings
Ltd., “Premia Re”). See “Operations—Other Operations” for
further details on Watford Re and Premia Re.
The board of directors of Arch Capital (the “Board”) has
authorized the investment in Arch Capital’s common shares
through a share repurchase program. Repurchases under the
share repurchase program may be effected from time to time in
open market or privately negotiated transactions through
December 31, 2019. Since the inception of the share repurchase
program in February 2007 through December 31, 2018, Arch
Capital has repurchased 386.2 million common shares for an
aggregate purchase price of $3.97 billion. At December 31,
2018, the total remaining authorization under the share
repurchase program was $163.7 million.
OPERATIONS
We classify our businesses into three underwriting segments —
insurance, reinsurance and mortgage — and two other operating
segments — ‘other’ and corporate (non-underwriting). For an
analysis of our underwriting results by segment, see note 4,
“Segment
financial
statements in Item 8 and “Management’s Discussion and
Analysis of Financial Condition and Results of Operations—
Results of Operations.”
to our consolidated
Information,”
Insurance Operations
Our insurance operations are conducted in Bermuda, the United
States, Europe, Canada, and Australia. Our
insurance
operations in Bermuda are conducted through Arch Insurance
(Bermuda), a division of Arch Re Bermuda, and Alternative Re
Limited.
In the U.S., our insurance group’s principal insurance
subsidiaries are Arch Insurance, Arch Specialty, Arch
Indemnity and Arch E&S. Arch Insurance is an admitted insurer
in 50 states, the District of Columbia, Puerto Rico, the U.S.
Virgin Islands and Guam. Arch Specialty is an approved excess
and surplus lines insurer in 49 states, the District of Columbia,
Puerto Rico and the U.S. Virgin Islands and an authorized
insurer in one state. Arch Indemnity is an admitted insurer in
49 states and the District of Columbia. Arch E&S, which is not
currently writing business, is an approved excess and surplus
lines insurer in 47 states and the District of Columbia and an
authorized insurer in one state. The headquarters for our
insurance group’s U.S. support operations
(excluding
underwriting units) is in Jersey City, New Jersey. The insurance
group has offices throughout the U.S., including five regional
offices located in Alpharetta, Georgia, Chicago, Illinois, New
York, New York, San Francisco, California and Dallas, Texas
and additional branch offices. In December 2018, the U.S.
insurance operations acquired McNeil, based in Cortland, New
York, which provides specialized risk management and
program administration.
Our insurance operations in Canada are conducted through Arch
Insurance Canada, a Canada domestic company which is
authorized in all Canadian provinces and territories. Arch
Insurance Canada is headquartered in Toronto, Ontario. Our
insurance operations in Europe are conducted on two platforms,
Arch Insurance Company Europe and Arch Syndicate 2012 (the
U.K. insurance operations are collectively referred to as “Arch
Insurance Europe”). Arch Insurance Europe conducts its
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operations from London, England. Arch Insurance Company
Europe is eligible by virtue of the U.S. Nonadmitted and
Reinsurance Reform Act of 2010 (“NRRA”) as an excess and
surplus lines insurer in 50 states, the District of Columbia, the
U.S. Virgin Islands, Guam, the Northern Mariana Islands and
American Samoa. Arch Insurance Company Europe also has
branches in Germany, Italy, Spain and Denmark. In January
2019, Arch Insurance Europe operations expanded to include
the Arch U.K. Regional Division, which underwrites the U.K.
commercial lines acquired from the Ardonaugh Group.
Arch Underwriting at Lloyd’s Ltd (“AUAL”) is the managing
agent of Arch Syndicate 2012 and is responsible for the daily
management of Arch Syndicate 2012. Arch Syndicate 2012
provides access to Lloyd’s extensive distribution network and
worldwide licenses. Arch Underwriting at Lloyd’s (Australia)
Pty Ltd, based in Sydney, Australia, is a Lloyd’s services
company which underwrites exclusively for Arch Syndicate
2012. Arch Underwriting Agency (Australia) Pty. Ltd. is an
Australian agency which also underwrites for Arch Syndicate
2012 and third parties.
Strategy. Our insurance group’s strategy is to operate in lines
of business in which underwriting expertise can make a
meaningful difference in operating results. The insurance group
focuses on talent-intensive rather than labor-intensive business
and seeks to operate profitably (on both a gross and net basis)
across all of its product lines. To achieve these objectives, our
insurance group’s operating principles are to:
business with
• Capitalize on profitable underwriting opportunities. Our
insurance group believes that its experienced management
and underwriting teams are positioned to locate and
identify
risk/reward
characteristics. As profitable underwriting opportunities
are identified, our insurance group will continue to seek to
make additions to its product portfolio in order to take
advantage of market trends. This includes adding
underwriting and other professionals with specific
expertise in specialty lines of insurance.
attractive
observed, with responsibility for the management of each
product line residing with the senior underwriting
executive in charge of such product line.
• Maintain a disciplined underwriting philosophy. Our
insurance group’s underwriting philosophy is to generate
an underwriting profit through prudent risk selection and
proper pricing. Our insurance group believes that the key
to this approach is adherence to uniform underwriting
standards across all types of business. Our insurance
the
group’s senior management closely monitors
underwriting process.
• Focus on providing superior claims management. Our
insurance group believes that claims handling is an integral
component of credibility in the market for insurance
products. Therefore, our insurance group believes that its
ability to handle claims expeditiously and satisfactorily is
a key to its success. Our insurance group employs
experienced claims professionals and also utilizes
experienced external claims managers (third party
administrators) where appropriate.
• Promote and utilize an efficient distribution system. Our
insurance group believes that promoting and utilizing a
multi-channel distribution system, provides efficient
access to its broad customer base. Our insurance group
works with select international, national and regional retail
and wholesale brokers and leading managing general
agencies, including McNeil, to distribute our insurance
products.
• Grow strategic partnerships in stable and niche areas. Our
insurance group aims to build more integrated long-term
alignment with strategic partners offering superior access
to niche opportunities, quality scalable businesses, or lines
with reliable defensive qualities.
Our insurance group writes business on both an admitted and
non-admitted basis. Our insurance group focuses on the
following areas:
• Centralize responsibility for underwriting. Our insurance
group consists of a range of product lines. The underwriting
executive in charge of each product line oversees all aspects
of the underwriting product development process within
such product line. Our insurance group believes that
centralizing the control of such product line with the
respective underwriting executive allows for close
management of underwriting and creates clear
accountability for results. Our U.S. insurance group has
four regional offices, and the executive in charge of each
region is primarily responsible for all aspects of the
marketing and distribution of our insurance group’s
products, including the management of broker and other
producer relationships in such executive’s respective
region. In our non-U.S. offices, a similar philosophy is
• Construction and national accounts: primary and excess
casualty coverages to middle and large accounts in the
construction industry and a wide range of products for
middle and large national accounts, specializing in loss
sensitive primary casualty insurance programs (including
large deductible, self-insured retention and retrospectively
rated programs).
• Excess and surplus casualty: primary and excess casualty
insurance coverages, including middle market energy
business, and contract binding, which primarily provides
casualty coverage through a network of appointed agents
to small and medium risks.
•
Lenders products: collateral protection, debt cancellation
and service contract reimbursement products to banks,
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2018 FORM 10-K
credit unions, automotive dealerships and original
equipment manufacturers and other specialty programs
that pertain to automotive lending and leasing.
• Professional lines: directors’ and officers’ liability, errors
and omissions liability, employment practices liability,
fiduciary liability, crime, professional indemnity and other
financial related coverages for corporate, private equity,
venture capital, real estate investment trust, limited
partnership, financial institution and not-for-profit clients
of all sizes and medical professional and general liability
insurance coverages for the healthcare industry. The
business is predominately written on a claims-made basis.
• Programs: primarily package policies, underwriting
workers’ compensation and umbrella liability business in
support of desirable package programs, targeting program
managers with unique expertise and niche products
offering general liability, commercial automobile, inland
marine and property business with minimal catastrophe
exposure.
• Property, energy, marine and aviation: primary and excess
including
insurance
general property
catastrophe-exposed property coverage, for commercial
clients. Coverages for marine include hull, war, specie and
liability. Aviation and stand-alone terrorism are also
offered.
coverages,
•
Travel, accident and health: specialty travel and accident
and related insurance products for individual, group
travelers, travel agents and suppliers, as well as accident
and health, which provides accident, disability and medical
plan insurance coverages for employer groups, medical
plan members, students and other participant groups.
• Other: includes alternative market risks (including captive
insurance programs), excess workers’ compensation and
employer’s liability insurance coverages for qualified self-
insured groups, associations and trusts, statutory Defense
Base Act workers compensation and employers liability,
and contract and commercial surety coverages, including
contract bonds (payment and performance bonds)
primarily for medium and
large contractors and
commercial surety bonds for Fortune 1000 companies and
smaller transaction business programs.
Underwriting Philosophy. Our insurance group’s underwriting
philosophy is to generate an underwriting profit (on both a gross
and net basis) through prudent risk selection and proper pricing
across all types of business. One key to this philosophy is the
adherence to uniform underwriting standards across each
product line that focuses on the following:
•
•
•
risk selection;
desired attachment point;
limits and retention management;
•
•
•
due diligence, including financial condition, claims
history, management, and product, class and territorial
exposure;
underwriting authority and appropriate approvals; and
collaborative decision making.
Marketing. Our insurance group’s products are marketed
principally through a group of licensed independent retail and
wholesale brokers. Clients (insureds) are referred to our
insurance group through a large number of international,
national and regional brokers and captive managers who receive
from the insured or insurer a set fee or brokerage commission
usually equal to a percentage of gross premiums. In the past,
our insurance group also entered into contingent commission
arrangements with some brokers that provided for the payment
of additional commissions based on volume or profitability of
business. Currently, some of our contracts with brokers provide
for additional commissions based on volume. We have also
entered into service agreements with select international
brokers that provide access to their proprietary industry
analytics. In general, our insurance group has no implied or
explicit commitments to accept business from any particular
broker and neither brokers nor any other third parties have the
authority to bind our insurance group, except in the case where
underwriting authority may be delegated contractually to select
program administrators. Such administrators are subject to a
due diligence financial and operational review prior to any such
delegation of authority and ongoing reviews and audits are
carried out as deemed necessary by our insurance group to
assure the continuing integrity of underwriting and related
business operations. See “Risk Factors—Risks Relating to Our
Company—We could be materially adversely affected to the
extent that managing general agents, general agents and other
producers exceed their underwriting authorities or if our agents,
our insureds or other third parties commit fraud or otherwise
breach obligations owed to us.” For information on major
brokers, see note 16, “Commitments and Contingencies—
Concentrations of Credit Risk,” to our consolidated financial
statements in Item 8.
Risk Management and Reinsurance. In the normal course of
business, our insurance group may cede a portion of its premium
on a quota share or excess of loss basis through treaty or
facultative reinsurance agreements. Reinsurance arrangements
do not relieve our insurance group from its primary obligations
to insureds. 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, our insurance
subsidiaries would be liable for such defaulted amounts. Our
principal insurance subsidiaries, with oversight by a group-
wide reinsurance steering committee (“RSC”), are selective
with regard to reinsurers, seeking to place reinsurance with only
those reinsurers which meet and maintain specific standards of
established criteria for financial strength. The RSC evaluates
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the financial viability of its reinsurers through financial
analysis, research and review of rating agencies’ reports and
also monitors reinsurance recoverables and collateral with
unauthorized reinsurers. The financial analysis includes
ongoing qualitative and quantitative assessments of reinsurers,
including a review of the financial stability, appropriate
licensing, reputation, claims paying ability and underwriting
philosophy of each reinsurer. Our insurance group will continue
to evaluate
its reinsurance requirements. See note 7,
“Reinsurance,” to our consolidated financial statements in Item
8.
risk management policies,
For catastrophe-exposed insurance business, our insurance
group seeks to limit the amount of exposure to catastrophic
losses it assumes through a combination of managing aggregate
limits, underwriting guidelines and reinsurance. For a
discussion of our
see
“Management’s Discussion and Analysis of Financial
Condition and Results of Operations—Critical Accounting
Policies, Estimates and Recent Accounting Pronouncements—
Ceded Reinsurance” and “Risk Factors—Risks Relating to Our
Industry—The failure of any of the loss limitation methods we
employ could have a material adverse effect on our financial
condition or results of operations.”
Claims Management. Our
insurance group’s claims
management function is performed by claims professionals, as
well as experienced external claims managers (third party
administrators), where appropriate. In addition to investigating,
evaluating and resolving claims, members of our insurance
group’s claims departments work with underwriting
professionals as functional teams in order to develop products
and services desired by the group’s clients.
Reinsurance Operations
Our reinsurance operations are conducted on a worldwide basis
through our reinsurance subsidiaries, Arch Re Bermuda, Arch
Re U.S. and Arch Re Europe. Arch Re Bermuda is a registered
Class 4 insurer and long-term insurer and is headquartered in
Hamilton, Bermuda. Arch Re U.S. is licensed or is an accredited
or otherwise approved reinsurer in 50 states, the District of
Columbia and Puerto Rico, the provinces of Ontario and
Quebec in Canada with its principal U.S. offices in Morristown,
New Jersey. Treaty operations in Canada are conducted through
the Canadian branch of Arch Re U.S. (“Arch Re Canada”). Arch
Re U.S. is also an admitted insurer in Guam. Our property
facultative reinsurance operations are conducted primarily
through Arch Re U.S. The property facultative reinsurance
operations have offices throughout the U.S., Canada and in
Europe. Arch Re Europe, licensed and authorized as a non-life
reinsurer and a life reinsurer, is headquartered in Dublin, Ireland
with branch offices in Zurich and London.
In February 2017, Arch Underwriters (Gulf) Limited (“Arch
Underwriters Gulf”) was licensed as an Insurance Manager by
the Dubai Financial Services Authority. Arch Underwriters
Gulf is based in the Dubai International Financial Centre and
provides underwriting, administrative and support services to
Arch Re Bermuda and certain employees and certain
administrative support services to Gulf Re.
Strategy. Our reinsurance group’s strategy is to capitalize on
our
financial capacity, experienced management and
operational flexibility to offer multiple products through our
operations. The reinsurance group’s operating principles are to:
• Actively select and manage risks. Our reinsurance group
only underwrites business that meets certain profitability
criteria, and it emphasizes disciplined underwriting over
premium growth. To this end, our reinsurance group
maintains
reinsurance
centralized
underwriting guidelines and authorities.
control
over
• Maintain flexibility and respond to changing market
reinsurance group’s organizational
conditions. Our
structure and philosophy allows it to take advantage of
increases or changes in demand or favorable pricing trends.
Our reinsurance group believes that its existing platforms
in Bermuda, the U.S., Europe, Dubai and Canada, broad
underwriting expertise and substantial capital facilitate
adjustments to its mix of business geographically and by
line and type of coverage. Our reinsurance group believes
that this flexibility allows it to participate in those market
opportunities that provide the greatest potential for
underwriting profitability.
• Maintain a low cost structure. Our reinsurance group
believes that maintaining tight control over its staffing level
and operating primarily as a broker market reinsurer
permits it to maintain low operating costs relative to its
capital and premiums.
Our reinsurance group writes business on both a proportional
and non-proportional basis and writes both treaty and
facultative business. In a proportional reinsurance arrangement
(also known as pro rata reinsurance, quota share reinsurance or
participating reinsurance), the reinsurer shares a proportional
part of the original premiums and losses of the reinsured. The
reinsurer pays the cedent a commission which is generally based
on the cedent’s cost of acquiring the business being reinsured
(including commissions, premium taxes, assessments and
miscellaneous administrative expenses) and may also include
a profit factor. Non-proportional (or excess of loss) reinsurance
indemnifies the reinsured against all or a specified portion of
losses on underlying insurance policies in excess of a specified
amount, which is called a “retention.” Non-proportional
business is written in layers and a reinsurer or group of
reinsurers accepts a band of coverage up to a specified amount.
The total coverage purchased by the cedent is referred to as a
“program.” Any liability exceeding the upper limit of the
program reverts to the cedent.
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The reinsurance group’s treaty operations generally seek to
write significant lines on less commoditized classes of
coverage, such as specialty property and casualty reinsurance
treaties. However, with respect to other classes of coverage,
such as property catastrophe and casualty clash, the reinsurance
group’s treaty operations participate in a relatively large number
of treaties where they believe that they can underwrite and
process the business efficiently. The reinsurance group’s
property facultative operations write reinsurance on a
facultative basis whereby they assume part of the risk under
primarily single insurance contracts. Facultative reinsurance is
typically purchased by ceding companies for individual risks
not covered by their reinsurance treaties, for unusual risks or
for amounts in excess of the limits on their reinsurance treaties.
Our reinsurance group focuses on the following areas:
• Casualty: provides coverage to ceding company clients on
third party liability and workers’ compensation exposures
from ceding company clients, primarily on a treaty basis.
Exposures include, among others, executive assurance,
professional liability, workers’ compensation, excess and
umbrella liability, excess motor and healthcare business.
• Marine and aviation: provides coverage for energy, hull,
cargo, specie, liability and transit, and aviation business,
including airline and general aviation risks. Business
written may also include space business, which includes
coverages for satellite assembly, launch and operation for
commercial space programs.
• Other specialty: provides coverage to ceding company
clients for proportional motor and other lines, including
surety, accident and health, workers’ compensation
catastrophe, agriculture, trade credit and political risk.
• Property catastrophe: provides protection for most
catastrophic losses that are covered in the underlying
policies written by reinsureds, including hurricane,
earthquake, flood, tornado, hail and fire, and coverage for
other perils on a case-by-case basis. Property catastrophe
reinsurance provides coverage on an excess of loss basis
when aggregate losses and loss adjustment expense from
a single occurrence or aggregation of losses from a covered
peril exceed the retention specified in the contract.
• Property excluding property catastrophe: provides
coverage for both personal lines and commercial property
exposures and principally covers buildings, structures,
equipment and contents. The primary perils in this business
include fire, explosion, collapse, riot, vandalism, wind,
tornado, flood and earthquake. Business is assumed on both
a proportional and excess of loss basis. In addition,
facultative business is written which focuses on individual
commercial property risks on an excess of loss basis.
• Other. includes life reinsurance business on both a
proportional and non-proportional basis, casualty clash
business and, in limited instances, non-traditional business
which is intended to provide insurers with risk management
solutions that complement traditional reinsurance.
Underwriting Philosophy. Our reinsurance group employs a
disciplined, analytical approach to underwriting reinsurance
risks that is designed to specify an adequate premium for a given
exposure commensurate with the amount of capital it
anticipates placing at risk. A number of our reinsurance group’s
underwriters are also actuaries. It is our reinsurance group’s
belief that employing actuaries on the front-end of the
underwriting process gives it an advantage in evaluating risks
and constructing a high quality book of business.
As part of the underwriting process, our reinsurance group
typically assesses a variety of factors, including:
•
•
•
•
•
adequacy of underlying rates for a specific class of business
and territory;
the reputation of the proposed cedent and the likelihood
of establishing a long-term relationship with the cedent,
the geographic area in which the cedent does business,
together with its catastrophe exposures, and our
aggregate exposures in that area;
historical loss data for the cedent and, where available,
for the industry as a whole in the relevant regions, in
order to compare the cedent’s historical loss experience
to industry averages;
projections of future loss frequency and severity; and
the perceived financial strength of the cedent.
Marketing. Our reinsurance group generally markets its
reinsurance products through brokers, except our property
facultative reinsurance group, which generally deals directly
with the ceding companies. Brokers do not have the authority
to bind our reinsurance group with respect to reinsurance
agreements, nor does our reinsurance group commit in advance
to accept any portion of the business that brokers submit to
them. Our reinsurance group generally pays brokerage fees to
brokers based on negotiated percentages of the premiums
written through such brokers. For information on major brokers,
see note 16,
and Contingencies—
Concentrations of Credit Risk,” to our consolidated financial
statements in Item 8.
“Commitments
Risk Management and Retrocession. Our reinsurance group
currently purchases a combination of per event excess of loss,
per risk excess of loss, proportional retrocessional agreements
and other structures that are available in the market. Such
arrangements reduce the effect of individual or aggregate losses
on, and in certain cases may also increase the underwriting
capacity of, our reinsurance group. Our reinsurance group will
continue to evaluate its retrocessional requirements based on
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2018 FORM 10-K
its net appetite for risk. See note 7, “Reinsurance,” to our
consolidated financial statements in Item 8.
For catastrophe exposed reinsurance business, our reinsurance
group seeks to limit the amount of exposure it assumes from
any one reinsured and the amount of the aggregate exposure to
catastrophe losses from a single event in any one geographic
zone. For a discussion of our risk management policies, see
“Management’s Discussion and Analysis of Financial
Condition and Results of Operations—Critical Accounting
Policies, Estimates and Recent Accounting Pronouncements—
Ceded Reinsurance” and “Risk Factors—Risks Relating to Our
Industry—The failure of any of the loss limitation methods we
employ could have a material adverse effect on our financial
condition or results of operations.”
Claims Management. Claims management includes the receipt
of initial loss reports, creation of claim files, determination of
whether further investigation is required, establishment and
adjustment of case reserves and payment of claims.
Additionally, audits are conducted for both specific claims and
overall claims procedures at the offices of selected ceding
companies. Our reinsurance group makes use of outside
consultants for claims work from time to time.
Mortgage Operations
Our mortgage operations provide U.S. and international
mortgage insurance and reinsurance operations as well as
participation in GSE credit risk-sharing transactions. Our
mortgage group includes direct mortgage insurance in the U.S.
primarily through Arch Mortgage Insurance Company and
United Guaranty Residential Insurance Company (together,
“Arch MI U.S.”); mortgage reinsurance primarily through Arch
Re Bermuda to mortgage insurers on both a proportional and
non-proportional basis globally; direct mortgage insurance in
Europe through Arch MI Europe and in Hong Kong through
Arch MI Asia Limited (“Arch MI Asia”); and participation in
various GSE credit risk-sharing products primarily through
Arch Re Bermuda.
In 2014 we completed the acquisition of CMG Mortgage
Insurance Company from its owners, PMI Mortgage Insurance
Co., (“PMI”) and CMFG Life Insurance Company (“CUNA
Mutual”) and acquired PMI’s mortgage insurance platform and
related assets. CMG Mortgage Insurance Company was
renamed “Arch Mortgage Insurance Company” and entered the
U.S. mortgage
insurance marketplace. Arch Mortgage
Insurance Company is licensed and operates in all 50 states, the
District of Columbia and Puerto Rico.
On December 31, 2016, we completed the acquisition of UGC
and its primary operating subsidiary, United Guaranty
Residential Insurance Company, which is licensed and operates
in all 50 states and the District of Columbia.
Arch Mortgage Insurance Company and United Guaranty
Residential Insurance Company have each been approved as an
eligible mortgage insurer by Fannie Mae and Freddie Mac,
subject to maintaining certain ongoing requirements (“eligible
mortgage insurer”). Arch Mortgage Guaranty Company offers
direct mortgage insurance to U.S. mortgage lenders with respect
to mortgages that lenders intend to retain in portfolio or include
in non-agency securitizations. Arch Mortgage Guaranty
Company, which is licensed in all 50 states and the District of
Columbia, insures mortgages that are not intended to be sold
to the GSEs, and it is therefore not approved by either GSE as
an eligible mortgage insurer.
Arch MI Europe was licensed and authorized by the Central
Bank of Ireland (“CBOI”) in 2011 to operate on a pan-European
basis under the European Freedom of Services Act. Arch MI
Europe is headquartered in Dublin, Ireland. Arch Underwriters
Europe Limited (“Arch Underwriters Europe”), an Irish
insurance and reinsurance
company authorized as an
intermediary by the CBOI, acts on behalf of Arch MI Europe
and Arch Re Europe with branch offices in Italy, Switzerland,
the U.K., and Finland. In 2017 we completed the acquisition of
Arch MI Asia from AIG. On January 17, 2019, Arch LMI was
authorized by APRA to write lenders’ mortgage insurance. Arch
LMI is headquartered in Sydney, Australia and will focus on
providing direct lenders’ mortgage insurance to the Australian
market.
Strategy. The mortgage insurance market operates on a distinct
underwriting cycle, with demand driven mainly by the housing
market and general economic conditions. As a result, the
creation of the mortgage group provides us with a more diverse
revenue stream. Our mortgage group’s strategy is to capitalize
on its financial capacity, mortgage insurance technology
platform, operational flexibility and experienced management
to offer mortgage insurance, reinsurance and other risk-sharing
products in the U.S. and around the world.
Our mortgage group’s operating principles and goals are to:
• Capitalize on profitable underwriting opportunities. Our
mortgage group believes that its experienced management,
analytics and underwriting teams are positioned to identify
risk/reward
and evaluate business with attractive
characteristics.
• Maintain a disciplined credit risk philosophy. Our
mortgage group’s credit risk philosophy is to generate
underwriting profit through disciplined credit risk analysis
and proper pricing. Our mortgage group believes that the
key to this approach is maintaining discipline across all
phases of the applicable housing and mortgage lending
cycles.
• Provide superior and innovative mortgage products and
services. Our mortgage group believes that it can leverage
ARCH CAPITAL
10
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its financial capacity, experience across insurance product
lines, and its analytics and technology to provide
innovative products and superior service. The mortgage
group believes that its delivery of tailored products that
meet the specific, evolving needs of its customers will be
a key to the group’s success.
portfolio, subject to an agreed aggregate loss limit. Pool
insurance may be in a first loss position with respect to
loans that do not have primary mortgage insurance policies,
or it may be in a second loss position, covering losses in
excess of those covered by the primary mortgage insurance
policy.
• Maintain our position as a leading provider of U.S.
mortgage
to our 2014
insurance business. Prior
acquisition, Arch Mortgage Insurance Company was the
leading provider of mortgage insurance products and
services to credit unions in the U.S. We broadened our
customer base into national and regional banks and
mortgage originators while maintaining and increasing its
share of the mortgage insurance credit union market. With
the acquisition of UGC, a leading provider of mortgage
insurance products and services to national and regional
banks and mortgage originators, we are the leading
provider of U.S. mortgage insurance.
Our mortgage group focuses on the following areas:
• Direct mortgage insurance in the United States. Under
their monoline insurance licenses, each of Arch’s eligible
mortgage insurers may only offer private mortgage
insurance covering first lien, one-to-four family residential
mortgages. Nearly all of our mortgage insurance written
provides first loss protection on loans originated by
mortgage lenders and sold to the GSEs. Each GSE’s
Congressional charter generally prohibits
from
purchasing a mortgage where the principal balance of the
mortgage is in excess of 80% of the value of the property
securing the mortgage unless the excess portion of the
mortgage is protected against default by lender recourse,
participation or by a qualified insurer. As a result, such
“high loan-to-value mortgages” purchased by Fannie Mae
or Freddie Mac generally are insured with private mortgage
insurance.
it
Mortgage insurance protects the insured lender, investor
or GSE against loss in the event of a borrower’s default. If
a borrower defaults on mortgage payments, private
mortgage insurance reduces, and may eliminate, losses to
the insured. Private mortgage insurance may also facilitate
the sale of mortgage loans in the secondary mortgage
market because of the credit enhancement it provides. Our
primary U.S. mortgage insurance policies predominantly
cover individual loans and are effective at the time the loan
is originated. We also may enter into insurance transactions
with lenders and investors, under which we insure a
portfolio of loans at or after origination. Although not
currently a significant product, we may offer mortgage
insurance on a “pool” basis in the future. Under pool
insurance, the mortgage insurer provides coverage on a
group of specified loans, typically for 100% of all
contractual or policy-defined losses on every loan in the
• Direct mortgage insurance in Europe and other countries
where we identify profitable underwriting opportunities.
Since 2011, Arch MI Europe has offered mortgage
insurance to European mortgage lenders. Arch MI
Europe’s mortgage insurance is primarily purchased by
European mortgage lenders in order to reduce lenders’
credit risk and regulatory capital requirements associated
with the insured mortgages. In certain European countries,
lenders purchase mortgage
facilitate
regulatory compliance with respect to high loan-to-value
residential lending. Arch MI Europe offers mortgage
insurance on both a “flow” basis to cover new originations
and through structured transactions to cover one or more
portfolios of previously originated residential loans. In
addition, with our acquisition of Arch MI Asia in 2017 and
regulatory approval of Arch LMI in January 2019, we are
focused on expanding origination opportunities for lenders
in Hong Kong and throughout Asia and Australia.
insurance
to
• Reinsurance. Arch Re Bermuda provides quota share
reinsurance covering U.S. and international mortgages.
Such amounts include a quota share reinsurance agreement
with PMI pursuant to which it agreed to provide 100%
quota share indemnity reinsurance to PMI for all
certificates of insurance that were issued by PMI from
January 1, 2009 through December 31, 2011 that were not
in default as of an agreed upon effective date. Other than
this quota share, no PMI legacy mortgage insurance
exposures were assumed.
• Other credit risk-sharing products. In addition to providing
traditional mortgage insurance and reinsurance, we offer
various credit risk-sharing products to government
agencies and mortgage lenders. The GSEs have reduced
their exposure to mortgage risk and continue to shift more
of it to the private sector, creating opportunities for insurers
to assume additional mortgage risk. In 2013, Arch Re
Bermuda became the first (re)insurance company to
participate in Freddie Mac’s program to transfer certain
credit risk in its single-family portfolio to the private sector.
Since that time, Arch Re Bermuda and its affiliates have
regularly participated in both Fannie Mae and Freddie Mac
risk sharing programs.
In 2017, we established Arch Mortgage Risk Transfer PCC Inc.
(“Arch MRT”) a District of Columbia based protected cell
captive insurer, licensed by District of Columbia Department
of Insurance, Securities and Banking as a mortgage insurer.
Arch MRT issues direct mortgage insurance to the GSEs
ARCH CAPITAL
11
2018 FORM 10-K
through incorporated protected cells and cedes 100% of the risk
to GSE approved reinsurers, including Arch Re U.S. Arch MRT
entered into one pilot transaction with each of the GSEs in 2018.
In 2018 we established Arch Credit Risk Services Inc.
(“ACRS”) and licensed it as a reinsurance intermediary in
several states. ACRS offers mortgage credit assessment and
underwriting advisory services with respect to participation in
GSE credit risk transfer transactions.
Underwriting Philosophy. Our mortgage group believes in a
disciplined, analytical approach to underwriting mortgage risks
by utilizing proprietary and third party models, including
forecasting delinquency and future home price movements with
the goal of ensuring that premiums are adequate for the risk
being insured. Experienced actuaries and statistical modelers
are engaged in analytics to inform the underwriting process. As
part of the underwriting process, our mortgage group typically
assesses a variety of factors, including the:
•
•
•
•
•
•
ability and willingness of the mortgage borrower to pay its
obligations under the mortgage loan being insured;
characteristics of the mortgage loan being insured and
value of the collateral securing the mortgage loan;
financial strength, quality of operations and reputation of
the lender originating the mortgage loan;
expected future home price movements which vary by
geography;
projections of future loss frequency and severity; and
adequacy of premium rates.
Sales and Distribution. We employ a sales force located
throughout the U.S. to directly sell mortgage insurance products
and services to our customers, which include mortgage
originators such as mortgage bankers, mortgage brokers,
commercial banks, savings institutions, credit unions and
community banks. Our largest single mortgage insurance
customer (including branches and affiliates) accounted for
6.9% of our primary new insurance written during 2018 with
no other customer accounting for greater than 3.4%. The
percentage of our primary new insurance written generated by
our top 10 customers was 25.2% in 2018. In Europe, Asia,
Bermuda and Australia, our products and services are/or will
be distributed on a direct basis and through brokers. Each
country represents a unique set of opportunities and challenges
that require knowledge of market conditions and client needs
to develop effective solutions.
Risk Management. Exposure to mortgage risk is monitored
globally and managed through underwriting guidelines,pricing,
reinsurance, utilization of proprietary
risk models,
concentration limits and limits on net probable loss resulting
from a severe economic downturn in the housing market. For
a discussion of our
risk management policies, see
“Management’s Discussion and Analysis of Financial
Condition and Results of Operations—Critical Accounting
Policies, Estimates and Recent Accounting Pronouncements—
Ceded Reinsurance” and “Risk Factors—Risks Relating to Our
Industry—The failure of any of the loss limitation methods we
employ could have a material adverse effect on our financial
condition or results of operations.”
Our mortgage group has ceded a portion of its premium on a
quota share basis through certain reinsurance agreements and
through aggregate excess of loss reinsurance agreements which
provide reinsurance coverage for delinquencies on portfolios
of in-force policies issued between certain periods. See note 7,
“Reinsurance,” to our consolidated financial statements in Item
8 for further details.
Reinsurance arrangements do not relieve our mortgage group
from its primary obligations to insured parties. 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
the agreements, our mortgage
their obligations under
subsidiaries would be liable for such defaulted amounts. For
our U.S. mortgage insurance business, in addition to utilizing
reinsurance, we have developed a proprietary risk model that
simulates the maximum loss resulting from severe economic
events impacting the housing market. See “Management’s
Discussion and Analysis of Financial Condition and Results of
Operations—Catastrophic Events and Severe Economic
Events.”
Claims Management. With respect to our direct mortgage
insurance business, the claims process generally begins with
notification by the insured or servicer to us of a default on an
insured loan. The insured is generally required to notify us of
a default after the borrower becomes two consecutive monthly
payments in default. Borrowers default for a variety of reasons,
including a reduction of income, unemployment, divorce,
illness, inability to manage credit, rising interest rate levels and
declining home prices. Upon notice of a default, in certain cases
we may coordinate with loan servicers to facilitate and enhance
retention workouts on insured loans. Retention workouts
include loan modifications and other loan repayment options,
which may enable borrowers to cure mortgage defaults and
retain ownership of their homes. If a retention workout is not
viable for a borrower, our loss on a loan may be mitigated
through a liquidation workout option, including a pre-
foreclosure sale or a deed-in-lieu of foreclosure.
In the U.S., our master policies generally provide that within
60 days of the perfection of a primary insurance claim, we have
the option of:
•
paying the insurance coverage percentage specified in the
certificate of insurance multiplied by the loss amount;
ARCH CAPITAL
12
2018 FORM 10-K
•
•
in the event the property is sold pursuant to an approved
prearranged sale, paying the lesser of (i) 100% of the loss
amount less the proceeds of sale of the property, or (ii) the
specified coverage percentage multiplied by the loss
amount; or
paying 100% of the loss amount in exchange for the
insured’s conveyance to us of good and marketable title to
the property, with us then selling the property for our own
account.
While we select the claim settlement option that best mitigates
the amount of our claim payment, in the U.S. we generally pay
the coverage percentage multiplied by the loss amount.
Other Operations
In 2014 we and HPS Investment Partners, LLC (formerly
Highbridge Principal Strategies, LLC) (“HPS”), sponsored the
formation of Watford Re. Arch Re Bermuda invested $100.0
million and acquired 2,500,000 common shares, approximately
11%, of Watford Re and a warrant to purchase up to 975,503
additional common shares. Watford Re’s strategy is to combine
a diversified reinsurance and insurance business with a
disciplined investment strategy comprised primarily of non-
investment grade credit assets. Watford Re has its own
management and board of directors and is responsible for the
overall profitability of its results. Arch Re Bermuda has
appointed two directors to serve on the nine person board of
directors of Watford Re. We performed an analysis of Watford
Re and concluded that Watford Re is a variable interest entity
and that we are the primary beneficiary of Watford Re. As such,
100% of the results of Watford Re are included in our
consolidated financial statements.
In 2017 we and Kelso & Company (“Kelso”) sponsored the
formation of Premia Re. Premia Re’s strategy is to reinsure or
acquire companies or reserve portfolios in the non-life property
and casualty insurance and reinsurance run-off market. Arch
Re Bermuda and certain Arch co-investors invested $100.0
million and acquired approximately 25% of Premia Re as well
as warrants to purchase additional common equity. Affiliates of
Kelso invested $300.0 million and acquired the balance of
Premia Re as well as warrants to purchase additional common
equity. Arch Re Bermuda is providing a 25% whole account
quota share reinsurance treaty on business written by Premia
Re, and subsidiaries of Arch Capital are providing certain
administrative and support services to Premia Re, in each case
pursuant to separate multi-year agreements. Arch Re Bermuda
has appointed two directors to serve on the seven person board
of directors of Premia Re.
Employees
As of February 15, 2019, Arch Capital and its subsidiaries
employed approximately 3,642 full-time employees.
RESERVES
Reserve estimates are derived after extensive consultation with
individual underwriters and claims professionals, actuarial
analysis of the loss reserve development and comparison with
industry benchmarks. Our reserves are established and
reviewed by experienced internal actuaries. Generally, reserves
are established without regard to whether we may subsequently
contest the claim. We do not currently discount our loss reserves
except for excess workers’ compensation and employers’
liability loss reserves in our insurance operations.
Reserves for losses and loss adjustment expenses (“Loss
Reserves”) represent estimates of what the insurer or reinsurer
ultimately expects to pay on claims at a given time, based on
facts and circumstances then known, and it is probable that the
ultimate liability may exceed or be less than such estimates.
Even actuarially sound methods can lead to subsequent
adjustments to reserves that are both significant and irregular
due to the nature of the risks written. Loss Reserves are
inherently subject to uncertainty.
In establishing Loss Reserves, including loss adjustment
expenses (“LAE”), we have made various assumptions relating
to the pricing of our reinsurance contracts and insurance policies
and have also considered available historical
industry
experience and current industry conditions. The timing and
amounts of actual claim payments related to recorded reserves
vary based on many factors including large individual losses
and changes in the legal environment, as well as general market
conditions. The ultimate amount of the claim payments could
differ materially from our estimated amounts. Certain lines of
business written by us, such as excess casualty, have loss
experience characterized as low frequency and high severity.
This may result in significant variability in loss payment
patterns and, therefore, may impact the related asset/liability
investment management process in order to be in a position, if
necessary, to make these payments. See “Management’s
Discussion and Analysis of Financial Condition and Results of
Operations—Critical Accounting Policies, Estimates and
Recent Accounting Pronouncements—Reserves for Losses and
Loss Adjustment Expenses.”
Our initial reserving method to date has to a large extent been
the expected loss method, which is commonly applied when
limited loss experience exists. We select the initial expected
loss and loss adjustment expense ratios based on information
derived by our underwriters and actuaries during the initial
pricing of the business, supplemented by industry data where
appropriate. These ratios consider, among other things, rate
changes and changes in terms and conditions that have been
observed in the market. Any estimates and assumptions made
as part of the reserving process could prove to be inaccurate
due to several factors, including the fact that relatively limited
historical information has been reported to us through
ARCH CAPITAL
13
2018 FORM 10-K
concentrated risk exposure could materially adversely affect
our financial condition and results of operations. Although we
monitor the financial condition of our reinsurers and
retrocessionaires and attempt to place coverages only with
substantial, financially sound carriers, we may not be successful
in doing so.
December 31, 2018. We employ a number of different reserving
methods depending on the segment, the line of business, the
availability of historical loss experience and the stability of that
loss experience. Over time, we have given additional weight to
our historical loss experience in our reserving process due to
the continuing maturation of our reserves, and the increased
availability and credibility of the historical experience.
For additional information regarding the key underlying
movements in our losses and loss adjustment expenses by
segment, see “Management’s Discussion and Analysis of
Financial Condition and Results of Operations—Results of
Operations.”
The following table represents an analysis of consolidated
losses and loss adjustment expenses and a reconciliation of the
beginning and ending reserve for losses and loss adjustment
expenses:
Loss Reserves at beginning of year
Year Ended December 31,
2017
$10,200,960
2016
$ 9,125,250
2018
$11,383,792
Unpaid losses and LAE recoverable
2,464,910
Net Loss Reserves at beginning of year
8,918,882
2,083,575
8,117,385
1,828,837
7,296,413
Net incurred losses and LAE relating to
losses occurring in:
Current year
Prior years
3,162,818
3,205,428
2,455,563
(272,712)
(237,982)
(269,964)
Total net incurred losses and LAE
2,890,106
2,967,446
2,185,599
Net Loss Reserves of acquired
business (1)
—
Retroactive reinsurance transaction (2)
(420,404)
—
—
551,096
—
Foreign exchange losses (gains)
(143,414)
186,963
(102,367)
Net paid losses and LAE relating to
losses occurring in:
Current year
Prior years
(524,048)
(505,424)
(445,700)
(1,682,116)
(1,847,488)
(1,367,656)
Total net paid losses and LAE
(2,206,164)
(2,352,912)
(1,813,356)
Net Loss Reserves at end of year
Unpaid losses and LAE recoverable
9,039,006
2,814,291
8,918,882
2,464,910
8,117,385
2,083,575
Loss Reserves at end of year
$11,853,297
$11,383,792
$10,200,960
(1)
(2)
2016 amount relates to our acquisition of UGC.
During the 2018 second quarter a subsidiary of the Company entered into a
retroactive reinsurance transaction with a third party reinsurer to reinsure runoff
liabilities associated with certain discontinued U.S. specialty casualty and
program exposures.
Unpaid and paid losses and loss adjustment expenses
recoverable were approximately $2.92 billion at December 31,
2018. We are subject to credit risk with respect to our
reinsurance and retrocessions because the ceding of risk to
reinsurers and retrocessionaires does not relieve us of our
liability to the clients or companies we insure or reinsure. Our
failure to establish adequate reinsurance or retrocessional
arrangements or the failure of our existing reinsurance or
to protect us from overly
retrocessional arrangements
ARCH CAPITAL
14
2018 FORM 10-K
INVESTMENTS
At December 31, 2018, total investable assets held by Arch
were $19.57 billion, excluding the $2.76 billion included in the
‘other’ segment (i.e., attributable to Watford Re). Our current
investment guidelines and approach stress preservation of
capital, market liquidity and diversification of risk. Our
investments are subject to market-wide risks and fluctuations,
as well as to risks inherent in particular securities. While
maintaining our emphasis on preservation of capital and
liquidity, we expect our portfolio to become more diversified
and, as a result, we may in the future expand into areas which
are not part of our current investment strategy.
The following table summarizes the fair value of investable
assets held by Arch (i.e., excluding the ‘other’ segment):
The credit quality distribution of our fixed maturities and fixed
maturities pledged under securities lending agreements are
shown below:
Rating (1)
U.S. government and
government agencies (2)
AAA
AA
A
BBB
BB
B
Lower than B
Not rated
Total
December 31, 2018
December 31, 2017
Fair Value
%
Fair Value
%
$ 4,194,676
3,551,039
2,129,336
3,069,656
1,251,205
275,201
183,614
61,271
165,904
28.2
23.9
14.3
20.6
8.4
1.8
1.2
0.4
1.1
$ 3,771,835
4,080,808
2,440,864
2,470,936
1,157,136
313,286
254,011
77,543
231,794
25.5
27.6
16.5
16.7
7.8
2.1
1.7
0.5
1.6
$ 14,881,902
100.0
$ 14,798,213
100.0
Estimated
Fair Value
% of
Total
(1)
(2)
For individual fixed maturities, S&P ratings are used. In the absence of an S&P
rating, ratings from Moody’s are used, followed by ratings from Fitch Ratings.
Includes U.S. government-sponsored agency mortgage backed securities and
agency commercial mortgage backed securities.
Investable assets (1):
December 31, 2018
Fixed maturities (2)
Short-term investments (2)
Cash
Equity securities (2)
Other investments (2)
Investments accounted for using the equity
method
Securities transactions entered into but not
settled at the balance sheet date
$ 14,881,902
995,926
583,027
368,843
1,261,525
1,493,791
(18,153)
Total investable assets held by Arch
$ 19,566,861
Average effective duration (in years)
Average S&P/Moody’s credit ratings (3)
Embedded book yield (4)
December 31, 2017
Fixed maturities (2)
Short-term investments (2)
Cash
Equity securities (2)
Other investments (2)
Investments accounted for using the equity
method
Securities transactions entered into but not
settled at the balance sheet date
3.38
AA/Aa2
2.89%
$ 14,798,213
1,509,713
551,696
576,040
1,476,960
1,041,322
(237,523)
Total investable assets held by Arch
$ 19,716,421
Average effective duration (in years)
Average S&P/Moody’s credit ratings (3)
Embedded book yield (4)
2.83
AA-/Aa2
2.32%
76.1
5.1
3.0
1.9
6.4
7.6
(0.1)
100.0
75.1
7.7
2.8
2.9
7.5
5.3
(1.2)
100.0
(1)
(2)
In securities lending transactions, we receive collateral in excess of the
fair value of the securities pledged. For purposes of this table, we have
excluded the collateral received under securities lending, at fair value and
included the securities pledged under securities lending, at fair value.
Includes investments carried as available for sale, at fair value and at fair
value under the fair value option.
(3) Average credit ratings on our investment portfolio on securities with
ratings by Standard & Poor’s Rating Services (“S&P”) and Moody’s
Investors Service (“Moody’s”).
(4) Before investment expenses.
See “Management’s Discussion and Analysis of Financial
Condition and Results of Operations—Financial Condition,
Liquidity and Capital Resources—Financial Condition—
Investable Assets” and note 8, “Investment Information,” to our
consolidated financial statements in Item 8.
The following table summarizes the pre-tax total return (before
investment expenses) of investment held by Arch compared to
the benchmark return (both based in U.S. Dollars) against which
we measured our portfolio during the periods:
Pre-tax total return (before
investment expenses):
Year Ended December 31, 2018
Year Ended December 31, 2017
Year Ended December 31, 2016
Arch
Portfolio (1)
Benchmark
Return
0.33%
5.87%
2.07%
(0.60)%
4.74 %
2.13 %
(1) Our investment expenses were approximately 0.36%, 0.30% and 0.34%,
respectively, of average invested assets in 2018, 2017 and 2016.
The benchmark return index is a customized combination of
indices intended to approximate a target portfolio by asset mix
and average credit quality while also matching the approximate
estimated duration and currency mix of our insurance and
reinsurance liabilities. See “Management’s Discussion and
Analysis of Financial Condition and Results of Operations—
General—Financial Measures—Total Return on Investments”.
ARCH CAPITAL
15
2018 FORM 10-K
Alleghany Corporation, Argo International Holdings, Ltd.,
AXA XL, AXIS Capital Holdings Limited, Berkshire
Hathaway, Inc., Chubb Limited, Everest Re Group Ltd.,
Hannover Rückversicherung AG, Lloyd’s, Markel Global
Reinsurance, Munich Re Group, PartnerRe Ltd.,
RenaissanceRe Holdings Ltd., SCOR Global P&C, SCOR
Global Life, Sompo International, Swiss Reinsurance Company
and Validus Re.
In our U.S. mortgage business, we compete with five active
U.S. mortgage insurers, which include the mortgage insurance
subsidiaries of Essent Group Ltd., Genworth Financial Inc.,
MGIC Investment Corporation, NMI Holdings Inc. and Radian
Group Inc. The private mortgage insurance industry is highly
competitive. Private mortgage insurers generally compete on
the basis of underwriting guidelines, pricing, terms and
conditions, financial strength, product and service offerings,
customer relationships, reputation, the strength of management,
technology, and innovation in the delivery and servicing of
insurance products. Arch MI U.S. and other private mortgage
insurers compete with federal and state government agencies
that sponsor their own mortgage insurance programs. The
private mortgage insurers’ principal government competitor is
the Federal Housing Administration (“FHA”) and, to a lesser
degree, the U.S. Department of Veterans Affairs (“VA”). Future
changes to the FHA program may impact the demand for private
mortgage insurance.
Arch MI U.S. and other private mortgage insurers increasingly
compete with multi-line reinsurers and capital markets
alternatives to private mortgage insurance. The GSEs continued
their respective mortgage credit risk transfer (“CRT”) programs
including the use of front and back-end transactions with
multiline reinsurers. These transactions continue to create
opportunities for multiline property casualty reinsurance
groups and capital markets participants. The ongoing expansion
of the GSEs risk transfer programs continue to attract additional
reinsurers into the market with approximately 40 reinsurers now
competing for business.
For other U.S. risk sharing products and non-U.S. mortgage
insurance opportunities, we have also seen
increased
competition from well capitalized and highly rated multiline
reinsurers. It is our expectation that the depth and capacity of
competitors from this segment will continue to increase over
the next several years as more residential mortgage credit risk
is borne by private capital.
RATINGS
Our ability to underwrite business is affected by the quality of
our claims paying ability and financial strength ratings as
evaluated by independent agencies. Such ratings from third
party internationally recognized statistical rating organizations
or agencies are instrumental in establishing the financial
security of companies in our industry. We believe that the
primary users of such ratings include commercial and
investment banks, policyholders, brokers, ceding companies
and investors. Insurance ratings are also used by insurance and
reinsurance intermediaries as an important means of assessing
the financial strength and quality of insurers and reinsurers, and
are often an important factor in the decision by an insured or
intermediary of whether to place business with a particular
insurance or reinsurance provider. Periodically, rating agencies
evaluate us to confirm that we continue to meet their criteria
for the ratings assigned to us by them. A.M. Best Company
(“A.M. Best”), Fitch Ratings (“Fitch”), Moody’s and S&P are
ratings agencies which have assigned financial strength and/or
issuer ratings to Arch Capital and/or one or more of its
subsidiaries. The ratings issued on our companies by these
agencies are announced publicly and are available directly from
the agencies. For further information on our financial strength
and/or issuer ratings, see “Management’s Discussion and
Analysis of Financial Condition and Results of Operations—
Liquidity and Capital Resources.”
COMPETITION
The worldwide reinsurance and insurance businesses are highly
competitive. We compete, and will continue to compete, with
major U.S. and non-U.S. insurers and reinsurers, some of which
have greater financial, marketing and management resources
than we have and longer-term relationships with insureds and
brokers than we have had. We compete with other insurers and
reinsurers primarily on the basis of overall financial strength,
ratings assigned by independent rating agencies, geographic
scope of business, strength of client relationships, premiums
charged, contract terms and conditions, products and services
offered, speed of claims payment, reputation, employee
experience, and qualifications and local presence.
In our insurance business, we compete with insurers that
provide specialty property and casualty lines of insurance,
including Alleghany Corporation, American Financial Group,
Inc., American International Group, Inc., AXA XL, AXIS
Capital Holdings Limited, Berkshire Hathaway, Inc., Chubb
Limited, CNA Financial Corp., Fairfax Financial Holdings
Limited, The Hartford Financial Services Group, Inc., Liberty
Mutual Insurance, Lloyd’s, Markel Insurance Company, RLI
Corp., Sompo International, Tokio Marine HCC, The Travelers
Companies, W.R. Berkley Corp. and Zurich Insurance Group.
In our reinsurance business, we compete with reinsurers that
provide property and casualty lines of reinsurance, including
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ENTERPRISE RISK MANAGEMENT
General. Enterprise Risk Management (“ERM”) is a key
element in our philosophy, strategy and culture. We employ an
ERM framework that includes underwriting, reserving,
investment, credit and operational risks. Risk appetite and
exposure limits are set by our executive management team,
reviewed with the Board and its committees and routinely
discussed with business unit management. These limits are
articulated in our risk appetite statement, which details risk
appetite, tolerances and limits for each major risk category, and
are integrated into our operating guidelines. Exposures are
aggregated and monitored periodically by our corporate risk
management team. The reporting, review and approval of risk
management information is integrated into our annual planning
process, capital modeling and allocation,
reinsurance
purchasing strategy and reviewed at insurance business
reviews, reinsurance underwriting meetings and board level
committees.
Risk Management Process and Procedures. The following
narrative provides an overview of our risk management
framework and our methodology for identifying, measuring,
managing and reporting on the key risks affecting us. It outlines
our approach to risk identification and assessment and provides
an overview of our risk appetite and tolerance for each of the
following major risks: underwriting (insurance) risk including
pricing, reserving and catastrophe; investment including
market and liquidity risks; strategic risk; group risk including
governance and capital market risk; credit risk; and operational
risk, including regulatory, investor relations (reputational risk),
rating agency and outsourcing risks.
The framework includes details of our risk philosophy and
policies to address the material risks confronting us; and
compliance, approach and procedures to control and or mitigate
these risks. The actions and policies implemented to meet our
business management and regulatory obligations form the core
of this framework. We have adopted a holistic approach to risk
management by analyzing risk from both a top-down and
bottom-up perspective.
Risk Identification and Assessment. The Finance, Investment
and Risk Committee (“FIR Committee”), Audit Committee and
Underwriting Oversight Committee of the Board oversee the
top-down and bottom-up review of our risks. Given the nature
and scale of our operations, these committees consider all
aforementioned risks within the scope of the assessment. Arch
Capital’s Chief Risk Officer (“CRO”) assists these committees
in the identification and assessment of all key risks. The CRO
is responsible for maintaining Arch Capital’s risk register and
continually reviewing and challenging risk assessments,
including the impact of emerging risks and significant business
developments. Board approval is required for any new high
level risks or change in inherent or residual designations.
Risk Monitoring and Control. Arch Capital’s risk management
framework requires risk owners to monitor key risks on a
continuous basis. The highest residual risks are actively
managed by the FIR Committee. The remaining risks are
managed and monitored at a process level by the risk owners
and/or the CRO. Risk owners have ultimate responsibility for
the day-to-day management of each designated risk, reporting
to the CRO on the satisfactory management and control of the
risk and timely escalation of significant issues that may arise
in relation to that risk. The CRO is responsible for overseeing
the monitoring of all risks across the business and for
communicating to the relevant risk owners if he becomes aware
of issues, or potential and actual breaches of risk appetite,
relevant to the assigned risks. A key element of these monitoring
activities is the evaluation of our position relative to risk
tolerances and limits approved by the Board.
Risk Reporting. Quarterly, the CRO compiles the results of the
key risk review process into a report to the FIR Committee for
review and discussion at their quarterly meeting. The report
includes an overview of selected key risks; changes in the rating
of high level risks in the Arch Capital risk register; a risk
dashboard that depicts the status of risk limit and tolerance
metrics; a summary of largest exposures and concentration
risks; and our reinsurance arrangements, including outstanding
and uncollectible recoveries. If necessary, risk management
matters reviewed at the FIR Committee meeting are presented
for discussion by the Board. The CRO is responsible for
immediately escalating any significant risk matters to executive
management, the FIR Committee and/or the Board for approval
of the required remediation. As part of our corporate
governance, the Board and certain of its committees hold
regular executive sessions with members of our management
team. These sessions are intended to ensure an open and frank
dialogue exists about various forms of risk across the
organization.
Implementation and Integration. We believe that an integrated
approach to developing, measuring and reporting our Own Risk
and Solvency Assessment (“ORSA”) is an integral part of the
risk management framework. The ORSA process provides the
link between Arch Capital’s risk profile, its board-approved risk
appetite including approved risk tolerances and limits, its
business strategy and its overall solvency requirements. The
ORSA is the entirety of the processes and procedures employed
to identify, assess, monitor, manage, and report the short- and
long-term risks we face or may face and to determine the capital
necessary to ensure that our overall solvency needs are met at
all times. The ORSA also makes the link between actual
reported results and the capital assessment.
The ORSA is the basis for risk reporting to the Board and its
committees and acts as a mechanism to embed the risk
management framework within our decision making processes
and operations. The Board has delegated responsibility for
supervision and oversight of the ORSA to the FIR Committee.
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This oversight includes regular reviews of the ORSA process
and output. An ORSA report is produced at least annually and
the results of each assessment are reported to the Board. The
Board actively participates in the ORSA process by steering
how the assessment is performed and challenging its results.
This assessment is also taken into account when formulating
strategic decisions.
The ORSA process and reporting are integral parts of our
business strategy,
into our
tailored specifically
organizational structure and risk management system with the
appropriate techniques in place to assess our overall solvency
needs, taking into consideration the nature, scale and
complexity of the risks inherent in the business.
to fit
We also take the results of the ORSA into account for our system
of governance, including long-term capital management,
business planning and new product development. The results
of the ORSA also contributes to various strategic decision-
making including how best to optimize capital management,
establishing the most appropriate premium levels and deciding
whether to retain or transfer risks.
For further discussion of our risk management policies, see
“Management’s Discussion and Analysis of Financial
Condition and Results of Operations—Critical Accounting
Policies, Estimates and Recent Accounting Pronouncements—
Ceded Reinsurance” and “Risk Factors—Risks Relating to Our
Industry—The failure of any of the loss limitation methods we
employ could have a material adverse effect on our financial
condition or results of operations.”
REGULATION
General
Our insurance and reinsurance subsidiaries are subject to
varying degrees of regulation and supervision in the various
jurisdictions in which they operate. We are subject to extensive
regulation under applicable statutes in these countries and any
other jurisdictions in which we operate. The current material
regulations under which we operate are described below. We
may become subject in the future to regulation in new
in existing
jurisdictions or
jurisdictions.
to additional
regulations
Bermuda
General. Our Bermuda insurance operating subsidiary, Arch Re
Bermuda, is a Class 4 general business insurer and a Class C
long-term insurer, and is subject to the Insurance Act 1978 of
Bermuda and related regulations, as amended (“Insurance
Act”). The Insurance Act imposes certain solvency and liquidity
standards and auditing and reporting requirements and grants
the Bermuda Monetary Authority (the “BMA”) powers to
supervise, investigate, require information and demand the
production of documents and intervene in the affairs of
insurance companies. Significant requirements include the
appointment of an independent auditor, the appointment of a
loss reserve specialist, the appointment of a principal
representative in Bermuda, the filing of annual Statutory
Financial Returns, the filing of annual financial statements in
accordance with U.S. generally accepted accounting principles
(“GAAP”), the filing of an annual capital and solvency return,
compliance with minimum and enhanced capital requirements,
compliance with certain restrictions on reductions of capital
and the payment of dividends and distributions, compliance
with group solvency and supervision rules, if applicable, and
compliance with the Insurance Code of Conduct (relating to
corporate governance, risk management and internal controls).
Arch Re Bermuda must also comply with a minimum liquidity
ratio and minimum solvency margin in respect of its general
business. The minimum liquidity ratio requires that the value
of relevant assets must not be less than 75% of the amount of
relevant liabilities. The minimum solvency margin, which
varies depending on the class of the insurer, is determined as a
percentage of either net reserves for losses and LAE or
premiums or pursuant to a risk-based capital measure. Arch Re
Bermuda is also subject to an enhanced capital requirement
(“ECR”) which is established by reference to either the
Bermuda Solvency Capital Requirement model (“BSCR”) or
an approved internal capital model. The BSCR model is a risk-
based capital model which provides a method for determining
an insurer’s capital requirements (statutory capital and surplus)
by taking into account the risk characteristics of different
aspects of the insurer’s business. The BMA has established a
target capital level for each Class 4 insurer equal to 120% of its
enhanced capital requirement. While a Class 4 insurer is not
currently required to maintain its available statutory economic
capital and surplus at this level, the target capital level serves
as an early warning tool for the BMA, and failure to maintain
statutory capital at least equal to the target capital level will
likely result in increased regulatory oversight. As a Class C
insurer, Arch Re Bermuda is also required to maintain available
statutory economic capital and surplus in respect of its long-
term business at a level equal to or in excess of its long-term
enhanced capital requirement which is established by reference
to either the Class C BSCR model or an approved internal
capital model.
Arch Re Bermuda is prohibited from declaring or paying any
dividends during any financial year if it is in breach of its general
business or long-term business enhanced capital requirements,
minimum solvency margins or its general business minimum
liquidity ratio or if the declaration or payment of such dividends
would cause such a breach. If it has failed to meet its minimum
solvency margins or minimum liquidity ratio on the last day of
any financial year, Arch Re Bermuda will be prohibited, without
the approval of the BMA, from declaring or paying any
dividends during the next financial year. In addition, Arch Re
Bermuda is prohibited from declaring or paying in any financial
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year dividends of more than 25% of its total statutory capital
and surplus (as shown on its previous financial year’s statutory
balance sheet) unless it files (at least seven days before payment
of such dividends) with the BMA an affidavit stating that it will
continue to meet the required margins. Without the approval of
the BMA, Arch Re Bermuda is prohibited from reducing by
15% or more its total statutory capital as set out in its previous
year’s financial statements and any application for such
approval must include an affidavit stating that it will continue
to meet the required margins.
On July 30, 2018 the Insurance Amendment (No. 2) Act 2018
amended the Insurance Act to provide for the prior payment of
policyholders’ liabilities ahead of general unsecured creditors
in the event of the liquidation or winding up of an insurer. The
amendments provide inter alia that,subject to certain statutorily
preferred debts, the insurance debts of an insurer must be paid
in priority to all other unsecured debts of the insurer. Insurance
debt is defined as a debt to which an insurer is or may become
liable pursuant to an insurance contract excluding debts owed
to an insurer under an insurance contract where the insurer is
the person insured.
Group Supervision. The BMA acts as group supervisor of our
group of insurance and reinsurance companies (“Group”) and
has designated Arch Re Bermuda as the designated insurer
(“Designated Insurer”). As our Group supervisor, the BMA
performs a number of functions including: (i) coordinating the
gathering and dissemination of information for other regulatory
authorities; (ii) carrying out supervisory reviews and
assessments of our Group; (iii) carrying out assessments of our
Group's compliance with
the rules on solvency, risk
concentration, intra-group transactions and good governance
procedures; (iv) planning and coordinating, through regular
meetings with other authorities, supervisory activities in respect
of our Group; (v) coordinating any enforcement action that may
need to be taken against our Group or any Group members; and
(vi) coordinating meetings of colleges of supervisors in order
to facilitate the carrying out of these functions. As Designated
Insurer, Arch Re Bermuda is required to facilitate compliance
by our Group with the group insurance solvency and
supervision rules.
On an annual basis, the Group is required to file Group statutory
financial statements, a Group statutory financial return, a Group
capital and solvency return, audited Group financial statements,
a Group Solvency Self-Assessment (“GSSA”), and a financial
condition report with the BMA. The GSSA is designed to
document our perspective on the capital resources necessary to
achieve our business strategies and remain solvent, and to
provide the BMA with insights on our risk management,
governance procedures and documentation related to this
process. In addition, the Designated Insurer is required to file
quarterly group financial returns with the BMA. The Group is
also required to maintain available Group statutory economic
capital and surplus in an amount that is at least equal to the
group enhanced capital requirement (“Group ECR”) and the
BMA has established a group target capital level equal to 120%
of the Group ECR.
The BMA maintains supervision over the controllers of all
Bermuda registered insurers, and accordingly, any person who,
directly or indirectly, becomes a holder of at least 10%, 20%,
33% or 50% of our ordinary shares must notify the BMA in
writing within 45 days of becoming such a holder (or ceasing
to be such a holder). The BMA may object to such a person and
require the holder to reduce its holding of ordinary shares and
direct, among other things, that voting rights attaching to the
ordinary shares shall not be exercisable
United States
General. Our U.S. based insurance operating subsidiaries are
subject to extensive governmental regulation and supervision
by the states and jurisdictions in which they are domiciled,
licensed and/or approved to conduct business. The insurance
laws and regulations of the state of domicile have the most
significant impact on operations. We currently have U.S.
in
insurance and/or reinsurance subsidiaries domiciled
Delaware, North Carolina, Missouri,Wisconsin and the District
of Columbia. State insurance regulation and supervision is
designed to protect policyholders rather than investors.
Generally, state regulatory authorities have broad regulatory
powers over such matters as licenses, standards of solvency,
premium rates, policy forms, marketing practices, claims
practices, investments, methods of accounting, form and
content of financial statements, certain aspects of governance,
enterprise risk management, amounts we are required to hold
as reserves for future payments, minimum capital and surplus
requirements, annual and other report filings and transactions
among affiliates. Our U.S. based subsidiaries are required to
file detailed quarterly statutory financial statements with state
insurance regulators. In addition, regulatory authorities conduct
periodic financial, claims and market conduct examinations.
Certain insurance regulatory requirements are highlighted
below. In addition to regulation applicable generally to U.S.
insurance and reinsurance companies, our U.S. mortgage
insurance operations are affected by federal and state regulation
relating to mortgage insurers, mortgage lenders, and the
origination, purchase and sale of residential mortgages. Arch
Insurance Company Europe is also subject to certain
governmental regulation and supervision in the states where it
writes excess and surplus lines insurance.
Holding Company Regulation. All states have enacted
legislation that regulates insurance holding company systems.
These regulations generally provide that each insurance
company in the system is required to register with the insurance
department of its state of domicile and furnish information
concerning the operations of companies within the holding
company system which may materially affect the operations,
management or financial condition of the insurers within the
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system. Notice to the state insurance departments is required
prior to the consummation of certain material transactions
between an insurer and any entity in its holding company system
and certain transactions may not be consummated without the
applicable insurance department’s prior approval or non-
disapproval after receiving notice. The holding company acts
also prohibit any person from directly or indirectly acquiring
control of a U.S. insurance or reinsurance company unless that
person has filed an application with specified information with
such company’s domiciliary commissioner and has obtained
the commissioner’s prior approval. Under most states’ statutes
acquiring 10% or more of the voting securities of an insurance
company or its parent company is presumptively considered an
acquisition of control of the insurance company, although such
presumption may be rebutted.
The National Association of Insurance Commissioners
(“NAIC”) has adopted amendments to the Insurance Holding
Company System Regulatory Act and Regulation, which,
among other changes, introduce the concept of “enterprise risk”
within an insurance holding company system. When the
amendments are adopted by a particular state, the amended
Insurance Holding Company System Regulatory Act and
Regulation impose more extensive informational requirements
on parents and other affiliates of licensed insurers or reinsurers
with the purpose of protecting them from enterprise risk,
including requiring an annual enterprise risk report by the
ultimate controlling person identifying the material risks within
the insurance holding company system that could pose
enterprise risk to the licensed companies and requiring a person
divesting its controlling interest to make a confidential advance
notice filing.
Regulation of Dividends and Other Payments from Insurance
Subsidiaries. The ability of an insurer to pay dividends or make
other distributions is subject to insurance regulatory limitations
of the insurer’s state of domicile. Such laws generally limit the
payment of dividends or other distributions above a specified
level. Dividends or other distributions in excess of such
thresholds are “extraordinary” and are subject to prior notice
and approval, or non-disapproval after receiving notice.
Credit for Reinsurance. Arch Re U.S. is subject to insurance
regulation and supervision that is similar to the regulation of
licensed primary insurers. However, except for certain
mandated provisions that must be included in order for a ceding
company to obtain credit for reinsurance ceded, the terms and
conditions of reinsurance agreements generally are not subject
to regulation by any governmental authority.
A primary insurer ordinarily will enter into a reinsurance
agreement only if it can obtain credit for the reinsurance ceded
on its U.S. statutory-basis financial statements. As a result of
the requirements relating to the provision of credit for
reinsurance, and Arch Re U.S. and Arch Re Bermuda are
indirectly subject to certain regulatory requirements imposed
by jurisdictions in which ceding companies are domiciled.
In general, credit for reinsurance is allowed if the reinsurer is
licensed or “accredited” in the state in which the primary insurer
is domiciled; or if none of the above applies, to the extent that
the reinsurance obligations of the reinsurer are collateralized
appropriately, typically through the posting of a letter of credit
for the benefit of the primary insurer or the deposit of assets
into a trust fund established for the benefit of the primary
insurer. Most states have adopted provisions of the NAIC Credit
for Reinsurance Model Law and Regulation that allow full
credit to U.S. ceding insurers for reinsurance ceded to reinsurers
that have been approved as “certified reinsurers” based upon
less than 100% collateralization. Arch Re Bermuda is approved
as a “certified reinsurer” in 33 states.
On April 4, 2018 the U.S. and the European Union (“EU”)
entered into the Bilateral Agreement between the United States
of America and the European Union on Prudential Matters
Regarding Insurance and Reinsurance (the “EU-US Covered
Agreement”) that, among other things, would eliminate
reinsurance collateral requirements for qualified U.S. reinsurers
operating in the EU insurance market, and eliminate reinsurance
collateral requirements for qualified EU reinsurers operating in
the U.S. insurance market. In December 2018, the U.S.
Secretary of the Treasury and the U.S. Trade Representative
announced that they had reached agreement with the U.K. on
a covered agreement (“UK Covered Agreement”) that would
extend terms nearly identical to the EU Covered Agreement to
insurers and reinsurers operating in the U.K. should the United
Kingdom ultimately leave the EU. The NAIC is finalizing
amendments to the Credit for Reinsurance Model Law and
Regulation that would implement the EU-US Covered
Agreement and the UK Covered Agreement and eliminate
reinsurance collateral requirements for qualified reinsurers
domiciled
jurisdictions deemed “Reciprocal
Jurisdictions”.
in other
Risk Management and ORSA. In 2012, the NAIC adopted the
Risk Management and Own Risk and Solvency Assessment
Model Act, which requires domestic insurers to maintain a risk
management framework and establishes a legal requirement for
domestic insurers to conduct an ORSA in accordance with the
NAIC’s ORSA Guidance Manual. The ORSA Model Act
provides that domestic insurers, or their insurance group, must
regularly conduct an ORSA consistent with a process
comparable to the ORSA Guidance Manual process. The ORSA
Model Act also provides that, no more than once a year, an
insurer’s domiciliary regulator may request that an insurer
submit an ORSA summary report, or any combination of reports
that together contain the information described in the ORSA
Guidance Manual, with respect to the insurer and/or the
insurance group of which it is a member. If and when the ORSA
Model Act is adopted by an individual state, the state may
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impose additional internal review and regulatory filing
requirements on licensed insurers and their parent companies.
Cybersecurity. The NAIC has adopted an Insurance Data
Security Model Law, which, when adopted by the states, will
require insurers, insurance producers and other entities required
to be licensed under state insurance laws to comply with certain
requirements under state insurance laws, such as developing
and maintaining a written information security program,
conducting risk assessments and overseeing the data security
practices of third-party vendors. In addition, certain state
insurance regulators are developing or have developed
regulations that may impose regulatory requirements relating
to cybersecurity on insurance and reinsurance companies
(potentially including insurance and reinsurance companies
that are not domiciled, but are licensed, in the relevant state).
For example, the New York State Department of Financial
Services has adopted a regulation pertaining to cybersecurity
for all banking and insurance entities under its jurisdiction,
effective as of March 1, 2017, and the California legislature
passed the California Consumer Privacy Act of 2018, which
takes effect January 1, 2020, both of which apply to us.We
cannot predict the impact these evolving laws and regulations
may have on our business, financial condition or results of
operations, but we could incur additional costs resulting from
compliance with such laws and regulations.
Risk-Based Capital Requirements. Licensed U.S. property and
casualty insurance and reinsurance companies are subject to
risk-based capital requirements that are designed to assess
capital adequacy and to raise the level of protection that
statutory surplus provides for policyholder obligations. The
risk-based capital model for property and casualty insurance
companies measures three major areas of risk facing property
and casualty insurers: underwriting, which encompasses the
risk of adverse loss developments and inadequate pricing;
declines in asset values arising from credit risk; and declines in
asset values arising from investment risks. An insurer will be
subject to varying degrees of regulatory action depending on
how its statutory surplus compares to its risk-based capital
calculation. Under the approved formula, an insurer’s total
adjusted capital is compared to its authorized control level risk-
based capital. If this ratio is above a minimum threshold, no
company or regulatory action is necessary. Below this threshold
are four distinct action levels at which an insurer’s domiciliary
state regulator can intervene with increasing degrees of
authority over an insurer as the ratio of surplus to risk-based
capital requirement decreases. The mildest regulatory action
requires an insurer to submit a plan for corrective action; the
most severe requires an insurer to be rehabilitated or liquidated.
Our mortgage insurance operations are not currently subject to
state risk-based capital requirements, but rather are subject to
state risk to capital or minimum policyholder position
requirements. The NAIC has established a Mortgage Guaranty
Insurance Working Group which is engaged in developing
changes to the Mortgage Guaranty Insurers Model Act,
including the development of a risk based capital model unique
to mortgage guaranty insurers.
Guaranty Funds. Most states require all admitted insurance
companies to participate in their respective guaranty funds
which cover certain claims against insolvent insurers. Solvent
insurers licensed in these states are required to cover the losses
paid on behalf of insolvent insurers by the guaranty funds and
are generally subject to annual assessments in the states by the
guaranty funds to cover these losses. Mortgage guaranty
insurance, among other lines of business, is typically exempt
from participation in guaranty funds.
Federal Regulation. Although state regulation is the dominant
form of regulation for insurance and reinsurance business, a
number of federal laws affect and apply to the insurance
industry. The Dodd-Frank Wall Street Reform and Consumer
Protection Act of 2010 (“Dodd-Frank”) created the Federal
Insurance Office (“FIO”) within the Department of Treasury,
which is not a federal regulator or supervisor of insurance, but
monitors the insurance industry for systemic risk, administers
the Terrorism Risk Insurance Program Reauthorization Act of
2015 (“TRIPRA”), consults with the states regarding insurance
matters and develops federal policy on aspects of international
insurance matters. See “Risk Factors-Risks Related to Our
Industry-We could face unanticipated losses from war,
terrorism and political instability, and these or other
unanticipated losses could have a material adverse effect on
our financial condition and results of operations” for more
information on TRIPRA. In addition, FIO is authorized to assist
the U.S. Secretary of the Treasury in negotiating “covered
agreements” between the U.S. and one or more foreign
governments or regulatory authorities that address insurance
prudential measures.
Certain other federal laws also directly or indirectly impact
mortgage insurers, including the Real Estate Settlement
Procedures Act of 1974 (“RESPA”), the Homeowners
Protection Act of 1998 (“HOPA”), the Equal Credit Opportunity
Act, the Fair Housing Act, the Truth In Lending Act (“TILA”),
the Fair Credit Reporting Act of 1970 (“FCRA”), and the Fair
Debt Collection Practices Act. Among other things, these laws
and their implementing regulations prohibit payments for
referrals of settlement service business, require fairness and
non-discrimination in granting or facilitating the granting of
credit, govern the circumstances under which companies may
obtain and use consumer credit information, define the manner
in which companies may pursue collection activities, and
require disclosures of the cost of credit and provide for other
consumer protections.
GSE Eligible Mortgage Insurer Requirements. GSEs impose
requirements on private mortgage insurers so that they may be
eligible to insure loans sold to the GSEs, known as the Private
Mortgage Insurer Eligibility Requirements or “PMIERs.” The
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PMIERs apply to our eligible mortgage insurers, but do not
apply to Arch Mortgage Guaranty Company, which is not GSE-
approved. The PMIERs impose limitations on the type of risk
insured, the forms and insurance policies issued, standards for
the geographic and customer diversification of risk, procedures
for claims handling, acceptable underwriting practices,
standards for certain reinsurance cessions and financial
requirements, among other things. The financial requirements
require an eligible mortgage insurer’s available assets, which
generally include only the most liquid assets of an insurer, to
meet or exceed “minimum required assets” as of each quarter
end. Minimum required assets are calculated from PMIERs
tables with several risk dimensions (including origination year,
original loan-to-value and original credit score of performing
loans, and the delinquency status of non-performing loans). Our
eligible mortgage insurers satisfied the PMIERs’ financial
requirements as of December 31, 2018.
On September 27, 2018, the GSEs released revised Private
Mortgage Insurer Eligibility Requirements or “revised
PMIERs”. The revised PMIERs become effective on March 31,
2019 and are not expected to have a significant impact on our
eligible mortgage insurers operations or have a material impact
on their capital position. While not yet effective, our eligible
mortgage insurers satisfied the revised PMIERs’ financial
requirements as of December 31, 2018.
United Kingdom
General. The Prudential Regulation Authority (“PRA”) and the
Financial Conduct Authority (“FCA”) regulate insurance and
reinsurance companies and the FCA regulates firms carrying
on insurance mediation activities operating in the U.K. both
under the Financial Services and Markets Act 2000 (the
“FSMA”). In May 2004, Arch Insurance Company Europe was
granted the relevant permissions for the classes of insurance
business which it underwrites in the U.K. In 2009, AUAL was
licensed and authorized by the relevant U.K. regulator and the
Lloyd’s Franchise Board and holds the relevant permissions for
the classes of insurance business which are underwritten in the
U.K. by Arch Syndicate 2012. Arch Syndicate 2012 has one
member, Arch Syndicate Investments Ltd. (“ASIL”). All U.K.
companies are also subject to a range of statutory provisions,
including the laws and regulations of the Companies Act 2006
(as amended) (the “U.K. Companies Act”).
The objectives of the PRA are to promote the safety and
soundness of all firms it supervises and to secure an appropriate
degree of protection for policyholders. The objectives of the
FCA are to ensure customers receive financial services and
products that meet their needs, to promote sound financial
systems and markets and to ensure that firms are stable and
resilient with transparent pricing information and which
compete effectively and have the interests of their customers
and the integrity of the market at the heart of how they run their
business. The PRA has responsibility for the prudential
regulation of banks and insurers, while the FCA has
responsibility for the conduct of business regulation in the
wholesale and retail markets. The PRA and the FCA adopt
separate methods of assessing regulated firms on a periodic
basis. Arch Insurance Europe and AUAL are subject to periodic
assessment by the PRA along with all regulated firms. Arch
Insurance Company Europe and AUAL are subject to regulation
by both the PRA and FCA.
Lloyd’s Supervision. The operations of AUAL and related Arch
Syndicate 2012 and its corporate member, ASIL, are subject to
the byelaws and regulations made by (or on behalf of) the
Council of Lloyd’s, and requirements made under those
byelaws. The Council of Lloyd’s, established in 1982 by
Lloyd’s Act 1982, has overall responsibility and control of
Lloyd’s. Those byelaws, regulations and requirements provide
a framework for the regulation of the Lloyd’s market, including
specifying conditions in relation to underwriting and claims
operations of Lloyd’s participants. Lloyd’s is also subject to the
provisions of the FSMA. Lloyd's is authorized by the PRA and
regulated by the PRA and FCA. Those entities acting within the
Lloyd’s market are required to comply with the requirements
of the FSMA and provisions of the PRA’s or FCA's rules,
although the PRA has delegated certain of its powers, including
some of those relating to prudential requirements, to Lloyd’s.
ASIL, as a member of Lloyd’s, is required to contribute 0.5%
of Arch Syndicate 2012’s premium income limit for each year
of account to the Lloyd’s central fund. The Lloyd’s central fund
is available if members of Lloyd’s assets are not sufficient to
meet claims for which the member is liable. As a member of
Lloyd’s, ASIL may also be required to contribute to the central
fund by way of a supplement to a callable layer of up to 3% of
Arch Syndicate 2012’s premium income limit for the relevant
year of account. In addition, AUAL, on behalf of Arch
Syndicate 2012, is approved to underwrite excess and surplus
lines insurance in most states in the U.S. through Lloyd’s
licenses. Such activities must be in compliance with the Lloyd’s
requirements.
Financial Resources. The European solvency framework and
prudential regime for insurers and reinsurers, the Solvency II
Directive 2009/138/EC “Solvency II”), took effect in full on
January 1, 2016. See “European Union Insurance and
and Reinsurance
Reinsurance Regulation—Insurance
Regulatory Regime” below for additional details.
Arch Insurance Company Europe and AUAL (on behalf of
Syndicate 2012) are required to meet economic risk-based
solvency requirements imposed under Solvency II. Solvency
II, together with European Commission “delegated acts” and
guidance issued by the European Insurance and Occupational
Pensions Authority (“EIOPA”) sets out classification and
eligibility requirements, including the features which capital
must display in order to qualify as regulatory capital.
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2018 FORM 10-K
Financial Services Compensation Scheme. The Financial
Services Compensation Scheme (“FSCS”) is a scheme
established under FSMA to compensate eligible policyholders
of insurance companies who may become insolvent. The FSCS
is funded by the levies that it has the power to impose on all
insurers. Arch Insurance Europe could be required to pay levies
to the FSCS.
Restrictions on Acquisition of Control. Under FSMA, the prior
consent of the PRA or FCA, as applicable, is required, before
any person can become a controller or increase its control over
any regulated company, including Arch Insurance Company
Europe and AUAL, or over the parent undertaking of any
regulated company. Therefore, the PRA's or FCA's prior
consent, as applicable, is required before any person can
become a controller of Arch Capital. Prior consent is also
required from Lloyd’s before any person can become a
controller or increase its control over a corporate member or a
managing agent or a parent undertaking of a corporate member
or managing agent. A controller is defined for these purposes
as a person who holds (either alone or in concert with others)
10% or more of the shares or voting power in the relevant
company or its parent undertaking.
they have “profits available
Restrictions on Payment of Dividends. Under English law, all
companies are restricted from declaring a dividend to their
for
shareholders unless
distribution.” The calculation as to whether a company has
sufficient profits is based on its accumulated realized profits
minus its accumulated realized losses. U.K. insurance
regulatory laws do not prohibit the payment of dividends, but
the PRA or FCA, as applicable, requires that insurance
companies and insurance intermediaries maintain certain
solvency margins and may restrict the payment of a dividend
by Arch Insurance Company Europe, AUAL or ASIL.
European Union Considerations. Through their respective
authorizations in the U.K., a Member State of the EU, Arch
Insurance Company Europe’s and AUAL’s authorizations are
recognized throughout the European Economic Area (“EEA”),
subject only
to certain notification and application
requirements. This authorization enables Arch Insurance
Company Europe and AUAL to exercise “passporting” rights
which allows Arch Insurance Company Europe and AUAL to
establish a branch in any other Member State of the EU, where
such entity will be subject to the insurance regulations of each
such Member State with respect to the conduct of its business
in such Member State, but remain subject only to the financial
and operational supervision by the PRA or FCA (as applicable).
The conditions for the establishment of branches in Member
States of the EU are set out in Solvency II. Arch Insurance
Company Europe currently has branches in Germany, Italy,
Spain and Denmark and may establish branches in other
Member States of the EU in the future. Further, through its
passporting rights, Arch Insurance Company Europe and
AUAL have the freedom to provide insurance services
anywhere in the EEA subject to compliance with certain rules
governing such provision, including notification to the PRA or
FCA, as applicable.
Following the referendum in June 2016 in which a majority of
voting U.K. citizens voted in favor of the U.K. leaving the EU
(“Brexit”), the U.K. withdrawal from the EU will lead to a loss
of passporting rights for financial institutions in the U.K.,
except to the extent that any aspect of the regime is preserved
in a separate agreement between the EU and the U.K. See “Risk
Industry—The United
to Our
Factors—Risks Related
Kingdom’s referendum vote in favor of leaving the EU could
adversely affect us.”
Canada
Arch Insurance Canada and Arch Re Canada are subject to
federal, as well as provincial and territorial, regulation in
Canada in the provinces and territories in which they underwrite
insurance/reinsurance. The Office of the Superintendent of
Financial Institutions (“OSFI”) is the federal regulatory body
that, under the Insurance Companies Act (Canada), prudentially
regulates federal Canadian and non-Canadian insurance and
reinsurance companies operating in Canada. Arch Insurance
Canada is licensed to carry on insurance business by OSFI and
in each province and territory. Arch Re Canada is licensed to
carry on reinsurance business by OSFI and in the provinces of
Ontario and Quebec.
Under the Insurance Companies Act (Canada), Arch Insurance
Canada is required to maintain an adequate amount of capital
in Canada, calculated in accordance with a test promulgated by
OSFI called the Minimum Capital Test, and Arch Re Canada is
required to maintain an adequate margin of assets over liabilities
in Canada, calculated in accordance with a test promulgated by
OSFI called the Branch Adequacy of Assets Test. OSFI has
implemented a
for assessing
risk-based methodology
insurance/reinsurance companies operating in Canada known
as its “Supervisory Framework.” In applying the Supervisory
Framework, OSFI considers the inherent risks of the business
and the quality of risk management for each significant activity
of each operating entity. Under the Insurance Companies Act
(Canada), approval of the Minister of Finance (Canada) is
required in connection with certain acquisitions of shares of, or
control of, Canadian insurance companies such as Arch
Insurance Canada, and notice to and/or approval of OSFI is
required in connection with the payment of dividends by or
redemption of shares by Canadian insurance companies such
as Arch Insurance Canada.
Ireland
General. The CBOI regulates insurance and reinsurance
companies and intermediaries authorized in Ireland. Our three
Irish operating subsidiaries are Arch Re Europe, Arch MI
Europe and Arch Underwriters Europe. Arch Re Europe was
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2018 FORM 10-K
licensed and authorized by the CBOI as a non-life reinsurer in
October 2008 and as a life reinsurer in November 2009. Arch
MI Europe was licensed and authorized by the CBOI as a non-
life insurer in December 2011. Arch Underwriters Europe was
registered by the CBOI as an insurance and reinsurance
intermediary in July 2014. Arch Re Europe, Arch MI Europe
and Arch Underwriters Europe are subject to the supervision of
the CBOI and must comply with Irish insurance acts and
regulations as well as with directions and guidance issued by
the CBOI.
Arch Re Europe and Arch MI Europe are required to comply
with Solvency II requirements. See “European Union Insurance
and Reinsurance Regulation—Insurance and Reinsurance
Regulatory Regime” below for additional details. As an
intermediary, Arch Underwriters Europe is subject to a different
regulatory regime and is not subject to solvency capital rules,
but must comply with requirements such as to maintain
professional indemnity insurance and to have directors that are
fit and proper. Our Irish subsidiaries are also subject to the
general body of Irish company laws and regulations including
the provisions of the Companies Act 2014.
Financial Resources. Arch Re Europe and Arch MI Europe are
required to meet economic risk-based solvency requirements
imposed under Solvency II. Solvency II, together with
European Commission “delegated acts” and guidance issued
by EIOPA sets out classification and eligibility requirements,
including the features which capital must display in order to
qualify as regulatory capital.
Restrictions on Acquisitions. Under Irish law, the prior consent
of the CBOI is required before any person can acquire or
increase a qualifying holding in an Irish insurer or reinsurer,
including Arch MI Europe and Arch Re Europe, or their parent
undertakings. A qualifying holding is defined for these purposes
as a direct or indirect holding that represents 10% or more of
the capital of, or voting rights, in the undertaking or makes it
possible
the
management of the undertaking.
to exercise a significant
influence over
Restrictions on Payment of Dividends. Under Irish company
law, Arch Re Europe, Arch MI Europe and Arch Underwriters
Europe are permitted to make distributions only out of profits
available for distribution. A company’s profits available for
distribution are its accumulated, realized profits, so far as not
previously utilized by distribution or capitalization, less its
accumulated, realized losses, so far as not previously written
off in a reduction or reorganization of capital duly made.
Further, the CBOI has powers to intervene if a dividend payment
were to lead to a breach of regulatory capital requirements.
European Union Considerations. As Arch Re Europe, Arch MI
Europe and Arch Underwriters Europe are authorized by the
CBOI in Ireland, a Member State of the EU, those authorizations
are recognized throughout the EEA. Subject only to certain
notification and application requirements, Arch Re Europe,
Arch MI Europe and Arch Underwriters Europe can provide
services, or establish a branch, in any other Member State of
the EEA. Although, in doing so, they may be subject to the laws
of such Member States with respect to the conduct of business
in such Member State, company law registrations and other
matters, they will remain subject to financial and operational
supervision by the CBOI only. Arch Re Accident & Health ApS
(“Arch Re Denmark”) is an underwriting agency underwriting
accident and health business for Arch Re Europe in Denmark.
Arch Re Europe also has a branch in the U.K., which
underwrites non-life reinsurance risk for Arch Re Europe. Arch
Re Europe also has a branch outside the EEA, Arch Reinsurance
Europe Designated Activity Company, Dublin (Ireland), Zurich
Branch (“Arch Re Europe Swiss Branch”).
As part of its application for registration, Arch Underwriters
Europe requested the CBOI to make the necessary notifications
to permit it to provide insurance and reinsurance intermediary
services in all EEA Member States. Arch Underwriters Europe
currently has branches in the following EU countries: the U.K.,
Italy and Finland.
Following Brexit, the U.K.'s withdrawal from the EU will lead
to a loss of passporting rights for EEA financial institutions
(including our Irish operating subsidiaries) into the U.K., except
to the extent that any aspect of the regime is preserved in a
separate agreement between the EU and the U.K. Absent such
agreement, the post-Brexit status and rules applicable to U.K.
branches of EEA financial institutions will be primarily driven
by U.K. law and regulation. See “Risks Relating to Our Industry
—The United Kingdom’s referendum vote in favor of leaving
the EU could adversely affect us.”
Switzerland
In December 2008, Arch Re Europe opened Arch Re Europe
Swiss Branch as a branch office. As Arch Re Europe is
domiciled outside of Switzerland and its activities are limited
to reinsurance, the Arch Re Europe Swiss Branch in Switzerland
is not required to be licensed by the Swiss insurance regulatory
authorities.
In August 2014, Arch Underwriters Europe opened a branch
office in Zurich (“Arch Underwriters Europe Swiss Branch”)
to render reinsurance advisory services to certain group
companies. Arch Underwriters Europe Swiss Branch is
registered with the commercial register of the Canton of Zurich.
Since its activities are limited to advisory services for
reinsurance matters, the Arch Underwriters Europe Swiss
Branch is not required to be licensed by the Swiss insurance
regulatory authorities.
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European Union
Insurance and Reinsurance Regulatory Regime. Solvency II
took effect in full on January 1, 2016. Solvency II imposes
economic risk-based solvency requirements across all EU
Member States and consists of three pillars: Pillar I-quantitative
capital requirements, based on a valuation of the entire balance
sheet; Pillar II-qualitative regulatory review, which includes
governance, internal controls, enterprise risk management and
supervisory review process; and Pillar III-market discipline,
which is accomplished through reporting of the insurer’s
financial condition to regulators and the public. Solvency II is
supplemented by European Commission Delegated Regulation
(EU) 2015/35 (the “Delegated Regulation”), other European
Commission “delegated acts” and binding technical standards,
and guidelines issued by EIOPA. The Delegated Regulation sets
out more detailed requirements for individual insurance and
reinsurance undertakings, as well as for groups, based on the
overarching provisions of Solvency II, which together make up
the core of the single prudential rulebook for insurance and
reinsurance undertakings in the EU.
Insurers and reinsurers established in a Member State of the EU
have the freedom to establish branches in and provide services
to all EEA states. Arch Insurance Company Europe and AUAL,
being established in the U.K. and regulated by the PRA and
FCA, are able, subject to regulatory notifications and there
being no objection from the relevant U.K. regulator and the
Member States concerned, to establish branches and provide
insurance and reinsurance services in all EEA Member States.
Following Brexit, the U.K.’s withdrawal from the EU will lead
to a loss of passporting rights from U.K. financial institutions
into the EU, except to the extent that any aspect of the regime
is preserved in a separate agreement between the U.K. and the
U.K. See “Risks Relating to Our Industry –The United
Kingdom’s referendum vote in favor of leaving the EU could
adversely affect us.”
Arch Re Europe and Arch MI Europe, being established in
Ireland and authorized by the CBOI are able, subject to similar
regulatory notifications and there being no objection from the
CBOI and the Member States concerned, to establish branches
and provide reinsurance services, and, in respect of Arch MI
Europe, insurance services in all EEA states.
Solvency II does not prohibit EEA insurers from obtaining
reinsurance from reinsurers licensed outside the EEA, such as
Arch Re Bermuda. As such, and subject to the specific rules in
each Member State, Arch Re Bermuda may do business from
Bermuda with insurers in EEA Member States, but it may not
directly operate its reinsurance business within the EEA. Article
172 of Solvency II provides that reinsurance contracts
concluded by insurance undertakings in the EEA with reinsurers
having their head office in a country whose solvency regime
has been determined to be equivalent to Solvency II shall be
treated in the same manner as reinsurance contracts with
undertakings in the EEA authorized under Solvency II. In this
regard, with effect from January 1, 2016, the supervisory
regime, including the solvency regime, in Bermuda has been
determined to be equivalent to that laid down in Solvency II,
except in relation to captives and special purpose insurers.
Solvency II also includes specific measures providing for the
supervision of insurance and reinsurance groups. However, as
a consequence of the above determination of equivalence,
pursuant to Article 260 of Solvency II, regulators within the
EEA are required to rely on the worldwide group supervision
exercised by the BMA. EIOPA has also indicated that, on a case
by case basis, groups subject to this worldwide supervision may
be exempted from any EEA sub-group supervision, where this
results in more efficient supervision of the group and does not
impair EEA supervisors in respect of their individual
responsibilities.
The Insurance Distribution Directive ("IDD") was published in
February 2016. EEA Member States were required to transpose
the IDD by October 1, 2018. It replaces the existing Insurance
Mediation Directive. The IDD applies to all distributors of
insurance and reinsurance products (including insurers and
reinsurers selling directly to customers) and strengthens the
regulatory regime applicable to distribution activities through
increased transparency, information and conduct requirements.
The principal impact of the IDD is on the insurance market,
however, requirements that apply across insurance and
include more specific conditions regarding
reinsurance
knowledge
continuing professional development
and
requirements for those involved in distribution of (re)insurance
products. The IDD continues
the existing ability for
intermediaries established in a Member State of the EU to
establish branches and provide services to all EEA states. Arch
Underwriters Europe, being established in Ireland and
authorized by the CBOI, is able, subject to regulatory
notifications and there being no objection from the CBOI, to
establish branches and provide services in all EEA states.
Privacy. The European General Data Protection Regulation (the
“GDPR”) came into effect on May 25, 2018. The GDPR aims
to introduce consistent data protection rules across the EU and
EEA, and its scope extends to certain entities not established
in the EEA if they process personal data or offer goods or
services to, or monitor the behavior of, EEA data subjects. The
GDPR contains a number of new requirements regarding the
processing of personal data about individuals, including
mandatory security breach reporting, new and strengthened
individual rights, evidenced data controller accountability for
compliance with the GDPR principles (including fairness and
transparency), maintenance of data processing activity records
and the implementation of “privacy by design,” including
through the completion of mandatory Data Protection Impact
Assessments in connection with higher risk data processing
activities.
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2018 FORM 10-K
Australia
APRA is an independent statutory authority that supervises
institutions across banking, insurance and superannuation and
promotes financial stability in Australia. Arch LMI was
authorized by APRA in January 2019 to conduct monoline
lenders’ mortgage insurance business in Australia. Major
regulatory requirements that are applicable to Arch LMI as an
insurance provider in Australia include requirements on
minimum capital levels and compliance with corporate
governance standards, including the risk management strategy
for our Australian mortgage insurance business.
Hong Kong
The Hong Kong insurance industry is regulated by the Insurance
Authority, the regulatory authority established pursuant to the
Insurance Ordinance (Cap. 41), whose principal function is to
regulate and supervise the insurance industry for the promotion
of the general stability of the insurance industry and for the
protection of existing and potential policyholders. Arch MI Asia
is authorized to carry on general business Class 14 (Credit) and
Class 16 (Miscellaneous Financial Loss), in or from Hong
Kong.
Major regulatory requirements that are applicable to Arch MI
Asia as a general business insurer include requirements on
minimum paid-up capital, minimum solvency margin and
maintenance of assets in Hong Kong.
TAX MATTERS
The following summary of the taxation of Arch Capital and the
taxation of our shareholders is based upon current law and is
for general
judicial or
information only. Legislative,
administrative changes may be forthcoming that could affect
this summary.
The following legal discussion (including and subject to the
matters and qualifications set forth in such summary) of certain
tax considerations (a) under “—Taxation of Arch Capital—
Bermuda” and “—Taxation of Shareholders—Bermuda” is
based upon the advice of Conyers Dill & Pearman Limited,
Hamilton, Bermuda and (b) under “—Taxation of Arch Capital-
United States,” “—Taxation of Shareholders-United States
Taxation,” “—Taxation of Our U.S. Shareholders” and “—
United States Taxation of Non-U.S. Shareholders” is based
upon the advice of Cahill Gordon & Reindel LLP, New York,
New York (the advice of such firms does not include accounting
matters, determinations or conclusions relating to the business
or activities of Arch Capital). The summary is based upon
current law and is for general information only. The tax
treatment of a holder of our common or preferred shares, or of
a person treated as a holder of our shares for U.S. federal income,
state, local or non-U.S. tax purposes, may vary depending on
the holder’s particular tax situation. Legislative, judicial or
administrative changes or interpretations may be forthcoming
that could be retroactive and could affect the tax consequences
to us or to holders of our shares.
Taxation of Arch Capital
Bermuda. Under current Bermuda law, Arch Capital is not
subject to tax on income or profits, withholding, capital gains
or capital transfers. Arch Capital has obtained from the Minister
of Finance under the Exempted Undertakings Tax Protection
Act 1966 of Bermuda an assurance that, in the event that
Bermuda enacts legislation imposing tax computed on profits,
income, any capital asset, gain or appreciation, or any tax in the
nature of estate duty or inheritance, the imposition of any such
tax shall not be applicable to Arch Capital or to any of our
operations or our shares, debentures or other obligations until
March 31, 2035. We could be subject to taxes in Bermuda after
that date. This assurance will be subject to the proviso that it is
not to be construed so as to prevent the application of any tax
or duty to such persons as are ordinarily resident in Bermuda
(we are not so currently affected) or to prevent the application
of any tax payable in accordance with the provisions of the Land
Tax Act 1967 of Bermuda or otherwise payable in relation to
any property leased to us or our insurance subsidiary. We pay
annual Bermuda government fees, and our Bermuda insurance
and reinsurance subsidiary pays annual insurance license fees.
In addition, all entities employing individuals in Bermuda are
required to pay a payroll tax and other sundry taxes payable,
directly or indirectly, to the Bermuda government.
United States. Arch Capital and its non-U.S. subsidiaries intend
to conduct their operations in a manner that will not cause them
to be treated as engaged in a trade or business in the U.S. and,
therefore, will not be required to pay U.S. federal income taxes
(other than U.S. excise taxes on insurance and reinsurance
premium and withholding taxes on dividends and certain other
U.S. source investment income). However, because definitive
identification of activities which constitute being engaged in a
trade or business in the U.S. is not provided by the Internal
Revenue Code of 1986, as amended (the “Code”), or regulations
or court decisions, there can be no assurance that the U.S.
Internal Revenue Service (“IRS”) will not contend successfully
that Arch Capital or its non-U.S. subsidiaries are or have been
engaged in a trade or business in the U.S. A foreign corporation
deemed to be so engaged would be subject to U.S. income tax,
as well as the branch profits tax, on its income, which is treated
as effectively connected with the conduct of that trade or
business unless the corporation is entitled to relief under the
permanent establishment provisions of a tax treaty. Such
income tax, if imposed, would be based on effectively
connected income computed in a manner generally analogous
to that applied to the income of a domestic corporation, except
that deductions and credits generally are not permitted unless
the foreign corporation has timely filed a U.S. federal income
tax return in accordance with applicable regulations. Penalties
may be assessed for failure to file tax returns. The 30% branch
ARCH CAPITAL
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2018 FORM 10-K
profits tax is imposed on net income after subtracting the regular
corporate tax and making certain other adjustments.
Under the income tax treaty between Bermuda and the U.S. (the
“Treaty”), Arch Capital's Bermuda insurance subsidiaries will
be subject to U.S. income tax on any insurance premium income
found to be effectively connected with a U.S. trade or business
only if that trade or business is conducted through a permanent
establishment in the U.S. No regulations interpreting the Treaty
have been issued. While there can be no assurances, Arch
Capital does not believe that any of its Bermuda insurance
subsidiaries has a permanent establishment in the U.S. Such
subsidiaries would not be entitled to the benefits of the Treaty
if (i) 50% or less of Arch Capital's shares were beneficially
owned, directly or indirectly, by Bermuda residents or U.S.
citizens or residents, or (ii) any such subsidiary's income were
used in substantial part to make disproportionate distributions
to, or to meet certain liabilities to, persons who are not Bermuda
residents or U.S. citizens or residents. While there can be no
assurances, Arch Capital believes that its Bermuda insurance
subsidiaries are eligible for Treaty benefits.
The Treaty clearly applies to premium income, but may be
construed as not protecting investment income. If Arch
Capital’s Bermuda insurance subsidiaries were considered to
be engaged in a U.S. trade or business and were entitled to the
benefits of the Treaty in general, but the Treaty were not found
to protect investment income, a portion of such subsidiaries’
investment income could be subject to U.S. federal income tax.
Non-U.S. insurance companies carrying on an insurance
business within the U.S. have a certain minimum amount of
effectively connected net investment income, determined in
accordance with a formula that depends, in part, on the amount
of U.S. risk insured or reinsured by such companies. If any of
Arch Capital's non-U.S. insurance subsidiaries is considered to
be engaged in the conduct of an insurance business in the U.S.,
a significant portion of such company's investment income
could be subject to U.S. income tax.
Non-U.S. corporations not engaged in a trade or business in the
U.S. are nonetheless subject to U.S. income tax on certain “fixed
or determinable annual or periodic gains, profits and income”
derived from sources within the U.S. as enumerated in
Section 881(a) of the Code (such as dividends and certain
interest on investments), subject to exemption under the Code
or reduction by applicable treaties.
The U.S. also imposes an excise tax on insurance and
reinsurance premiums paid to non-U.S. insurers or reinsurers
with respect to risks located in the U.S. The rates of tax, unless
reduced by an applicable U.S. tax treaty, are 4% for non-life
insurance premiums and 1% for life insurance and all
reinsurance premiums.
The Tax Cuts and Jobs Act of 2017 (the “Tax Cuts Act”) was
signed into law by the President of the United States in 2017.
For taxable years beginning after 2017, the Tax Cuts Act
imposes a 10% minimum tax (reduced to 5% for the 2018
taxable year and increased to 12.5% for the 2026 taxable year
and the subsequent taxable years) on the “modified taxable
income” of a U.S. corporation (or a non-U.S. corporation
engaged in a U.S. trade or business) over such corporation’s
regular U.S. federal income tax, reduced by certain tax credits.
The “modified taxable income” of a corporation is determined
without deduction for certain payments by such corporation to
its non-U.S. affiliates (including reinsurance premiums).
United Kingdom. Our U.K. subsidiaries are companies
incorporated and have their central management and control in
the U.K., and are therefore resident in the U.K. for corporation
tax purposes. As a result, they will be subject to U.K.
corporation tax on their respective profits. The U.K. branches
of Arch Re Europe and Arch Underwriters Europe will be
subject to U.K. corporation tax on the profits (both income
profits and chargeable gains) attributable to each branch. The
main rate of U.K. corporation tax for the financial year starting
April 1, 2018 is 19% on profits. It has been announced that the
U.K. corporation tax rate will remain at 19% on profits for the
financial year starting April 1, 2019, and will reduce to 17% on
profits for the financial year starting April 1, 2020.
Canada. Arch Insurance Canada, a Canadian federal insurance
company, commenced underwriting in 2013. Arch Re U.S.,
through a branch, commenced underwriting reinsurance in
Canada in January 2015. Arch Insurance Canada is taxed on its
worldwide income. Arch Re U.S. is taxed on its net business
income earned in Canada. The general federal corporate income
tax rate in Canada is currently 15%. Provincial and territorial
corporate income tax rates are added to the general federal
corporate income tax rate and generally vary between 11% and
16%.
Ireland. Each of Arch Re Europe, Arch MI Europe and Arch
Underwriters Europe is incorporated and resident in Ireland for
corporation tax purposes and will be subject to Irish corporate
tax on its worldwide profits, including the profits of the
branches of Arch Re Europe and Arch Underwriters Europe.
Any creditable foreign tax payable will be creditable against
Arch Re Europe’s Irish corporate tax liability on the results of
Arch Re Europe’s branches with the same principle applied to
Arch Underwriters Europe’s branches. The current rate of Irish
corporation tax applicable to such trading profits is 12.5%.
Switzerland. Arch Re Europe Swiss Branch and Arch
Underwriters Europe Swiss Branch are subject to Swiss
corporation tax on the profit which is allocated to the branch.
The effective tax rate is approximately 21.15% for Swiss
federal, cantonal and communal corporation taxes on the profit.
The effective tax rate of the annual cantonal and communal
capital taxes on the equity which is allocated to Arch Re Europe
ARCH CAPITAL
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2018 FORM 10-K
Swiss Branch and Arch Underwriters Europe Swiss Branch is
approximately 0.17%.
Denmark. Arch Re Denmark, established as a subsidiary of
Arch Re Bermuda, is subject to Danish corporation taxes on its
profits at a rate of 22% for 2016 and onwards.
Hong Kong. Arch MI Asia is subject to Hong Kong corporate
tax on its assessable profits at a rate of 16.5%. Assessable profits
are the net profits for the basis period, arising in or derived from
Hong Kong.
Australia. Arch LMI, an Australian incorporated and tax
resident company, is subject to Australian corporate tax on its
worldwide profits. The current rate of Australian corporation
tax applicable to such profits is 30%.
Taxation of Shareholders
Bermuda. Currently, there is no Bermuda withholding tax on
dividends paid by us.
investment
United States—General. The following summary sets forth
certain U.S. federal income tax considerations related to the
purchase, ownership and disposition of our common shares and
our non-cumulative preferred shares (“preferred shares”).
Unless otherwise stated, this summary deals only with
shareholders (“U.S. holders”) that are U.S. Persons (as defined
below) who hold their common shares and preferred shares as
capital assets and as beneficial owners. The following
discussion is only a general summary of the U.S. federal income
tax matters described herein and does not purport to address all
of the U.S. federal income tax consequences that may be
relevant to a particular shareholder in light of such shareholder’s
specific circumstances. In addition, the following summary
does not describe the U.S. federal income tax consequences that
may be relevant to certain types of shareholders, such as banks,
insurance companies, regulated investment companies, real
estate
financial asset securitization
investment trusts, dealers in securities or traders that adopt a
mark-to-market method of tax accounting, tax exempt entities,
expatriates, U.S. holders that hold our common shares or
preferred shares through a non-U.S. broker or other non-U.S.
intermediary, persons who hold the common shares or preferred
shares as part of a hedging or conversion transaction or as part
of a straddle, who may be subject to special rules or treatment
under the Code or persons required for U.S. federal income tax
purposed to recognize income no later than such income is
reported on such persons’ applicable financial statements. This
discussion is based upon the Code, the Treasury regulations
promulgated there under and any relevant administrative
rulings or pronouncements or judicial decisions, all as in effect
on the date of this annual report and as currently interpreted,
and does not take into account possible changes in such tax laws
or interpretations thereof, which may apply retroactively. This
discussion does not include any description of the tax laws of
trusts,
any state or local governments within the U.S., or of any foreign
government, that may be applicable to our common shares or
preferred shares or the shareholders. Persons considering
making an investment in the common shares or preferred shares
should consult their own tax advisors concerning the
application of the U.S. federal tax laws to their particular
situations as well as any tax consequences arising under the
laws of any state, local or foreign taxing jurisdiction prior to
making such investment.
If an entity that is treated as a partnership holds our common
shares or preferred shares, the tax treatment of a partner will
generally depend upon the status of the partner and the activities
of the partnership. If you are a partner of a partnership holding
our common shares or preferred shares, you should consult your
tax advisor.
For purposes of this discussion, the term “U.S. Person” means:
•
•
•
•
an individual who is a citizen or resident of the U.S.;
a corporation or entity treated as a corporation created or
organized under the laws of the U.S., any state thereof, or
the District of Columbia;
an estate the income of which is subject to U.S. federal
income taxation regardless of its source;
a trust if either (i) a court within the U.S. is able to exercise
primary supervision over the administration of such trust
and one or more U.S. persons have the authority to control
all substantial decisions of such trust or (ii) the trust has a
valid election in effect to be treated as a U.S. person for
U.S. federal income tax purposes; or
•
any other person or entity that is treated for U.S. federal
income tax purposes as if it were one of the foregoing.
person
“related
(“CFC”),
United States—Taxation of Dividends. The preferred shares
should be properly classified as equity rather than debt for U.S.
federal income tax purposes. Subject to the discussions below
relating to the potential application of the controlled foreign
corporation
insurance
income” (“RPII”) and passive foreign investment companies
(“PFIC”) rules, as defined below, cash distributions, if any,
made with respect to our common shares or preferred shares
will constitute dividends for U.S. federal income tax purposes
to the extent paid out of our current or accumulated earnings
and profits (as computed using U.S. tax principles). If a U.S.
holder of our common shares or our preferred shares is an
individual or other non-corporate holder, dividends paid, if any,
to that holder that constitute qualified dividend income
generally will be taxable at the rate applicable for long-term
capital gains (generally up to 20%), provided that such person
meets a holding period requirement. Generally in order to meet
the holding period requirement, the U.S. Person must hold the
common shares for more than 60 days during the 121-day period
beginning 60 days before the ex-dividend date and must hold
preferred shares for more than 90 days during the 181-day
period beginning 90 days before the ex-dividend date.
ARCH CAPITAL
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2018 FORM 10-K
Dividends paid, if any, with respect to common shares or
preferred shares generally will be qualified dividend income,
provided the common shares or preferred shares are readily
tradable on an established securities market in the U.S. in the
year in which the shareholder receives the dividend (which
should be the case for shares that are listed on the NASDAQ
Stock Market or the New York Stock Exchange) and Arch
Capital is not considered to be a passive foreign investment
company in either the year of the distribution or the preceding
taxable year. No assurance can be given that the preferred shares
will be considered readily tradable on an established securities
market in the U.S. See “—Taxation of Our U.S. Shareholders”
below.
A U.S. holder that is an individual, estate or a trust that does
not fall into a special class of trusts that is exempt from such
tax, will be subject to a 3.8% tax on the lesser of (1) the U.S.
holder’s “net investment income” for the relevant taxable year
and (2) the excess of the U.S. holder’s modified adjusted gross
income for the taxable year over a certain threshold (which in
the case of individual will be between $125,000 and $250,000,
depending on the individual’s circumstances). A U.S. holder’s
net investment income will generally include its dividend
income and its net gains from the disposition of our common
shares and preferred shares, unless such dividend income or net
gains are derived in the ordinary course of the conduct of a trade
or business (other than a trade or business that consists of certain
passive or trading activities).
Distributions with respect to the common shares and the
preferred shares will not be eligible for the dividends received
deduction allowed to U.S. corporations under the Code. To the
extent distributions on our common shares and preferred shares
exceed our earnings and profits, they will be treated first as a
return of the U.S. holder's basis in our common shares and our
preferred shares to the extent thereof, and then as gain from the
sale of a capital asset.
United States—Sale, Exchange or Other Disposition. Subject
to the discussions below relating to the potential application of
the CFC, RPII and PFIC rules, holders of common shares and
preferred shares generally will recognize capital gain or loss
for U.S. federal income tax purposes on the sale, exchange or
disposition of common shares or preferred shares, as applicable.
United States—Redemption of Preferred Shares. A redemption
of the preferred shares will be treated under section 302 of the
Code as a dividend if we have sufficient earnings and profits,
unless the redemption satisfies one of the tests set forth in
section 302(b) of the Code enabling the redemption to be treated
as a sale or exchange, subject to the discussion herein relating
to the potential application of the CFC, RPII and PFIC rules.
Under the relevant Code section 302(b) tests, the redemption
should be treated as a sale or exchange only if it (1) is
substantially disproportionate, (2) constitutes a complete
termination of the holder's stock interest in us or (3) is “not
essentially equivalent to a dividend.” In determining whether
any of these tests are met, shares considered to be owned by
the holder by reason of certain constructive ownership rules set
forth in the Code, as well as shares actually owned, must
generally be taken into account. It may be more difficult for a
U.S. Person who owns, actually or constructively by operation
of the attribution rules, any of our other shares to satisfy any of
the above requirements. The determination as to whether any
of the alternative tests of section 302(b) of the Code is satisfied
with respect to a particular holder of the preference shares
depends on the facts and circumstances as of the time the
determination is made.
Taxation of Our U.S. Shareholders
Controlled Foreign Corporation Rules. We or any of our non-
U.S. subsidiaries will be treated as a CFC with respect to any
taxable year if at any time during such taxable year, one or more
“10% Shareholders” (as defined below) collectively own more
than 50% of us or such non-U.S. subsidiary (as applicable) by
vote or value (taking into account shares actually owned by
such U.S. holder as well as shares attributed to such U.S. holder
under the Code or the regulations thereunder). For taxable years
beginning on or before December 31, 2017, a 10% Shareholder
means any shareholder who was considered to own, actually or
constructively, 10% or more of the total combined voting power
of our shares or those of our non-U.S. subsidiaries (as
applicable). Under the Tax Cuts Act, for taxable years beginning
after December 31, 2017, a 10% Shareholder also includes any
shareholder who
to own, actually or
constructively, 10% or more of the value of our shares or those
of our non-U.S. subsidiaries (as applicable). As a result, for
taxable years beginning after December 31, 2017, the voting
cut-back limitation contained in our bye-laws that limits the
votes conferred by the Controlled Shares (as defined in our bye-
laws) of any U.S. Person to 9.9% of the total voting power of
all our shares entitled to vote will not prevent any U.S. holder
from being treated as a 10% Shareholder.
is considered
Status as a CFC would not cause us or any of our non-U.S.
subsidiaries to be subject to U.S. federal income tax. Such status
also would have no adverse U.S. federal income tax
consequences for any U.S. holder that is not a 10% Shareholder
with respect to us or any of such non-U.S. subsidiaries (as
applicable). If we are or were a CFC with respect to any taxable
year, a U.S. holder that is considered a 10% U.S. Shareholder
would be subject to current U.S. federal income taxation (at
ordinary income tax rates) to the extent of all or a portion of
the undistributed earnings and profits of Arch Capital and our
subsidiaries attributable to “subpart F income” (including
certain insurance premium income and investment income) and
may be taxable at ordinary income tax rates on any gain
recognized on a sale or other disposition (including by way of
repurchase or liquidation) of our common shares or preferred
shares to the extent of the current and accumulated earnings
and profits attributable to such common shares or preferred
ARCH CAPITAL
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2018 FORM 10-K
shares. For taxable years beginning after December 31, 2017,
a helpful limitation, which provides that a U.S. shareholder
would not be subject to the current inclusion rules of Subpart
F for a taxable year unless the non-U.S. corporation was a CFC
for an uninterrupted period of 30 days or more during such
taxable year, will no longer apply.
Related Person Insurance Income Rules. Generally, we do not
expect the gross RPII of any of our non-U.S. subsidiaries to
equal or exceed 20% of its gross insurance income in any
taxable year for the foreseeable future (the “RPII 20% gross
income exception”). Consequently, we do not expect any U.S.
person owning common shares or preferred shares to be
required to include in gross income for U.S. federal income tax
purposes RPII income, but there can be no assurance that this
will be the case.
the Code generally provides
Section 953(c)(7) of
that
Section 1248 of the Code (which generally would require a U.S.
holder to treat certain gains attributable to the sale, exchange
or disposition of common shares or preferred shares as a
dividend) will apply to the sale or exchange by a U.S.
shareholder of shares in a foreign corporation that is
characterized as a CFC under the RPII rules if the foreign
corporation would be taxed as an insurance company if it were
a domestic corporation, regardless of whether the U.S.
shareholder is a 10% U.S. Shareholder or whether the
corporation qualifies for the RPII 20% gross income exception.
Although existing U.S. Treasury Department (“Treasury”)
regulations do not address the question, proposed Treasury
regulations issued in April 1991 create some ambiguity as to
whether Section 1248 and the requirement to file Form 5471
would apply when the foreign corporation has a foreign
insurance subsidiary that is a CFC for RPII purposes and that
would be taxed as an insurance company if it were a domestic
corporation. We believe that Section 1248 and the requirement
to file Form 5471 will not apply to a less than 10% U.S.
Shareholder because Arch Capital is not directly engaged in the
insurance business. There can be no assurance, however, that
the IRS will interpret the proposed regulations in this manner
or that the Treasury will not take the position that Section 1248
and the requirement to file Form 5471 will apply to dispositions
of our common shares or our preferred shares.
If the IRS or Treasury were to make Section 1248 and the
Form 5471 filing requirement applicable to the sale of our
shares, we would notify shareholders that Section 1248 of the
Code and the requirement to file Form 5471 will apply to
dispositions of our shares. Thereafter, we would send a notice
after the end of each calendar year to all persons who were
shareholders during the year notifying them that Section 1248
and the requirement to file Form 5471 apply to dispositions of
our shares by U.S. holders. We would attach to this notice a
copy of Form 5471 completed with all our information and
instructions for completing the shareholder information.
Tax-Exempt Shareholders. Tax-exempt entities may be required
to treat certain Subpart F insurance income, including RPII, that
is includible in income by the tax-exempt entity as unrelated
business taxable income. Prospective investors that are tax
exempt entities are urged to consult their own tax advisors as
to the potential impact of the unrelated business taxable income
provisions of the Code.
Passive Foreign Investment Companies. Sections 1291 through
1298 of the Code contain special rules applicable with respect
to foreign corporations that are PFICs. In general, a foreign
corporation will be a PFIC if 75% or more of its income
constitutes “passive income” or 50% or more of its assets
produce passive income. If we were to be characterized as a
PFIC, U.S. holders would be subject to a penalty tax at the time
of their sale of (or receipt of an “excess distribution” with
respect to) their common shares or preferred shares. In general,
a shareholder receives an “excess distribution” if the amount
of the distribution is more than 125% of the average distribution
with respect to the shares during the three preceding taxable
years (or shorter period during which the taxpayer held the
stock). In general, the penalty tax is equivalent to an interest
charge on taxes that are deemed due during the period the
shareholder owned the shares, computed by assuming that the
excess distribution or gain (in the case of a sale) with respect
to the shares was taxable in equal portions throughout the
holder’s period of ownership. The interest charge is equal to the
applicable rate imposed on underpayments of U.S. federal
income tax for such period. A U.S. shareholder may avoid some
of the adverse tax consequences of owning shares in a PFIC by
making a qualified electing fund (“QEF”) election. A QEF
election is revocable only with the consent of the IRS and has
the following consequences to a shareholder:
•
•
For any year in which Arch Capital is not a PFIC, no income
tax consequences would result.
For any year in which Arch Capital is a PFIC, the
shareholder would include in its taxable income a
proportionate share of the net ordinary income and net
capital gains of Arch Capital and certain of its non-U.S.
subsidiaries.
For taxable years beginning on or before December 31, 2017,
the determination of whether the active insurance company
exception applies to an insurance company was made on a case-
by-case basis and the analysis was inherently subjective. Under
the Tax Cuts Act, for taxable years beginning after December
31, 2017, the active insurance company exception applies only
if (i) the company would be taxed as an insurance company
were it a U.S. corporation and (ii) either (A) loss and loss
adjustment expense and certain reserves constitute more than
25% of the company’s gross assets for the relevant year or (B)
loss and loss adjustment expenses and certain reserves
constitute more than 10% of the company’s gross assets for the
relevant year and, based on the applicable facts and
circumstances, the company is predominantly engaged in an
ARCH CAPITAL
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2018 FORM 10-K
FATCA Withholding. Sections 1471 through 1474 to the Code,
the Foreign Account Tax Compliance Act
known as
(“FATCA”), impose a withholding tax of 30% on U.S.-source
interest, dividends and certain other types of income, which is
received by a foreign financial institution (“FFI”), unless such
FFI enters into an agreement with the IRS to obtain certain
information as to the identity of the direct and indirect owners
of accounts in such institution. In addition, a 30% withholding
tax may be imposed on the above payments to certain non-
financial foreign entities which do not (i) certify to each
respective withholding agent that they have no “substantial U.S.
owners” (i.e., a U.S. 10% direct or indirect shareholder), or (ii)
provide such withholding agent with the certain information as
to the identity of such substantial U.S. owners. The U.S. has
entered into intergovernmental agreements to implement
FATCA (“IGAs”) with a number of jurisdictions. Bermuda has
signed an IGA with the U.S. Different rules than those described
above may apply under such an IGA.
Although dividends with respect to our common shares or
preferred shares will generally be treated as foreign source for
U.S. federal withholding tax purposes, it is unclear whether, for
FATCA purposes, some or all of our dividends may be
recharacterized as U.S. source dividends. Treasury regulations
addressing this topic have not yet been issued.
Prospective investors are urged to consult their own tax advisors
as to the filing and information requirements that may be
imposed on them in respect of their ownership of our common
share or preferred shares.
Other Tax Laws. Shareholders should consult their own tax
advisors with respect to the applicability to them of the tax laws
of other jurisdictions.
insurance business and the failure of the company to satisfy the
preceding 25% test is due solely to run-off related or other
specified circumstances involving the insurance business. The
PFIC statutory provisions contain a look-through rule that states
that, for purposes of determining whether a foreign corporation
is a PFIC, such foreign corporation shall be treated as if it
“received directly its proportionate share of the income” and as
if it “held its proportionate share of the assets” of any other
corporation in which it owns at least 25% of the stock. We
believe that we were not a PFIC for any taxable year beginning
on or before December 31, 2017 and we are not expecting to
become a PFIC for any taxable year beginning after December
31, 2017 and we will use reasonable best efforts to cause us and
each of our majority owned non-U.S. insurance subsidiaries not
to constitute a PFIC.
In April 2015, the IRS issued proposed regulations in an attempt
to define the foreign insurance company exception to the PFIC
rules (the “proposed PFIC insurance regulations”). The
proposed PFIC insurance regulations are likely to be revised in
light of the modified active insurance company exception
contained in the Tax Cuts Act (as described above).
No regulations interpreting the substantive PFIC provisions
have yet been finalized. It is possible that the regulations
interpreting the PFIC provisions will be issued in the future and
contain rules different from those in the proposed PFIC
insurance regulations. Each U.S. holder should consult its own
tax advisor as to the effects of these rules.
United States Taxation of Non-U.S. Shareholders
Taxation of Dividends. Cash distributions, if any, made with
respect to common shares or preferred shares held by
shareholders who are not U.S. Persons (“Non-U.S. holders”)
generally will not be subject to U.S. withholding tax.
Sale, Exchange or Other Disposition. Non-U.S. holders of
common shares or preferred shares generally will not be subject
to U.S. federal income tax with respect to gain realized upon
the sale, exchange or other disposition of such shares unless
such gain is effectively connected with a U.S. trade or business
of the Non-U.S. holder in the U.S. or such person is present in
the U.S. for 183 days or more in the taxable year the gain is
realized and certain other requirements are satisfied.
Information Reporting and Backup Withholding. Non-U.S.
holders of common shares or preferred shares will not be subject
to U.S. information reporting or backup withholding with
respect to dispositions of common shares effected through a
non-U.S. office of a broker, unless the broker has certain
connections to the U.S. or is a U.S. person. No U.S. backup
withholding will apply to payments of dividends, if any, on our
common shares or our preferred shares.
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2018 FORM 10-K
ITEM 1A. RISK FACTORS
Set forth below are risk factors relating to our business. These
risks and uncertainties are not the only ones we face. There may
be additional risks that we currently consider not to be material
or of which we are not currently aware, and any of these risks
could cause our actual results to differ materially from historical
or anticipated results. You should carefully consider these risks
along with the other information provided in this report,
including our “Management’s Discussion and Analysis of
Financial Condition and Results of Operations” and our
accompanying consolidated financial statements, as well as the
information under the heading “Cautionary Note Regarding
Forward-Looking Statements” before investing in any of our
securities. We may amend, supplement or add to the risk factors
described below from time to time in future reports filed with
the SEC.
Risks Relating to Our Industry
We operate in a highly competitive environment, and we may
not be able to compete successfully in our industry.
The insurance and reinsurance industry is highly competitive.
We compete on an international and regional basis with major
U.S. and non-U.S. insurers and reinsurers, many of which have
greater financial, marketing and management resources than
we do. We also compete with new companies that continue to
be formed to enter the insurance and reinsurance markets, as
well as with other capital market participants that create
alternative products intended to compete with reinsurance
products. Certain new companies entering the insurance and
reinsurance markets are pursuing more aggressive investment
strategies than do we and other traditional reinsurers, which
may result in downward pressure on premium rates. In our U.S.
mortgage business, we compete with other private mortgage
insurers, with the Federal Housing Administration, and,
increasingly, with well capitalized multiline reinsurers and
capital markets alternatives to private mortgage insurance.
Competition within the private mortgage insurance industry
could result in the loss of customers, lower premiums, riskier
credit guidelines and other changes that could lower our
revenues or increase our expenses.
increased competition as a result of
In addition, there has been significant consolidation in the
insurance and reinsurance sector in recent years and we may
experience
that
consolidation, with consolidated entities having enhanced
market power. These consolidated entities may use their
enhanced market power and broader capital base to negotiate
price reductions for products and services that compete with
ours, and we may experience rate declines and possibly write
less business. Any failure by us to effectively compete could
adversely affect our financial condition and results of
operations.
The insurance and reinsurance industry is highly cyclical, and
we expect to continue to experience periods characterized by
excess underwriting capacity and unfavorable premium rates.
Historically,
insurers and reinsurers have experienced
significant fluctuations in operating results due to competition,
frequency of occurrence or severity of catastrophic events,
levels of capacity, general economic conditions, changes in
equity, debt and other investment markets, changes in
legislation, case law and prevailing concepts of liability and
other factors. In particular, demand for reinsurance is influenced
significantly by the underwriting results of primary insurers and
prevailing general economic conditions. The supply of
insurance and reinsurance is related to prevailing prices and
levels of surplus capacity that, in turn, may fluctuate in response
to changes in rates of return being realized in the insurance and
reinsurance industry on both underwriting and investment
sides. As a result, the insurance and reinsurance business
historically has been a cyclical industry characterized by
periods of intense price competition due to excessive
underwriting capacity as well as periods when shortages of
capacity permitted favorable premium levels and changes in
terms and conditions. The supply of insurance and reinsurance
has increased over the past several years and may increase
further, either as a result of capital provided by new entrants or
by the commitment of additional capital by existing insurers or
reinsurers. Continued increases in the supply of insurance and
reinsurance may have consequences for us, including fewer
contracts written, lower premium rates, increased expenses for
customer acquisition and retention, and less favorable policy
terms and conditions.
Claims for catastrophic events could cause large losses and
substantial volatility in our results of operations and could have
a material adverse effect on our financial position and results
of operations.
We have large aggregate exposures to natural and man-made
catastrophic events. Catastrophes can be caused by various
events, including hurricanes, floods, tsunamis, windstorms,
earthquakes, hailstorms, tornadoes, explosions, severe winter
fires, droughts and other natural disasters.
weather,
Catastrophes can also cause losses in non-property business
such as workers’ compensation or general liability. In addition
to the nature of the property business, we believe that economic
and geographic trends affecting insured property, including
inflation, property value appreciation and geographic
concentration tend to generally increase the size of losses from
catastrophic events over time. Actual losses from future
ARCH CAPITAL
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2018 FORM 10-K
catastrophic events may vary materially from estimates due to
the inherent uncertainties in making such determinations
resulting from several factors,
the potential
inaccuracies and inadequacies in the data provided by clients,
brokers and ceding companies, the modeling techniques and
the application of such techniques, the contingent nature of
business interruption exposures, the effects of any resultant
demand surge on claims activity and attendant coverage issues.
including
In addition, over the past several years, changing weather
patterns and climatic conditions, such as global warming, have
added to the unpredictability and frequency of natural disasters
in certain parts of the world and created additional uncertainty
as to future trends and exposures. Although the loss experience
of catastrophe insurers and reinsurers has historically been
characterized as low frequency, there is a growing consensus
today that climate change increases the frequency and severity
of extreme weather events and, in recent years, the frequency
of major catastrophes appears to have increased. Claims for
catastrophic events, or an unusual frequency of smaller losses
in a particular period, could expose us to large losses, cause
substantial volatility in our results of operations and could have
a material adverse effect on our ability to write new business.
Additionally, we cannot predict how legal, regulatory and/or
social responses to concerns around global climate change may
impact our business. Although we attempt to manage our
exposure to such events through the use of underwriting
controls, risk models, and the purchase of third-party
reinsurance, catastrophic events are inherently unpredictable
and the actual nature of such events when they occur could be
more frequent or severe than contemplated in our pricing and
risk management expectations. As a result, the occurrence of
one or more catastrophic events could have an adverse effect
on our results of operations and financial condition.
We could face unanticipated losses from war, terrorism, cyber-
attacks and political
these or other
unanticipated losses could have a material adverse effect on
our financial condition and results of operations.
instability, and
We have substantial exposure to unexpected, large losses
resulting from future man-made catastrophic events, such as
acts of war, acts of terrorism and political instability. These risks
are inherently unpredictable. It is difficult to predict the timing
of such events with statistical certainty or estimate the amount
of loss any given occurrence will generate. In certain instances,
we specifically insure and reinsure risks resulting from acts of
terrorism. We may also insure against risk related to
cybersecurity and cyber-attacks. In addition, our exposure to
cyber-attacks includes exposure to ‘silent cyber’ risks, meaning
risks and potential losses associated with policies where cyber
risk is not specifically included nor excluded in the policies.
Even in cases where we attempt to exclude losses from
terrorism, cybersecurity and certain other similar risks from
some coverages written by us, we may not be successful in
doing so. Moreover, irrespective of the clarity and inclusiveness
of policy language, there can be no assurance that a court or
arbitration panel will not limit enforceability of policy language
or otherwise issue a ruling adverse to us. Accordingly, while
we believe our reinsurance programs, together with the
coverage provided under the Terrorism Risk Insurance Act of
2002, as amended under the Terrorism Risk Insurance
Extension Act of 2005 and the Terrorism Risk Insurance
Program Reauthorization Act of 2007, and amended and
extended again by TRIPRA, are sufficient to reasonably limit
our net losses relating to potential future terrorist attacks, we
can offer no assurance that our available capital will be adequate
to cover losses when they materialize. To the extent that an act
of terrorism is certified by the Secretary of the Treasury and
aggregate industry insured losses resulting from the act of
terrorism exceeds the prescribed program trigger, our U.S.
insurance operations may be covered under TRIPRA for up to
81% for 2019 and 80% for 2020, in each case subject to a
mandatory deductible of 20% of our prior year’s direct earned
premium for covered property and liability coverages. The
program trigger for calendar year 2019 is $180 million and
$200 million in 2020. If an act (or acts) of terrorism result in
covered losses exceeding the $100 billion annual limit, insurers
with losses exceeding their deductibles will not be responsible
for additional losses. It is not possible to completely eliminate
our exposure to unforecasted or unpredictable events, and to
the extent that losses from such risks occur, our financial
condition and results of operations could be materially
adversely affected.
Political, regulatory, legislative and industry initiatives could
adversely affect our business.
Governmental authorities in the U.S. and worldwide have
become increasingly interested in potential risks posed by the
insurance industry as a whole, and to commercial and financial
systems in general and there may be increased regulatory
intervention in our industry in the future. For example, in the
U.S., the federal government (including federal consumer
protection authorities) has increased its scrutiny of the
insurance regulatory framework in recent years, and various
state legislators are considering or have enacted laws that will
alter and likely increase state regulation of insurance and
reinsurance companies and holding companies. The U.S.
mortgage insurance industry has also been subject to increased
federal and state regulatory scrutiny (including by state
insurance regulatory authorities), which could generate new
regulations, regulatory actions or investigations.
In the EU, Solvency II imposed economic risk-based solvency
requirements across all EU Member States covering
quantitative capital requirements, qualitative regulatory
reviews and market discipline. In addition, Solvency II imposes
significant requirements for our EU-based regulated companies
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2018 FORM 10-K
which require substantial documentation and implementation
effort.
The BMA has also implemented and imposed additional
requirements on the commercial insurance companies it
regulates, driven, in large part, by Solvency II. The European
Commission has adopted a decision concluding that Bermuda
meets the full equivalence criteria under Solvency II.
While we cannot predict the exact nature, timing or scope of
any possible governmental initiatives, such proposals could
adversely affect our business by, among other things: providing
reinsurance capacity in markets and to consumers that we target;
requiring our further participation in industry pools and
guaranty associations; expanding the scope of coverage under
existing policies (e.g., following large disasters); further
regulating the terms of insurance or reinsurance contracts; or
disproportionately benefiting the companies of one country
over those of another.
In addition, increased scrutiny by insurance regulators of
investments in or acquisitions of insurers or insurance holding
companies by private equity firms or hedge funds may result
in imposition of additional regulatory requirements and
restrictions. We have in the past partnered with private equity
firms in making investments and may do so in the future. This
increased scrutiny may make
to complete
investments with private equity or hedge funds should we seek
to do so.
it difficult
Underwriting risks and reserving for losses are based on
probabilities and related modeling, which are subject to
inherent uncertainties.
Our success is dependent upon our ability to assess accurately
the risks associated with the businesses that we insure and
reinsure. We establish reserves for losses and loss adjustment
expenses which represent estimates involving actuarial and
statistical projections, at a given point in time, of our
expectations of the ultimate settlement and administration costs
of losses incurred. We utilize actuarial models as well as
available historical insurance industry loss ratio experience and
loss development patterns to assist in the establishment of loss
reserves. Most or all of these factors are not directly
quantifiable, particularly on a prospective basis, and the effects
of these and unforeseen factors could negatively impact our
ability to accurately assess the risks of the policies that we write.
Changes in the assumptions used by these models or by
management could lead to an increase in our estimate of
ultimate losses in the future. In addition, there may be
significant reporting lags between the occurrence of the insured
event and the time it is actually reported to the insurer and
additional lags between the time of reporting and final
settlement of claims. Unfavorable development in any of these
factors could cause the level of reserves to be inadequate. In
addition, the estimation of loss reserves is also more difficult
during times of adverse economic and market conditions due
to unexpected changes
in behavior of claimants and
policyholders, including an increase in fraudulent reporting of
exposures and/or losses, reduced maintenance of insured
properties or increased frequency of small claims. Changes in
the level of inflation also result in an increased level of
uncertainty in our estimation of loss reserves. As a result, actual
losses and loss adjustment expenses paid will deviate, perhaps
substantially, from the reserve estimates reflected in our
financial statements.
If our loss reserves are determined to be inadequate, we will be
required to increase loss reserves at the time of such
determination with a corresponding reduction in our net income
in the period in which the deficiency becomes known. It is
possible that claims in respect of events that have occurred could
exceed our claim reserves and have a material adverse effect
on our results of operations, in a particular period, or our
financial condition in general. As a compounding factor,
although most insurance contracts have policy limits, the nature
of property and casualty insurance and reinsurance is such that
losses can exceed policy limits for a variety of reasons and could
significantly exceed the premiums received on the underlying
policies, thereby further adversely affecting our financial
condition.
In accordance with mortgage insurance industry practice, we
establish loss reserves only for loans in our existing delinquency
inventory. Because our mortgage insurance reserving process
does not take account of the impact of future losses from loans
that are not delinquent, mortgage insurance loss reserves are
not intended to be an estimate of total future losses. Our
expectation of total future losses under our mortgage insurance
policies in force at any period end is not reflected in our financial
statements. In addition to establishing loss reserves for
delinquent loans, under GAAP, we are required to establish a
premium deficiency reserve for our mortgage insurance
products if the amount of expected future losses for a particular
product and maintenance costs for such product exceeds
expected future premiums, existing reserves and the anticipated
investment income. We evaluate whether a premium deficiency
exists quarterly. There can be no assurance that premium
deficiency reserves will not be required in future periods. If this
were to occur, our results of operations and financial condition
could be adversely affected.
As of December 31, 2018, our consolidated reserves for unpaid
losses and loss adjustment expenses, net of unpaid losses and
loss adjustment expenses recoverable, were approximately
$9.04 billion. Such reserves were established in accordance
with applicable insurance laws and GAAP. Loss reserves are
inherently subject to uncertainty. In establishing the reserves
for losses and loss adjustment expenses, we have made various
assumptions relating to the pricing of our reinsurance contracts
and insurance policies and have also considered available
historical industry experience and current industry conditions.
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Any estimates and assumptions made as part of the reserving
process could prove to be inaccurate due to several factors,
including the fact that relatively limited historical information
has been reported to us through December 31, 2018.
The failure of any of the loss limitation methods we employ
could have a material adverse effect on our financial condition
or results of operations.
in addition
insurance business,
We seek to limit our loss exposure by writing a number of our
reinsurance contracts on an excess of loss basis, adhering to
maximum limitations on reinsurance written in defined
geographical zones, limiting program size for each client and
prudent underwriting of each program written. In the case of
proportional treaties, we may seek per occurrence limitations
or loss ratio caps to limit the impact of losses from any one or
series of events. In our insurance operations, we seek to limit
our exposure through the purchase of reinsurance. For our U.S.
to utilizing
mortgage
reinsurance, we have developed a proprietary risk model that
simulates the maximum loss resulting from a severe economic
event impacting the housing market. We cannot be certain that
any of these loss limitation methods will be effective. We also
seek to limit our loss exposure by geographic diversification.
Geographic zone limitations involve significant underwriting
judgments, including the determination of the area of the zones
and the inclusion of a particular policy within a particular zone’s
limits. Various provisions of our policies, negotiated to limit
our risk, such as limitations or exclusions from coverage or
choice of forum, may not be enforceable in the manner we
intend, as it is possible that a court or regulatory authority could
nullify or void an exclusion or limitation, or legislation could
be enacted modifying or barring the use of these exclusions and
limitations. Disputes relating to coverage and choice of legal
forum may also arise. Underwriting is inherently a matter of
judgment, involving important assumptions about matters that
are inherently unpredictable and beyond our control, and for
which historical experience and probability analysis may not
provide sufficient guidance. No assurances can be made that
these loss limitation methods will be effective and mitigate our
loss exposure. One or more catastrophic events or severe
economic events could result in claims that substantially exceed
our expectations, or the protections set forth in our policies
could be voided, which, in either case, could have a material
adverse effect on our financial condition or our results of
operations, possibly
the extent of eliminating our
shareholders’ equity. See “Management’s Discussion and
Analysis of Financial Condition and Results of Operations—
Catastrophic Events and Severe Economic Events.” Depending
on business opportunities and the mix of business that may
comprise our insurance, reinsurance and mortgage insurance
portfolio, we may seek to adjust our self-imposed limitations
on probable maximum pre-tax loss for catastrophe exposed
business and mortgage default exposed business.
to
Adverse developments in the financial markets could have a
material adverse effect on our results of operations, financial
position and our businesses, and may also limit our access to
capital; our policyholders, reinsurers and retrocessionaires
may also be affected by such developments, which could
adversely affect their ability to meet their obligations to us.
Adverse developments in the financial markets, such as
disruptions, uncertainty or volatility in the capital and credit
markets, may result in realized and unrealized capital losses
that could have a material adverse effect on our results of
operations, financial position and our businesses, and may also
limit our access to capital required to operate our business.
Depending on market conditions, we could incur additional
realized and unrealized losses on our investment portfolio in
future periods, which could have a material adverse effect on
our results of operations, financial condition and business.
Economic conditions could also have a material impact on the
frequency and severity of claims and therefore could negatively
impact our underwriting returns. In addition, our policyholders,
reinsurers and
retrocessionaires may be affected by
developments in the financial markets, which could adversely
affect their ability to meet their obligations to us. The volatility
in the financial markets could continue to significantly affect
our investment returns, reported results and shareholders’
equity.
The United Kingdom’s referendum vote in favor of leaving the
EU could adversely affect us.
In a referendum in June 2016, a majority of voting U.K. citizens
voted in favor of Brexit, whereby the U.K. will leave the EU.
The U.K. government invoked Article 50 of the Treaty on
European Union (“Article 50”) in 2017 and will have to
withdraw from the EU on March 29, 2019, unless an extension
to this deadline is agreed between the U.K government and the
EU. There remains considerable uncertainty as to exactly when
Brexit will take effect; the extent of any transitional period
allowing a continuation of passporting; and the ultimate
structure of the U.K’s future relationship with the EU. During
this period and beyond, the impact of the U.K.’s withdrawal on
the U.K. and European economies and the broader global
economy could be significant,
in negative
consequences, such as increased volatility and illiquidity, and
potentially lower economic growth in various markets in the
U.K., Europe and globally and could continue to contribute to
instability in global financial and foreign exchange markets.
Brexit could also have the effect of disrupting the free
movement of goods, services and people between the U.K. and
the EU. We anticipate that Brexit may disrupt our U.K.
domiciled entities, including our Lloyd’s syndicate, and their
ability to “passport” within the EU. Similarly, Brexit may
disrupt the ability of our EU domiciled entities to access the
U.K. markets although the U.K is attempting to mitigate this
by introducing a temporary permissions regime which, in the
event of there being no transitional period, will allow firms that
resulting
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2018 FORM 10-K
wish to continue carrying out regulated activities in the U.K. in
the longer term to operate in the U.K for a limited period after
withdrawal, while they seek authorization from the U.K.
regulators. The full effects of Brexit are uncertain and will
depend on any agreements the U.K. may make to retain access
to EU markets.
The availability of reinsurance, retrocessional coverage and
capital market transactions to limit our exposure to risks may
be limited, and counterparty credit and other risks associated
with our reinsurance arrangements may result in losses which
could adversely affect our financial condition and results of
operations.
The negative impact of these events on economic conditions
and global markets could have an adverse effect on our business,
financial condition and liquidity. For example, this crisis may
cause the value of the European currencies, including the Euro
and the British Pound Sterling, to further depreciate against the
U.S. Dollar, which in turn could materially adversely impact
assets denominated in such currencies held in our investment
portfolio or results of our European book of business. In
addition, the applicable legal framework and the terms of our
Euro-denominated
reinsurance
agreements generally do not address withdrawal by a member
state from the Eurozone or a break-up of the EU, which could
create uncertainty in our payment obligations and rights under
those policies and agreements in the event that such a
withdrawal or break-up does occur.
insurance policies and
Additionally, a contagion effect of a possible default of one or
more EU Member States and/or their withdrawal from the
Eurozone, or the failure of financial institutions, on the global
economy, including other EU Member States and our
counterparties located in those countries, or a break-up of the
EU could have a material adverse effect on our business,
financial condition, results of operations and liquidity. As a
result of Brexit, other European countries may seek to conduct
referenda with respect to their continuing membership with the
EU. Given these possibilities and others we may not anticipate,
as well as the lack of comparable precedent, the full extent to
which our business, results of operations and financial condition
could be adversely affected by Brexit is uncertain.
The risk associated with underwriting treaty reinsurance
business could adversely affect us.
Like other reinsurers, our reinsurance group does not separately
evaluate each of the individual risks assumed under reinsurance
treaties. Therefore, we are largely dependent on the original
underwriting decisions made by ceding companies. We are
subject to the risk that the ceding companies may not have
adequately evaluated the risks to be reinsured and that the
premiums ceded may not adequately compensate us for the risks
we assume.
reinsurance
agreements. Our
For the purposes of managing risk, we use reinsurance,
retrocessional coverage and capital markets transactions. In the
normal course of business, our insurance subsidiaries cede a
portion of their premiums through pro rata, excess of loss and
facultative
reinsurance
subsidiaries purchase a limited amount of retrocessional
coverage as part of their aggregate risk management program.
In addition, our 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 our reinsurance
subsidiaries, and the ceding company. Economic conditions
could also have a material impact on our ability to manage our
risk aggregations through reinsurance or capital markets
transactions. The availability and cost of reinsurance and
retrocessional protection is subject to market conditions, which
are beyond our control. As a result of such market conditions
and other factors, we may not be able to successfully mitigate
risk through reinsurance and retrocessional arrangements.
Further, we are subject to credit risk with respect to our
reinsurance and retrocessions because the ceding of risk to
reinsurers and retrocessionaires does not relieve us of our
liability to the clients or companies we insure or reinsure. We
monitor the financial condition of our reinsurers and attempt to
place coverages only with carriers we view as substantial and
financially sound. Although we have not experienced any
material credit losses to date, an inability of our reinsurers or
retrocessionaires to meet their obligations to us could have a
material adverse effect on our financial condition and results
of operations. Our losses for a given event or occurrence may
increase if our reinsurers or retrocessionaires dispute or fail to
meet their obligations to us or the reinsurance or retrocessional
protections purchased by us are exhausted or are otherwise
unavailable for any reason. Our failure to establish adequate
reinsurance or retrocessional arrangements or the failure of our
existing reinsurance or retrocessional arrangements to protect
us from overly concentrated risk exposure could adversely
affect our financial condition and results of operations.
Our reliance on brokers subjects us to their credit risk.
In accordance with industry practice, we generally pay amounts
owed on claims under our insurance and reinsurance contracts
to brokers, and these brokers, in turn, pay these amounts to the
clients that have purchased insurance or reinsurance from us.
In some jurisdictions, if a broker fails to make such payment,
we may remain liable to the insured or ceding insurer for the
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2018 FORM 10-K
deficiency. Likewise, in certain jurisdictions, when the insured
or ceding company pays the premiums for these contracts to
brokers for payment to us, these premiums are considered to
have been paid and the insured or ceding company will no
longer be liable to us for those amounts, whether or not we have
actually received the premiums from the broker. Consequently,
we assume a degree of credit risk associated with our brokers.
To date, we have not experienced any losses related to this credit
risk.
Emerging claim and coverage issues may adversely affect our
business.
As industry practices and legal, judicial, social and other
environmental conditions change, unexpected and unintended
issues related to claims and coverage may emerge, including
new or expanded theories of liability. These or other changes
could impose new financial obligations on us by extending
coverage beyond our underwriting intent or otherwise require
us to make unplanned modifications to the products and services
that we provide, or cause the delay or cancellation of products
and services that we provide. In some instances, these changes
may not become apparent until sometime after we have issued
insurance or reinsurance contracts that are affected by the
changes. As a result, the full extent of liability under our
insurance or reinsurance contracts may not be known for many
years after a contract is issued. The effects of unforeseen
developments or substantial government intervention could
adversely impact our ability to achieve our goals.
Risks Relating to Our Company
Acquisitions, the addition of new lines of insurance or
reinsurance business, expansion into new geographic regions
and/or entering into joint ventures or partnerships expose us
to risks.
We may seek, from time to time, to acquire other companies,
acquire selected blocks of business, expand our business lines,
expand into new geographic regions and/or enter into joint
ventures or partnerships. Such activities expose us to challenges
and risks, including: integrating financial and operational
reporting systems; establishing satisfactory budgetary and other
financial controls; funding increased capital needs, overhead
expenses or cash flow shortages that may occur if anticipated
sales and revenues are not realized or are delayed, whether by
general economic or market conditions or unforeseen internal
difficulties; obtaining management personnel required for
regulatory
expanded operations; obtaining necessary
permissions; and establishing adequate reserves for any
acquired book of business. In addition, the value of assets
acquired may be lower than expected or may diminish due to
credit defaults or changes in interest rates; the liabilities
assumed may be greater than expected; and assets and liabilities
acquired may be subject to foreign currency exchange rate
fluctuation. We may also be subject to financial exposures in
the event that the sellers of the entities or business we acquire
are unable or unwilling to meet their indemnification,
reinsurance and other contractual obligations to us.
Changes in current accounting principles and practices and
financial reporting requirements may materially affect our
reported financial results and our reported financial condition.
Our failure to manage successfully any of the foregoing
challenges and risks may adversely impact our results of
operations.
Our financial statements are prepared in accordance with
GAAP, which is periodically revised by the Financial
Accounting Standards Board (“FASB”), and they are subject to
the accounting-related rules and interpretations of the SEC. We
are required to adopt new and revised accounting standards
implemented by the FASB. Unanticipated developments in
accounting practices may require us to incur considerable
additional expenses to comply with such developments,
particularly if we are required to prepare information relating
to prior periods for comparative purposes or to apply the new
requirements retroactively. The
in
accounting principles, practices and standards, particularly
those that apply to insurance companies, cannot be predicted
but may affect the calculation of net earnings, shareholders'
equity and other relevant financial statement line items. In
addition, such changes may cause additional volatility in
reported earnings, decrease the understandability of our
financial results and affect the comparability of our reported
results with the results of others.
impact of changes
The ultimate performance of the Arch MI U.S. mortgage
insurance portfolio remains uncertain.
Arch MI U.S. had risk in force of approximately $71.0 billion,
before external reinsurance, as of December 31, 2018,
including $4.7 billion of risk in force originated in 2008 and
prior. The presence of multiple higher-risk characteristics in a
loan materially increases the likelihood of a claim on such a
loan unless there are other characteristics to mitigate the
risk. The mix of business in our insured loan portfolio may
affect losses and remain uncertain.
control,
including,
The frequency and severity of claims we incur will be uncertain
and will depend largely on general economic factors outside of
in
our
unemployment, home prices and interest rates in the U.S.
Deteriorating economic conditions in the U.S. could adversely
affect the performance of our acquired U.S. mortgage insurance
portfolio and could adversely affect our results of operations
and financial condition.
among others,
changes
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2018 FORM 10-K
Generally, we cannot cancel mortgage insurance coverage or
adjust renewal premiums during the life of a mortgage insurance
policy. As a result, higher than anticipated claims generally
cannot be offset by premium increases on policies in force or
mitigated by our non-renewal or cancellation of insurance
coverage. The premiums charged on the acquired UGC insured
loan portfolio, and the associated investment income, may not
be adequate to compensate us for the risks and costs associated
with the insurance coverage provided to customers.
A downgrade in our ratings or our inability to obtain a rating
for our operating insurance and reinsurance subsidiaries may
adversely affect our relationships with clients and brokers and
negatively impact sales of our products.
Third-party rating agencies, such as A.M. Best, assess and rate
the financial strength of insurers and reinsurers based upon
criteria established by the rating agencies, which criteria are
subject to change. Ratings are an important factor in
establishing the competitive position of insurance and
reinsurance companies. Insureds, ceding insurers, brokers and
reinsurance intermediaries use these ratings as one measure by
which to assess the financial strength and quality of insurers
and reinsurers. These ratings are often an important factor in
the decision by an insured, ceding insurer, broker or
intermediary of whether to place business with a particular
insurance or reinsurance provider.
The financial strength ratings of our operating insurance and
reinsurance subsidiaries are subject to periodic review as rating
agencies evaluate us to confirm that we continue to meet their
criteria for ratings assigned to us by them. Such ratings may be
revised downward or revoked at the sole discretion of such
ratings agencies in response to a variety of factors, including a
minimum capital adequacy ratio, management, earnings,
capitalization and risk profile. For further information on our
financial strength and/or issuer ratings, see “Management’s
Discussion and Analysis of Financial Condition and Results of
Operations—Liquidity and Capital Resources.” We can offer
no assurances that our ratings will remain at their current levels
or that any of our ratings which under review or watch by ratings
agencies will remain unchanged. We believe it is possible that
rating agencies may heighten the level of scrutiny they apply
when analyzing companies in our industry, may increase the
frequency and scope of their reviews, may request additional
information from the companies that they rate (including
additional information regarding the valuation of investment
securities held), and may adjust upward the capital and other
requirements employed in their models for maintenance of
certain rating levels.
A ratings downgrade or the potential for such a downgrade, or
failure to obtain a necessary rating, could adversely affect our
relationships with agents, brokers, wholesalers, intermediaries,
clients and other distributors of our existing products and
services, as well as new sales of our products and services. In
addition, under certain of the reinsurance agreements assumed
by our reinsurance operations, upon the occurrence of a ratings
downgrade or other specified triggering event with respect to
our reinsurance operations, such as a reduction in surplus by
specified amounts during specified periods, our ceding
company clients may be provided with certain rights, including,
among other things, the right to terminate the subject
reinsurance agreement and/or to require that our reinsurance
operations post additional collateral. Any ratings downgrade or
failure to obtain a necessary rating could adversely affect our
ability to compete in our markets, could cause our premiums
and earnings to decrease and could have a material adverse
impact on our financial condition and results of operations. In
addition, a downgrade in ratings of certain of our operating
subsidiaries would in certain cases constitute an event of default
under our credit facilities. See “Management’s Discussion and
Analysis of Financial Condition and Results of Operations—
Contractual Obligations and Commercial Commitments—
Letter of Credit and Revolving Credit Facilities” for a
discussion of our credit facilities.
We can offer no assurances that our ratings will remain at their
current levels or that any of our ratings under review or watch
by rating agencies will remain unchanged.
Our success will depend on our ability to maintain and enhance
effective operating procedures and internal controls and our
enterprise risk management (“ERM”) program.
Operational risk and losses can result from, among other things,
fraud, errors, failure to document transactions properly or to
obtain proper internal authorization, failure to comply with
regulatory requirements, information technology failures,
failure to appropriately transition new hires or external events.
We continue to enhance our operating procedures and internal
controls (including information technology initiatives and
controls over financial reporting) to effectively support our
business and our regulatory and reporting requirements. Our
management does not expect that our disclosure controls or our
internal controls will prevent all errors and all fraud. A control
system, no matter how well conceived and operated, can
provide only reasonable, not absolute, assurance that the
objectives of the control system are met. Further, the design of
a control system must reflect the fact that there are resource
constraints, and the benefits of controls must be considered
relative to their costs. As a result of the inherent limitations in
all control systems, no evaluation of controls can provide
absolute assurance that all control issues and instances of fraud,
if any, within the company have been detected. These inherent
limitations include the realities that judgments in decision
making can be faulty, and that breakdowns can occur because
of simple error or mistake. Additionally, controls can be
circumvented by the individual acts of some persons or by
collusion of two or more people. The design of any system of
controls also is based in part upon certain assumptions about
the likelihood of future events, and there can be no assurance
that any design will succeed in achieving its stated goals under
all potential future conditions; over time, controls may become
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2018 FORM 10-K
inadequate because of changes in conditions, or the degree of
compliance with the policies or procedures may deteriorate. As
a result of the inherent limitations in a cost-effective control
system, misstatement due to error or fraud may occur and not
be detected. Accordingly, our disclosure controls and
procedures are designed to provide reasonable, not absolute,
assurance that our goals are met. Any ineffectiveness in our
controls or procedures could have a material adverse effect on
our business.
We operate within an ERM framework designed to assess and
monitor our risks. However, there can be no assurance that we
can effectively review and monitor all risks or that all of our
employees will operate within the ERM framework. There can
be no assurance that our ERM framework will result in us
accurately identifying all risks and accurately limiting our
exposures based on our assessments.
Our business is dependent upon insurance and reinsurance
brokers and intermediaries, and the loss of important broker
relationships could materially adversely affect our ability to
market our products and services.
We market our insurance and reinsurance products primarily
through brokers and intermediaries. We derive a significant
portion of our business from a limited number of brokers.
During 2018, approximately 11.4% and 9.3% of our gross
premiums written were generated from or placed by Aon
Corporation and its subsidiaries and Marsh & McLennan
Companies and its subsidiaries, respectively. No other broker
and no one insured or reinsured accounted for more than 10%
of gross premiums written for 2018. Some of our competitors
have higher financial strength ratings, offer a larger variety of
products, set lower prices for insurance coverage, offer higher
commissions and/or have had longer term relationships with
the brokers we use than we have. This may adversely impact
our ability to attract and retain brokers to sell our insurance
products or brokers may increasingly promote products offered
by other companies. The failure or inability of brokers to market
our insurance products successfully, or loss of all or a substantial
portion of the business provided by these brokers could have a
material adverse impact on our business, financial condition
and results of operations.
We could be materially adversely affected to the extent that
managing general agents, general agents and other producers
exceed their underwriting authorities or if our agents, our
insureds or other third parties commit fraud or otherwise
breach obligations owed to us.
For certain business conducted by our insurance group,
following our underwriting, financial, claims and information
technology due diligence reviews, we authorize managing
general agents, general agents and other producers to write
business on our behalf within underwriting authorities
prescribed by us. In addition, our mortgage group delegates the
underwriting of a significant percentage of its primary new
insurance written to certain mortgage lenders. Under this
delegated underwriting program, the approved customer may
determine whether mortgage loans meet our mortgage
insurance program guidelines and commit us to issue mortgage
insurance. We rely on the underwriting controls of these agents
to write business within the underwriting authorities provided
by us. Although we have contractual protections in some
instances and we monitor such business on an ongoing basis,
our monitoring efforts may not be adequate or our agents may
exceed their underwriting authorities or otherwise breach
obligations owed to us. In addition, our agents, our insureds or
other third parties may commit fraud or otherwise breach their
obligations to us. To the extent that our agents, our insureds or
other third parties exceed their underwriting authorities,
commit fraud or otherwise breach obligations owed to us in the
future, our financial condition and results of operations could
be materially adversely affected.
We are exposed to credit risk in certain of our business
operations.
for
the deductible amount
In addition to exposure to credit risk related to our investment
portfolio, reinsurance recoverables and reliance on brokers and
other agents (each discussed elsewhere in this section), we are
exposed to credit risk in other areas of our business related to
policyholders. We are exposed to credit risk in our insurance
group’s surety unit where we guarantee to a third party that our
policyholder will satisfy certain performance or financial
obligations. If our policyholder defaults, we may suffer losses
and be unable to be reimbursed by our policyholder. We are
exposed to credit risk in our insurance group’s construction and
national accounts units where we write large deductible
insurance policies. Under these policies, we are typically
obligated to pay the claimant the full amount of the claim
(shown as “contractholder payables” on our consolidated
balance sheets). We are subsequently reimbursed by the
policyholder
(shown as
“contractholder receivables” on our consolidated balance
sheets), which can be a set amount per claim and/or an aggregate
amount for all covered claims. As such, we are exposed to credit
risk from the policyholder. We are also exposed to credit risk
from policyholders on smaller deductibles in other insurance
group lines, such as healthcare and excess and surplus casualty.
Additionally, we write retrospectively rated policies (i.e.,
policies in which premiums are adjusted after the policy period
based on the actual loss experience of the policyholder during
the policy period). In this instance, we are exposed to credit risk
to the extent the adjusted premium is greater than the original
premium. While we generally seek to mitigate this risk through
collateral agreements that require the posting of collateral in
such forms as cash and letters of credit from banks, our efforts
to mitigate the credit risk that we have to our policyholders may
not be successful. Although we have not experienced any
material credit losses to date, an increased inability of our
policyholders to meet their obligations to us could have a
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2018 FORM 10-K
material adverse effect on our financial condition and results
of operations.
Our investment performance may affect our financial results
and ability to conduct business.
Our operating results depend in part on the performance of our
investment portfolio. A significant portion of cash and invested
assets held by Arch consists of fixed maturities (76.1% as of
December 31, 2018). Although our current
investment
guidelines and approach stress preservation of capital, market
liquidity and diversification of risk, our investments are subject
to market-wide risks and fluctuations. In addition, we are
subject to risks inherent in particular securities or types of
securities, as well as sector concentrations. Changing market
conditions could materially affect the future valuation of
securities in our investment portfolio, which could cause us to
impair some portion of those securities. We may not be able to
realize our investment objectives, which could have a material
adverse effect on our financial results. In the event that we are
unsuccessful in correlating our investment portfolio with our
expected insurance and reinsurance liabilities, we may be
forced to liquidate our investments at times and prices that are
not optimal, which could have a material adverse effect on our
financial results and ability to conduct our business.
Foreign currency exchange rate fluctuation may adversely
affect our financial results.
We write business on a worldwide basis, and our results of
operations may be affected by fluctuations in the value of
currencies other than the U.S. Dollar. The primary foreign
currencies in which we operate are the Euro, the British Pound
Sterling, the Australian Dollar and the Canadian Dollar.
Changes in foreign currency exchange rates can reduce our
revenues, increase our liabilities and costs and cause
fluctuations in the valuation of our investment portfolio. We
may therefore suffer losses solely as a result of exchange rate
fluctuations. In order to mitigate our exposure to foreign
currency fluctuations in our net insurance liabilities, we have
invested and expect to continue to invest in securities
denominated in currencies other than the U.S. Dollar. In
addition, we may replicate investment positions in foreign
currencies using derivative financial instruments. Net foreign
exchange gains, excluding amounts reflected in the ‘other’
segment, were $58.7 million for 2018, compared to losses of
$113.3 million for 2017 and gains of $31.4 million for 2016.
Changes in the value of investments due to foreign currency
rate movements are reflected as a direct increase or decrease to
shareholders' equity and are not included in the statement of
income. We have chosen not to hedge certain currency risks on
capital contributed to certain subsidiaries, including to Arch
Insurance Europe held in British Pound Sterling, and may
continue to choose not to hedge our currency risks. There can
be no assurances that arrangements to match projected
liabilities in foreign currencies with investments in the same
currencies or derivative financial instruments will mitigate the
negative impact of exchange rate fluctuations, and we may
suffer losses solely as a result of exchange rate fluctuations.
We may be adversely affected by changes in economic
conditions, including interest rate changes.
Our operating results are affected by, and we are exposed to,
significant financial and capital markets risk, including changes
in interest rates, real estate values, foreign currency exchange
rates, market volatility, the performance of the economy in
general, the performance of our investment portfolio and other
factors outside our control. Interest rates are highly sensitive to
many factors, including the fiscal and monetary policies of the
U.S. and other major economies, inflation, economic and
political conditions and other factors beyond our control.
Although we attempt to take measures to manage the risks of
investing in changing interest rate environments, we may not
be able to mitigate interest rate sensitivity effectively. Despite
our mitigation efforts, an increase in interest rates could have
a material adverse effect on our book value.
Our investment portfolio includes residential mortgage backed
securities (“RMBS”). As of December 31, 2018, RMBS
constituted approximately 2.7% of cash and invested assets held
by Arch. As with other fixed income investments, the fair value
of these securities fluctuates depending on market and other
general economic conditions and interest rate trends. In periods
of declining interest rates, mortgage prepayments generally
increase and RMBS are prepaid more quickly, requiring us to
reinvest the proceeds at the then current market rates.
Conversely, in periods of rising rates, mortgage prepayments
generally fall, preventing us from taking full advantage of the
higher level of rates. The residential mortgage market in the
U.S has experienced a variety of difficulties in certain
underwriting periods. A decline or an extended flattening in
residential property values may result in additional increases in
delinquencies and losses on residential mortgage loans
generally, especially with respect to any residential mortgage
loans where the aggregate loan amounts (including any
subordinate loans) are close to or greater than the related
property values. These developments may have a significant
adverse effect on the prices of loans and securities, including
those in our investment portfolio and may have other wide
ranging consequences, including downward pressure on
economic growth and the potential for increased insurance and
reinsurance exposures, which could have an adverse impact on
our results of operations, financial condition, business and
operations.
Mortgage insurance losses result when a borrower becomes
unable to continue to make mortgage payments and the home
of such borrower cannot be sold for an amount that covers
unpaid principal and interest and the expenses of the sale.
Deteriorating economic conditions increase the likelihood that
borrowers will have insufficient income to pay their mortgages
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2018 FORM 10-K
and can adversely affect housing values. In addition, natural
disasters or other catastrophic events could result in increased
claims if such events adversely affected the employment and
income of borrowers and the value of homes. Any of these
events or deteriorating economic conditions could cause our
mortgage insurance losses to increase and adversely affect our
results of operations and
financial condition. See
“Management’s Discussion and Analysis of Financial
Condition and Results of Operations—Catastrophic Events and
Severe Economic Events.”
Our portfolio includes commercial mortgage backed securities
(“CMBS”). At December 31, 2018, CMBS constituted
approximately 3.7% of cash and invested assets held by Arch.
The commercial real estate market may experience price
deterioration, which could lead to delinquencies and losses on
commercial real estate mortgages.
In addition, in each year, a significant portion of our mortgage
insurance premiums will be from mortgage insurance written
in prior years. The length of time insurance remains in force,
referred to as persistency, is a significant driver of mortgage
insurance revenues. Factors affecting persistency include:
current mortgage interest rates compared to those rates on
mortgages in our insurance in force, which affects the likelihood
of the insurance in force to be subject to cancellation due to
borrower refinancing; the amount of home equity, as
homeowners with more equity in their homes can generally
more readily move to a new residence or refinance their existing
mortgage; and mortgage insurance cancellation policies and
practices of mortgage investors and mortgage services and the
cancellation of borrower-paid mortgage insurance, either upon
request of the borrower or as required by law based upon the
amortization of the loan. In 2018, the GSEs announced changes
to various mortgage insurance termination requirements that
are intended to further simplify the process of evaluating
borrower-initiated
insurance
termination. Among other things, these changes update
evidence of value requirements for borrower requested
cancellation based on the original value of the property and the
current value of the property, raise Fannie Mae’s loan-to-value
ratio for cancellation based on substantial improvements from
75% or less to 80% or less, provide clarification regarding what
constitutes substantial improvements to the property, allow
servicers to respond to either verbal or written requests for
mortgage insurance cancellation by a borrower, and provide
servicers flexibility in evaluating the payment history of
borrowers that have been impacted by certain disaster events.
Fannie Mae’s changes in this area must be implemented by
March 1, 2019, although certain requirements have been
implemented as early as January 1, 2019. Freddie Mac’s new
requirements became effective October 1, 2018. If these or other
factors cause the length of time our mortgage insurance policies
remain in force to decline, our mortgage insurance revenues
could be adversely affected.
for mortgage
requests
Significant, continued volatility in financial markets, changes
in interest rates, a lack of pricing transparency, decreased
market liquidity, declines in equity prices and the strengthening
or weakening of foreign currencies against the U.S. Dollar,
individually or in tandem, could have a material adverse effect
on our results of operations, financial condition or cash flows
through realized losses, impairments and changes in unrealized
positions.
Uncertainty Relating to the Determination of LIBOR and the
Potential Phasing out of LIBOR after 2021 may Adversely
Affect our Cost of Capital, Net Investment Income and
Mortgage Reinsurance Costs.
On July 27, 2017, the U.K. Financial Conduct Authority
announced that it intends to stop persuading or compelling
banks to submit LIBOR rates after 2021. Accordingly, it is
uncertain whether ICE, the entity responsible for administering
LIBOR, will continue to quote LIBOR after 2021. In addition,
in early 2018, the ICE stated its intention to continue to
administer and quote LIBOR after 2021, possibly employing
an alternative methodology. Therefore, no assurance can be
given that LIBOR on any date accurately represents the London
interbank rate or the rate applicable to actual loans in U.S.
dollars for the relevant period between leading European banks,
or that the underlying methodology for LIBOR will not change.
Efforts to identify a set of alternative U.S. dollar reference
interest rates include proposals by the Alternative Reference
Rates Committee of the Federal Reserve Board and the Federal
Reserve Bank of New York. There is currently no definitive
information regarding the future of LIBOR or of any particular
replacement rate that may be established or any other reforms
to LIBOR that may be adopted in the United Kingdom, in the
U.S. or elsewhere.
Uncertainty as to the nature of such potential changes,
alternative reference rates or other reforms may adversely affect
the value of and trading market for LIBOR-based securities.
Moreover, any future reform, replacement or disappearance of
LIBOR may adversely affect the value of and return of our
investment portfolio, our cost of capital and our cost of
issuing Bellemeade mortgage risk transfer securities.
The determination of
the amount of allowances and
impairments taken on our investments is highly subjective and
could materially impact our results of operations or financial
position.
On a quarterly basis, we perform reviews of our investments to
determine whether declines in fair value below the cost basis
are considered other-than-temporary in accordance with
applicable accounting guidance regarding the recognition and
presentation of other-than-temporary impairments. The process
of determining whether a security is other-than-temporarily
impaired requires judgment and involves analyzing many
factors. These factors include: an analysis of the liquidity,
business prospects and overall financial condition of the issuer;
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2018 FORM 10-K
the time period in which there was a significant decline in value;
the significance of the decline; and the analysis of specific credit
events. There can be no assurance that our management has
accurately assessed the level of impairments taken and
allowances reflected in our financial statements. Furthermore,
additional impairments may need to be taken or allowances
provided for in the future. Historical trends may not be
indicative of future impairments or allowances. Further, rapidly
changing and unpredictable credit and equity market conditions
could materially affect the valuation of securities carried at fair
value as reported within our consolidated financial statements
and the period-to-period changes in value could vary
significantly. Decreases in value could have a material adverse
effect on our financial condition and results of operations.
Certain of our investments are illiquid and are difficult to sell,
or to sell in significant amounts at acceptable prices, to
generate cash to meet our needs.
Our investments in certain securities, including certain fixed
income and structured securities, investments in funds
accounted for using the equity method, other alternative
investments and strategic investments in joint ventures such as
Watford Re, Premia Re and others, may be illiquid due to
contractual provisions or investment market conditions. If we
require significant amounts of cash on short notice in excess of
anticipated cash requirements, then we may have difficulty
selling these investments in a timely manner or may be forced
to sell or terminate them at unfavorable values.
We may require additional capital or credit in the future, which
may not be available or may only be available on unfavorable
terms.
The capital requirements of our businesses depend on many
factors, including regulatory and rating agency requirements,
the performance of our investment portfolio, our ability to write
new business successfully, the frequency and severity of
catastrophe events and our ability to establish premium rates
and reserves at levels sufficient to cover losses. We may need
to raise additional funds through equity or debt financings. Any
equity or debt financing, if available at all, may be on terms that
are unfavorable to us. Equity financings could be dilutive to our
existing shareholders and could result in the issuance of
securities that have rights, preferences and privileges that are
senior to those of our outstanding securities. If we are not able
to obtain adequate capital, our business, results of operations
and financial condition could be adversely affected. See
“Management’s Discussion and Analysis of Financial
Condition and Results of Operations—Financial Condition,
Liquidity and Capital Resources—Liquidity and Capital
Resources.”
The loss of our key employees or our inability to retain them
could negatively impact our business.
Our success has been, and will continue to be, dependent on
our ability to retain the services of our existing key executive
officers and to attract and retain additional qualified personnel
in the future. The pool of talent from which we actively recruit
is limited. Although, to date, we have not experienced
difficulties in attracting and retaining key personnel, the
inability to attract and retain qualified personnel could have a
material adverse effect on our financial condition and results
of operations. In addition, our underwriting staff is critical to
our success in the production of business. While we do not
consider any of our key executive officers or underwriters to
be irreplaceable, the loss of the services of our key executive
officers or underwriters or the inability to hire and retain other
highly qualified personnel in the future could delay or prevent
us from fully implementing our business strategy which could
affect our financial performance.
Our information technology systems may be unable to meet the
demands of customers.
Our information technology systems service our insurance
portfolios. Accordingly, we are highly dependent on the
effective operation of these systems. While we believe that the
systems are adequate to service our insurance portfolios, there
can be no assurance that they will operate in all manners in
which we intend or possess all of the functionality required by
customers currently or in the future.
Our customers, especially our mortgage insurance customers,
require that we conduct our business in a secure manner,
electronically via
the Internet or via electronic data
transmission. We must continually invest significant resources
in establishing and maintaining electronic connectivity with
customers. In order to integrate electronically with customers
in the mortgage insurance industry, we require electronic
connections between our systems and those of the industry's
largest mortgage servicing systems and leading loan origination
systems. Our mortgage group currently possesses connectivity
with certain of these external systems, but there is no assurance
that such connectivity is sufficient and we are continually
undertaking new electronic integration efforts with third-party
loan servicing and origination systems. Our business, financial
condition and operating results may be adversely affected if we
do not possess or timely acquire the requisite set of electronic
integrations necessary to keep pace with the technological
demands of customers.
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Technology breaches or failures, including, but not limited to,
those resulting from a malicious cyber attack on us or our
business partners and service providers, could disrupt or
otherwise negatively impact our business and/or expose us to
litigation.
We rely on information technology systems to process, transmit,
store and protect the electronic information, financial data and
proprietary models
to our business.
that are critical
Furthermore, a significant portion of the communications
between our employees and our business partners and service
providers depends on information technology and electronic
information exchange. Like all companies, our information
technology systems are vulnerable
to data breaches,
interruptions or failures due to events that may be beyond our
control, including, but not limited to, natural disasters, power
outages, theft, terrorist attacks, computer viruses, hackers,
errors in usage and general technology failures. Additionally,
our employees and vendors may use portable computers or
mobile devices which may contain duplicate or similar
information to that in our computer systems, and these devices
can be stolen, lost or damaged. Security breaches could expose
us to the loss or misuse of our information, litigation and
potential liability. In addition, cyber incidents that impact the
availability, reliability, speed, accuracy or other proper
functioning of these systems could have a significant negative
impact on our operations and possibly our results. A cyber
incident could also result in a violation of applicable privacy
and other laws, damage our reputation, cause a loss of
customers, adversely affect our stock price, cause us to incur
remediation costs, increased cybersecurity protection costs and/
or increased insurance premiums, and/or give rise to monetary
fines and other penalties, any of which could be significant and
could adversely affect our business.
We have outsourced certain technology and business process
functions to third parties and may continue do so in the future.
Our outsourcing of certain technology and business process
functions to third parties may expose us to increased risk related
to data security, service disruptions or the effectiveness of our
control system, which could result in monetary and reputational
damage or harm to competitive position. These risks could
increase as vendors increasingly offer cloud-based software
services rather than software services which can be run within
our data centers.
We believe that we have established and implemented
appropriate security measures to provide reasonable assurance
that our information technology systems are secure and
appropriate controls and procedures to enable us to identify and
respond to unauthorized access to such systems. We regularly
engage third parties to evaluate and test the adequacy of our
most critical security measures, controls and procedures.
Despite these security measures, controls and procedures,
disruptions to and breaches of our information technology
systems are possible. Because we rely on our technology
systems for many critical functions, including connecting with
our customers, if such systems were to fail or be attacked or
breached, we may experience a significant disruption in our
operations and in the business we receive and process, which
could adversely affect our results of operations and financial
condition.
the
regulatory environment
In addition,
surrounding
information security and privacy is increasingly changing. We
are subject to EU, U.S. federal, state and other foreign laws and
regulations regarding the protection of personal data and
information. These laws and regulations are complex and
sometimes conflict. We could be subject to fines, penalties and/
or regulatory enforcement actions in one or more jurisdictions
if any person, including any employee, disregards or breaches,
whether intentionally or negligently, controls intended to
protect the confidential information of our employees or clients.
As an example, the New York State Department of Financial
Services adopted a regulation pertaining to cybersecurity for
all banking and insurance entities under its jurisdiction that
came into effect March 1, 2017. Additionally, GDPR came into
effect on May 25, 2018, and requires businesses offering goods
and services to, or monitoring the behavior of, customers in the
EU to comply with onerous accountability obligations and
significantly enhanced conditions to processing personal data.
Non-compliance with the GDPR could result in a fine of up to
4% of a firm’s global annual revenue per violation. As a result,
our ability to conduct our business and our results of operations
might be materially and adversely affected.
If the volume of low down payment mortgage originations
declines, the amount of mortgage insurance we write in the U.S.
could decline, which would reduce our mortgage insurance
revenues.
The size of the U.S. mortgage insurance market depends in large
part upon the volume of low down payment home mortgage
originations. Factors affecting the volume of low down payment
mortgage originations include, among others: restrictions on
mortgage credit due to stringent underwriting standards and
liquidity issues affecting lenders; changes in mortgage interest
rates and home prices, and other economic conditions in the
U.S. and regional economies; population trends, including the
rate of household formation; and U.S. government housing
policy. A decline in the volume of low down payment home
mortgage originations could decrease demand for mortgage
insurance, decrease our U.S. new insurance written and reduce
mortgage insurance revenues.
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2018 FORM 10-K
If the role of the GSEs in the U.S. housing market changes, or
if the GSEs change other policies or practices, the amount of
mortgage insurance that we write could decline, which would
reduce our mortgage insurance revenues.
The GSEs are the beneficiaries of the significant majority of
the insurance policies we issue as a result of their purchases,
statutorily required or otherwise, of qualifying mortgage loans
from lenders or investors. The charters of the GSEs require
credit enhancement for low down payment mortgages in order
for such loans to be eligible for purchase or guarantee by the
GSEs. If the charters of the GSEs were amended to change or
eliminate the acceptability of private mortgage insurance, our
mortgage insurance business could decline significantly.
The premiums we charge for mortgage insurance on insured
loans and the associated investment income may not be
adequate to compensate for future losses from these loans.
We set premiums at the time a policy is issued based upon our
expectations regarding likely performance over the life of
insurance coverage. We generally cannot cancel mortgage
insurance coverage or adjust renewal premiums during the life
of a mortgage insurance policy. As a result, losses from higher
than anticipated claims generally cannot be offset by premium
increases on policies in force or mitigated by non-renewal or
cancellation of insurance coverage. The premiums we charge
on our insurance in force and the associated investment income
may not be adequate to compensate us for the risks and costs
associated with the insurance coverage provided to customers.
An increase in the number or size of claims, compared to what
we anticipate, could adversely affect Arch MI U.S.’s results of
operations and financial condition.
New GSE eligibility requirements for mortgage insurers could
require us to contribute additional capital to Arch MI U.S. in
the future, and could negatively impact our results of operations
and financial condition, or reduce our operating flexibility.
Substantially all of Arch MI U.S.’s insurance written has been
for loans sold to the GSEs. The PMIERs apply to Arch Mortgage
Insurance Company and United Guaranty Residential
Insurance Company, which are GSE-approved mortgage
insurers (“eligible mortgage insurers”). The PMIERs impose
limitations on the type of risk insured, the forms and insurance
policies issued, standards for the geographic and customer
diversification of risk, procedures for claims handling,
acceptable underwriting practices, standards for certain
reinsurance cessions and financial requirements, among other
things. The financial requirements require a mortgage insurer’s
available assets, which generally include only the most liquid
assets of an insurer, to meet or exceed “minimum required
assets” as of each quarter end. Our eligible mortgage insurers
each satisfied the PMIERs’ financial requirements as of
December 31, 2018.
The revised PMIERs also impose additional operational
requirements in areas such as claim processing, loss mitigation,
underwriting, quality control, and reporting. The revised
requirements have caused us to make changes to our business
practices and incur additional costs in order to achieve and
maintain compliance with the PMIERs. While we do not expect
the revised PMIERs to have a significant impact on our
operations or a material impact on our capital position the
increase in capital required to satisfy the revised PMIERs may
decrease our return on capital.
While we intend to continue to comply with these requirements,
there can be no assurance that the GSEs will continue to treat
Arch Mortgage Insurance Company or United Guaranty
Residential Insurance Company as eligible mortgage insurers.
If either or both of the GSEs were to cease to consider Arch
Mortgage Insurance Company or United Guaranty Residential
Insurance Company as eligible mortgage insurers and,
therefore, cease accepting our mortgage insurance products, our
results of operations and financial condition would be adversely
affected.
The mix of business we write affects Arch MI U.S.’s losses and
will affect the minimum required assets Arch MI U.S. is required
to maintain in order to comply with PMIERs financial
requirements.
Our mortgage insurance portfolio includes loans with loan-to-
value ratios exceeding 95%, loans with FICO scores below 620,
adjustable rate mortgages, (“ARMs”), and less-than A quality
loans. Even when housing values are stable or rising, we expect
higher default and claim rates for high loan-to-value loans,
loans with lower FICO scores, ARMs and less-than A quality
loans. Although we attempt to incorporate the higher default
and claim rates associated with these loans into our
underwriting and pricing models, there can be no assurance that
the premiums earned and the associated investment income will
adequately compensate us for future losses from these loans.
From time to time, we change the types of loans that we insure
and the requirements under which we insure them. In 2017 and
2018, we modestly expanded our underwriting guidelines and
we may further expand such guidelines in the future.
The geographic mix of Arch MI U.S.’s business could increase
losses and harm our financial performance. We are affected by
economic downturns and other events in specific regions of the
United States where a large portion of our U.S. mortgage
insurance business is concentrated. As of December 31, 2018,
7.7% of Arch MI U.S.’s primary risk-in-force was located in
Texas, 6.3% was located in California and 5.0% was located in
Florida. See “Management’s Discussion and Analysis of
Financial Condition and Results of Operations—Critical
Accounting Policies, Estimates and Recent Accounting
Pronouncements—Mortgage Operations
Supplemental
Information.”
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2018 FORM 10-K
Arch MI U.S.’s minimum required assets under the PMIERs
will be determined, in part, by the particular risk profiles of the
loans it insures. If, absent other changes, Arch MI U.S.’s mix
of business changes to include more loans with higher loan-to-
value ratios or lower credit scores, it will have a higher
minimum required asset amount under the PMIERs and,
accordingly, be required to hold more capital in order to
maintain GSE eligibility.
Potential changes to state mortgage insurance regulations
could reduce Arch MI U.S.’s profitability and its ability to
compete with credit enhancement alternatives to mortgage
insurance.
The NAIC, which reviews state insurance laws and regulations,
has established a Mortgage Guaranty Insurance Working Group
(“Working Group”) to make recommendations to the NAIC's
Financial Condition Committee regarding changes to the
NAIC’s Mortgage Guaranty Insurance Model Act. The
Working Group has released a drafts of the Model Act which
includes proposed changes to minimum statutory capital
requirements.
If the NAIC revises the Model Act, some state legislatures are
likely to enact and implement part or all of the revised
provisions. While we cannot predict the effect that any NAIC
recommendations or future legislation may have on Arch MI
U.S., such changes could reduce Arch MI U.S.’s profitability
and its ability to compete with credit enhancement alternatives
to mortgage insurance, which could adversely affect our
financial condition or results of operations.
If servicers fail to adhere to appropriate servicing standards or
experience disruptions to their businesses, our mortgage
insurance operations could be adversely affected.
We depend on reliable, consistent third-party servicing of the
loans that we insure. Among other things, our mortgage
insurance policies require our customers and their servicers to
timely submit premium and reports and utilize commercially
reasonable efforts to limit and mitigate loss when a loan is in
default. Without reliable, consistent third-party servicing, our
insurance subsidiaries may be unable to correctly record new
loans as they are underwritten, receive and process payments
on insured loans and/or properly recognize and establish
reserves on loans when a default exists or occurs but is not
reported to us. In addition, if these servicers fail to limit and
mitigate losses when appropriate, our losses may unexpectedly
increase. If one or more servicers failed to adhere to these
requirements, our financial results could be adversely affected.
The implementation of the Basel III Capital Accord may
adversely affect the use of mortgage insurance by certain banks.
With certain exceptions, the Basel III Rules became effective
on January 1, 2014. If further implementation of the Basel III
ratio at
increases
the capital
loan-to-value
Rules
requirements of banking
organizations with respect to the residential mortgages we
insure or does not provide sufficiently favorable treatment for
the use of mortgage insurance, it could adversely affect the
demand for mortgage insurance. In December 2017, the Basel
Committee published final revisions to the Basel Capital
Accord that will be implemented by each participating country
by January 1, 2022. Under these revised rules, banks using the
standardized approach for credit risk management will
determine the risk-weight for residential mortgages based on
the
loan origination, without
consideration of mortgage insurance. Under the standardized
approach, after the appropriate risk-weight is determined, the
existence of mortgage insurance could be considered, but only
if the company issuing the insurance has a lower risk-weight
than the underlying exposure. Mortgage insurance issued by
private companies would not meet this test. Therefore, under
the latest Basel Capital Accord, mortgage insurance could not
mitigate credit and lower the capital charge under the
standardized approach. If the Basel Capital Accord is
implemented in the United States in this form, mortgage
insurance would not lower the loan-to-value ratio of residential
loans for capital purposes, and therefore may decrease the
demand for this product. It is possible that the U.S. regulatory
agencies could determine that their current capital rules are at
least as stringent as the Basel Committee’s 2017 revisions, in
which case no change would be mandated. However, if the U.S.
agencies decide to implement the new standards as specifically
drafted by the Basel Committee, mortgage insurance would not
lower the loan-to-value ratio of residential loans for capital
purposes, and therefore may decrease the demand for this
product.
Further, it is possible (but not mandated by the Basel Capital
Accord) that the banking agencies and the GSEs might likewise
discontinue taking mortgage insurance into account when
determining a mortgage’s loan-to-value ratio for prudential
(non-capital) purposes. Additionally, a new riskbased capital
proposal for the GSEs was published for comment by the FHFA
in 2018. Under this proposal the capital requirements of these
GSEs would take into account the existence of credit mitigants,
such as mortgage insurance. However, as proposed, mortgage
insurance issued by monoline companies would result in less
capital relief than the capital relief afforded by other forms of
credit mitigation, such as the issuance of credit-linked notes.
The final form ofthe rule is likely to change based on comments
received from industry participants and the views of the new
director of the FHFA. However, if adopted as proposed, these
capital regulations might incent the GSEs to favor these forms
of credit risk mitigation when they have the option to use these
instruments.If these developments should occur, they would
adversely affect the demand for mortgage insurance in the U.S.
which would adversely affect our U.S. mortgage insurance
operations.
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2018 FORM 10-K
Some of the provisions of our bye-laws and our shareholders
agreement may have the effect of hindering, delaying or
preventing third party takeovers or changes in management
initiated by shareholders. These provisions may also prevent
our shareholders from receiving premium prices for their shares
in an unsolicited takeover.
Some provisions of our bye-laws could have the effect of
discouraging unsolicited takeover bids from third parties or
changes in management initiated by shareholders. These
provisions may encourage companies interested in acquiring us
to negotiate in advance with our board of directors, since the
board has the authority to overrule the operation of several of
the limitations.
are U.S. persons unless we receive assurance satisfactory to us
that they are not U.S. persons.
The bye-laws also provide that the affirmative vote of at least
66 2/3% of the outstanding voting power of our shares
(excluding shares owned by any person (and such person’s
affiliates and associates) that is the owner of 15% or more (a
“15% Holder”) of our outstanding voting shares) shall be
required for various corporate actions, including: merger or
consolidation of the company into a 15% Holder; sale of any
or all of our assets to a 15% Holder; the issuance of voting
securities to a 15% Holder; or amendment of these provisions;
provided, however, the supermajority vote will not apply to any
transaction approved by the board.
Among other things, our bye-laws provide: for a classified
board of directors, in which the directors of the class elected at
each annual general meeting holds office for a term of three
years, with the term of each class expiring at successive annual
general meetings of shareholders; that the number of directors
is determined by the board from time to time by a vote of the
majority of our board; that directors may only be removed for
cause, and cause removal shall be deemed to exist only if the
director whose removal is proposed has been convicted of a
felony or been found by a court to be liable for gross negligence
or misconduct in the performance of his or her duties; that our
board has the right to fill vacancies, including vacancies created
by an expansion of the board; and for limitations on a
shareholder’s right to raise proposals or nominate directors at
general meetings. Our bye-laws provide that certain provisions
which may have anti-takeover effects may be repealed or altered
only with prior board approval and upon the affirmative vote
of holders of shares representing at least 65% of the total voting
power of our shares entitled generally to vote at an election of
directors.
The bye-laws also contain a provision limiting the rights of any
U.S. person (as defined in section 7701(a)(30) of the Internal
Revenue Code of 1986, as amended (the “Code”)) that owns
shares of Arch Capital, directly, indirectly or constructively
(within the meaning of section 958 of the Code), representing
more than 9.9% of the voting power of all shares entitled to
vote generally at an election of directors. The votes conferred
by such shares of such U.S. person will be reduced by whatever
amount is necessary so that after any such reduction the votes
conferred by the shares of such person will constitute 9.9% of
the total voting power of all shares entitled to vote generally at
an election of directors. Notwithstanding this provision, the
board may make such final adjustments to the aggregate number
of votes conferred by the shares of any U.S. person that the
board considers fair and reasonable in all circumstances to
ensure that such votes represent 9.9% of the aggregate voting
power of the votes conferred by all shares of Arch Capital
entitled to vote generally at an election of directors. Arch Capital
will assume that all shareholders (other than specified persons)
The provisions described above may have the effect of making
more difficult or discouraging unsolicited takeover bids from
third parties. To the extent that these effects occur, shareholders
could be deprived of opportunities to realize takeover premiums
for their shares and the market price of their shares could be
depressed. In addition, these provisions could also result in the
entrenchment of incumbent management.
There are regulatory limitations on the ownership and transfer
of our common shares.
The jurisdictions in which our insurance and reinsurance
subsidiaries operate have laws and regulations that require
regulatory approval of a change in control of an insurer or an
insurer's holding company. Where such laws apply to us and
our subsidiaries, there can be no effective change in our control
unless the person seeking to acquire control has filed a statement
with the regulators and has obtained prior approval for the
proposed change from such regulators. The usual measure for
a presumptive change in control pursuant to these laws is the
acquisition of 10% or more of the voting power of the insurance
company or its parent, although this presumption is rebuttable.
Consequently, a person may not acquire 10% or more of our
common shares without the prior approval of the applicable
insurance regulators. These laws may discourage potential
acquisition proposals and may delay, deter or prevent a change
in control of us, including transactions that some shareholders
might consider to be desirable.
Our insurance and reinsurance subsidiaries are subject to
regulation in various jurisdictions, and failure to comply with
existing regulations or material changes in the regulation of
their operations, or any investigations, inquiries or demands
by government authorities, could adversely affect us.
Our insurance and reinsurance subsidiaries are subject to the
laws and regulations of a number of jurisdictions worldwide,
including Bermuda, the states in the U.S. in which such
subsidiaries conduct business, the U.K., certain EU Member
States, Canada, Switzerland, Australia and Hong Kong.
Existing laws and regulations, among other things, limit the
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2018 FORM 10-K
amount of dividends that can be paid to us by our insurance and
reinsurance subsidiaries, prescribe solvency and capital
adequacy standards, impose restrictions on the amount and type
of investments that can be held to meet solvency and capital
adequacy requirements, require the maintenance of reserve
liabilities, and require pre-approval of acquisitions and certain
affiliate transactions. Failure to comply with these laws and
regulations or to maintain appropriate authorizations, licenses,
and/or exemptions under applicable laws and regulations may
cause governmental authorities to preclude or suspend our
insurance or reinsurance subsidiaries from carrying on some or
all of their activities, place one or more of them into
rehabilitation or liquidation proceedings, impose monetary
penalties or other sanctions on them or our affiliates, or
commence insurance company delinquency proceedings
insurance or reinsurance subsidiaries. The
against our
application of
laws and regulations by various
governmental authorities, including authorities outside the
U.S., may affect our liquidity and restrict our ability to expand
our business operations through acquisitions or to pay dividends
on our ordinary shares. Furthermore, compliance with legal and
regulatory requirements may result in significant expenses,
which could have a negative impact on our profitability.
these
In addition to legal and regulatory requirements, the insurance
and reinsurance industry has experienced substantial volatility
as a result of investigations, litigation and regulatory activity
by various
insurance, governmental and enforcement
authorities, including the SEC, concerning certain practices
within the insurance and reinsurance industry. Our involvement
in any investigations, litigations or regulatory activity,
including any related lawsuits, would cause us to incur legal
costs and, if we or any of our insurance or reinsurance
subsidiaries were found to have violated any laws or
regulations, we could be required to pay fines and damages and
incur other sanctions, perhaps in material amounts, which could
have a material negative impact on our profitability.
Any such litigation or failure to comply with applicable laws
could result in the imposition of significant restrictions on our
ability to do business, and could also result in suspensions,
injunctions, monetary damages, fines or other sanctions, any or
all of which could adversely affect our financial condition and
results of operations.
Our reinsurance subsidiaries may be required to provide
collateral to ceding companies, by applicable regulators, their
contracts or other commercial considerations. Their ability to
conduct business could be significantly and negatively affected
if they are unable to do so.
Arch Re Bermuda is a registered Bermuda insurance company
and is not licensed or admitted as an insurer in any jurisdiction
in the U.S., although Arch Re Bermuda has been approved as
a “certified reinsurer” in certain U.S. states that allow reduced
collateral for reinsurance ceded to such reinsurers. Arch Re
Bermuda's contracts generally require it to post a letter of credit
or provide other security, even in U.S. states where it has been
approved for reduced collateral. State credit for reinsurance
rules also generally provide that certified reinsurers such as
Arch Re Bermuda must provide 100% collateral in the event
their certified status is “terminated” or upon the entry of an
order of rehabilitation, liquidation or conservation against a
ceding insurer.
Although, to date, Arch Re Bermuda has not experienced any
difficulties in providing collateral when required, if we are
unable to post security in the form of letters of credit or trust
funds when required, the operations of Arch Re Bermuda could
be significantly and negatively affected.
Arch Capital is a holding company and is dependent on
dividends and other distributions
its operating
subsidiaries.
from
Arch Capital is a holding company whose assets primarily
consist of the shares in our subsidiaries. Generally, Arch Capital
depends on its available cash resources, liquid investments and
dividends or other distributions from subsidiaries to make
payments, including the payment of debt service obligations
and operating expenses it may incur and any payments of
dividends, redemption amounts or liquidation amounts with
respect to our preferred shares and common shares, and to fund
the share repurchase program. The ability of our regulated
insurance and reinsurance subsidiaries to pay dividends or make
distributions is dependent on their ability to meet applicable
regulatory standards. In addition, the ability of our insurance
and reinsurance subsidiaries to pay dividends to Arch Capital
and to intermediate parent companies owned by Arch Capital
could be constrained by our dependence on financial strength
ratings from independent rating agencies. Our ratings from
these agencies depend to a large extent on the capitalization
levels of our insurance and reinsurance subsidiaries. We believe
that Arch Capital has sufficient cash resources and available
dividend capacity to service its indebtedness and other current
outstanding obligations. See “Management’s Discussion and
Analysis of Financial Condition and Results of Operations—
Financial Condition, Liquidity and Capital Resources—
Liquidity and Capital Resources.”
The service of process and enforcement of judgments against
us or our directors or officers may be difficult.
We are a Bermuda company and some of our officers and
directors are residents of various jurisdictions outside the U.S.
All or a substantial portion of our assets and the assets of those
persons may be located outside the U.S. As a result, it may be
difficult for investors to effect service of process within the U.S.
upon those persons or to recover against us or those persons on
judgments of U.S. courts based on civil liabilities provisions of
the U.S. federal securities laws even though we have appointed
National Registered Agents, Inc., New York, New York, as our
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2018 FORM 10-K
agent for service of process with respect to actions based on
offers and sales of securities made in the U.S. Because there is
no treaty in effect between the U.S. and Bermuda providing for
reciprocal recognition and enforcement of judgments of U.S.
courts in civil and commercial matters, a final judgment for the
payment of money rendered by a court in the U.S. based on
civil liability, whether or not predicated solely upon the U.S.
federal securities laws, would not be automatically enforceable
in Bermuda, and there are grounds upon which Bermuda courts
may not enforce judgments of U.S. courts. Further, no claim
may be brought in Bermuda against us or our directors and
officers for violation of U.S. federal securities laws, as such
laws do not have force of law in Bermuda. A Bermuda court
may, however, impose civil liability on us or our directors and
officers in a suit brought in the Supreme Court of Bermuda if
the facts alleged in the complaint constitute or give rise to a
cause of action under Bermuda law.
Our international business is subject to applicable laws and
regulations relating to sanctions and foreign corrupt practices,
the violation of which could adversely affect our operations.
We must comply with all applicable economic sanctions and
anti-bribery laws and regulations of the U.S. and other foreign
jurisdictions where we operate, including the U.K. and the
European Community. U.S. laws and regulations applicable to
us include the economic trade sanctions laws and regulations
administered by the Treasury’s Office of Foreign Assets Control
as well as certain laws administered by the U.S. Department of
State. New sanction regimes may be initiated, or existing
sanctions expanded, at any time, which can immediately impact
our business activities. In addition, we are subject to the Foreign
Corrupt Practices Act and other anti-bribery laws such as the
U.K. Bribery Act that generally bar corrupt payments or
unreasonable gifts to foreign governments or officials.
Although we have policies and controls in place that are
designed to ensure compliance with these laws and regulations,
it is possible that an employee or intermediary could fail to
comply with applicable laws and regulations. In such event, we
could be exposed to civil penalties, criminal penalties and other
sanctions, including fines or other punitive actions. In addition,
such violations could damage our business and/or our
reputation. Such criminal or civil sanctions, penalties, other
sanctions, and damage to our business and/or reputation could
have a material adverse effect on our financial condition and
results of operations.
Risk Relating to Our Shares
The market price of our common shares may experience
volatility, thereby causing a potential loss of value to our
investors.
The market price for our common shares may fluctuate
substantially and could cause investment losses. The price of
our common shares may not remain at or exceed current levels.
In addition to the risk factors described herein, the following
factors may have an adverse impact on the market price for our
common shares: announcements by us or our competitors of
acquisitions, investments or strategic alliances; changes in the
value of our assets; our actual or anticipated quarterly and
annual operating results; changes in expectations of future
financial performance or changes in estimates of securities
analysts; issuances by us of shares or other securities; sales, or
the possibility or perception of future sales, by our existing
shareholders; our share repurchase program; changes in general
conditions in the economy, the insurance industry or the
financial markets; changes in market valuation of companies
in the insurance and reinsurance industry; fluctuations in stock
market processes and volumes; the addition or departure of key
personnel; changes in tax law; and adverse press or news
announcements affecting us or the industry.
General market conditions and unpredictable factors could
adversely affect market prices for our outstanding preferred
shares.
There can be no assurance about the market prices for our series
of preferred shares that are traded publicly. Several factors,
many of which are beyond our control, will influence the fair
value of our preferred shares, including, but not limited to:
• whether dividends have been declared and are likely to be
declared on any series of our preferred shares from time to
time;
•
our creditworthiness, financial condition, performance and
prospects;
• whether the ratings on any series of our preferred shares
provided by any ratings agency have changed;
•
•
the market for similar securities; and
economic, financial, geopolitical, regulatory or judicial
events that affect us and/or the insurance or financial
markets generally.
Dividends on our preferred shares are non-cumulative.
Dividends on our preferred shares are non-cumulative and
payable only out of lawfully available funds of Arch Capital
under Bermuda law. Consequently, if Arch Capital's board of
directors (or a duly authorized committee of the board) does
not authorize and declare a dividend for any dividend period
with respect to any series of our preferred shares, holders of
such preferred shares would not be entitled to receive any such
dividend, and such unpaid dividend will not accrue and will
never be payable. Arch Capital will have no obligation to pay
dividends for a dividend period on or after the dividend payment
date for such period if its board of directors (or a duly authorized
committee of the board) has not declared such dividend before
the related dividend payment date; if dividends on our series E
or series F preferred shares are authorized and declared with
respect to any subsequent dividend period, Arch Capital will be
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2018 FORM 10-K
free to pay dividends on any other series of preferred shares
and/or our common shares. In the past, we have not paid
dividends on our common shares.
Our preferred shares are equity and are subordinate to our
existing and future indebtedness.
Our preferred shares are equity interests and do not constitute
indebtedness. As such, these preferred shares will rank junior
to all of our indebtedness and other non-equity claims with
respect to assets available to satisfy our claims, including in our
liquidation. As of December 31, 2018, our total long-term debt
was $1.73 billion, excluding the ‘other’ segment. We may incur
additional debt in the future. Our existing and future
indebtedness may restrict payments of dividends on our
preferred shares. Additionally, unlike indebtedness, where
principal and interest would customarily be payable on
specified due dates, in the case of preferred shares,
(1) dividends are payable only if declared by the board of
directors of Arch Capital (or a duly authorized committee of
the board) and (2) as described under “Risks Relating to Our
Company—Arch Capital is a holding company and is
dependent on dividends and other distributions from its
operating subsidiaries,” we are subject to certain regulatory and
other constraints affecting our ability to pay dividends and make
other payments.
The voting rights of holders of our preferred shares are limited.
Holders of our preferred shares have no voting rights with
respect to matters that generally require the approval of voting
shareholders. The limited voting rights of holders of our
preferred shares include the right to vote as a class on certain
fundamental matters that affect the preference or special rights
of our preferred shares as set forth in the certificate of
designations relating to each series of preferred shares. In
addition, if dividends on our series E or series F preferred shares
have not been declared or paid for the equivalent of six dividend
payments, whether or not for consecutive dividend periods,
holders of the outstanding series E or series F preferred shares
will be entitled to vote for the election of two additional
directors to our board of directors subject to the terms and to
the limited extent as set forth in the certificate of designations
relating to such series of preferred shares.
There is no limitation on our issuance of securities that rank
equally with or senior to our preferred shares.
We may issue additional securities that rank equally with or
senior to our series E and series F preferred shares without
limitation. The issuance of securities ranking equally with or
senior to our preferred shares may reduce the amount available
for dividends and the amount recoverable by holders of such
series in the event of a liquidation, dissolution or winding-up
of Arch Capital.
Risks Relating to Taxation
We and our non-U.S. subsidiaries may become subject to U.S.
federal income taxation and/or the U.S. federal income tax
liabilities of our U.S. subsidiaries may increase, including as
a result of changes in tax law.
Arch Capital and its non-U.S. subsidiaries intend to operate
their business in a manner that will not cause them to be treated
as engaged in a trade or business in the U.S. and, thus, will not
be required to pay U.S. federal income taxes (other than U.S.
excise taxes on insurance and reinsurance premium and
withholding taxes on certain U.S. source investment income)
on their income. However, because there is uncertainty as to
the activities which constitute being engaged in a trade or
business in the U.S., there can be no assurances that the IRS
will not contend successfully that Arch Capital or its non-U.S.
subsidiaries are engaged in a trade or business in the U.S. If
Arch Capital or any of its non-U.S. subsidiaries were subject
to U.S. income tax, our shareholders' equity and earnings could
be adversely affected.
Congress has been considering several legislative proposals
intended to eliminate certain perceived tax advantages of
Bermuda and other non-U.S. insurance companies. There is no
assurance that any such legislative proposal will not be enacted
into law and any such enacted law would not adversely affect
income tax liabilities of us or any of our subsidiaries.
The newly enacted U.S. tax law and its implementation may
have a material and adverse impact on our operations and
financial condition.
The Tax Cuts Act includes significant changes to the taxation
of business entities. These changes include, among others, a
permanent reduction to the corporate income tax rate.
Notwithstanding the reduction in the corporate income tax rate,
the overall impact of this tax reform is uncertain, and our
business and financial condition could be materially and
adversely affected.
Certain provisions in the Tax Cuts Act could have a material
and adverse impact on our financial condition and business
operation. One such provision imposes a 10% minimum tax
(reduced to 5% for the 2018 taxable year and increased to 12.5%
for the 2026 taxable year and the subsequent taxable years) on
the “modified taxable income” of a U.S. corporation (or a non-
U.S. corporation engaged in a U.S. trade or business) over such
corporation’s regular U.S. federal income tax, reduced by
certain tax credits. The “modified taxable income” of a
corporation is determined without deduction for certain
payments by such corporation to its non-U.S. affiliates
(including reinsurance premiums). The reinsurance agreements
between our U.S.-based property casualty insurance and
reinsurance subsidiaries and Arch Re Bermuda were canceled
on a cutoff basis as of January 1, 2018. As such, the level of
ARCH CAPITAL
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2018 FORM 10-K
subject business ceded to Arch Re Bermuda was substantially
lower in 2018 than in prior periods. Other provisions of the Tax
Cuts Act that could have a material and adverse impact on us
include a provision that defers or disallows a U.S. corporation’s
deduction of interest expense to the extent such interest expense
exceeds a specified percentage of such U.S. corporation’s
“adjusted taxable income” and a provision that adjusts the
manner in which a U.S. property and casualty insurance
company computes its loss reserve. There is no assurance that
subsequent change in tax laws will materially and adversely
affect our operations and financial condition.
Our non-U.K. companies may be subject to U.K. tax that may
have a material adverse effect on our results of operations.
We intend to operate in such a manner so that none of our
companies, other than our U.K. subsidiaries and branch
operations (the “U.K. Group”), should be resident in the U.K.
for tax purposes or carry on a trade, whether or not through a
permanent establishment, in the U.K. Accordingly, we do not
expect that any of our other subsidiaries, other than the U.K.
Group, should be subject to U.K. tax. Case law has held that
whether or not a trade is being carried on in the U.K. is a matter
of fact and emphasis is placed on where the operations take
place from which the profits in substance arise. HM Revenue
and Customs might contend successfully that one or more of
our subsidiaries, in addition to the U.K. Group, is carrying on
a trade in the U.K. For U.K. tax purposes, a non-U.K. tax
resident company will be subject to U.K. corporation tax only
if it carries on a trade through a permanent establishment in the
U.K. However, that subsidiary may still be subject to U.K.
income tax if it carries on a trade in the U.K., without a
permanent establishment, unless it is entitled to the protection
afforded by a double tax treaty between the U.K. and the
jurisdiction in which that company is resident. If any of our
subsidiaries is treated as resident, or carrying on a trade, in the
U.K., whether or not through a permanent establishment, and,
therefore, subject to U.K. tax, our results of operations could
be materially adversely affected.
We may become subject to taxes in Bermuda after March 31,
2035, which may have a material adverse effect on our results
of operations.
Under current Bermuda law, we are not subject to tax on income,
profits, withholding, capital gains or capital
transfers.
Furthermore, we have obtained from the Minister of Finance
of Bermuda under the Exempted Undertakings Tax Protection
Act 1966 of Bermuda, an assurance that, in the event that
Bermuda enacts legislation imposing tax computed on profits,
income, any capital asset, gain or appreciation, or any tax in the
nature of estate duty or inheritance tax, then the imposition of
the tax will not be applicable to us or our operations until
March 31, 2035. We could be subject to taxes in Bermuda after
that date. This assurance does not, however, prevent the
imposition of taxes on any person ordinarily resident in
Bermuda or any company in respect of its ownership of real
property or leasehold interests in Bermuda.
The impact of Bermuda's letter of commitment to the OECD to
eliminate harmful tax practices is uncertain and could
adversely affect our tax status in Bermuda.
The Organization for Economic Cooperation and Development
(“OECD”) has published reports and launched a global
initiative among member and non-member countries on
measures to limit harmful tax competition. These measures are
largely directed at counteracting the effects of tax havens and
preferential tax regimes in countries around the world. Bermuda
was not listed in the most recent report as an uncooperative tax
haven jurisdiction because it had previously committed to
eliminate harmful tax practices, to embrace international tax
standards for transparency, to exchange information and to
eliminate an environment that attracts business with no
substantial domestic activity. We are not able predict what
changes will arise from the commitment or whether such
changes will subject us to additional taxes.
The impact of commitments made by the government of
Bermuda in order to avoid being named on the EU’s list of non-
cooperative tax jurisdictions is uncertain and could have an
adverse effect on our results of operations.
Following a year-long screening process, on December 5, 2017
the Council of the European Union published its list of non-
cooperative jurisdictions for tax purposes (the “EU Blacklist”).
Bermuda was not named on the EU Blacklist due to
commitments made by its government to improve certain
“substance requirement” deficiencies that were identified by
the EU during the screening process. This commitment led to
the passing of the Economic Substance Act 2018 (the
“Substance Act”) in December 2018. The Substance Act
requires certain entities resident in Bermuda to demonstrate that
they have adequate economic substance in Bermuda. Broadly,
this is expected to be the case where an entity can demonstrate
it has adequate income generating activities, employees,
premises, and expenditure incurred in Bermuda, although the
meaning of "adequate" in this context remains unclear. Further,
the speed with which the Substance Act was implemented, and
the uncertainties in its interpretation, make it difficult to predict
its future impact. Any entity found to be lacking adequate
economic substance may be fined or ordered by a court to take
action to remedy such failure (or face being struck off the
companies register). The EU is expected to announce whether
the Substance Act is sufficient to keep Bermuda off the EU
Blacklist in February 2018. The nature and scope of the
sanctions that may be applied as a result of Bermuda being
included in the EU Blacklist is still being considered. Sanctions
that the EU has recommended Member States adopt include,
inter alia, increased auditing of taxpayers using structures or
arrangements involving listed jurisdictions and the imposition
ARCH CAPITAL
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2018 FORM 10-K
The EU’s review of harmful tax competition could adversely
affect our business, financial condition and results of
operations.
During 2017, the EU Economic and Financial Affairs Council
(“ECOFIN”) released a list of noncooperative jurisdictions for
tax purposes. The stated aim of this list, and accompanying
report, was to promote good governance worldwide in order to
maximize efforts to prevent tax fraud and tax evasion. Bermuda
was not on the list of non-cooperative jurisdictions, but did
feature in the report (along with approximately 40 other
jurisdictions) as having committed to address concerns relating
to economic substance by December 31, 2018. In accordance
with that commitment, Bermuda has enacted legislation that
requires certain entities in Bermuda engaged in “relevant
activities” to maintain a substantial economic presence in
Bermuda and to satisfy economic substance requirements. The
list of “relevant activities” includes carrying on as a business
any one or more of: banking, insurance, fund management,
financing, leasing, headquarters, shipping, distribution and
service center, intellectual property and holding entities. Any
entity that must satisfy economic substance requirements but
fails to do so could face automatic disclosure to competent
authorities in the EU of the information filed by the entity with
the Bermuda Registrar of Companies in connection with the
economic substance requirements and may also face financial
penalties, restriction or regulation of its business activities and/
or may be struck off as a registered entity in Bermuda.
At present, the impact of these new economic substance
requirements is unclear, and it is impossible to predict the nature
and effect of these requirements on us. The new economic
substance requirements may increase the complexity and costs
of carrying on our business and adversely affect our financial
condition and results of operations.
of withholding taxes on payments made to such jurisdictions.
As a result, there is a risk that both the adoption of the Substance
Act, possible further legislative changes, and the imposition of
sanctions in circumstances where Bermuda is ultimately
included on the EU Blacklist, could result in increased tax
liabilities and/or compliance costs for Arch.
We may become subject to increased taxation in Bermuda and
other countries as a result of the OECD's plan on “Base erosion
and profit shifting.”
The OECD, with the support of the G20, initiated the “base
erosion and profit shifting” (“BEPS”) project in 2013 in
response to concerns that international tax standards have not
kept pace with changes in global business practices and that
changes are needed to international tax laws to address
situations where multinationals may pay little or no tax in
certain jurisdictions by shifting profits away from jurisdictions
where the activities creating those profits may take place. In
October 2015, the OECD issued “final reports” in connection
with the BEPS project. The final reports were approved for
adoption by the G20 finance ministers in November 2015. The
final reports provide the basis for international standards for
corporate taxation that are designed to prevent, among other
things, the artificial shifting of income to tax havens and low-
tax jurisdictions, the erosion of the tax base through interest
deductions on intercompany debt and the artificial avoidance
of permanent establishments (i.e., tax nexus with a jurisdiction).
Legislation to adopt these standards has been enacted or is
currently under consideration in a number of jurisdictions to
implement these standards, including country by country
reporting. As a result, our income may be taxed in jurisdictions
where it is not currently taxed and at higher rates of tax than
currently taxed, which may substantially increase our effective
tax rate. Also, the adoption of these standards may increase the
complexity and costs associated with tax compliance and
adversely affect our financial position and results of operations.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
We lease office space in Bermuda where our principal offices
are located. Our insurance group leases space for offices in the
U.S., Canada, Bermuda, Europe and Australia. Our reinsurance
group leases space for offices in the U.S., Bermuda, Europe,
Canada and Dubai. Our mortgage group leases space for offices
in the U.S., Hong Kong and Australia. We believe that the above
described office space is adequate for our needs. However, as
we continue to develop our business, we may open additional
office locations in 2019.
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2018 FORM 10-K
ITEM 3. LEGAL PROCEEDINGS
We, in common with the insurance industry in general, are
subject to litigation and arbitration in the normal course of our
business. As of December 31, 2018, we were not a party to any
litigation or arbitration which is expected by management to
have a material adverse effect on our results of operations and
financial condition and liquidity.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
As of February 20, 2019, and based on information provided to us by our transfer agent and proxy solicitor, there were 860 holders
of record of our common shares (NASDAQ: ACGL) and approximately 43,000 beneficial holders of our common shares.
HOLDERS
The following table summarizes our purchases of common shares for the 2018 fourth quarter:
ISSUER PURCHASES OF EQUITY SECURITIES
Period
Total Number of
Shares Purchased (1)
Average Price Paid
per Share
Total Number of
Shares Purchased as
Part of Publicly
Announced Plans or
Programs
Approximate Dollar
Value of Shares that
May Yet be
Purchased Under the
Plan or Programs (2)
Issuer Purchases of Common Shares
10/1/2018-10/31/2018
11/1/2018-11/30/2018
12/1/2018-12/31/2018
Total
559,024
1,042,896
2,156,733
3,758,653
$
$
$
$
26.69
27.99
26.85
27.14
549,043
922,344
2,152,147
3,623,534
$
$
$
$
247,339
221,529
163,739
163,739
(1) Includes repurchases by Arch Capital of shares, from time to time, from employees in order to facilitate the payment of withholding taxes
on restricted shares granted and the exercise of stock appreciation rights. We purchased these shares at their fair market value, as determined
by reference to the closing price of our common shares on the day the restricted shares vested or the stock appreciation rights were exercised.
(2) Remaining amount available at December 31, 2018 under Arch Capital’s share repurchase authorization, under which repurchases may be
effected from time to time in open market or privately negotiated transactions through December 31, 2019.
ARCH CAPITAL
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2018 FORM 10-K
PERFORMANCE GRAPH
The following graph compares the cumulative total shareholder return on our common shares for each of the last five years through
December 31, 2018 to the cumulative total return, assuming reinvestment of dividends, of (1) S&P 500 Composite Stock Index
(“S&P 500 Index”) and (2) the S&P 500 Property & Casualty Insurance Index. The share price performance presented below is
not necessarily indicative of future results.
CUMULATIVE TOTAL SHAREHOLDER RETURN (1)(2)(3)
Company Name/Index
Arch Capital Group Ltd.
S&P 500 Index
S&P 500 Property & Casualty Insurance Index
Base Period
12/31/13
12/31/14
12/31/15
12/31/16
12/31/17
12/31/18
$100.00
$100.00
$100.00
$99.01
$113.69
$115.74
$116.85
$115.26
$126.77
$144.56
$129.05
$146.68
$152.07
$157.22
$179.52
$134.29
$150.33
$171.10
(1)
(2)
(3)
Stock price appreciation plus dividends.
The above graph assumes that the value of the investment was $100 on December 31, 2013.
This graph is not “soliciting material,” is not deemed filed with the SEC and is not to be incorporated by reference in any filing by us under the Securities
Act of 1933 or the Securities and Exchange Act of 1934, whether made before or after the date hereof and irrespective of any general incorporation language
in any such filing.
ARCH CAPITAL
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2018 FORM 10-K
ITEM 6. SELECTED FINANCIAL DATA
The following tables set forth summary historical consolidated financial and operating data (including the results of the ‘other’
segment) and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results
of Operations” and our financial statements and the related notes.
(U.S. dollars in thousands except share data)
2018
2017
Year Ended December 31,
2016
2015
2014
Statement of Income Data:
Net premiums written
Net premiums earned
Net investment income
Equity in net income (loss) of investments accounted for using
the equity method
Net realized gains (losses)
Total revenues
Income before income taxes
Net income
Net (income) loss attributable to noncontrolling interests
Net income available to Arch
Preferred dividends
Loss on redemption of preferred shares
Net income available to Arch common shareholders
Diluted net income per share
Cash dividends per share
After-tax operating income available to Arch common
shareholders (1)
After-tax operating income available to Arch common
shareholders per share — diluted (1)
After-tax return on average common equity (2)
After-tax operating return on average common equity (2)
Weighted average common shares and common share
equivalents outstanding — diluted (2)
$
5,346,747
$
4,961,373
$
4,031,391
$
3,817,531
$
3,891,938
5,231,975
563,633
45,641
(405,344)
5,450,568
841,772
727,821
30,150
757,971
(41,645)
(2,710)
713,616
1.73
—
909,190
2.20
8.4%
10.7%
$
$
$
$
$
4,844,532
470,872
142,286
149,141
3,884,822
366,742
48,475
137,586
5,627,375
4,463,556
757,277
629,709
(10,431)
619,278
(46,041)
(6,735)
566,502
1.36
—
447,155
1.07
7.2%
5.7%
$
$
$
$
$
855,552
824,178
(131,440)
692,738
(28,070)
—
664,668
1.78
—
577,444
1.54
10.9%
9.4%
$
$
$
$
$
3,733,905
348,090
25,455
(185,842)
3,936,590
567,194
526,582
11,156
537,738
(21,938)
—
515,800
1.36
—
565,199
1.49
8.9%
9.7%
$
$
$
$
$
3,593,748
302,585
19,883
102,917
3,988,873
844,247
821,260
13,095
834,355
(21,938)
—
812,417
2.01
—
617,312
1.53
14.7%
11.2%
$
$
$
$
$
412,906,478
417,785,025
374,152,479
378,116,229
404,766,966
(1) After-tax operating income available to Arch common shareholders is defined as net income available to Arch common shareholders, excluding net realized
gains or losses, net impairment losses included in earnings, equity in net income or loss of investments accounted for using the equity method, net foreign
exchange gains or losses, transaction costs and other and loss on redemption of preferred shares, net of income taxes. The presentation of after-tax operating
income available to Arch common shareholders is a “non-GAAP financial measure” as defined in Regulation G. See “Management’s Discussion and Analysis
of Financial Condition and Results of Operations—General—Comment on Non-GAAP Financial Measures” for further details.
Equals after-tax operating income available to Arch common shareholders divided by the average of beginning and ending common shareholders’ equity
for each period presented. For the 2016 period, the return on average common shareholders’ equity reflects the weighted impact of the $1.10 billion of
convertible non-voting common equivalent preferred shares, which were issued on December 31, 2016 as part of the UGC acquisition.
(2)
ARCH CAPITAL
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2018 FORM 10-K
(U.S. dollars in thousands except share data)
2018
2017
December 31,
2016
2015
2014
Balance Sheet Data:
Total investable assets (1)
Premiums receivable
Reinsurance recoverables on unpaid and paid losses and loss
adjustment expenses
Total assets
Reserves for losses and loss adjustment expenses:
Before unpaid losses and loss adjustment expenses
recoverable
Net of unpaid losses and loss adjustment expenses
recoverable
Unearned premiums:
Before ceded unearned premiums
Net of ceded unearned premiums
Senior notes
Revolving credit agreement borrowings
Total liabilities
Total shareholders’ equity
Total shareholders' equity available to Arch
Preferred shareholders' equity
Common shareholders' equity available to Arch
Common shares and common share equivalents outstanding,
net of treasury shares (2)
Book value per share (2) (3)
$
$
$
22,324,524
$
22,156,488
$
20,493,952
$
16,340,938
$
15,762,730
1,299,150
1,135,249
1,072,435
983,443
948,695
2,919,372
32,218,329
2,540,143
32,051,658
2,114,138
29,372,109
1,867,373
23,138,931
1,812,845
21,967,742
11,853,297
11,383,792
10,200,960
9,125,250
9,036,448
9,039,006
8,918,882
8,117,385
7,296,413
7,258,145
3,753,636
2,778,167
1,733,528
455,682
21,780,650
10,231,387
9,439,827
780,000
3,622,314
2,695,703
1,732,884
816,132
21,805,723
10,040,013
9,196,602
872,555
3,406,870
2,547,303
1,732,258
756,650
20,060,984
9,105,572
8,253,718
772,555
2,333,932
1,906,323
791,306
530,434
16,028,376
6,905,373
6,166,542
325,000
2,231,578
1,854,500
791,141
100,000
14,887,435
6,860,795
6,091,714
325,000
8,659,827
$
8,324,047
$
7,481,163
$
5,841,542
$
5,766,714
402,454,834
409,956,417
406,651,011
367,883,349
382,103,802
21.52
$
20.30
$
18.40
$
15.88
$
15.09
(1)
(2)
(3)
This table excludes the collateral received and reinvested and includes the securities pledged under securities lending agreements, at fair value.
Reflects the impact of outstanding convertible non-voting common equivalent preferred shares which were issued on December 31, 2016 as part of the
UGC acquisition.
Excludes the effects of stock options and restricted stock units.
ARCH CAPITAL
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2018 FORM 10-K
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
involve
The following discussion and analysis contains forward-
inherent risks and
looking statements which
uncertainties. All statements other than statements of historical
fact are forward-looking statements. These statements are based
on our current assessment of risks and uncertainties. Actual
results may differ materially from those expressed or implied
in these statements and, therefore, undue reliance should not be
placed on them. Important factors that could cause actual events
or results to differ materially from those indicated in such
statements are discussed in this report, including the sections
entitled “Cautionary Note Regarding Forward-Looking
Statements,” and “Risk Factors.”
This discussion and analysis should be read in conjunction with
our audited consolidated financial statements and notes thereto
presented under Item 8. Tabular amounts are in U.S. Dollars in
thousands, except share amounts, unless otherwise noted.
GENERAL
Overview
Arch Capital Group Ltd. (“Arch Capital” and, together with its
subsidiaries, “we” or “us”) is a Bermuda public limited liability
company with approximately $11.17 billion in capital at
December 31, 2018 and, through operations in Bermuda, the
United States, Europe and Canada, writes specialty lines of
property and casualty insurance and reinsurance, as well as
mortgage insurance and reinsurance, on a worldwide basis. It
is our belief that our underwriting platform, our experienced
management team and our strong capital base have enabled us
to establish a strong presence in the insurance and reinsurance
markets.
The worldwide property casualty insurance and reinsurance
industry is highly competitive and has traditionally been subject
to an underwriting cycle in which a hard market (high premium
rates, restrictive underwriting standards, as well as terms and
conditions, and underwriting gains) is eventually followed by
a soft market (low premium rates, relaxed underwriting
standards, as well as broader terms and conditions, and
underwriting losses). Property casualty market conditions may
affect, among other things, the demand for our products, our
ability to increase premium rates, the terms and conditions of
the insurance policies we write, changes in the products offered
by us or changes in our business strategy.
The financial results of the property casualty insurance and
reinsurance industry are influenced by factors such as the
frequency and/or severity of claims and losses, including
natural disasters or other catastrophic events, variations in
interest rates and financial markets, changes in the legal,
regulatory and judicial environments, inflationary pressures
and general economic conditions. These factors influence,
among other things, the demand for insurance or reinsurance,
the supply of which is generally related to the total capital of
competitors in the market.
Mortgage insurance and reinsurance is subject to similar cycles
to property casualty except that they have historically been more
dependent on macroeconomic conditions.
Current Outlook
Our objective is to achieve an average operating return on
average equity of 15% or greater over the insurance cycle,
which we believe to be an attractive return to our common
shareholders given the risks we assume. We continue to look
for opportunities to find acceptable books of business to
underwrite without sacrificing underwriting discipline and
continue to write a portion of our overall book in catastrophe-
exposed business which has the potential to increase the
volatility of our operating results.
The broad property casualty insurance market environment
continues to be competitive, with only a few specialty areas
providing opportunities to deploy capital at returns which meet
our risk-adjusted return requirements. In most of our insurance
lines of business, rate increases appear to be in excess of loss
cost trends. However, the spread between rate changes and loss
trend is a key variable in assessing expected returns and, in
specialty lines, is volatile by nature. Our underwriting teams
continue to execute a disciplined strategy by emphasizing small
and medium-sized accounts over large accounts, shrinking
premiums in more commoditized lines such as general liability
and directors and officers, and by utilizing reinsurance
purchases to reduce volatility on large account, high capacity
business. Writings in property catastrophe-exposed business
continued to remain low in 2018.
Our mortgage segment continues to experience generally
favorable market conditions, with pricing in the U.S. stabilizing
in the third quarter following the rate changes announced in the
first half of 2018. Our results continue to reflect our success in
making high quality credit underwriting risk decisions and
building customer relationships.
Arch remains committed to providing solutions across many
offerings as the marketplace evolves, including new mortgage
credit risk transfer programs initiated by government sponsored
enterprises, or “GSEs,” in 2018. Such programs have begun
generating business with banks developing new systems to
handle the programs and momentum beginning to build. In
ARCH CAPITAL
56
2018 FORM 10-K
addition, we completed multiple Bellemeade risk transfers to
the capital markets throughout 2018, increasing our protection
for mortgage tail risk.
FINANCIAL MEASURES
Management uses the following three key financial indicators
in evaluating our performance and measuring the overall
growth in value generated for Arch Capital’s common
shareholders:
Book Value per Share
and
common
Book value per share represents total common shareholders’
equity available to Arch divided by the number of common
shares
equivalents outstanding.
share
Management uses growth in book value per share as a key
measure of the value generated for our common shareholders
each period and believes that book value per share is the key
driver of Arch Capital’s share price over time. Book value per
share is impacted by, among other factors, our underwriting
results, investment returns and share repurchase activity, which
has an accretive or dilutive impact on book value per share
depending on the purchase price. Book value per share was
$21.52 at December 31, 2018, a 6.0% increase from $20.30 at
December 31, 2017. The growth in 2018 reflected strong
underwriting results, partially offset by the impact of an increase
in interest rates on our fixed income securities.
Operating Return on Average Common Equity
Operating return on average common equity (“Operating
ROAE”) represents annualized after-tax operating income
available to Arch common shareholders divided by average
common shareholders’ equity available to Arch during the
period. After-tax operating income available to Arch common
shareholders, a “non-GAAP measure” as defined in the SEC
rules, represents net income available to Arch common
shareholders, excluding net realized gains or losses, net
impairment losses recognized in earnings, equity in net income
or loss of investments accounted for using the equity method,
net foreign exchange gains or losses and transaction costs and
other, net of income taxes. Management uses Operating ROAE
as a key measure of the return generated to Arch common
shareholders. See “Comment on Non-GAAP Financial
Measures.” Our Operating ROAE was 10.7% for 2018,
compared to 5.7% for 2017 and 9.4% for 2016. The higher
Operating ROAE for 2018 reflected strong mortgage insurance
underwriting performance, while 2017 returns reflected a
higher level of catastrophic loss activity.
Total Return on Investments
Total return on investments includes investment income, equity
in net income or loss of investments accounted for using the
equity method, net realized gains and losses and the change in
unrealized gains and losses generated by Arch’s investment
portfolio. Total return is calculated on a pre-tax basis and before
investment expenses excluding amounts reflected in the ‘other’
segment, and reflects the effect of financial market conditions
along with foreign currency fluctuations. Management uses
total return on investments as a key measure of the return
generated to Arch common shareholders on the capital held in
the business, and compares the return generated by our
investment portfolio against benchmark returns which we
measured our portfolio against during the periods.
The following table summarizes the pre-tax total return (before
investment expenses) of investment held by Arch compared to
the benchmark return (both based in U.S. Dollars) against which
we measured our portfolio during the periods:
Pre-tax total return (before investment
expenses):
Year Ended December 31, 2018
Year Ended December 31, 2017
Year Ended December 31, 2016
Arch
Portfolio (1)
Benchmark
Return
0.33%
5.87%
2.07%
-0.60%
4.74%
2.13%
(1) Our investment expenses were approximately 0.36%, 0.30%
and 0.34%, respectively, of average invested assets in 2018,
2017 and 2016.
Total return for our investment portfolio outperformed that of
the benchmark return index in 2018, reflecting strong
performance from our alternative investments. Excluding
foreign exchange, total return was 1.13% for 2018, compared
to 4.98% for 2017 and 2.35% for 2016. Total return for 2018
reflected the impact of rising interest rates and widening credit
spreads, which dampened the total return on our investment
grade fixed income portfolio, and negative returns on equities.
The benchmark return index is a customized combination of
indices intended to approximate a target portfolio by asset mix
and average credit quality while also matching the approximate
estimated duration and currency mix of our insurance and
reinsurance liabilities. Although the estimated duration and
average credit quality of this index will move as the duration
and rating of its constituent securities change, generally we do
not adjust the composition of the benchmark return index except
to incorporate changes to the mix of liability currencies and
durations noted above. The benchmark return index should not
be interpreted as expressing a preference for or aversion to any
particular sector or sector weight. The index is intended solely
to provide, unlike many master indices that change based on
the size of their constituent indices, a relatively stable basket
of investable indices. At December 31, 2018, the benchmark
return index had an average credit quality of “Aa2” by Moody’s,
an estimated duration of 3.23 years.
ARCH CAPITAL
57
2018 FORM 10-K
The benchmark return index included weightings to the
following indices:
ICE BoAML 1-10 Year U.S. Corporate & All Yankees, A -
AAA Rated Index
ICE BoAML 1-5 Year U.S. Treasury Index
ICE BoAML 1-10 Year U.S. Municipal Securities Index
ICE BoAML 3-5 Year Fixed Rate Asset Backed Securities
Index
Bloomberg Barclays CMBS Invest Grade Aaa Total Return
Index
MSCI ACWI Net Total Return USD Index
ICE BoAML German Government 1-10 Year Index
ICE BoAML U.S. Mortgage Backed Securities Index
Hedge Fund Research HFRX Fixed Income Credit Index
Hedge Fund Research HFRX Equal Weighted Strategies
ICE BoAML 5-10 Year U.S. Treasury Index
ICE BoAML 1-5 Year U.K. Gilt Index
ICE BoAML U.S. High Yield Constrained Index
ICE BoAML 1-5 Year Australian Governments Index
S&P Leveraged Loan Total Return Index
ICE BoAML 0-3 Month U.S. Treasury Bill Index
ICE BoAML 1-5 Year Canada Government Index
ICE BoAML 20+ Year Canada Government Index
%
20.00%
15.00
14.50
7.00
5.00
5.00
5.00
4.00
3.50
3.50
3.00
3.00
2.50
2.50
2.50
2.00
1.50
0.50
Total
100.00%
COMMENT ON NON-GAAP FINANCIAL MEASURES
Throughout this filing, we present our operations in the way we
believe will be the most meaningful and useful to investors,
analysts, rating agencies and others who use our financial
information in evaluating the performance of our company. This
presentation includes the use of after-tax operating income
available to Arch common shareholders, which is defined as
net income available to Arch common shareholders, excluding
net realized gains or losses, net impairment losses recognized
in earnings, equity in net income or loss of investments
accounted for using the equity method, net foreign exchange
gains or losses, transaction costs and other, loss on redemption
of preferred shares and income taxes, and the use of annualized
operating return on average common equity. The presentation
of after-tax operating income available to Arch common
shareholders and annualized operating return on average
common equity are non-GAAP financial measures as defined
in Regulation G. The reconciliation of such measures to net
income available to Arch common shareholders and annualized
return on average common equity (the most directly comparable
GAAP financial measures) in accordance with Regulation G is
included under “Results of Operations” below.
We believe that net realized gains or losses, net impairment
losses recognized in earnings, equity in net income or loss of
investments accounted for using the equity method, net foreign
impairment
losses recognized
represent other-than-temporary declines
exchange gains or losses, transaction costs and other and loss
on redemption of preferred shares in any particular period are
not indicative of the performance of, or trends in, our business.
Although net realized gains or losses, net impairment losses
recognized in earnings, equity in net income or loss of
investments accounted for using the equity method and net
foreign exchange gains or losses are an integral part of our
operations, the decision to realize investment gains or losses,
the recognition of the change in the carrying value of
investments accounted for using the fair value option in net
realized gains or losses, the recognition of net impairment
losses, the recognition of equity in net income or loss of
investments accounted for using the equity method and the
recognition of foreign exchange gains or losses are independent
of the insurance underwriting process and result, in large part,
from general economic and financial market conditions.
Furthermore, certain users of our financial information believe
that, for many companies, the timing of the realization of
investment gains or losses is largely opportunistic. In addition,
in earnings on our
net
investments
in
expected recovery values on securities without actual
realization. The use of the equity method on certain of our
investments in certain funds that invest in fixed maturity
securities is driven by the ownership structure of such funds
(either limited partnerships or limited liability companies). In
applying the equity method, these investments are initially
recorded at cost and are subsequently adjusted based on our
proportionate share of the net income or loss of the funds (which
include changes in the market value of the underlying securities
in the funds). This method of accounting is different from the
way we account for our other fixed maturity securities and the
timing of the recognition of equity in net income or loss of
investments accounted for using the equity method may differ
from gains or losses in the future upon sale or maturity of such
investments. Transaction costs and other include advisory,
financing, legal, severance, incentive compensation and other
transaction costs related to acquisitions, including UGC.
During the 2016 fourth quarter, transaction costs and other
included non-recurring expenses related to a change in the our
approach on the deferral of certain internal underwriting costs
which are no longer being deferred. We believe that transaction
costs and other, due to their non-recurring nature, are not
indicative of the performance of, or trends in, our business
performance. The loss on redemption of preferred shares related
to the redemption of our Series C preferred shares in September
2017 and January 2018 and had no impact on shareholders'
equity or cash flows. Due to these reasons, we exclude net
realized gains or losses, net impairment losses recognized in
earnings, equity in net income or loss of investments accounted
for using the equity method, net foreign exchange gains or
losses, transaction costs and other and loss on redemption of
preferred shares from the calculation of after-tax operating
income available to Arch common shareholders. In addition,
income tax expense for 2017 included a $21.5 million charge
ARCH CAPITAL
58
2018 FORM 10-K
due to the revaluation of the Company’s net deferred tax asset
resulting from the reduction in the U.S. corporate income tax
rate from 35% to 21% effective January 1, 2018. Due to the
non-recurring nature of this item, we excluded it from after-tax
operating income available to Arch common shareholders.
We believe that showing net income available to Arch common
shareholders exclusive of the items referred to above reflects
the underlying fundamentals of our business since we evaluate
the performance of and manage our business to produce an
underwriting profit. In addition to presenting net income
available to Arch common shareholders, we believe that this
presentation enables investors and other users of our financial
information to analyze our performance in a manner similar to
how management analyzes performance. We also believe that
this measure follows industry practice and, therefore, allows
the users of financial information to compare our performance
with our industry peer group. We believe that the equity analysts
and certain rating agencies which follow us and the insurance
industry as a whole generally exclude these items from their
analyses for the same reasons.
to our
includes
information
the presentation of
Our segment
consolidated underwriting income or loss and a subtotal of
underwriting income or loss before the contribution from the
‘other’ segment. Such measures represent
the pre-tax
profitability of our underwriting operations and include net
premiums earned plus other underwriting income, less losses
and loss adjustment expenses, acquisition expenses and other
operating expenses. Other operating expenses include those
operating expenses that are incremental and/or directly
individual underwriting operations.
attributable
Underwriting income or loss does not incorporate items
included in our corporate (non-underwriting) segment. While
these measures are presented in note 4, “Segment Information,”
to our consolidated financial statements in Item 8, they are
considered non-GAAP financial measures when presented
elsewhere on a consolidated basis. The reconciliations of
underwriting income or loss to income before income taxes (the
most directly comparable GAAP financial measure) on a
consolidated basis and a subtotal before the contribution from
the ‘other’ segment, in accordance with Regulation G, is shown
in note 4, “Segment Information,” to our consolidated financial
statements in Item 8.
We measure segment performance for our three underwriting
segments based on underwriting income or loss. We do not
manage our assets by underwriting segment, with the exception
of goodwill and intangible assets, and, accordingly, investment
income and other non-underwriting related items are not
allocated to each underwriting segment. For the ‘other’
segment, performance is measured based on net income or loss.
Along with consolidated underwriting income, we provide a
subtotal of underwriting income or loss before the contribution
from the ‘other’ segment. Pursuant to generally accepted
accounting principles, Watford Re is considered a variable
interest entity and we concluded that we are the primary
beneficiary of Watford Re. As such, we consolidate the results
of Watford Re in our consolidated financial statements,
although we only own approximately 11% of Watford Re’s
common equity. Watford Re has its own management and board
of directors that is responsible for its overall profitability. In
addition, we do not guarantee or provide credit support for
Watford Re. Since Watford Re is an independent company, the
assets of Watford Re can be used only to settle obligations of
Watford Re and Watford Re is solely responsible for its own
liabilities and commitments. Our financial exposure to Watford
Re is limited to our investment in Watford Re’s common and
preferred shares and counterparty credit risk (mitigated by
collateral) arising from the reinsurance transactions. We believe
that presenting certain information excluding the ‘other’
segment enables investors and other users of our financial
information to analyze our performance in a manner similar to
how our management analyzes performance.
Our presentation of segment information includes the use of a
current year loss ratio which excludes favorable or adverse
development in prior year loss reserves. This ratio is a non-
GAAP financial measure as defined in Regulation G. The
reconciliation of such measure to the loss ratio (the most directly
comparable GAAP financial measure) in accordance with
Regulation G is shown on the individual segment pages.
Management utilizes the current year loss ratio in its analysis
of the underwriting performance of each of our underwriting
segments.
Total return on investments includes investment income, equity
in net income or loss of investments accounted for using the
equity method, net realized gains and losses and the change in
unrealized gains and losses generated by Arch’s investment
portfolio. Total return is calculated on a pre-tax basis and before
investment expenses, excludes amounts reflected in the ‘other’
segment, and reflects the effect of financial market conditions
along with foreign currency fluctuations. In addition, total
return incorporates the timing of investment returns during the
periods. There is no directly comparable GAAP financial
measure for total return. Management uses total return on
investments as a key measure of the return generated to Arch
common shareholders on the capital held in the business, and
compares the return generated by our investment portfolio
against benchmark returns which we measured our portfolio
against during the periods.
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2018 FORM 10-K
their respective segments and who are directly accountable to
our chief operating decision makers, the President and Chief
Executive Officer of Arch Capital and the Chief Financial
Officer of Arch Capital. 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 our three
underwriting segments based on underwriting income or loss.
We do not manage our assets by underwriting segment, with
the exception of goodwill and intangible assets, and,
accordingly, investment income is not allocated to each
underwriting segment.
in accounting guidance
We determined our reportable segments using the management
regarding
approach described
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 our consolidated
financial statements. Intersegment business is allocated to the
segment accountable for the underwriting results.
Insurance Segment
The following tables set forth our insurance segment’s
underwriting results:
Gross premiums written
Premiums ceded
Net premiums written
Change in unearned premiums
Net premiums earned
Losses and loss adjustment
expenses
Acquisition expenses
Other operating expenses
Underwriting income (loss)
Underwriting Ratios
Loss ratio
Acquisition expense ratio
Other operating expense ratio
Combined ratio
Year Ended December 31,
2017
$ 3,081,086
(958,646)
2,122,440
(9,422)
2,113,018
2018
$ 3,262,332
(1,050,207)
2,212,125
(6,464)
2,205,661
% Change
5.9
4.2
4.4
(1,520,680)
(1,622,444)
(349,702)
(364,138)
(28,859)
$
(323,639)
(359,524)
$ (192,589)
68.9%
15.9%
16.5%
101.3%
76.8%
15.3%
17.0%
109.1%
n/m
% Point
Change
(7.9)
0.6
(0.5)
(7.8)
RESULTS OF OPERATIONS
The following table summarizes our consolidated financial
data, including a reconciliation of net income available to Arch
common shareholders to after-tax operating income available
to Arch common shareholders. Each line item reflects the
impact of our approximate 11% ownership of Watford Re’s
common equity.
Year Ended December 31,
2017
2016
2018
Net income available to Arch
common shareholders
Net realized (gains) losses
Net impairment losses
recognized in earnings
Equity in net (income) loss of
investments accounted for using
the equity method
Net foreign exchange (gains)
losses
Transaction costs and other
Loss on redemption of preferred
shares
Income tax expense (benefit) (1)
After-tax operating income
available to Arch common
shareholders
Beginning common
shareholders’ equity
Ending common
shareholders’ equity
Average common shareholders’
equity (2)
Annualized return on average
common equity % (2)
Annualized operating return on
average common equity % (2)
$ 713,616
$ 566,502
$ 664,668
297,755
(148,836)
(77,081)
2,829
7,138
30,442
(45,641)
(142,286)
(48,475)
(59,890)
12,377
2,710
(14,566)
113,613
22,150
6,735
22,139
(31,987)
41,729
—
(1,852)
$ 909,190
$ 447,155
$ 577,444
$ 8,324,047
$ 7,481,163
$ 5,841,542
8,659,827
8,324,047
7,481,163
$ 8,491,937
$ 7,902,605
$ 6,113,718
8.4
10.7
7.2
5.7
10.9
9.4
(1) Income tax on net realized gains or losses, net impairment losses
recognized in earnings, equity in net income or loss of investments
accounted for using the equity method, net foreign exchange gains or
losses, transaction costs and other and loss on redemption of preferred
shares reflects the relative mix reported by jurisdiction and the varying
tax rates in each jurisdiction.
(2) 2016 period reflects the weighted impact of the $1.10 billion of
convertible non-voting common equivalent preferred shares issued on
December 31, 2016 as part of the UGC acquisition.
Results in all periods presented reflected the impact of current
insurance and reinsurance market conditions and the impact of
low interest yields on our investment portfolio.
Segment Information
We classify our businesses into three underwriting segments —
insurance, reinsurance and mortgage — and two other operating
segments — corporate (non-underwriting) and ‘other.’ Our
insurance, reinsurance and mortgage segments each have
managers who are responsible for the overall profitability of
ARCH CAPITAL
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2018 FORM 10-K
Gross premiums written
Premiums ceded
Net premiums written
Change in unearned premiums
Net premiums earned
Losses and loss adjustment
expenses
Acquisition expenses
Other operating expenses
Underwriting income
Underwriting Ratios
Loss ratio
Acquisition expense ratio
Other operating expense ratio
Combined ratio
Year Ended December 31,
2016
$ 3,027,049
(954,768)
2,072,281
1,623
2,073,904
2017
$ 3,081,086
(958,646)
2,122,440
(9,422)
2,113,018
% Change
1.8
2.4
1.9
(1,622,444)
(1,359,313)
(323,639)
(359,524)
$ (192,589)
(304,050)
(350,260)
60,281
$
76.8%
15.3%
17.0%
109.1%
65.5%
14.7%
16.9%
97.1%
(419.5)
% Point
Change
11.3
0.6
0.1
12.0
The insurance segment consists of our insurance underwriting
units which offer specialty product lines on a worldwide basis.
Product lines include:
• Construction and national accounts: primary and excess
casualty coverages to middle and large accounts in the
construction industry and a wide range of products for middle
and large national accounts, specializing in loss sensitive
large
insurance programs
primary casualty
deductible, self-insured retention and retrospectively rated
programs).
(including
• Excess and surplus casualty: primary and excess casualty
insurance coverages, including middle market energy business,
and contract binding, which primarily provides casualty
coverage through a network of appointed agents to small and
medium risks.
•
Lenders products: collateral protection, debt cancellation
and service contract reimbursement products to banks, credit
unions, automotive dealerships and original equipment
manufacturers and other specialty programs that pertain to
automotive lending and leasing.
liability, employment practices
• Professional lines: directors’ and officers’ liability, errors
and omissions
liability,
fiduciary liability, crime, professional indemnity and other
financial related coverages for corporate, private equity, venture
capital, real estate investment trust, limited partnership,
financial institution and not-for-profit clients of all sizes and
medical professional and general liability insurance coverages
for the healthcare industry. The business is predominately
written on a claims-made basis.
• Programs: primarily package policies, underwriting
workers’ compensation and umbrella liability business in
support of desirable package programs, targeting program
managers with unique expertise and niche products offering
general liability, commercial automobile, inland marine and
property business with minimal catastrophe exposure.
• Property, energy, marine and aviation: primary and excess
general property insurance coverages, including catastrophe-
exposed property coverage, for commercial clients. Coverages
for marine include hull, war, specie and liability. Aviation and
stand-alone terrorism are also offered.
•
Travel, accident and health: specialty travel and accident
and related insurance products for individual, group travelers,
travel agents and suppliers, as well as accident and health, which
provides accident, disability and medical plan insurance
coverages for employer groups, medical plan members,
students and other participant groups.
• Other: includes alternative market risks (including captive
insurance programs), excess workers’ compensation and
employer’s liability insurance coverages for qualified self-
insured groups, associations and trusts, and contract and
commercial surety coverages, including contract bonds
(payment and performance bonds) primarily for medium and
large contractors and commercial surety bonds for Fortune 1000
companies and smaller transaction business programs.
Premiums Written.
The following tables set forth our insurance segment’s net
premiums written by major line of business:
Year Ended December 31,
2018
2017
Amount
$ 450,406
393,263
%
20.4
17.8
Amount
$ 452,748
386,618
%
21.3
18.2
320,937
14.5
327,648
15.4
290,401
13.1
247,738
11.7
219,174
168,467
96,094
273,383
$2,212,125
9.9
7.6
4.3
12.4
100.0
172,240
179,511
96,867
259,070
$2,122,440
8.1
8.5
4.6
12.2
100.0
Professional lines
Programs
Construction and
national accounts
Travel, accident and
health
Property, energy,
marine and aviation
Excess and surplus
casualty
Lenders products
Other
Total
2018 versus 2017: Net premiums written by the insurance
segment were 4.2% higher in 2018 than in 2017. The increase
in net premiums written reflected growth in travel, due to both
new business and growth in existing accounts, and in property,
primarily due to new business and rate increases. These
increases were partially offset by a reduction in contract binding
and accident and health in response to market conditions.
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2018 FORM 10-K
Professional lines
Programs
Construction and
national accounts
Travel, accident and
health
Property, energy,
marine and aviation
Excess and surplus
casualty
Lenders products
Other
Total
Year Ended December 31,
2017
2016
Amount
$ 452,748
386,618
%
21.3
18.2
Amount
$ 440,149
330,322
%
21.2
15.9
327,648
15.4
328,997
15.9
247,738
11.7
224,380
10.8
172,240
179,511
96,867
259,070
$2,122,440
8.1
8.5
4.6
12.2
100.0
175,376
8.5
214,863
105,650
252,544
10.4
5.1
12.2
$2,072,281
100.0
Year Ended December 31,
2017
2016
Amount
$ 444,137
364,639
%
21.0
17.3
Amount
$ 431,391
357,715
%
20.8
17.2
324,517
15.4
322,072
15.5
257,358
12.2
219,169
10.6
173,779
195,154
97,043
256,391
$2,113,018
8.2
9.2
4.6
12.1
100.0
188,938
9.1
219,046
98,517
237,056
10.6
4.8
11.4
$2,073,904
100.0
Professional lines
Programs
Construction and
national accounts
Travel, accident and
health
Property, energy,
marine and aviation
Excess and surplus
casualty
Lenders products
Other
Total
2017 versus 2016: Net premiums written by the insurance
segment were 2.4% higher in 2017 than in 2016. The increase
in net premiums written reflected growth in programs, due to
the continued effects of two newer programs, in travel, accident
and health, reflecting both new travel business and continued
expansion in existing travel accounts, and in professional lines,
reflecting increases in small and medium sized accounts. Such
amounts were partially offset by a reduction in excess and
surplus casualty in response to market conditions.
Net Premiums Earned.
The following tables set forth our insurance segment’s net
premiums earned by major line of business:
Year Ended December 31,
2018
2017
Amount
$ 458,425
389,186
%
20.8
17.6
Amount
$ 444,137
364,639
%
21.0
17.3
322,440
14.6
324,517
15.4
297,147
13.5
257,358
12.2
205,069
172,424
94,248
266,722
$2,205,661
9.3
7.8
4.3
12.1
100.0
173,779
195,154
97,043
256,391
$2,113,018
8.2
9.2
4.6
12.1
100.0
Professional lines
Programs
Construction and
national accounts
Travel, accident and
health
Property, energy,
marine and aviation
Excess and surplus
casualty
Lenders products
Other
Total
Net premiums earned by the insurance segment were 4.4%
higher in 2018 than in 2017, reflecting changes in net premiums
written over the previous five quarters. Net premiums earned
by the insurance segment were 1.9% higher in 2017 than in
2016.
Losses and Loss Adjustment Expenses.
The table below shows the components of the insurance
segment’s loss ratio:
Year Ended December 31,
2017
77.2 %
2018
70.0 %
(1.1)%
68.9 %
(0.4)%
76.8 %
2016
67.1 %
(1.6)%
65.5 %
Current year
Prior period reserve
development
Loss ratio
Current Year Loss Ratio.
2018 versus 2017: The insurance segment’s current year loss
ratio was 7.2 points lower in 2018 than in 2017. The 2018 loss
ratio included 3.4 points of current year catastrophic event
activity, primarily related to Hurricanes Florence and Michael
and the California wildfires, compared to 10.3 points in 2017,
primarily related to Hurricanes Harvey, Irma and Maria and
California wildfires. The balance of the change in the 2018 loss
ratio resulted, in part, from changes in mix of business and the
level of large attritional losses.
2017 versus 2016: The insurance segment’s current year loss
ratio was 10.1 points higher in 2017 than in 2016. The 2017
loss ratio included 10.3 points of current year catastrophic event
activity, primarily related to Hurricanes Harvey, Irma and Maria
and the California wildfires, compared to 2.2 points in 2016.
The 2017 loss ratio also reflected changes in the level of
attritional large losses and changes in the mix of business.
Prior Period Reserve Development.
The insurance segment’s net favorable development was $24.4
million, or 1.1 points, for 2018, compared to $8.6 million, or
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2018 FORM 10-K
0.4 points, for 2017, and $33.1 million, or 1.6 points, for 2016.
See note 5, “Reserve for Losses and Loss Adjustment
Expenses,” to our consolidated financial statements in Item 8
for information about the insurance segment’s prior year reserve
development.
Underwriting Expenses.
2018 versus 2017: The insurance segment’s underwriting
expense ratio was 32.4% in 2018, compared to 32.3% in 2017.
The comparison of the underwriting expense ratios reflects
changes in the mix of business due to growth in lines of business
with higher acquisition costs.
2017 versus 2016: The insurance segment’s underwriting
expense ratio was 32.3% in 2017, compared to 31.6% in 2016
reflecting changes in the level of reinsurance ceded on a quota
share basis and changes in the mix of business.
Reinsurance Segment
The following tables set forth our reinsurance segment’s
underwriting results:
Gross premiums written
Premiums ceded
Net premiums written
Change in unearned premiums
Net premiums earned
Other underwriting income
Losses and loss adjustment
expenses
Acquisition expenses
Other operating expenses
Underwriting income
Underwriting Ratios
Loss ratio
Acquisition expense ratio
Other operating expense ratio
Combined ratio
Year Ended December 31,
2017
$ 1,640,399
(465,925)
1,174,474
(31,853)
1,142,621
11,336
2018
$ 1,912,522
(539,950)
1,372,572
(111,356)
1,261,216
(682)
% Change
16.6
16.9
10.4
(846,882)
(211,280)
(133,350)
69,022
$
(773,923)
(221,250)
(146,663)
12,121
$
67.1%
16.8%
10.6%
94.5%
67.7%
19.4%
12.8%
99.9%
469.4
% Point
Change
(0.6)
(2.6)
(2.2)
(5.4)
Gross premiums written
Premiums ceded
Net premiums written
Change in unearned premiums
Net premiums earned
Other underwriting income
Losses and loss adjustment
expenses
Acquisition expenses
Other operating expenses
Underwriting income
Underwriting Ratios
Loss ratio
Acquisition expense ratio
Other operating expense ratio
Combined ratio
Year Ended December 31,
2016
$ 1,494,397
(440,541)
1,053,856
2,376
1,056,232
36,403
2017
$ 1,640,399
(465,925)
1,174,474
(31,853)
1,142,621
11,336
% Change
9.8
11.4
8.2
(773,923)
(221,250)
(146,663)
12,121
$
(475,762)
(212,258)
(142,616)
$ 261,999
67.7%
19.4%
12.8%
99.9%
45.0%
20.1%
13.5%
78.6%
(95.4)
% Point
Change
22.7
(0.7)
(0.7)
21.3
The reinsurance segment consists of our reinsurance
underwriting units which offer specialty product lines on a
worldwide basis. Product lines include:
• Casualty: provides coverage to ceding company clients on
third party liability and workers’ compensation exposures from
ceding company clients, primarily on a treaty basis. Exposures
include, among others, executive assurance, professional
liability, workers’ compensation, excess and umbrella liability,
excess motor and healthcare business.
• Marine and aviation: provides coverage for energy, hull,
cargo, specie, liability and transit, and aviation business,
including airline and general aviation risks. Business written
may also include space business, which includes coverages for
satellite assembly, launch and operation for commercial space
programs.
• Other specialty: provides coverage to ceding company
clients for proportional motor and other lines, including surety,
accident and health, workers’ compensation catastrophe,
agriculture, trade credit and political risk.
• Property catastrophe: provides protection for most
catastrophic losses that are covered in the underlying policies
written by reinsureds, including hurricane, earthquake, flood,
tornado, hail and fire, and coverage for other perils on a case-
by-case basis. Property catastrophe reinsurance provides
coverage on an excess of loss basis when aggregate losses and
loss adjustment expense from a single occurrence or
aggregation of losses from a covered peril exceed the retention
specified in the contract.
• Property excluding property catastrophe: provides
coverage for both personal lines and commercial property
exposures and principally covers buildings, structures,
equipment and contents. The primary perils in this business
include fire, explosion, collapse, riot, vandalism, wind, tornado,
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2018 FORM 10-K
flood and earthquake. Business is assumed on both a
proportional and excess of loss basis. In addition, facultative
business is written which focuses on individual commercial
property risks on an excess of loss basis.
• Other: includes life reinsurance business on both a
proportional and non-proportional basis, casualty clash
business and, in limited instances, non-traditional business
which is intended to provide insurers with risk management
solutions that complement traditional reinsurance.
Premiums Written.
The following tables set forth our reinsurance segment’s net
premiums written by major line of business:
Year Ended December 31,
2017
2016
Amount
$ 459,213
340,429
243,693
70,155
32,759
28,225
$1,174,474
$ 708,694
465,780
$1,174,474
%
39.1
29.0
20.7
6.0
2.8
2.4
100.0
60.3
39.7
100.0
Amount
$ 348,852
305,252
267,548
75,789
37,790
18,625
$1,053,856
$ 558,671
495,185
$1,053,856
%
33.1
29.0
25.4
7.2
3.6
1.8
100.0
53.0
47.0
100.0
Other specialty
Casualty
Property excluding
property catastrophe
Property catastrophe
Marine and aviation
Other
Total
Pro rata
Excess of loss
Total
Year Ended December 31,
2018
2017
Amount
$ 507,971
400,178
310,293
79,624
38,013
36,493
$1,372,572
$ 782,268
590,304
$1,372,572
%
37.0
29.2
22.6
5.8
2.8
2.7
100.0
57.0
43.0
100.0
Amount
$ 459,213
340,429
243,693
70,155
32,759
28,225
$1,174,474
$ 708,694
465,780
$1,174,474
%
39.1
29.0
20.7
6.0
2.8
2.4
100.0
60.3
39.7
100.0
Other specialty
Casualty
Property excluding
property catastrophe
Property catastrophe
Marine and aviation
Other
Total
Pro rata
Excess of loss
Total
2018 versus 2017: Gross premiums written by the reinsurance
segment in 2018 were 16.6% higher than in 2017, while net
premiums written were 16.9% higher than in 2017. The increase
in net premiums written reflected growth in casualty lines and
property lines, primarily due to new business and rate increases,
and in other specialty, primarily due to new international motor
contracts. Net premiums written in 2018 also included
reinstatement premiums of $4.0 million, primarily for
Hurricanes Florence and Michael, Typhoon Jebi, California
wildfires and adjustments for other events, compared to $15.9
million in 2017 for Hurricanes Harvey, Irma, Maria, as well as
adjustments for other events.
2017 versus 2016: Gross premiums written by the reinsurance
segment in 2017 were 9.8% higher than in 2016, while net
premiums written were 11.4% higher than in 2016. Premiums
written reflected growth in other specialty business, primarily
in international motor quota share contracts, and in casualty
business, primarily due to a $45.4 million retroactive
reinsurance contract which was substantially earned in the
period and resulted in a corresponding increase to losses and
loss adjustment expenses. Net premiums written in 2017
included reinstatement premiums of $15.9 million for
Hurricanes Harvey, Irma and Maria. Such amounts were
partially offset by a reduction in property excluding property
catastrophe business, primarily related to a targeted reduction
in onshore energy writings.
Net Premiums Earned.
The following tables set forth our reinsurance segment’s net
premiums earned by major line of business:
Year Ended December 31,
2018
2017
Amount
$ 474,568
347,034
287,788
75,249
39,238
37,339
$1,261,216
$ 719,860
541,356
$1,261,216
%
37.6
27.5
22.8
6.0
3.1
3.0
100.0
57.1
42.9
100.0
Amount
$ 408,566
341,122
255,453
73,300
36,214
27,966
$1,142,621
$ 657,490
485,131
$1,142,621
%
35.8
29.9
22.4
6.4
3.2
2.4
100.0
57.5
42.5
100.0
Other specialty
Casualty
Property excluding
property catastrophe
Property catastrophe
Marine and aviation
Other
Total
Pro rata
Excess of loss
Total
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2018 FORM 10-K
Year Ended December 31,
2017
2016
Amount
$ 408,566
341,122
255,453
73,300
36,214
27,966
$1,142,621
$ 657,490
485,131
$1,142,621
%
35.8
29.9
22.4
6.4
3.2
2.4
100.0
57.5
42.5
100.0
Amount
$ 329,994
300,160
282,018
73,803
52,579
17,678
$1,056,232
$ 561,986
494,246
$1,056,232
%
31.2
28.4
26.7
7.0
5.0
1.7
100.0
53.2
46.8
100.0
Other specialty
Casualty
Property excluding
property catastrophe
Property catastrophe
Marine and aviation
Other
Total
Pro rata
Excess of loss
Total
Net premiums earned in 2018 were 10.4% higher than in 2017,
reflecting changes in net premiums written over the previous
five quarters, including the mix and type of business written.
Net premiums earned in 2017 were 8.2% higher than in 2016.
Other Underwriting Income (Loss).
Other underwriting loss in 2018 was $0.7 million, compared to
other underwriting income of $11.3 million in 2017 and $36.4
million in 2016. The 2016 period included $19.1 million related
to a contract which was commuted during the 2016 second
quarter. This contract had been reflected as a deposit accounting
liability (i.e., a contract that, in accordance with GAAP, does
not pass risk transfer) prior to the commutation.
Losses and Loss Adjustment Expenses.
The table below shows the components of the reinsurance
segment’s loss ratio:
Year Ended December 31,
2017
2018
2016
78.1 %
82.2 %
65.7 %
(11.0)%
67.1 %
(14.5)%
67.7 %
(20.7)%
45.0 %
Current year
Prior period reserve
development
Loss ratio
Current Year Loss Ratio.
2018 versus 2017: The reinsurance segment’s current year loss
ratio was 4.1 points lower in 2018 than in 2017. The 2018 loss
ratio included 10.1 points for current year catastrophic event
activity, primarily related to Hurricanes Florence and Michael,
Typhoon Jebi and the California wildfires, compared to 16.0
points in 2017, primarily related to Hurricanes Harvey, Irma
and Maria and the California wildfires. The 2018 loss ratio
includes the impact of a large attritional casualty loss arising
from the California wildfires that increased the loss ratio by 1.7
points. The balance of the change in the 2018 current year loss
ratio resulted, in part, from the effects of market conditions and
changes in the mix of business.
2017 versus 2016: The reinsurance segment’s current year loss
ratio was 16.5 points higher in 2017 than in 2016. The 2017
loss ratio included 16.0 points for current year catastrophic
event activity, primarily related to Hurricanes Harvey, Irma and
Maria and the California wildfires, compared to 4.1 points in
2016. In addition, the loss ratio for 2017 reflects the impact of
the retroactive reinsurance contract noted above (net premiums
earned at a high loss ratio), which increased the current year
loss ratio by 1.3 points. The balance of the change in the 2017
current year loss ratio resulted, in part, from the effects of market
conditions and changes in the mix of business.
Prior Period Reserve Development.
The reinsurance segment’s net favorable development was
$138.5 million, or 11.0 points, for 2018, compared to $165.4
million, or 14.5 points, for 2017, and $218.8 million, or 20.7
points, for 2016. See note 5, “Reserve for Losses and Loss
financial
Adjustment Expenses,”
statements in Item 8 for information about the reinsurance
segment’s prior year reserve development.
to our consolidated
Underwriting Expenses.
2018 versus 2017: The underwriting expense ratio for the
reinsurance segment was 27.4% in 2018, compared to 32.2%
in 2017, reflecting lower operating expenses of $13.3 million
due to lower performance based compensation costs, a
reduction of 1.1 points in the expense ratio. In addition, federal
excise taxes decreased by $19.7 million, a reduction of 1.6
points in the expense ratio, due to the non-renewal of certain
reinsurance agreements between our U.S. based insurance and
reinsurance subsidiaries and Arch Re Bermuda on a cutoff basis
as of January 1, 2018 and the impact of a loss portfolio transfer
in 2017. The remainder of the change was due to changes in the
mix and type of business.
2017 versus 2016: The underwriting expense ratio for the
reinsurance segment was 32.2% in 2017, compared to 33.6%
in 2016. Due to intercompany loss portfolio transfers effective
on December 31, 2017 that transferred $1.36 billion of net
retained reserves for losses and allocated loss adjustment
expenses between subsidiaries, the reinsurance segment’s 2017
acquisition expense ratio reflected 1.2 points of federal excise
taxes in connection with such activity.
Mortgage Segment
Our mortgage operations include U.S. and international
mortgage insurance and reinsurance operations as well as
participation in GSE credit risk-sharing transactions. Our
mortgage group includes direct mortgage insurance in the U.S.
primarily through Arch Mortgage Insurance Company and
United Guaranty Residential Insurance Company (together,
“Arch MI U.S.”); mortgage reinsurance through Arch Re
Bermuda to mortgage insurers on both a proportional and non-
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2018 FORM 10-K
proportional basis globally; direct mortgage insurance in
Europe through Arch MI Europe and in Hong Kong through
Arch MI Asia; and participation in various GSE credit risk-
sharing products primarily through Arch Re Bermuda.
The following tables set forth our mortgage segment’s
underwriting results. On December 31, 2016, we completed the
acquisition of UGC. As such, the 2018 and 2017 results reflect
the combination of Arch and UGC while the 2016 results do
not reflect UGC activity.
Gross premiums written
Premiums ceded
Net premiums written
Change in unearned premiums
Net premiums earned
Other underwriting income
Losses and loss adjustment
expenses
Acquisition expenses
Other operating expenses
Underwriting income
Underwriting Ratios
Loss ratio
Acquisition expense ratio
Other operating expense ratio
Combined ratio
Gross premiums written
Premiums ceded
Net premiums written
Change in unearned premiums
Net premiums earned
Other underwriting income
Losses and loss adjustment
expenses
Acquisition expenses
Other operating expenses
Underwriting income
Underwriting Ratios
Loss ratio
Acquisition expense ratio
Other operating expense ratio
Combined ratio
Year Ended December 31,
2017
$ 1,368,138
(256,796)
1,111,342
(54,176)
1,057,166
15,737
2018
$ 1,360,708
(202,833)
1,157,875
28,361
1,186,236
13,033
% Change
(0.5)
4.2
12.2
(81,289)
(134,677)
(118,595)
(142,432)
$ 856,953
(100,598)
(146,336)
$ 691,292
6.9%
10.0%
12.0%
28.9%
12.7%
9.5%
13.8%
36.0%
24.0
% Point
Change
(5.8)
0.5
(1.8)
(7.1)
Year Ended December 31,
2016
$ 499,725
(108,259)
391,466
(104,750)
286,716
17,024
2017
$ 1,368,138
(256,796)
1,111,342
(54,176)
1,057,166
15,737
% Change
173.8
183.9
268.7
(134,677)
(28,943)
(100,598)
(146,336)
$ 691,292
(21,790)
(96,672)
$ 156,335
12.7%
9.5%
13.8%
36.0%
10.1%
7.6%
33.7%
51.4%
342.2
% Point
Change
2.6
1.9
(19.9)
(15.4)
Premiums Written.
The following table sets forth our mortgage segment’s net
premiums written by client location and underwriting location
(i.e., where the business is underwritten):
Net premiums written by
client location
United States
Other
Total
Net premiums written by
underwriting location
United States
Other
Total
Year Ended December 31,
2017
2018
2016
$ 1,051,375
106,500
$ 1,157,875
$ 1,005,437
105,905
$ 1,111,342
$
948,323
209,552
$ 1,157,875
$
903,329
208,013
$ 1,111,342
$
$
$
$
280,509
110,957
391,466
186,826
204,640
391,466
2018 versus 2017: Gross premiums written by the mortgage
segment in 2018 were 0.5% lower than in 2017. The reduction
in gross premiums written primarily reflected a lower level of
Australian mortgage reinsurance business partially offset by
higher U.S. premiums due to insurance in force growth. Net
premiums written for 2018 were 4.2% higher than in the 2017
period and reflected lower ceded premiums on the quota share
agreement with AIG that continues to run-off, partially offset
by higher ceded premiums related to Bellemeade transactions
in 2018. The 2017 period also reflected higher retrocessions of
Australian mortgage reinsurance business. The persistency rate
of the primary portfolio of mortgage loans of Arch MI U.S. was
81.5% at December 31, 2018 compared
to 81.8% at
December 31, 2017. The persistency rate represents the
percentage of mortgage insurance in force at the beginning of
a 12-month period that remains in force at the end of such period.
2017 versus 2016: Gross premiums written by the mortgage
segment in 2017 were 173.8% higher than in 2016, while net
premiums written increased 183.9%, primarily reflecting
growth in insurance in force due to the acquisition of UGC,
Arch MI U.S. generated $69.5 billion of new insurance written
(“NIW”) during 2018 compared to $62.0 billion during 2017.
NIW represents the original principal balance of all loans that
received coverage during the period.
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2018 FORM 10-K
Net Premiums Earned.
The following table sets forth our mortgage segment’s net
premiums earned by client location and underwriting location
(i.e., where the business is underwritten):
Net premiums earned by
client location
United States
Other
Total
Net premiums earned by
underwriting location
United States
Other
Total
Year Ended December 31,
2017
2018
2016
$ 1,116,007
70,229
$ 1,186,236
$ 1,014,439
42,727
$ 1,057,166
$ 1,009,765
176,471
$ 1,186,236
$
901,858
155,308
$ 1,057,166
$
$
$
$
265,527
21,189
286,716
155,929
130,787
286,716
Net premiums earned for 2018 were 12.2% higher than in 2017,
primarily due to growth in insurance in force for Arch MI U.S.
Growth from 2016 to 2017 primarily reflected the impact of the
acquisition of UGC, which occurred as of December 31, 2016.
Other Underwriting Income.
Other underwriting income, which is primarily related to GSE
risk-sharing transactions receiving derivative accounting
treatment, was $13.0 million for 2018, compared to $15.7
million for 2017 and $17.0 million for 2016.
Losses and Loss Adjustment Expenses.
The table below shows the components of the mortgage
segment’s loss ratio:
Current year
Prior period reserve
development
Loss ratio
Year Ended December 31,
2017
2018
2016
16.0 %
21.7 %
17.5 %
(9.1)%
6.9 %
(9.0)%
12.7 %
(7.4)%
10.1 %
Unlike property and casualty business for which we estimate
ultimate losses on premiums earned, losses on mortgage
insurance business are only recorded at the time a borrower is
delinquent on their mortgage, in accordance with primary
mortgage insurance industry practice. Because our primary
mortgage insurance reserving process does not take into
account the impact of future losses from loans that are not
delinquent, mortgage insurance loss reserves are not an estimate
of ultimate losses. In addition to establishing loss reserves for
delinquent loans, under GAAP, we are required to establish a
premium deficiency reserve for our mortgage insurance
products if the amount of expected future losses and
maintenance costs exceeds expected future premiums, existing
reserves and the anticipated investment income for such
product. We assess the need for a premium deficiency reserve
on a quarterly basis and perform a full analysis annually. No
such reserve was established during 2018, 2017 or 2016.
Current Year Loss Ratio.
2018 versus 2017: The mortgage segment’s current year loss
ratio was 5.7 points lower in 2018 compared to 2017. The
current year loss ratio for 2018 reflects the current favorable
macroeconomic environment as the percentage of loans in
default on first lien business decreased from 2.23% at December
31, 2017 to 1.60% at December 31, 2018. In addition, the loss
ratio for 2017 was slightly impacted by delinquencies
emanating from new notices from areas impacted by the 2017
third quarter hurricanes that subsequently cured during 2018.
2017 versus 2016: The mortgage segment’s current year loss
ratio was 4.2 points higher in 2017 compared to 2016. The
current year loss ratio for 2017 reflects changes in the mix of
business due to the UGC acquisition when compared to 2016,
and the minor impact of delinquencies emanating from new
notices from areas impacted by the 2017 third quarter
hurricanes.
We insure mortgages for homes in areas that have been impacted
by catastrophic events, including 2018 events such as
Hurricanes Florence and Michael and the California wildfires,
and 2017 events such as Hurricanes Harvey and Irma.
Generally, mortgage insurance losses occur only when a credit
event occurs and, following a physical damage event, when the
home is restored to pre-storm condition. Our ultimate claims
exposure will depend on the number of delinquency notices
received and the ultimate claim rate related to such notices. In
the event of natural disasters, cure rates are influenced by the
adequacy of homeowners and flood insurance carried on a
related property, and a borrower's access to aid from
government entities and private organizations, in addition to
other factors which generally impact cure rates in unaffected
areas.
Prior Period Reserve Development.
The mortgage segment’s net favorable development was $107.6
million, or 9.1 points, for 2018, compared to $95.0 million, or
9.0 points, for 2017, and $21.2 million, or 7.4 points, for 2016.
The 2017 increase in net favorable development was primarily
on the acquired UGC reserves. See note 5, “Reserve for Losses
and Loss Adjustment Expenses,” to our consolidated financial
statements in Item 8 for information about the mortgage
segment’s prior year reserve development.
Underwriting Expenses.
2018 versus 2017: The underwriting expense ratio for the
mortgage segment was 22.0% for 2018, compared to 23.3% for
2017, reflecting the increase in net premiums earned combined
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2018 FORM 10-K
with a $3.9 million decrease in other operating expenses due to
expense savings from integration efforts. This decrease was
partially offset by a higher level of acquisition expenses, due
to higher NIW.
2017 versus 2016: The underwriting expense ratio for the
mortgage segment was 23.3% for 2017, compared to 41.3% for
2016. The decrease in the underwriting expense ratio primarily
reflects the higher level of net premiums earned from the impact
of the UGC acquisition.
Corporate (Non-Underwriting) Segment
The corporate (non-underwriting) segment results include net
investment income, other income (loss), corporate expenses,
transaction costs and other, amortization of intangible assets,
interest expense, items related to our non-cumulative preferred
shares, net realized gains or losses, net impairment losses
included in earnings, equity in net income or loss of investments
accounted for using the equity method, net foreign exchange
gains or losses and income taxes. Such amounts exclude the
results of the ‘other’ segment.
Net Investment Income.
The components of net investment income were derived from
the following sources:
Fixed maturities
Equity securities
Short-term investments
Other (1)
Gross investment income
Investment expenses (2)
Net investment income
$
$
$
$
Year Ended December 31,
2017
336,894
12,703
9,343
79,789
438,729
(56,657)
382,072
2018
403,449
12,650
17,802
70,946
504,847
(66,889)
437,958
2016
242,310
13,823
3,619
66,300
326,052
(48,859)
277,193
$
$
(1) Amounts include dividends and other distributions on investment funds,
term loan investments, funds held balances, cash balances and other.
Investment expenses were approximately 0.36% of average invested
assets for 2018, compared to 0.30% for 2017 and 0.34% for 2016.
(2)
The pre-tax investment income yield was 2.36% for 2018,
compared to 2.06% for 2017 and 1.92% for 2016. The higher
level of net investment income for 2018 compared to 2017 and
2016 reflected an increase in the embedded book yield on fixed
income securities, partially offset by a higher level of
expenses.The pre-tax investment income yields were calculated
based on amortized cost. Yields on future investment income
may vary based on financial market conditions, investment
allocation decisions and other factors.
necessary to support our worldwide insurance and reinsurance
operations and costs associated with operating as a publicly
traded company. The lower level of corporate expenses in 2018
compared to 2017 and 2016 was primarily due to lower
incentive compensation costs.
Transaction Costs and Other.
Transaction costs and other were $11.4 million for 2018,
compared to $22.2 million for 2017 and $41.7 million for 2016.
Amounts for 2018 were primarily attributable to the write off
of intangible assets related to insurance licenses for a subsidiary
of UGC which was merged with another subsidiary. For 2017,
transaction costs and other primarily related to severance and
severance related costs related to the UGC acquisition. For
2016, transaction costs and other included $32.3 million of non-
recurring costs such as advisory, financing and legal related to
the UGC acquisition.
Amortization of Intangible Assets.
Amortization of intangible assets for 2018 was $105.7 million,
compared to $125.8 million for 2017 and $19.3 million for
2016. Amounts in 2018 and 2017 primarily related to
amortization of finite-lived intangible assets related to the UGC
acquisition.
Interest Expense.
Interest expense was $101.0 million for 2018, compared to
$103.6 million for 2017 and $53.5 million for 2016. Interest
expense reflects amounts related to our outstanding senior
notes, revolving credit agreement borrowings and other. We
issued $950.0 million of senior notes in December 2016 in
connection with the UGC acquisition and borrowed $400.0
million on our revolving credit agreement, resulting in higher
borrowing costs in 2017 when compared to 2016. We repaid
$375 million and $125 million of our revolving credit
agreement borrowings during 2018 and 2017, respectively,
resulting in lower borrowing costs for 2018 than in 2017.
Loss on Redemption of Preferred Shares.
In September 2017, we redeemed $230 million of 6.75% Series
C preferred shares and, in accordance with GAAP, recorded a
loss of $6.7 million to remove original issuance costs related
to the redeemed shares from additional paid-in capital. In
January 2018, we redeemed the remaining $92.3 million of
6.75% Series C preferred shares outstanding and recorded a
loss of $2.7 million. Such adjustments had no impact on total
shareholders’ equity or cash flows.
Corporate Expenses.
Net Realized Gains (Losses).
Corporate expenses were $58.6 million for 2018, compared to
$61.6 million for 2017 and $49.4 million for 2016. Such
amounts primarily represent certain holding company costs
We recorded net realized loss of $284.4 million for 2018,
compared to net realized gains of $148.8 million for 2017 and
net realized gains of $69.6 million for 2016. Currently, our
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2018 FORM 10-K
portfolio is actively managed to maximize total return within
certain guidelines. The effect of financial market movements
on the investment portfolio will directly impact net realized
gains and losses as the portfolio is adjusted and rebalanced. Net
realized gains or losses from the sale of fixed maturities
primarily results from our decisions to reduce credit exposure,
to change duration targets, to rebalance our portfolios or due to
relative value determinations. Net realized gains or losses also
includes realized and unrealized contract gains and losses on
our derivative instruments, changes in the fair value of assets
and liabilities accounted for using the fair value option along
with re-measurement of contingent consideration liability
amounts.
Net Impairment Losses Recognized in Earnings.
For 2018, we recorded $2.8 million of credit related
impairments in earnings, compared to $7.1 million in 2017 and
$30.4 million in 2016. The impairment losses recorded in 2018
were primarily related to foreign currency. The impairment
losses recorded in 2017 were primarily related to foreign
currency and the liquidation of one portfolio, while the 2016
period included reductions on two asset backed securities based
on information received from external investment managers
and a review of cash flow projections in order to determine
expected recovery values. See note 8, “Investment Information
—Other-Than-Temporary Impairments,” to our consolidated
financial statements in Item 8 for additional information.
Equity in Net Income (Loss) of Investments Accounted for Using
the Equity Method.
We recorded $45.6 million of equity in net income related to
investments accounted for using the equity method for 2018,
compared to $142.3 million for 2017 and $48.5 million for
2016. The 2017 results reflected strong returns on funds
invested in global equities and other strategies. Investments
accounted for using the equity method totaled $1.49 billion at
December 31, 2018, compared to $1.04 billion at December 31,
2017. See note 8, “Investments—Equity in Net Income (Loss)
of Investments Accounted For Using the Equity Method,” to
our consolidated financial statements in Item 8 for additional
information.
Net Foreign Exchange Gains or Losses.
Net foreign exchange gains for 2018 were $58.7 million,
compared to net foreign exchange losses for 2017 of $113.3
million and net foreign exchange gains for 2016 of $31.4
million. Amounts in such periods were primarily unrealized and
resulted from the effects of revaluing our net insurance
liabilities required to be settled in foreign currencies at each
balance sheet date.
Income Tax Expense.
Our income tax provision on income before income taxes
resulted in an expense of 13.1% for 2018, compared to an
expense of 17.1% for 2017 and an expense of 4.3% for 2016.
Our effective tax rate fluctuates from year to year consistent
with the relative mix of income or loss reported by jurisdiction
and the varying tax rates in each jurisdiction. Income tax
expense for 2017 included a net $8.1 million charge due to the
revaluation of our net U.S. deferred tax asset resulting from the
reduction in the U.S. corporate income tax rate from 35% to
21% effective January 1, 2018.
See note 14, “Income Taxes,” to our consolidated financial
statements in Item 8 for a reconciliation of the difference
between the provision for income taxes and the expected tax
provision at the weighted average statutory tax rate for 2018,
2017 and 2016.
Other Segment
The ‘other’ segment includes the results of Watford Re.
Pursuant to generally accepted accounting principles, Watford
Re is considered a variable interest entity and we concluded
that we are the primary beneficiary of Watford Re. As such, we
consolidate the results of Watford Re in our consolidated
financial statements, although we only own approximately 11%
of Watford Re’s common equity. See note 11, “Variable Interest
Entity and Noncontrolling Interests,” and note 4, “Segment
Information,” to our consolidated financial statements in Item
8 for additional information.
CRITICAL ACCOUNTING POLICIES, ESTIMATES
AND RECENT ACCOUNTING PRONOUNCEMENTS
The preparation of consolidated financial statements in
accordance with GAAP requires us to make many estimates
and judgments that affect the reported amounts of assets,
liabilities (including reserves), revenues and expenses, and
related disclosures of contingent liabilities. On an ongoing
basis, we evaluate our estimates, including those related to
revenue recognition, insurance and other reserves, reinsurance
recoverables, allowance for doubtful accounts, investment
valuations, goodwill and intangible assets, bad debts, income
taxes, contingencies and litigation. We base our estimates on
historical experience, where possible, and on various other
assumptions that we believe to be reasonable under the
circumstances, which form the basis for our judgments about
the carrying values of assets and liabilities that are not readily
apparent from other sources. Estimates and judgments 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 December 31,
2018. Actual results will differ from these estimates and such
differences may be material. We believe that the following
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2018 FORM 10-K
critical accounting policies affect significant estimates used in
the preparation of our consolidated financial statements.
Reserves for Losses and Loss Adjustment Expenses
We are required by applicable insurance laws and regulations
and GAAP to establish reserves for losses and loss adjustment
expenses, or Loss Reserves, that arise from the business we
underwrite. Loss Reserves for our insurance, reinsurance and
mortgage operations are balance sheet liabilities representing
estimates of future amounts required to pay losses and loss
adjustment expenses for insured or reinsured events which have
occurred at or before the balance sheet date. Loss Reserves do
not reflect contingency reserve allowances to account for future
loss occurrences. Losses arising from future events will be
estimated and recognized at the time the losses are incurred and
could be substantial.
See note 6, “Short Duration Contracts,” to our consolidated
financial statements in Item 8 for additional information on our
reserving process.
At December 31, 2018 and 2017, our Loss Reserves, net of
unpaid losses and loss adjustment expenses recoverable, by type
and by operating segment were as follows:
Insurance segment:
Case reserves
IBNR reserves
Total net reserves
Reinsurance segment:
Case reserves
Additional case reserves
IBNR reserves
Total net reserves
Mortgage segment:
Case reserves
IBNR reserves
Total net reserves (1)
Other segment:
Case reserves
Additional case reserves
IBNR reserves
Total net reserves
Total:
Case reserves
Additional case reserves
IBNR reserves
Total net reserves
December 31,
2018
2017
$
1,489,644
3,266,796
4,756,440
$
1,648,910
3,272,351
4,921,261
1,082,917
191,002
1,578,907
2,852,826
1,033,413
158,377
1,499,962
2,691,752
355,606
122,304
477,910
364,052
36,512
551,266
951,830
443,069
104,169
547,238
260,876
32,587
465,168
758,631
3,292,219
227,514
5,519,273
9,039,006
3,386,268
190,964
5,341,650
8,918,882
$
$
(1) At December 31, 2018, total net reserves include $375.8 million from
U.S. primary mortgage insurance business, of which 72.8% represents
policy years 2008 and prior and the remainder from later policy years. At
December 31, 2017, total net reserves include $477.1 million from U.S.
primary mortgage insurance business, of which 79.8% represents policy
years 2008 and prior and the remainder from later policy years.
At December 31, 2018 and 2017, the insurance segment’s Loss
Reserves by major line of business, net of unpaid losses and
loss adjustment expenses recoverable, were as follows:
Professional lines (1)
Construction and national accounts
Excess and surplus casualty (2)
Programs
Property, energy, marine and aviation
Travel, accident and health
Lenders products
Other (3)
Total net reserves
December 31,
2018
1,247,914
1,166,143
631,370
482,045
388,710
83,836
52,007
704,415
4,756,440
$
$
2017
1,308,261
1,094,300
672,903
644,340
437,518
86,122
53,912
623,905
4,921,261
$
$
(1)
(2)
(3)
Includes professional liability, executive assurance and healthcare
business.
Includes casualty and contract binding business.
Includes alternative markets, excess workers’ compensation and surety
business.
At December 31, 2018 and 2017, the reinsurance segment’s
Loss Reserves by major line of business, net of unpaid losses
and loss adjustment expenses recoverable, were as follows:
Casualty (1)
Other specialty (2)
Property excluding property catastrophe (3)
Marine and aviation
Property catastrophe
Other (4)
Total net reserves
December 31,
2018
$ 1,551,550
582,420
422,612
130,683
90,635
74,926
$ 2,852,826
2017
$ 1,489,933
523,321
376,020
135,484
98,622
68,372
$ 2,691,752
(1)
(2)
(3)
(3)
Includes executive assurance, professional
compensation, excess motor, healthcare and other.
Includes non-excess motor, surety, accident and health, workers’
compensation catastrophe, agriculture, trade credit and other.
Includes facultative business.
Includes life, casualty clash and other.
liability, workers’
Potential Variability in Loss Reserves
The tables below summarize the effect of reasonably likely
scenarios on the key actuarial assumptions used to estimate our
Loss Reserves, net of unpaid losses and loss adjustment
expenses recoverable, at December 31, 2018 by underwriting
segment (excluding the ‘other’ segment). The scenarios shown
in the tables summarize the effect of (i) changes to the expected
loss ratio selections used at December 31, 2018, which
represent loss ratio point increases or decreases to the expected
loss ratios used, and (ii) changes to the loss development
patterns used in our reserving process at December 31, 2018,
which represent claims reporting that is either slower or faster
than the reporting patterns used. We believe that the illustrated
sensitivities are indicative of the potential variability inherent
in the estimation process of those parameters. The results show
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2018 FORM 10-K
the impact of varying each key actuarial assumption using the
chosen sensitivity on our IBNR reserves, on a net basis and
across all accident years.
INSURANCE SEGMENT
Reserving lines selected assumptions:
Property, energy, marine and aviation
Third party occurrence business
Third party claims-made business
All other
Increase (decrease) in Loss Reserves:
Higher
Expected Loss
Ratios
Slower Loss
Development
Patterns
5 points
10
10
10
3 months
6
6
6
Property, energy, marine and aviation
Third party occurrence business
Third party claims-made business
All other
$
22,535
242,617
116,092
138,959
$
25,570
128,893
124,271
148,815
INSURANCE SEGMENT
Reserving lines selected assumptions:
Property, energy, marine and aviation
Third party occurrence business
Third party claims-made business
Multi-line and other specialty
Increase (decrease) in Loss Reserves:
Lower
Expected Loss
Ratios
Faster Loss
Development
Patterns
(5) points
(10)
(10)
(10)
(3) months
(6)
(6)
(6)
Property, energy, marine and aviation
Third party occurrence business
Third party claims-made business
Multi-line and other specialty
$
(21,926)
(242,224)
(116,092)
(133,762)
$
(20,646)
(115,036)
(95,565)
(103,161)
REINSURANCE SEGMENT
Reserving lines selected assumptions:
Casualty
Other specialty
Property excluding property
catastrophe
Property catastrophe
Marine and aviation
Other
Increase (decrease) in Loss Reserves:
Casualty
Other specialty
Property excluding property
catastrophe
Property catastrophe
Marine and aviation
Other
Higher
Expected Loss
Ratios
Slower Loss
Development
Patterns
10 points
5
6 months
3
5
5
5
5
3
3
3
3
$
113,253
58,548
$
131,860
33,113
14,449
2,719
7,243
4,972
36,179
4,874
11,212
3,270
REINSURANCE SEGMENT
Reserving lines selected assumptions:
Casualty
Other specialty
Property excluding property
catastrophe
Property catastrophe
Marine and aviation
Other
Increase (decrease) in Loss Reserves:
Casualty
Other specialty
Property excluding property
catastrophe
Property catastrophe
Marine and aviation
Other
Lower
Expected Loss
Ratios
Faster Loss
Development
Patterns
(10) points
(5)
(6) months
(3)
(5)
(5)
(5)
(5)
(3)
(3)
(3)
(3)
$
(113,264)
(58,548)
$
(104,119)
(52,975)
(14,475)
(2,719)
(7,255)
(4,972)
(33,988)
(3,028)
(11,130)
(3,067)
It is not necessarily appropriate to sum the total impact for a
specific factor or the total impact for a specific business
category as the business categories are not perfectly correlated.
In addition, the potential variability shown in the tables above
are reasonably likely scenarios of changes in our key
assumptions at December 31, 2018 and are not meant to be a
“best case” or “worst case” series of outcomes and, therefore,
it is possible that future variations may be more or less than the
amounts set forth above.
For our mortgage segment, we considered the sensitivity of loss
reserve estimates at December 31, 2018 by assessing the
potential changes resulting from a parallel shift in severity and
default to claim rate. For example, assuming all other factors
remain constant, for every one percentage point change in
primary claim severity (which we estimate to be 27% of the
unpaid principal balance at December 31, 2018), we estimated
that our loss reserves would change by approximately $17.0
million at December 31, 2018. For every one percentage point
change in our primary net default to claim rate (which we
estimate to be approximately 36% at December 31, 2018), we
estimated a $13.0 million change in our loss reserves at
December 31, 2018.
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2018 FORM 10-K
Simulation Results
In order to illustrate the potential volatility in our Loss Reserves,
we used a Monte Carlo simulation approach to simulate a range
of results based on various probabilities. Both the probabilities
and related modeling are subject to inherent uncertainties. The
simulation relies on a significant number of assumptions, such
as the potential for multiple entities to react similarly to external
events, and includes other statistical assumptions. The
simulation results shown for each segment do not add to the
total simulation results, as the individual segment simulation
results do not reflect the diversification effects across our
segments.
At December 31, 2018, our recorded Loss Reserves by
underwriting segment, net of unpaid losses and loss adjustment
expenses recoverable, and the results of the simulation were as
follows:
Insurance
Segment
Reinsurance
Segment
Mortgage
Segment
Total
$4,756,440
$2,852,826
$477,910
$8,087,176
$5,772,504
$3,577,073
$571,959
$9,483,035
$3,799,556
$2,219,249
$390,240
$6,777,556
Loss
Reserves (1)
Simulation
results:
90th
percentile (2)
10th
percentile (3)
(1) Net of reinsurance recoverables. Excludes amounts reflected in the ‘other’
segment.
(2) Simulation results indicate that a 90% probability exists that the net
reserves for losses and loss adjustment expenses will not exceed the
indicated amount.
(3) Simulation results indicate that a 10% probability exists that the net
reserves for losses and loss adjustment expenses will be at or below the
indicated amount.
For informational purposes, based on the total simulation
results, a change in our Loss Reserves to the amount indicated
at the 90th percentile would result in a decrease in income before
income taxes of approximately $1.40 billion, or $3.38 per
diluted share, while a change in our Loss Reserves to the amount
indicated at the 10th percentile would result in an increase in
income before income taxes of approximately $1.31 billion, or
$3.17 per diluted share. The simulation results noted above are
informational only, and no assurance can be given that our
ultimate losses will not be significantly different than the
simulation results shown above, and such differences could
directly and significantly impact earnings favorably or
unfavorably in the period they are determined. We do not have
significant exposure to pre-2002 liabilities, such as asbestos-
related illnesses and other long-tail liabilities. It is difficult to
provide meaningful trend information for certain liability/
casualty coverages for which the claim-tail may be especially
long, as claims are often reported and ultimately paid or settled
years, or even decades, after the related loss events occur. Any
estimates and assumptions made as part of the reserving process
could prove to be inaccurate due to several factors, including
the fact that relatively limited historical information has been
reported to us through December 31, 2018.
Mortgage Operations Supplemental Information
The mortgage segment’s insurance in force (“IIF”) and risk in
force (“RIF”) were as follows at December 31, 2018 and 2017:
(U.S. Dollars in millions)
December 31,
2018
2017
Amount
%
Amount
%
Insurance In Force (IIF) (1):
U.S. primary mortgage
insurance
Mortgage reinsurance
Other (2)
Total
Risk In Force (RIF) (3):
U.S. primary mortgage
insurance
Mortgage reinsurance
Other (2)
Total
$ 276,538
72.1
$ 253,914
25,975
81,147
$ 383,660
6.8
21.2
100.0
28,017
69,905
$ 351,836
$
70,995
92.3
$
64,904
2,217
3,728
76,940
2.9
4.8
100.0
$
2,473
2,921
70,298
$
72.2
8.0
19.9
100.0
92.3
3.5
4.2
100.0
(1) Represents the aggregate dollar amount of each insured mortgage loan’s
(2)
current principal balance.
Includes participation in GSE credit risk-sharing transactions and
international insurance business.
(3) Represents the aggregate amount of each insured mortgage loan’s current
principal balance multiplied by the insurance coverage percentage
specified in the policy for insurance policies issued and after contract
limits and/or loss ratio caps for credit risk-sharing or reinsurance
transactions.
The insurance in force and risk in force for our U.S. primary
mortgage insurance business by policy year were as follows at
December 31, 2018:
(U.S. Dollars in
millions)
Policy year:
IIF
RIF
Amount
%
Amount
%
Delinquency
Rate (1)
2008 and prior $ 20,501
709
2009
646
2010
2,530
2011
9,650
2012
16,823
2013
18,274
2014
33,781
2015
52,324
2016
54,287
2017
67,013
2018
$ 276,538
Total
7.4
0.3
0.2
0.9
3.5
6.1
6.6
12.2
18.9
19.6
24.2
100.0
$
4,738
162
175
701
2,664
4,676
4,947
8,849
13,407
13,793
16,883
$ 70,995
6.7
0.2
0.2
1.0
3.8
6.6
7.0
12.5
18.9
19.4
23.8
100.0
(1) Represents the ending percentage of loans in default.
9.07%
3.25%
2.62%
1.57%
0.78%
0.89%
0.97%
0.69%
0.77%
0.55%
0.15%
1.60%
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2018 FORM 10-K
The insurance in force and risk in force for our U.S. primary
mortgage insurance business by policy year were as follows at
December 31, 2017:
(U.S. Dollars in
millions)
Policy year:
IIF
RIF
Amount
%
Amount
%
Delinquency
Rate (1)
2008 and prior $ 26,140
1,072
2009
1,089
2010
3,828
2011
13,247
2012
21,840
2013
22,884
2014
41,991
2015
62,020
2016
59,803
2017
10.3
0.4
0.4
1.5
5.2
8.6
9.0
16.5
24.4
23.6
$
6,003
253
295
1,046
3,629
5,996
6,112
10,828
15,643
15,099
9.2
0.4
0.5
1.6
5.6
9.2
9.4
16.7
24.1
23.3
Total
$ 253,914
100.0
$ 64,904
100.0
(1) Represents the ending percentage of loans in default.
10.24%
2.94%
2.31%
1.37%
0.75%
0.95%
1.10%
0.77%
0.80%
0.35%
2.23%
(U.S. Dollars in millions)
December 31,
Total RIF by State:
Texas
California
Florida
Virginia
Georgia
North Carolina
Illinois
Washington
Maryland
Minnesota
Others
Total
2018
2017
Amount
%
Amount
%
$
$
5,491
4,505
3,541
2,931
2,573
2,505
2,482
2,408
2,407
2,400
39,752
70,995
7.7
6.3
5.0
4.1
3.6
3.5
3.5
3.4
3.4
3.4
56.0
100.0
$
$
5,151
3,803
2,881
2,773
2,331
2,410
2,229
2,294
2,234
2,165
36,633
64,904
7.9
5.9
4.4
4.3
3.6
3.7
3.4
3.5
3.4
3.3
56.4
100.0
The following table provides supplemental disclosures for our
U.S. primary mortgage insurance business related to insured
loans and loss metrics for the years ended December 31, 2018
and 2017:
The following tables provide supplemental disclosures on risk
in force for our U.S. primary mortgage insurance business at
December 31, 2018 and 2017:
(U.S. Dollars in thousands, except loan
and claim count)
Rollforward of insured loans in default:
Beginning delinquent number of loans
(U.S. Dollars in millions)
December 31,
2018
2017
Amount
%
Amount
%
Credit quality (FICO):
>=740
680-739
620-679
<620
Total
Weighted average FICO
score
Loan-to-Value (LTV):
95.01% and above
90.01% to 95.00%
85.01% to 90.00%
85.00% and below
Total
$
$
$
$
41,066
23,954
5,485
490
70,995
743
7,918
39,370
20,643
3,064
70,995
Weighted average LTV
93.0%
57.8
33.7
7.7
0.7
100.0
11.2
55.5
29.1
4.3
100.0
$
$
$
$
37,794
21,213
5,159
738
64,904
743
6,337
36,174
19,482
2,911
64,904
92.9%
58.2
32.7
7.9
1.1
100.0
9.8
55.7
30.0
4.5
100.0
Total RIF, net of
external reinsurance
$
55,755
$
49,100
New notices (1)
Cures
Paid claims
Ending delinquent number of loans (1)(2)
Year Ended December 31,
2018
2017
27,068
37,310
(39,896)
(3,817)
20,665
29,691
41,846
(38,413)
(6,056)
27,068
Ending number of policies in force (2)
1,289,295
1,213,382
Delinquency rate (1)(2)
1.60%
2.23%
Losses:
Number of claims paid
Total paid claims
Average per claim
Severity (3)
Average reserve per default (in
thousands) (1)(2)
3,817
159,474
41.8
102.0%
17.4
$
$
$
6,056
265,924
43.9
103.4%
16.5
$
$
$
(1)
(2)
(3)
2018 year includes no new notices and approximately 200 ending
delinquent loans at December 31, 2018 from areas impacted by the 2017
third quarter hurricanes.
Includes first lien primary and pool policies.
Represents total paid claims divided by RIF of loans for which claims
were paid.
The risk-to-capital ratio, which represents total current (non-
delinquent) risk in force, net of reinsurance, divided by total
statutory capital, for Arch MI U.S. was approximately 13.0 to
1 at December 31, 2018, compared to 10.8 to 1 at December 31,
2017.
Ceded Reinsurance
In the normal course of business, our insurance and mortgage
insurance operations cede a portion of their premium on a quota
share or excess of loss basis through treaty or facultative
reinsurance agreements. Our reinsurance operations also obtain
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2018 FORM 10-K
by
our
reinsurance
reinsurance whereby another reinsurer contractually agrees to
indemnify it for all or a portion of the reinsurance risks
underwritten
operations. Such
arrangements, where one reinsurer provides reinsurance to
another reinsurer, are usually referred to as “retrocessional
reinsurance” arrangements. In addition, our 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 our reinsurance operations, and the ceding
company. 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, our insurance
or reinsurance operations would be liable for such defaulted
amounts.
The availability and cost of reinsurance and retrocessional
protection is subject to market conditions, which are beyond
our control. Although we believe that our insurance and
reinsurance operations have been successful in obtaining
adequate reinsurance and retrocessional protection, it is not
certain that they will be able to continue to obtain adequate
protection at cost effective levels. As a result of such market
conditions and other factors, our insurance, reinsurance and
mortgage operations may not be able to successfully mitigate
risk through reinsurance and retrocessional arrangements and
may lead to increased volatility in our results of operations in
future periods. See “Risk Factors—Risks Relating to Our
Industry—The failure of any of the loss limitation methods we
employ could have a material adverse effect on our financial
condition or results of operations.”
Effective July 1, 2018, our insurance operations had in effect a
reinsurance program which provided coverage for certain
property-catastrophe related losses equal to $275 million in
excess of a $75 million retention per occurrence. Such amounts
compare to $200 million in excess of a $150 million retention
per occurrence prior to July 1, 2018.
For purposes of managing risk, we reinsure a portion of our
exposures, paying to reinsurers a part of the premiums received
on the policies we write, and we may also use retrocessional
protection. On a consolidated basis, ceded premiums written
represented 23.2% of gross premiums written for 2018,
compared to 22.1% for 2017 and 22.5% for 2016. We monitor
the financial condition of our reinsurers and attempt to place
coverages only with substantial, financially sound carriers. If
the financial condition of our reinsurers or retrocessionaires
deteriorates, resulting in an impairment of their ability to make
payments, we will provide for probable losses resulting from
our inability to collect amounts due from such parties, as
appropriate. We evaluate the credit worthiness of all the
reinsurers to which we cede business. If our analysis indicates
that there is significant uncertainty regarding our ability to
collect amounts due from reinsurers, managing general agents,
brokers and other clients, we will record a provision for doubtful
accounts. See “Risk Factors—Risks Relating to Our Company
—We are exposed to credit risk in certain of our business
operations” and “Financial Condition, Liquidity and Capital
Resources—Financial Condition—Premiums Receivable and
Reinsurance Recoverables” for further details.
Premium Revenues and Related Expenses
Insurance premiums written are generally recorded at the policy
inception and are primarily earned on a pro rata basis over the
terms of the policies for all products, usually 12 months.
Premiums written
insurance
include estimates
operations’ programs, specialty lines, collateral protection
business and for participation in involuntary pools. Such
premium estimates are derived from multiple sources which
include the historical experience of the underlying business,
similar business and available industry information. Unearned
premium reserves represent the portion of premiums written
that relates to the unexpired terms of in-force insurance policies.
in our
Reinsurance premiums written include amounts reported by
brokers and ceding companies, supplemented by our own
estimates of premiums where reports have not been received.
The determination of premium estimates requires a review of
our experience with the ceding companies, familiarity with each
market, the timing of the reported information, an analysis and
understanding of the characteristics of each line of business,
and management’s judgment of the impact of various factors,
including premium or loss trends, on the volume of business
written and ceded to us. On an ongoing basis, our underwriters
review the amounts reported by these third parties for
reasonableness based on their experience and knowledge of the
subject class of business, taking into account our historical
experience with the brokers or ceding companies. In addition,
reinsurance contracts under which we assume business
generally contain specific provisions which allow us to perform
audits of the ceding company to ensure compliance with the
terms and conditions of the contract, including accurate and
timely reporting of information. Based on a review of all
available information, management establishes premium
estimates where reports have not been received. Premium
estimates are updated when new information is received and
differences between such estimates and actual amounts are
recorded in the period in which estimates are changed or the
actual amounts are determined. Premiums written are recorded
based on the type of contracts we write. Premiums on our excess
of loss and pro rata reinsurance contracts are estimated when
the business is underwritten. For excess of loss contracts,
premiums are recorded as written based on the terms of the
contract. Estimates of premiums written under pro rata contracts
are recorded in the period in which the underlying risks incept
and are based on information provided by the brokers and the
ceding companies. For multi-year reinsurance treaties which
are payable in annual installments, generally, only the initial
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2018 FORM 10-K
annual installment is included as premiums written at policy
inception due to the ability of the reinsured to commute or
cancel coverage during the term of the policy. The remaining
annual installments are included as premiums written at each
successive anniversary date within the multi-year term.
Reinstatement premiums for our insurance and reinsurance
operations are recognized at the time a loss event occurs, where
coverage limits for the remaining life of the contract are
reinstated under pre-defined contract terms. Reinstatement
premiums, if obligatory, are fully earned when recognized. The
accrual of reinstatement premiums is based on an estimate of
losses and
reflects
management’s judgment, as described above in “—Reserves
for Losses and Loss Adjustment Expenses.”
loss adjustment expenses, which
The amount of reinsurance premium estimates included in
premiums receivable and the amount of related acquisition
expenses by type of business were as follows at December 31,
2018:
Other specialty
Casualty
Property excluding
property catastrophe
Marine and aviation
Property catastrophe
Other
Total
Gross
Amount
$ 248,580
224,025
104,250
49,072
1,759
80,295
$ 707,981
December 31, 2018
Acquisition
Expenses
$ (59,304)
(71,613)
(32,656)
(13,084)
(103)
(11,673)
$ (188,433)
Net
Amount
$ 189,276
152,412
71,594
35,988
1,656
68,622
$ 519,548
Premium estimates are reviewed by management at least
quarterly. Such review includes a comparison of actual reported
premiums to expected ultimate premiums along with a review
of the aging and collection of premium estimates. Based on
management’s review, the appropriateness of the premium
estimates is evaluated, and any adjustment to these estimates is
recorded in the period in which it becomes known. Adjustments
to premium estimates could be material and such adjustments
could directly and significantly impact earnings favorably or
unfavorably in the period they are determined because the
estimated premium may be fully or substantially earned.
A significant portion of amounts included as premiums
receivable, which represent estimated premiums written, net of
commissions, are not currently due based on the terms of the
underlying contracts. Based on currently available information,
management believes that the premium estimates included in
premiums receivable will be collectible and, therefore, no
provision for doubtful accounts has been recorded on the
premium estimates at December 31, 2018.
Reinsurance premiums assumed, irrespective of the class of
business, are generally earned on a pro rata basis over the terms
of the underlying policies or reinsurance contracts. Contracts
and policies written on a “losses occurring” basis cover claims
that may occur during the term of the contract or policy, which
is typically 12 months. Accordingly, the premium is earned
evenly over the term. Contracts which are written on a “risks
attaching” basis cover claims which attach to the underlying
insurance policies written during the terms of such contracts.
Premiums earned on such contracts usually extend beyond the
original term of the reinsurance contract, typically resulting in
recognition of premiums earned over a 24-month period.
Certain of our reinsurance contracts include provisions that
adjust premiums or acquisition expenses based upon the
experience under the contracts. Premiums written and earned,
as well as related acquisition expenses, are recorded based upon
the projected experience under such contracts.
Retroactive reinsurance reimburses a ceding company for
liabilities incurred as a result of past insurable events covered
by the underlying policies reinsured. In certain instances,
reinsurance contracts cover losses both on a prospective basis
and on a retroactive basis and, accordingly, we bifurcate the
prospective and retrospective elements of these reinsurance
contracts and accounts for each element separately where
practical. Underwriting income generated in connection with
retroactive reinsurance contracts is deferred and amortized into
income over the settlement period while losses are charged to
income immediately. Subsequent changes in estimated amount
or timing of cash flows under such retroactive reinsurance
contracts are accounted for by adjusting the previously deferred
amount to the balance that would have existed had the revised
estimate been available at the inception of the reinsurance
transaction, with a corresponding charge or credit to income.
Mortgage guaranty insurance policies are contracts that are
generally non-cancelable by the insurer, are renewable at a fixed
price, and provide for payment of premiums on a monthly,
annual or single basis. Upon renewal, we are not able to re-
underwrite or re-price our policies. Consistent with industry
accounting practices, premiums written on a monthly basis are
earned as coverage is provided. Premiums written on an annual
basis are amortized on a monthly pro rata basis over the year
of coverage. Primary mortgage insurance premiums written on
policies covering more than one year are referred to as single
premiums. A portion of the revenue from single premiums is
recognized in premiums earned in the current period, and the
remaining portion is deferred as unearned premiums and earned
over the estimated expiration of risk of the policy. If single
premium policies related to insured loans are canceled due to
repayment by the borrower and the policy is a non-refundable
product, the remaining unearned premium related to each
canceled policy is recognized as earned premium upon
notification of the cancellation.
Unearned premiums represent the portion of premiums written
that is applicable to the estimated unexpired risk of insured
loans. A portion of premium payments may be refundable if the
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2018 FORM 10-K
insured cancels coverage, which generally occurs when the loan
is repaid, the loan amortizes to a sufficiently low amount to
trigger a lender permitted or legally required cancellation, or
the value of the property has increased sufficiently in
accordance with the terms of the contract. Premium refunds
reduce premiums earned in the consolidated statements of
income. Generally, only unearned premiums are refundable.
involves significant
mortgage business
reliance upon
assumptions and estimates with regard to the likelihood,
magnitude and timing of potential losses and premium
revenues. The models, assumptions and estimates we use to
evaluate the need for a PDR may prove to be inaccurate,
especially during an extended economic downturn or a period
of extreme market volatility and uncertainty.
Acquisition costs that are directly related and incremental to
the successful acquisition or renewal of business are deferred
and amortized based on the type of contract. For property and
casualty
insurance and reinsurance contracts, deferred
acquisition costs are amortized over the period in which the
related premiums are earned. Consistent with mortgage
insurance industry accounting practice, amortization of
acquisition costs related to the mortgage insurance contracts for
each underwriting year’s book of business is recorded in
proportion to estimated gross profits. Estimated gross profits
are comprised of earned premiums and losses and loss
adjustment expenses. For each underwriting year, we estimate
the rate of amortization to reflect actual experience and any
changes to persistency or loss development.
Acquisition expenses and other expenses related to our
underwriting operations that vary with, and are directly related
to, the successful acquisition or renewal of business are deferred
and amortized based on the type of contract. Our insurance and
reinsurance operations capitalize incremental direct external
costs that result from acquiring a contract but do not capitalize
salaries, benefits and other internal underwriting costs. For our
mortgage insurance operations, which include a substantial
direct sales force, both external and certain internal direct costs
are deferred and amortized. Deferred acquisition costs are
carried at their estimated realizable value and take into account
anticipated losses and loss adjustment expenses, based on
historical and current experience, and anticipated investment
income.
A premium deficiency occurs if the sum of anticipated losses
and loss adjustment expenses, unamortized acquisition costs
and maintenance costs and anticipated investment income
exceed unearned premiums. A premium deficiency reserve
(“PDR”) is recorded by charging any unamortized acquisition
costs to expense to the extent required in order to eliminate the
deficiency. If the premium deficiency exceeds unamortized
acquisition costs then a liability is accrued for the excess
deficiency.
To assess the need for a PDR on our mortgage exposures, we
develop loss projections based on modeled loan defaults related
to our current policies in force. This projection is based on recent
trends in default experience, severity and rates of defaulted
loans moving to claim, as well as recent trends in the rate at
which loans are prepaid, and incorporates anticipated interest
income. Evaluating the expected profitability of our existing
mortgage insurance business and the need for a PDR for our
No premium deficiency charges were recorded by us during
2018, 2017 and 2016.
Fair Value Measurements
Accounting guidance regarding fair value measurements
addresses how companies should measure fair value when they
are required to use a fair value measure for recognition or
disclosure purposes under GAAP and provides a common
definition of fair value to be used throughout GAAP. It defines
fair value as the price that would be received to sell an asset or
paid to transfer a liability in an orderly fashion between market
participants at the measurement date. In addition, it establishes
a three-level valuation hierarchy for the disclosure of fair value
measurements. The valuation hierarchy is based upon the
transparency of inputs to the valuation of an asset or liability
as of the measurement date. The level in the hierarchy within
which a given fair value measurement falls is determined based
on the lowest level input that is significant to the measurement
(Level 1 being the highest priority and Level 3 being the lowest
priority).
We determine the existence of an active market based on our
judgment as to whether transactions for the financial instrument
occur in such market with sufficient frequency and volume to
provide reliable pricing information. The independent pricing
sources obtain market quotations and actual transaction prices
for securities that have quoted prices in active markets. We use
quoted values and other data provided by nationally recognized
independent pricing sources as inputs into our process for
determining fair values of our fixed maturity investments. To
validate the techniques or models used by pricing sources, our
review process includes, but is not limited to: quantitative
analysis (e.g., comparing the quarterly return for each managed
portfolio to their target benchmark, with significant differences
identified and investigated); a review of the average number of
prices obtained in the pricing process and the range of resulting
fair values; initial and ongoing evaluation of methodologies
used by outside parties to calculate fair value; comparing the
fair value estimates to our knowledge of the current market; a
comparison of the pricing services’ fair values to other pricing
services’ fair values for the same investments; and back-testing,
which includes randomly selecting purchased or sold securities
and comparing the executed prices to the fair value estimates
from the pricing service. Where multiple quotes or prices were
obtained, a price source hierarchy was maintained in order to
determine which price source would be used (i.e., a price
obtained from a pricing service with more seniority in the
ARCH CAPITAL
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2018 FORM 10-K
other factors (e.g., interest rates, market conditions, etc.) is
recorded as a component of other comprehensive income or
loss. The amount of the credit loss of an impaired debt security
is the difference between the amortized cost and the greater of
(i) the present value of expected future cash flows and (ii) the
fair value of the security. In instances where no credit loss exists
but it is more likely than not that we will have to sell the debt
security prior to the anticipated recovery, the decline in fair
value below amortized cost is recognized as an OTTI in
earnings. In periods after the recognition of an OTTI on debt
securities, we account for such securities as if they had been
purchased on the measurement date of the OTTI at an amortized
cost basis equal to the previous amortized cost basis less the
OTTI recognized in earnings. For debt securities for which
OTTI were recognized in earnings, the difference between the
new amortized cost basis and the cash flows expected to be
collected will be accreted or amortized into net investment
income.
For 2018, we recorded $2.8 million of credit related
impairments in earnings, compared to $7.1 million in 2017 and
$30.4 million in 2016. See note 8, “Investment Information—
Other-Than-Temporary Impairments,” to our consolidated
financial statements in Item 8 for additional information.
Reclassifications
We have reclassified the presentation of certain prior year
information to conform to the current presentation. Such
reclassifications had no effect on our net income, shareholders’
equity or cash flows.
Recent Accounting Pronouncements
See note 3(q), “Significant Accounting Policies—Recent
Accounting Pronouncements,” to our consolidated financial
statements in Item 8 for disclosures concerning recent
accounting pronouncements.
hierarchy will be used from a less senior one in all cases). The
hierarchy prioritizes pricing services based on availability and
reliability and assigns the highest priority to index providers.
Based on the above review, we will challenge any prices for a
security or portfolio which are considered not to be
representative of fair value.
The independent pricing sources obtain market quotations and
actual transaction prices for securities that have quoted prices
in active markets. Each source has its own proprietary method
for determining the fair value of securities that are not actively
traded. In general, these methods involve the use of “matrix
pricing” in which the independent pricing source uses
observable market inputs including, but not limited to,
investment yields, credit risks and spreads, benchmarking of
like securities, broker-dealer quotes, reported trades and sector
groupings to determine a reasonable fair value. In addition,
pricing vendors use model processes, such as an Option
Adjusted Spread model, to develop prepayment and interest
rate scenarios. The Option Adjusted Spread model is commonly
used to estimate fair value for securities such as mortgage
backed and asset backed securities. In certain circumstances,
when fair values are unavailable from these independent pricing
sources, quotes are obtained directly from broker-dealers who
are active in the corresponding markets. Such quotes are subject
to the validation procedures noted above.
We review our securities measured at fair value and discuss the
proper classification of such investments with investment
advisors and others. See note 9, “Fair Value,” to our
consolidated financial statements in Item 8 for a summary of
our financial assets and liabilities measured at fair value at
December 31, 2018 by valuation hierarchy.
Other-Than-Temporary Impairments
On a quarterly basis, we perform reviews of our investments to
determine whether declines in fair value below the cost basis
are considered other-than-temporary in accordance with
applicable accounting guidance regarding the recognition and
presentation of other-than-temporary impairments (“OTTI”).
The process of determining whether a security is other-than-
temporarily impaired requires judgment and involves analyzing
many factors. These factors include: an analysis of the liquidity,
business prospects and overall financial condition of the issuer;
the time period in which there was a significant decline in value;
the significance of the decline; and the analysis of specific credit
events.
For debt securities, we separate an OTTI into two components
when there are credit related losses associated with the impaired
debt security for which we assert that we do not have the intent
to sell the security, and it is more likely than not that we will
not be required to sell the security before recovery of its cost
basis. The amount of the OTTI related to a credit loss is
recognized in earnings, and the amount of the OTTI related to
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2018 FORM 10-K
FINANCIAL CONDITION
Investable Assets
At December 31, 2018, total investable assets held by Arch
were $19.57 billion, excluding the $2.76 billion included in the
‘other’ segment (i.e., attributable to Watford Re).
Investable Assets Held by Arch
The Finance, Investment and Risk Committee (“FIR”) of our
board of directors establishes our investment policies and sets
the parameters for creating guidelines for our investment
managers. The FIR reviews the implementation of the
investment strategy on a regular basis. Our current approach
stresses preservation of capital, market
liquidity and
diversification of risk. While maintaining our emphasis on
preservation of capital and liquidity, we expect our portfolio to
become more diversified and, as a result, we may expand into
areas which are not currently part of our investment strategy.
Our Chief Investment Officer administers the investment
portfolio, oversees our investment managers and formulates
investment strategy in conjunction with the FIR.
The following table summarizes the fair value of investable
assets held by Arch (i.e., excluding the ‘other’ segment):
Estimated
Fair Value
% of
Total
Investable assets (1):
December 31, 2018
Fixed maturities (2)
Short-term investments (2)
Cash
Equity securities (2)
Other investments (2)
Investments accounted for using the equity
method
Securities transactions entered into but not
settled at the balance sheet date
$ 14,881,902
995,926
583,027
368,843
1,261,525
1,493,791
(18,153)
Total investable assets held by Arch
$ 19,566,861
Average effective duration (in years)
Average S&P/Moody’s credit ratings (3)
Embedded book yield (4)
December 31, 2017
Fixed maturities (2)
Short-term investments (2)
Cash
Equity securities (2)
Other investments (2)
Investments accounted for using the equity
method
Securities transactions entered into but not
settled at the balance sheet date
3.38
AA/Aa2
2.89%
$ 14,798,213
1,509,713
551,696
576,040
1,476,960
1,041,322
(237,523)
Total investable assets held by Arch
$ 19,716,421
Average effective duration (in years)
Average S&P/Moody’s credit ratings (3)
Embedded book yield (4)
2.83
AA-/Aa2
2.32%
76.1
5.1
3.0
1.9
6.4
7.6
(0.1)
100.0
75.1
7.7
2.8
2.9
7.5
5.3
(1.2)
100.0
(1)
(2)
In securities lending transactions, we receive collateral in excess of the
fair value of the securities pledged. For purposes of this table, we have
excluded the collateral received under securities lending, at fair value and
included the securities pledged under securities lending, at fair value.
Includes investments carried as available for sale, at fair value and at fair
value under the fair value option.
(3) Average credit ratings on our investment portfolio on securities with
ratings by Standard & Poor’s Rating Services (“S&P”) and Moody’s
Investors Service (“Moody’s”).
(4) Before investment expenses.
At December 31, 2018, approximately $14.08 billion, or 72%,
of total investable assets held by Arch were internally managed,
compared to $13.73 billion, or 70%, at December 31, 2017.
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2018 FORM 10-K
The following table summarizes our fixed maturities and fixed
maturities pledged under securities lending agreements (“Fixed
Maturities”) by type:
The following table provides information on the severity of the
unrealized loss position as a percentage of amortized cost for
all Fixed Maturities which were in an unrealized loss position:
Severity of gross
unrealized losses:
December 31, 2018
0-10%
10-20%
20-30%
Greater than 30%
Total
December 31, 2017
0-10%
10-20%
20-30%
Greater than 30%
Total
Estimated
Fair Value
Gross
Unrealized
Losses
% of
Total Gross
Unrealized
Losses
$
$
$
$
8,722,837
87,188
3,359
2,363
8,815,747
9,598,768
82,638
2,108
1,881
9,685,395
$
$
$
$
(190,170)
(13,012)
(1,058)
(1,266)
(205,506)
(93,057)
(11,269)
(671)
(1,184)
(106,181)
92.5
6.3
0.5
0.6
100.0
87.6
10.6
0.6
1.1
100.0
The following table summarizes our top ten exposures to fixed
income corporate issuers by fair value at December 31, 2018,
excluding guaranteed amounts and covered bonds:
JPMorgan Chase & Co.
Bank of America Corporation
Wells Fargo & Company
Apple Inc.
Citigroup Inc.
Nestle S.A.
Daimler AG
Morgan Stanley
The Goldman Sachs Group, Inc.
Deere & Company
Total
Estimated
Fair Value
Credit
Rating (1)
$
$
203,200
190,088
171,886
164,486
152,321
114,889
108,692
102,420
94,379
91,792
1,394,153
A-/A1
A-/A3
A/Aa3
AA+/Aa1
A/A2
AA-/Aa2
A/A2
BBB+/A3
BBB+/A3
A/A2
(1) Average credit ratings as assigned by S&P and Moody’s, respectively.
Estimated
Fair Value
% of
Total
December 31, 2018
Corporate bonds
Mortgage backed securities
Municipal bonds
Commercial mortgage backed securities
U.S. government and government agencies
Non-U.S. government securities
Asset backed securities
Total
December 31, 2017
Corporate bonds
Mortgage backed securities
Municipal bonds
Commercial mortgage backed securities
U.S. government and government agencies
Non-U.S. government securities
Asset backed securities
Total
$
5,735,526
535,763
1,012,308
729,442
3,601,269
1,713,891
1,553,703
$ 14,881,902
$
4,787,272
328,924
2,158,840
545,817
3,484,257
1,704,337
1,788,766
$ 14,798,213
38.5
3.6
6.8
4.9
24.2
11.5
10.4
100.0
32.4
2.2
14.6
3.7
23.5
11.5
12.1
100.0
The following table provides the credit quality distribution of
our Fixed Maturities. For individual fixed maturities, S&P
ratings are used. In the absence of an S&P rating, ratings from
Moody’s are used, followed by ratings from Fitch Ratings.
December 31, 2018
U.S. government and gov’t agencies (1)
AAA
AA
A
BBB
BB
B
Lower than B
Not rated
Total
December 31, 2017
U.S. government and gov’t agencies (1)
AAA
AA
A
BBB
BB
B
Lower than B
Not rated
Total
Estimated
Fair Value
% of
Total
$
4,194,676
3,551,039
2,129,336
3,069,656
1,251,205
275,201
183,614
61,271
165,904
$ 14,881,902
$
3,771,835
4,080,808
2,440,864
2,470,936
1,157,136
313,286
254,011
77,543
231,794
$ 14,798,213
28.2
23.9
14.3
20.6
8.4
1.8
1.2
0.4
1.1
100.0
25.5
27.6
16.5
16.7
7.8
2.1
1.7
0.5
1.6
100.0
(1)
Includes U.S. government-sponsored agency mortgage backed
securities and agency commercial mortgage backed securities.
ARCH CAPITAL
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2018 FORM 10-K
The following table provides information on our structured
residential mortgage-backed
securities, which
securities (RMBS), commercial mortgage-backed securities
(CMBS) and asset backed securities (“ABS”):
include
Agencies
Investment
Grade
Below
Investment
Grade
Total
Dec. 31, 2018
RMBS
CMBS
ABS
Total
Dec. 31, 2017
RMBS
CMBS
ABS
Total
$
$
$
$
488,862
104,547
—
593,409
$
15,410
602,865
1,485,150
$ 2,103,425
284,466
3,112
—
287,578
$
14,581
465,980
1,691,232
$ 2,171,793
$
$
$
$
31,491
22,030
68,553
122,074
$
535,763
729,442
1,553,703
$ 2,818,908
29,877
76,725
97,534
204,136
$
328,924
545,817
1,788,766
$ 2,663,507
The following table provides information on the fair value of
our Eurozone investments at December 31, 2018:
Country (1)
Germany
Netherlands
France
Luxembourg
Spain
Ireland
Finland
Italy
Austria
Portugal
Greece
Supranational (4)
Estonia
Total
Sovereign
(2)
Corporate
Bonds
Other
(3)
$ 338,409
77,088
—
—
—
—
—
—
—
—
74
—
—
$ 415,571
$
3,119
143,308
33,080
10,858
1,324
4,727
4,349
—
—
—
—
—
—
$ 200,765
$
45,834
23,420
31,442
12,555
8,144
1,482
1,821
1,748
1,122
897
496
—
—
$ 128,961
Total
$ 387,362
243,816
64,522
23,413
9,468
6,209
6,170
1,748
1,122
897
570
—
—
$ 745,297
(1)
(2)
(3)
The country allocations set forth in the table are based on various
assumptions made by us in assessing the country in which the underlying
credit risk resides, including a review of the jurisdiction of organization,
business operations and other factors. Based on such analysis, we do
not believe that we have any other Eurozone investments at
December 31, 2018.
Includes securities issued and/or guaranteed by Eurozone governments.
Includes bank loans, equities and other.
At December 31, 2018, our investment portfolio included
$368.8 million of equity securities, compared to $576.0 million
at December 31, 2017. Our equity portfolio includes publicly
traded common stocks in the natural resources, energy,
consumer staples and other sectors.
The following table summarizes our other investments:
Available for sale securities:
Asia and emerging markets
Investment grade fixed income
Credit related funds
Other
Total available for sale (1)
Fair value option:
Term loan investments (par value:
$288,841 and $326,339)
Lending
Credit related funds
Energy
Investment grade fixed income
Infrastructure
Private equity
Real estate
Total fair value option
Total
December 31,
2018
2017
$
— $
—
—
—
—
135,140
53,878
18,365
57,606
264,989
281,635
326,085
524,112
152,361
117,509
101,902
45,371
24,383
14,252
1,261,525
$ 1,261,525
399,099
132,131
132,709
102,347
82,291
23,593
13,716
1,211,971
$ 1,476,960
(1) The Company reviewed the accounting treatment for three limited
partnership investments which were accounted for as available for sale
at December 31, 2017 during the 2018 first quarter and determined, based
on reconsideration during the period of the Company’s percentage
ownership, that the equity method of accounting was appropriate for such
investments.
The following table summarizes our investments accounted for
using the equity method:
Credit related funds
Equities
Real estate
Lending
Private equity
Infrastructure
Energy
Total
December 31,
$
2018
429,402
375,273
232,647
125,041
114,019
113,748
103,661
$ 1,493,791
$
2017
263,034
292,762
176,328
66,093
96,310
99,338
47,457
$ 1,041,322
Our investment strategy allows for the use of derivative
instruments. We utilize various derivative instruments such as
futures contracts to enhance investment performance, replicate
investment positions or manage market exposures and duration
risk that would be allowed under our investment guidelines if
implemented in other ways. See note 10, “Derivative
Instruments,” to our consolidated financial statements in Item
8 for additional disclosures concerning derivatives.
Accounting guidance regarding fair value measurements
addresses how companies should measure fair value when they
are required to use a fair value measure for recognition or
disclosure purposes under GAAP and provides a common
definition of fair value to be used throughout GAAP. See note
9, “Fair Value,” to our consolidated financial statements in Item
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2018 FORM 10-K
8 for a summary of our financial assets and liabilities measured
at fair value at December 31, 2018 and 2017 segregated by level
in the fair value hierarchy.
The following table details our reinsurance recoverables at
December 31, 2018:
Investable Assets in the ‘Other’ Segment
Investable assets in the ‘other’ segment are managed by Watford
Re. The board of directors of Watford Re establishes their
investment policies and guidelines. Watford Re’s investments
are accounted for using the fair value option with changes in
the carrying value of such investments recorded in net realized
gains or losses.
The following table summarizes investable assets in the ‘other’
segment:
Investments accounted for using the fair
value option:
Other investments
Fixed maturities
Short-term investments
Equity securities
Total
Fixed maturities available for sale, at fair
value
Equity securities
Cash
Securities sold but not yet purchased
Securities transactions entered into but
not settled at the balance sheet date
December 31,
2018
2017
$
1,050,414
922,819
282,131
56,638
2,312,002
$
924,410
1,177,033
256,755
67,868
2,426,066
393,351
32,206
63,529
(7,790)
—
—
54,503
(34,375)
(35,635)
(6,127)
Total investable assets included in ‘other’
segment
$
2,757,663
$
2,440,067
Reinsurance Recoverables
At December 31, 2018 and 2017, approximately 63.0% and
69.9% of reinsurance recoverables on paid and unpaid losses
(not including ceded unearned premiums) of $2.92 billion and
$2.54 billion, respectively, were due from carriers which had
an A.M. Best rating of “A-” or better while 37.0% and 30.1%,
respectively, were from companies not rated. For items not
rated, over 90% of such amount was collateralized through
reinsurance trusts or letters of credit at December 31, 2018 and
2017. The largest reinsurance recoverables from any one carrier
was approximately 2.7% and 2.2%, respectively, of total
shareholders’ equity available to Arch at December 31, 2018
and 2017.
% of Total
A.M. Best
Rating (1)
Everest Reinsurance Company
Munich Reinsurance America, Inc.
Hannover Rückversicherung AG
Swiss Reinsurance America Corporation
XL Catlin plc
Partner Reinsurance Company of the U.S.
Transatlantic Reinsurance Company
Berkley Insurance Company
Lloyd’s syndicates (2)
Liberty Mutual Insurance Company
Renaissance Reinsurance
All other -- fully collateralized reinsurers (3)
All other -- “A-” or better
All other -- not rated (4)
Total
6.4
5.1
4.7
4.3
4.1
4.1
3.4
3.1
2.9
2.5
2.2
12.9
20.0
24.3
100.0
A+
A+
A+
A+
A+
A
A+
A+
A
A
A
NR
(1) The financial strength ratings are as of February 4, 2019 and were assigned
by A.M. Best based on its opinion of the insurer’s financial strength as
of such date. An explanation of the ratings listed in the table follows: the
rating of “A+” is designated “Superior”; and the “A” rating is designated
“Excellent.”
(2) The A.M. Best group rating of “A” (Excellent) has been applied to all
Lloyd’s syndicates.
(3) Such amount is fully collateralized through reinsurance trusts.
(4) Over 90% of such amount is collateralized through reinsurance trusts or
letters of credit.
Reserves for Losses and Loss Adjustment Expenses
We establish reserves for losses and LAE (Loss Reserves)
which represent estimates involving actuarial and statistical
projections, at a given point in time, of our expectations of the
ultimate settlement and administration costs of losses incurred.
Estimating Loss Reserves is inherently difficult, which is
exacerbated by the fact that we have relatively limited historical
experience upon which to base such estimates. We utilize
actuarial models as well as available historical insurance
industry loss ratio experience and loss development patterns to
assist in the establishment of Loss Reserves. Actual losses and
loss adjustment expenses paid will deviate, perhaps
substantially, from the reserve estimates reflected in our
financial statements. See “Management’s Discussion and
Analysis of Financial Condition and Results of Operations—
Critical Accounting Policies, Estimates and Recent Accounting
Pronouncements—Reserves for Losses and Loss Adjustment
Expenses” and “Business—Reserves” for further details.
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2018 FORM 10-K
Shareholders’ Equity and Book Value per Share
Total shareholders’ equity available to Arch was $9.44 billion
at December 31, 2018, compared
to $9.20 billion at
December 31, 2017. The increase in 2018 was primarily
attributable to underwriting results, partially offset by share
repurchases.
The following table presents the calculation of book value per
share:
(U.S. dollars in thousands, except share
data)
Total shareholders’ equity available to
Arch
Less preferred shareholders’ equity
Common shareholders’ equity available to
Arch
Common shares and common share
equivalents outstanding, net of treasury
shares (1)
Book value per share
December 31,
2018
2017
$
9,439,827
$
9,196,602
780,000
872,555
$
8,659,827
$
8,324,047
402,454,834
409,956,417
$
21.52
$
20.30
(1) Excludes the effects of 20,076,593 and 19,770,174 stock options and
1,307,304 and 913,488 restricted stock units outstanding at December 31,
2018 and 2017, respectively.
LIQUIDITY
This section does not include information specific to Watford
Re. We do not guarantee or provide credit support for Watford
Re, and our financial exposure to Watford Re is limited to our
investment in Watford Re’s common and preferred shares and
counterparty credit risk (mitigated by collateral) arising from
reinsurance transactions with Watford Re.
Liquidity is a measure of our ability to access sufficient cash
flows to meet the short-term and long-term cash requirements
of our business operations.
Arch Capital is a holding company whose assets primarily
consist of the shares in its subsidiaries. Generally, Arch Capital
depends on its available cash resources, liquid investments and
dividends or other distributions from its subsidiaries to make
payments, including the payment of debt service obligations
and operating expenses it may incur and any dividends or
liquidation amounts with respect to our preferred and common
shares.
In 2018, Arch Capital received dividends of $398.7 million
from Arch Re Bermuda, our Bermuda-based reinsurer and
insurer. In 2018, Arch-U.S. received $25.0 million of dividends
from Arch Re U.S., our U.S. licensed reinsurer, and $525.0
million of dividends from Arch U.S. MI Holdings. Arch U.S.
MI Holdings received aggregate dividends and return of capital
from subsidiaries of $971.1 million in 2018. Arch U.S. MI
Holdings used such proceeds to pay down $375.0 million of its
revolving credit agreement borrowings and pay dividends to
Arch-U.S.
Our insurance and reinsurance operations provide liquidity in
that premiums are received in advance, sometimes substantially
in advance, of the time losses are paid. The period of time from
the occurrence of a claim through the settlement of the liability
may extend many years into the future. Sources of liquidity
include cash flows from operations, financing arrangements or
routine sales of investments.
As part of our investment strategy, we seek to establish a level
of cash and highly liquid short-term and intermediate-term
securities which, combined with expected cash flow, is believed
by us to be adequate to meet our foreseeable payment
obligations. However, due to the nature of our operations, cash
flows are affected by claim payments that may comprise large
payments on a limited number of claims and which can fluctuate
from year to year. We believe that our liquid investments and
cash flow will provide us with sufficient liquidity in order to
meet our claim payment obligations. However, the timing and
amounts of actual claim payments related to recorded Loss
Reserves vary based on many factors, including large individual
losses, changes in the legal environment, as well as general
market conditions. The ultimate amount of the claim payments
could differ materially from our estimated amounts. Certain
lines of business written by us, such as excess casualty, have
loss experience characterized as low frequency and high
severity. The foregoing may result in significant variability in
loss payment patterns. The impact of this variability can be
exacerbated by the fact that the timing of the receipt of
reinsurance recoverables owed to us may be slower than
anticipated by us. Therefore, the irregular timing of claim
payments can create significant variations in cash flows from
operations between periods and may require us to utilize other
sources of liquidity to make these payments, which may include
the sale of investments or utilization of existing or new credit
facilities or capital market transactions. If the source of liquidity
is the sale of investments, we may be forced to sell such
investments at a loss, which may be material.
We expect that our liquidity needs, including our anticipated
insurance obligations and operating and capital expenditure
needs, for the next twelve months, at a minimum, will be met
by funds generated from underwriting activities and investment
income, as well as by our balance of cash, short-term
investments, proceeds on the sale or maturity of our
investments, and our credit facilities.
ARCH CAPITAL
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2018 FORM 10-K
Dividend Restrictions
Arch Capital has no material restrictions on its ability to make
distributions to shareholders, however the ability of our
regulated insurance and reinsurance subsidiaries to pay
dividends or make distributions or other payments to us is
limited by the applicable local laws and relevant regulations of
the various countries and states in which we operate. See note
23, “Statutory Information,” to our consolidated financial
statements in Item 8 for additional information on dividend
restrictions.
The payment of dividends from Arch Re Bermuda is, under
certain circumstances, limited under Bermuda law, which
requires our Bermuda operating subsidiary to maintain certain
measures of solvency and liquidity.
Our U.S. insurance and reinsurance subsidiaries are subject to
insurance laws and regulations in the jurisdictions in which they
operate. The ability of our regulated insurance subsidiaries to
pay dividends or make distributions is dependent on their ability
to meet applicable regulatory standards. These regulations
include restrictions that limit the amount of dividends or other
distributions, such as loans or cash advances, available to
shareholders without prior approval of the insurance regulatory
authorities. Each state requires prior regulatory approval of any
payment of extraordinary dividends.
We also have insurance subsidiaries that are the parent company
for other insurance subsidiaries, which means that dividends
and other distributions will be subject to multiple layers of
regulations in order for our insurance subsidiaries to be able to
dividend funds to Arch Capital. The inability of the subsidiaries
of Arch Capital to pay dividends and other permitted
distributions could have a material adverse effect on Arch
Capital’s cash requirements and our ability to make principal,
interest and dividend payments on the senior notes, preferred
shares and common shares.
In addition to meeting applicable regulatory standards, the
ability of our insurance and reinsurance subsidiaries to pay
dividends is also constrained by our dependence on the financial
strength ratings of our insurance and reinsurance subsidiaries
from independent rating agencies. The ratings from these
agencies depend to a large extent on the capitalization levels of
our insurance and reinsurance subsidiaries. We believe that
Arch Capital has sufficient cash resources and available
dividend capacity to service its indebtedness and other current
outstanding obligations.
Restricted Assets
insurance,
reinsurance and mortgage
Our
insurance
subsidiaries are required to maintain assets on deposit, which
primarily consist of fixed maturities, with various regulatory
authorities to support their operations. The assets on deposit are
available to settle insurance and reinsurance liabilities to third
parties. Our insurance and reinsurance subsidiaries maintain
assets in trust accounts as collateral for insurance and
reinsurance transactions with affiliated companies and also
have investments in segregated portfolios primarily to provide
collateral or guarantees for letters of credit to third parties. At
December 31, 2018 and 2017, such amounts approximated
$6.76 billion and $6.01 billion, respectively, excluding amounts
related to the ‘other’ segment.
Our investments in certain securities, including certain fixed
income and structured securities, investments in funds
accounted for using the equity method, other alternative
investments and investments in ventures such as Watford Re
and others may be illiquid due to contractual provisions or
investment market conditions. If we require significant amounts
of cash on short notice in excess of anticipated cash
requirements, then we may have difficulty selling these
investments in a timely manner or may be forced to sell or
terminate them at unfavorable values. Our unfunded investment
commitments
totaled approximately $1.77 billion at
December 31, 2018 and are callable by our investment
managers. The
investment
commitments is uncertain and may require us to access cash on
short notice.
the funding of
timing of
Cash Flows
The following table summarizes our cash flows from operating,
investing and financing activities, excluding amounts related
to the ‘other’ segment:
Year Ended December 31,
2017
2018
2016
Total cash provided by
(used for):
Operating activities
Investing activities
Financing activities
Effects of exchange rate
changes on foreign currency
cash
$ 1,331,278
(268,734)
(987,679)
$
809,580
(884,452)
(166,829)
$ 1,103,529
(2,597,738)
1,830,042
(16,383)
15,584
(14,005)
Increase (decrease) in cash
$
58,482
$ (226,117) $
321,828
• Cash provided by operating activities for 2018 was higher
than in 2017, primarily reflecting an increase in premiums
collected, a lower level of net losses paid and lower purchases
of tax and loss bonds. The 2017 period reflected a higher level
of paid losses and purchases of tax and loss bonds, while 2016
reflected lower net losses paid.
• Cash used for investing activities for 2018 was lower than
in 2017, reflecting changes in cash collateral related to
securities lending for both. Activity for 2016 reflected our
acquisition of UGC, which closed on December 31, 2016.
• Cash used for financing activities for 2018 was higher than
the cash used in 2017, reflecting share repurchases of $282.8
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2018 FORM 10-K
million, a $375 million repayment of borrowing on our
revolving credit and changes in cash collateral related to
securities lending. Activity for 2017 reflected changes in cash
collateral related to securities lending and a $125 million
repayment of borrowing on our revolving credit agreement.
Cash provided by financing activities for 2016 reflected various
capital raising activity, such as the issuance of $950.0 million
of senior notes and $450.0 million of preferred shares combined
with $400.0 million of borrowings under our revolving credit
facility in order to fund some of the cash consideration portion
of the UGC acquisition.
CAPITAL RESOURCES
This section does not include information specific to Watford
Re. We do not guarantee or provide credit support for Watford
Re, and our financial exposure to Watford Re is limited to our
investment in Watford Re’s common and preferred shares and
counterparty credit risk (mitigated by collateral) arising from
reinsurance transactions with Watford Re.
Investments
The following table provides an analysis of our capital structure:
At December 31, 2018, our investable assets were $19.57
billion, excluding the $2.76 billion of investable assets related
to the ‘other’ segment. The primary goals of our asset liability
management process are to satisfy the insurance liabilities,
manage the interest rate risk embedded in those insurance
liabilities and maintain sufficient liquidity to cover fluctuations
in projected liability cash flows, including debt service
obligations. Generally, the expected principal and interest
payments produced by our fixed income portfolio adequately
fund the estimated runoff of our insurance reserves. Although
this is not an exact cash flow match in each period, the
substantial degree by which the fair value of the fixed income
portfolio exceeds the expected present value of the net insurance
liabilities, as well as the positive cash flow from newly sold
policies and the large amount of high quality liquid bonds,
provide assurance of our ability to fund the payment of claims
and to service our outstanding debt without having to sell
securities at distressed prices or access credit facilities.
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, could
have a material adverse effect on financial markets and
economic conditions in the U.S. and throughout the world. In
turn, this could have a material adverse effect on our business,
financial condition and results of operations and, in particular,
this could have a material adverse effect on the value and
liquidity of securities in our investment portfolio. Our
investment portfolio as of December 31, 2018 included $415.6
million of securities issued and/or guaranteed by Eurozone
governments at fair value, $3.60 billion of obligations of the
U.S. government and government agencies at fair value and
$1.01 billion of municipal bonds at fair value. Please refer to
Item 1A “Risk Factors” for a discussion of other risks relating
to our business and investment portfolio.
(U.S. dollars in thousands, except
share data)
December 31,
2018
2017
Debt:
Senior notes, due May 2034
Arch-U.S. senior notes, due Nov 2043 (1)
Arch Finance senior notes, due Dec 2026 (1)
$
Arch Finance senior notes, due Dec 2046 (1)
$
300,000
500,000
500,000
450,000
300,000
500,000
500,000
450,000
Deferred debt issuance costs on senior notes
(16,472)
(17,116)
Revolving credit agreement borrowings due
Oct 2021 (2)
Total
—
375,000
$ 1,733,528
$ 2,107,884
Shareholders’ equity available to Arch:
Series C non-cumulative preferred shares (3)
Series E non-cumulative preferred shares
Series F non-cumulative preferred shares
Common shareholders’ equity
Total
—
450,000
330,000
8,659,827
$ 9,439,827
92,555
450,000
330,000
8,324,047
$ 9,196,602
Total capital available to Arch
$11,173,355
$11,304,486
Senior notes to total capital (%)
Revolving credit agreement borrowings to
total capital (%)
Debt to total capital (%)
Preferred to total capital (%)
Debt and preferred to total capital (%)
15.5
—
15.5
7.0
22.5
15.3
3.3
18.6
7.7
26.4
(1) Fully and unconditionally guaranteed by Arch Capital.
(2) $500 million unsecured facility for revolving loans and letters of credit.
(3) Redeemed on January 2, 2018.
Arch Capital and Arch-U.S. are each holding companies and,
accordingly, they conduct substantially all of their operations
through their operating subsidiaries. Arch Capital Finance LLC
(“Arch Finance”) is a wholly owned subsidiary of Arch U.S.
MI Holdings Inc., a U.S. holding company. As a result, Arch
Capital, Arch-U.S. and Arch Finance's cash flows and their
ability to service their debt depends upon the earnings of their
operating subsidiaries and on their ability to distribute the
earnings, loans or other payments from such subsidiaries to
Arch Capital, Arch-U.S. and Arch Finance, respectively.
See note 17, “Debt and Financing Arrangements,” to our
consolidated financial statements in Item 8 for additional
disclosures concerning our senior notes and revolving credit
ARCH CAPITAL
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2018 FORM 10-K
agreement borrowings. For additional information on our
preferred shares, see note 19, “Shareholders’ Equity,” to our
consolidated financial statements in Item 8.
During 2018, 2017 and 2016, we made interest payments of
$100.1 million, $103.7 million and $50.4 million, respectively,
related to our senior notes and other financing arrangements.
In November 2017, Arch Capital, Arch-U.S. and Arch Finance
filed a universal shelf registration statement with the SEC. This
registration statement allows for the possible future offer and
sale by us of various types of securities, including unsecured
debt securities, preference shares, common shares, warrants,
share purchase contracts and units and depositary shares. The
shelf registration statement enables us to efficiently access the
public debt and/or equity capital markets in order to meet our
future capital needs. The shelf registration statement also allows
selling shareholders to resell common shares that they own in
one or more offerings from time to time. We will not receive
any proceeds from any shares offered by the selling
shareholders.
Capital Adequacy
We monitor our capital adequacy on a regular basis and will
seek to adjust our capital base (up or down) according to the
needs of our business. The future capital requirements of our
business will depend on many factors, including our ability to
write new business successfully and to establish premium rates
and reserves at levels sufficient to cover losses. Our ability to
underwrite is largely dependent upon the quality of our claims
paying and financial strength ratings as evaluated by
independent rating agencies. In particular, we require (1)
sufficient capital to maintain our financial strength ratings, as
issued by several ratings agencies, at a level considered
necessary by management to enable our key operating
subsidiaries to compete; (2) sufficient capital to enable our
underwriting subsidiaries to meet the capital adequacy tests
performed by statutory agencies in the U.S. and other key
markets; and (3) our non-U.S. operating companies are required
to post letters of credit and other forms of collateral that are
necessary for them to operate as they are “non-admitted” under
U.S. state insurance regulations.
In addition, Arch MI U.S. is required to maintain compliance
with the GSEs requirements, known as the Private Mortgage
Insurer Eligibility Requirements or “PMIERs.” The financial
requirements require an eligible mortgage insurer’s available
assets, which generally include only the most liquid assets of
an insurer, to meet or exceed “minimum required assets” as of
each quarter end. Minimum required assets are calculated from
PMIERs tables with several risk dimensions (including
origination year, original loan-to-value and original credit score
of performing loans, and the delinquency status of non-
performing loans) and are subject to a minimum amount. Arch
MI U.S. satisfied the PMIERs’ financial requirements as of
December 31, 2018 with a PMIER sufficiency ratio of 141%,
compared to 129% at December 31, 2017.
As part of our capital management program, we may seek to
raise additional capital or may seek to return capital to our
shareholders through share repurchases, cash dividends or other
methods (or a combination of such methods). Any such
determination will be at the discretion of our board of directors
and will be dependent upon our profits, financial requirements
and other factors, including legal restrictions, rating agency
requirements and such other factors as our board of directors
deems relevant.
To the extent that our existing capital is insufficient to fund our
future operating requirements or maintain such ratings, we may
need to raise additional funds through financings or limit our
growth. We can provide no assurance that, if needed, we would
be able to obtain additional funds through financing on
satisfactory terms or at all. Any adverse developments in the
financial markets, such as disruptions, uncertainty or volatility
in the capital and credit markets, may result in realized and
unrealized capital losses that could have a material adverse
effect on our results of operations, financial position and our
businesses, and may also limit our access to capital required to
operate our business. In addition to common share capital, we
depend on external sources of finance to support our
underwriting activities, which can be in the form (or any
combination) of debt securities, preference shares, common
equity and bank credit facilities providing loans and/or letters
of credit.
Arch Capital, through its subsidiaries, provides financial
support to certain of its insurance subsidiaries and affiliates,
through certain reinsurance arrangements beneficial to the
ratings of such subsidiaries. Historically, our U.S.-based
insurance, reinsurance and mortgage insurance subsidiaries
have entered into separate reinsurance arrangements with Arch
Re Bermuda covering individual lines of business. The
reinsurance agreements between our U.S.-based property
casualty insurance and reinsurance subsidiaries and Arch Re
Bermuda were canceled on a cutoff basis as of January 1, 2018.
As a result, the level of subject business ceded to Arch Re
Bermuda was substantially lower in 2018 than in prior periods.
Except as described in the above paragraph, or where express
reinsurance, guarantee or other financial support contractual
arrangements are in place, each of Arch Capital’s subsidiaries
or affiliates is solely responsible for its own liabilities and
commitments (and no other Arch Capital subsidiary or affiliate
is so responsible). Any reinsurance arrangements, guarantees
or other financial support contractual arrangements that are in
place are solely for the benefit of the Arch Capital subsidiary
or affiliate involved and third parties (creditors or insureds of
such entity) are not express beneficiaries of such arrangements.
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2018 FORM 10-K
Share Repurchase Program
The board of directors of Arch Capital has authorized the
investment in Arch Capital’s common shares through a share
repurchase program. Since the inception of the share repurchase
program through December 31, 2018, Arch Capital has
repurchased approximately 386.2 million common shares for
an aggregate purchase price of $3.97 billion. At December 31,
2018, approximately $163.7 million of share repurchases were
available under the program. Repurchases under the program
may be effected from time to time in open market or privately
negotiated transactions through December 31, 2019. 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. We will continue
to monitor our share price and, depending upon results of
operations, market conditions and the development of the
economy, as well as other factors, we will consider share
repurchases on an opportunistic basis.
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2018 FORM 10-K
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
This section does not include information specific to Watford Re. We do not guarantee or provide credit support for Watford Re,
and our financial exposure to Watford Re is limited to our investment in Watford Re’s common and preferred shares and counterparty
credit risk (mitigated by collateral) arising from reinsurance transactions with Watford Re.
Contractual Obligations
The following table provides an analysis of our contractual commitments at December 31, 2018:
Operating activities
Estimated gross payments for losses and loss adjustment expenses (1)
Deposit accounting liabilities (2)
Contractholder payables (3)
Operating lease obligations
Purchase obligations
Contingent consideration liabilities (4)
Investing activities
Unfunded investment commitments (5)
Financing activities
Securities lending payable (6)
Senior notes (including interest payments)
Capital lease obligations
Total contractual obligations and commitments
Total
2019
Payment due by period
2020 and
2021
2022 and
2023
Thereafter
$ 10,820,538
15,739
2,079,111
193,151
39,471
68,215
$ 2,782,107
7,640
674,417
31,088
23,224
58,000
$ 3,247,828
1,149
720,908
59,842
15,925
10,215
$ 1,719,215
1,625
288,657
47,476
315
—
$ 3,071,388
5,325
395,129
54,745
7
—
1,765,282
1,765,282
—
—
—
274,125
3,525,752
13,070
$ 18,794,454
274,125
90,465
6,204
$ 5,712,552
—
180,929
6,866
$ 4,243,662
—
180,929
—
$ 2,238,217
—
3,073,429
—
$ 6,600,023
(1) The estimated expected contractual commitments related to the reserves for losses and loss adjustment expenses are presented on a gross basis (i.e., not
reflecting any corresponding reinsurance recoverable amounts that would be due to us). It should be noted that until a claim has been presented to us,
determined to be valid, quantified and settled, there is no known obligation on an individual transaction basis, and while estimable in the aggregate, the
timing and amount contain significant uncertainty.
(2) The estimated expected contractual commitments related to deposit accounting liabilities have been estimated using projected cash flows from the underlying
contracts. It should be noted that, due to the nature of such liabilities, the timing and amount contain significant uncertainty.
(3) Certain insurance policies written by our insurance operations feature large deductibles, primarily in construction and national accounts lines. Under such
contracts, we are obligated to pay the claimant for the full amount of the claim and are subsequently reimbursed by the policyholder for the deductible amount.
In the event we are unable to collect from the policyholder, we would be liable for such defaulted amounts.
(4) Pursuant to our 2014 acquisition of the CMG Entities, we are required to make remaining contingent consideration payments as re-calculated over an earn-
out period. For purposes of this table, the maximum exposure has been shown using an estimated payout pattern.
(5) Unfunded investment commitments are callable by our investment managers. We have assumed that such investments will be funded in the next year but
the funding may occur over a longer period of time, due to market conditions and other factors.
(6) As part of our securities lending program, we loan securities to third parties and receive collateral in the form of cash or securities. Such collateral is due
back to the third parties at the close of the securities lending transactions, a majority of which is overnight and continuous by nature.
Letter of Credit and Revolving Credit Facilities
In the normal course of its operations, the Company enters into
agreements with financial institutions to obtain secured and
unsecured credit facilities.
On October 26, 2016, Arch Capital and certain of its subsidiaries
entered into an $850.0 million five-year credit facility (the
“Credit Facility”) with a syndication of lenders. The Credit
Facility consists of a $350.0 million secured facility for letters
of credit (the “Secured Facility”) and a $500.0 million
unsecured facility for revolving loans and letters of credit (the
“Unsecured Facility”). Obligations of each borrower under the
Secured Facility for letters of credit are secured by cash and
eligible securities of such borrower held in collateral
accounts. Subject to the receipt of commitments, the Secured
Facility may be increased by up to an aggregate of $350.0
million, and the Unsecured Facility may be increased to an
amount not to exceed $750.0 million. Arch Capital has a one-
time option to convert any or all outstanding revolving loans
of Arch Capital and/or Arch-U.S. to term loans with the same
terms as the revolving loans except that any prepayments may
not be re-borrowed. Arch-U.S. guarantees the obligations of
Arch Capital, and Arch Capital guarantees the obligations of
Arch-U.S. Borrowings of revolving loans may be made at a
variable rate based on LIBOR or an alternative base rate at the
option of Arch Capital. Secured letters of credit are available
for issuance on behalf of Arch Capital insurance and
reinsurance subsidiaries. The Credit Facility is structured such
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2018 FORM 10-K
that each party that requests a letter of credit or borrowing does
so only for itself and for only its own obligations.
have assigned financial strength ratings to one or more of Arch
Capital’s subsidiaries.
The Credit Facility contains certain restrictive covenants
customary for facilities of this type, including restrictions on
indebtedness, consolidated tangible net worth, minimum
shareholders’ equity levels and minimum financial strength
ratings. Arch Capital and its subsidiaries which are party to the
agreement were in compliance with all covenants contained
therein at December 31, 2018.
Commitments under the Credit Facility will expire on October
26, 2021, and all loans then outstanding must be repaid. Letters
of credit issued under the Unsecured Facility will not have an
expiration date later than October 26, 2022.
Under the $350.0 million secured letter of credit facility, Arch
Capital’s subsidiaries had $174.8 million of letters of credit
outstanding and remaining capacity of $175.2 million at
December 31, 2018. In addition, certain of Arch Capital’s
subsidiaries had outstanding letters of credit of $167.5 million,
which were issued in the normal course of business. When
issued, these letters of credit are secured by a portion of the
investment portfolio. At December 31, 2018, these letters of
credit were secured by investments with a fair value of $362.0
million.
The Company’s outstanding revolving credit agreement
borrowings were as follows:
Year Ended December 31,
2017
2018
Arch-U.S.
Total revolving credit
agreement borrowings
$
$
— $
375,000
— $
375,000
RATINGS
Our ability to underwrite business is affected by the quality of
our claims paying ability and financial strength ratings as
evaluated by independent agencies. Such ratings from third
party internationally recognized statistical rating organizations
or agencies are instrumental in establishing the financial
security of companies in our industry. We believe that the
primary users of such ratings include commercial and
investment banks, policyholders, brokers, ceding companies
and investors. Insurance ratings are also used by insurance and
reinsurance intermediaries as an important means of assessing
the financial strength and quality of insurers and reinsurers, and
are often an important factor in the decision by an insured or
intermediary of whether to place business with a particular
insurance or reinsurance provider. Periodically, rating agencies
evaluate us to confirm that we continue to meet their criteria
for the ratings assigned to us by them. S&P, Moody’s, A.M.
Best Company and Fitch Ratings are ratings agencies which
If we are not able to obtain adequate capital, our business, results
of operations and financial condition could be adversely
affected, which could include, among other things, the
following possible outcomes: (1) potential downgrades in the
financial strength ratings assigned by ratings agencies to our
operating subsidiaries, which could place those operating
subsidiaries at a competitive disadvantage compared to higher-
rated competitors; (2) reductions in the amount of business that
our operating subsidiaries are able to write in order to meet
capital adequacy-based tests enforced by statutory agencies;
and (3) any resultant ratings downgrades could, among other
things, affect our ability to write business and increase the cost
of bank credit and letters of credit. In addition, under certain of
the reinsurance agreements assumed by our reinsurance
operations, upon the occurrence of a ratings downgrade or other
specified triggering event with respect to our reinsurance
operations, such as a reduction in surplus by specified amounts
during specified periods, our ceding company clients may be
provided with certain rights, including, among other things, the
right to terminate the subject reinsurance agreement and/or to
require that our reinsurance operations post additional
collateral.
The ratings issued on our companies by these agencies are
announced publicly and are available directly from the
agencies. Our Internet site (www.ir.archcapgroup.com, under
Credit Ratings) contains information about our ratings, but such
information on our website is not incorporated by reference into
this report.
CATASTROPHIC EVENTS AND SEVERE ECONOMIC
EVENTS
We have large aggregate exposures to natural and man-made
catastrophic events and severe economic events. Catastrophes
can be caused by various events, including hurricanes, floods,
windstorms, earthquakes, hailstorms, tornadoes, explosions,
severe winter weather, fires, droughts and other natural
disasters. Catastrophes can also cause losses in non-property
business such as mortgage insurance, workers’ compensation
or general liability. In addition to the nature of property
business, we believe that economic and geographic trends
affecting insured property, including inflation, property value
appreciation and geographic concentration, tend to generally
increase the size of losses from catastrophic events over time.
We have substantial exposure to unexpected, large losses
resulting from future man-made catastrophic events, such as
acts of war, acts of terrorism and political instability. These risks
are inherently unpredictable. It is difficult to predict the timing
of such events with statistical certainty or estimate the amount
of loss any given occurrence will generate. It is not possible to
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2018 FORM 10-K
completely eliminate our exposure
to unforecasted or
unpredictable events and, to the extent that losses from such
risks occur, our financial condition and results of operations
could be materially adversely affected. Therefore, claims for
natural and man-made catastrophic events could expose us to
large losses and cause substantial volatility in our results of
operations, which could cause the value of our common shares
to fluctuate widely. In certain instances, we specifically insure
and reinsure risks resulting from terrorism. Even in cases where
we attempt to exclude losses from terrorism and certain other
similar risks from some coverages written by us, we may not
be successful in doing so. Moreover, irrespective of the clarity
and inclusiveness of policy language, there can be no assurance
that a court or arbitration panel will limit enforceability of policy
language or otherwise issue a ruling adverse to us.
We seek to limit our loss exposure by writing a number of our
reinsurance contracts on an excess of loss basis, adhering to
maximum limitations on reinsurance written in defined
geographical zones, limiting program size for each client and
prudent underwriting of each program written. In the case of
proportional treaties, we may seek per occurrence limitations
or loss ratio caps to limit the impact of losses from any one or
series of events. In our insurance operations, we seek to limit
our exposure through the purchase of reinsurance. We cannot
be certain that any of these loss limitation methods will be
effective. We also seek to limit our loss exposure by geographic
diversification. Geographic zone limitations involve significant
underwriting judgments, including the determination of the area
of the zones and the inclusion of a particular policy within a
particular zone's limits. There can be no assurance that various
provisions of our policies, such as limitations or exclusions
from coverage or choice of forum, will be enforceable in the
manner we intend. Disputes relating to coverage and choice of
legal forum may also arise. Underwriting is inherently a matter
of judgment, involving important assumptions about matters
that are inherently unpredictable and beyond our control, and
for which historical experience and probability analysis may
not provide sufficient guidance. One or more catastrophic or
other events could result in claims that substantially exceed our
expectations, which could have a material adverse effect on our
financial condition or our results of operations, possibly to the
extent of eliminating our shareholders' equity.
For our natural catastrophe exposed business, we seek to limit
the amount of exposure we will assume from any one insured
or reinsured and the amount of the exposure to catastrophe
losses from a single event in any geographic zone. We monitor
our exposure to catastrophic events, including earthquake and
wind and periodically reevaluate the estimated probable
maximum pre-tax loss for such exposures. Our estimated
probable maximum pre-tax loss is determined through the use
of modeling techniques, but such estimate does not represent
our total potential loss for such exposures.
Our models employ both proprietary and vendor-based systems
and include cross-line correlations for property, marine,
offshore energy, aviation, workers compensation and personal
accident. We seek to limit the probable maximum pre-tax loss
to a specific level for severe catastrophic events. Currently, we
seek to limit our 1-in-250 year return period net probable
maximum loss from a severe catastrophic event in any
geographic zone to approximately 25% of total shareholders’
equity available to Arch. We reserve the right to change this
threshold at any time.
Based on in-force exposure estimated as of January 1, 2019,
our modeled peak zone catastrophe exposure is a windstorm
affecting the Northeastern U.S., with a net probable maximum
pre-tax loss of $374 million, followed by windstorms affecting
Florida Tri-County and the Gulf of Mexico with net probable
maximum pre-tax losses of $330 million and $299 million,
respectively. Our exposures to other perils, such as U.S.
earthquake and international events, were less than the
exposures arising from U.S. windstorms and hurricanes in both
periods. As of January 1, 2019, our modeled peak zone
earthquake exposure
(San Francisco area earthquake)
represented approximately 77% of our peak zone catastrophe
exposure, and our modeled peak zone international exposure
(Japan earthquake) was substantially less than both our peak
zone windstorm and earthquake exposures.
We also have significant exposure to losses due to mortgage
defaults resulting from severe economic events in the future.
For our U.S. mortgage insurance business, we have developed
a proprietary risk model (“Realistic Disaster Scenario” or
“RDS”) that simulates the maximum loss resulting from a
severe economic downturn impacting the housing market. The
RDS models the collective impact of adverse conditions for key
economic indicators, the most significant of which is a decline
in home prices. The RDS model projects paths of future home
prices, unemployment rates, income levels and interest rates
and assumes correlation across states and geographic regions.
The resulting future performance of our in-force portfolio is
then estimated under the economic stress scenario, reflecting
loan and borrower information.
Currently, we seek to limit our modeled RDS loss from a severe
economic event to approximately 25% of total tangible
shareholders’ equity available to Arch (total shareholders’
equity available to Arch less goodwill and intangible assets).
We reserve the right to change this threshold at any time. Based
on in-force exposure estimated as of January 1, 2019, our
modeled RDS loss was less than 12% of tangible shareholders’
equity available to Arch.
Net probable maximum loss estimates are net of expected
reinsurance recoveries, before income tax and before excess
reinsurance reinstatement premiums. RDS loss estimates are
net of expected reinsurance recoveries and after income tax.
Catastrophe loss estimates are reflective of the zone indicated
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2018 FORM 10-K
and not the entire portfolio. Since hurricanes and windstorms
can affect more than one zone and make multiple landfalls, our
catastrophe loss estimates include clash estimates from other
zones. Our catastrophe loss estimates and RDS loss estimates
do not represent our maximum exposures and it is highly likely
that our actual incurred losses would vary materially from the
modeled estimates. There can be no assurances that we will not
suffer pre-tax losses greater than 25% of our total shareholders'
equity or tangible shareholders’ equity from one or more
catastrophic events or severe economic events due to several
factors, including the inherent uncertainties in estimating the
frequency and severity of such events and the margin of error
in making such determinations resulting from potential
inaccuracies and inadequacies in the data provided by clients
and brokers, the modeling techniques and the application of
such techniques or as a result of a decision to change the
percentage of shareholders' equity exposed to a single
catastrophic event or severe economic event. In addition, actual
losses may increase if our reinsurers fail to meet their
obligations to us or the reinsurance protections purchased by
us are exhausted or are otherwise unavailable. See “Risk Factors
—Risk Relating to Our Industry.” Depending on business
opportunities and the mix of business that may comprise our
insurance, reinsurance and mortgage portfolios, we may seek
to adjust our self-imposed limitations on probable maximum
pre-tax loss for catastrophe exposed business and mortgage
default exposed business. See “—Critical Accounting Policies,
Estimates and Recent Accounting Pronouncements—Ceded
Reinsurance” for a discussion of our catastrophe reinsurance
programs.
OFF-BALANCE SHEET ARRANGEMENTS
interest entities
We have entered into various aggregate excess of loss
reinsurance agreements with various special purpose
reinsurance companies domiciled in Bermuda. These are
special purpose variable
that are not
consolidated in our financial results because we do not have the
unilateral power to direct those activities that are significant to
its economic performance. As of December 31, 2018, our
estimated off-balance sheet maximum exposure to loss from
such entities was $11.2 million. See note 11, “Variable Interest
Entity and Noncontrolling Interests,” to our consolidated
financial statements in Item 8 for additional information.
MARKET SENSITIVE INSTRUMENTS AND RISK
MANAGEMENT
Our investment results are subject to a variety of risks, including
risks related to changes in the business, financial condition or
results of operations of the entities in which we invest, as well
as changes in general economic conditions and overall market
conditions. We are also exposed to potential loss from various
market risks, including changes in equity prices, interest rates
and foreign currency exchange rates.
In accordance with the SEC’s Financial Reporting Release No.
48, we performed a sensitivity analysis to determine the effects
that market risk exposures could have on the future earnings,
fair values or cash flows of our financial instruments as of
December 31, 2018. Market risk represents the risk of changes
in the fair value of a financial instrument and consists of several
components, including liquidity, basis and price risks.
The sensitivity analysis performed as of December 31, 2018
presents hypothetical losses in cash flows, earnings and fair
values of market sensitive instruments which were held by us
on December 31, 2018 and are sensitive to changes in interest
rates and equity security prices. This risk management
discussion and the estimated amounts generated from the
following sensitivity analysis represent forward-looking
statements of market risk assuming certain adverse market
conditions occur. Actual results in the future may differ
materially from
to actual
developments in the global financial markets. The analysis
methods used by us to assess and mitigate risk should not be
considered projections of future events of losses.
these projected results due
We have not included Watford Re in the following analyses as
we do not guarantee or provide credit support for Watford Re,
and our 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
the reinsurance transactions.
The focus of the SEC’s market risk rules is on price risk. For
purposes of specific risk analysis, we employ sensitivity
analysis to determine the effects that market risk exposures
could have on the future earnings, fair values or cash flows of
our financial instruments. The financial instruments included
in the following sensitivity analysis consist of all of our
investments and cash.
Investment Market Risk
Fixed Income Securities. We invest in interest rate sensitive
securities, primarily debt securities. We consider the effect of
interest rate movements on the market value of our fixed
maturities, fixed maturities pledged under securities lending
agreements, short-term investments and certain of our other
investments which invest in fixed income securities and the
corresponding change in unrealized appreciation. As interest
rates rise, the market value of our interest rate sensitive
securities falls, and the converse is also true. Based on historical
observations, there is a low probability that all interest rate yield
curves would shift in the same direction at the same time.
Furthermore, at times interest rate movements in certain credit
sectors exhibit a much lower correlation to changes in U.S.
Treasury yields. Accordingly, the actual effect of interest rate
ARCH CAPITAL
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2018 FORM 10-K
movements may differ materially from the amounts set forth in
the following tables.
The following table summarizes the effect that an immediate,
parallel shift in the interest rate yield curve would have had on
our investment portfolio at December 31, 2018 and 2017:
(U.S. dollars in
billions)
Dec. 31, 2018
Total fair value
Change from base
Change in
unrealized value
Dec. 31, 2017
Total fair value
Change from base
Change in
unrealized value
Interest Rate Shift in Basis Points
-100
-50
-
+50
+100
$ 19.23
$ 18.91
$ 18.62
$18.30
$17.98
3.3%
1.6%
(1.7)%
(3.4)%
$ 0.61
$ 0.30
$ (0.32)
$ (0.63)
$ 19.11
$ 18.85
$ 18.59
$18.33
$18.09
2.8%
1.4%
(1.4)%
(2.7)%
$ 0.52
$ 0.26
$ (0.26)
$ (0.50)
In addition, we consider the effect of credit spread movements
on the market value of our fixed maturities, fixed maturities
pledged under securities lending agreements, short-term
investments and certain of our other investments and
investments accounted for using the equity method which invest
in fixed income securities and the corresponding change in
unrealized appreciation. As credit spreads widen, the fair value
of our fixed income securities falls, and the converse is also
true.
The following table summarizes the effect that an immediate,
parallel shift in credit spreads in a static interest rate
environment would have had on the portfolio at December 31,
2018 and 2017:
(U.S. dollars in
billions)
Dec. 31, 2018
Total fair value
Change from base
Change in
unrealized value
Dec. 31, 2017
Total fair value
Change from base
Change in
unrealized value
Credit Spread Shift in Percentage
-100
-50
-
+50
+100
$ 19.08
$ 18.84
$ 18.62
$18.39
$18.15
2.5%
1.2%
(1.2)%
(2.5)%
$ 0.47
$ 0.22
$ (0.22)
$ (0.47)
$ 18.96
$ 18.77
$ 18.59
$18.40
$18.22
2.0%
1.0%
(1.0)%
(2.0)%
$ 0.37
$ 0.19
$ (0.19)
$ (0.37)
Another method that attempts to measure portfolio risk is Value-
at-Risk (“VaR”). VaR attempts to take into account a broad
cross-section of risks facing a portfolio by utilizing relevant
securities volatility data skewed towards the most recent
months and quarters. VaR measures the amount of a portfolio
at risk for outcomes 1.65 standard deviations from the mean
based on normal market conditions over a one year time horizon
and is expressed as a percentage of the portfolio’s initial value.
In other words, 95% of the time, should the risks taken into
account in the VaR model perform per their historical
tendencies, the portfolio’s loss in any one year period is
expected to be less than or equal to the calculated VaR, stated
as a percentage of the measured portfolio’s initial value. As of
December 31, 2018, our portfolio’s VaR was estimated to be
3.02%, compared to an estimated 3.10% at December 31, 2017.
Equity Securities, Privately Held Securities and Other
Investments. Our investment portfolio includes an allocation to
equity securities, privately held securities and certain other
investments. At December 31, 2018 and 2017, the fair value of
our investments in equity securities, privately held securities
and certain other investments totaled $368.8 million and $576.0
million, respectively. These securities are exposed to price risk,
which is the potential loss arising from decreases in fair value.
An immediate hypothetical 10% depreciation in the value of
each position would reduce the fair value of such investments
by approximately $36.9 million and $57.6 million at
December 31, 2018 and 2017, respectively, and would have
decreased book value per share by approximately $0.09 and
$0.14, respectively.
Investment-Related Derivatives. At December 31, 2018, the
notional value of all derivative instruments (excluding to-be-
announced mortgage backed securities which are included in
the fixed income securities analysis above and foreign currency
forward contracts which are included in the foreign currency
exchange risk analysis below) was $4.95 billion, compared to
$2.44 billion at December 31, 2017. If the underlying exposure
of each investment-related derivative held at December 31,
2018 depreciated by 100 basis points, it would have resulted in
a reduction in net income of approximately $49.5 million, and
a decrease in book value per share of $0.12, compared to $24.4
million and $0.06, respectively, on
investment-related
derivatives held at December 31, 2017. If the underlying
exposure of each investment-related derivative held at
December 31, 2018 appreciated by 100 basis points, it would
have resulted in an increase in net income of approximately
$49.5 million, and an increase in book value per share of $0.12,
compared to $24.4 million and $0.06, respectively, on
investment-related derivatives held at December 31, 2017. See
note 10, “Derivative Instruments,” to our consolidated financial
statements in Item 8 for additional disclosures concerning
derivatives.
For further discussion on investment activity, please refer to
“—Financial Condition, Liquidity and Capital Resources—
Financial Condition—Investable Assets.”
Foreign Currency Exchange Risk
Foreign currency rate risk is the potential change in value,
income and cash flow arising from adverse changes in foreign
ARCH CAPITAL
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2018 FORM 10-K
Although the Company generally attempts to match the
currency of its projected liabilities with investments in the same
currencies, from time to time the Company may elect to over
or underweight one or more currencies, which could increase
the Company’s exposure to foreign currency fluctuations and
increase the volatility of the Company’s shareholders’ equity.
Historical observations indicate a low probability that all
foreign currency exchange rates would shift against the U.S.
Dollar in the same direction and at the same time and,
accordingly, the actual effect of foreign currency rate
movements may differ materially from the amounts set forth
above. For further discussion on foreign exchange activity,
please refer to “—Results of Operations.”
Effects of Inflation
We do not believe that inflation has had a material effect on our
consolidated results of operations, except insofar as inflation
may affect our reserves for losses and loss adjustment expenses
and interest rates. The potential exists, after a catastrophe loss,
for the development of inflationary pressures in a local
economy. The anticipated effects of inflation on us are
considered in our catastrophe loss models. The actual effects
of inflation on our results cannot be accurately known until
claims are ultimately settled.
currency exchange rates. Through our subsidiaries and
branches located in various foreign countries, we conduct our
insurance and reinsurance operations in a variety of local
currencies other than the U.S. Dollar. We generally hold
investments in foreign currencies which are intended to mitigate
our exposure to foreign currency fluctuations in our net
insurance liabilities. We may also utilize foreign currency
forward contracts and currency options as part of our investment
strategy. See note 10, “Derivative Instruments,” to our
consolidated financial statements in Item 8 for additional
information.
The following table provides a summary of our net foreign
currency exchange exposures, as well as foreign currency
derivatives in place to manage these exposures:
(U.S. dollars in thousands, except
per share data)
December 31,
2018
December 31,
2017
Net assets (liabilities), denominated in
foreign currencies, excluding
shareholders’ equity and derivatives
Shareholders’ equity denominated in
foreign currencies (1)
Net foreign currency forward contracts
outstanding (2)
Net exposures denominated in foreign
currencies
Pre-tax impact of a hypothetical 10%
appreciation of the U.S. Dollar against
foreign currencies:
Shareholders’ equity
Book value per share
Pre-tax impact of a hypothetical 10%
decline of the U.S. Dollar against foreign
currencies:
Shareholders’ equity
Book value per share
$
(561,311) $
401,966
478,678
345,743
241,442
(123,732)
$
158,809
$
623,977
$
$
$
$
(15,881) $
(0.04) $
(62,398)
(0.15)
15,881
0.04
$
$
62,398
0.15
(1)
(2)
Represents capital contributions held in the foreign currencies of our
operating units.
Represents the net notional value of outstanding foreign currency
forward contracts.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Reference is made to the information appearing above under the subheading “Market Sensitive Instruments and Risk Management”
under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operation,” which information
is hereby incorporated by reference.
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2018 FORM 10-K
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to Financial Statements
Page No.
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets
At December 31, 2018 and December 31, 2017
Consolidated Statements of Income
For the years ended December 31, 2018, 2017 and 2016
Consolidated Statements of Comprehensive Income
For the years ended December 31, 2018, 2017 and 2016
Consolidated Statements of Changes in Shareholders’ Equity
For the years ended December 31, 2018, 2017 and 2016
Consolidated Statements of Cash Flows
For the years ended December 31, 2018, 2017 and 2016
Notes to Consolidated Financial Statements
Note 1 - General
Note 2 - Businesses Acquired
Note 3 - Significant Accounting Policies
Note 4 - Segment Information
Note 5 - Reserve for Losses and Loss Adjustment Expenses
Note 6 - Short Duration Contracts
Note 7 - Reinsurance
Note 8 - Investment Information
Note 9 - Fair Value
Note 10 - Derivative Instruments
Note 11 - VIE and Noncontrolling Interests
Note 12 - Other Comprehensive Income (Loss)
Note 13 - Earnings Per Common Share
Note 14 - Income Taxes
Note 15 - Transactions with Related Parties
Note 16 - Commitments and Contingencies
Note 17 - Debt and Financing Arrangements
Note 18 - Goodwill and Intangible Assets
Note 19 - Shareholders’ Equity
Note 20 - Share-Based Compensation
Note 21 - Retirement Plans
Note 22 - Legal Proceedings
Note 23 - Statutory Information
Note 24 - Unaudited Condensed Quarterly Financial Information
Note 25 - Guarantor Financial Information
Note 26 - Subsequent Event
94
96
97
98
99
100
101
101
101
110
117
119
131
133
139
145
146
149
151
151
154
154
156
157
158
160
162
162
163
166
167
175
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2018 FORM 10-K
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of Arch Capital Group Ltd.
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets of Arch Capital Group Ltd. and its subsidiaries (the “Company”)
as of December 31, 2018 and 2017, and the related consolidated statements of income, of comprehensive income, of changes in
shareholders’ equity, and of cash flows for each of the three years in the period ended December 31, 2018, including the related
notes and financial statement schedules listed in the index appearing under Item 15(a)(2) (collectively referred to as the “consolidated
financial statements”). We also have audited the Company's internal control over financial reporting as of December 31, 2018,based
on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations
of the Treadway Commission (COSO).
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position
of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the three years
in the period ended December 31, 2018, in conformity with accounting principles generally accepted in the United States of
America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting
as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO.
Basis for Opinions
The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control
over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in
Management's Annual Report on Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to
express opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting
based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United
States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities
laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the
audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether
due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement
of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such
procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial
statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as
well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial
reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness
exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits
also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide
a reasonable basis for our opinions.
ARCH CAPITAL
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2018 FORM 10-K
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted
accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain
to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets
of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable
assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that
could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because
of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
PricewaterhouseCoopers LLP
New York, New York
February 28, 2019
We have served as the Company’s or its predecessor’s auditor since 1995.
ARCH CAPITAL
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2018 FORM 10-K
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(U.S. dollars in thousands, except share data)
Assets
Investments:
Fixed maturities available for sale, at fair value (amortized cost: $14,829,902 and $13,869,460)
Short-term investments available for sale, at fair value (amortized cost: $956,238 and $1,468,955)
Collateral received under securities lending, at fair value (amortized cost: $274,125 and $476,605)
Equity securities, at fair value
Other investments available for sale, at fair value (cost: $0 and $198,163)
Investments accounted for using the fair value option
Investments accounted for using the equity method
Total investments
Cash
Accrued investment income
Securities pledged under securities lending, at fair value (amortized cost: $266,786 and $463,181)
Premiums receivable
Reinsurance recoverable on unpaid and paid losses and loss adjustment expenses
Contractholder receivables
Ceded unearned premiums
Deferred acquisition costs
Receivable for securities sold
Goodwill and intangible assets
Other assets
Total assets
Liabilities
Reserve for losses and loss adjustment expenses
Unearned premiums
Reinsurance balances payable
Contractholder payables
Collateral held for insured obligations
Senior notes
Revolving credit agreement borrowings
Securities lending payable
Payable for securities purchased
Other liabilities
Total liabilities
Commitments and Contingencies
Redeemable noncontrolling interests
Shareholders’ Equity
Non-cumulative preferred shares
Convertible non-voting common equivalent preferred shares
Common shares ($0.0011 par, shares issued: 570,737,283 and 549,872,226)
Additional paid-in capital
Retained earnings
Accumulated other comprehensive income (loss), net of deferred income tax
Common shares held in treasury, at cost (shares: 168,282,449 and 156,938,409)
Total shareholders' equity available to Arch
Non-redeemable noncontrolling interests
Total shareholders' equity
Total liabilities, noncontrolling interests and shareholders' equity
December 31,
2018
2017
$
$
$
14,699,010
955,880
274,133
338,899
—
3,983,571
1,493,791
21,745,284
646,556
114,641
268,395
1,299,150
2,919,372
2,079,111
975,469
569,574
36,246
634,920
929,611
32,218,329
11,853,297
3,753,636
393,107
2,079,111
236,630
1,733,528
455,682
274,125
90,034
911,500
21,780,650
13,876,003
1,469,042
476,615
495,804
264,989
4,216,237
1,041,322
21,840,012
606,199
113,133
464,917
1,135,249
2,540,143
1,978,414
926,611
535,824
205,536
652,611
1,053,009
32,051,658
11,383,792
3,622,314
323,496
1,978,414
240,183
1,732,884
816,132
476,605
449,186
782,717
21,805,723
206,292
205,922
780,000
—
634
1,793,781
9,426,299
(178,720)
(2,382,167)
9,439,827
791,560
10,231,387
32,218,329
$
872,555
489,627
611
1,230,617
8,562,889
118,044
(2,077,741)
9,196,602
843,411
10,040,013
32,051,658
$
$
$
$
ARCH CAPITAL
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2018 FORM 10-K
See Notes to Consolidated Financial Statements
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(U.S. dollars in thousands, except share data)
Revenues
Net premiums written
Change in unearned premiums
Net premiums earned
Net investment income
Net realized gains (losses)
Other-than-temporary impairment losses
Less investment impairments recognized in other comprehensive income, before taxes
Net impairment losses recognized in earnings
Other underwriting income
Equity in net income of investments accounted for using the equity method
Other income (loss)
Total revenues
Expenses
Losses and loss adjustment expenses
Acquisition expenses
Other operating expenses
Corporate expenses
Amortization of intangible assets
Interest expense
Net foreign exchange losses (gains)
Total expenses
Income before income taxes
Income taxes:
Current tax (benefit) expense
Deferred tax expense (benefit)
Income tax expense
Net income
Net (income) loss attributable to noncontrolling interests
Net income available to Arch
Preferred dividends
Loss on redemption of preferred shares
Net income available to Arch common shareholders
Net income per common share and common share equivalent
Basic
Diluted
Year Ended December 31,
2017
2016
2018
$
$
5,346,747
(114,772)
5,231,975
563,633
(405,344)
$
4,961,373
(116,841)
4,844,532
470,872
149,141
(2,829)
—
(2,829)
15,073
45,641
2,419
5,450,568
2,890,106
805,135
677,809
78,994
105,670
120,484
(69,402)
4,608,796
(7,138)
—
(7,138)
30,253
142,286
(2,571)
5,627,375
2,967,446
775,458
684,451
83,752
125,778
117,431
115,782
4,870,098
4,031,391
(146,569)
3,884,822
366,742
137,586
(30,794)
352
(30,442)
57,173
48,475
(800)
4,463,556
2,185,599
667,625
624,090
81,746
19,343
66,252
(36,651)
3,608,004
841,772
757,277
855,552
85,863
28,088
113,951
727,821
30,150
757,971
(41,645)
(2,710)
713,616
$
$
(45,736)
173,304
127,568
629,709
(10,431)
619,278
(46,041)
(6,735)
566,502
$
$
50,745
(19,371)
31,374
824,178
(131,440)
692,738
(28,070)
—
664,668
1.76
1.73
$
$
1.40
1.36
$
$
1.83
1.78
$
$
$
$
Weighted average common shares and common share equivalents outstanding
Basic
Diluted
404,347,621
412,906,478
404,138,364
417,785,025
362,376,342
374,152,479
ARCH CAPITAL
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2018 FORM 10-K
See Notes to Consolidated Financial Statements
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(U.S. dollars in thousands)
Comprehensive Income
Net income
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 year
Portion of other-than-temporary impairment losses recognized in other comprehensive
income, net of deferred income tax
Reclassification of net realized gains, net of income taxes, included in net income
Foreign currency translation adjustments
Comprehensive income
Net (income) loss attributable to noncontrolling interests
Other comprehensive (income) loss attributable to noncontrolling interests
Comprehensive income available to Arch
$
Year Ended December 31,
2017
2016
2018
$
727,821
$
629,709
$
824,178
(270,057)
252,904
(21,013)
—
144,573
(24,830)
577,507
30,150
3,346
611,003
$
—
(67,863)
47,014
861,764
(10,431)
530
851,863
$
(352)
(56,361)
(20,381)
726,071
(131,440)
68
594,699
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2018 FORM 10-K
See Notes to Consolidated Financial Statements
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(U.S. dollars in thousands)
Non-cumulative preferred shares
Balance at beginning of year
Preferred shares issued
Preferred shares redeemed
Balance at end of year
Convertible non-voting common equivalent preferred shares
Balance at beginning of year
Series D preferred shares issued
Preferred shares converted to common shares
Balance at end of year
Common shares
Balance at beginning of year
Common shares issued, net
Balance at end of year
Additional paid-in capital
Balance at beginning of year
Preferred shares converted to common shares
Other changes
Balance at end of year
Retained earnings
Balance at beginning of year
Cumulative effect of an accounting change (see Note 3)
Balance at beginning of year, as adjusted
Net income
Net (income) loss attributable to noncontrolling interests
Preferred share dividends
Loss on redemption of preferred shares
Balance at end of year
Accumulated other comprehensive income (loss)
Balance at beginning of year
Unrealized appreciation (decline) in value of available-for-sale investments, net of deferred
income tax:
Balance at beginning of year
Cumulative effect of an accounting change (see Note 3)
Balance at beginning of year, as adjusted
Unrealized holding gains (losses) during period, net of reclassification adjustment
Unrealized holding gains (losses) during period attributable to noncontrolling interests
Portion of other-than-temporary impairment losses recognized in other comprehensive
income, net of deferred income tax
Balance at end of year
Foreign currency translation adjustments, net of deferred income tax:
Balance at beginning of year
Foreign currency translation adjustments
Foreign currency translation adjustments attributable to noncontrolling interests
Balance at end of year
Balance at end of year
Common shares held in treasury, at cost
Balance at beginning of year
Shares repurchased for treasury
Balance at end of year
Total shareholders’ equity available to Arch
Non-redeemable noncontrolling interests
Total shareholders’ equity
Year Ended December 31,
2017
2016
2018
$
$
872,555
—
(92,555)
780,000
$
772,555
330,000
(230,000)
872,555
325,000
450,000
(2,445)
772,555
489,627
—
(489,627)
—
611
23
634
1,230,617
489,608
73,556
1,793,781
8,562,889
149,794
8,712,683
727,821
30,150
(41,645)
(2,710)
9,426,299
1,101,304
—
(611,677)
489,627
582
29
611
531,687
611,653
87,277
1,230,617
7,996,701
(314)
7,996,387
629,709
(10,431)
(46,041)
(6,735)
8,562,889
—
1,101,304
—
1,101,304
577
5
582
467,339
—
64,348
531,687
7,332,032
—
7,332,032
824,178
(131,439)
(28,070)
—
7,996,701
118,044
(114,541)
(16,502)
157,400
(149,794)
7,606
(125,484)
3,700
—
(114,178)
(39,356)
(24,830)
(356)
(64,542)
(178,720)
(27,641)
—
(27,641)
185,041
—
—
157,400
(86,900)
47,014
530
(39,356)
118,044
50,085
—
50,085
(77,374)
—
(352)
(27,641)
(66,587)
(20,381)
68
(86,900)
(114,541)
(2,077,741)
(304,426)
(2,382,167)
9,439,827
791,560
10,231,387
$
(2,034,570)
(43,171)
(2,077,741)
9,196,602
843,411
10,040,013
$
(1,941,904)
(92,666)
(2,034,570)
8,253,718
851,854
9,105,572
$
ARCH CAPITAL
99
2018 FORM 10-K
See Notes to Consolidated Financial Statements
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(U.S. dollars in thousands)
Operating Activities
Net income
Adjustments to reconcile net income to net cash provided by operating activities:
Net realized (gains) losses
Net impairment losses recognized in earnings
Equity in net income or loss of investments accounted for using the
equity method and other income or loss
Amortization of intangible assets
Share-based compensation
Changes in:
Reserve for losses and loss adjustment expenses, net of unpaid losses and loss adjustment expenses
recoverable
Unearned premiums, net of ceded unearned premiums
Premiums receivable
Deferred acquisition costs
Reinsurance balances payable
Other items, net
Net cash provided by operating activities
Investing Activities
Purchases of fixed maturity investments
Purchases of equity securities
Purchases of other investments
Proceeds from sales of fixed maturity investments
Proceeds from sales of equity securities
Proceeds from sales, redemptions and maturities of other investments
Proceeds from redemptions and maturities of fixed maturity investments
Net settlements of derivative instruments
Net (purchases) sales of short-term investments
Change in cash collateral related to securities lending
Acquisitions, net of cash
Purchases of fixed assets
Other
Net cash provided by (used for) investing activities
Financing Activities
Proceeds from issuance of preferred shares, net
Redemption of preferred shares
Purchases of common shares under share repurchase program
Proceeds from common shares issued, net
Proceeds from borrowings
Repayments of borrowings
Change in cash collateral related to securities lending
Dividends paid to redeemable noncontrolling interests
Other
Preferred dividends paid
Net cash provided by (used for) financing activities
Effects of exchange rate changes on foreign currency cash and restricted cash
Increase (decrease) in cash and restricted cash
Cash and restricted cash, beginning of year
Cash and restricted cash, end of year
Income taxes paid
Interest paid
Non-cash consideration paid in convertible non-voting common equivalent preferred shares
Year Ended December 31,
2017
2018
2016
$
727,821
$
629,709
$
824,178
387,550
2,829
36,694
105,670
55,776
243,734
114,772
(211,296)
(37,847)
73,438
60,181
1,559,322
(33,327,660)
(1,001,149)
(2,014,622)
31,513,271
1,118,445
1,561,958
892,755
44,699
485,473
180,883
—
(29,809)
21,736
(554,020)
—
(92,555)
(282,762)
(7,608)
218,259
(576,401)
(180,883)
(17,989)
(7,226)
(41,645)
(988,810)
(19,133)
(2,641)
727,284
724,643
$
119,775
(980) $
$
— $
$
$
$
$
(174,517)
7,138
(79,540)
125,778
67,798
614,534
116,841
(31,405)
(78,378)
8,529
(111,609)
1,094,878
(36,806,913)
(1,021,016)
(2,020,624)
35,686,779
1,056,401
1,528,617
907,417
(28,563)
(734,554)
12,540
—
(22,841)
90,875
(1,351,882)
319,694
(230,000)
—
(21,048)
253,415
(197,000)
(12,540)
(17,989)
(51,896)
(46,041)
(3,405)
(178,507)
30,442
5,644
19,343
56,581
372,244
146,569
(71,613)
(38,597)
31,542
179,603
1,377,429
(35,532,810)
(665,702)
(1,389,406)
34,559,966
751,728
1,149,328
755,007
(17,068)
(123,410)
(155,248)
(1,992,720)
(15,303)
(27,795)
(2,703,433)
434,899
(2,445)
(75,256)
(2,418)
1,386,741
(219,171)
155,248
(17,989)
4,130
(28,070)
1,635,669
18,124
(21,191)
(242,285)
969,569
727,284
$
51,781
117,374
$
$
— $
288,474
681,095
969,569
50,621
63,288
1,101,304
ARCH CAPITAL
100
2018 FORM 10-K
See Notes to Consolidated Financial Statements
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. General
Arch Capital Group Ltd. (“Arch Capital”) is a Bermuda public
limited
insurance,
reinsurance and mortgage insurance on a worldwide basis
through its wholly owned subsidiaries.
liability company which provides
As used herein, the “Company” means Arch Capital and its
subsidiaries. Similarly, “Common Shares” means the common
shares of Arch Capital. The Company’s consolidated financial
statements include the results of Watford Holdings Ltd., and its
wholly owned subsidiaries (“Watford Re”). See note 11,
“Variable Interest Entity and Noncontrolling Interests”.
The Company has reclassified the presentation of certain prior
year information to conform to the current presentation. Such
reclassifications had no effect on the Company’s net income,
shareholders’ equity or cash flows. Tabular amounts are in U.S.
Dollars in thousands, except share amounts, unless otherwise
noted.
2. Business Acquired
McNeil
On December 6, 2018, the Company closed the acquisition of
McNeil & Co. (“McNeil”), a nationwide leader in specialized
risk management and insurance programs headquartered in
Cortland, New York.
Arch MI Asia Limited
On July 1, 2017, the Company completed its previously
announced acquisition of AIG United Guaranty Insurance
(Asia) Limited (renamed “Arch MI Asia Limited”) following
the payment of $40.0 million to AIG. Arch MI Asia Limited
compliments
the Company’s existing private mortgage
insurance businesses, which have operations in the United
States, Europe and Australia.
3.
Significant Accounting Policies
(a) Basis of Presentation
The 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 Arch Capital and its subsidiaries, including Arch Reinsurance
Ltd. (“Arch Re Bermuda”), Arch Reinsurance Company (“Arch
Re U.S.”), Arch-U.S., Arch Insurance Company, Arch Specialty
Insurance Company, Arch Excess & Surplus Insurance
Company, Arch Indemnity Insurance Company, Arch Insurance
Canada Ltd. (“Arch Insurance Canada”), Arch Reinsurance
Europe Underwriting Designated Activity Company (“Arch Re
Europe”), Arch Mortgage Insurance Company, Arch Mortgage
Guaranty Company, United Guaranty Residential Insurance
Company, Arch Mortgage Insurance Designated Activity
Company (“Arch MI Europe”), Arch Insurance Company
(Europe) Limited (“Arch Insurance Company Europe”),
Lloyd’s of London syndicate 2012 and related companies
(“Arch Syndicate 2012”), Gulf Reinsurance Limited and
Watford Re. All significant intercompany transactions and
balances have been eliminated in consolidation.
requires management
The preparation of financial statements in conformity with
GAAP
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 materially from those estimates and
assumptions. The Company’s principal estimates include:
• The reserve for losses and loss adjustment expenses;
• Reinsurance recoverable on unpaid and paid losses and loss
for
the provision
including
adjustment expenses,
uncollectible amounts;
• Estimates of written and earned premiums;
• The valuation of the investment portfolio and assessment
of other-than-temporary impairments (“OTTI”);
• The valuation of purchased intangible assets;
• The assessment of goodwill and intangible assets for
impairment; and
•
the valuation of deferred tax assets.
The Company has reclassified the presentation of certain prior
year information to conform to the current presentation. Such
reclassifications had no effect on the Company’s net income,
shareholders’ equity or cash flows.
In 2018, the shareholders approved a three-for-one stock split
of the Company's common shares. All historical share and per
share amounts reflect the effect of the stock split.
(b) Premium Revenues and Related Expenses
Insurance. Insurance premiums written are generally recorded
at the policy inception and are primarily earned on a pro rata
basis over the terms of the policies for all products, usually 12
months. Premiums written include estimates in the Company’s
programs, specialty lines, lenders products business and for
participation in involuntary pools. Such premium estimates are
derived from multiple sources which include the historical
experience of the underlying business, similar business and
available industry information. Unearned premium reserves
represent the portion of premiums written that relates to the
unexpired terms of in-force insurance policies.
ARCH CAPITAL
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2018 FORM 10-K
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Reinsurance. Reinsurance premiums written include amounts
reported by brokers and ceding companies, supplemented by
the Company’s own estimates of premiums where reports have
not been received. The determination of premium estimates
requires a review of the Company’s experience with the ceding
companies, familiarity with each market, the timing of the
reported information, an analysis and understanding of the
characteristics of each line of business, and management’s
judgment of the impact of various factors, including premium
or loss trends, on the volume of business written and ceded to
the Company. On an ongoing basis,
the Company’s
underwriters review the amounts reported by these third parties
for reasonableness based on their experience and knowledge of
the subject class of business, taking into account the Company’s
historical experience with the brokers or ceding companies. In
addition, reinsurance contracts under which the Company
assumes business generally contain specific provisions which
allow the Company to perform audits of the ceding company
to ensure compliance with the terms and conditions of the
contract,
reporting of
information. Based on a review of all available information,
management establishes premium estimates where reports have
not been received. Premium estimates are updated when new
information is received and differences between such estimates
and actual amounts are recorded in the period in which estimates
are changed or the actual amounts are determined.
including accurate and
timely
Reinsurance premiums written are recorded based on the type
of contracts the Company writes. Premiums on the Company’s
excess of loss and pro rata reinsurance contracts are estimated
when the business is underwritten. For excess of loss contracts,
premiums are recorded as written based on the terms of the
contract. Estimates of premiums written under pro rata contracts
are recorded in the period in which the underlying risks are
expected to incept and are based on information provided by
the brokers and the ceding companies. For multi-year
reinsurance treaties which are payable in annual installments,
generally, only the initial annual installment is included as
premiums written at policy inception due to the ability of the
reinsured to commute or cancel coverage during the term of the
policy. The remaining annual installments are included as
premiums written at each successive anniversary date within
the multi-year term.
Reinstatement premiums for the Company’s insurance and
reinsurance operations are recognized at the time a loss event
occurs, where coverage limits for the remaining life of the
contract are reinstated under pre-defined contract terms.
Reinstatement premiums, if obligatory, are fully earned when
recognized. The accrual of reinstatement premiums is based on
an estimate of losses and loss adjustment expenses, which
reflects management’s judgment.
Premium estimates are reviewed by management at least
quarterly. Such review includes a comparison of actual reported
premiums to expected ultimate premiums along with a review
of the aging and collection of premium estimates. Based on
management’s review, the appropriateness of the premium
estimates is evaluated, and any adjustment to these estimates is
recorded in the period in which it becomes known. Adjustments
to premium estimates could be material and such adjustments
could directly and significantly impact earnings favorably or
unfavorably in the period they are determined because the
estimated premium may be fully or substantially earned. A
significant portion of amounts
included as premiums
receivable, which represent estimated premiums written, net of
commissions, are not currently due based on the terms of the
underlying contracts.
Reinsurance premiums written, irrespective of the class of
business, are generally earned on a pro rata basis over the terms
of the underlying policies or reinsurance contracts. Contracts
and policies written on a “losses occurring” basis cover claims
that may occur during the term of the contract or policy, which
is typically 12 months. Accordingly, the premium is earned
evenly over the term. Contracts which are written on a “risks
attaching” basis cover claims which attach to the underlying
insurance policies written during the terms of such contracts.
Premiums earned on such contracts usually extend beyond the
original term of the reinsurance contract, typically resulting in
recognition of premiums earned over a 24-month period.
Certain of the Company’s reinsurance contracts include
provisions that adjust premiums or acquisition expenses based
upon the experience under the contracts. Premiums written and
earned, as well as related acquisition expenses, are recorded
based upon the projected experience under such contracts.
The Company also writes certain reinsurance business that is
intended to provide insurers with risk management solutions
that complement traditional reinsurance. Under these contracts,
the Company assumes a measured amount of insurance risk in
exchange for an anticipated margin, which is typically lower
than on traditional reinsurance contracts. The terms and
conditions of these contracts may include additional or return
premiums based on loss experience, loss corridors, sublimits
and caps. Examples of such business include aggregate stop-
loss coverages, financial quota share coverages and multi-year
retrospectively rated excess of loss coverages. If these contracts
are deemed to transfer risk, they are accounted for as
reinsurance. Otherwise, such contracts are accounted for under
the deposit method.
Mortgage. Mortgage guaranty insurance policies are contracts
that are generally non-cancelable by the insurer, are renewable
at a fixed price, and provide for payment of premiums on a
monthly, annual or single basis. Upon renewal, the Company
is not able to re-underwrite or re-price its policies. Consistent
with industry accounting practices, premiums written on a
monthly basis are earned as coverage is provided. Premiums
written on an annual basis are amortized on a monthly pro rata
basis over the year of coverage. Primary mortgage insurance
premiums written on policies covering more than one year are
ARCH CAPITAL
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2018 FORM 10-K
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
referred to as single premiums. A portion of the revenue from
single premiums is recognized in premiums earned in the
current period, and the remaining portion is deferred as
unearned premiums and earned over the estimated expiration
of risk of the policy. If single premium policies related to insured
loans are canceled due to repayment by the borrower and the
policy is a non-refundable product, the remaining unearned
premium related to each canceled policy is recognized as earned
premium upon notification of the cancellation.
Unearned premiums represent the portion of premiums written
that is applicable to the estimated unexpired risk of insured
loans. A portion of premium payments may be refundable if the
insured cancels coverage, which generally occurs when the loan
is repaid, the loan amortizes to a sufficiently low amount to
trigger a lender permitted or legally required cancellation, or
the value of the property has increased sufficiently in
accordance with the terms of the contract. Premium refunds
reduce premiums earned in the consolidated statements of
income. Generally, only unearned premiums are refundable.
Acquisition Costs. Acquisition costs that are directly related and
incremental to the successful acquisition or renewal of business
are deferred and amortized based on the type of contract. The
Company’s insurance and reinsurance operations capitalize
incremental direct external costs that result from acquiring a
contract but do not capitalize salaries, benefits and other internal
underwriting costs. For the Company’s mortgage insurance
operations, which include a substantial direct sales force, both
external and certain internal direct costs are deferred and
amortized. For property and casualty insurance and reinsurance
contracts, deferred acquisition costs are amortized over the
period in which the related premiums are earned. Consistent
with mortgage
industry accounting practice,
amortization of acquisition costs related to the mortgage
insurance contracts for each underwriting year’s book of
business is recorded in proportion to estimated gross profits.
Estimated gross profits are comprised of earned premiums and
losses and loss adjustment expenses. For each underwriting
year, the Company estimates the rate of amortization to reflect
actual experience and any changes to persistency or loss
development.
insurance
Deferred acquisition costs are carried at their estimated
realizable value and take into account anticipated losses and
loss adjustment expenses, based on historical and current
experience, and anticipated investment income.
A premium deficiency occurs if the sum of anticipated losses
and loss adjustment expenses, unamortized acquisition costs
and maintenance costs exceed unearned premiums (including
expected future premiums) and anticipated investment income.
A premium deficiency reserve (“PDR”) is recorded by charging
any unamortized acquisition costs to expense to the extent
required in order to eliminate the deficiency. If the premium
deficiency exceeds unamortized acquisition costs then a
liability is accrued for the excess deficiency.
To assess the need for a PDR on mortgage exposures, the
Company develops loss projections based on modeled loan
defaults related to its current policies in force. This projection
is based on recent trends in default experience, severity and
rates of defaulted loans moving to claim, as well as recent trends
in the rate at which loans are prepaid, and incorporates
anticipated
the expected
profitability of the Company’s existing mortgage insurance
business and the need for a PDR for its mortgage business
involves significant reliance upon assumptions and estimates
with regard to the likelihood, magnitude and timing of potential
losses and premium revenues.
income. Evaluating
interest
No premium deficiency charges were recorded by the Company
during 2018, 2017 or 2016.
(c) Deposit Accounting
Certain assumed reinsurance contracts that are deemed not to
transfer insurance risk, are accounted for using the deposit
method of accounting. However, it is possible that the Company
could incur financial losses on such contracts. Management
exercises significant judgment in the assumptions used in
determining whether assumed contracts should be accounted
for as reinsurance contracts or deposit contracts. For those
contracts that contain only significant underwriting risk, the
estimated profit margin is deferred and amortized over the
contract period and such amount is included in the Company’s
underwriting results. When the estimated profit margin is
explicit, the margin is reflected as other underwriting income
and any adverse financial results on such contracts are reflected
as incurred losses. When the estimated profit margin is implicit,
the margin is reflected as an offset to paid losses and any adverse
financial results on such contracts are reflected as incurred
losses. Additional judgments are required when applying the
accounting guidance with respect to the revenue recognition
criteria for contracts deemed to transfer only significant
underwriting risk. For those contracts that contain only
significant timing risk, an accretion rate is established at
inception of the contract based on actuarial estimates whereby
the deposit accounting liability is increased to the estimated
amount payable over the contract term. The accretion on the
deposit is based on the expected rate of return required to fund
the expected future payment obligations. Periodically the
Company reassesses the estimated ultimate liability and the
related expected rate of return. The accretion of the deposit
accounting liability as well as changes to the estimated ultimate
liability and the accretion rate would be reflected as part of
interest expense in the Company’s results of operations. Any
negative accretion in a deposit accounting liability is shown in
other underwriting income in the Company’s results of
operations.
ARCH CAPITAL
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2018 FORM 10-K
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Under some of these contracts, the ceding company retains the
related assets on a funds-held basis. Such amounts are included
in “Other assets” on the Company’s balance sheet. Interest
income produced by those assets are recorded as part of net
investment income in the Company's results of operations.
(d) Retroactive Accounting
Retroactive reinsurance reimburses a ceding company for
liabilities incurred as a result of past insurable events covered
by the underlying policies reinsured. In certain instances,
reinsurance contracts cover losses both on a prospective basis
and on a retroactive basis and, accordingly, the Company
bifurcates the prospective and retrospective elements of these
reinsurance contracts and accounts for each element separately
where practical. Underwriting income generated in connection
with retroactive reinsurance contracts is deferred and amortized
into income over the settlement period while losses are charged
to income immediately. Subsequent changes in estimated
amount or timing of cash flows under such retroactive
reinsurance contracts are accounted for by adjusting the
previously deferred amount to the balance that would have
existed had the revised estimate been available at the inception
of the reinsurance transaction, with a corresponding charge or
credit to income.
(e) Reinsurance Ceded
In the normal course of business, the Company purchases
reinsurance to increase capacity and to limit the impact of
individual losses and events on its underwriting results by
reinsuring certain levels of risk with other insurance enterprises
or reinsurers. The Company uses pro rata, excess of loss and
facultative
reinsurance contracts. Reinsurance ceding
commissions that represent a recovery of acquisition costs are
recognized as a reduction to acquisition costs while the
remaining portion is deferred. The accompanying consolidated
statement of income reflects premiums and losses and loss
adjustment expenses and acquisition costs, net of reinsurance
ceded. See note 7, “Reinsurance” for information on the
Company's reinsurance usage. Reinsurance premiums ceded
and unpaid losses and loss adjustment expenses recoverable are
estimated in a manner consistent with that of the original
policies issued and the terms of the reinsurance contracts. If the
reinsurers are unable to satisfy their obligations under the
agreements,
reinsurance
subsidiaries would be liable for such defaulted amounts.
the Company’s
insurance or
(f) Cash
Cash includes cash equivalents, which are investments with
original maturities of three months or less that are not managed
by external or internal investment advisors.
(g) Investments
The Company currently classifies substantially all of its fixed
maturity investments and short-term investments as “available
for sale” and, accordingly, they are carried at estimated fair
value (also known as fair value) with the changes in fair value
recorded as an unrealized gain or loss component of
accumulated other comprehensive income in shareholders’
equity. The fair value of fixed maturity securities and equities
securities is generally determined from quotations received
from nationally recognized pricing services, or when such
prices are not available, by reference to broker or underwriter
bid indications. Short-term investments comprise securities due
to mature within one year of the date of issue. Short-term
investments include certain cash equivalents which are part of
investment portfolios under the management of external and
internal investment managers.
The Company enters into securities lending agreements with
financial institutions to enhance investment income whereby it
loans certain of its securities to third parties, primarily major
brokerage firms, for short periods of time through a lending
agent. Such securities have been reclassified as “Securities
pledged under securities lending, at fair value.” The Company
maintains legal control over the securities it lends, retains the
earnings and cash flows associated with the loaned securities
and receives a fee from the borrower for the temporary use of
the securities. Collateral received is required at a rate of 102%
or greater of the fair value of the loaned securities including
accrued investment income and is monitored and maintained
by the lending agent. Such collateral is reflected as “Collateral
received under securities lending, at fair value.”
The Company’s investment portfolio includes certain funds
that, due to their ownership structure, are accounted for by the
Company using the equity method. In applying the equity
method, these investments are initially recorded at cost and are
subsequently adjusted based on the Company’s proportionate
share of the net income or loss of the funds (which include
changes in the fair value of the underlying securities in the
funds). Such investments are generally recorded on a one to
three month lag based on the availability of reports from the
investment funds. Changes in the carrying value of such
investments are recorded in net income as “Equity in net income
(loss) of investments accounted for using the equity method.”
As such, fluctuations in the carrying value of the investments
accounted for using the equity method may increase the
volatility of the Company’s reported results of operations.
The Company’s investment portfolio includes equity securities
that are accounted for at fair value. Such holdings primarily
include publicly traded common stocks. Dividend income on
equities is reflected in net investment income. Changes in fair
value on equity securities are included in “Net realized gains
(losses)” in the consolidated statement of income.
ARCH CAPITAL
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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company elected to carry certain fixed maturity securities,
equity securities and other investments at fair value under the
fair value option afforded by accounting guidance regarding the
fair value option for financial assets and liabilities. The fair
value for certain of the Company’s other investments are
determined using net asset values (“NAVs”) as advised by
external fund managers. The NAV is based on the fund
manager’s valuation of the underlying holdings in accordance
with the fund’s governing documents.
Changes in fair value of investments accounted for using the
fair value option are included in “Net realized gains (losses).”
The primary reasons for electing the fair value option were to
address simplification and cost-benefit considerations.
The Company invests in limited partner interests and shares of
limited liability companies. Such amounts are included in
investments accounted for using the equity method, other
investments available for sale and investments accounted for
using the fair value option. These investments can often have
characteristics of a variable interest entity (“VIE”). A VIE refers
to entities that have 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 the characteristic of a
controlling financial interest. If the Company is determined to
be the primary beneficiary, it is required to consolidate the VIE.
The primary beneficiary 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. At inception of the VIE as well as on
an ongoing basis, the Company determines whether it is the
primary beneficiary based on an analysis of the Company’s
level of involvement in the VIE, the contractual terms, and the
overall structure of the VIE. The Company's maximum
exposure to loss with respect to these investments is limited to
the investment carrying amounts reported in the Company's
consolidated balance sheet and any unfunded commitment.
The Company performs quarterly reviews of its investments to
determine whether declines in fair value below the cost basis
are considered other-than-temporary in accordance with
applicable accounting guidance regarding the recognition and
presentation of OTTI. The process of determining whether a
security is other-than-temporarily impaired requires judgment
and involves analyzing many factors. These factors include (i)
an analysis of the liquidity, business prospects and overall
financial condition of the issuer, (ii) the time period in which
there was a significant decline in value, (iii) the significance of
the decline and (iv) the analysis of specific credit events.
When there are credit-related losses associated with debt
securities for which the Company does not have an intent to
sell and it is more likely than not that it will not be required to
sell the security before recovery of its cost basis, the amount of
the OTTI related to a credit loss is recognized in earnings and
the amount of the OTTI related to other factors (e.g., interest
rates, market conditions, etc.) is recorded as a component of
other comprehensive income (loss). The amount of the credit
loss of an impaired debt security is the difference between the
amortized cost and the greater of (i) the present value of
expected future cash flows and (ii) the fair value of the security.
In instances where no credit loss exists but it is more likely than
not that the Company will have to sell the debt security prior
to the anticipated recovery, the decline in fair value below
amortized cost is recognized as an OTTI in earnings. In periods
after the recognition of an OTTI on debt securities, the
Company accounts for such securities as if they had been
purchased on the measurement date of the OTTI at an amortized
cost basis equal to the previous amortized cost basis less the
OTTI recognized in earnings. For debt securities for which
OTTI were recognized in earnings, the difference between the
new amortized cost basis and the cash flows expected to be
collected will be accreted or amortized into net investment
income. See note 8, “Investment Information” for additional
information.
Net investment income includes interest and dividend income
together with amortization of market premiums and discounts
and is net of investment management and custody fees.
Anticipated prepayments and expected maturities are used in
applying the interest method for certain investments such as
mortgage and other asset-backed securities. When actual
prepayments differ significantly from anticipated prepayments,
the effective yield is recalculated to reflect actual payments to
date and anticipated future payments. The net investment in
such securities is adjusted to the amount that would have existed
had the new effective yield been applied since the acquisition
of the security. Such adjustments, if any, are included in net
investment income when determined.
Investment gains or losses realized on the sale of investments,
except for certain fund investments, are determined on a first-
in, first-out basis and are reflected in net income. Investment
gains or losses realized on the sale of certain fund investments
are determined on an average cost basis. Unrealized
appreciation or decline in the value of available for sale
securities, which are carried at fair value, is excluded from net
income and recorded as a separate component of accumulated
other comprehensive income, net of applicable deferred income
tax.
(h) Derivative Instruments
The Company recognizes all derivative instruments, including
its
embedded derivative
consolidated balance sheets. The Company employs the use of
derivative instruments within its operations to mitigate risks
arising from assets and liabilities held in foreign currencies as
instruments, at fair value
in
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well as part of its overall investment strategy. For such
instruments, changes in assets and liabilities measured at fair
value are recorded as “Net realized gains” in the consolidated
statements of income. In addition, the Company’s derivative
instruments include amounts related to underwriting activities
where an insurance or reinsurance contract meets the
accounting definition of a derivative instrument. For such
contracts, changes in fair value are reflected in “Other
underwriting income” in the consolidated statements of income
as the underlying contract originates from the Company’s
underwriting operations. For the periods ended 2018, 2017, and
2016, the Company did not designate any derivative
instruments as hedges under the relevant accounting guidance.
See note 10, “Derivative Instruments” for additional
information.
(i) Reserves for Losses and Loss Adjustment Expenses
Insurance and Reinsurance. The reserve for losses and loss
adjustment expenses consists of estimates of unpaid reported
losses and loss adjustment expenses and estimates for losses
incurred but not reported. The reserve for unpaid reported losses
and loss adjustment expenses, established by management
based on reports from ceding companies and claims from
insureds, excludes estimates of amounts related to losses under
high deductible policies, and represents the estimated ultimate
cost of events or conditions that have been reported to or
specifically identified by the Company. Such reserves are
supplemented by management’s estimates of reserves for losses
incurred for which reports or claims have not been received.
The Company’s reserves are based on a combination of
reserving methods, incorporating both Company and industry
loss development patterns. The Company selects the initial
expected loss and loss adjustment expense ratios based on
information derived by its underwriters and actuaries during
the initial pricing of the business, supplemented by industry
data where appropriate. Such ratios consider, among other
things, rate changes and changes in terms and conditions that
have been observed in the market. These estimates are reviewed
regularly and, as experience develops and new information
becomes known, the reserves are adjusted as necessary. Such
adjustments, if any, are reflected in income in the period in
which they are determined. As actual loss information has been
reported, the Company has developed its own loss experience
and its reserving methods include other actuarial techniques.
Over time, such techniques have been given further weight in
its reserving process based on the continuing maturation of the
Company’s reserves. Inherent in the estimates of ultimate losses
and loss adjustment expenses are expected trends in claims
severity and frequency and other factors which may vary
significantly as claims are settled. Accordingly, ultimate losses
and loss adjustment expenses may differ materially from the
amounts recorded in the accompanying consolidated financial
statements. Losses and loss adjustment expenses are recorded
on an undiscounted basis, except for excess workers’
compensation and employers’ liability business written by the
Company’s insurance operations.
Mortgage. The reserves for mortgage guaranty insurance losses
and loss adjustment expenses are the estimated claim settlement
costs on notices of delinquency that have been received by the
Company, as well as loan delinquencies that have been incurred
but have not been reported by the lenders. Consistent with
primary mortgage insurance industry accounting practice, the
Company does not establish loss reserves for future claims on
insured loans that are not currently delinquent (defined as two
consecutive missed payments). The Company establishes loss
reserves on a case-by-case basis when insured loans are reported
delinquent using estimated claim rates and average claim sizes
for each cohort, net of any salvage recoverable. The Company
also reserves for delinquencies that have occurred but have not
yet been reported to the Company prior to the close of an
accounting period. To determine this reserve, the Company
estimates the number of delinquencies not yet reported using
historical information regarding late reported delinquencies and
applies estimated claim rates and claim sizes for the estimated
delinquencies not yet reported.
The establishment of reserves across the Company’s segments
is an inherently uncertain process, are necessarily based on
estimates, and the ultimate net cost may vary from such
estimates. The methods for making such estimates and for
establishing the resulting liability are reviewed and updated
using the most current information available. Any resulting
adjustments, which may be material, are reflected in current
operations.
(j) Contractholder Receivables and Payables and Collateral
Held for Insured Obligations
in
feature
large deductibles, primarily
Certain insurance policies written by the Company’s insurance
operations
its
construction and national accounts lines of business. Under
such contracts, the Company is obligated to pay the claimant
for the full amount of the claim. The Company is subsequently
reimbursed by the policyholder for the deductible amount.
These amounts are included on a gross basis in the consolidated
balance sheet in contractholder payables and contractholder
receivables, respectively. In the event that the Company is
unable to collect from the policyholder, the Company would be
liable for such defaulted amounts. Collateral, primarily in the
form of letters of credit, cash and trusts, is obtained from the
policyholder to mitigate the Company’s credit risk. In the
instances where the Company receives collateral in the form of
cash, the Company reflects it in “Collateral held for insured
obligations.”
(k) Foreign Exchange
Assets and liabilities of foreign operations whose functional
currency is not the U.S. Dollar are translated at the prevailing
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
exchange rates at each balance sheet date. Revenues and
expenses of such foreign operations are translated at average
exchange rates during the year. The net effect of the translation
adjustments for foreign operations is included in accumulated
other comprehensive income, net of applicable deferred income
tax. Monetary assets and liabilities, such as premiums
receivable and the reserve for losses and loss adjustment
expenses, denominated in foreign currencies are revalued at the
exchange rate in effect at the balance sheet date with the
resulting foreign exchange gains and losses included in net
income. Accounts that are classified as non-monetary, such as
deferred acquisition costs and the unearned premium reserves,
are not revalued. In the case of foreign currency denominated
fixed maturity securities which are classified as “available for
sale,” the change in exchange rates between the local currency
in which the investments are denominated and the Company’s
functional currency at each balance sheet date is included in
unrealized appreciation or decline in value of securities, a
component of accumulated other comprehensive income, net
of applicable deferred income tax.
(l) Income Taxes
Deferred income taxes reflect the expected future tax
consequences of temporary differences between the carrying
amounts of assets and liabilities for financial reporting purposes
and amounts used for income tax purposes. A valuation
allowance is recorded if it is more likely than not that some or
all of a deferred tax asset may not be realized. The Company
considers future taxable income and feasible tax planning
strategies in assessing the need for a valuation allowance. In
the event the Company determines that it will not be able to
realize all or part of its deferred income tax assets in the future,
an adjustment to the deferred income tax assets would be
charged to income in the period in which such determination is
made. In addition, if the Company subsequently assesses that
the valuation allowance is no longer needed, a benefit would
be recorded to income in the period in which such determination
is made. See note 14, “Income Taxes” for additional
information.
The Company recognizes a tax benefit where it concludes that
it is more likely than not that the tax benefit will be sustained
on audit by the taxing authority based solely on the technical
merits of the associated tax position. If the recognition threshold
is met, the Company recognizes a tax benefit measured at the
largest amount of the tax benefit that, in the Company’s
judgment, is greater than 50% likely to be realized. The
Company records interest and penalties related to unrecognized
tax benefits in the provision for income taxes.
(m) Share-Based Payment Arrangements
The Company applies a fair value based measurement method
in accounting for its share-based payment arrangements with
eligible employees and directors. Compensation expense is
estimated based on the fair value of the award at the grant date
and is recognized in net income over the requisite service period
with a corresponding increase in shareholders’ equity. No value
is attributed to awards that employees forfeit because they fail
to satisfy vesting conditions. The Company’s (i) time-based
awards generally vest over a three year period with one-third
vesting on the first, second and third anniversaries of the grant
date and (ii) performance-based awards cliff vest after each
three-year performance period based on achievement of the
specified performance criteria. The share-based compensation
expense associated with awards that have graded vesting
features and vest based on service conditions only is calculated
on a straight-line basis over the requisite service period for the
entire award. Compensation expense recognized in connection
with performance awards is based on the achievement of the
specified performance and service conditions. The final
measure of compensation expense recognized over the requisite
service period reflects the final performance outcome. During
the recognition period compensation expense is accrued based
on the performance condition that is probable of achievement.
For awards granted to retirement-eligible employees where no
service is required for the employee to retain the award, the
grant date fair value is immediately recognized as compensation
expense at the grant date because the employee is able to retain
the award without continuing to provide service. For employees
near retirement eligibility, attribution of compensation cost is
over the period from the grant date to the retirement eligibility
date. These charges had no impact on the Company’s cash flows
or total shareholders’ equity. See note 20, “Share-Based
Compensation” for information relating to the Company’s
share-based payment awards.
(n) Guaranty Fund and Other Related Assessments
Liabilities for guaranty fund and other related assessments in
the Company’s insurance and reinsurance operations are
accrued when the Company receives notice that an amount is
payable, or earlier if a reasonable estimate of the assessment
can be made.
(o) Treasury Shares
Treasury shares are common shares purchased by the Company
and not subsequently canceled. These shares are recorded at
cost and result in a reduction of the Company’s shareholders’
equity in its Consolidated Balance Sheets.
(p) Goodwill and Intangible Assets
Goodwill represents the excess of the purchase price of an
acquisition over the fair value of the net assets acquired and is
assigned to the applicable reporting unit at acquisition.
Goodwill is evaluated for impairment on an annual basis.
Impairment tests may be performed more frequently if the facts
and circumstances
impairment. In
performing impairment tests, the Company may first assess
indicate a possible
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
qualitative factors to determine whether it is more likely than
not (that is, more than a 50% probability) that the fair value of
a reporting unit exceeds its carrying amount as a basis for
determining whether it is necessary to perform the two-step
goodwill impairment test described in the accounting guidance.
Indefinite-lived intangible assets, such as insurance licenses are
evaluated for impairment similar to goodwill. Finite-lived
intangible assets and liabilities include the value of acquired
insurance and reinsurance contracts, which are estimated based
on the present value of future expected cash flows and amortized
in proportion to the estimated profits expected to be realized.
Other finite-lived intangible assets or liabilities, including
favorable or unfavorable contracts, are amortized over their
useful lives. Finite-lived intangible assets and liabilities are
periodically reviewed for indicators of impairment. An
impairment is recognized when the carrying amount is not
recoverable from its undiscounted cash flows and is measured
as the difference between the carrying amount and fair value.
If goodwill or intangible assets are impaired, such assets are
written down to their fair values with the related expense
recorded in the Company’s results of operations.
(q) Recent Accounting Pronouncements
Recently Issued Accounting Standards Adopted
improving
instruments and provides
The Company adopted Financial Accounting Standards Board
(“FASB”) Accounting Standard Update (“ASU”) 2016-01,
“Financial Instruments - Overall (Subtopic 825-10) -
Recognition and Measurement of Financial Assets and
Financial Liabilities,” which enhances the reporting model for
financial
improved financial
information to readers of the financial statements. Among other
the recognition and
provisions focused on
measurement of financial instruments, the ASU significantly
changes the income statement impact of equity instruments and
the recognition of changes in fair value of financial liabilities
attributable to an entity's own credit risk when the fair value
option is elected. The ASU requires equity instruments that do
not result in consolidation and are not accounted for under the
equity method to be measured at fair value with any changes
in fair value recognized in net income rather than other
comprehensive income. Upon adoption of this ASU, the
Company recorded a cumulative effect adjustment of $149.8
million in retained earnings and an offsetting decrease in
accumulated other comprehensive income. The adoption of this
ASU did not have a material impact on the Company's financial
position, cash flows, or total comprehensive income, but may
increase volatility in the Company's results of operations in
future periods.
The Company adopted ASU 2014-09, “Revenue from
Contracts with Customers (Topic 606),” which creates a new
comprehensive revenue recognition standard that serves as a
single source of revenue guidance for all companies in all
industries. The guidance applies to all companies that either
enter into contracts with customers to transfer goods or services
or enter into contracts for the transfer of non-financial assets,
unless those contracts are within the scope of other standards,
such as insurance contracts or financial instruments. The ASU
also requires enhanced disclosures about revenue. The
Company adopted the ASU using the modified retrospective
method, whereby the cumulative effect of adoption was
recognized as an adjustment to retained earnings at the date of
initial application. The impact of the adoption of this ASU was
not material, mostly because the accounting for insurance
contracts is outside of the scope of ASU 2014-09.
The Company adopted ASU 2016-18, “Statement of Cash
Flows (Topic 230) - Restricted Cash,” which 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 revised presentation required
in this ASU is reflected in the Company’s consolidated
statements of cash flows for both periods presented. The
adoption of this ASU did not have any effect on the Company’s
results of operations, financial position or comprehensive
income.
The Company adopted ASU 2016-15, “Statement of Cash
Flows (Topic 230) - Classification of Certain Cash Receipts
and Cash Payments,” which addresses several clarifications on
the presentation and classification of certain cash receipts and
cash payments in the statement of cash flows. Among several
other cash flow issues, the ASU specifically addresses the
classification of debt prepayment or debt issuance costs,
contingent consideration payments made after a business
combination and distributions received from equity method
investees. The ASU also provides a broader principle on
identifying the type of activity of the cash flow item by focusing
on the cash flow item’s nature and the predominant source or
use of that item. The adoption of this ASU did not have a
material impact on the Company’s consolidated financial
statements.
The Company adopted ASU 2016-16, “Income Taxes (Topic
740) - Intra-Entity Transfers of Assets Other than Inventory,”
which requires entities to recognize current and deferred
income tax resulting from an intra-entity asset transfer when
the transfer occurs. Previously, recognition of income tax
consequences under GAAP was not allowed until the asset had
been sold to a third party. The adoption of this ASU did not have
a material impact on the Company’s consolidated financial
statements.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Recently Issued Accounting Standards Not Yet Adopted
ASU 2016-13, “Financial Instruments - Credit Losses (Topic
326),” was issued in June, 2016. The ASU changes how entities
will measure credit losses for most financial assets and certain
other instruments that aren’t measured at fair value through net
income. The ASU requires an entity to estimate its lifetime
“expected credit loss” and record an allowance that, when
deducted from the amortized cost basis of the financial asset,
presents the net amount expected to be collected on the financial
asset. The ASU is effective for the 2020 first quarter, though
early application is permitted in the 2019 first quarter, and
should be applied on a modified retrospective basis for the
majority of the provisions with a cumulative-effect adjustment
to retained earnings at the beginning of the year of adoption.
Upon adoption, the Company expects the new standard to have
an impact on certain type of investment securities, reinsurance
recoverables and contractholder receivables. 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 March, 2017. This
ASU shortens the amortization period for certain callable debt
securities held at a premium and requires the premium to be
amortized to the earliest call date. However, the new guidance
does not require an accounting change for securities held at a
discount whose discount continues to be amortized to maturity.
The standard is effective for financial statements issued for
fiscal years, and interim periods within those fiscal years,
beginning after December 15, 2018, with early adoption
permitted. The adoption of the guidance requires a modified
retrospective approach with a cumulative-effect adjustment to
retained earnings. The adoption of this ASU is not expected to
have a material effect on the Company’s consolidated financial
statements.
ASU 2018-02 “Income Statement-Reporting Comprehensive
Income (Topic 220) - Reclassification of Certain Tax Effects
from Accumulated Other Comprehensive Income,” was issued
in February 2018 to allow the reclassification of the stranded
tax effects in accumulated other comprehensive income
(“AOCI”) resulting from the Tax Cuts and Jobs Act of 2017
(“Tax Cuts Act”). Current guidance requires the effect of a
change in tax laws or rates on deferred tax balances to be
reported in income from continuing operations in the
accounting period that includes the period of enactment, even
if the related income tax effects were originally charged or
credited directly to AOCI. The amount of the reclassification
would include the effect of the change in the U.S. federal
corporate income tax rate on the gross deferred tax amounts
and related valuation allowances, if any, at the date of the
enactment of the Tax Cuts Act related to items in AOCI. The
updated guidance is effective for reporting periods beginning
after December 15, 2018 and is to be applied retrospectively to
each period in which the effect of the Tax Cuts Act related to
items remaining in AOCI are recognized or at the beginning of
the period of adoption. Early adoption is permitted. The
adoption of this ASU is not expected to have a material effect
on the Company’s results of operations, financial position or
liquidity.
ASU 2018-07 “Improvements to Nonemployee Share-Based
Payment Accounting” was issued in June, 2018 to simplify the
accounting for share-based payments granted to nonemployees
for goods and services. Under this ASU, most of the guidance
on such payments to nonemployees would be aligned with the
requirements for share-based payments granted to employees.
The ASU is effective for reporting periods beginning after
December 15, 2018. The Company has granted share-based
payment awards only to employees as defined by accounting
guidance and does not expect this guidance to have a material
impact on its consolidated financial statements.
ASU 2018-11,“Leases: Targeted Improvements (Topic 842),”
was issued in July, 2018. This ASU will ease implementation
of the lease standard (ASU 2016-02). The guidance provides
an alternative transition method by which leases are recognized
at the date of adoption. Entities that elect this transition option
will still be required to adopt the new leases standard using the
modified retrospective transition method required by the
standard, but
they will recognize a cumulative-effect
adjustment to the opening balance of retained earnings in the
period of adoption rather than in the earliest period presented.
The Company will adopt this alternative transition method as
of January 1, 2019 for leases existing at the date of adoption.
The Company will also elect certain practical expedients that
allow the Company not to reassess existing leases under the
new guidance. Based on the Company’s analysis, the primary
impact of adoption will be the recognition of a right of use asset
and a lease liability for operating leases pertaining to the
Company’s real estate portfolio that are expected to represent
less than one percent of the Company’s Total Assets and Total
Liabilities, respectively.
to
- Changes
ASU 2018-13, “Fair Value Measurement (Topic 820):
Disclosure Framework
the Disclosure
Requirements for Fair Value Measurement,” was issued in
August, 2018. The ASU modifies the disclosure requirements
on fair value measurement as part of the disclosure framework
project with the objective to improve the effectiveness of
disclosures in the notes to the financial statements. The
amendments in this update allow for removal of (1) the amount
and reasons for transfer between Level 1 and Level 2 of the fair
value hierarchy; (2) the policy for transfers between levels; and
(3) the valuation processes for Level 3 fair value measurements.
The ASU is effective for fiscal years beginning after December
15, 2019 and interim periods within those fiscal years. The
Company is currently evaluating the impact of the new guidance
on its consolidated financial statements.
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ASU 2018-15, “Intangibles - Goodwill and Other - Internal-
Use Software (Subtopic 350-40),” was issued in the 2018 third
quarter. This ASU aligns the requirements for capitalizing
certain implementation costs incurred in a cloud computing
arrangement that is a service contract with the requirements for
capitalizing implementation costs incurred to develop or obtain
internal-use software. The standard is effective for financial
statements issued for fiscal years, and interim periods within
those fiscal years, beginning after December 15, 2019, with
early adoption permitted. The guidance provides flexibility in
adoption, allowing for either retrospective adjustment or
prospective adjustment for all implementation costs incurred
after the date of adoption. The Company is currently evaluating
the impact of the new guidance on the consolidated financial
statements.
4. Segment Information
The Company classifies its businesses into three underwriting
segments — insurance, reinsurance and mortgage — and two
other operating segments — ‘other’ and corporate (non-
its reportable
underwriting). The Company determined
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
financial statements.
Intersegment business is allocated to the segment accountable
for the underwriting results.
the Company’s consolidated
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 President and Chief Executive Officer of Arch Capital and
the Chief Financial Officer of Arch Capital. 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: primary and excess
casualty coverages to middle and large accounts in the
construction industry and a wide range of products for
middle and large national accounts, specializing in loss
sensitive primary casualty insurance programs (including
•
•
•
•
•
•
•
large
deductible,
retrospectively rated programs).
self-insured
retention
and
Excess and surplus casualty: primary and excess casualty
insurance coverages, including middle market energy
business, and contract binding, which primarily provides
casualty coverage through a network of appointed agents
to small and medium risks.
Lenders products: collateral protection, debt cancellation
and service contract reimbursement products to banks,
credit unions, automotive dealerships and original
equipment manufacturers and other specialty programs
that pertain to automotive lending and leasing.
Professional lines: directors’ and officers’ liability, errors
and omissions liability, employment practices liability,
fiduciary liability, crime, professional indemnity and
other financial related coverages for corporate, private
equity, venture capital, real estate investment trust, limited
partnership, financial institution and not-for-profit clients
of all sizes and medical professional and general liability
insurance coverages for the healthcare industry. The
business is predominately written on a claims-made basis.
Programs: primarily package policies, underwriting
workers’ compensation and umbrella liability business in
support of desirable package programs, targeting program
managers with unique expertise and niche products
offering general liability, commercial automobile, inland
marine and property business with minimal catastrophe
exposure.
Property, energy, marine and aviation: primary and
excess general property insurance coverages, including
catastrophe-exposed property coverage, for commercial
clients. Coverages for marine include hull, war, specie
and liability. Aviation and stand-alone terrorism are also
offered.
Travel, accident and health: specialty travel and accident
and related insurance products for individual, group
travelers, travel agents and suppliers, as well as accident
and health, which provides accident, disability and
medical plan insurance coverages for employer groups,
medical plan members, students and other participant
groups.
insurance
Other: includes alternative market risks (including
excess workers’
captive
programs),
insurance
compensation and employer’s
coverages for qualified self-insured groups, associations
and trusts, and contract and commercial surety coverages,
including contract bonds (payment and performance
bonds) primarily for medium and large contractors and
commercial surety bonds for Fortune 1000 companies and
smaller transaction business programs.
liability
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The reinsurance segment consists of
the Company’s
reinsurance underwriting units which offer specialty product
lines on a worldwide basis. Product lines include:
on both a proportional and excess of loss basis. In addition,
is written which focuses on
facultative business
commercial property risks on an excess of loss basis.
•
Casualty: provides coverage to ceding company clients
on third party liability and workers’ compensation
exposures from ceding company clients, primarily on a
treaty basis. Exposures include, among others, executive
assurance, professional liability, workers’ compensation,
excess and umbrella liability, excess motor and healthcare
business.
• Marine and aviation: provides coverage for energy, hull,
cargo, specie, liability and transit, and aviation business,
including airline and general aviation risks. Business
written may also include space business, which includes
coverages for satellite assembly, launch and operation for
commercial space programs.
•
•
•
Other specialty: provides coverage to ceding company
clients for proportional motor and other lines including
surety, accident and health, workers’ compensation
catastrophe, agriculture, trade credit and political risk.
Property catastrophe: provides protection for most
catastrophic losses that are covered in the underlying
policies written by reinsureds, including hurricane,
earthquake, flood, tornado, hail and fire, and coverage for
other perils on a case-by-case basis. Property catastrophe
reinsurance provides coverage on an excess of loss basis
when aggregate losses and loss adjustment expense from
a single occurrence of a covered peril exceed the retention
specified in the contract.
Property excluding property catastrophe: provides
coverage for both personal lines and commercial property
exposures and principally covers buildings, structures,
equipment and contents. The primary perils in this
business include fire, explosion, collapse, riot, vandalism,
wind, tornado, flood and earthquake. Business is assumed
•
Other. includes life reinsurance business on both a
proportional and non-proportional basis, casualty clash
business and, in limited instances, non-traditional
business which is intended to provide insurers with risk
management solutions
traditional
reinsurance.
that complement
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. AMIC and UGRIC (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
government sponsored enterprise, or “GSE.”
The corporate (non-underwriting) segment results include net
investment income, other income (loss), other expenses
incurred by the Company, interest expense, net realized gains
or losses, net impairment losses included in earnings, equity in
net income or loss of investments accounted for using the equity
method, net foreign exchange gains or losses, transaction costs
and other, income taxes and items related to the Company’s
non-cumulative preferred shares. Such amounts exclude the
results of the ‘other’ segment.
The ‘other’ segment includes the results of Watford Re (see note
11, “Variable Interest Entity and Noncontrolling Interests”).
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
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 Arch common shareholders, summary information regarding net premiums
written and earned by major line of business and net premiums written by location:
Gross premiums written (1)
Premiums ceded
Net premiums written
Change in unearned premiums
Net premiums earned
Other underwriting income (loss)
Losses and loss adjustment expenses
Acquisition expenses
Other operating expenses
Underwriting income (loss)
Net investment income
Net realized gains (losses)
Net impairment losses recognized in earnings
Equity in net income (loss) of investments
accounted for using the equity method
Other income (loss)
Corporate expenses
Transaction costs and other
Amortization of intangible assets
Interest expense
Net foreign exchange gains (losses)
Income (loss) before income taxes
Income tax expense
Net income (loss)
Dividends attributable to redeemable
noncontrolling interests
Amounts attributable to nonredeemable
noncontrolling interests
Net income (loss) available to Arch
Preferred dividends
Loss on redemption of preferred shares
Net income (loss) available to Arch common
shareholders
Underwriting Ratios
Loss ratio
Acquisition expense ratio
Other operating expense ratio
Combined ratio
$
Year Ended December 31, 2018
Insurance
$ 3,262,332
(1,050,207)
2,212,125
(6,464)
2,205,661
—
(1,520,680)
(349,702)
(364,138)
(28,859)
$
Reinsurance
1,912,522
(539,950)
1,372,572
(111,356)
1,261,216
(682)
(846,882)
(211,280)
(133,350)
69,022
$
$
Mortgage
$ 1,360,708
(202,833)
1,157,875
28,361
1,186,236
13,033
(81,289)
(118,595)
(142,432)
856,953
$
Sub-Total
$ 6,534,423
(1,791,851)
4,742,572
(89,459)
4,653,113
12,351
(2,448,851)
(679,577)
(639,920)
897,116
437,958
(284,429)
(2,829)
45,641
2,419
(58,608)
(11,386)
(105,670)
(101,019)
58,711
877,904
(113,924)
763,980
—
—
763,980
(41,645)
(2,710)
Other
735,015
(130,840)
604,175
(25,313)
578,862
2,722
(441,255)
(125,558)
(37,889)
(23,118)
125,675
(120,915)
—
—
—
—
(9,000)
—
(19,465)
10,691
(36,132)
(27)
(36,159)
$
Total
6,961,004
(1,614,257)
5,346,747
(114,772)
5,231,975
15,073
(2,890,106)
(805,135)
(677,809)
873,998
563,633
(405,344)
(2,829)
45,641
2,419
(58,608)
(20,386)
(105,670)
(120,484)
69,402
841,772
(113,951)
727,821
(18,357)
(18,357)
48,507
(6,009)
—
—
48,507
757,971
(41,645)
(2,710)
$
719,625
$
(6,009)
$
713,616
68.9%
15.9%
16.5%
101.3%
67.1%
16.8%
10.6%
94.5%
6.9%
10.0%
12.0%
28.9%
52.6%
14.6%
13.8%
81.0%
76.2%
21.7%
6.5%
104.4%
55.2%
15.4%
13.0%
83.6%
Goodwill and intangible assets
$
114,012
$
— $
513,258
$
627,270
$
7,650
$
634,920
Total investable assets
Total assets
Total liabilities
$ 19,566,861
28,845,473
19,518,395
$ 2,757,663
3,372,856
2,262,255
$ 22,324,524
32,218,329
21,780,650
(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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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Gross premiums written (1)
Premiums ceded
Net premiums written
Change in unearned premiums
Net premiums earned
Other underwriting income
Losses and loss adjustment expenses
Acquisition expenses, net
Other operating expenses
Underwriting income (loss)
Net investment income
Net realized gains (losses)
Net impairment losses recognized in earnings
Equity in net income (loss) of investments
accounted for using the equity method
Other income (loss)
Corporate expenses
Transaction costs and other
Amortization of intangible assets
Interest expense
Net foreign exchange gains (losses)
Income before income taxes
Income tax (expense) benefit
Net income
Dividends attributable to redeemable
noncontrolling interests
Amounts attributable to nonredeemable
noncontrolling interests
Net income (loss) available to Arch
Preferred dividends
Loss on redemption of preferred shares
Net income (loss) available to Arch common
shareholders
Underwriting Ratios
Loss ratio
Acquisition expense ratio
Other operating expense ratio
Combined ratio
$
Year Ended December 31, 2017
Insurance
$ 3,081,086
(958,646)
2,122,440
(9,422)
2,113,018
—
(1,622,444)
(323,639)
(359,524)
(192,589)
$
Reinsurance
$ 1,640,399
(465,925)
1,174,474
(31,853)
1,142,621
11,336
(773,923)
(221,250)
(146,663)
12,121
$
Mortgage
$ 1,368,138
(256,796)
1,111,342
(54,176)
1,057,166
15,737
(134,677)
(100,598)
(146,336)
691,292
$
Sub-Total
$ 6,088,254
(1,679,998)
4,408,256
(95,451)
4,312,805
27,073
(2,531,044)
(645,487)
(652,523)
510,824
382,072
148,798
(7,138)
142,286
(2,571)
(61,602)
(22,150)
(125,778)
(103,592)
(113,345)
747,804
(127,547)
620,257
—
—
620,257
(46,041)
(6,735)
Other
600,304
(47,187)
553,117
(21,390)
531,727
3,180
(436,402)
(129,971)
(31,928)
(63,394)
88,800
343
—
—
—
—
—
—
(13,839)
(2,437)
9,473
(21)
9,452
Total
$ 6,368,425
(1,407,052)
4,961,373
(116,841)
4,844,532
30,253
(2,967,446)
(775,458)
(684,451)
447,430
470,872
149,141
(7,138)
142,286
(2,571)
(61,602)
(22,150)
(125,778)
(117,431)
(115,782)
757,277
(127,568)
629,709
(18,344)
(18,344)
7,913
(979)
—
—
7,913
619,278
(46,041)
(6,735)
$
567,481
$
(979)
$
566,502
76.8%
15.3%
17.0%
109.1%
67.7%
19.4%
12.8%
99.9%
12.7%
9.5%
13.8%
36.0%
58.7%
15.0%
15.1%
88.8%
82.1%
24.4%
6.0%
112.5%
61.3%
16.0%
14.1%
91.4%
Goodwill and intangible assets
$
22,310
$
211
$
622,440
$
644,961
$
7,650
$
652,611
Total investable assets
Total assets
Total liabilities
$ 19,716,421
29,037,004
19,959,574
$ 2,440,067
3,014,654
1,846,149
$ 22,156,488
32,051,658
21,805,723
(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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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Gross premiums written (1)
Premiums ceded
Net premiums written
Change in unearned premiums
Net premiums earned
Other underwriting income
Losses and loss adjustment expenses
Acquisition expenses, net
Other operating expenses
Underwriting income (loss)
Net investment income
Net realized gains (losses)
Net impairment losses recognized in earnings
Equity in net income (loss) of investments
accounted for using the equity method
Other income (loss)
Corporate expenses
Transaction costs and other
Amortization of intangible assets
Interest expense
Net foreign exchange gains (losses)
Income before income taxes
Income tax benefit
Net income
Dividends attributable to redeemable
noncontrolling interests
Amounts attributable to nonredeemable
noncontrolling interests
Net income available to Arch
Preferred dividends
Net income available to Arch common
shareholders
Underwriting Ratios
Loss ratio
Acquisition expense ratio
Other operating expense ratio
Combined ratio
Year Ended December 31, 2016
Insurance
Reinsurance
Mortgage
Sub-Total
$ 3,027,049
(954,768)
2,072,281
1,623
2,073,904
—
(1,359,313)
(304,050)
(350,260)
60,281
$
$ 1,494,397
(440,541)
1,053,856
2,376
1,056,232
36,403
(475,762)
(212,258)
(142,616)
261,999
$
$
$
499,725
(108,259)
391,466
(104,750)
286,716
17,024
(28,943)
(21,790)
(96,672)
156,335
$ 5,019,363
(1,501,760)
3,517,603
(100,751)
3,416,852
53,427
(1,864,018)
(538,098)
(589,548)
478,615
$
277,193
69,586
(30,442)
48,475
(800)
(49,396)
(41,729)
(19,343)
(53,464)
31,409
710,104
(31,375)
678,729
—
—
678,729
(28,070)
Other
535,094
(21,306)
513,788
(45,818)
467,970
3,746
(321,581)
(129,527)
(25,163)
(4,555)
89,549
68,000
—
—
—
—
—
—
(12,788)
5,242
145,448
1
145,449
Total
$ 5,202,134
(1,170,743)
4,031,391
(146,569)
3,884,822
57,173
(2,185,599)
(667,625)
(614,711)
474,060
366,742
137,586
(30,442)
48,475
(800)
(49,396)
(41,729)
(19,343)
(66,252)
36,651
855,552
(31,374)
824,178
(18,349)
(18,349)
(113,091)
14,009
—
(113,091)
692,738
(28,070)
$
650,659
$
14,009
$
664,668
65.5%
14.7%
16.9%
97.1%
45.0%
20.1%
13.5%
78.6%
10.1%
7.6%
33.7%
51.4%
54.6%
15.7%
17.3%
87.6%
68.7%
27.7%
5.4%
101.8%
56.3%
17.2%
15.8%
89.3%
Goodwill and intangible assets
$
25,206
$
956
$
747,741
$
773,903
$
7,650
$
781,553
Total investable assets
Total assets
Total liabilities
$ 18,636,189
26,989,359
18,855,858
$ 1,857,763
2,382,750
1,205,126
$ 20,493,952
29,372,109
20,060,984
(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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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following tables provide summary information regarding net premiums written and earned by major line of business and net
premiums written by location:
INSURANCE SEGMENT
Net premiums earned (1)
Professional lines (2)
Programs
Construction and national accounts
Travel, accident and health
Property, energy, marine and aviation
Excess and surplus casualty (3)
Lenders products
Other (4)
Total
Net premiums written by underwriting location (1)
United States
Europe
Other
Total
2018
Year Ended December 31,
2017
2016
$
$
$
$
458,425
389,186
322,440
297,147
205,069
172,424
94,248
266,722
2,205,661
1,736,651
401,974
73,500
2,212,125
$
$
$
$
444,137
364,639
324,517
257,358
173,779
195,154
97,043
256,391
2,113,018
1,715,467
344,836
62,137
2,122,440
$
$
$
$
431,391
357,715
322,072
219,169
188,938
219,046
98,517
237,056
2,073,904
1,690,208
327,034
55,039
2,072,281
Insurance segment results include premiums assumed through intersegment transactions and exclude premiums ceded through intersegment transactions.
(1)
(2) Includes professional liability, executive assurance and healthcare business.
(3)
(4)
Includes casualty and contract binding business.
Includes alternative markets, excess workers' compensation and surety business.
REINSURANCE SEGMENT
Net premiums earned (1)
Other specialty (2)
Casualty (3)
Property excluding property catastrophe
Property catastrophe
Marine and aviation
Other (4)
Total
Net premiums written by underwriting location (1)
United States
Bermuda
Europe and other
Total
2018
Year Ended December 31,
2017
2016
$
$
$
$
474,568
347,034
287,788
75,249
39,238
37,339
1,261,216
413,550
487,523
471,499
1,372,572
$
$
$
$
408,566
341,122
255,453
73,300
36,214
27,966
1,142,621
399,379
350,681
424,414
1,174,474
$
$
$
$
329,994
300,160
282,018
73,803
52,579
17,678
1,056,232
432,683
277,625
343,548
1,053,856
(1) Reinsurance segment results include premiums assumed through intersegment transactions and exclude premiums ceded through intersegment transactions.
(2)
(3)
(4)
Includes proportional motor, surety, accident and health, workers’ compensation catastrophe, agriculture, trade credit and other.
Includes executive assurance, professional liability, workers’ compensation, excess motor, healthcare and other.
Includes life, casualty clash and other.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MORTGAGE SEGMENT
Net premiums earned by underwriting location
United States
Other
Total
Net premiums written by underwriting location
United States
Other
Total
OTHER SEGMENT
Net premiums earned (1)
Casualty (2)
Other specialty (3)
Property catastrophe
Property excluding property catastrophe
Marine and aviation
Other (4)
Total
Net premiums written by underwriting location (1)
United States
Europe
Bermuda
Total
Year Ended December 31,
2017
2018
2016
1,009,765
176,471
1,186,236
948,323
209,552
1,157,875
$
$
$
$
901,858
155,308
1,057,166
903,329
208,013
1,111,342
$
$
$
$
155,929
130,787
286,716
186,826
204,640
391,466
Year Ended December 31,
2017
2018
2016
277,589
204,485
10,998
2,802
420
82,568
578,862
49,800
91,635
462,740
604,175
$
$
$
$
333,275
135,855
12,690
1,392
1,024
47,491
531,727
11,750
91,463
449,904
553,117
$
$
$
$
320,767
101,768
11,421
1,436
1,811
30,767
467,970
5,714
50,195
457,879
513,788
$
$
$
$
$
$
$
$
(1) Other segment results include premiums assumed through intersegment transactions and exclude premiums ceded through intersegment transactions.
(2)
(3)
(4)
Includes professional liability, excess motor, programs and other.
Includes proportional motor and other.
Includes mortgage and other.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. 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:
Reserve for losses and loss adjustment expenses at beginning of year
Unpaid losses and loss adjustment expenses recoverable
Net reserve for losses and loss adjustment expenses at beginning of year
$
Net incurred losses and loss adjustment expenses relating to losses occurring in:
Current year
Prior years
Total net incurred losses and loss adjustment expenses
Net losses and loss adjustment expense reserves of acquired business (1)
Retroactive reinsurance transaction (2)
Foreign exchange (gains) losses
Net paid losses and loss adjustment expenses relating to losses occurring in:
Current year
Prior years
Total net paid losses and loss adjustment expenses
Net reserve for losses and loss adjustment expenses at end of year
Unpaid losses and loss adjustment expenses recoverable
Reserve for losses and loss adjustment expenses at end of year
2018
11,383,792
2,464,910
8,918,882
Year Ended December 31,
2017
10,200,960
2,083,575
8,117,385
$
$
3,162,818
(272,712)
2,890,106
—
(420,404)
3,205,428
(237,982)
2,967,446
—
—
2016
9,125,250
1,828,837
7,296,413
2,455,563
(269,964)
2,185,599
551,096
—
(143,414)
186,963
(102,367)
(524,048)
(1,682,116)
(2,206,164)
(505,424)
(1,847,488)
(2,352,912)
(445,700)
(1,367,656)
(1,813,356)
9,039,006
2,814,291
11,853,297
$
8,918,882
2,464,910
11,383,792
$
8,117,385
2,083,575
10,200,960
$
(1) The 2016 amount related to the acquisition of UGC.
(2) During the 2018 second quarter, a subsidiary of the Company entered into a retroactive reinsurance transaction with a third party
reinsurer to reinsure runoff liabilities associated with certain discontinued U.S. specialty casualty and program exposures.
2018 Prior Year Reserve Development
During 2018, the Company recorded estimated net favorable
development on prior year loss reserves of $272.7 million,
which consisted of $138.5 million from the reinsurance
segment, $24.4 million from the insurance segment, $107.6
million from the mortgage segment and $2.2 million from the
‘other’ segment.
The reinsurance segment’s net favorable development of
$138.5 million, or 11.0 points of net earned premium, consisted
of $110.4 million from short-tailed lines and $28.1 million of
net favorable development from medium-tailed and long-tailed
lines. Favorable development in short-tailed lines included
$80.8 million from property catastrophe and property other than
property catastrophe reserves, primarily from the 2008 to 2017
underwriting years (i.e., losses attributable to contracts having
an inception or renewal date within the given twelve-month
period). The net reduction of loss estimates for the reinsurance
segment’s short-tailed lines primarily resulted from varying
levels of reported and paid claims activity than previously
anticipated which led to decreases in certain loss ratio selections
during 2018. Net favorable development of $28.1 million in
medium-tailed and long-tailed lines included reductions in
casualty reserves of $12.5 million, primarily from the 2002 to
2010 underwriting years, and in marine and aviation reserves
of $15.6 million, spread across most underwriting years.
from medium-tailed
The insurance segment’s net favorable development of $24.4
million, or 1.1 points of net earned premium, consisted of $48.4
million of net favorable development from short-tailed lines
and $26.3 million of net favorable development from long-
tailed lines, partially offset by $50.3 million of net adverse
development
Favorable
development in short-tailed lines predominantly consisted of
$50.1 million of net favorable development in property lines,
primarily from the 2010 to 2017 accident years (i.e., the year
in which a loss occurred), partially offset by $5.0 million of
adverse development on travel, accident and health business
from the 2013 to 2017 accident years. Net favorable
development in long-tailed lines of $26.3 million included
$19.7 million of net favorable development on executive
lines.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
assurance business, primarily from the 2015 accident year, and
$1.4 million of net favorable development in casualty business,
primarily from the 2009 to 2015 accident years. Net adverse
development in medium tailed lines of $50.3 million was
primarily due to net adverse development in contract binding
business for accident years 2013 to 2017.
The mortgage segment’s net favorable development of $107.6
million, or 9.1 points of net earned premium, included $103.4
million of favorable development on U.S. primary mortgage
business. Such development was primarily driven by lower than
expected claim emergence across most origination years and
also reflected $26.3 million related to second lien and other
portfolios, primarily due to subrogation recoveries.
2017 Prior Year Reserve Development
During 2017, the Company recorded estimated net favorable
development on prior year loss reserves of $238.0 million,
which consisted of $165.4 million from the reinsurance
segment, $8.6 million from the insurance segment and $95.0
million from the mortgage segment, less adverse development
of $31.0 million from the ‘other’ segment.
The reinsurance segment’s net favorable development of
$165.4 million, or 14.5 points of net earned premium, consisted
of $101.0 million from short-tailed lines and $64.4 million of
net favorable development from medium-tailed and long-tailed
lines. Favorable development in short-tailed lines included
$82.6 million from property catastrophe and property other than
property catastrophe reserves, primarily from the 2009 to 2016
underwriting years. The net reduction of loss estimates for the
reinsurance segment’s short-tailed lines primarily resulted from
varying levels of reported and paid claims activity than
previously anticipated which led to decreases in certain loss
ratio selections during 2017. Net favorable development of
$64.4 million in medium-tailed and long-tailed lines included
reductions in casualty reserves of $43.7 million, primarily from
the 2002 to 2013 underwriting years, and in marine and aviation
reserves of $19.6 million, spread across most underwriting
years.
from medium-tailed
The insurance segment’s net favorable development of $8.6
million, or 4.0 points of net earned premium, consisted of $14.9
million of net favorable development from short-tailed lines
and $11.8 million of net favorable development from long-
tailed lines, partially offset by $18.1 million of net adverse
development
Favorable
development in short-tailed lines predominantly consisted of
$22.8 million of net favorable development in property lines,
primarily from the 2011 to 2016 accident years, partially offset
by $11.8 million of adverse development on travel, accident
and health business from the 2014 to 2016 accident years. Net
favorable development in long-tailed lines of $11.8 million
included $10.0 million of net favorable development on
executive assurance business, primarily from the 2013 accident
lines.
year, and $8.3 million of net favorable development in casualty
business, primarily from the 2007 to 2013 accident years. Net
adverse development in medium-tailed lines of $18.1 million
included $56.3 million of net adverse development in program
business, primarily from the 2013 to 2015 accident years and
primarily driven by a few inactive programs that were non-
renewed in 2015 and early in 2016, partially offset by $36.2
million of net favorable development in professional liability
business, primarily from the 2010 to 2016 accident years.
The mortgage segment’s net favorable development of $95.0
million, or 9.0 points of net earned premium, for 2017, included
$89.3 million of favorable development on U.S. primary
mortgage business. Such development was primarily driven by
lower than expected claim emergence across most origination
years and also reflected $33.8 million related to second lien and
other portfolios, primarily due to subrogation recoveries.
2016 Prior Year Reserve Development
During 2016, the Company recorded estimated net favorable
development on prior year loss reserves of $270 million, which
consisted of $218.8 million from the reinsurance segment,
$33.1 million from the insurance segment, $21.2 million from
the mortgage segment less adverse development of $3.1 million
from the ‘other’ segment.
The reinsurance segment’s net favorable development of
$218.8 million, or 20.7 points of net earned premium, consisted
of $133.8 million from short-tailed lines and $85.0 million of
net favorable development from medium-tailed and long-tailed
lines. Favorable development in short-tailed lines included
$113.6 million from property catastrophe and property other
than property catastrophe reserves, primarily from the 2009 to
2015 underwriting years. The net reduction of loss estimates
for the reinsurance segment’s short-tailed lines primarily
resulted from varying levels of reported and paid claims activity
than previously anticipated which led to decreases in certain
loss ratio selections during 2016. Net favorable development
of $85.0 million in medium-tailed and long-tailed lines included
reductions in casualty reserves of $86.1 million, primarily from
the 2002 to 2013 underwriting years.
The insurance segment’s net favorable development of $33.1
million, or 1.6 points of net earned premium, consisted of $8.7
million of net favorable development from short-tailed lines
and $24.4 million of net favorable development from medium-
tailed and long-tailed lines. Favorable development in short-
tailed lines predominantly consisted of $17.2 million of net
favorable development in property lines, primarily from the
2008 to 2014 accident years, partially offset by $11.1 million
of adverse development on travel, accident and health business
from the 2012 to 2015 accident years. Net favorable
development in medium-tailed and long-tailed lines of $24.4
million included $53.8 million of net favorable development
on professional lines, primarily from the 2008 to 2012 accident
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
years, partially offset by $33.1 million of net adverse
development in program business, primarily from the 2013 to
2015 accident years. The adverse development in program
business was primarily driven by a few inactive programs that
were non-renewed in 2015 and early in 2016.
The mortgage segment’s net favorable development of $21.2
million, or 7.4 points of net earned premium, for 2016, included
$18.5 million of favorable development on U.S. primary
mortgage business, reflecting a decrease in the number of
delinquent loans and a lower claim rate on such loans. Such
development was primarily from the 2004 to 2008 and 2014
origination years. The mortgage segment also experienced net
favorable development of $2.7 million on U.S. mortgage
reinsurance business.
6. Short Duration Contracts
The Company’s reserves for losses and loss adjustment
expenses primarily relate to short-duration contracts with
various characteristics (e.g., type of coverage, geography,
claims duration). The Company considered such information
in determining the level of disaggregation for disclosures
related to its short-duration contracts, as detailed in the table
below:
Reportable
segment
Insurance
Level of
disaggregation
Included lines of business
Property energy,
marine and aviation
Property energy, marine and
aviation
Third party
occurrence business
Third party claims-
made business
Multi-line and other
specialty
Excess and surplus casualty
(excluding contract binding);
construction and national
accounts; and other (including
alternative market risks, excess
workers’ compensation and
employer’s liability insurance
coverages)
Professional lines
Programs; contract binding (part
of excess and surplus casualty);
travel, accident and health;
lenders products; and other
(contract and commercial surety
coverages)
Reinsurance
Casualty
Casualty
Property catastrophe
Property catastrophe
Property excluding
property catastrophe
Property excluding property
catastrophe
Marine and aviation Marine and aviation
Other specialty
Other specialty
Mortgage
Direct mortgage
insurance in the U.S.
Mortgage insurance on U.S.
primary exposures
Entity and Noncontrolling Interests”; (ii) certain mortgage
business, including non-U.S. primary business, second lien and
student loan exposures, global mortgage reinsurance and
participation in various GSE credit risk-sharing products; and
(iii) certain reinsurance business, including casualty clash and
non-traditional lines. Such amounts are included as reconciling
items.
The Company is required to establish reserves for losses and
loss adjustment expenses (“Loss Reserves”) that arise from the
business the Company underwrites. Loss Reserves for the
insurance, reinsurance and mortgage segments represent
estimates of future amounts required to pay losses and loss
adjustment expenses for insured or reinsured events which have
occurred at or before the balance sheet date. Loss Reserves do
not reflect contingency reserve allowances to account for future
loss occurrences. Losses arising from future events will be
estimated and recognized at the time the losses are incurred and
could be substantial.
Insurance Segment
Loss Reserves for the insurance segment are comprised of (1)
estimated amounts for (1) reported losses (“case reserves”) and
(2) incurred but not reported losses (“IBNR reserves”).
Generally, claims personnel determine whether to establish a
case reserve for the estimated amount of the ultimate settlement
of individual claims. The estimate reflects the judgment of
claims personnel based on general corporate reserving
practices, the experience and knowledge of such personnel
regarding the nature and value of the specific type of claim and,
where appropriate, advice of counsel. The Company also
contracts with a number of outside third party administrators
in the claims process who, in certain cases, have limited
authority to establish case reserves. The work of such
administrators is reviewed and monitored by our claims
personnel. Loss Reserves are also established to provide for
loss adjustment expenses and represent the estimated expense
of settling claims, including legal and other fees and the general
expenses of administering the claims adjustment process.
Periodically, adjustments to the case reserves may be made as
additional information is reported or payments are made. IBNR
reserves are established to provide for incurred claims which
have not yet been reported at the balance sheet date as well as
to adjust for any projected variance in case reserving. Actuaries
estimate ultimate losses and loss adjustment expenses using
various generally accepted actuarial methods applied to known
losses and other relevant information. Like case reserves, IBNR
reserves are adjusted as additional information becomes known
or payments are made. The process of estimating reserves
involves a considerable degree of judgment by management
and, as of any given date, is inherently uncertain.
The Company determined the following to be insignificant for
disclosure purposes: (i) amounts included in the ‘other’ segment
(i.e., Watford Re) as described in note 11, “Variable Interest
Ultimate losses and loss adjustment expenses are generally
determined by extrapolation of claim emergence and settlement
patterns observed in the past that can reasonably be expected
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
to persist into the future. In forecasting ultimate losses and loss
adjustment expenses with respect to any line of business, past
experience with respect to that line of business is the primary
resource, developed through both industry and company
experience, but cannot be relied upon in isolation. Uncertainties
in estimating ultimate losses and loss adjustment expenses are
magnified by the length of the time lag between when a claim
actually occurs and when it is reported and settled. This time
lag is sometimes referred to as the “claim-tail.” During this
period additional facts regarding coverages written in prior
accident years, as well as about actual claims and trends, may
become known and, as a result, may lead to adjustments of the
related Loss Reserves. If the Company determines that an
adjustment is appropriate, the adjustment is recorded in the
accounting period in which such determination is made.
Accordingly, should Loss Reserves need to be increased or
decreased in the future from amounts currently established,
future results of operations would be negatively or positively
impacted respectively. The Company authorizes managing
general agents, general agents and other producers to write
program business on the Company’s behalf within prescribed
underwriting authorities. This delegated authority process
introduces additional complexity to the actuarial determination
of unpaid future losses and loss adjustment expenses. In order
to monitor adherence to the underwriting guidelines given to
such parties, the Company periodically performs underwriting
and claims due diligence reviews.
In determining ultimate losses and loss adjustment expenses,
the cost to indemnify claimants, provide needed legal defense
and other services for insureds and administer the investigation
and adjustment of claims are considered. These claim costs are
influenced by many factors that change over time, such as
expanded coverage definitions as a result of new court
decisions, inflation in costs to repair or replace damaged
property, inflation in the cost of medical services and legislated
changes in statutory benefits, as well as by the particular, unique
facts that pertain to each claim. As a result, the rate at which
claims arose in the past and the costs to settle them may not
always be representative of what will occur in the future. The
factors influencing changes in claim costs are often difficult to
isolate or quantify and developments in paid and incurred losses
from historical trends are frequently subject to multiple and
conflicting interpretations. Changes in coverage terms or claims
handling practices may also cause future experience and/or
development patterns to vary from the past. A key objective of
actuaries in developing estimates of ultimate losses and loss
adjustment expenses, and resulting IBNR reserves, is to identify
aberrations and systemic changes occurring within historical
experience and adjust for them so that the future can be
projected more reliably. Because of the factors previously
discussed, this process requires the substantial use of informed
judgment and is inherently uncertain.
Although Loss Reserves are initially determined based on
underwriting and pricing analyses, the Company’s insurance
segment applies several generally accepted actuarial methods,
as discussed below, on a quarterly basis to evaluate the Loss
Reserves, in addition to the expected loss method, in particular
for Loss Reserves from more mature accident years (the year
in which a loss occurred). Each quarter, as part of the reserving
process, the segments’ actuaries reaffirm that the assumptions
used in the reserving process continue to form a sound basis for
the projection of liabilities. If actual loss activity differs
substantially from expectations based on historical information,
an adjustment to Loss Reserves may be supported. The
Company places more or less reliance on a particular actuarial
method based on the facts and circumstances at the time the
estimates of Loss Reserves are made.
These methods generally fall into one of the following
categories or are hybrids of one or more of the following
categories:
• Expected loss methods - these methods are based on the
assumption that ultimate losses vary proportionately with
premiums. Expected loss and loss adjustment expense
ratios are typically developed based upon the information
derived by underwriters and actuaries during the initial
pricing of the business, supplemented by industry data
available from organizations, such as statistical bureaus
and consulting firms, where appropriate. These ratios
consider, among other things, rate increases and changes
in terms and conditions that have been observed in the
market. Expected loss methods are useful for estimating
ultimate losses and loss adjustment expenses in the early
years of long-tailed lines of business, when little or no paid
or incurred loss information is available, and is commonly
applied when limited loss experience exists for a company.
• Historical incurred loss development methods - these
methods assume that the ratio of losses in one period to
losses in an earlier period will remain constant in the future.
These methods use incurred losses (i.e., the sum of
cumulative historical loss payments plus outstanding case
reserves) over discrete periods of time to estimate future
losses. Historical incurred loss development methods may
be preferable to historical paid loss development methods
because they explicitly take into account open cases and
the claims adjusters’ evaluations of the cost to settle all
loss
known claims. However, historical
development methods necessarily assume that case
reserving practices are consistently applied over time.
Therefore, when there have been significant changes in
how case reserves are established, using incurred loss data
to project ultimate losses may be less reliable than other
methods.
incurred
• Historical paid loss development methods - these methods,
like historical incurred loss development methods, assume
that the ratio of losses in one period to losses in an earlier
period will remain constant. These methods use historical
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
loss payments over discrete periods of time to estimate
future losses and necessarily assume that factors that have
affected paid losses in the past, such as inflation or the
effects of litigation, will remain constant in the future.
Because historical paid loss development methods do not
use incurred losses to estimate ultimate losses, they may
be more reliable than the other methods that use incurred
losses in situations where there are significant changes in
how incurred losses are established by a company’s claims
adjusters. However, historical paid loss development
methods are more leveraged (meaning that small changes
in payments have a larger impact on estimates of ultimate
losses) than actuarial methods that use incurred losses
because cumulative loss payments take much longer to
equal the expected ultimate losses than cumulative
incurred amounts. In addition, and for similar reasons,
historical paid loss development methods are often slow to
react to situations when new or different factors arise than
those that have affected paid losses in the past.
• Adjusted historical paid and incurred loss development
methods - these methods take traditional historical paid and
incurred loss development methods and adjust them for the
estimated impact of changes from the past in factors such
as inflation, the speed of claim payments or the adequacy
of case reserves. Adjusted historical paid and incurred loss
development methods are often more reliable methods of
predicting ultimate losses in periods of significant change,
provided the actuaries can develop methods to reasonably
quantify the impact of changes. As such, these methods
utilize more judgment than historical paid and incurred loss
development methods.
• Bornhuetter-Ferguson (“B-F”) paid and incurred loss
methods - these methods utilize actual paid and incurred
losses and expected patterns of paid and incurred losses,
taking the initial expected ultimate losses into account to
determine an estimate of expected ultimate losses. The B-
F paid and incurred loss methods are useful when there are
few reported claims and a relatively less stable pattern of
reported losses.
• Frequency-Severity methods - These methods utilize actual
paid and incurred claim experience, but break the data
down into its component pieces: claim counts, often
expressed as a ratio to exposure or premium (frequency),
and average claim size (severity). The component pieces
are projected to an ultimate level and multiplied together
to result in an estimate of ultimate loss. These methods are
especially useful when the severity of claims can be
confined to a relatively stable range of estimated ultimate
average claim value.
• Additional analyses - other methodologies are often used
in the reserving process for specific types of claims or
events, such as catastrophic or other specific major events.
These include vendor catastrophe models, which are
typically used in the estimation of Loss Reserves at the
early stage of known catastrophic events before
information has been reported to an insurer or reinsurer.
In the initial reserving process for short-tail insurance lines
(consisting of property, energy, marine and aviation and other
exposures including travel, accident and health and lenders
products), the Company relies on a combination of the reserving
methods discussed above. For catastrophe-exposed business,
the reserving process also includes the usage of catastrophe
models for known events and a heavy reliance on analysis of
individual catastrophic events and management judgment. The
development of losses on short-tail business can be unstable,
especially for policies characterized by high severity, low
frequency losses. As time passes, for a given accident year,
additional weight is given to the paid and incurred B-F loss
development methods and historical paid and incurred loss
development methods in the reserving process. The Company
makes a number of key assumptions in their reserving process,
including that historical paid and reported development patterns
are stable, catastrophe models provide useful information about
our exposure to catastrophic events that have occurred and
underwriters’ judgment as to potential loss exposures can be
relied on. The expected loss ratios used in the initial reserving
process for short-tail business have varied over time due to
changes in pricing, reinsurance structure, estimates of
catastrophe losses, policy changes (such as attachment points,
class and limits) and geographical distribution. As losses in
short-tail lines are reported relatively quickly, expected loss
ratios are selected for the current accident year based upon
actual attritional loss ratios for earlier accident years, adjusted
for rate changes, inflation, changes in reinsurance programs and
expected attritional losses based on modeling. Furthermore,
ultimate losses for short-tail business are known in a reasonably
short period of time.
In the initial reserving process for medium-tail and long-tail
insurance lines (consisting of third party occurrence business,
third party claims made business, and other exposures including
surety, programs and contract binding exposures), the Company
primarily relies on the expected loss method. The development
of the Company’s medium-tail and long-tail business may be
unstable, especially if there are high severity major events, as
a portion of the Company’s casualty business is in high excess
layers. As time passes, for a given accident year, additional
weight is given to the paid and incurred B-F loss development
methods and historical paid and incurred loss development
methods in the reserving process. The Company makes a
number of key assumptions in reserving for medium-tail and
long-tail lines, including that the pricing loss ratio is the best
estimate of the ultimate loss ratio at the time the policy is entered
into, that the loss development patterns, which are based on a
combination of company and industry loss development
patterns and adjusted to reflect differences in the insurance
segment’s mix of business, are reasonable and that claims
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
personnel and underwriters analyses of our exposure to major
events are assumed to be the best estimate of exposure to the
known claims on those events. The expected loss ratios used in
the initial reserving process for medium-tail and long-tail
business for recent accident years have varied over time, in
some cases significantly, from earlier accident years. As the
credibility of historical experience for earlier accident years
increases, the experience from these accident years will be
given a greater weighting in the actuarial analysis to determine
future accident year expected loss ratios, adjusted for changes
in pricing, loss trends, terms and conditions and reinsurance
structure.
In 2018, the Company entered into a loss portfolio transfer and
adverse development cover reinsurance agreement accounted
for as retroactive reinsurance. The agreement transfers Loss
Reserves and future favorable or adverse development on
certain runoff programs, within multi-line and other specialty
business, and certain third party occurrence business (the
“Covered Lines”). As incurred losses and allocated loss
adjustment expenses for the Covered Lines are ceded to the
reinsurer, the Company is not exposed to changes in the amount,
timing and uncertainty of cash flows arising from the Covered
Lines. To avoid distortion, the incurred losses and allocated
loss adjustment expenses and cumulative paid losses and loss
adjustment expenses for the Covered Lines are excluded
entirely from the tables below. Reinsurance recoverables at
December 31, 2018 included $245.8 million related to this
reinsurance agreement.
The following tables present information on the insurance segment’s short-duration insurance contracts:
Property, energy, marine and aviation ($000’s except claim count)
Incurred losses and allocated loss adjustment expenses, net of reinsurance
Accident
year
2009
unaudited
2010
unaudited
2011
unaudited
2012
unaudited
2013
unaudited
2014
unaudited
2015
unaudited
2016
unaudited
2017
unaudited
Year ended December 31,
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
$ 256,308
$ 259,695
199,725
$ 231,277
188,449
267,016
$ 220,007
152,342
268,029
233,398
$ 205,570
139,993
227,170
232,368
158,214
$ 199,259
128,691
215,580
204,923
155,401
146,228
$ 197,398
129,073
206,981
198,444
147,450
142,896
111,020
$ 191,934
127,613
205,514
196,362
141,199
146,643
109,172
103,983
$
38,430
$ 116,140
28,470
$ 143,156
65,689
34,222
Cumulative paid losses and allocated loss adjustment expenses, net of reinsurance
$ 168,721
105,803
139,979
92,911
31,859
$ 159,430
87,437
98,480
21,235
$ 173,141
110,903
165,281
137,629
83,773
25,624
$ 177,202
117,956
195,151
160,380
109,358
52,438
23,243
$ 177,557
120,030
200,052
166,953
117,958
77,201
64,417
24,645
$ 190,815
125,994
200,923
192,392
134,675
136,286
104,024
100,986
281,004
Total
$ 178,153
119,447
197,717
179,355
121,936
84,124
76,325
83,326
30,227
Total
All outstanding liabilities before 2009, net of reinsurance
Liabilities for losses and loss adjustment expenses, net of reinsurance
December 31, 2018
Total of IBNR
liabilities plus
expected
development on
reported claims
Cumulative
number of
reported
claims
$
1,896
1,187
1,064
3,038
2,101
12,868
11,507
3,143
43,281
63,437
3,617
3,658
4,197
4,232
4,231
3,861
4,493
6,048
6,048
2,453
2018
$ 191,430
121,159
199,600
189,123
132,242
130,725
101,404
104,430
244,784
179,457
$1,594,354
$ 178,816
119,647
197,059
179,677
123,975
86,911
85,370
97,569
138,955
29,765
1,237,744
25,620
$ 382,230
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Third party occurrence business ($000’s except claim count)
Incurred losses and allocated loss adjustment expenses, net of reinsurance
Accident
year
2009
unaudited
2010
unaudited
2011
unaudited
2012
unaudited
2013
unaudited
2014
unaudited
2015
unaudited
2016
unaudited
2017
unaudited
Year ended December 31,
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
$ 236,168
$ 230,643
217,459
$ 231,947
235,309
233,987
$ 230,981
230,792
240,485
240,924
$ 233,823
230,981
253,710
262,370
282,525
$ 234,449
233,286
258,474
267,990
296,459
329,379
$ 226,929
229,618
252,332
270,539
306,378
335,231
358,461
$ 220,739
223,647
253,648
257,111
301,807
338,647
391,762
389,672
$
5,618
$
$
$
20,162
6,755
Cumulative paid losses and allocated loss adjustment expenses, net of reinsurance
$ 103,601
72,740
43,303
30,805
6,837
71,986
45,594
25,165
6,964
43,727
25,517
7,009
$ 126,824
102,440
73,280
58,402
29,207
9,206
$ 142,359
117,316
113,302
83,133
71,321
40,206
11,110
$ 149,370
132,833
134,321
107,982
101,170
71,497
44,532
11,686
$ 221,298
215,530
246,976
252,732
281,768
342,858
398,676
394,281
417,190
Total
$ 156,787
142,570
152,699
129,519
122,103
112,578
88,436
41,934
13,395
Total
All outstanding liabilities before 2009, net of reinsurance
Liabilities for losses and loss adjustment expenses, net of reinsurance
Third party claims-made business ($000’s except claim count)
Incurred losses and allocated loss adjustment expenses, net of reinsurance
Accident
year
2009
unaudited
2010
unaudited
2011
unaudited
2012
unaudited
2013
unaudited
2014
unaudited
2015
unaudited
2016
unaudited
2017
unaudited
Year ended December 31,
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
$ 284,308
$ 318,554
285,454
$ 308,848
311,585
282,888
$ 307,365
333,227
325,151
310,964
$ 304,122
338,993
316,424
313,827
295,986
$ 304,228
331,922
311,114
312,282
313,670
260,667
$ 307,528
315,420
316,658
307,500
317,289
276,056
255,994
$ 303,793
298,917
296,106
283,928
314,551
295,274
274,602
272,732
$
11,398
$
55,601
13,989
$ 108,303
71,011
13,596
Cumulative paid losses and allocated loss adjustment expenses, net of reinsurance
$ 187,293
163,239
128,471
67,651
18,613
$ 149,913
128,259
71,342
17,429
$ 202,236
198,511
171,963
118,536
85,408
13,609
$ 236,185
214,886
205,140
161,244
134,802
62,576
8,879
$ 245,717
229,400
224,456
184,604
174,900
127,969
51,389
10,470
$ 301,909
287,825
288,319
275,654
294,754
278,840
276,446
291,430
270,555
Total
$ 250,438
238,885
240,552
209,376
198,156
172,963
100,147
68,218
9,294
Total
All outstanding liabilities before 2009, net of reinsurance
Liabilities for losses and loss adjustment expenses, net of reinsurance
December 31, 2018
Total of IBNR
liabilities plus
expected
development on
reported claims
Cumulative
number of
reported
claims
$
35,059
37,599
49,925
70,595
90,607
127,656
184,313
237,966
306,585
377,969
50,361
62,652
71,018
65,720
66,918
75,322
77,072
76,270
80,606
57,688
December 31, 2018
Total of IBNR
liabilities plus
expected
development on
reported claims
Cumulative
number of
reported
claims
$
8,073
11,252
24,770
27,916
58,923
50,437
94,539
111,019
161,218
213,449
10,907
12,335
11,759
14,752
14,529
13,925
13,480
15,212
15,820
10,653
2018
$ 214,940
218,487
239,499
242,775
274,189
339,216
391,552
405,637
417,495
429,713
$3,173,503
$ 159,642
148,251
160,451
143,045
149,012
161,863
139,332
87,479
52,299
16,998
1,218,372
134,229
$2,089,360
2018
$ 288,185
285,174
285,912
273,280
287,299
278,644
256,863
305,253
283,410
270,203
$2,814,223
$ 246,953
244,411
250,972
223,843
214,411
205,739
125,258
126,371
67,003
12,180
1,717,141
105,520
$1,202,602
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Multi-line and other specialty ($000’s except claim count)
Incurred losses and allocated loss adjustment expenses, net of reinsurance
Accident
year
2009
unaudited
2010
unaudited
2011
unaudited
2012
unaudited
2013
unaudited
2014
unaudited
2015
unaudited
2016
unaudited
2017
unaudited
Year ended December 31,
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
$ 207,671
$ 216,268
172,583
$ 212,738
175,942
182,683
$ 206,057
168,860
188,262
252,627
$ 196,062
166,643
182,385
263,530
274,555
$ 195,157
158,000
176,000
257,574
282,436
348,683
$ 191,653
154,763
172,276
255,343
273,565
372,406
397,204
$ 189,457
153,686
171,842
254,051
280,049
368,613
417,353
480,501
$
62,166
$ 114,262
49,804
$ 143,199
91,013
51,179
Cumulative paid losses and allocated loss adjustment expenses, net of reinsurance
$ 160,203
125,726
117,513
165,429
86,560
$ 154,804
110,927
102,988
78,217
$ 177,192
135,835
136,253
189,464
152,201
108,939
$ 178,028
140,359
147,769
208,620
184,835
204,999
141,335
$ 179,659
143,614
151,235
221,842
220,543
253,533
249,330
180,017
$ 185,080
154,092
168,913
247,042
271,695
387,171
420,775
504,857
551,920
Total
$ 179,796
146,846
157,224
231,778
237,916
306,518
304,338
323,950
187,760
Total
All outstanding liabilities before 2009, net of reinsurance
Liabilities for losses and loss adjustment expenses, net of reinsurance
December 31, 2018
Total of IBNR
liabilities plus
expected
development on
reported claims
Cumulative
number of
reported
claims
$
2,292
3,136
4,482
8,102
12,404
25,654
43,362
76,648
142,735
278,704
33,724
37,930
44,942
55,738
72,296
111,115
132,517
175,923
213,874
157,528
2018
$ 183,117
152,170
169,996
246,754
274,710
397,410
442,386
513,112
577,626
568,410
$3,525,691
$ 177,413
146,709
159,196
232,503
251,061
340,771
349,949
381,291
361,761
213,723
2,614,377
21,825
$ 933,139
The following table presents the average annual percentage payout of incurred losses and allocated loss adjustment expenses by
age, net of reinsurance, as of December 31, 2018:
Property, energy, marine and aviation
Third party occurrence business
Third party claims-made business
Multi-line and other specialty
Reinsurance Segment
Average annual percentage payout of incurred losses and allocated loss adjustment expenses by age, net of reinsurance
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
Year 7
Year 8
Year 9
Year 10
19.1%
3.0%
4.6%
32.5%
38.0%
8.4%
19.0%
28.0%
17.5%
10.8%
19.5%
11.9%
9.9%
12.0%
13.9%
10.2%
5.4%
12.9%
10.9%
6.1%
3.7%
9.0%
6.5%
4.6%
0.7%
6.9%
6.9%
1.6%
(0.2)%
3.7 %
3.4 %
1.4 %
0.2%
3.0%
1.8%
—%
0.3 %
1.3 %
(1.2)%
(1.3)%
Loss Reserves for the Company’s reinsurance segment are
comprised of (1) case reserves, (2) additional case reserves
(“ACRs”) and (3) IBNR reserves. The Company receives
reports of claims notices from ceding companies and records
case reserves based upon the amount of reserves recommended
by the ceding company. Case reserves may be supplemented
by ACRs, which may be estimated by the Company’s claims
personnel ahead of official notification from the ceding
company, or when judgment regarding the size or severity of
the known event differs from the ceding company. In certain
instances, the Company establishes ACRs even when the ceding
company does not report any liability on a known event. In
addition, specific claim information reported by ceding
companies or obtained through claim audits can alert the
Company to emerging trends such as changing legal
liability, claims from
interpretations of coverage and
unexpected sources or classes of business, and significant
changes in the frequency or severity of individual claims. Such
information is often used in the process of estimating IBNR
reserves. IBNR reserves are established to provide for incurred
claims which have not yet been reported at the balance sheet
date as well as to adjust for any projected variance in case
reserving. Actuaries estimate ultimate
loss
adjustment expenses using various generally accepted actuarial
methods applied
losses and other relevant
information. Like case reserves, IBNR reserves are adjusted as
additional information becomes known or payments are made.
involves a
The process of estimating Loss Reserves
considerable degree of judgment by management and, as of any
given date, is inherently uncertain.
losses and
to known
The estimation of Loss Reserves for the reinsurance segment
is subject to the same risk factors as the estimation of Loss
Reserves for the insurance segment. In addition, the inherent
uncertainties of estimating such reserves are even greater for
reinsurers, due primarily to the following factors: (1) the claim-
tail for reinsurers is generally longer because claims are first
reported to the ceding company and then to the reinsurer through
one or more intermediaries, (2) the reliance on premium
estimates, where reports have not been received from the ceding
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
company, in the reserving process, (3) the potential for writing
a number of reinsurance contracts with different ceding
companies with the same exposure to a single loss event, (4)
the diversity of loss development patterns among different types
of reinsurance contracts, (5) the necessary reliance on the
ceding companies for information regarding reported claims
and (6) the differing reserving practices among ceding
companies.
segment devote
As with the insurance segment, the process of estimating Loss
Reserves for the reinsurance segment involves a considerable
degree of judgment by management and, as of any given date,
is inherently uncertain. As discussed above, such uncertainty is
greater for reinsurers compared to insurers. As a result, our
reinsurance operations obtain information from numerous
sources to assist in the process. Pricing actuaries from the
reinsurance
to
understanding and analyzing a ceding company’s operations
and loss history during the underwriting of the business, using
a combination of ceding company and industry statistics. Such
statistics normally include historical premium and loss data by
class of business, individual claim information for larger
claims, distributions of insurance limits provided, loss reporting
and payment patterns, and rate change history. This analysis is
used to project expected loss ratios for each treaty during the
upcoming contract period.
considerable
effort
situations, the Company attempts to resolve the dispute with
the ceding company. Most situations are resolved amicably and
without the need for litigation or arbitration. However, in the
infrequent situations where a resolution is not possible, the
Company will vigorously defend its position in such disputes.
Although Loss Reserves are initially determined based on
underwriting and pricing analysis, the Company applies several
generally accepted actuarial methods, as discussed above, on a
quarterly basis to evaluate its Loss Reserves in addition to the
expected loss method, in particular for reserves from more
mature underwriting years (the year in which business is
underwritten). Each quarter, as part of the reserving process,
the Company’s actuaries reaffirm that the assumptions used in
the reserving process continue to form a sound basis for
projection of
loss activity differs
substantially from expectations based on historical information,
an adjustment to Loss Reserves may be supported. Estimated
Loss Reserves for more mature underwriting years are now
based more on actual loss activity and historical patterns than
on the initial assumptions based on pricing indications. More
recent underwriting years rely more heavily on internal pricing
assumptions. The Company places more or less reliance on a
particular actuarial method based on
facts and
circumstances at the time the estimates of Loss Reserves are
made.
liabilities. If actual
the
As mentioned above, there can be a considerable time lag from
the time a claim is reported to a ceding company to the time it
is reported to the reinsurer. The lag can be several years in some
cases and may be attributed to a number of reasons, including
the time it takes to investigate a claim, delays associated with
the litigation process, the deterioration in a claimant’s physical
condition many years after an accident occurs, the case
reserving approach of the ceding company, etc. In the reserving
process, the Company assumes that such lags are predictable,
on average, over time and therefore the lags are contemplated
in the loss reporting patterns used in their actuarial methods.
This means that the reinsurance segment must rely on estimates
for a longer period of time than does an insurance company.
Backlogs in the recording of assumed reinsurance can also
complicate the accuracy of loss reserve estimation. As of
December 31, 2018 there were no significant backlogs related
to the processing of assumed reinsurance information at our
reinsurance operations.
The reinsurance segment relies heavily on information reported
by ceding companies, as discussed above. In order to determine
information,
the accuracy and completeness of such
underwriters, actuaries, and claims personnel often perform
audits of ceding companies and regularly review information
received from ceding companies for unusual or unexpected
results. Material findings are usually discussed with the ceding
companies. The Company sometimes encounters situations
where they determine that a claim presentation from a ceding
company is not in accordance with contract terms. In these
In the initial reserving process for short-tail reinsurance lines
(consisting of property excluding property catastrophe and
property catastrophe exposures), the Company relies on a
combination of the reserving methods discussed above. For
known catastrophic events, the reserving process also includes
the usage of catastrophe models and a heavy reliance on analysis
which includes ceding company inquiries and management
judgment. The development of property losses may be unstable,
especially where there is high catastrophic exposure, may be
characterized by high severity, low frequency losses for excess
and catastrophe-exposed business and may be highly correlated
across contracts. As time passes, for a given underwriting year,
additional weight is given to the paid and incurred B-F loss
development methods and historical paid and incurred loss
development methods in the reserving process. The Company
makes a number of key assumptions in reserving for short-tail
lines, including that historical paid and reported development
patterns are stable, catastrophe models provide useful
information about our exposure to catastrophic events that have
occurred and our underwriters’ judgment and guidance received
from ceding companies as to potential loss exposures may be
relied on. The expected loss ratios used in the initial reserving
process for property exposures have varied over time due to
changes in pricing, reinsurance structure, estimates of
catastrophe losses, terms and conditions and geographical
distribution. As losses in property lines are reported relatively
quickly, expected loss ratios are selected for the current
underwriting year incorporating the experience for earlier
underwriting years, adjusted for rate changes, inflation, changes
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
in reinsurance programs, expectations about present and future
market conditions and expected attritional losses based on
modeling. Due to the short-tail nature of property business,
reported loss experience emerges quickly and ultimate losses
are known in a reasonably short period of time.
In the initial reserving process for medium-tail and long-tail
reinsurance lines (consisting of casualty, other specialty, marine
and aviation and other exposures), the Company primarily relies
on the expected loss method. The development of medium-tail
and long-tail business may be unstable, especially if there are
high severity major events, with business written on an excess
of loss basis typically having a longer tail than business written
on a pro rata basis. As time passes, for a given underwriting
year, additional weight is given to the paid and incurred B-F
loss development methods and historical paid and incurred loss
development methods in the reserving process. Our reinsurance
operations make a number of key assumptions in reserving for
medium-tail and long-tail lines, including that the pricing loss
ratio is the best estimate of the ultimate loss ratio at the time
the contract is entered into, historical paid and reported
development patterns are stable and claims personnel and
underwriters analyses of our exposure to major events are
assumed to be our best estimate of our exposure to the known
claims on those events. The expected loss ratios used in our
reinsurance operations’ initial reserving process for medium-
tail and long-tail contracts have varied over time due to changes
in pricing, terms and conditions and reinsurance structure. As
the credibility of historical experience for earlier underwriting
years increases, the experience from these underwriting years
will be used in the actuarial analysis to determine future
underwriting year expected loss ratios, adjusted for changes in
pricing, loss trends, terms and conditions and reinsurance
structure.
The following tables present information on the reinsurance segment’s short-duration insurance contracts:
Casualty ($000’s)
Incurred losses and allocated loss adjustment expenses, net of reinsurance
Accident
year
2009
unaudited
2010
unaudited
2011
unaudited
2012
unaudited
2013
unaudited
2014
unaudited
2015
unaudited
2016
unaudited
2017
unaudited
Year ended December 31,
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
$ 264,480
$ 284,826
195,690
$ 302,754
196,680
152,868
$ 282,973
199,759
156,477
146,883
$ 278,150
191,255
150,389
144,812
168,454
$ 267,531
180,620
145,464
140,684
161,653
217,119
$ 251,072
169,558
141,168
128,804
157,664
222,346
221,440
$ 236,678
163,692
138,025
118,515
151,365
219,445
220,485
212,415
$
3,239
$
$
$
19,340
2,180
Cumulative paid losses and allocated loss adjustment expenses, net of reinsurance
$ 105,497
54,296
22,654
8,827
2,525
73,749
39,111
11,945
1,329
46,999
21,441
2,313
$ 134,997
72,570
39,982
15,600
10,146
3,963
$ 149,179
83,198
56,246
27,018
23,712
16,171
4,467
$ 159,636
94,225
65,948
38,493
44,315
41,141
20,285
5,705
$ 233,385
159,617
131,996
112,924
139,105
232,855
228,753
225,043
262,678
Total
$ 169,140
102,156
73,075
50,045
56,084
64,055
47,155
25,677
6,428
Total
All outstanding liabilities before 2009, net of reinsurance
Liabilities for losses and loss adjustment expenses, net of reinsurance
December 31, 2018
Total of IBNR
liabilities plus
expected
development on
reported claims
Cumulative
number of
reported
claims
$
23,066
28,667
27,389
35,014
46,862
59,924
74,096
90,163
100,635
232,788
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
2018
$ 229,352
153,833
129,198
121,523
137,497
229,403
235,910
247,457
249,862
275,614
$2,009,649
$ 176,526
110,752
78,356
61,845
64,778
91,670
70,895
51,653
29,376
7,582
743,433
271,596
$1,537,812
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Property catastrophe ($000’s)
Incurred losses and allocated loss adjustment expenses, net of reinsurance
December 31, 2018
Total of IBNR
liabilities plus
expected
development on
reported claims
$
1
165
(122)
91
465
1,287
(1,334)
8,864
Cumulative
number of
reported
claims
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
2018
$
13,690
42,367
141,909
97,066
28,479
20,586
4,664
12,617
45,517
72,695
$ 479,590
Accident
year
2009
unaudited
2010
unaudited
2011
unaudited
2012
unaudited
2013
unaudited
2014
unaudited
2015
unaudited
2016
unaudited
2017
unaudited
Year ended December 31,
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
$
74,406
$
32,329
92,783
$
19,638
47,040
203,928
$
18,130
38,740
183,818
150,095
$
16,999
38,643
165,421
123,138
66,815
$
16,750
42,154
152,746
108,615
47,542
44,905
$
15,814
42,552
148,913
102,141
36,216
30,625
32,210
$
15,480
42,349
148,187
99,915
31,735
25,154
16,882
22,814
Cumulative paid losses and allocated loss adjustment expenses, net of reinsurance
$
9,913
$
13,355
8,445
$
$
13,192
23,340
59,506
14,755
31,273
82,096
25,850
$
15,006
37,207
113,268
70,840
12,081
$
15,009
38,388
127,940
83,852
19,070
13,668
$
15,034
39,963
133,416
90,757
23,904
19,851
(3,689)
$
15,051
41,204
135,903
92,916
25,768
18,330
(3,224)
(7,528)
$
13,538
42,553
145,987
99,101
29,191
22,327
10,603
16,233
78,404
Total
$
13,448
41,258
137,945
94,045
27,542
19,159
884
1,038
28,736
Total
All outstanding liabilities before 2009, net of reinsurance
Liabilities for losses and loss adjustment expenses, net of reinsurance
$
$
13,445
41,436
138,333
94,655
27,784
18,751
1,148
1,305
27,476
25,463
389,796
795
90,589
Property excluding property catastrophe ($000’s)
Incurred losses and allocated loss adjustment expenses, net of reinsurance
Accident
year
2009
unaudited
2010
unaudited
2011
unaudited
2012
unaudited
2013
unaudited
2014
unaudited
2015
unaudited
2016
unaudited
2017
unaudited
Year ended December 31,
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
$ 215,898
$ 193,095
142,370
$ 170,632
128,120
206,299
$ 163,862
117,896
179,130
155,798
$ 163,105
112,218
166,638
121,450
115,395
$ 161,027
110,263
162,988
123,595
76,864
143,078
$ 158,150
108,137
158,847
119,032
70,525
117,057
213,438
$ 148,637
104,365
157,551
114,621
66,159
98,948
188,073
175,193
$
66,121
$ 116,563
37,778
$ 133,842
76,414
47,484
Cumulative paid losses and allocated loss adjustment expenses, net of reinsurance
$ 140,019
93,343
140,893
77,939
25,973
$ 138,188
88,181
121,037
26,072
$ 142,531
95,533
145,387
93,151
42,704
23,509
$ 143,640
96,681
147,439
101,820
49,790
62,797
75,296
$ 144,448
97,326
148,540
102,796
52,968
71,677
118,438
33,191
$ 147,851
101,187
155,295
112,406
64,437
90,699
183,747
144,617
255,485
Total
$ 145,558
97,756
148,788
103,432
53,767
76,619
148,889
94,313
25,135
Total
All outstanding liabilities before 2009, net of reinsurance
Liabilities for losses and loss adjustment expenses, net of reinsurance
December 31, 2018
Total of IBNR
liabilities plus
expected
development on
reported claims
Cumulative
number of
reported
claims
$
677
1,463
3,749
3,301
2,850
5,785
14,017
21,416
27,440
80,569
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
2018
$ 147,699
100,407
154,280
110,941
63,660
88,429
187,936
136,710
237,905
221,278
$1,449,245
$ 146,035
97,697
149,060
102,610
55,648
78,260
159,754
98,126
115,914
29,358
1,032,462
4,589
$ 421,372
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Marine and aviation ($000’s)
Incurred losses and allocated loss adjustment expenses, net of reinsurance
Accident
year
2009
unaudited
2010
unaudited
2011
unaudited
2012
unaudited
2013
unaudited
2014
unaudited
2015
unaudited
2016
unaudited
2017
unaudited
Year ended December 31,
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
$
49,837
$
41,300
40,974
$
$
35,522
42,297
39,322
$
33,814
38,519
32,910
59,021
$
30,963
35,425
35,845
58,869
39,029
$
29,720
33,522
32,402
55,030
37,854
30,982
$
28,292
31,907
28,780
52,260
36,807
29,193
33,782
28,044
31,157
27,183
51,052
35,372
27,389
37,570
27,353
$
27,092
30,325
27,244
49,693
35,271
25,687
31,780
22,727
28,738
Total
Cumulative paid losses and allocated loss adjustment expenses, net of reinsurance
$
6,858
$
16,189
8,523
$
$
19,311
13,402
4,420
$
22,416
16,751
12,121
2,658
$
22,491
18,478
16,528
11,438
4,940
$
22,834
20,218
19,227
27,527
13,842
4,190
$
23,424
26,529
15,944
33,295
18,519
8,001
2
$
23,911
27,176
16,617
35,031
21,505
11,592
13,420
(7,321)
24,011
27,538
21,971
36,227
22,508
12,463
19,021
(1,686)
1,651
Total
All outstanding liabilities before 2009, net of reinsurance
Liabilities for losses and loss adjustment expenses, net of reinsurance
Other specialty ($000’s)
Incurred losses and allocated loss adjustment expenses, net of reinsurance
Accident
year
2009
unaudited
2010
unaudited
2011
unaudited
2012
unaudited
2013
unaudited
2014
unaudited
2015
unaudited
2016
unaudited
2017
unaudited
Year ended December 31,
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
$
60,519
$
49,729
43,327
$
44,643
33,029
111,939
$
38,585
26,188
96,897
220,373
$
36,475
23,943
92,835
209,461
250,247
$
34,481
22,945
91,215
199,250
224,173
275,308
$
35,639
22,593
89,395
193,549
214,239
256,735
210,349
$
36,080
22,356
88,033
191,472
210,697
258,643
201,875
222,374
Cumulative paid losses and allocated loss adjustment expenses, net of reinsurance
$
9,243
$
27,483
4,071
$
$
30,345
13,501
28,762
30,215
16,659
57,599
44,904
$
30,192
17,687
69,698
119,940
56,274
$
30,075
18,472
74,285
142,174
117,679
68,953
$
30,557
19,058
77,714
152,998
143,336
146,920
54,806
$
31,318
19,282
79,464
160,628
159,422
182,603
114,909
64,680
$
37,019
22,117
87,430
194,484
211,767
251,837
200,065
219,923
274,622
Total
$
31,436
19,900
81,681
164,730
168,992
195,817
138,982
137,654
74,500
Total
All outstanding liabilities before 2009, net of reinsurance
Liabilities for losses and loss adjustment expenses, net of reinsurance
2018
$
26,476
28,515
24,854
46,011
34,526
23,684
31,707
23,545
26,291
28,124
$ 293,733
$
24,254
27,113
21,894
37,711
23,776
14,637
20,846
504
6,472
1,996
179,203
16,118
$ 130,648
2018
$
35,495
21,503
85,533
192,687
209,288
246,727
197,231
214,107
264,006
331,820
$1,798,397
$
31,429
19,920
82,786
169,057
174,030
202,233
145,929
161,559
165,926
74,300
1,227,169
9,100
$ 580,328
December 31, 2018
Total of IBNR
liabilities plus
expected
development on
reported claims
Cumulative
number of
reported
claims
$
1,597
130
2,046
5,070
8,757
7,340
6,587
12,237
13,156
20,582
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
December 31, 2018
Total of IBNR
liabilities plus
expected
development on
reported claims
Cumulative
number of
reported
claims
$
1,301
1,218
1,622
17,581
22,085
25,557
31,932
37,828
67,191
152,632
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
ARCH CAPITAL
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table presents the average annual percentage payout of incurred losses and allocated loss adjustment expenses by
age, net of reinsurance, as of December 31, 2018:
Average annual percentage payout of incurred losses and allocated loss adjustment expenses by age, net of reinsurance
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
Year 7
Year 8
Year 9
Year 10
1.9%
22.9%
29.2%
9.4%
26.5%
7.6%
28.0%
38.2%
25.4%
36.4%
10.0%
19.1%
11.3%
16.5%
12.3%
11.3%
8.4%
5.0%
8.5%
4.6%
11.4%
2.5%
1.5%
1.5%
3.1%
8.6%
1.5%
1.4%
6.5%
1.8%
7.1%
1.3%
0.2%
7.3%
1.8%
4.6%
0.2%
0.4%
0.9%
2.1%
4.9 %
(5.6)%
0.3 %
(0.6)%
0.2 %
3.2%
—%
0.3%
0.9%
—%
Casualty
Property catastrophe
Property excluding property catastrophe
Marine and aviation
Other specialty
Mortgage Segment
The Company’s mortgage segment includes (1) direct mortgage
insurance in the U.S., (2) direct mortgage insurance in Europe,
(3) global mortgage reinsurance and (4) participation in various
GSE credit risk-sharing products, with the latter three categories
along with second lien and student loan exposures excluded on
the basis of insignificance for the purposes of presenting
disclosures related to short duration contracts.
For direct mortgage insurance business, the Company
establishes case reserves for loans that have been reported as
delinquent by loan servicers as well as those that are delinquent
but not reported (IBNR reserves). The Company’s U.S.
mortgage insurance operations also reserve for the expenses of
adjusting claims related to these delinquencies. The trigger that
creates a case reserve estimate is that an insured loan is reported
to us as being two payments in arrears. The actuarial reviews
and documentation created in the reserving process are
completed in accordance with generally accepted actuarial
standards. The selected assumptions reflect the actuary’s
judgment based on historical data and experience combined
with information concerning current underwriting, economic,
judicial, regulatory and other influences on ultimate claim
settlements.
Because the reserving process requires the Company to forecast
future conditions, it is inherently uncertain and requires
significant judgment and estimation. The use of different
estimates would result in the establishment of different reserve
levels. Additionally, changes in accounting estimates are likely
to occur from period to period as economic conditions change
and the ultimate liability may vary significantly from the
estimates used. Major risk factors include (but are not limited
to) changes in home prices and borrower equity, which can limit
the borrower’s ability to sell the property and satisfy the
outstanding loan balance, and changes in unemployment, which
can affect the borrower’s income and ability to make mortgage
payments.
The lead methodology used by the Company is a frequency-
severity method based on
inventory of pending
delinquencies. Each month the loan servicers report the
delinquency status of each insured loan. Using the frequency-
severity method allows the Company to take advantage of its
knowledge of the number of delinquent loans and the coverage
the
provided (“risk size”) on those loans by directly relating the
reserves to these amounts. The delinquencies are grouped into
homogeneous cohorts for analysis, reflecting product type and
age of delinquency. A claim rate is then developed for each
cohort which represents the frequency with which the
delinquencies become claims. The claim rates are based on an
analysis of the patterns of emerging cure counts and claim
counts, the foreclosure status of the pending delinquencies, the
product and geographical mix of the delinquencies and our view
of future economic and claim conditions, which include trends
in home prices and unemployment. Claim rates can vary
materially by age of delinquency, depending on the mix of
delinquencies and economic conditions.
Claim size estimates are determined by examining the risk sizes
on the delinquent loans and estimating the portion of risk that
will be paid, as well as any expenses. This is done based on a
review of historical development patterns, an assessment of
economic conditions and the level of equity the borrowers may
have in their homes, as well as considering economic conditions
and loss mitigation opportunities. Mortgage insurance is
generally not subject to large claim sizes, as with some other
lines of insurance. A claim size over $250,000 is rare, and this
helps reduce the volatility of claim size estimates. The claim
rate and claim size assumptions generate case reserves for the
population of reported delinquencies. The reserve for
unreported delinquencies (included in IBNR reserves) is
estimated by looking at historical patterns of reporting. Claim
rates and claim sizes can then be assigned to estimated
unreported delinquencies using assumptions made in the
establishment of case reserves.
Mortgage insurance Loss Reserves are short-tail, in the sense
that the vast majority of delinquencies are resolved within two
years of being reported. While reserves are initially analyzed
by reserve cohort, as described above, they are also rolled up
by underwriting year to ensure that reserve assumptions are
consistent with the performance of the underwriting year. The
accuracy of prior reserve assumptions is also checked in
hindsight to determine if adjustments to the assumptions are
needed.
Loss Reserves for the Company’s mortgage reinsurance
business and GSE credit-risk sharing
transactions are
comprised of case reserves and IBNR reserves. The Company’s
mortgage reinsurance operations receive reports of delinquent
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
loans and claims notices from ceding companies and record
case reserves based upon the amount of reserves recommended
by the ceding company. In addition, specific claim and
delinquency information reported by ceding companies is used
in the process of estimating IBNR reserves.
The tables below include the acquired business of UGC across all periods presented. Due to the length of time for which claims
incurred typically remain outstanding prior to payment and the Company’s formation of the mortgage segment in 2014, the Company
determined that seven accident years was sufficient for its current disclosures. The following table presents information on the
mortgage segment’s short-duration insurance contracts:
Direct mortgage insurance business in the U.S. ($000’s except claim count)
Incurred losses and allocated loss adjustment expenses, net of reinsurance
December 31, 2018
Accident
year
2012
unaudited
2013
unaudited
2014
unaudited
2015
unaudited
2016
unaudited
2017
unaudited
Year ended December 31,
2012
2013
2014
2015
2016
2017
2018
2012
2013
2014
2015
2016
2017
2018
520,835
480,592
469,311
475,317
419,668
316,095
469,238
411,793
297,151
222,790
467,296
405,809
279,434
197,238
183,556
459,467
395,693
266,027
198,001
170,532
179,376
Total
$
Cumulative paid losses and allocated loss adjustment expenses, net of reinsurance
(106,065)
186,605
41,447
327,605
203,957
20,099
395,695
308,956
129,159
16,159
426,024
353,189
201,925
92,431
11,462
441,577
373,909
233,879
151,222
72,201
8,622
All outstanding liabilities before 2012, net of reinsurance
$
2018
458,065
393,149
265,992
194,677
148,715
132,220
132,318
1,725,136
448,151
382,200
247,038
171,337
113,357
48,112
3,966
1,414,161
36,051
347,026
Total of IBNR
liabilities plus
expected
development on
reported claims
Cumulative
number of paid
claims
223
237
393
490
876
2,765
13,590
15,036
9,386
6,170
4,330
3,040
1,413
132
The following table presents the average annual percentage payout of incurred losses and allocated loss adjustment expenses by
age, net of reinsurance, as of December 31, 2018:
Average annual percentage payout of incurred losses and allocated loss adjustment expenses by age, net of reinsurance
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
Year 7
2.9%
42.7%
28.5%
12.1%
5.6%
2.8%
1.4%
U.S. Primary
Other Segment
Loss Reserves for the ‘other’ segment (i.e., Watford Re) are
comprised of case reserves, ACRs and IBNR reserves. For all
business assumed by Watford Re, the Company acts as
reinsurance underwriting manager, provides actuarial and risk
management services and recommends a level of Loss Reserves
to Watford Re. 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
the reinsurance
transactions. The estimation of Loss Reserves for Watford Re
is subject to the same risk factors as the estimation of Loss
Reserves for the Company’s insurance, reinsurance and
mortgage segments as described earlier. Watford Re performs
its own reserve reviews and sets its reserves independently. As
noted previously, the Company determined that amounts in the
‘other’ segment are insignificant for the purposes of these
footnote disclosures.
For the year ended December 31, 2018, the Company did not
make any significant changes in its methodologies or
assumptions as described above (a) to determine the presented
amounts of IBNR reserves, (b) for expected development on
case reserves.
The Company measures claim frequency information on an
individual claim count basis. Claim counts are provided for the
insurance and mortgage segments, where reliable information
is available. For insurance business, any claim which is reported
to the Company is included in the count, even if it is
subsequently settled without liability to the Company. The
Company does not include claim count information for losses
from U.S. insurance pool business where individual loss
information is unavailable and impracticable to obtain. For
mortgage business, only delinquencies which subsequently
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
become claims are included in the claim count. For reinsurance
business, claim counts are not provided. A significant amount
of the Company’s reinsurance business is written on a
proportional basis, for which individual loss information is
typically unavailable and impracticable to obtain.
For the year ended December 31, 2018, the Company did not
make any significant changes in its methodologies or
assumptions as described above to calculate the cumulative
claim frequency.
The following table represents a reconciliation of the
disclosures of net incurred and paid loss development tables to
the reserve for losses and loss adjustment expenses at December
31, 2018:
Net outstanding liabilities
Insurance
Property, energy, marine and aviation
Third party occurrence business
Third party claims-made business
Multi-line and other specialty
Reinsurance
Casualty
Property catastrophe
Property excluding property catastrophe
Marine and aviation
Other specialty
Mortgage
U.S. primary
Other short duration lines not included in disclosures (1)
Total for short duration lines
Unpaid losses and loss adjustment expenses recoverable
Insurance
Property, energy, marine and aviation
Third party occurrence business
Third party claims-made business
Multi-line and other specialty
Reinsurance
Casualty
Property catastrophe
Property excluding property catastrophe
Marine and aviation
Other specialty
Mortgage
U.S. primary
Other short duration lines not included in disclosures (2) (3)
Intercompany eliminations
Total for short duration lines
Lines other than short duration
Discounting
Unallocated claims adjustment expenses
December 31,
2018
$
382,230
2,089,360
1,202,602
933,139
1,537,812
90,589
421,372
130,648
580,328
347,026
1,106,103
8,821,209
313,715
996,451
684,063
156,964
524,304
266,710
44,180
26,956
117,408
25,579
326,423
(643,532)
2,839,221
35,320
(21,145)
178,692
192,867
Total gross reserves for losses and loss adjustment
expenses
$ 11,853,297
(1)
(2)
(3)
Includes net outstanding liabilities of $952 million for the ‘other’ segment.
Includes unpaid loss and loss adjustment expenses recoverable of $40.5 million
for the ‘other segment.
Includes unpaid loss and loss adjustment expenses recoverable of $245.8
million related to the loss portfolio transfer reinsurance agreement.
7. Reinsurance
In the normal course of business, the Company’s insurance
subsidiaries cede a 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:
Premiums Written
Direct
Assumed
Ceded
Net
Premiums Earned
Direct
Assumed
Ceded
Net
Losses and Loss
Adjustment Expenses
Direct
Assumed
Ceded
Net
Year Ended December 31,
2017
2018
2016
$ 4,838,902
2,122,102
(1,614,257)
$ 5,346,747
$ 4,447,457
1,920,968
(1,407,052)
$ 4,961,373
$ 3,337,690
1,864,444
(1,170,743)
$ 4,031,391
$ 4,799,842
1,988,038
(1,555,905)
$ 5,231,975
$ 4,379,131
1,856,573
(1,391,172)
$ 4,844,532
$ 3,192,653
1,730,884
(1,038,715)
$ 3,884,822
$ 2,472,133
1,307,317
(889,344)
$ 2,890,106
$ 2,568,327
1,442,077
(1,042,958)
$ 2,967,446
$ 1,976,853
847,038
(638,292)
$ 2,185,599
Reinsurance Recoverables
The Company monitors the financial condition of its reinsurers
and attempts to place coverages only with substantial,
financially sound carriers. Although the Company has not
experienced any material credit losses to date, an inability of
its reinsurers or retrocessionaires to meet their obligations to it
over the relevant exposure periods for any reason could have a
material adverse effect on its financial condition and results of
operations. The following table summarizes the Company’s
reinsurance recoverables on paid and unpaid losses (not
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
including ceded unearned premiums) at December 31, 2018
and 2017:
Reinsurance recoverable on unpaid and
paid losses and loss adjustment expenses
% due from carriers with A.M. Best rating
of “A-” or better
% due from unrated fully collateralized
reinsurers (1)
% due from all other carriers with no A.M.
Best rating (2)
Largest balance due from any one carrier
as % of total shareholders’ equity
December 31,
2018
2017
$ 2,919,372
$ 2,540,143
63.0%
69.9%
12.9%
4.2%
24.1%
25.9%
2.7%
2.2%
(1) Such amount is fully collateralized through reinsurance trusts.
(2) Over 90% of such amount is collateralized through reinsurance trusts or
letters of credit.
Bellemeade Re
companies domiciled
The Company has entered into various aggregate excess of loss
mortgage reinsurance agreements with various special purpose
(the
reinsurance
“Bellemeade Agreements”). For the respective coverage
periods, the Company will retain the first layer of the respective
aggregate losses and the special purpose reinsurance companies
will provide second layer coverage up to the outstanding
coverage amount. The Company will then retain losses in excess
in Bermuda
of the outstanding coverage limit. The aggregate excess of loss
reinsurance coverage decreases over a ten-year period as the
underlying covered mortgages amortize.
The following table summarizes the respective coverages and
retentions at December 31, 2018:
Initial
Coverage at
Issuance
Coverage at
Dec. 31,
2018
First Layer
Retention
Bellemeade 2015-1 Ltd. (1) $
Bellemeade 2017-1 Ltd. (2)
Bellemeade 2018-1 Ltd. (3)
Bellemeade 2018-2 Ltd. (4)
Bellemeade 2018-3 Ltd. (5)
300,000
368,100
374,460
653,278
506,110
$
43,246
304,373
374,460
653,278
506,110
$
129,900
165,700
168,510
352,258
179,331
(1)
(2)
(3)
(4)
(5)
Issued in July 2015, covering in-force policies issued between January
1, 2009 and March 31, 2013.
Issued in October 2017, covering in-force policies issued between January
1, 2017 and June 30, 2017.
Issued in April 2018, covering in-force policies issued between July 1,
2017 and December 31, 2017.
Issued in August 2018, covering in-force policies issued between April
1, 2013 and December 31, 2015.
Issued in October 2018, covering in-force policies issued between January
1, 2018 and June 30, 2018.
See Note 11, “Variable Interest Entity and Noncontrolling
Interests.”
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8.
Investment Information
At December 31, 2018, total investable assets of $22.32 billion included $19.57 billion held by the Company and $2.76 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 securities classified as available for
sale:
December 31, 2018
Fixed maturities (1):
Corporate bonds
Mortgage backed securities
Municipal bonds
Commercial mortgage backed securities
U.S. government and government agencies
Non-U.S. government securities
Asset backed securities
Total
Equity securities (3)
Short-term investments
Total
December 31, 2017
Fixed maturities (1):
Corporate bonds
Mortgage backed securities
Municipal bonds
Commercial mortgage backed securities
U.S. government and government agencies
Non-U.S. government securities
Asset backed securities
Total
Equity securities
Other investments
Short-term investments
Total
Estimated
Fair
Value
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Cost or
Amortized
Cost
OTTI
Unrealized
Losses (2)
$
$
$
$
5,537,548
541,193
1,013,395
729,442
3,758,698
1,771,338
1,600,896
14,952,510
955,880
15,908,390
4,434,439
316,141
2,158,840
545,817
3,484,257
1,612,754
1,780,143
14,332,391
504,333
264,989
1,469,042
16,570,755
$
$
$
$
14,476
3,991
5,380
2,650
27,189
14,477
8,060
76,223
36
76,259
30,943
1,640
20,285
2,131
2,188
48,764
5,147
111,098
88,739
66,946
650
267,433
$
$
$
$
(105,428) $
(3,216)
(11,891)
(10,751)
(8,474)
(50,948)
(14,798)
(205,506)
5,628,500
540,418
1,019,906
737,543
3,739,983
1,807,809
1,607,634
15,081,793
(394)
(205,900) $
956,238
16,038,031
(32,340) $
(2,561)
(12,308)
(4,268)
(28,769)
(17,321)
(8,614)
(106,181)
(5,583)
(120)
(563)
(112,447) $
4,435,836
317,062
2,150,863
547,954
3,510,838
1,581,311
1,783,610
14,327,474
421,177
198,163
1,468,955
16,415,769
$
$
$
$
(69)
(6)
—
—
—
—
—
(75)
—
(75)
(73)
(15)
—
—
—
—
—
(88)
—
—
—
(88)
(1)
In securities lending transactions, the Company receives collateral in excess of the fair value of the fixed maturities 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 OTTI recognized in accumulated other comprehensive income (“AOCI”). It does not include the change in fair value subsequent to the
impairment measurement date. At December 31, 2018, the net unrealized gain related to securities for which a non-credit OTTI was recognized in AOCI
was nil, compared to a net unrealized loss of $0.3 million at December 31, 2017.
(3) Effective January 1, 2018, the Company adopted new accounting guidance for financial instruments (see Note 3). As a result, equity securities are no longer
accounted for as available for sale and are excluded from this table.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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:
December 31, 2018
Fixed maturities (1):
Corporate bonds
Mortgage backed securities
Municipal bonds
Commercial mortgage backed securities
U.S. government and government agencies
Non-U.S. government securities
Asset backed securities
Total
Equity securities (2)
Short-term investments
Total
December 31, 2017
Fixed maturities (1):
Corporate bonds
Mortgage backed securities
Municipal bonds
Commercial mortgage backed securities
U.S. government and government agencies
Non-U.S. government securities
Asset backed securities
Total
Equity securities
Other investments
Short-term investments
Total
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
$
$
$
$
2,983,195
84,296
233,081
223,341
635,049
1,028,340
533,592
5,720,894
122,878
5,843,772
2,320,716
221,113
1,030,389
225,164
2,646,415
1,218,514
1,111,246
8,773,557
166,562
15,025
109,528
9,064,672
$
$
$
$
(68,910)
(695)
(2,074)
(2,831)
(1,354)
(35,524)
(8,832)
(120,220)
(394)
(120,614)
(25,411)
(1,715)
(8,438)
(1,899)
(26,501)
(15,546)
(5,915)
(85,425)
(5,583)
(120)
(563)
(91,691)
$
$
$
$
1,234,865
109,009
408,155
193,956
391,102
389,671
368,095
3,094,853
—
3,094,853
279,082
28,380
132,469
57,291
111,879
93,530
209,207
911,838
—
—
—
911,838
$
$
$
$
(36,518)
(2,521)
(9,817)
(7,920)
(7,120)
(15,424)
(5,966)
(85,286)
—
(85,286)
(6,929)
(846)
(3,870)
(2,369)
(2,268)
(1,775)
(2,699)
(20,756)
—
—
—
(20,756)
$
$
$
$
4,218,060
193,305
641,236
417,297
1,026,151
1,418,011
901,687
8,815,747
122,878
8,938,625
2,599,798
249,493
1,162,858
282,455
2,758,294
1,312,044
1,320,453
9,685,395
166,562
15,025
109,528
9,976,510
$
$
$
$
(105,428)
(3,216)
(11,891)
(10,751)
(8,474)
(50,948)
(14,798)
(205,506)
(394)
(205,900)
(32,340)
(2,561)
(12,308)
(4,268)
(28,769)
(17,321)
(8,614)
(106,181)
(5,583)
(120)
(563)
(112,447)
(1)
In securities lending transactions, the Company receives collateral in excess of the fair value of the fixed maturities pledged. For purposes of this table, the
Company has excluded the collateral received and reinvested and included the fixed maturities pledged. See “—Securities Lending Agreements.”
(2) Effective January 1, 2018, the Company adopted new accounting guidance for financial instruments (see Note 3). As a result, equity securities are no longer
accounted for as available for sale and are excluded from this table.
At December 31, 2018, on a lot level basis, approximately 5,870 security lots out of a total of approximately 8,450 security lots
were in an unrealized loss position and the largest single unrealized loss from a single lot in the Company’s fixed maturity portfolio
was $2.6 million. The Company believes that such securities were temporarily impaired at December 31, 2018. At December 31,
2017, on a lot level basis, approximately 3,830 security lots out of a total of approximately 7,450 security lots were in an unrealized
loss position and the largest single unrealized loss from a single lot in the Company’s fixed maturity portfolio was $1.3 million.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The contractual maturities of the Company’s fixed maturities and fixed maturities pledged under securities lending agreements
are shown in the following table. 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.
Maturity
Due in one year or less
Due after one year through five years
Due after five years through 10 years
Due after 10 years
Mortgage backed securities
Commercial mortgage backed securities
Asset backed securities
Total (1)
December 31, 2018
December 31, 2017
Estimated
Fair Value
Amortized
Cost
Estimated
Fair Value
Amortized
Cost
$
$
276,682
8,666,297
2,919,232
218,768
12,080,979
541,193
729,442
1,600,896
14,952,510
$
$
279,135
8,738,944
2,951,582
226,537
12,196,198
540,418
737,543
1,607,634
15,081,793
$
$
550,711
7,436,153
3,369,635
333,791
11,690,290
316,141
545,817
1,780,143
14,332,391
$
$
548,771
7,434,801
3,369,750
325,526
11,678,848
317,062
547,954
1,783,610
14,327,474
(1)
In securities lending transactions, the Company receives collateral in excess of the fair value of the fixed maturities pledged. For purposes of this table, the
Company has excluded the collateral received and reinvested and included the fixed maturities pledged. See “—Securities Lending Agreements.”
Securities Lending Agreements
The Company enters into securities lending agreements with financial institutions to enhance investment income whereby it loans
certain of its securities to third parties, primarily major brokerage firms, for short periods of time through a lending agent. The
Company maintains legal control over the securities it lends, retains the earnings and cash flows associated with the loaned securities
and receives a fee from the borrower for the temporary use of the securities. An indemnification agreement with the lending agent
protects the Company in the event a borrower becomes insolvent or fails to return any of the securities on loan to the Company.
The Company receives collateral in the form of cash or securities. Cash collateral primarily consists of short-term investments.
At December 31, 2018, the fair value of the cash collateral received on securities lending was $19.0 million and the fair value of
security collateral received was $255.1 million. At December 31, 2017, the fair value of the cash collateral received on securities
lending was $199.9 million and the fair value of security collateral received was $276.7 million.
The Company’s securities lending transactions were accounted for as secured borrowings with significant investment categories
as follows:
Overnight and
Continuous
Remaining Contractual Maturity of the Agreements
Less than 30
Days
90 Days or
More
30-90 Days
Total
December 31, 2018
U.S. government and government agencies
Corporate bonds
Equity securities
Total
$
$
219,276
$
— $
32,583
$
— $
251,859
7,129
15,137
—
—
—
—
—
—
7,129
15,137
241,542
$
— $
32,583
$
— $
274,125
Gross amount of recognized liabilities for securities lending in offsetting disclosure in Note 10
Amounts related to securities lending not included in offsetting disclosure in Note 10
$
$
—
274,125
December 31, 2017
U.S. government and government agencies
Corporate bonds
Equity securities
Total
$
$
Gross amount of recognized liabilities for securities lending in offsetting disclosure in Note 10
Amounts related to securities lending not included in offsetting disclosure in Note 10
343,425
$
20,309
$
76,086
$
— $
439,820
28,003
8,782
—
—
—
—
380,210
$
20,309
$
76,086
$
—
—
— $
$
$
28,003
8,782
476,605
—
476,605
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Equity Securities, at Fair Value
At December 31, 2018, the Company held $338.9 million of
equity securities, at fair value, compared to $495.8 million at
December 31, 2017. Pursuant to new accounting guidance (see
note 3, “Significant Accounting Policies - Recent Accounting
Pronouncements”), changes in fair value on equity securities
are recorded through net income effective January 1, 2018.
Other Investments
The following table summarizes the Company’s other
investments, including available for sale and fair value option
components:
Available for sale securities:
Asia and emerging markets
Investment grade fixed income
Credit related funds
Other
Total available for sale (1)
Fair value option:
Term loan investments (par value:
$1,369,216 and $1,223,453)
Lending
Credit related funds
Energy
Investment grade fixed income
Infrastructure
Private equity
Real estate
Total fair value option
Total
December 31,
2018
2017
$
— $
—
—
—
—
135,140
53,878
18,365
57,606
264,989
1,282,287
1,200,882
524,112
202,123
117,509
101,902
45,371
24,383
14,252
2,311,939
$ 2,311,939
399,099
181,744
132,709
102,347
82,291
23,593
13,716
2,136,381
$ 2,401,370
(1) The Company reviewed the accounting treatment for three limited
partnership investments which were accounted for as available for sale
at December 31, 2017 during the 2018 first quarter and determined, based
on reconsideration during the period of the Company’s percentage
ownership, that the equity method of accounting was appropriate for such
investments.
Investments Accounted For Using the Equity Method
The following table summarizes the Company’s investments
accounted for using the equity method:
Credit related funds
Equities
Real estate
Lending
Private equity
Infrastructure
Energy
Total
December 31,
$
2018
429,402
375,273
232,647
125,041
114,019
113,748
103,661
$ 1,493,791
$
2017
263,034
292,762
176,328
66,093
96,310
99,338
47,457
$ 1,041,322
In applying the equity method, investments are initially
recorded at cost and are subsequently adjusted based on the
Company’s proportionate share of the net income or loss of the
funds (which include changes in the fair value of the underlying
securities in the funds). Such investments are generally
recorded on a one to three month lag based on the availability
of reports from the investment funds.
A summary of financial information for the Company’s
investments accounted for using the equity method is as
follows:
Invested assets
Total assets
Total liabilities
Net assets
Total revenues
Total expenses
Net income (loss)
$
$
December 31,
2018
$ 28,299,386
29,833,681
3,406,612
$ 26,427,069
2017
$ 22,351,894
23,932,507
2,734,662
$ 21,197,845
Year Ended December 31,
2017
3,867,874
782,773
3,085,101
2018
4,565,354
1,135,602
3,429,752
$
$
$
$
2016
2,279,737
656,940
1,622,797
Certain of the Company’s other investments and investments
accounted for using the equity method are in investment funds
for which the Company has the option to redeem at agreed upon
values as described in each investment fund’s subscription
agreement. Depending on the terms of the various subscription
agreements, investments in investment funds may be redeemed
daily, monthly, quarterly or on other terms. Two common
redemption restrictions which may impact the Company’s
ability to redeem these investment funds are gates and lockups.
A gate is a suspension of redemptions which may be
implemented by the general partner or investment manager of
the fund in order to defer, in whole or in part, the redemption
request in the event the aggregate amount of redemption
requests exceeds a predetermined percentage of the investment
fund's net assets which may otherwise hinder the general partner
or investment manager's ability to liquidate holdings in an
orderly fashion in order to generate the cash necessary to fund
extraordinarily large redemption payouts. A lockup period is
the initial amount of time an investor is contractually required
to hold the security before having the ability to redeem. If the
investment funds are eligible to be redeemed, the time to redeem
such fund can take weeks or months following the notification.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Fair Value Option
Net Investment Income
The following table summarizes the Company’s assets and
liabilities which are accounted for using the fair value option:
The components of net investment income were derived from
the following sources:
Fixed maturities
Other investments
Short-term investments
Equity securities
December 31,
2018
$ 1,245,562
2,311,939
322,177
103,893
2017
$ 1,642,855
2,136,381
297,426
139,575
Investments accounted for using the fair
value option
$ 3,983,571
$ 4,216,237
Limited Partnership Interests
In the normal course of its activities, the Company invests in
limited partnerships as part of its overall investment strategy.
Such amounts are included in ‘investments accounted for using
the equity method’ and ‘investments accounted for using the
fair value option.’ Based on the new accounting guidance for
consolidation, the Company determined that these limited
partnership interests represented variable interests in the funds
because the general partner did not have a significant interest
in the funds. The Company’s maximum exposure to loss with
respect to these investments is limited to the investment
carrying amounts reported in the Company’s consolidated
balance sheet and any unfunded commitment.
The following table summarizes investments in limited
partnership interests where the Company has a variable interest
by balance sheet item:
December 31,
2018
2017
Investments accounted for using the
equity method (1)
Investments accounted for using the fair
value option (2)
Total
$ 1,493,791
$ 1,041,322
162,398
130,470
$ 1,656,189
$ 1,171,792
(1) Aggregate unfunded commitments were $1.22 billion at December 31,
2018, compared to $1.02 billion at December 31, 2017.
(2) Aggregate unfunded commitments were $117.5 million at December 31,
2018, compared to $100.4 million at December 31, 2017.
$
Fixed maturities
Equity securities
Short-term investments
Other (1)
Gross investment income
Investment expenses
Net investment income
$
$
$
Year Ended December 31,
2017
385,919
11,752
10,964
154,266
562,901
(92,029)
470,872
2018
470,912
13,154
18,793
152,868
655,727
(92,094)
563,633
$
$
2016
295,502
12,536
6,071
132,815
446,924
(80,182)
366,742
(1)
Includes income distributions from investment funds, term loan
investments and other items.
Net Realized Gains (Losses)
Net realized gains (losses) were as follows, excluding the other-
than-temporary impairment provisions:
Year Ended December 31,
2017
2018
2016
Available for sale securities:
Gross gains on investment
sales
Gross losses on investment
sales
Change in fair value of assets
and liabilities accounted for
using the fair value option:
Fixed maturities
Other investments
Equity securities
Short-term investments
Equity securities, at fair value
(1):
Net realized gains (losses)
on sales during the period
Net unrealized gains (losses)
on equity securities still held
at reporting date
$
69,299
$ 286,415
$ 309,896
(223,123)
(203,873)
(214,447)
(90,898)
(90,778)
(5,984)
(461)
(40,117)
(22,828)
29,451
51,124
18,707
272
47,890
58,687
366
93
—
—
—
—
Derivative instruments (2)
Other (3)
Net realized gains (losses)
15,636
(16,090)
$ (405,344)
(7,356)
(25,599)
$ 149,141
(22,612)
(42,287)
$ 137,586
(1) Pursuant to new accounting guidance (see Note 3), changes in fair value
on equity securities are recorded through net income effective January 1,
2018.
(2) See Note 10 for information on the Company’s derivative instruments.
(3)
Includes the re-measurement of contingent consideration liability
amounts.
Equity in Net Income (Loss) of Investments Accounted For
Using the Equity Method
The Company recorded equity in net income related to
investments accounted for using the equity method of $45.6
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
million for 2018, compared to $142.3 million for 2017 and
$48.5 million for 2016.
Other-Than-Temporary Impairments
The Company performs quarterly reviews of its available for
sale investments in order to determine whether declines in fair
value below the amortized cost basis were considered other-
than-temporary in accordance with applicable guidance.
The following table details the net impairment losses
recognized in earnings by asset class:
impaired was due to market and sector-related factors (i.e., not
credit losses). At December 31, 2018, the Company did not
intend to sell these securities, or any other securities which were
in an unrealized loss position, and determined that it is more
likely than not that the Company will not be required to sell
such securities before recovery of their cost basis.
The following table provides a roll forward of the amount
related to credit losses recognized in earnings for which a
portion of an OTTI was recognized in accumulated other
comprehensive income:
Year Ended December 31,
2017
2018
2016
$
(437)
(1,232)
$
(1,488)
(2,884)
(964)
(5,674)
(290)
(811)
—
—
(2,770)
(59)
—
—
(376)
—
(426)
(375)
(5,549)
—
(1,422)
(167)
(823)
(14,736)
—
(726)
(22,923)
—
(3,990)
(3,529)
Balance at start of year
$
767
$
13,138
$
26,875
Year Ended December 31,
2017
2018
2016
Credit loss impairments
recognized on securities
not previously impaired
Credit loss impairments
recognized on securities
previously impaired
Reductions for increases
in cash flows expected to
be collected that are
recognized over the
remaining life of the
security
Reductions for securities
sold during the period
—
—
31
2,186
210
582
—
—
—
(130)
(12,612)
(16,505)
Balance at end of year
$
637
$
767
$
13,138
Fixed maturities:
Mortgage backed securities $
Corporate bonds
Non-U.S. government
securities
Asset backed securities
U.S. government and
government agencies
Municipal bonds
Total
Short-term investments
Equity securities
Other investments
Net impairment losses
recognized in earnings
$
(2,829)
$
(7,138)
$
(30,442)
Restricted Assets
A description of the methodology and significant inputs used
to measure the amount of net impairment losses recognized in
earnings in 2018 is as follows:
• Corporate bonds – the Company reviewed the business
prospects, credit ratings, estimated loss given default
factors, foreign currency impacts and information received
from asset managers and rating agencies for certain
corporate bonds. Impairment losses were primarily from
foreign currency impacts;
• Mortgage backed securities – the Company utilized
underlying data provided by asset managers, cash flow
projections and additional
information from credit
agencies in order to determine an expected recovery value
for each security;
• Equity securities – the Company utilized information
received from asset managers on common stocks,
including the business prospects, recent events, industry
and market data and other factors. Impairment losses were
primarily on equities which were in an unrealized loss
position for a significant length of time.
The Company believes that the OTTI included in accumulated
other comprehensive income at December 31, 2018 on the
securities which were considered by the Company to be
The Company is required to maintain assets on deposit, which
primarily consist of fixed maturities, with various regulatory
authorities to support its insurance and reinsurance operations.
The Company’s
insurance and reinsurance subsidiaries
maintain assets in trust accounts as collateral for insurance and
reinsurance transactions with affiliated companies and also
have investments in segregated portfolios primarily to provide
collateral or guarantees for letters of credit to third parties.
The following table details the value of the Company’s
restricted assets:
December 31,
2018
2017
Assets used for collateral or guarantees:
Affiliated transactions
Third party agreements
Deposits with U.S. regulatory authorities
Deposits with non-U.S. regulatory
authorities
$ 4,623,483
2,181,682
689,114
$ 4,323,726
1,674,304
616,987
59,624
55,895
Total restricted assets
$ 7,553,903
$ 6,670,912
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Reconciliation of Cash and Restricted Cash
The following table details reconciliation of cash and restricted
cash within the Consolidated Balance Sheets:
Cash
Restricted cash (included in ‘other
assets’)
2018
$ 646,556
December 31,
2017
$ 606,199
2016
$ 842,942
78,087
121,085
126,627
Cash and restricted cash
$ 724,643
$ 727,284
$ 969,569
9. Fair Value
Accounting guidance regarding fair value measurements
addresses how companies should measure fair value when they
are required to use a fair value measure for recognition or
disclosure purposes under GAAP and provides a common
definition of fair value to be used throughout GAAP. It defines
fair value as the price that would be received to sell an asset or
paid to transfer a liability in an orderly fashion between market
participants at the measurement date. In addition, it establishes
a three-level valuation hierarchy for the disclosure of fair value
measurements. The valuation hierarchy is based upon the
transparency of inputs to the valuation of an asset or liability
as of the measurement date. The level in the hierarchy within
which a given fair value measurement falls is determined based
on the lowest level input that is significant to the measurement
(Level 1 being the highest priority and Level 3 being the lowest
priority).
The levels in the hierarchy are defined as follows:
Level 1:
Level 2:
Level 3:
to
Inputs
the valuation methodology are
observable inputs that reflect quoted prices
(unadjusted) for identical assets or liabilities in
active markets
Inputs to the valuation methodology include
quoted prices for similar assets and liabilities in
active markets, and inputs that are observable for
the asset or liability, either directly or indirectly,
for substantially the full term of the financial
instrument
to
Inputs
the valuation methodology are
unobservable and significant to the fair value
measurement
Following is a description of the valuation methodologies used
for securities measured at fair value, as well as the general
classification of such securities pursuant to the valuation
hierarchy. The Company reviews its securities measured at fair
the proper classification of such
value and discusses
investments with investment advisers and others.
The Company determines the existence of an active market
based on its judgment as to whether transactions for the financial
to provide
reliable pricing
instrument occur in such market with sufficient frequency and
information. The
volume
independent pricing sources obtain market quotations and
actual transaction prices for securities that have quoted prices
in active markets. The Company uses quoted values and other
data provided by nationally recognized independent pricing
sources as inputs into its process for determining fair values of
its fixed maturity investments. To validate the techniques or
models used by pricing sources, the Company's review process
includes, but is not limited to: (i) quantitative analysis (e.g.,
comparing the quarterly return for each managed portfolio to
its target benchmark, with significant differences identified and
investigated); (ii) a review of the prices obtained in the pricing
process and the range of resulting fair values; (iii) initial and
ongoing evaluation of methodologies used by outside parties
to calculate fair value; (iv) a comparison of the fair value
estimates to the Company’s knowledge of the current market;
(v) a comparison of the pricing services' fair values to other
pricing services' fair values for the same investments; and (vi)
periodic back-testing, which includes randomly selecting
purchased or sold securities and comparing the executed prices
to the fair value estimates from the pricing service. A price
source hierarchy was maintained in order to determine which
price source would be used (i.e., a price obtained from a pricing
service with more seniority in the hierarchy will be used over
a less senior one in all cases). The hierarchy prioritizes pricing
services based on availability and reliability and assigns the
highest priority to index providers. Based on the above review,
the Company will challenge any prices for a security or portfolio
which are considered not to be representative of fair value.
In certain circumstances, when fair values are unavailable from
these independent pricing sources, quotes are obtained directly
from broker-dealers who are active in the corresponding
markets. Such quotes are subject to the validation procedures
noted above. Of the $20.4 billion of financial assets and
liabilities measured at fair value at December 31, 2018,
approximately $217.9 million, or 1.1%, were priced using non-
binding broker-dealer quotes. Of the $20.9 billion of financial
assets and liabilities measured at fair value at December 31,
2017, approximately $181.5 million, or 0.9%, were priced using
non-binding broker-dealer quotes.
Fixed maturities
The Company uses the market approach valuation technique to
estimate the fair value of its fixed maturity securities, when
possible. The market approach includes obtaining prices from
independent pricing services, such as index providers and
pricing vendors, as well as to a lesser extent quotes from broker-
dealers. The independent pricing sources obtain market
quotations and actual transaction prices for securities that have
quoted prices in active markets. Each source has its own
proprietary method for determining the fair value of securities
that are not actively traded. In general, these methods involve
the use of “matrix pricing” in which the independent pricing
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
source uses observable market inputs including, but not limited
to, investment yields, credit risks and spreads, benchmarking
of like securities, broker-dealer quotes, reported trades and
sector groupings to determine a reasonable fair value. The
following describes the significant inputs generally used to
determine the fair value of the Company’s fixed maturity
securities by asset class:
• U.S. government and government agencies — valuations
provided by independent pricing services, with all prices
provided through index providers and pricing vendors. The
Company determined that all U.S. Treasuries would be
classified as Level 1 securities due to observed levels of trading
activity, the high number of strongly correlated pricing quotes
received on U.S. Treasuries and other factors. The fair values
of U.S. government agency securities are generally determined
using the spread above the risk-free yield curve. As the yields
for the risk-free yield curve and the spreads for these securities
are observable market inputs, the fair values of U.S. government
agency securities are classified within Level 2.
• Corporate bonds — valuations provided by independent
pricing services, substantially all through index providers and
pricing vendors with a small amount through broker-dealers.
The fair values of these securities are generally determined
using the spread above the risk-free yield curve. These spreads
are generally obtained from the new issue market, secondary
trading and from broker-dealers who trade in the relevant
security market. As the significant inputs used in the pricing
process for corporate bonds are observable market inputs, the
fair value of these securities are classified within Level 2.
• Mortgage-backed securities — valuations provided by
independent pricing services, substantially all through pricing
vendors and index providers with a small amount through
broker-dealers. The fair values of these securities are generally
determined through the use of pricing models (including Option
Adjusted Spread) which use spreads to determine the expected
average life of the securities. These spreads are generally
obtained from the new issue market, secondary trading and from
broker-dealers who trade in the relevant security market. The
pricing services also review prepayment speeds and other
indicators, when applicable. As the significant inputs used in
the pricing process for mortgage-backed securities are
observable market inputs, the fair value of these securities are
classified within Level 2.
•
Municipal bonds — valuations provided by independent
pricing services, with all prices provided through index
providers and pricing vendors. The fair values of these securities
are generally determined using spreads obtained from broker-
dealers who trade in the relevant security market, trade prices
and the new issue market. As the significant inputs used in the
pricing process for municipal bonds are observable market
inputs, the fair value of these securities are classified within
Level 2.
• Commercial mortgage-backed securities — valuations
provided by independent pricing services, substantially all
through index providers and pricing vendors with a small
amount through broker-dealers. The fair values of these
securities are generally determined through the use of pricing
models which use spreads to determine the appropriate average
life of the securities. These spreads are generally obtained from
the new issue market, secondary trading and from broker-
dealers who trade in the relevant security market. As the
significant inputs used in the pricing process for commercial
mortgage-backed securities are observable market inputs, the
fair value of these securities are classified within Level 2.
• Non-U.S. government securities — valuations provided by
independent pricing services, with all prices provided through
index providers and pricing vendors. The fair values of these
securities are generally based on international indices or
valuation models which include daily observed yield curves,
cross-currency basis index spreads and country credit spreads.
As the significant inputs used in the pricing process for non-
U.S. government securities are observable market inputs, the
fair value of these securities are classified within Level 2.
• Asset-backed securities — valuations provided by
independent pricing services, substantially all through index
providers and pricing vendors with a small amount through
broker-dealers. The fair values of these securities are generally
determined through the use of pricing models (including Option
Adjusted Spread) which use spreads to determine the
appropriate average life of the securities. These spreads are
generally obtained from the new issue market, secondary
trading and from broker-dealers who trade in the relevant
security market. As the significant inputs used in the pricing
process for asset-backed securities are observable market
inputs, the fair value of these securities are classified within
Level 2. A small number of securities are included in Level 3
due to a low level of transparency on the inputs used in the
pricing process.
Equity securities
The Company determined
that exchange-traded equity
securities would be included in Level 1 as their fair values are
based on quoted market prices in active markets. Other equity
securities are included in Level 2 of the valuation hierarchy.
Other investments
The Company determined that exchange-traded investments
would be included in Level 1 as their fair values are based on
quoted market prices in active markets. Other investments also
include term loan investments for which fair values are
estimated by using quoted prices of term loan investments with
similar characteristics, pricing models or matrix pricing. Such
investments are generally classified within Level 2. A small
number of securities are included in Level 3 due to a low level
of transparency on the inputs used in the pricing process. The
fair values for certain of the Company’s other investments are
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
determined using net asset values as advised by external fund
managers, based on the fund manager’s valuation of the
underlying holdings in accordance with the fund’s governing
documents. Certain investments that are measured at fair value
using the net asset value per share (or its equivalent) practical
expedient have not been classified in the fair value hierarchy.
Derivative instruments
The Company’s futures contracts, foreign currency forward
contracts, interest rate swaps and other derivatives trade in the
over-the-counter derivative market. The Company uses the
market approach valuation technique to estimate the fair value
for these derivatives based on significant observable market
inputs from third party pricing vendors, non-binding broker-
dealer quotes and/or recent trading activity. As the significant
inputs used in the pricing process for these derivative
instruments are observable market inputs, the fair value of these
securities are classified within Level 2.
Short-term investments
The Company determined that certain of its short-term
investments held in highly liquid money market-type funds,
Treasury bills and commercial paper would be included in Level
1 as their fair values are based on quoted market prices in active
markets. The fair values of other short-term investments are
generally determined using the spread above the risk-free yield
curve and are classified within Level 2.
Contingent consideration liabilities
liabilities (included
Contingent consideration
in ‘other
liabilities’ in the consolidated balance sheets) include amounts
related to the Company’s 2014 acquisition of CMG Mortgage
Insurance Company and its affiliated mortgage insurance
companies (the “CMG Entities”) and other acquisitions. Such
amounts are remeasured at fair value at each balance sheet date
with changes in fair value recognized in ‘net realized gains
the fair value of contingent
(losses).’ To determine
consideration
the Company estimates future
liabilities,
payments using an income approach based on modeled inputs
which include a weighted average cost of capital. The Company
determined that contingent consideration liabilities would be
included within Level 3.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table presents the Company’s financial assets and liabilities measured at fair value by level at December 31, 2018:
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
Fair Value Measurement Using:
Significant
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Estimated
Fair Value
Assets measured at fair value (1):
Available for sale securities:
Fixed maturities:
Corporate bonds
Mortgage backed securities
Municipal bonds
Commercial mortgage backed securities
U.S. government and government agencies
Non-U.S. government securities
Asset backed securities
Total
Short-term investments
Equity securities, at fair value
Derivative instruments (4)
Fair value option:
Corporate bonds
Non-U.S. government bonds
Mortgage backed securities
Municipal bonds
Commercial mortgage backed securities
Asset backed securities
U.S. government and government agencies
Short-term investments
Equity securities
Other investments
Other investments measured at net asset value (2)
Total
Total assets measured at fair value
Liabilities measured at fair value:
Contingent consideration liabilities
Securities sold but not yet purchased (3)
Derivative instruments (4)
Total liabilities measured at fair value
$
$
$
$
5,537,548 $
541,193
1,013,395
729,442
3,758,698
1,771,338
1,600,896
14,952,510
— $
—
—
—
3,657,181
—
—
3,657,181
5,529,407 $
540,884
1,013,395
729,438
101,517
1,771,338
1,600,896
11,286,875
955,880
353,794
73,893
852,585
79,066
16,731
7,144
—
178,790
111,246
322,177
103,893
1,254,220
1,057,719
3,983,571
875,881
321,927
—
—
—
—
—
—
—
111,138
278,579
48,827
39,107
79,999
31,867
73,893
846,827
79,066
16,731
7,144
—
178,790
108
43,598
55,066
1,152,408
477,651
2,379,738
20,319,648 $
5,332,640 $
13,852,372 $
8,141
309
—
4
—
—
—
8,454
—
—
—
5,758
—
—
—
—
—
—
—
—
62,705
68,463
76,917
(66,665) $
(7,790)
(20,664)
(95,119) $
— $
—
—
— $
— $
(7,790)
(20,664)
(28,454) $
(66,665)
—
—
(66,665)
(1)
(2)
(3)
(4)
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 Note 8.
In accordance with applicable accounting guidance, certain investments that are measured at fair value using the net asset value per share (or its equivalent)
practical expedient have not been classified in the fair value hierarchy. The fair value amounts presented in this table are intended to permit reconciliation
of the fair value hierarchy to the amounts presented in the consolidated balance sheets.
Represents the Company’s obligations to deliver securities that it did not own at the time of sale. Such amounts are included in “other liabilities” on the
Company’s consolidated balance sheets.
See Note 10.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table presents the Company’s financial assets and liabilities measured at fair value by level at December 31, 2017:
Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
Fair Value Measurement Using:
Significant
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Estimated
Fair Value
Assets measured at fair value (1):
Available for sale securities:
Fixed maturities:
Corporate bonds
Mortgage backed securities
Municipal bonds
Commercial mortgage backed securities
U.S. government and government agencies
Non-U.S. government securities
Asset backed securities
Total
Equity securities
Short-term investments
Other investments
Other investments measured at net asset value (2)
Total other investments
Derivative instruments (4)
Fair value option:
Corporate bonds
Non-U.S. government bonds
Mortgage backed securities
Municipal bonds
Commercial mortgage backed securities
Asset backed securities
U.S. government and government agencies
Short-term investments
Equity securities
Other investments
Other investments measured at net asset value (2)
Total
$
$
4,434,439
316,141
2,158,840
545,817
3,484,257
1,612,754
1,780,143
14,332,391
$
— $
—
—
—
3,408,902
—
—
3,408,902
4,424,979
315,754
2,158,840
545,277
75,355
1,612,754
1,775,143
10,908,102
504,333
498,182
1,469,042
1,420,732
6,151
48,310
1,816
1,816
15,747
1,056,508
195,788
20,491
15,210
11,997
99,354
271
257,260
72,135
986,636
74,611
74,611
—
—
—
—
—
—
—
231,019
40,166
67,440
82,291
420,916
2,715,650
76,427
188,562
264,989
15,747
1,068,725
195,788
20,491
15,210
11,997
99,354
231,290
297,426
139,575
1,128,094
1,008,287
4,216,237
9,460
387
—
540
—
—
5,000
15,387
—
—
—
—
—
12,217
—
—
—
—
—
—
—
—
59,167
71,384
86,771
Total assets measured at fair value
$
20,802,739
$
5,823,343
$
13,695,776
$
Liabilities measured at fair value:
Contingent consideration liabilities
Securities sold but not yet purchased (3)
Derivative instruments (4)
Total liabilities measured at fair value
$
$
(60,996) $
(34,375)
(20,464)
(115,835) $
— $
—
—
— $
— $
(34,375)
(20,464)
(54,839) $
(60,996)
—
—
(60,996)
(1)
(2)
(3)
(4)
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 Note 8.
In accordance with applicable accounting guidance, certain investments that are measured at fair value using the net asset value per share (or its equivalent)
practical expedient have not been classified in the fair value hierarchy. The fair value amounts presented in this table are intended to permit reconciliation
of the fair value hierarchy to the amounts presented in the consolidated balance sheets.
Represents the Company’s obligations to deliver securities that it did not own at the time of sale. Such amounts are included in “other liabilities” on the
Company’s consolidated balance sheets.
See Note 10.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table presents a reconciliation of the beginning and ending balances for all financial assets and liabilities measured
at fair value on a recurring basis using Level 3 inputs for 2018 and 2017:
Year Ended December 31, 2018
Balance at beginning of year
Total gains or (losses) (realized/unrealized)
Included in earnings (2)
Included in other comprehensive income
Purchases, issuances, sales and settlements
Purchases
Issuances
Sales
Settlements
Transfers in and/or out of Level 3
Balance at end of year
Year Ended December 31, 2017
Balance at beginning of year
Total gains or (losses) (realized/unrealized)
Included in earnings (2)
Included in other comprehensive income
Purchases, issuances, sales and settlements
Purchases
Issuances
Sales
Settlements
Transfers in and/or out of Level 3
Balance at end of year
$
$
$
Available For Sale
Assets
Fair Value Option
Structured
Securities (1)
Corporate
Bonds
Corporate
Bonds
Other
Investments
Total
Liabilities
Contingent
Consideration
Liabilities
$
5,927
$
9,460
$
12,217
$
59,167
$
86,771
$
(60,996)
4
(11)
—
—
(5,003)
(604)
—
313
$
(1)
(296)
802
—
—
(1,824)
—
8,141
$
(334)
—
—
—
—
(6,125)
—
5,758
$
(1,416)
—
6,250
—
(296)
(1,000)
—
62,705
$
(1,747)
(307)
7,052
—
(5,299)
(9,553)
—
76,917
$
(5,669)
—
—
—
—
—
—
(66,665)
11,289
$
18,344
$
— $
25,000
$
54,633
$
(122,350)
3,779
7
—
—
(13,640)
(1,457)
5,949
5,927
$
688
713
4,935
—
(14,897)
(455)
132
9,460
$
1,021
—
—
—
—
(275)
11,471
12,217
$
4
—
1,348
—
—
(901)
33,716
59,167
$
5,492
720
6,283
—
(28,537)
(3,088)
51,268
86,771
$
(10,837)
—
—
—
—
72,191
—
(60,996)
Includes asset backed securities, mortgage backed securities and commercial mortgage backed securities.
(1)
(2) Gains or losses were included in net realized gains (losses).
Financial Instruments Disclosed, But Not Carried, At Fair
Value
Fair Value Measurements on a Non-Recurring Basis
The Company uses various financial instruments in the normal
course of its business. The carrying values of cash, accrued
investment income, receivable for securities sold, certain other
assets, payable for securities purchased and certain other
liabilities approximated their fair values at December 31, 2018,
due to their respective short maturities. As these financial
instruments are not actively traded, their respective fair values
are classified within Level 2.
At December 31, 2018, the Company’s senior notes were
carried at their cost, net of debt issuance costs, of $1.73 billion
and had a fair value of $1.88 billion. At December 31, 2017,
the Company’s senior notes were carried at their cost, net of
debt issuance costs, of $1.73 billion and had a fair value of $2.04
billion. The fair values of the senior notes were obtained from
a third party pricing service and are based on observable market
inputs. As such, the fair value of the senior notes is classified
within Level 2.
The Company measures the fair value of certain assets on a
non-recurring basis, generally quarterly, annually, or when
events or changes in circumstances indicate that the carrying
amount of the assets may not be recoverable. These assets
include investments accounted for using the equity method,
certain other investments, goodwill and intangible assets, and
long-lived assets. The Company uses a variety of techniques to
measure the fair value of these assets when appropriate, as
described below:
Investments accounted for using the equity method. When the
Company determines that the carrying value of these assets may
not be recoverable, the Company records the assets at fair value
with the loss recognized in income. In such cases, the Company
measures the fair value of these assets using the techniques
discussed above in “—Fair Value Measurements on a Recurring
Basis.”
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Goodwill and Intangible Assets. The Company tests goodwill
and intangible assets for impairment whenever events or
changes in circumstances indicate the carrying amount may not
be recoverable. When the Company determines goodwill and
intangible assets may be impaired, the Company uses
techniques including discounted expected future cash flows, to
measure fair value.
Long-Lived Assets. The Company tests its long-lived assets for
impairment whenever events or changes in circumstances
indicate the carrying amount of a long-lived asset may not be
recoverable.
10. Derivative Instruments
The Company’s investment strategy allows for the use of
derivative instruments. The Company’s derivative instruments
are recorded on its consolidated balance sheets at fair value.
The Company utilizes exchange traded U.S. Treasury note,
Eurodollar and other futures contracts and commodity futures
to manage portfolio duration or replicate investment positions
in its portfolios and the Company routinely utilizes foreign
currency forward contracts, currency options, index futures
contracts and other derivatives as part of its total return
objective. In addition, certain of the Company’s investments
are managed in portfolios which incorporate the use of foreign
currency forward contracts which are intended to provide an
economic hedge against foreign currency movements.
In addition, the Company purchases to-be-announced mortgage
backed securities (“TBAs”) as part of its investment strategy.
TBAs represent commitments to purchase a future issuance of
agency mortgage backed securities. For the period between
purchase of a TBA and issuance of the underlying security, the
Company’s position is accounted for as a derivative. The
Company purchases TBAs in both long and short positions to
enhance investment performance and as part of its overall
investment strategy.
The following table summarizes information on the fair values
and notional values of the Company’s derivative instruments:
Estimated Fair Value
Asset
Derivatives
Liability
Derivatives
Notional
Value (1)
December 31, 2018
Futures contracts (2)
$
51,800
$
(2,115) $ 3,153,518
Foreign currency forward
contracts (2)
TBAs (3)
Other (2)
Total
December 31, 2017
Futures contracts (2)
Foreign currency forward
contracts (2)
$
$
TBAs (3)
Other (2)
Total
8,147
8,292
13,946
(7,796)
1,008,907
—
8,132
(10,753)
2,213,981
82,185
$
(20,664)
3,371
$
(1,542) $ 1,452,497
4,478
27,184
7,898
(4,381)
—
686,941
27,066
(14,541)
1,457,345
$
42,931
$
(20,464)
(1) Represents the absolute notional value of all outstanding
contracts, consisting of long and short positions.
(2) The fair value of asset derivatives are included in ‘other assets’
and the fair value of liability derivatives are included in ‘other
liabilities.’ Such amounts include risk in force on GSE credit-risk
sharing transactions that are accounted for as derivatives.
(3) The fair value of TBAs are included in ‘fixed maturities available
for sale, at fair value.’
The Company did not hold any derivatives which were
designated as hedging instruments at December 31, 2018 or
2017.
The Company’s derivative instruments can be traded under
master netting agreements, which establish terms that apply to
all derivative transactions with a counterparty. In the event of
a bankruptcy or other stipulated event of default, such
agreements provide that the non-defaulting party may elect to
terminate all outstanding derivative transactions, in which case
all individual derivative positions (loss or gain) with a
counterparty are closed out and netted and replaced with
a single amount, usually referred to as the termination
amount, which is expressed in a single currency. The resulting
single net amount, where positive, is payable to the party “in-
the-money” regardless of whether or not it is the defaulting
party, unless the parties have agreed that only the non-
defaulting party is entitled to receive a termination payment
where the net amount is positive and is in its favor. Effectively,
contractual close-out netting reduces the derivatives credit
exposure from a gross to a net exposure. At December 31, 2018,
$80.4 million and $18.9 million, respectively, of asset
derivatives and liability derivatives were subject to a master
netting agreement compared to $40.6 million and $19.6 million,
respectively, at December 31, 2017. The remaining derivatives
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
included in the table above were not subject to a master netting
agreement.
All realized and unrealized contract gains and losses on the
Company’s derivative instruments are reflected in net realized
gains (losses) in the consolidated statements of income, as
summarized in the following table:
Derivatives not designated
as hedging instruments
Net realized gains (losses):
Year Ended December 31,
2018
2017
2016
Futures contracts
$
48,443
$
9,318
$
(5,474)
Foreign currency forward
contracts
TBAs
Other
Total
(21,770)
(14,495)
(9,588)
(133)
9
577
(10,904)
(2,188)
(8,127)
$
15,636
$
(7,356)
$
(22,612)
statements. The Company concluded that Watford Re should
be reflected in a separate operating segment (‘other’) and
provides the income statement and total investable assets, total
assets and total liabilities of Watford Re within Note 4.
Because Watford Re is an independent company, the assets of
Watford Re can be used only to settle obligations of Watford
Re and Watford Re is solely responsible for its own liabilities
and commitments. The Company’s financial exposure to
Watford Re is limited to its investment in Watford Re’s common
shares and counterparty credit risk (mitigated by collateral)
arising from the reinsurance transactions.
The following table provides the carrying amount and balance
sheet caption in which the assets and liabilities of Watford Re
are reported:
11. Variable Interest Entity and Noncontrolling
Interests
Watford Holdings Ltd.
In March 2014, Watford Re raised approximately $1.1 billion
of capital consisting of $907.3 million in common equity
($895.6 million net of issuance costs) and $226.6 million in
preference equity ($219.2 million net of issuance costs and
discount). The Company invested $100.0 million and acquired
2,500,000 common shares, approximately 11% of Watford
Holdings Ltd.’s common equity, and a warrant to purchase up
to 975,503 additional common shares. The warrants expire on
March 31, 2020, and are exercisable at any time following the
listing of the common shares on a U.S. national securities
exchange. The exercise price of the warrants is determined on
the date of exercise based on certain targeted returns for existing
common shareholders. As of December 31, 2018, the exercise
price was $77.94 per share.
Assets
Investments accounted for using the
fair value option
Fixed maturities available for sale, at
fair value
Equity securities, at fair value
Cash
Accrued investment income
Premiums receivable
Reinsurance recoverable on unpaid
and paid losses and LAE
Ceded unearned premiums
Deferred acquisition costs, net
Receivable for securities sold
Goodwill and intangible assets
Other assets
Total assets of consolidated VIE
Liabilities
Reserves for losses and loss
adjustment expenses
Unearned premiums
Reinsurance balances payable
Revolving credit agreement
borrowings
Subsidiaries of the Company act as Watford Re’s reinsurance
and insurance underwriting managers.
Payable for securities purchased
Other liabilities
Total liabilities of consolidated VIE $
December 31,
2018
2017
$
2,312,003
$
2,426,066
393,351
32,206
63,529
19,461
227,301
86,445
61,587
80,858
24,507
7,650
63,959
3,372,857
$
1,032,760
$
$
$
390,114
21,034
455,682
60,142
302,524
2,262,256
$
$
—
—
54,503
18,261
177,492
42,777
24,762
85,961
36,374
7,650
140,808
3,014,654
798,262
330,644
18,424
441,132
42,501
215,186
1,846,149
220,622
HPS Investment Partners, LLC (“HPS”) manages Watford Re’s
non-investment grade credit portfolios, and the Company
manages Watford Re’s investment grade portfolios, each under
separate long term services agreements. John Rathgeber,
previously Vice Chairman of Arch Worldwide Reinsurance
Group, is CEO of Watford Re. In addition, Maamoun Rajeh
and Nicolas Papadopoulo, both officers of the Company, serve
on the board of directors of Watford Re.
The Company concluded that Watford Re is a VIE and that the
Company is the primary beneficiary. The Company includes
the results of Watford Re in its consolidated financial
Redeemable noncontrolling interests
$
220,992
The following table summarizes Watford Re’s cash flow from
operating, investing and financing activities.
Year Ended December 31,
2017
2016
2018
Total cash provided by (used
for):
Operating activities
Investing activities
Financing activities
229,315
(285,281)
(2,406)
286,558
(467,418)
162,152
275,175
(105,695)
(195,647)
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table sets forth activity in the redeemable non-
controlling interests:
Balance, beginning of year
Accretion of preference share
issuance costs
2018
$ 205,922
December 31,
2017
$ 205,553
2016
$ 205,182
370
369
371
Balance, end of year
$ 206,292
$ 205,922
$ 205,553
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’ as summarized in the table below:
December 31,
2017
2018
2016
Amounts attributable to non-
redeemable noncontrolling interests
Dividends attributable to
redeemable noncontrolling interests
Net (income) loss attributable to
noncontrolling interests
$
48,507
$
7,913
$(113,091)
(18,357)
(18,344)
(18,349)
$
30,150
$ (10,431) $(131,440)
Bellemeade Re
The Company has entered into various aggregate excess of loss
mortgage reinsurance agreements with various special purpose
reinsurance companies domiciled in Bermuda (the Bellemeade
Agreements). At the time the Bellemeade Agreements were
entered into, the applicability of the accounting guidance that
addresses VIEs was evaluated. As a result of the evaluation of
the Bellemeade Agreements, the Company concluded that these
entities are VIEs. However, given that the ceding insurers do
not have the unilateral power to direct those activities that are
significant to their economic performance, the Company does
not consolidate such entities in its consolidated financial
statements.
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 December 31, 2018. 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.’
The following table sets forth activity in the non-redeemable
noncontrolling interests:
Balance, beginning of year
Amounts attributable to noncontrolling
interests
Other comprehensive (income) loss attributable
to noncontrolling interests
Balance, end of year
Redeemable noncontrolling interests
December 31,
2018
$ 843,411
2017
$ 851,854
(48,507)
(7,913)
(3,344)
(530)
$ 791,560
$ 843,411
The Company accounts for redeemable noncontrolling interests
in the mezzanine section of its consolidated balance sheet. Such
redeemable noncontrolling interests relate to the 9,065,200
cumulative redeemable preference shares (“Watford Preference
Shares”) issued in late March 2014 with a par value of $0.01
per share and a liquidation preference of $25.00 per share. The
Watford Preference Shares were issued at a discounted amount
of $24.50 per share. Holders of the Watford Preference Shares
will be entitled to receive, if declared by Watford Re’s board,
quarterly cash dividends on the last day of March, June,
September, and December. Dividends will accrue from the
closing date to June 30, 2019 at a fixed rate of 8.5% per annum.
From June 30, 2019 and subsequent, dividends will accrue
based on a floating rate equal to the 3 month U.S. dollar LIBOR
(with a 1% floor) plus a margin based on the difference between
the fixed rate and the 5 year mid swap rate to the floating rate
as set out on the Bloomberg Screen IRSB 18. The Watford
Preference Shares may be redeemed by Watford Re on or after
June 30, 2019 or at the option of the preferred shareholders at
any time on or after June 30, 2034. Because the redemption
features are not solely within the control of Watford Re, the
Company accounts for the redeemable noncontrolling interests
in the Watford Preference Shares in the mezzanine section of
its consolidated balance sheets. Preferred dividends on the
Watford Preference Shares, including the accretion of the
discount and issuance costs, was $19.6 million for 2018, 2017
and 2016. Preferred dividends, including the accretion of the
discount and issuance costs, are included in ‘amounts
attributable to noncontrolling interests’ in the Company’s
consolidated statements of income.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table presents total assets of the Bellemeade
entities, as well as the Company’s maximum exposure to loss
associated with these VIEs, calculated as the spread between
contractual payments and the value of the underlying notional
amount of VIE assets or liabilities.
Maximum Exposure to Loss
Total
VIE
Assets
On-
Balance
Sheet
Off-
Balance
Sheet
Total
December 31, 2018
Bellemeade 2015-1
Ltd. (Jul-15)
Bellemeade 2017-1
Ltd. (Oct-17)
Bellemeade 2018-1
Ltd. (Apr-18)
Bellemeade 2018-2
Ltd. (Aug-18)
Bellemeade 2018-3
Ltd. (Oct-18)
$
43,246
$
112
$
498
$
610
304,373
374,460
653,278
506,110
165
132
874
469
1,312
1,477
3,539
3,671
4,005
4,879
1,836
2,305
Total
$1,881,467
$
1,752
$
11,190
$ 12,942
December 31, 2017
Bellemeade 2015-1
Ltd. (Jul-15)
Bellemeade 2016-1
Ltd. (May-16)
Bellemeade 2017-1
Ltd. (Oct-17)
92,390
135,201
347,139
Total
$ 574,730
$
See Note 7, “Reinsurance.”
471
20
391
882
832
527
1,303
547
1,867
2,258
$
3,226
$ 4,108
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. Other Comprehensive Income (Loss)
The following table presents the changes in each component of AOCI, net of noncontrolling interests:
Year Ended December 31, 2018
Beginning balance
Cumulative effect of an accounting change
Other comprehensive income (loss) before reclassifications
Amounts reclassified from accumulated other comprehensive income
Net current period other comprehensive income (loss)
Ending balance
Year Ended December 31, 2017
Beginning balance
Other comprehensive income (loss) before reclassifications
Amounts reclassified from accumulated other comprehensive income
Net current period other comprehensive income (loss)
Ending balance
Year Ended December 31, 2016
Beginning balance
Other comprehensive income (loss) before reclassifications
Amounts reclassified from accumulated other comprehensive income
Net current period other comprehensive income (loss)
Ending balance
Unrealized
Appreciation on
Available-For-Sale
Investments
Foreign Currency
Translation
Adjustments
Total
$
$
$
$
$
$
$
157,400
(149,794)
(266,357)
144,573
(121,784)
(114,178) $
(27,641) $
252,904
(67,863)
185,041
157,400
$
$
50,085
(21,365)
(56,361)
(77,726)
(27,641) $
(39,356) $
—
(25,186)
—
(25,186)
(64,542) $
(86,900) $
47,544
—
47,544
(39,356) $
(66,587) $
(20,313)
—
(20,313)
(86,900) $
118,044
(149,794)
(291,543)
144,573
(146,970)
(178,720)
(114,541)
300,448
(67,863)
232,585
118,044
(16,502)
(41,678)
(56,361)
(98,039)
(114,541)
The following tables present details about amounts reclassified from accumulated other comprehensive income and the tax effects
allocated to each component of other comprehensive income (loss):
Details About
AOCI Components
Consolidated Statement of Income
Line Item That Includes
Reclassification
Amounts Reclassified from AOCI
Year Ended December 31,
2017
2016
2018
Unrealized appreciation on available-for-sale investments
Net realized gains
Other-than-temporary impairment losses
Total before tax
Income tax (expense) benefit
Net of tax
$
$
(153,822) $
82,542
$
(2,829)
(156,651)
12,078
(144,573) $
(7,138)
75,404
(7,541)
67,863
$
95,448
(30,794)
64,654
(8,293)
56,361
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Following are the related tax effects allocated to each component of other comprehensive income (loss):
Year Ended December 31, 2018
Unrealized appreciation (decline) in value of investments:
Unrealized holding gains (losses) arising during period
Portion of other-than-temporary impairment losses recognized in other comprehensive
income (loss)
Less reclassification of net realized gains (losses) included in net income
Foreign currency translation adjustments
Other comprehensive income (loss)
Year Ended December 31, 2017
Unrealized appreciation (decline) in value of investments:
Unrealized holding gains (losses) arising during period
Portion of other-than-temporary impairment losses recognized in other comprehensive
income (loss)
Less reclassification of net realized gains (losses) included in net income
Foreign currency translation adjustments
Other comprehensive income (loss)
Year Ended December 31, 2016
Unrealized appreciation (decline) in value of investments:
Unrealized holding gains (losses) arising during period
Before Tax
Amount
Tax Expense
(Benefit)
Net of Tax
Amount
$
(294,267)
$
(24,210)
$
(270,057)
—
(156,651)
(25,006)
—
(12,078)
(176)
(162,622)
$
(12,308)
$
—
(144,573)
(24,830)
(150,314)
266,559
$
13,655
$
252,904
—
75,404
47,549
238,704
$
—
7,541
535
6,649
$
—
67,863
47,014
232,055
(26,159)
$
(5,146)
$
(21,013)
$
$
$
$
Portion of other-than-temporary impairment losses recognized in other comprehensive
income (loss)
Less reclassification of net realized gains (losses) included in net income
Foreign currency translation adjustments
Other comprehensive income (loss)
(352)
64,654
(20,120)
—
8,293
261
$
(111,285)
$
(13,178)
$
(352)
56,361
(20,381)
(98,107)
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
13. Earnings Per Common Share
The calculation of basic earnings per common share is computed by dividing income available to Arch common shareholders by
the weighted average number of Common Shares and common share equivalents outstanding. The following table sets forth the
computation of basic and diluted earnings per common share:
Numerator:
Net income
Amounts attributable to noncontrolling interests
Net income available to Arch
Preferred dividends
Loss on redemption of preferred shares
Net income available to Arch common shareholders
Denominator:
Weighted average common shares outstanding
Series D preferred securities (1)
Weighted average common shares outstanding – basic
Effect of dilutive common share equivalents:
Nonvested restricted shares
Stock options (2)
Weighted average common shares and common share equivalents outstanding – diluted
Earnings per common share:
Basic
Diluted
Year Ended December 31,
2017
2018
2016
$
727,821
30,150
757,971
(41,645)
(2,710)
$
629,709
(10,431)
619,278
(46,041)
(6,735)
713,616
$
566,502
$
824,178
(131,440)
692,738
(28,070)
—
664,668
401,036,376
3,311,245
404,347,621
1,474,207
7,084,650
412,906,478
377,531,628
26,606,736
404,138,364
3,936,594
9,710,067
417,785,025
362,271,729
104,613
362,376,342
3,877,077
7,899,060
374,152,479
1.76
1.73
$
$
1.40
1.36
$
$
1.83
1.78
$
$
$
$
(1) The company has determined that, based on a review of the terms, features and rights of the Company’s non-voting common equivalent preferred shares
compared to the rights of the Company’s common shareholders, the underlying common shares that the convertible securities convert to were common
share equivalents at the time of their issuance.
(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 2018, 2017 and 2016, the number of stock
options excluded were 5,673,821, 2,603,451 and 2,168,187, respectively.
14. Income Taxes
Arch Capital is incorporated under the laws of Bermuda and,
under current Bermuda law, is not obligated to pay any taxes
in Bermuda based upon income or capital gains. The Company
has received a written undertaking from the Minister of Finance
in Bermuda under the Exempted Undertakings Tax Protection
Act 1966 that, in the event that any legislation is enacted in
Bermuda imposing any tax computed on profits, income, gain
or appreciation on any capital asset, or any tax in the nature of
estate duty or inheritance tax, such tax will not be applicable to
Arch Capital or any of its operations until March 31, 2035. This
undertaking does not, however, prevent the imposition of taxes
on any person ordinarily resident in Bermuda or any company
in respect of its ownership of real property or leasehold interests
in Bermuda.
Arch Capital and its non-U.S. subsidiaries will be subject to
U.S. federal income tax only to the extent that they derive U.S.
source income that is subject to U.S. withholding tax or income
that is effectively connected with the conduct of a trade or
business within the U.S. and is not exempt from U.S. tax under
an applicable income tax treaty with the U.S. Arch Capital and
its non-U.S. subsidiaries will be subject to a withholding tax on
dividends from U.S. investments and interest from certain U.S.
payors (subject to reduction by any applicable income tax
treaty). Arch Capital and its non-U.S. subsidiaries intend to
conduct their operations in a manner that will not cause them
to be treated as engaged in a trade or business in the United
States and, therefore, will not be required to pay U.S. federal
income taxes (other than U.S. excise taxes on insurance and
reinsurance premium and withholding taxes on dividends and
certain other U.S. source investment income). However,
because there is uncertainty as to the activities which constitute
being engaged in a trade or business within the United States,
there can be no assurances that the U.S. Internal Revenue
Service will not contend successfully that Arch Capital or its
non-U.S. subsidiaries are engaged in a trade or business in the
United States. If Arch Capital or any of its non-U.S. subsidiaries
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
were subject to U.S. income tax, Arch Capital’s shareholders’
equity and earnings could be materially adversely affected.
Arch Capital has subsidiaries and branches that operate in
various jurisdictions around the world that are subject to tax in
the jurisdictions in which they operate. The significant
jurisdictions in which Arch Capital’s subsidiaries and branches
are subject to tax are the United States, United Kingdom,
Ireland, Canada, Switzerland, Australia and Denmark.
The components of income taxes attributable to operations were
as follows:
Year Ended December 31,
2017
2018
2016
Current expense (benefit):
United States
Non-U.S.
Deferred expense (benefit):
United States
Non-U.S.
Income tax expense
$
$
73,078
12,785
85,863
19,544
8,544
28,088
113,951
$
$
(51,705)
5,969
(45,736)
169,093
4,211
173,304
127,568
$
$
40,300
10,445
50,745
(14,641)
(4,730)
(19,371)
31,374
The Company’s income or loss before income taxes was earned
in the following jurisdictions:
2018
Income (loss) Before Income Taxes:
Year Ended December 31,
2017
2016
Bermuda
United States
Other
Total
$
$
388,492
440,823
12,457
841,772
$
$
406,054
381,157
(29,934)
757,277
$
$
801,155
51,577
2,820
855,552
The expected tax provision computed on pre-tax income or loss
at the weighted average tax rate has been calculated as the sum
of the pre-tax income in each jurisdiction multiplied by that
jurisdiction’s applicable statutory tax rate. The 2018 applicable
statutory tax rates by jurisdiction were as follows: Bermuda
(0.0%), United States (21.0%), United Kingdom (19.0%),
Ireland (12.5%), Denmark (22.0%), Canada (26.5%), Gibraltar
(10.0%), Australia (30.0%), Hong Kong (16.5%) and the
Netherlands (20.0%). The United States rate was 35% in 2017
and 2016.
A reconciliation of the difference between the provision for
income taxes and the expected tax provision at the weighted
average tax rate follows:
Expected income tax
expense (benefit) computed
on pre-tax income
at weighted average income
tax rate
Addition (reduction) in
income tax expense
(benefit) resulting from:
Tax-exempt investment
income
Meals and entertainment
State taxes, net of U.S.
federal tax benefit
Foreign branch taxes
Prior year adjustment
Foreign exchange gains &
losses
Changes in applicable tax
rate
Dividend withholding
taxes
Change in valuation
allowance
Contingent consideration
Share based compensation
Other
Year Ended December 31,
2017
2018
2016
$
91,529
$
126,262
$
17,365
(4,790)
1,060
2,086
5,428
(2,522)
1,293
(13,330)
1,063
732
5,752
(559)
(572)
(128)
7,745
6,594
232
18,396
740
(5,356)
(379)
14,798
3,785
(18,733)
393
(8,830)
954
1,073
5,496
(4,756)
223
1,209
3,319
4,730
9,353
—
1,238
Income tax expense
(benefit)
$
113,951
$
127,568
$
31,374
The effect of a change in tax laws or rates on deferred taxes
assets and liabilities is recognized in income in the period in
which such change is enacted.
On December 22, 2017, the Tax Cuts Act was signed into law
by the President of the United States which significantly
changes the U.S. tax law in many way including a reduction of
the U.S. federal income tax rate from 35% to 21% effective
January 1, 2018. Also on December 22, 2017, the Securities
and Exchange Commission issued, Staff Accounting Bulletin
No. 118 (“SAB 118”) which provides guidance on accounting
for tax effects of the Tax Cuts Act. SAB 118 provided a
measurement period of up to one year from the enactment date
to complete the accounting. During 2018, the Company
finalized its accounting for the income tax impact of the Tax
Cuts Act resulting in a tax expense of $1.2 million primarily
attributable to the write down of temporary differences
identified following the filing of the Company’s 2017 corporate
tax return offset by AMT credits that are currently recoverable.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Deferred income tax assets and liabilities reflect temporary
differences based on enacted tax rates between the carrying
amounts of assets and liabilities for financial reporting and
income tax purposes. Significant components of the Company’s
deferred income tax assets and liabilities were as follows:
Deferred income tax assets:
Net operating loss
Uncrystallized losses
AMT credit carryforward
Discounting of net loss reserves
Deferred ceding commission
Net unearned premium reserve
Compensation liabilities
Foreign tax credit carryforward
Interest expense
Goodwill and intangible assets
Bad debt reserves
Net unrealized foreign exchange gains
Net unrealized decline of investments
Other, net
December 31,
2018
2017
$
24,089
$
33,723
7,960
2,652
43,130
—
68,305
20,492
9,116
1,387
17,127
5,626
949
13,453
3,418
9,132
12,327
33,659
6,934
47,682
20,234
6,610
3,815
3,688
5,073
464
1,602
1,628
186,571
(30,591)
155,980
Deferred tax assets before valuation allowance
217,704
Valuation allowance
Deferred tax assets net of valuation allowance
(44,659)
173,045
Deferred income tax liabilities:
Depreciation and amortization
Deposit accounting liability
Contingency reserve
Deferred policy acquisition costs
Other, net
Total deferred tax liabilities
Net deferred income tax assets
(2,559)
(2,292)
(2,333)
(2,392)
(112,852)
(110,632)
(32,105)
—
(735)
(1,061)
(150,543)
(116,418)
$
22,502
$
39,562
The Company provides a valuation allowance to reduce certain
deferred tax assets to an amount which management expects to
more likely than not be realized. As of December 31, 2018, the
Company’s valuation allowance was $44.7 million, compared
to $30.6 million at December 31, 2017. The valuation
allowance in both periods was primarily attributable to
valuation allowance on the Company’s U.K. Canadian and
Australian operations and certain other deferred tax assets
relating to loss carryforwards that have a limited use.
At December 31, 2018, the Company’s net operating loss
carryforwards and tax credits were as follows:
Operating Loss Carryforwards
United Kingdom
Ireland
Australia
Hong Kong
United States (1) (2)
Tax Credits
U.K. foreign tax credits
U.S. refundable AMT credits
Year Ended December 31,
2018
Expiration
$
59,500
14,000
16,000
12,800
24,400
No expiration
No expiration
No expiration
No expiration
2029 - 2038
9,116
2,652
No expiration
No expiration
(1) Includes $4.6 million net operating loss carryforwards from Watford Re.
(2) On January 30, 2014, the Company’s U.S. mortgage operations underwent
an ownership change for U.S. federal income tax purposes as a result of the
Company’s acquisition of the CMG Entities. As a result of this ownership
change, a limitation has been imposed upon the utilization of approximately
$9.6 million of the Company’s existing U.S. net operating loss carryforwards.
Utilization is limited to approximately $0.6 million per year in accordance with
Section 382 of the Internal Revenue Code of 1986 as amended (“the Code”).
The Company’s U.S. mortgage operations are eligible for a tax
deduction, subject to certain limitations, under Section 832(e)
of the Code for amounts required by state law or regulation to
be set aside in statutory contingency reserves. The deduction is
allowed only to the extent that the Company purchases non-
interest bearing U.S. Mortgage Guaranty Tax and Loss Bonds
(“T&L Bonds”) issued by the U.S. Treasury Department in an
amount equal to the tax benefit derived from deducting any
portion of the statutory contingency reserves. T&L Bonds are
reflected in ‘other assets’ on the Company’s balance sheet and
totaled approximately $182.7 million at December 31, 2018,
compared to $177.2 million at December 31, 2017.
Deferred income tax liabilities have not been accrued with
respect to the undistributed earnings of the Company's U.S.,
U.K. and Ireland subsidiaries as it is the Company’s intention
that all such earnings will be indefinitely reinvested. If the
earnings were to be distributed, as dividends or otherwise, such
amounts may be subject to withholding tax in the jurisdiction
of the paying entity. The Company no longer intends to
indefinitely reinvest earnings from the Company's Canada
subsidiary, however, no income or withholding taxes have been
accrued as the Canada subsidiary does not have positive
cumulative earnings and profits and therefore a distribution
from this particular subsidiary would not be subject to income
taxes or withholding taxes. Potential tax implications of
repatriation from the Company’s unremitted earnings that are
indefinitely reinvested are driven by facts at the time of
distribution. Therefore it is not practicable to estimate the
income tax liabilities that might be incurred if such earnings
were remitted. Distributions from the U.K. or Ireland would not
be subject to withholding tax and no deferred income tax
liability would need to be accrued.
The Company recognizes interest and penalties relating to
unrecognized tax benefits in the provision for income taxes. As
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
of December 31, 2018, the Company’s total unrecognized tax
benefits, including interest and penalties, were $2.0 million. If
recognized, the full amount of the unrecognized tax benefit
would generally decrease the current year annual effective tax
rate. A reconciliation of the beginning and ending amount of
unrecognized tax benefits is as follows:
December 31,
2018
2017
Balance at beginning of year
$
2,008
$
2,008
Additions based on tax positions related to the
current year
Additions for tax positions of prior years
Reductions for tax positions of prior years
Settlements
Balance at end of year
—
—
—
—
2,008
$
—
—
—
—
2,008
$
The Company or its subsidiaries or branches files income tax
returns in the U.S. federal jurisdiction and various state, local
and foreign jurisdictions.The following table details open tax
years that are potentially subject to examination by local tax
authorities, in the following major jurisdictions:
Jurisdiction
United States
United Kingdom
Ireland
Canada
Switzerland
Denmark
Tax Years
2015-2018
2017-2018
2014-2018
2014-2018
2017-2018
2015-2018
As of December 31, 2018, the Company’s current income tax
recoverable (included in “Other assets”) was $21.2 million.
15. Transactions with Related Parties
Kewsong Lee, a director of Arch Capital until November 2,
2017, resigned from Arch Capital’s Board of Directors because
of the expansion of his duties at The Carlyle Group (“Carlyle”)
following his promotion to co-CEO effective January 1, 2018.
As part of its investment philosophy, the Company invests a
portion of its investment portfolio in alternative investment
funds. As of December 31, 2017, the total value of the
Company’s investments in funds or other investments managed
by Carlyle was approximately $293.0 million, and the Company
had aggregate unfunded commitments to funds managed by
Carlyle of $468.8 million. The Company may make additional
commitments to funds managed by Carlyle from time to time.
During 2017 and 2016, the Company made aggregate capital
contributions to funds managed by Carlyle of $131.8 million
and $62.1 million, respectively. During 2017 and 2016, the
Company received aggregate cash distributions from funds
managed by Carlyle of $55.6 million and $21.5 million,
respectively.
Certain directors and executive officers of the Company own
common and preference shares of Watford Re. See note 11,
“Variable Interest Entity and Noncontrolling Interests,” for
information about Watford Re.
16. Commitments and Contingencies
Concentrations of Credit Risk
The creditworthiness of a counterparty is evaluated by the
Company, taking into account credit ratings assigned by
independent agencies. The credit approval process involves an
the
assessment of
counterparty, country and industry credit exposure limits.
Collateral may be required, at the discretion of the Company,
on certain transactions based on the creditworthiness of the
counterparty.
including, among others,
factors,
losses and
The areas where significant concentrations of credit risk may
exist include unpaid losses and loss adjustment expenses
recoverable, contractholder receivables, ceded unearned
loss adjustment expenses
premiums, paid
recoverable net of reinsurance balances payable, investments
and cash and cash equivalent balances. A credit exposure exists
with respect to reinsurance recoverables as they may become
uncollectible. The Company manages its credit risk in its
reinsurance relationships by transacting with reinsurers that it
considers financially sound and, if necessary, the Company may
hold collateral in the form of funds, trust accounts and/or
irrevocable letters of credit. This collateral can be drawn on for
amounts that remain unpaid beyond specified time periods on
an individual reinsurer basis. In addition, certain insurance
policies written by the Company’s insurance operations feature
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remaining amount of contingent consideration payments is
$68.2 million over the remaining earn-out period. To the extent
that the adjusted book value of the CMG Entities drops below
the cumulative amount paid by the Company, no additional
payments would be due.
Leases and Purchase Obligations
At December 31, 2018,
rental
the
commitments, exclusive of escalation clauses and maintenance
costs and net of rental income, for all of the Company’s
operating leases are as follows:
future minimum
2019
2020
2021
2022
2023
2024 and thereafter
Total
$
$
31,088
30,491
29,351
26,068
21,408
54,745
193,151
All of these leases are for the rental of office space, with
expiration terms that range from 2019 to 2030. Rental expense,
net of income from subleases, was approximately $27.6 million,
$31.1 million and $24.2 million for 2018, 2017 and 2016,
respectively.
At December 31, 2018, the Company has entered into capital
lease agreements. The future lease payments for the Company’s
capital leases are expected to be $6.2 million, $4.8 million and
$2.1 million for 2019, 2020 and 2021, respectively.
The Company has also entered into certain agreements which
commit the Company to purchase goods or services, primarily
related to software and computerized systems. Such purchase
obligations were approximately $39.5 million and $29.7
million at December 31, 2018 and 2017, respectively.
Employment and Other Arrangements
At December 31, 2018, the Company has entered into
employment agreements with certain of its executive officers.
Such employment arrangements provide for compensation in
the form of base salary, annual bonus, share-based awards,
participation in the Company’s employee benefit programs and
the reimbursements of expenses.
large deductibles, primarily in its construction and national
accounts lines of business. Under such contracts, the Company
is obligated to pay the claimant for the full amount of the claim.
The Company is subsequently reimbursed by the policyholder
for the deductible amount. These amounts are included on a
gross basis in the consolidated balance sheet in contractholder
payables and contractholder receivables, respectively. In the
event that the Company is unable to collect from the
policyholder, the Company would be liable for such defaulted
amounts. Collateral, primarily in the form of letters of credit,
cash and trusts, is obtained from the policyholder to mitigate
the Company’s credit risk. In the instances where the company
receives collateral in the form of cash, the Company records a
related liability in “Collateral held for insured obligations.”
In addition, the Company underwrites a significant amount of
its business through brokers and a credit risk exists should any
of these brokers be unable to fulfill their contractual obligations
with respect to the payments of insurance and reinsurance
balances owed
table
summarizes the percentage of the Company’s gross premiums
written generated from or placed by the largest brokers:
the Company. The following
to
Broker
Aon Corporation and its
subsidiaries
Marsh & McLennan Companies
and its subsidiaries
Year Ended December 31,
2018
2017
2016
11.4%
11.3%
14.4%
9.3%
10.7%
13.5%
No other broker and no one insured or reinsured accounted for
more than 10% of gross premiums written for 2018, 2017 and
2016.
The Company’s available for sale investment portfolio is
managed in accordance with guidelines that have been tailored
to meet specific investment strategies, including standards of
diversification, which limit the allowable holdings of any single
issue. There were no investments in any entity in excess of 10%
of the Company’s shareholders’ equity at December 31, 2018
other than investments issued or guaranteed by the United States
government or its agencies.
Investment Commitments
The Company’s investment commitments, which are primarily
related to agreements entered into by the Company to invest in
funds and separately managed accounts when called upon, were
approximately $1.77 billion and $1.70 billion at December 31,
2018 and 2017, respectively.
Contingent Consideration Liability
Pursuant to the Company’s 2014 acquisition of the CMG
Entities, the Company made a contingent consideration
payment of $71.7 million in April 2017. The maximum
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
17. Debt and Financing Arrangements
The Company’s senior notes payable at December 31, 2018 and
2017 were as follows:
2034 notes (1)
2043 notes (2)
2026 notes (3)
2046 notes (4)
Interest
(Fixed)
7.350%
5.144%
4.011%
5.031%
Principal
Amount
300,000
500,000
500,000
450,000
$ 1,750,000
Carrying Amount at
December 31,
2018
297,150
494,723
496,417
445,238
$ 1,733,528
2017
297,053
494,621
496,043
445,167
$ 1,732,884
(1) Senior notes of Arch Capital issued on May 4, 2004 and due May 1, 2034
(“2034 notes”).
(2) Senior notes of Arch-U.S., a wholly-owned subsidiary of Arch Capital,
issued on December 13, 2013 and due November 1, 2043 (“2043 notes”), fully
and unconditionally guaranteed by Arch Capital.
(3) Senior notes of Arch Capital Finance LLC (“Arch Finance”), a wholly-
owned finance subsidiary of Arch Capital, issued on December 8, 2016 and
due December 15, 2026 (“2026 notes”), fully and unconditionally guaranteed
by Arch Capital.
(4) Senior notes of Arch Finance issued on December 8, 2016 and due December
15, 2046 (“2046 notes”), fully and unconditionally guaranteed by Arch Capital.
The 2034 notes are Arch Capital’s senior unsecured obligations
and rank equally with all of its existing and future senior
unsecured indebtedness. Interest payments on the 2034 notes
are due on May 1st and November 1st of each year. Arch Capital
may redeem the 2034 notes at any time and from time to time,
in whole or in part, at a “make-whole” redemption price.
The 2043 notes are unsecured and unsubordinated obligations
of Arch-U.S. and Arch Capital, respectively, and rank equally
and ratably with the other unsecured and unsubordinated
indebtedness of Arch-U.S. and Arch Capital, respectively.
Interest payments on the 2043 notes are due on May 1st and
November 1st of each year. Arch-U.S. may redeem the 2043
notes at any time and from time to time, in whole or in part, at
a “make-whole” redemption price.
ratably with
The 2026 notes are unsecured and unsubordinated obligations
of Arch Finance and Arch Capital, respectively, and rank
the other unsecured and
equally and
unsubordinated indebtedness of Arch Finance and Arch Capital,
respectively. Interest payments on the 2026 notes are due on
June 15th and December 15th of each year. Arch Finance may
redeem the 2026 notes at any time and from time to time, in
whole or in part, at a “make-whole” redemption price.
The 2046 notes are unsecured and unsubordinated obligations
of Arch Finance and Arch Capital, respectively, and rank
the other unsecured and
equally and
unsubordinated indebtedness of Arch Finance and Arch Capital,
respectively. Interest payments on the 2046 notes are due on
June 15th and December 15th of each year. Arch Finance may
ratably with
redeem the 2046 notes at any time and from time to time, in
whole or in part, at a “make-whole” redemption price.
Letter of Credit and Revolving Credit Facilities
In the normal course of its operations, the Company enters into
agreements with financial institutions to obtain secured and
unsecured credit facilities.
On October 26, 2016, Arch Capital and certain of its subsidiaries
entered into an $850.0 million five-year credit facility (the
“Credit Facility”) with a syndication of lenders. The Credit
Facility consists of a $350.0 million secured facility for letters
of credit (the “Secured Facility”) and a $500.0 million
unsecured facility for revolving loans and letters of credit (the
“Unsecured Facility”). Obligations of each borrower under the
Secured Facility for letters of credit are secured by cash and
eligible securities of such borrower held in collateral
accounts. Subject to the receipt of commitments, the Secured
Facility may be increased by up to an aggregate of $350.0
million, and the Unsecured Facility may be increased to an
amount not to exceed $750.0 million. Arch Capital has a one-
time option to convert any or all outstanding revolving loans
of Arch Capital and/or Arch-U.S. to term loans with the same
terms as the revolving loans except that any prepayments may
not be re-borrowed. Arch-U.S. guarantees the obligations of
Arch Capital, and Arch Capital guarantees the obligations of
Arch-U.S. Borrowings of revolving loans may be made at a
variable rate based on LIBOR or an alternative base rate at the
option of Arch Capital. Secured letters of credit are available
for issuance on behalf of Arch Capital insurance and
reinsurance subsidiaries. The Credit Facility is structured such
that each party that requests a letter of credit or borrowing does
so only for itself and for only its own obligations.
The Credit Facility contains certain restrictive covenants
customary for facilities of this type, including restrictions on
indebtedness, consolidated tangible net worth, minimum
shareholders’ equity levels and minimum financial strength
ratings. Arch Capital and its subsidiaries which are party to the
agreement were in compliance with all covenants contained
therein at December 31, 2018.
Commitments under the Credit Facility will expire on October
26, 2021, and all loans then outstanding must be repaid. Letters
of credit issued under the Unsecured Facility will not have an
expiration date later than October 26, 2022.
Under the $350.0 million secured letter of credit facility, Arch
Capital’s subsidiaries had $174.8 million of letters of credit
outstanding and remaining capacity of $175.2 million at
December 31, 2018. In addition, certain of Arch Capital’s
subsidiaries had outstanding letters of credit of $167.5 million,
which were issued in the normal course of business. When
issued, these letters of credit are secured by a portion of the
investment portfolio. At December 31, 2018, these letters of
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credit were secured by investments with a fair value of $362.0
million.
18. Goodwill and Intangible Assets
Watford Re has access to a $100 million letter of credit facility
expiring on May 16, 2019 and an $800 million secured credit
facility expiring on November 30, 2021, that provides for
borrowings and the issuance of letters of credit not to exceed
$400 million. Borrowings of revolving loans may be made by
Watford Re at a variable rate based on LIBOR or an alternative
base rate at the option of Watford Re. At December 31, 2018,
Watford Re had $68.9 million in outstanding letters of credit
under the two facilities and $455.7 million of borrowings
outstanding under the secured credit facility, backed by Watford
Re’s investment portfolio. Watford Re was in compliance with
all covenants contained in both of its credit facilities at
December 31, 2018. 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 the reinsurance
transactions.
The Company’s outstanding revolving credit agreement
borrowings were as follows:
Arch-U.S.
Watford Re
Total revolving credit agreement
borrowings
Year Ended December 31,
2018
2017
— $
455,682
375,000
441,132
455,682
$
816,132
$
$
The following table shows an analysis of goodwill and
intangible assets:
Intangible
assets
(indefinite
life)
Intangible
assets
(finite life)
Total
Goodwill
$ 204,022
$
68,174
$ 509,357
$ 781,553
806
—
(6,592)
198,236
51,476
—
—
—
—
—
2,300
3,106
(125,778)
(125,778)
322
(6,270)
68,174
386,201
652,611
—
—
43,000
94,476
(105,670)
(105,670)
(6,300)
—
(6,300)
(92)
—
(105)
(197)
$ 249,620
$
61,874
$ 323,426
$ 634,920
$ 256,668
$
61,874
$ 662,101
$ 980,643
—
—
(337,190)
(337,190)
(7,048)
—
(1,485)
(8,533)
$ 249,620
$
61,874
$ 323,426
$ 634,920
Net balance at
Dec. 31, 2016
Acquisitions
Amortization
Foreign currency
movements and
other adjustments
Net balance at
Dec. 31, 2017
Acquisitions
Amortization
Impairment (1)
Foreign currency
movements and
other adjustments
Net balance at
Dec. 31, 2018
Gross balance at
Dec. 31, 2018
Accumulated
amortization
Foreign currency
movements and
other adjustments
Net balance at
Dec. 31, 2018
(1) The impairment to the indefinite-lived intangible assets during the year
ended December 31, 2018 of $6.3 million related to insurance licenses from
the acquisition of UGC that were forfeited as a result of the merger of two
subsidiaries. The impairment was recorded in “corporate expenses” in the
consolidated statement of income.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table presents the components of goodwill and
intangible assets:
19. Shareholders’ Equity
Gross
Balance
Accumulated
Amortization
Foreign
Currency
Translation
Adjustment
and Other
Net
Balance
Authorized and Issued
The authorized share capital of Arch Capital consists of 1.8
billion Common Shares, par value of $0.0011 per share, and 50
million Preferred Shares, par value of $0.01 per share.
Dec. 31, 2018
Acquired
insurance
contracts
Operating
platform
Distribution
relationships
Goodwill
Insurance
licenses
Unfavorable
service
contract
Other
Total
Dec. 31, 2017
Acquired
insurance
contracts
Operating
platform
Distribution
relationships
Goodwill
Insurance
licenses
Unfavorable
service
contract
Other
Total
$ 435,067
$
(271,981)
$
(150)
$ 162,936
47,400
(35,402)
—
11,998
186,611
256,668
61,874
(36,718)
—
—
(1,335)
(7,048)
148,558
249,620
—
61,874
(9,533)
2,556
7,949
(1,038)
—
—
(1,584)
1,518
$ 980,643
$
(337,190)
$
(8,533)
$ 634,920
$ 435,067
$
(182,947)
$
(150)
$ 251,970
44,900
(26,422)
—
18,478
147,611
205,192
68,174
(28,321)
—
—
(1,230)
(6,956)
118,060
198,236
—
68,174
(9,533)
1,056
6,997
(827)
—
—
(2,536)
229
$ 892,467
$
(231,520)
$
(8,336)
$ 652,611
The estimated remaining amortization expense for the
Company’s intangible assets with finite lives is as follows:
2019
2020
2021
2022
2023
2024 and thereafter
Total
$
$
77,529
49,689
33,043
27,149
24,908
111,108
323,426
Common Shares
The following table presents a roll-forward of changes in Arch
Capital’s issued and outstanding Common Shares:
Common Shares:
Shares issued and
outstanding, beginning
of year
Shares issued (1)
Conversion of Series D
preferred shares (2)
Restricted shares
issued, net of
cancellations
Shares issued and
outstanding, end of year
Common shares in
treasury, end of year
Shares issued and
outstanding, end of year
Year Ended December 31,
2017
2018
2016
549,872,226
523,932,303
519,323,547
2,757,506
3,388,344
3,447,336
17,022,600
21,265,860
—
1,084,951
1,285,719
1,161,420
570,737,283
549,872,226
523,932,303
(168,282,449)
(156,938,409)
(155,569,752)
402,454,834
392,933,817
368,362,551
(1)
(2)
Includes shares issued from the exercise of stock options and stock
appreciation rights, and shares issued from the employee share purchase
plan.
Such shares represent common shares that were issued upon conversion
of the non-voting common equivalent preference shares issued in
connection with the AIG acquisition.
Three-For-One Common Share Split
In May 2018, shareholders approved a proposal to amend the
memorandum of association by sub-dividing the authorized
common shares of Arch Capital to effect a three-for-one split
of Arch Capital’s common shares. The share split changed the
Company’s authorized common shares to 1.8 billion common
shares (600 million previously), with a par value of $.0011 per
share ($.0033 previously). Information pertaining to the
composition of the Company’s shareholders’ equity accounts,
shares and earnings per share has been retroactively restated in
the accompanying financial statements and notes to the
consolidated financial statements to reflect the share split.
The estimated remaining useful lives of these assets range from
one to eighteen years at December 31, 2018.
Share Repurchase Program
Other than the impairment described above, the Company’s
annual impairment reviews for goodwill and intangible assets
did not result in the recognition of impairment losses for 2018,
2017 and 2016.
The board of directors of Arch Capital has authorized the
investment in Arch Capital’s common shares through a share
repurchase program. At December 31, 2018, approximately
$163.7 million of share repurchases were available under the
program. Repurchases under the program may be effected from
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
time to time in open market or privately negotiated transactions
through December 31, 2019. 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.
Repurchases of Arch Capital’s common shares in connection
with the share repurchase plan and other share-based
transactions were held in the treasury under the cost method,
and the cost of the common shares acquired is included in
‘Common shares held in treasury, at cost.’ At December 31,
2018, Arch Capital held 168.3 million shares for an aggregate
cost of $2.38 billion in treasury, at cost.
The Company’s repurchases under the share repurchase
program were as follows:
Year Ended December 31,
2017
2018
2016
Aggregate cost of shares
repurchased
$
282,762
$
— $
75,256
Shares repurchased
10,559,850
—
3,420,411
Average price per share
repurchased
$
26.78
$
— $
22.00
Since the inception of the share repurchase program through
December 31, 2018, Arch Capital has
repurchased
approximately 386.2 million common shares for an aggregate
purchase price of $3.97 billion.
Convertible Non-Voting Common Equivalent Preferred
Shares
On December 31, 2016, the Company completed the acquisition
of all of the outstanding shares of capital stock of UGC. Based
upon a formula set forth in the Stock Purchase Agreement, AIG
received 1,276,282 of Arch Capital’s Series D convertible non-
voting common equivalent preferred shares (“Series D
Preferred Shares”). Each Series D Preferred Share converts to
10 shares of Arch Capital fully paid non-assessable common
stock.
The Company determined, based on a review of the terms
features and rights of the series D preferred shares compared
to the rights of the Company’s common shareholders, the
underlying 38,288,460 common shares (split adjusted) that the
convertible securities convert
to were common share
equivalents at the time of their issuance.
In June 2017, Arch Capital completed an underwritten public
secondary offering of 21,265,860 common shares (split
adjusted) by AIG following transfer of 708,862 Series D
Preferred Shares. In March 2018, Arch Capital completed an
underwritten public secondary offering of 17,022,600 common
shares (split adjusted) by AIG following transfer of 567,420
Series D Preferred Shares. Proceeds from the sale of common
shares pursuant to the public offering were received by AIG.
At December 31, 2018, no Series D Preferred Shares were
outstanding.
Series F Preferred Shares
In August 2017 and November 2017, Arch Capital completed
combined $330 million of underwritten public offerings ($230
million in August 2017 and $100 million in November 2017)
of 13.2 million depositary shares (the “Series F Depositary
Shares”), each of which represents a 1/1,000th interest in a share
of its 5.45% Non-Cumulative Preferred Shares, Series F, have
a $0.01 par value and $25,000 liquidation preference per share
(equivalent to $25 liquidation preference per Series F
Depositary Share) (the “Series F Preferred Shares”). Each
Series F Depositary Share, evidenced by a depositary receipt,
entitles the holder, through the depositary, to a proportional
fractional interest in all rights and preferences of the Series F
Preferred Shares represented thereby (including any dividend,
liquidation, redemption and voting rights).
Holders of Series F Preferred Shares will be entitled to receive
dividend payments only when, as and if declared by our board
of directors or a duly authorized committee of the board. Any
such dividends will be payable from, and including, the date of
original issue on a noncumulative basis, quarterly in arrears on
the last day of March, June, September and December of each
year, at an annual rate of 5.45%. Dividends on the Series F
Preferred Shares are not cumulative. The Company will be
restricted from paying dividends on or repurchasing its common
shares unless certain dividend payments are made on the Series
F Preferred Shares.
Except in specified circumstances relating to certain tax or
corporate events, the Series F Preferred Shares are not
redeemable prior to August 17, 2022 (the fifth anniversary of
the issue date). On and after that date, the Series F Preferred
Shares will be redeemable at the Company’s option, in whole
or in part, at a redemption price of $25,000 per share of the
Series F Preferred Shares (equivalent to $25 per depositary
share), plus any declared and unpaid dividends, without
accumulation of any undeclared dividends to, but excluding,
the redemption date. The Series F Depositary Shares will be
redeemed if and to the extent the related Series F Preferred
Shares are redeemed by the Company. Neither the Series F
Depositary Shares nor the Series F Preferred Shares have a
stated maturity, nor will they be subject to any sinking fund or
mandatory redemption. The Series F Preferred Shares are not
convertible into any other securities. The Series F Preferred
Shares will not have voting rights, except under limited
circumstances. The net proceeds from the Series F Preferred
Share offerings were used to redeem the Company’s
outstanding 6.75% Series C Non-Cumulative Preferred Shares.
Series E Preferred Shares
On September 29, 2016, Arch Capital completed a $450 million
underwritten public offering of 18.0 million depositary shares
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(the “Series E Depositary Shares”), each of which represents a
1/1,000th interest in a share of its 5.25% Non-Cumulative
Preferred Shares, Series E, have a $0.01 par value and $25,000
liquidation preference per share (equivalent to $25 liquidation
preference per Series E Depositary Share) (the “Series E
Preferred Shares”). Each Series E Depositary Share, evidenced
by a depositary receipt, entitles the holder, through the
depositary, to a proportional fractional interest in all rights and
preferences of the Series E Preferred Shares represented thereby
(including any dividend, liquidation, redemption and voting
rights).
Holders of Series E Preferred Shares will be entitled to receive
dividend payments only when, as and if declared by our board
of directors or a duly authorized committee of the board. Any
such dividends will be payable from, and including, the date of
original issue on a non-cumulative basis, quarterly in arrears
on the last day of March, June, September and December of
each year, at an annual rate of 5.25%. Dividends on the Series
E Preferred Shares are not cumulative. The Company will be
restricted from paying dividends on or repurchasing its common
shares unless certain dividend payments are made on the Series
E preferred shares.
Except in specified circumstances relating to certain tax or
corporate events, the Series E Preferred Shares are not
redeemable prior to September 29, 2021 (the fifth anniversary
of the issue date). On and after that date, the Series E Preferred
Shares will be redeemable at the Company’s option, in whole
or in part, at a redemption price of $25,000 per share of the
Series E Preferred Shares (equivalent to $25 per Series E
Depositary Share), plus any declared and unpaid dividends,
without accumulation of any undeclared dividends to, but
excluding, the redemption date. The Series E Depositary Shares
will be redeemed if and to the extent the related Series E
Preferred Shares are redeemed by the Company. Neither the
Series E Depositary Shares nor the Series E Preferred Shares
have a stated maturity, nor will they be subject to any sinking
fund or mandatory redemption. The Series E Preferred Shares
are not convertible into any other securities. The Series E
Preferred Shares will not have voting rights, except under
limited circumstances.
Series C Preferred Shares
On January 2, 2018, Arch Capital redeemed all outstanding
6.75% Series C non-cumulative preferred shares. The preferred
shares were redeemed at a redemption price equal to $25 per
share, plus all declared and unpaid dividends to (but excluding)
the redemption date. In accordance with GAAP, following the
redemption, original issuance costs related to such shares have
been removed from additional paid-in capital and recorded as
a “loss on redemption of preferred shares.” Such adjustment
had no impact on total shareholders’ equity or cash flows.
20. Share-Based Compensation
Long Term Incentive and Share Award Plans
to
provide
The Company utilizes share-based compensation plans for
officers, other employees and directors of Arch Capital and its
subsidiaries
compensation
opportunities, to encourage long-term service, to recognize
individual contributions and
reward achievement of
performance goals and to promote the creation of long-term
value for shareholders by aligning the interests of such persons
with those of shareholders.
competitive
The 2018 Long-Term Incentive and Share Award Plan (the
“2018 Plan”) became effective as of May 9, 2018 following
approval by shareholders of the Company. The 2018 Plan
provides for the issuance of restricted stock units, performance
units, restricted shares, performance shares, stock options and
stock appreciation rights and other equity-based awards to our
employees and directors. The 2018 Plan authorizes the issuance
of 34,500,000 common shares and will terminate as to future
awards on February 28, 2028. At December 31, 2018,
32,890,632 shares are available for future issuance.
The 2015 Long Term Incentive and Share Award Plan (the
(“2015 Plan”) authorizes the issuance of 12,900,000 common
shares and became effective as of May 7, 2015 following
approval by shareholders of the Company. The 2015 Plan
provides for the issuance of share-based awards to our
employees and directors and will terminate as to future awards
on February 26, 2025. At December 31, 2018, 251,820 shares
are available for future issuance.
The 2012 Long Term Incentive and Share Award Plan (the
“2012 Plan”) became effective as of May 9, 2012 following
approval by shareholders of the Company. The 2012 Plan
authorizes the issuance of 22,301,772 common shares and will
terminate as to future awards on February 28, 2022. At
December 31, 2018, 389,406 shares are available for grant
under the 2012 Plan.
Upon shareholder approval on May 6, 2016, the Amended and
Restated Arch Capital Group Ltd. 2007 Employee Share
Purchase Plan (the “ESPP”) became effective and a total of
4,689,777 common shares were reserved for issuance. The
purpose of the ESPP is to give employees of Arch Capital and
its subsidiaries an opportunity to purchase common shares
through payroll deductions, thereby encouraging employees to
share in the economic growth and success of Arch Capital and
its subsidiaries. The ESPP is designed to qualify as an
“employee share purchase plan” under Section 423 of the Code.
At December 31, 2018, approximately 3,281,686 shares remain
available for issuance.
ARCH CAPITAL
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Stock Options and Stock Appreciation Rights
Restricted Common Shares and Restricted Units
The Company generally issues stock options and SARs to
eligible employees, with exercise prices equal to the fair market
values of the Company’s Common Shares on the grant dates.
Such grants generally vest over a three year period with one-
third vesting on the first, second and third anniversaries of the
grant date.
The Company also issues restricted share and unit awards to
eligible employees and directors, for which the fair value is
equal to the fair market values of the Company’s Common
Shares on the grant dates. Restricted share and unit awards
generally vest over a three year period with one-third vesting
on the first, second and third anniversaries of the grant date.
The grant date fair value is determined using the Black-Scholes
option valuation model. The expected life assumption was
based on an expected term analysis, which incorporated the
Company’s historical exercise experience. Expected volatility
is based on the Company’s daily historical trading data of its
common shares. The table below summarizes the assumptions
used.
Dividend yield
Expected volatility
Risk free interest rate
Expected option life
Year Ended December 31,
2017
2018
2016
— %
21.3%
2.8%
6.0 years
— %
21.3%
2.0%
6.0 years
— %
21.7%
1.4%
6.0 years
A summary of stock option and SAR activity under the
Company’s Long Term Incentive and Share Award Plans during
2018 is presented below:
Year Ended December 31, 2018
Number of
Options /
SARs
Weighted
Average
Exercise
Price
Weighted
Average
Contractual
Term
Aggregate
Intrinsic
Value
Outstanding,
beginning of
year
Granted
19,770,174
3,158,715
Exercised
(2,649,229)
Forfeited or
expired
Outstanding,
end of year
Exercisable,
end of year
(203,067)
20,076,593
16,162,208
$
$
$
$
$
$
17.22
27.22
11.99
28.68
19.37
17.29
5.44
$ 161,666
4.59
$ 160,363
The aggregate intrinsic value of stock options and SARs
exercised represents the difference between the exercise price
of the stock options and SARs and the closing market price of
the Company’s common shares on the exercise dates. During
2018, the Company received proceeds of $6.6 million from the
exercise of stock options and recognized a tax benefit of $4.9
million from the exercise of stock options and SARs.
A summary of restricted share and restricted unit activity under
the Company’s Long Term Incentive and Share Award Plans
for 2018 is presented below:
Unvested Shares:
Unvested balance, beginning of year
Granted
Vested
Forfeited
Restricted
Common
Shares
Restricted
Unit
Awards
2,517,009
484,940
(1,269,057)
(113,607)
456,477
1,078,347
(223,929)
(56,337)
Unvested balance, end of year
1,619,285
1,254,558
Weighted Average Grant Date Fair
Value:
Unvested balance, beginning of year
Granted
Vested
Forfeited
Unvested balance, end of year
$
$
$
$
$
27.76
26.76
25.89
28.56
28.88
$
$
$
$
$
28.94
26.90
27.04
27.78
27.58
The following table presents the weighted average grant date
fair value of restricted shares and restricted unit awards granted
and the aggregate fair value of restricted shares and unit awards
vesting in each year.
Year Ended December 31,
2017
2016
2018
Restricted shares and restricted
unit awards granted
Weighted average grant date
fair value
Aggregate fair value of vested
restricted shares and units
awards
$
$
1,563,287
1,747,176
1,442,940
26.86
$
32.02
39,898
$ 133,848
$
$
23.91
45,206
The aggregate intrinsic value of restricted units outstanding at
December 31, 2018 was $34.6 million, and the aggregate
intrinsic value of restricted units vested and deferred was $1.1
million.
Year Ended December 31,
2017
2016
2018
Weighted average grant date
fair value
Aggregate intrinsic value of
Options/SARs exercised
$
$
7.50
43,468
$
$
8.15
64,173
$
$
5.71
59,617
ARCH CAPITAL
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Performance Awards
Share-Based Compensation Expense
The Company also issues performance share and unit awards
(“performance awards”) to eligible employees, which are
earned based on the achievement of pre-established threshold,
target and maximum goals over three-year performance
periods. Final payouts depend on the level of achievement along
with each employees continued service through the vest date.
The grant date fair value of the performance awards is measured
using a Monte Carlo simulation model, which incorporated the
assumptions summarized in the table below. Expected volatility
is based on the Company’s daily historical trading data of its
common shares. The cumulative compensation expense
recognized and unrecognized as of any reporting period date
represents the adjusted estimate of performance shares and units
that will ultimately be awarded, valued at their original grant
date fair values.
Year Ended December 31,
2017
2018
2016
Expected volatility
Risk free interest rate
16.2%
2.6%
—%
—%
—%
—%
Unvested Shares:
Unvested balance, beginning of
year
Granted
Vested
Forfeited
Unvested balance, end of year
Weighted Average Grant Date
Fair Value:
Unvested balance, beginning of
year
Granted
Vested
Forfeited
Unvested balance, end of year
Performance
Shares
Performance
Units
—
730,520
—
(15,192)
715,328
$
$
$
$
$
— $
24.77
$
— $
24.65
24.77
$
$
—
12,993
—
0
12,993
—
24.71
—
0.00
24.71
The following table presents the weighted average grant date
fair values of performance awards granted.
The following tables present pre-tax and after-tax share-based
compensation expense recognized as well as the unrecognized
compensation cost associated with unvested awards and the
weighted average period over which it is expected to be
recognized.
Year Ended December 31,
2017
2016
2018
Pre-Tax
Stock options and SARs
Restricted share and unit awards
Performance awards
ESPP
Total
After-Tax
Stock options and SARs
Restricted share and unit awards
Performance awards
ESPP
Total
$
$
$
$
16,272
34,025
4,414
1,224
55,935
14,894
29,044
4,127
1,114
49,179
$
$
$
$
18,536
46,884
—
2,443
67,863
16,219
37,708
—
2,171
56,098
$
$
$
$
14,095
40,398
—
2,089
56,582
11,885
31,660
—
1,861
45,406
December 31, 2018
Restricted
Common
Shares and
Units
Performance
Common
Shares and
Units
Stock
Options and
SARs
$
16,478
$
42,979
$
4,768
1.57
1.44
1.43
Unrecognized
compensation cost related
to unvested awards
Weighted average
recognition period (years)
21. Retirement Plans
For purposes of providing employees with retirement benefits,
the Company maintains defined contribution retirement plans.
Contributions are based on
the participants’ eligible
compensation. For 2018, 2017 and 2016, the Company
expensed $40.8 million, $40.7 million and $30.6 million,
respectively, related to these retirement plans.
22. Legal Proceedings
Performance awards
Weighted average grant date
fair value
Year Ended December 31,
2017
2016
2018
743,513
—
$
24.77
$
— $
The Company, in common with the insurance industry in
general, is subject to litigation and arbitration in the normal
course of its business. As of December 31, 2018, the Company
was not a party to any litigation or arbitration which is expected
by management to have a material adverse effect on the
Company’s results of operations and financial condition and
liquidity.
—
—
The issuance of share-based awards and amortization thereon
has no effect on the Company’s consolidated shareholders’
equity.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
23. Statutory Information
The statutory net income (loss) for the Company’s principal
operating subsidiaries for 2018, 2017 and 2016 was as follows:
The Company’s insurance and reinsurance subsidiaries are
subject to insurance and/or reinsurance laws and regulations in
the jurisdictions in which they operate. These regulations
include certain restrictions on the amount of dividends or other
distributions available to shareholders without prior approval
of the insurance regulatory authorities.
The actual and required statutory capital and surplus for the
Company’s principal operating subsidiaries at December 31,
2018 and 2017:
Statutory net income
(loss):
Bermuda
Ireland
United States
United Kingdom
Canada
Bermuda
Year Ended December 31,
2017
2018
2016
$
919,554
$
881,665
$
886,492
29,223
292,831
(18,467)
2,525
(14,438)
500,412
(33,257)
158
26,935
67,826
(7,512)
621
Actual capital and surplus (1):
Bermuda
Ireland
United States
United Kingdom
Canada
Required capital and surplus:
Bermuda
Ireland
United States
United Kingdom
Canada
December 31,
2018
2017
$ 11,605,652
653,055
4,195,477
386,892
59,096
$ 9,841,225
543,929
4,850,148
320,857
63,390
$ 4,718,345
429,117
1,783,268
271,864
33,189
$ 3,761,939
383,966
1,816,919
270,242
35,846
(1) Such amounts include ownership interests in affiliated insurance
and reinsurance subsidiaries.
the National Association
There were no state-prescribed or permitted regulatory
accounting practices for any of the Company’s insurance or
reinsurance entities that resulted in reported statutory surplus
that differed from that which would have been reported under
the prescribed practices of the respective regulatory authorities,
including
Insurance
Commissioners. The differences between statutory financial
statements and statements prepared in accordance with GAAP
vary by jurisdiction, however, with the primary differences
being that statutory financial statements may not reflect
deferred acquisition costs, certain net deferred tax assets,
goodwill and intangible assets, unrealized appreciation or
depreciation on debt securities and certain unauthorized
reinsurance recoverables and include contingency reserves.
of
The Company has two Bermuda based subsidiaries: Arch Re
Bermuda, a Class 4 insurer and long-term insurer, and Watford
Re, a Class 4 insurer. Under the Bermuda Insurance Act 1978
(the “Insurance Act”), these subsidiaries are required to
maintain minimum statutory capital and surplus equal to the
greater of a minimum solvency margin and the enhanced capital
requirement as determined by the Bermuda Monetary Authority
(“BMA”). The enhanced capital requirement is calculated
based on the Bermuda Solvency Capital Requirement model,
a risk-based model
the risk
characteristics of different aspects of the company’s business.
At December 31, 2018 and 2017, all such requirements were
met.
into account
takes
that
The ability of these subsidiaries to pay dividends is limited
under Bermuda law and regulations. Under the Insurance Act,
Arch Re Bermuda is restricted with respect to the payment of
dividends. Arch Re Bermuda is prohibited from declaring or
paying in any financial year dividends of more than 25% of its
total statutory capital and surplus (as shown on its previous
financial year’s statutory balance sheet) unless it files, at least
seven days before payment of such dividends, with the Bermuda
Monetary Authority an affidavit stating that it will continue to
meet the required margins following the declaration of those
dividends. Accordingly, Arch Re Bermuda can pay
approximately $2.62 billion to Arch Capital during 2019
without providing an affidavit to the BMA.
Ireland
The Company has two Irish subsidiaries: Arch Re Europe, an
authorized life and non-life reinsurer, and Arch MI Europe, an
authorized non-life insurer. Irish authorized reinsurers and
insurers, such as Arch Re Europe and Arch MI Europe, are also
subject to the general body of Irish laws and regulations
including the provisions of the Companies Act 2014. Arch Re
Europe and Arch MI Europe are subject to the supervision of
the Central Bank of Ireland (“CBOI”) and must comply with
Irish insurance acts and regulations as well as with directions
and guidance issued by the CBOI. These subsidiaries are
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
required to maintain a minimum level of capital. At December
31, 2018 and 2017, these requirements were met.
The amount of dividends these subsidiaries are permitted to
declare is limited to accumulated, realized profits, so far as not
previously utilized by distribution or capitalization, less its
accumulated, realized losses, so far as not previously written
off in a reduction or reorganization of capital duly made. The
solvency and capital requirements must still be met following
any distribution. Dividends or distributions, if any, made by
Arch Re Europe would result in an increase in available capital
at Arch Re Bermuda.
United States
The Company’s U.S. insurance and reinsurance subsidiaries are
subject to insurance laws and regulations in the jurisdictions in
which they operate. The ability of the Company’s regulated
insurance subsidiaries to pay dividends or make distributions
is dependent on their ability to meet applicable regulatory
standards. These regulations include restrictions that limit the
amount of dividends or other distributions, such as loans or cash
advances, available to shareholders without prior approval of
the insurance regulatory authorities.
Dividends or distributions, if any, made by Arch Re U.S. would
result in an increase in available capital at Arch-U.S., the
Company’s U.S. holding company. Arch Re U.S. can declare a
maximum of approximately $123.2 million of dividends during
2019 subject to the approval of the Commissioner of the
Delaware Department of Insurance.
Arch Mortgage Insurance Company and United Guaranty
Residential Insurance Company have each been approved as an
eligible mortgage insurer by Fannie Mae and Freddie Mac,
subject to maintaining certain ongoing requirements (“eligible
mortgage insurers”). In April 2015, the GSEs published
comprehensive, revised requirements, known as the Private
Mortgage Insurer Eligibility Requirements or “PMIERs.” As
clarified and revised by the Guidance Letters issued by the GSEs
in December 2016 and March 2017, the PMIERs apply to the
Company’s eligible mortgage insurers, but do not apply to Arch
Mortgage Guaranty Company, which is not GSE-approved.
The amount of assets required to satisfy the revised financial
requirements of the PMIERs at any point in time will be affected
by many factors, including macro-economic conditions, the
size and composition of our eligible mortgage insurers’
mortgage insurance portfolio at the point in time, and the
amount of risk ceded to reinsurers that may be deducted in our
calculation of “minimum required assets.”
The Company’s U.S. mortgage insurance subsidiaries are
subject to detailed regulation by their domiciliary and primary
regulators, the Wisconsin Office of the Commissioner of
Insurance (“Wisconsin OCI”) for Arch Mortgage Insurance
Company and Arch Mortgage Guaranty Company, the North
Carolina Department of Insurance (“NC DOI”) for United
Guaranty Residential Insurance Company, and by state
insurance departments in each state in which they are licensed.
As mandated by state insurance laws, mortgage insurers are
generally mono-line companies restricted to writing a single
type of insurance business, such as mortgage insurance
business. Each company is subject to either Wisconsin or North
Carolina statutory requirements as to payment of dividends.
Generally, both Wisconsin and North Carolina law precludes
any dividend before giving at least 30 days’ notice to the
Wisconsin OCI or NC DOI, as applicable, and prohibits paying
any dividend unless it is fair and reasonable to do so. In addition,
the state regulators and the GSEs limit or restrict our eligible
mortgage insurers’ ability to pay stockholder dividends or
otherwise return capital to shareholders. Under respective states
law, our U.S. mortgage subsidiaries can declare a maximum of
approximately $324.4 million of dividends during 2019. In
certain instances, approval by the GSEs would be required for
dividends or other forms of return of capital to shareholders due
to the requirements under PMIERs, including the minimum
required assets imposed on our eligible mortgage insurers by
the GSEs. Such dividend would result in an increase in available
capital at Arch U.S. MI Holdings Inc., a subsidiary of Arch-
U.S.
Mortgage insurance companies licensed in Wisconsin or North
Carolina are required to establish contingency loss reserves for
purposes of statutory accounting in an amount equal to at least
50% of net earned premiums. These amounts generally cannot
be withdrawn for a period of 10 years and are separate liabilities
for statutory accounting purposes, which affects the ability to
pay dividends. However, with prior regulatory approval, a
mortgage insurance company may make early withdrawals
from the contingency reserve when incurred losses exceed 35%
of net premiums earned in a calendar year.
Under Wisconsin and North Carolina law, as well as that of 14
other states, a mortgage insurer must maintain a minimum
amount of statutory capital relative to its risk in force in order
for the mortgage insurer to continue to write new business.
While formulations of minimum capital vary in certain
jurisdictions, the most common measure applied allows for a
maximum risk-to-capital ratio of 25 to 1. Wisconsin and North
Carolina both require a mortgage insurer to maintain a
“minimum policyholder position” calculated in accordance
with their respective regulations. Policyholders' position
consists primarily of statutory policyholders' surplus plus the
statutory contingency reserve, less ceded reinsurance. While
the statutory contingency reserve is reported as a liability on
the statutory balance sheet, for risk-to-capital ratio calculations,
it is included as capital for purposes of statutory capital.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
United Kingdom
The Prudential Regulation Authority (“PRA”) and the Financial
Conduct Authority (“FCA”) regulate insurance and reinsurance
companies and the FCA regulates firms carrying on insurance
mediation activities operating in the U.K., both under the
Financial Services and Markets Act 2000. The Company’s
European insurance operations are conducted on two platforms:
Arch Insurance Company Europe and Arch Syndicate 2012.
Arch Syndicate 2012 has one member, Arch Syndicate
is managed by Arch
Investments Ltd. (“ASIL”) and
Underwriting at Lloyd’s Ltd (“AUAL”). All U.K. companies
are also subject to a range of statutory provisions, including the
laws and regulations of the Companies Acts 2006 (as amended)
(the “U.K. Companies Acts”).
Arch Insurance Company Europe and AUAL (on behalf of
itself, Arch Syndicate 2012 and ASIL) must maintain a margin
of solvency at all times under the Solvency II Directive from
the European Insurance and Occupational Pensions Authority.
The regulations stipulate that insurers are required to maintain
the minimum capital requirement and solvency capital
requirement at all times. The capital requirements are calculated
by reference to standard formulae defined in Solvency II. At
December 31, 2018 and 2017, our subsidiaries were in
compliance with these requirements.
As a corporate member of Lloyd’s, ASIL is subject to the
oversight of the Council of Lloyd’s. The capital required to
support a Syndicate’s underwriting capacity, or funds at
Lloyd’s, is assessed annually and is determined by Lloyd’s in
accordance with the capital adequacy rules established by the
PRA. The Company has provided capital to support the
underwriting of Arch Syndicate 2012 in the form of pledged
assets provided by Arch Re Bermuda. The amount which the
Company provides as funds at Lloyd’s is not available for
distribution to the Company for the payment of dividends.
Lloyd’s is supervised by the PRA and required to implement
certain rules prescribed by the PRA under the Lloyd’s Act of
1982 regarding the operation of the Lloyd’s market. With
respect to managing agents and corporate members, Lloyd’s
prescribes certain minimum standards relating to management
and control, solvency and other requirements and monitors
managing agents’ compliance with such standards.
Under U.K. law, all U.K. companies are restricted from
declaring a dividend to their shareholders unless they have
“profits available for distribution.” The calculation as to
whether a company has sufficient profits is based on its
accumulated realized profits minus its accumulated realized
losses. U.K. insurance regulatory laws do not prohibit the
payment of dividends, but the PRA or FCA, as applicable,
requires that insurance companies and insurance intermediaries
maintain certain solvency margins and may restrict the payment
of a dividend by Arch Insurance Company Europe, AUAL and
ASIL.
Canada
Arch Insurance Canada and the Canadian branch of Arch Re
U.S. (“Arch Re Canada”) are subject to federal, as well as
provincial and territorial, regulation in Canada. The Office of
the Superintendent of Financial Institutions (“OSFI”) is the
federal regulatory body that, under the Insurance Companies
Act (Canada), regulates federal Canadian and non-Canadian
insurance companies operating in Canada. Arch Insurance
Canada and Arch Re Canada are subject to regulation in the
provinces and territories in which they underwrite insurance/
reinsurance, and the primary goal of insurance/reinsurance
regulation at the provincial and territorial levels is to govern
the market conduct of insurance/reinsurance companies. Arch
Insurance Canada is licensed to carry on insurance business by
OSFI and in each province and territory. Arch Re Canada is
licensed to carry-on reinsurance business by OSFI and in the
provinces of Ontario and Quebec.
Under the Insurance Companies Act (Canada), Arch Insurance
Canada is required to maintain an adequate amount of capital
in Canada, calculated in accordance with a test promulgated by
OSFI called the Minimum Capital Test (“MCT”), and Arch Re
Canada is required to maintain an adequate margin of assets
over liabilities in Canada, calculated in accordance with a test
promulgated by OSFI called the Branch Adequacy of Assets
Test. Dividends or distributions, if any, made by Arch Insurance
Canada would result in an increase in available capital at Arch
Insurance Company (see “—United States” section).
ARCH CAPITAL
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
24. Unaudited Condensed Quarterly Financial Information
The following table summarizes the 2018 and 2017 unaudited condensed quarterly financial information:
Year Ended December 31, 2018
Net premiums written
Net premiums earned
Net investment income
Net realized gains (losses)
Net impairment losses recognized in earnings
Underwriting income (loss)
Net income (loss) attributable to Arch
Preferred dividends
Net income (loss) available to Arch common shareholders
Net income (loss) per common share -- basic
Net income (loss) per common share -- diluted
Year Ended December 31, 2017
Net premiums written
Net premiums earned
Net investment income
Net realized gains (losses)
Net impairment losses recognized in earnings
Underwriting income (loss)
Net income (loss) attributable to Arch
Preferred dividends
Net income (loss) available to Arch common shareholders
Net income (loss) per common share -- basic
Net income (loss) per common share -- diluted
Fourth
Quarter
Third
Quarter
Second
Quarter
First
Quarter
$
$
$
$
$
$
1,301,754
1,369,435
157,217
(166,030)
(1,705)
166,955
136,494
(10,403)
126,091
0.31
0.31
1,111,015
1,224,755
125,415
26,978
(1,723)
182,111
214,640
(11,105)
203,535
0.50
0.49
$
$
$
$
$
$
1,333,553
1,290,878
144,024
(51,705)
(492)
234,581
227,408
(10,402)
217,006
0.54
0.53
1,325,403
1,261,886
116,459
66,275
(1,878)
(142,172)
(33,656)
(12,369)
(52,760)
(0.13)
(0.13)
$
$
$
$
$
$
1,298,896
1,336,763
135,668
(76,611)
(470)
235,465
243,646
(10,403)
233,243
0.58
0.56
1,248,695
1,240,874
111,124
21,735
(1,730)
195,419
185,167
(11,349)
173,818
0.43
0.42
$
$
$
$
$
$
1,412,544
1,234,899
126,724
(110,998)
(162)
236,997
150,423
(10,437)
137,276
0.34
0.33
1,276,260
1,117,017
117,874
34,153
(1,807)
212,072
253,127
(11,218)
241,909
0.60
0.58
ARCH CAPITAL
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
25. Guarantor Financial Information
The following tables present condensed consolidating balance sheets at December 31, 2018 and 2017 and condensed consolidating
statements of income, comprehensive income and cash flows for 2018, 2017 and 2016 for Arch Capital, Arch-U.S., a 100% owned
subsidiary of Arch Capital, and Arch Capital's other subsidiaries.
Condensed Consolidating Balance Sheet
Assets
Total investments
Cash
Investments in subsidiaries
Due from subsidiaries and affiliates
Premiums receivable
Reinsurance recoverable on unpaid and paid losses and loss
adjustment expenses
Contractholder receivables
Ceded unearned premiums
Deferred acquisition costs
Goodwill and intangible assets
Other assets
Total assets
Liabilities
Reserve for losses and loss adjustment expenses
Unearned premiums
Reinsurance balances payable
Contractholder payables
Collateral held for insured obligations
Senior notes
Revolving credit agreement borrowings
Due to subsidiaries and affiliates
Other liabilities
Total liabilities
December 31, 2018
Arch Capital
(Parent
Guarantor)
Arch-U.S.
(Subsidiary
Issuer)
Other Arch
Capital
Subsidiaries
Consolidating
Adjustments
and
Eliminations
Arch Capital
Consolidated
$
$
$
104
6,125
9,735,256
9
—
—
—
—
—
—
12,588
9,754,082
$
$
452,674
5,940
3,999,243
2
—
—
—
—
—
—
80,949
4,538,808
$
$
— $
—
—
—
—
297,150
—
—
17,105
314,255
— $
—
—
—
—
494,723
—
536,805
26,270
1,057,798
$
$
$
21,307,206
634,491
—
1,802,686
1,834,389
8,618,660
2,079,111
1,730,262
618,535
634,920
1,466,438
40,726,698
17,345,142
4,508,429
928,346
2,079,111
236,630
941,655
455,682
1,265,892
1,699,768
29,460,655
$
$
$
(14,700)
—
(13,734,499)
(1,802,697)
(535,239)
(5,699,288)
—
(754,793)
(48,961)
—
(211,082)
(22,801,259)
(5,491,845)
(754,793)
(535,239)
—
—
—
(1,802,697)
(467,484)
(9,052,058)
21,745,284
646,556
—
—
1,299,150
2,919,372
2,079,111
975,469
569,574
634,920
1,348,893
32,218,329
11,853,297
3,753,636
393,107
2,079,111
236,630
1,733,528
455,682
—
1,275,659
21,780,650
Redeemable noncontrolling interests
—
—
220,992
(14,700)
206,292
Shareholders' Equity
Total shareholders' equity available to Arch
Non-redeemable noncontrolling interests
Total shareholders' equity
9,439,827
—
9,439,827
3,481,010
—
3,481,010
10,253,491
791,560
11,045,051
(13,734,501)
—
(13,734,501)
9,439,827
791,560
10,231,387
Total liabilities, noncontrolling interests and shareholders'
equity
$
9,754,082
$
4,538,808
$
40,726,698
$
(22,801,259) $
32,218,329
ARCH CAPITAL
167
2018 FORM 10-K
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Condensed Consolidating Balance Sheet
Assets
Total investments
Cash
Investments in subsidiaries
Due from subsidiaries and affiliates
Premiums receivable
Reinsurance recoverable on unpaid and paid losses and loss
adjustment expenses
Contractholder receivables
Ceded unearned premiums
Deferred acquisition costs
Goodwill and intangible assets
Other assets
Total assets
Liabilities
Reserve for losses and loss adjustment expenses
Unearned premiums
Reinsurance balances payable
Contractholder payables
Collateral held for insured obligations
Deposit accounting liabilities
Senior notes
Revolving credit agreement borrowings
Due to subsidiaries and affiliates
Other liabilities
Total liabilities
December 31, 2017
Arch Capital
(Parent
Guarantor)
Arch-U.S.
(Subsidiary
Issuer)
Other Arch
Capital
Subsidiaries
Consolidating
Adjustments
and
Eliminations
Arch Capital
Consolidated
$
$
$
96,540
9,997
9,396,621
394
—
—
—
—
—
—
13,176
9,516,728
$
$
— $
—
—
—
—
—
297,053
—
235
22,838
320,126
46,281
30,380
4,097,765
—
—
—
—
—
—
—
49,585
4,224,011
$
$
— $
—
—
—
—
—
494,621
—
536,919
29,317
1,060,857
$
$
$
21,711,891
565,822
—
1,828,864
2,967,701
8,442,192
1,978,414
2,165,789
693,053
652,611
1,860,505
42,866,842
17,236,401
4,861,491
2,155,947
1,978,414
240,183
—
941,210
816,132
1,292,104
1,949,696
31,471,578
(14,700) $
—
(13,494,386)
(1,829,258)
(1,832,452)
(5,902,049)
—
(1,239,178)
(157,229)
—
(86,671)
(24,555,923) $
(5,852,609) $
(1,239,177)
(1,832,451)
—
—
—
—
—
(1,829,258)
(293,343)
(11,046,838)
21,840,012
606,199
—
—
1,135,249
2,540,143
1,978,414
926,611
535,824
652,611
1,836,595
32,051,658
11,383,792
3,622,314
323,496
1,978,414
240,183
—
1,732,884
816,132
—
1,708,508
21,805,723
Redeemable noncontrolling interests
—
—
220,622
(14,700)
205,922
Shareholders' Equity
Total shareholders' equity available to Arch
Non-redeemable noncontrolling interests
Total shareholders' equity
9,196,602
—
9,196,602
3,163,154
—
3,163,154
10,331,231
843,411
11,174,642
(13,494,385)
—
(13,494,385)
9,196,602
843,411
10,040,013
Total liabilities, noncontrolling interests and shareholders'
equity
$
9,516,728
$
4,224,011
$
42,866,842
$
(24,555,923) $
32,051,658
ARCH CAPITAL
168
2018 FORM 10-K
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Condensed Consolidating Statement of Income and
Comprehensive Income
Revenues
Net premiums earned
Net investment income
Net realized gains (losses)
Net impairment losses recognized in earnings
Other underwriting income
Equity in net income (loss) of investments accounted for using
the equity method
Other income (loss)
Total revenues
Expenses
Losses and loss adjustment expenses
Acquisition expenses
Other operating expenses
Corporate expenses
Amortization of intangible assets
Interest expense
Net foreign exchange (gains) losses
Total expenses
Income (loss) before income taxes
Income tax (expense) benefit
Income (loss) before equity in net income of subsidiaries
Equity in net income of subsidiaries
Net income
Net (income) loss attributable to noncontrolling interests
Net income available to Arch
Preferred dividends
Loss on redemption of preferred shares
Net income available to Arch common shareholders
Comprehensive income (loss) available to Arch
Year Ended December 31, 2018
Arch Capital
(Parent
Guarantor)
Arch-U.S.
(Subsidiary
Issuer)
Other Arch
Capital
Subsidiaries
Consolidating
Adjustments
and
Eliminations
Arch Capital
Consolidated
$
$
$
— $
49
29
—
—
—
1,918
1,996
—
—
—
64,279
—
22,147
30
86,456
(84,460)
—
(84,460)
842,431
757,971
—
757,971
(41,645)
(2,710)
713,616
611,003
$
$
— $
3,902
(2,676)
—
—
—
—
1,226
—
—
—
2,422
—
48,103
—
50,525
(49,299)
13,314
(35,985)
388,260
352,275
—
352,275
—
—
352,275
292,973
$
$
5,231,975
649,394
(410,014)
(2,829)
15,073
45,641
501
5,529,741
2,890,106
805,135
677,809
12,293
105,670
138,672
(59,607)
4,570,078
959,663
(127,265)
832,398
—
832,398
28,875
861,273
—
—
861,273
730,828
$
— $
(89,712)
7,317
—
—
—
—
(82,395)
—
—
—
—
—
(88,438)
(9,825)
(98,263)
15,868
—
15,868
(1,230,691)
(1,214,823)
1,275
(1,213,548)
—
—
5,231,975
563,633
(405,344)
(2,829)
15,073
45,641
2,419
5,450,568
2,890,106
805,135
677,809
78,994
105,670
120,484
(69,402)
4,608,796
841,772
(113,951)
727,821
—
727,821
30,150
757,971
(41,645)
(2,710)
$
$
(1,213,548) $
713,616
(1,023,801) $
611,003
ARCH CAPITAL
169
2018 FORM 10-K
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Condensed Consolidating Statement of Income and
Comprehensive Income
Revenues
Net premiums earned
Net investment income
Net realized gains (losses)
Net impairment losses recognized in earnings
Other underwriting income
Equity in net income (loss) of investments accounted for using
the equity method
$
Other income (loss)
Total revenues
Expenses
Losses and loss adjustment expenses
Acquisition expenses
Other operating expenses
Corporate expenses
Amortization of intangible assets
Interest expense
Net foreign exchange (gains) losses
Total expenses
Income (loss) before income taxes
Income tax (expense) benefit
Income (loss) before equity in net income of subsidiaries
Equity in net income of subsidiaries
Net income
Net (income) loss attributable to noncontrolling interests
Net income available to Arch
Preferred dividends
Loss on repurchase of preferred shares
Net income available to Arch common shareholders
Comprehensive income (loss) available to Arch
$
$
Year Ended December 31, 2017
Arch Capital
(Parent
Guarantor)
Arch-U.S.
(Subsidiary
Issuer)
Other Arch
Capital
Subsidiaries
Consolidating
Adjustments
and
Eliminations
Arch Capital
Consolidated
— $
243
—
—
—
—
(482)
(239)
—
—
—
67,450
—
23,560
2
91,012
(91,251)
—
(91,251)
710,529
619,278
—
619,278
(46,041)
(6,735)
566,502
851,863
$
$
— $
1,420
—
—
—
—
—
1,420
—
—
—
4,152
—
47,993
—
52,145
(50,725)
10,333
(40,392)
303,991
263,599
—
263,599
—
—
263,599
288,752
$
$
4,844,532
559,963
149,141
(7,138)
30,253
142,286
(2,089)
5,716,948
2,967,446
775,458
684,451
12,150
125,778
135,342
68,900
4,769,525
947,423
(137,901)
809,522
—
809,522
(11,721)
797,801
—
—
797,801
983,475
$
— $
(90,754)
—
—
—
—
—
(90,754)
—
—
—
—
—
(89,464)
46,880
(42,584)
(48,170)
—
(48,170)
(1,014,520)
(1,062,690)
1,290
(1,061,400)
—
—
(1,061,400) $
4,844,532
470,872
149,141
(7,138)
30,253
142,286
(2,571)
5,627,375
2,967,446
775,458
684,451
83,752
125,778
117,431
115,782
4,870,098
757,277
(127,568)
629,709
—
629,709
(10,431)
619,278
(46,041)
(6,735)
566,502
$
$
(1,272,227) $
851,863
ARCH CAPITAL
170
2018 FORM 10-K
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Condensed Consolidating Statement of Income
and Comprehensive Income
Revenues
Net premiums earned
Net investment income
Net realized gains (losses)
Net impairment losses recognized in earnings
Other underwriting income
Equity in net income (loss) of investments accounted for
using the equity method
Other income (loss)
Total revenues
Expenses
Losses and loss adjustment expenses
Acquisition expenses
Other operating expenses
Corporate expenses
Amortization of intangible assets
Interest expense
Net foreign exchange (gains) losses
Total expenses
Income (loss) before income taxes
Income tax (expense) benefit
Income (loss) before equity in net income of
subsidiaries
Equity in net income of subsidiaries
Net income
Net (income) loss attributable to noncontrolling interests
Net income available to Arch
Preferred dividends
Net income available to Arch common shareholders
Comprehensive income (loss) available to Arch
Year Ended December 31, 2016
Arch Capital
(Parent
Guarantor)
Arch-U.S.
(Subsidiary
Issuer)
Other Arch
Capital
Subsidiaries
Consolidating
Adjustments
and
Eliminations
Arch Capital
Consolidated
$
— $
$
$
$
— $
694
12
—
—
—
180
886
—
—
—
49,540
—
23,769
—
73,309
(72,423)
—
(72,423)
765,161
692,738
—
692,738
(28,070)
664,668
594,699
$
$
— $
3,162
5
—
—
—
—
3,167
—
—
—
1,940
—
27,165
—
29,105
(25,938)
8,676
(17,262)
54,497
37,235
—
37,235
—
37,235
13,444
$
$
3,884,822
393,114
137,569
(30,442)
73,671
48,475
(980)
4,506,229
2,185,599
667,625
624,090
30,266
19,343
60,757
(17,217)
3,570,463
935,766
(40,050)
895,716
—
895,716
(132,727)
762,989
—
762,989
684,447
(30,228)
—
—
(16,498)
—
—
(46,726)
—
—
—
—
—
(45,439)
(19,434)
(64,873)
18,147
—
18,147
(819,658)
(801,511)
1,287
(800,224)
—
(800,224) $
3,884,822
366,742
137,586
(30,442)
57,173
48,475
(800)
4,463,556
2,185,599
667,625
624,090
81,746
19,343
66,252
(36,651)
3,608,004
855,552
(31,374)
824,178
—
824,178
(131,440)
692,738
(28,070)
664,668
$
$
(697,891) $
594,699
ARCH CAPITAL
171
2018 FORM 10-K
Condensed Consolidating Statement
of Cash Flows
Operating Activities
Net Cash Provided By (Used For)
Operating Activities
Investing Activities
Purchases of fixed maturity investments
Purchases of equity securities
Purchases of other investments
Proceeds from the sales of fixed maturity investments
Proceeds from the sales of equity securities
Proceeds from the sales, redemptions and maturities
of other investments
Proceeds from redemptions and maturities of fixed
maturity investments
Net settlements of derivative instruments
Net (purchases) sales of short-term investments
Change in cash collateral related to securities lending
Contributions to subsidiaries
Purchases of fixed assets
Other
Net Cash Provided By (Used For)
Investing Activities
Financing Activities
Redemption of preferred shares
Purchases of common shares under share repurchase
program
Proceeds from common shares issued, net
Proceeds from intercompany borrowings
Proceeds from borrowings
Repayments of intercompany loans
Repayments of borrowings
Change in cash collateral related to securities lending
Dividends paid to redeemable noncontrolling
interests
Dividends paid to parent (1)
Other
Preferred dividends paid
Net Cash Provided By (Used For)
Financing Activities
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Year Ended December 31, 2018
Arch Capital
(Parent
Guarantor)
Arch-U.S.
(Subsidiary
Issuer)
Other Arch
Capital
Subsidiaries
Consolidating
Adjustments
and
Eliminations
Arch Capital
Consolidated
$
324,319
$
481,751
$
1,703,181
$
(949,929) $
1,559,322
1,241,363
—
—
(1,241,363)
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
1,275
948,654
—
—
(33,327,660)
(1,001,149)
(2,014,622)
31,513,271
1,118,445
1,561,958
892,755
44,699
485,473
180,883
—
(29,809)
21,736
(554,020)
(92,555)
(282,762)
(7,608)
—
218,259
—
(576,401)
(180,883)
(17,989)
—
(7,226)
(41,645)
—
—
—
—
—
—
—
—
96,476
—
—
(110)
(4)
(906,482)
(44,830)
—
535,947
—
—
—
—
7,674
—
(98,500)
—
—
(33,662,541)
(956,319)
(2,014,622)
32,218,687
1,118,445
1,561,958
892,755
44,699
381,323
180,883
98,500
(29,699)
21,740
96,362
(506,191)
(144,191)
(92,555)
(282,762)
(7,608)
—
—
—
—
—
—
—
—
(41,645)
(424,570)
—
—
—
—
218,259
—
(576,401)
(180,883)
(19,264)
(948,654)
(7,226)
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
(24,440)
30,380
5,940
$
Effects of exchange rate changes on foreign currency
cash and restricted cash
Increase (decrease) in cash and restricted cash
Cash and restricted cash, beginning of year
Cash and restricted cash, end of period
$
—
(3,889)
10,048
6,159
$
(1,514,169)
949,929
(988,810)
(19,133)
25,688
686,856
712,544
$
—
—
—
— $
(19,133)
(2,641)
727,284
724,643
(1)
Included in net cash provided by (used for) operating activities in the Arch Capital (Parent Guarantor) and/or Arch-U.S. (Subsidiary Issuer) columns.
ARCH CAPITAL
172
2018 FORM 10-K
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Condensed Consolidating Statement
of Cash Flows
Operating Activities
Net Cash Provided By (Used For)
Operating Activities
Investing Activities
Purchases of fixed maturity investments
Purchases of equity securities
Purchases of other investments
Proceeds from the sales of fixed maturity investments
Proceeds from the sales of equity securities
Proceeds from the sales, redemptions and maturities of
other investments
Proceeds from redemptions and maturities of fixed
maturity investments
Net settlements of derivative instruments
Net (purchases) sales of short-term investments
Change in cash collateral related to securities lending
Contributions to subsidiaries
Issuance of intercompany loans
Repayment of intercompany loans
Acquisitions, net of cash
Purchases of fixed assets
Other
Net Cash Provided By (Used For)
Investing Activities
Financing Activities
Proceeds from issuance of preferred shares, net
Redemption of preferred shares
Proceeds from common shares issued, net
Proceeds from intercompany borrowings
Proceeds from borrowings
Repayments of intercompany borrowings
Repayments of borrowings
Change in cash collateral related to securities lending
Dividends paid to redeemable noncontrolling interests
Dividends paid to parent (1)
Other
Preferred dividends paid
Net Cash Provided By (Used For)
Financing Activities
Year Ended December 31, 2017
Arch Capital
(Parent
Guarantor)
Arch-U.S.
(Subsidiary
Issuer)
Other Arch
Capital
Subsidiaries
Consolidating
Adjustments
and
Eliminations
Arch Capital
Consolidated
$
159,130
$
(10,289) $
1,649,751
$
(703,714) $
1,094,878
—
—
—
—
—
—
—
—
(93,864)
—
20,457
—
—
—
(18)
—
—
—
—
—
—
—
—
—
(4,586)
—
(73,700)
—
47,000
—
—
—
(36,806,913)
(1,021,016)
(2,020,624)
35,686,779
1,056,401
1,528,617
907,417
(28,563)
(636,104)
12,540
(423,998)
(47,000)
80,840
—
(22,823)
111,516
—
—
—
—
—
—
—
—
—
—
477,241
47,000
(127,840)
—
—
(20,641)
(36,806,913)
(1,021,016)
(2,020,624)
35,686,779
1,056,401
1,528,617
907,417
(28,563)
(734,554)
12,540
—
—
—
—
(22,841)
90,875
(73,425)
(31,286)
(1,622,931)
375,760
(1,351,882)
319,694
(230,000)
(21,048)
—
—
—
(100,000)
—
—
—
—
(46,041)
(77,395)
—
—
—
—
—
—
—
—
—
—
—
—
—
—
(41,575)
71,955
30,380
$
—
—
477,244
47,000
253,415
(127,840)
(97,000)
(12,540)
(19,264)
(702,442)
(72,537)
—
—
—
(477,244)
(47,000)
—
127,840
—
—
1,275
702,442
20,641
—
319,694
(230,000)
(21,048)
—
253,415
—
(197,000)
(12,540)
(17,989)
—
(51,896)
(46,041)
(253,964)
327,954
(3,405)
18,124
(209,020)
895,876
686,856
$
—
—
—
— $
18,124
(242,285)
969,569
727,284
Effects of exchange rate changes on foreign currency cash
and restricted cash
Increase (decrease) in cash and restricted cash
Cash and restricted cash, beginning of year
Cash and restricted cash, end of period
—
8,310
1,738
10,048
$
$
(1)
Included in net cash provided by (used for) operating activities in the Arch Capital (Parent Guarantor) and/or Arch-U.S. (Subsidiary Issuer) columns.
ARCH CAPITAL
173
2018 FORM 10-K
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Condensed Consolidating Statement
of Cash Flows
Operating Activities
Net Cash Provided By (Used For)
Operating Activities
Investing Activities
Purchases of fixed maturity investments
Purchases of equity securities
Purchases of other investments
Proceeds from the sales of fixed maturity investments
Proceeds from the sales of equity securities
Proceeds from the sales, redemptions and maturities of
other investments
Proceeds from redemptions and maturities of fixed
maturity investments
Net settlements of derivative instruments
Net (purchases) sales of short-term investments
Change in cash collateral related to securities lending
Contributions to subsidiaries
Issuance of intercompany loans
Acquisitions, net of cash
Purchases of fixed assets
Other
Net Cash Provided By (Used For)
Investing Activities
Financing Activities
Proceeds from issuance of Series C preferred shares issued,
net
Redemption of preferred shares
Purchases of common shares under share repurchase
program
Proceeds from common shares issued, net
Proceeds from intercompany borrowings
Proceeds from borrowings
Repayments of borrowings
Change in cash collateral relating to securities lending
Dividends paid to redeemable noncontrolling
Dividends paid to parent (1)
Other
Preferred dividends paid
Net Cash Provided By (Used For)
Financing Activities
Effects of exchange rate changes on foreign currency cash
and restricted cash
Increase (decrease) in cash and restricted cash
Cash and restricted cash, beginning of year
Cash and restricted cash, end of period
Year Ended December 31, 2016
Arch Capital
(Parent
Guarantor)
Arch-U.S.
(Subsidiary
Issuer)
Other Arch
Capital
Subsidiaries
Consolidating
Adjustments
and
Eliminations
Arch Capital
Consolidated
$
148,209
$
6,395
$
1,445,953
$
(223,128) $
1,377,429
—
—
—
—
—
—
—
—
(2,075)
—
(479,912)
—
—
(8)
2,000
—
—
—
—
—
—
41,500
—
(40,963)
—
(887,650)
—
—
—
—
(35,532,810)
(665,702)
(1,389,406)
34,559,966
751,728
1,149,328
713,507
(17,068)
(80,372)
(155,248)
(546,269)
(1,460,000)
(1,992,720)
(15,295)
(29,795)
—
—
—
—
—
—
—
—
—
—
1,913,831
1,460,000
—
—
—
(35,532,810)
(665,702)
(1,389,406)
34,559,966
751,728
1,149,328
755,007
(17,068)
(123,410)
(155,248)
—
—
(1,992,720)
(15,303)
(27,795)
(479,995)
(887,113)
(4,710,156)
3,373,831
(2,703,433)
434,899
(2,445)
(75,256)
(2,418)
—
—
—
—
—
—
(48)
(28,070)
—
—
—
435,450
500,000
—
—
—
—
—
200
—
—
—
—
1,478,381
960,000
1,386,741
(219,171)
155,248
(19,264)
(221,853)
3,978
—
—
—
—
(1,913,831)
(1,460,000)
—
—
—
1,275
221,853
—
—
434,899
(2,445)
(75,256)
(2,418)
—
1,386,741
(219,171)
155,248
(17,989)
—
4,130
(28,070)
326,662
935,650
3,524,060
(3,150,703)
1,635,669
—
(5,124)
6,862
1,738
$
—
54,932
17,023
71,955
$
(21,191)
238,666
657,210
895,876
$
$
—
—
—
— $
(21,191)
288,474
681,095
969,569
(1)
Included in net cash provided by (used for) operating activities in the Arch Capital (Parent Guarantor) and/or Arch-U.S. (Subsidiary Issuer) columns.
ARCH CAPITAL
174
2018 FORM 10-K
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
26. Subsequent Event
Business Acquired
On November 1, 2018, the Company announced that its U.K. insurance operations entered into a renewal rights transaction with
The Ardonagh Group of a U.K. commercial lines book of business, consisting of commercial property, casualty, motor, professional
liability, personal accident and travel business. The transaction closed on January 1, 2019.
ARCH CAPITAL
175
2018 FORM 10-K
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Management’s Annual Report on Internal Control Over
Financial Reporting
is responsible for establishing and
Our management
maintaining adequate internal control over financial reporting,
as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange
Act. Our management assessed the effectiveness of our internal
control over financial reporting as of December 31, 2018. In
making this assessment, management used the criteria set forth
by the Committee of Sponsoring Organizations (COSO) of the
Treadway Commission
Internal Control-Integrated
Framework (2013).
in
Based on our assessment, management determined that, as of
December 31, 2018, our internal control over financial
reporting was effective. The effectiveness of our internal control
over financial reporting as of December 31, 2018 has been
audited by PricewaterhouseCoopers LLP, an independent
registered public accounting firm, as stated in their report
included in Item 8.
Changes in Internal Control Over Financial Reporting
There have been no changes in internal control over financial
reporting that occurred in connection with our evaluation
required pursuant to Rules 13a-15 and 15d-15 under the
Exchange Act during the fiscal quarter ended December 31,
2018 that have materially affected, or are reasonably likely to
materially affect, internal control over financial reporting.
None.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
In connection with the filing of this Form 10-K, our
management, including the Chief Executive Officer and Chief
Financial Officer, conducted an evaluation, as of December 31,
2018, for the purposes set forth in the applicable rules under
the Securities and Exchange Act of 1934, as amended (the
“Exchange Act”). Based on that evaluation, the Chief Executive
Officer and Chief Financial Officer concluded that the
disclosure controls and procedures are effective.
We continue to enhance our operating procedures and internal
controls (including information technology initiatives and
controls over financial reporting) to effectively support our
business and our regulatory and reporting requirements. Our
management does not expect that our disclosure controls or our
internal controls will prevent all errors and all fraud. A control
system, no matter how well conceived and operated, can
provide only reasonable, not absolute, assurance that the
objectives of the control system are met. Further, the design of
a control system must reflect the fact that there are resource
constraints, and the benefits of controls must be considered
relative to their costs. As a result of the inherent limitations in
all control systems, no evaluation of controls can provide
absolute assurance that all control issues and instances of fraud,
if any, within the company have been detected. These inherent
limitations include the realities that judgments in decision
making can be faulty, and that breakdowns can occur because
of simple error or mistake. Additionally, controls can be
circumvented by the individual acts of some persons or by
collusion of two or more people.
The design of any system of controls also is based in part upon
certain assumptions about the likelihood of future events, and
there can be no assurance that any design will succeed in
achieving its stated goals under all potential future conditions;
over time, controls may become inadequate because of changes
in conditions, or the degree of compliance with the policies or
procedures may deteriorate. As a result of the inherent
limitations in a cost-effective control system, misstatement due
to error or fraud may occur and not be detected. Accordingly,
our disclosure controls and procedures are designed to provide
reasonable, not absolute, assurance that the disclosure controls
and procedures are met.
ARCH CAPITAL
176
2018 FORM 10-K
the President announced that the U.S. would withdraw from the
Joint Comprehensive Plan of Action and begin reinstituting
Iranian sanctions. Since May 8, 2018, our non-U.S. subsidiaries
operating under General License H have not entered into any
new transactions that had previously been permitted under
General License H. On June 27, 2018, OFAC revoked General
License H and added regulations which authorized all
transactions and activities ordinarily incident and necessary to
the winding down of activities previously approved under
General License H through November 4, 2018. Our non-U.S.
subsidiaries operating under General License H completed their
wind down activities by November 4, 2018, in accordance with
all applicable laws and regulations.
ITEM 9B. OTHER INFORMATION
Disclosure of Certain Activities Under Section 13(r) of the
Securities Exchange Act of 1934
Section 13(r) of the Securities Exchange Act of 1934, as
amended, requires an issuer to disclose in its annual or quarterly
reports whether it or an affiliate knowingly engaged in certain
activities described in that section, including certain activities
related to Iran during the period covered by the report.
On January 16, 2016, the Office of Foreign Assets Control of
the U.S. Department of the Treasury (“OFAC”) adopted
General License H which authorized non-U.S. entities that are
owned or controlled by a U.S. person to engage in certain
activities with Iran so long as they complied with certain
specific requirements set forth therein.
As and when allowed by the applicable law and regulations,
certain of our non-U.S. subsidiaries provide global marine and
energy policies and global marine reinsurance which may have
some exposure to Iran. The global marine policies and
reinsurance provide coverage for vessels navigating into and
out of ports worldwide. In light of European Union and U.S.
modifications to Iran sanctions in 2016, including the issuance
of General License H, and consistent with General License H,
we have been notified that certain of our policyholders shipped
cargo to and from Iran, and that such cargo may include
transporting crude oil from Iran to another country. Since these
policies insure multiple voyages and fleets containing multiple
ships, we are unable to attribute gross revenues or net profits
from these policies to activities involving Iran. On May 8, 2018,
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
there is a grant of a waiver, including any implicit waiver, we
will disclose the nature of such amendment or waiver on our
website or in a report on Form 8-K, to the extent required by
applicable law or the rules and regulations of any exchange
applicable to us. Our website address is intended to be an
inactive, textual reference only and none of the material on our
website is incorporated by reference into this report.
The information required by this item is incorporated by
reference from the information to be included in our definitive
proxy statement (“Proxy Statement”) for our annual meeting of
shareholders to be held in 2018, which we intend to file with
the SEC pursuant to Regulation 14A before May 1, 2019.
Copies of our code of ethics applicable to our chief executive
officer, chief financial officer and principal accounting officer
or controller are available free of charge to investors upon
written request addressed to the attention of Arch Capital’s
corporate secretary, Waterloo House, 100 Pitts Bay Road,
Pembroke HM 08, Bermuda. In addition, our code of ethics and
certain other basic corporate documents, including the charters
of our audit committee, compensation committee and
nominating committee are posted on our website. If any
substantive amendments are made to the code of ethics or if
ARCH CAPITAL
177
2018 FORM 10-K
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by
reference from the information to be included in the Proxy
Statement which we intend to file pursuant to Regulation 14A
with the SEC before May 1, 2019, which Proxy Statement is
incorporated by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
Other than the information set forth below, the information required by this item is incorporated by reference from the information
to be included in the Proxy Statement which we intend to file pursuant to Regulation 14A with the SEC before May 1, 2019, which
Proxy Statement is incorporated by reference.
The following information is as of December 31, 2018:
Plan Category
Equity compensation plans approved by security holders
Equity compensation plans not approved by security holders
Total
________________________
Column A
Column B
Column C
Number of Securities to
be Issued Upon Exercise
of Outstanding Stock
Options(1), Warrants
and Rights
Weighted-Average
Exercise Price of
Outstanding
Stock Options(1),
Warrants and Rights ($)
21,383,897
—
21,383,897
$
$
19.37
—
19.37
Number of Securities
Remaining Available for
Future Issuance Under
Equity Compensation
Plans (Excluding
Securities Reflected in
Column A
37,136,857
—
37,136,857 (2
)
(1)
(2)
Includes all vested and unvested stock options outstanding of 20,076,593 and restricted stock and performance units outstanding of 1,307,304. The weighted
average exercise price does not take into account restricted stock units. In addition, the weighted average remaining contractual life of the Company's
outstanding exercisable stock options and SARs at December 31, 2018 was 5.4 years.
Includes 3,281,686 common shares remaining available for future issuance under our Employee Share Purchase Plan and 33,855,171 common shares remaining
available for future issuance under our equity compensation plans. Shares available for future issuance under our equity compensation plans may be issued
in the form of stock options, SARs, restricted shares, restricted share units payable in common shares or cash, share awards in lieu of cash awards, dividend
equivalents, performance shares and performance units and other share-based awards. In addition, 9,784,515 common shares, or 28.9% of the 33,855,171
common shares remaining available for future issuance may be issued in connection with full value awards (i.e., awards other than stock options or SARs).
178
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
The information required by this item is incorporated by
reference from the information to be included in the Proxy
Statement which we intend to file pursuant to Regulation 14A
with the SEC before May 1, 2019, which Proxy Statement is
incorporated by reference.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this item is incorporated by
reference from the information to be included in our Proxy
Statement which we intend to file pursuant to Regulation 14A
with the SEC before May 1, 2019, which Proxy Statement is
incorporated by reference.
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Financial Statements, Financial Statement Schedules and Exhibits.
1.
Financial Statements
Included in Part II – see Item 8 of this report.
2.
Financial Statement Schedules
III. Supplementary Insurance Information
For the years ended December 31, 2018, 2017 and 2016
IV. Reinsurance
For the years ended December 31, 2018, 2017 and 2016
VI. Supplementary Information for Property and Casualty Insurance Underwriters
For the years ended December 31, 2018, 2017 and 2016
Page No.
186
187
188
Schedules other than those listed above are omitted for the reason that they are not applicable or the information is provided in Item 8
of this report.
ARCH CAPITAL
179
2018 FORM 10-K
3. Exhibits
Exhibit
Number
Exhibit Description
Memorandum of Association of ACGL
Bye-Laws of ACGL
ACGL Certificate of Deposit of Memorandum of Increase of Share Capital
Certificate of Designations of Series E Non-Cumulative Preferred Shares
Certificate of Designations of Series F Non-Cumulative Preferred Shares
Specimen Common Share Certificate
Specimen Series E Non-Cumulative Preferred Share Certificate
Specimen Series F Non-Cumulative Preferred Share Certificate
Indenture, dated as of May 4, 2004, between ACGL, as issuer, and JPMorgan
Chase Bank, N.A. (formerly JPMorgan Chase Bank) (“JPMCB”), as trustee
First Supplemental Indenture, dated as of May 4, 2004, between ACGL, as issuer,
and JPMCB, as trustee
Indenture, dated as of December 13, 2013, among Arch Capital Group (U.S.) Inc.
(“Arch U.S.”), as issuer, ACGL, as guarantor, and The Bank of New York Mellon
(“BNYM”), as trustee
First Supplemental Indenture, dated as of December 13, 2013, among Arch U.S.,
as issuer, ACGL, as guarantor, and BNYM, as trustee
Second Supplemental Indenture, dated as of May 10, 2018, among Arch Capital
Finance LLC, as issuer, ACGL, as guarantor, and BNYM, as trustee
Deposit Agreement, dated September 29, 2016, between ACGL, as issuer, and
American Stock Transfer & Trust Company, LLC (“AST”), as depositary, registrar
and transfer agent and as dividend disbursing agent and redemption agent, and the
holders from time to time of the depositary receipts
Deposit Agreement, dated August 17, 2017, between ACGL, as issuer, and AST, as
depositary, registrar and transfer agent and as dividend disbursing agent and
redemption agent, and the holders from time to time of the depositary receipts
Form of Depositary Receipt, dated September 29, 2016
Form of Depositary Receipt, dated August 17, 2017
Indenture, dated as of December 8, 2016, among Arch Capital Finance LLC, as
issuer, ACGL, as guarantor, and BNYM, as trustee
First Supplemental Indenture, dated as of December 8, 2016, among Arch Capital
Finance LLC, as issuer, ACGL, as guarantor, and BNYM, as trustee
ACGL 2002 Long Term Incentive and Share Award Plan (“2002 Plan”)†
First Amendment to the 2002 Plan†
Second Amendment to the 2002 Plan†
Third Amended and Restated ACGL Incentive Compensation Plan†
First Amendment to Third Amended and Restated ACGL Incentive Compensation
Plan†
Form
S-4
10-Q
10-K
8-K
8-K
10-K405
8-K
8-K
8-K
8-K
8-K
8-K
8-K
8-K
8-K
8-K
8-K
8-K
8-K
10-Q
10-Q
10-K
10-Q
10-Q
Incorporated by Reference
Original
Number
Date Filed
Filed
Herewith
3.1
3
3.3
4.1
4.1
4.1
4.2
4.2
99.2
99.3
4.1
4.2
4.1
4.3
4.3
4.4
4.4
4.1
4.2
10.1
10.4
10.6
10.7
10.1
September 8, 2000
August 5, 2016
February 28, 2011
September 29, 2016
August 17, 2017
April 2, 2001
September 29, 2016
August 17, 2017
May 7, 2004
May 7, 2004
December 13, 2013
December 13, 2013
May 15, 2018
September 29, 2016
August 17, 2017
September 29, 2016
August 17, 2017
December 9, 2016
December 9, 2016
August 14, 2002
November 12, 2003
March 2, 2009
August 5, 2016
May 5, 2017
April 3, 2007
March 27, 2012
March 26, 2015
March 28, 2018
March 23, 2016
ACGL 2007 Long Term Incentive and Share Award Plan†
ACGL 2012 Long Term Incentive and Share Award Plan†
ACGL 2015 Long Term Incentive and Share Award Plan†
ACGL 2018 Long Term Incentive and Share Award Plan†
ACGL Amended and Restated 2007 Employee Share Purchase Plan†
DEF 14A
DEF 14A
DEF 14A
DEF 14A
DEF 14A
Restricted Share Unit Agreement, dated as of February 20, 2003, between ACGL
and Constantine Iordanou (“February RSU Agreement”)†
10-K
10.7.15
March 10, 2004
First Amendment to February RSU Agreement dated as of December 9, 2008
grant†
Second Amendment to February RSU Agreement dated as of July 9, 2009 grant†
Form of Restricted Share Agreement, dated as of May 13, 2015, between ACGL
and each of Constantine Iordanou, Marc Grandisson, W. Preston Hutchings,
Nicolas Papadopoulo, Maamoun Rajeh, Andrew Rippert and Louis T. Petrillo†
Form of Restricted Share Agreement, dated as of May 13, 2016, between ACGL
and each of Constantine Iordanou, Marc Grandisson, W. Preston Hutchings,
Nicolas Papadopoulo, Maamoun Rajeh, Andrew Rippert and Louis T. Petrillo†
10-K
10.10.9
March 2, 2009
10-Q
10-Q
10.1
10.2
November 9, 2009
August 7, 2015
10-Q
10.2
August 5, 2016
Form of Restricted Share Agreement, dated as of May 4, 2017, between ACGL and
each of the Non-Employee Directors of ACGL†
10-Q
10.3
August 4, 2017
3.1
3.2
3.3
4.1.1
4.1.2
4.2.1
4.2.2
4.2.3
4.3.1
4.3.2
4.3.3
4.3.4
4.3.5
4.4.1
4.4.2
4.5.1
4.5.2
4.6.1
4.6.2
10.1.1
10.1.2
10.1.3
10.2.1
10.2.2
10.3.1
10.3.2
10.3.3
10.3.4
10.3.5
10.4.1
10.4.2
10.4.3
10.4.4
10.4.5
10.4.6
ARCH CAPITAL
180
2018 FORM 10-K
10.4.7
10.4.8
10.4.9
10.4.10
10.4.11
10.5
10.6.1
10.6.2
10.6.3
10.6.4
10.6.5
10.6.6
10.6.7
10.6.8
10.6.9
10.6.10
10.6.11
10.7.1
10.7.2
10.7.3
10.7.4
10.7.5
10.7.6
10.7.7
10.7.8
10.7.9
10.7.10
10.7.11
10.7.12
Form of Restricted Share Agreement, dated as of May 8, 2017, between ACGL and
each of Constantine Iordanou, Marc Grandisson, W. Preston Hutchings, Nicolas
Papadopoulo, Maamoun Rajeh, Andrew Rippert and Louis T. Petrillo†
Form of Restricted Share Agreement, dated as of September 19, 2017, between
ACGL and each of Nicolas Papadopoulo and Maamoun Rajeh†
Form of Restricted Share Agreement for Named Executive Officers and certain
Executive Officers of ACGL and subsidiaries†
Form of Restricted Share Agreement between ACGL and each of the Non-
Employee Directors of ACGL†
Restricted Share Agreement, dated as of May 9, 2018, between ACGL and
Constantine Iordanou†
Form of Performance Restricted Share Agreement for Named Executive Officers
and certain Executive Officers of ACGL and subsidiaries†
Form of Non-Qualified Stock Option Agreement, dated as of May 13, 2015,
between ACGL and each of Constantine Iordanou, Marc Grandisson and W.
Preston Hutchings†
Non-Qualified Stock Option Agreement, dated as of February 26, 2016, between
ACGL and Constantine Iordanou†
Form of Non-Qualified Stock Option Agreement, dated as of May 13, 2016,
between ACGL and each of Constantine Iordanou, Marc Grandisson, W. Preston
Hutchings, Nicolas Papadopoulo, Maamoun Rajeh, Andrew Rippert and Louis T.
Petrillo†
Non-Qualified Stock Option Agreement, dated as of February 24, 2017, between
ACGL and Constantine Iordanou†
Form of Non-Qualified Stock Option Agreement, dated as of May 8, 2017,
between ACGL and each of Constantine Iordanou, Marc Grandisson, W. Preston
Hutchings, Nicolas Papadopoulo, Maamoun Rajeh, Andrew Rippert and Louis T.
Petrillo†
10-Q
10.4
August 4, 2017
10-K
10.4.13
February 28, 2018
10-Q
10-Q
10-Q
10-Q
10-Q
10-Q
10-Q
10.3
10.6
10.7
10.5
10.3
10.6
10.3
August 8, 2018
August 8, 2018
August 8, 2018
August 8, 2018
August 7, 2015
August 5, 2016
August 5, 2016
10-Q
10.22
November 3, 2017
10-Q
10.5
August 4, 2017
Non-Qualified Stock Option Agreement, dated as of September 19, 2017, between
ACGL and Maamoun Rajeh†
10-K
10.5.6
February 28, 2018
Non-Qualified Stock Option Agreement, dated as of September 19, 2017, between
ACGL and Nicolas Papadopoulo†
10-K
10.5.7
February 28, 2018
Form of Non-Qualified Stock Option Agreement for Named Executive Officers
and certain Executive Officers of ACGL and subsidiaries†
Non-Qualified Stock Option Agreement, dated as of May 9, 2018, between ACGL
and Constantine Iordanou†
Non-Qualified Stock Option Agreement, dated as of March 1, 2018, between
ACGL and Constantine Iordanou†
Non-Qualified Stock Option Agreement, dated as of April 9, 2018, between ACGL
and Marc Grandisson†
Form of Share Appreciation Right Agreement, dated as of May 9, 2008, between
ACGL and each of Constantine Iordanou, John D. Vollaro, Marc Grandisson, W.
Preston Hutchings and Louis T. Petrillo†
Form of Share Appreciation Right Agreement, dated as of May 6, 2009, between
ACGL and each of Constantine Iordanou, Marc Grandisson, W. Preston Hutchings
and John D. Vollaro†
Share Appreciation Right Agreement, dated as of February 25, 2010, between
ACGL and Constantine Iordanou†
Form of Share Appreciation Right Agreement, dated as of May 5, 2010, between
ACGL and each of Constantine Iordanou, Marc Grandisson, W. Preston Hutchings
and Louis T. Petrillo†
Share Appreciation Right Agreement, dated as of May 6, 2011, between ACGL and
Marc Grandisson†
Share Appreciation Right Agreement, dated as of May 6, 2011, between ACGL and
W. Preston Hutchings†
Share Appreciation Right Agreement, dated as of May 6, 2011, between ACGL and
Constantine Iordanou†
Share Appreciation Right Agreement, dated as of May 6, 2011, between ACGL and
Louis T. Petrillo†
Share Appreciation Right Agreement, dated as of May 6, 2011, between ACGL and
Maamoun Rajeh†
Share Appreciation Right Agreement dated as of February 29, 2012, between
ACGL and Constantine Iordanou†
Share Appreciation Right Agreement, dated as of May 9, 2012, between ACGL and
Andrew Rippert†
Share Appreciation Right Agreement, dated as of May 9, 2012 between ACGL and
Maamoun Rajeh†
10-Q
10-Q
10-Q
10-Q
10-Q
10.4
10.8
10.4
10.5
10.1
August 8, 2018
August 8, 2018
May 9, 2018
May 9, 2018
November 10, 2008
10-K
10.12.4
February 26, 2010
10-Q
10-Q
10-Q
10-Q
10.4
10.4
10.7
10.9
November 9, 2012
November 8, 2010
November 8, 2011
November 8, 2011
10-Q
10.10
November 8, 2011
10-Q
10.12
November 8, 2011
10-Q
10-Q
10-Q
10-Q
10.1
10.5
10.3
10.2
November 3, 2017
November 9, 2012
November 3, 2017
November 3, 2017
ARCH CAPITAL
181
2018 FORM 10-K
10.7.13
10.7.14
10.7.15
10.7.16
10.7.17
10.7.18
10.7.19
10.7.20
10.7.21
10.7.22
10.7.23
10.7.24
10.7.25
10.8.1
10.8.2
10.8.3
10.9
10.10
10.11
10.12
10.13
10.14
10.15
10.16
10.17
10.18.1
10.18.2
10.18.3
10.19
21
23
24
31.1
Form of Share Appreciation Right Agreement, dated as of May 9, 2012, between
ACGL and each of Constantine Iordanou, Marc Grandisson, W. Preston Hutchings
and Louis T. Petrillo†
Share Appreciation Right Agreement, dated as of July 1, 2012 between ACGL and
Maamoun Rajeh†
Share Appreciation Right Agreement, dated as of November 12, 2012, between
Arch Capital Group Ltd. and Andrew Rippert†
Form of Share Appreciation Right Agreement, dated as of November 12, 2012,
between ACGL and each of Constantine Iordanou, Marc Grandisson, W. Preston
Hutchings, Maamoun Rajeh and Louis T. Petrillo†
Share Appreciation Right Agreement, dated as of May 9, 2013, between Arch
Capital Group Ltd. and Andrew Rippert†
Form of Share Appreciation Right Agreement, dated as of May 9, 2013, between
ACGL and each of Constantine Iordanou, Marc Grandisson, W. Preston Hutchings,
Maamoun Rajeh and Louis T. Petrillo†
10-Q
10.3
November 9, 2012
10-Q
10-Q
10-Q
10.4
10.9
10.3
November 3, 2017
November 3, 2017
August 9, 2013
10-Q
10.11
November 3, 2017
10-Q
10.2
November 8, 2013
Share Appreciation Right Agreement, dated as of February 4, 2014, between Arch
Capital Group Ltd. and Andrew Rippert†
10-Q
10.12
November 3, 2017
Share Appreciation Right Agreement, dated as of February 28, 2014, between
ACGL and Constantine Iordanou†
10-Q
10.6
August 8, 2014
Share Appreciation Right Agreement, dated as of May 13, 2014, between ACGL
and Andrew Rippert†
10-Q
10.14
November 3, 2017
Form of Share Appreciation Right Agreement, dated as of May 13, 2014, between
ACGL and each of Constantine Iordanou, Marc Grandisson, W. Preston Hutchings,
Maamoun Rajeh and Louis T. Petrillo†
10-Q
10.3
August 8, 2014
Share Appreciation Right Agreement, dated as of July 1, 2014, between ACGL and
Maamoun Rajeh†
10-Q
10.15
November 3, 2017
Share Appreciation Right Agreement, dated as of November 6, 2014, between
ACGL and Marc Grandisson†
Share Appreciation Right Agreement, dated as of February 27, 2015, between
ACGL and Constantine Iordanou†
Employment Agreement, dated as of October 27, 2008, between ACGL and John
D. Vollaro†
Amendment to Employment Agreement, dated February 27, 2015, between ACGL
and John D. Vollaro†
Second Amendment to Employment Agreement, dated as of January 1, 2018,
between ACGL and John D. Vollaro†
Employment Agreement, dated as of February 1, 2018, between ACGL and W.
Preston Hutchings†
Service Agreement, dated September 21, 2017 between ACGL and Constantine
Iordanou
Employment Agreement, dated as of September 19, 2017 between ACGL and
Maamoun Rajeh†
Employment Agreement, dated as of September 19, 2017 between ACGL and
Nicholas Papadopoulo†
Employment Agreement, dated as of October 30, 2017, between ACGL and
Andrew Rippert†
10-Q
10-Q
8-K
10-Q
10-Q
10-Q
8-K
10.2
10.5
10.1
10.1
10.1
10.2
10.1
May 8, 2015
August 5, 2016
October 28, 2008
May 8, 2015
May 9, 2018
August 8, 2018
September 22, 2017
10-Q
10.26
November 3, 2017
10-Q
10.27
November 3, 2017
10-Q
10.28
November 3, 2017
Employment Agreement, dated as of May 25, 2018, between ACGL and François
Morin†
8-K/A
10.1
July 26, 2018
Employment Agreement, dated as of April 9, 2018, between ACGL and Marc
Grandisson†
Employment Agreement, dated as of November 13, 2018, between Arch Capital
Services Inc. and Louis Petrillo (filed herewith)†
Arch U.S. Executive Supplemental Non-Qualified Savings and Retirement Plan†
Stock Purchase Agreement, dated as of August 15, 2016, between ACGL and
American International Group, Inc. (“AIG”)
First Amendment to Stock Purchase Agreement between ACGL and AIG
Second Amendment to Stock Purchase Agreement between ACGL and AIG
Second Amended and Restated Credit Agreement, dated as of October 26, 2016, by
and among ACGL, certain of its subsidiaries as subsidiary borrowers, Bank of
America, N.A., as Administrative Agent, Fronting Bank and L/C Administrator,
and the lenders party thereto
Subsidiaries of Registrant (filed herewith)
Consent of PricewaterhouseCoopers LLP (filed herewith)
Power of Attorney (filed herewith)
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-
Oxley Act of 2002 (filed herewith)
8-K/A
10.1
April 11, 2018
10-K
8-K
10-Q
10-Q
8-K
10.24
2.1
10.1
10.2
10.1
March 2, 2009
August 16, 2016
August 4, 2017
August 4, 2017
October 26, 2016
X
X
X
X
X
ARCH CAPITAL
182
2018 FORM 10-K
31.2
32.1
32.2
101
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-
Oxley Act of 2002 (filed herewith)
Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-
Oxley Act of 2002 (filed herewith)
Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-
Oxley Act of 2002 (filed herewith)
The following financial information from ACGL’s Annual Report on Form 10-K
for the year ended December 31, 2018 formatted in XBRL: (i) Consolidated
Balance Sheets at December 31, 2018 and 2017; (ii) Consolidated Statements of
Income for the years ended December 31, 2018, 2017 and 2016; (iii) Consolidated
Statements of Comprehensive Income for the years ended December 31, 2018,
2017 and 2016; (iv) Consolidated Statements of Changes in Shareholders’ Equity
for the years ended December 31, 2018, 2017 and 2016; (v) Consolidated
Statements of Cash Flows for the years ended December 31, 2018, 2017 and 2016;
and (vi) Notes to Consolidated Financial Statements
† Management contract or compensatory plan or arrangement.
X
X
X
X
ARCH CAPITAL
183
2018 FORM 10-K
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this
report to be signed on its behalf by the undersigned, thereunto duly authorized.
SIGNATURES
ARCH CAPITAL GROUP LTD.
(Registrant)
By:
/s/ Marc Grandisson
Name: Marc Grandisson
Title:
President and Chief Executive Officer (Principal Executive
Officer)
February 28, 2019
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on
behalf of the Registrant and in the capacities and on the dates indicated.
Name
Title
Date
/s/ Marc Grandisson
Marc Grandisson
/s/ François Morin
François Morin
President and Chief Executive Officer (Principal Executive Officer)
Executive Vice President and Chief Financial Officer (Principal Financial
Officer and Principal Accounting Officer)
*
Constantine Iordanou
Chairman of the Board
*
John L. Bunce. Jr.
Director
*
Eric W. Doppstadt
Director
*
Laurie S. Goodman
Director
February 28, 2019
February 28, 2019
February 28, 2019
February 28, 2019
February 28, 2019
February 28, 2019
ARCH CAPITAL
184
2018 FORM 10-K
Name
*
Title
Date
Louis J. Paglia
Director
February 28, 2019
*
John M. Pasquesi
Director
*
Brian S. Posner
Director
*
Eugene S. Sunshine
Director
*
John D. Vollaro
Director
February 28, 2019
February 28, 2019
February 28, 2019
February 28, 2019
___________________
*
By François Morin, as attorney-in-fact and agent, pursuant to a power of attorney, a copy of which has been filed with the
Securities and Exchange Commission as Exhibit 24 to this report.
/s/ François Morin
Name:
François Morin
Attorney-in-Fact
ARCH CAPITAL
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2018 FORM 10-K
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
SUPPLEMENTARY INSURANCE INFORMATION
(U.S. dollars in thousands)
SCHEDULE III
Deferred
Acquisition
Costs
Reserves for
Losses and
Loss
Adjustment
Expenses
Unearned
Premiums
Net
Premiums
Earned
Net
Investment
Income (1)
Net Losses
and Loss
Adjustment
Expenses
Incurred
Amortization
of Deferred
Acquisition
Costs
Other
Operating
Expenses (2)
Net
Premiums
Written
December 31, 2018
Insurance
Reinsurance
Mortgage
Other
Total
December 31, 2017
Insurance
Reinsurance
Mortgage
Other
Total
December 31, 2016
Insurance
Reinsurance
Mortgage
Other
Total
$152,360
166,276
170,080
80,858
$569,574
$7,093,018
3,215,909
511,610
1,032,760
$11,853,297
$1,549,183
710,774
1,103,565
390,114
$3,753,636
$2,205,661
1,261,216
1,186,236
578,862
$5,231,975
$159,224
150,582
140,057
85,961
$535,824
$6,952,676
3,053,694
579,160
798,262
$11,383,792
$1,451,390
633,810
1,206,470
330,644
$3,622,314
$2,113,018
1,142,621
1,057,166
531,727
$4,844,532
$152,983
121,806
86,392
86,379
$447,560
$6,502,745
2,506,239
681,167
510,809
$10,200,960
$1,403,822
532,759
1,176,809
293,480
$3,406,870
$2,073,904
1,056,232
286,716
467,970
$3,884,822
NM
NM
NM
NM
NM
NM
NM
NM
NM
NM
NM
NM
NM
NM
NM
$1,520,680
846,882
81,289
441,255
$2,890,106
$1,622,444
773,923
134,677
436,402
$2,967,446
$1,622,444
773,923
134,677
436,402
$2,967,446
$349,702
211,280
118,595
125,558
$805,135
$323,639
221,250
100,598
129,971
$775,458
$323,639
221,250
100,598
129,971
$775,458
$364,138
133,350
142,432
37,889
$677,809
$2,212,125
1,372,572
1,157,875
604,175
$5,346,747
$359,524
146,663
146,336
31,928
$684,451
$2,122,440
1,174,474
1,111,342
553,117
$4,961,373
$359,524
146,663
146,336
31,928
$684,451
$2,122,440
1,174,474
1,111,342
553,117
$4,961,373
(1)
(2)
The Company does not manage its assets by segment and, accordingly, net investment income is not allocated to each underwriting segment. See note 4,
“Segment Information,” to our consolidated financial statements in Item 8 for information related to the ‘other’ segment.
Certain other operating expenses relate to the Company’s corporate segment (non-underwriting). Such amounts are not reflected in the table above. note
4, “Segment Information,” to our consolidated financial statements in Item 8 for information related to the corporate segment.
ARCH CAPITAL
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2018 FORM 10-K
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
REINSURANCE
(U.S. dollars in thousands)
Gross Amount
Ceded to Other
Companies (1)
Assumed From
Other
Companies (1)
Net
Amount
Percentage of
Amount
Assumed to Net
SCHEDULE IV
$
$
$
$
$
$
3,232,234
213,809
1,139,099
253,760
4,838,902
3,050,876
152,404
1,110,319
133,858
4,447,457
2,999,106
62,427
209,351
66,806
3,337,690
$
$
$
$
$
$
(1,050,207)
(539,950)
(202,833)
(130,840)
(1,614,257)
(958,646)
(465,925)
(256,796)
(47,187)
(1,407,052)
(954,768)
(440,541)
(108,259)
(21,306)
(1,170,743)
$
$
$
$
$
$
30,098
1,698,713
221,609
481,255
2,122,102
30,210
1,487,995
257,819
466,446
1,920,968
27,943
1,431,970
290,374
468,288
1,864,444
$
$
$
$
$
$
2,212,125
1,372,572
1,157,875
604,175
5,346,747
2,122,440
1,174,474
1,111,342
553,117
4,961,373
2,072,281
1,053,856
391,466
513,788
4,031,391
1.4%
123.8%
19.1%
79.7%
39.7%
1.4%
126.7%
23.2%
84.3%
38.7%
1.3%
135.9%
74.2%
91.1%
46.2%
Year Ended December 31, 2018
Premiums Written:
Insurance
Reinsurance
Mortgage
Other
Total
Year Ended December 31, 2017
Premiums Written:
Insurance
Reinsurance
Mortgage
Other
Total
Year Ended December 31, 2016
Premiums Written:
Insurance
Reinsurance
Mortgage
Other
Total
(1) Certain amounts included in the gross premiums written of each segment are related to intersegment transactions and are included in the
gross premiums written of each segment. 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.
ARCH CAPITAL
187
2018 FORM 10-K
SCHEDULE VI
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
SUPPLEMENTARY INFORMATION FOR PROPERTY AND CASUALTY INSURANCE UNDERWRITERS
(U.S. dollars in thousands)
Column A
Column B
Column C
Column D
Column E
Column F
Column G
Column H
Column I
Column J
Column K
Affiliation
with
Registrant
Deferred
Acquisition
Costs
Reserves for
Losses and
Loss
Adjustment
Expenses
Discount, if
any,
deducted in
Column C
Net Losses and Loss
Adjustment Expenses
Incurred Related to
Unearned
Premiums
Net
Premiums
Earned
Net
Investment
Income
(a)
Current
Year
(b)
Prior
Years
Amortization
of Deferred
Acquisition
Costs
Net Paid
Losses and
Loss
Adjustment
Expenses
Net
Premiums
Written
Consolidated
Subsidiaries
2018
2017
2016
$
569,574 $ 11,853,297 $
21,145 $ 3,753,636 $ 5,231,975 $
563,633 $ 3,162,818 $ (272,712) $
805,135 $ 2,206,164 $ 5,346,747
535,824
11,383,792
447,560
10,200,960
20,016
18,246
3,622,314
4,844,532
470,872
3,205,428
(237,982)
3,406,870
3,884,822
366,742
2,455,563
(269,964)
775,458
667,625
2,352,912
4,961,373
1,813,356
4,031,391
ITEM 16. FORM 10-K SUMMARY
Not applicable.
ARCH CAPITAL
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2018 FORM 10-K
ARCH CAPITAL GROUP LTD.
CORPORATE INFORMATION
Directors
Constantine Iordanou 3, 4
Chairman
John L. Bunce, Jr. 2, 3, 4, 5
Managing Director of Greyhawk Capital Management, LLC
and Senior Advisor to Hellman & Friedman LLC
Eric W. Doppstadt 4, 5
Vice President and Chief Investment Officer of the
Ford Foundation
Laurie S. Goodman 1, 6
Vice President at the Urban Institute and
Founder and Co-Director of its Housing Finance Policy Center
Yiorgos Lillikas 1, 6
President of the Parliamentarian Committee for International
and European Affairs of the Republic of Cyprus,
Former Minister of Foreign Affairs of the Republic of
Cyprus (E.U.) and Former Minister of Commerce, Industry
and Tourism of the Republic of Cyprus
Louis J. Paglia 1, 2, 5, 6
Founder of Oakstone Capital LLC and Former Executive
Vice President of UIL Holdings Corporation
John M. Pasquesi 2, 3, 4, 5, 6
Lead Director
Vice Chairman
Managing Member of Otter Capital LLC
Brian S. Posner 1, 4, 6
President of Point Rider Group LLC
Eugene S. Sunshine 1, 2, 5
Former Senior Vice President for Business and Finance
at Northwestern University
John D. Vollaro 4, 6
Senior Advisor
Former Executive Vice President, Chief Financial Officer
and Treasurer
Officers
Dennis R. Brand
Chairman, Worldwide Services
David E. Gansberg
Chief Executive Officer of Global Mortgage Group
Marc Grandisson 3
President and Chief Executive Officer
Director
W. Preston Hutchings
Senior Vice President and Chief Investment Officer, and
President of Arch Investment Management Ltd.
François Morin
Executive Vice President, Chief Financial Officer
and Treasurer
Nicolas Papadopoulo
Chairman and Chief Executive Officer of Arch Worldwide
Insurance Group and Chief Underwriting Officer for Property
and Casualty Operations
Louis T. Petrillo
General Counsel
President of Arch Capital Services Inc.
Maamoun Rajeh
Chairman and Chief Executive Officer of Arch Worldwide
Reinsurance Group
Andrew T. Rippert
Chief Innovation and Strategic Investment Officer
Carl D. Sullo
Chief Human Resources Officer
Real Estate and Administrative Services
1 Audit Committee
2 Compensation Committee
3 Executive Committee
4 Finance, Investment and Risk Committee
5 Nominating and Governance Committee
6 Underwriting Oversight Committee
SHAREHOLDER INFORMATION
Corporate Address
Waterloo House, Ground Floor
100 Pitts Bay Road
Pembroke HM 08
Bermuda
(441) 278-9250
(441) 278-9255 facsimile
Market Information
The common shares of Arch Capital Group Ltd. are
listed on the NASDAQ Global Select Market under the
symbol ACGL.
Transfer Agent
American Stock Transfer & Trust Company, LLC
6201 15th Avenue
Brooklyn, New York 11219
Shareholder Inquiries
François Morin
Executive Vice President, Chief Financial Officer
and Treasurer
(441) 278-9250
(441) 278-9255 facsimile
Arch Capital Group Ltd.
Waterloo House, Ground Floor | 100 Pitts Bay Road, Pembroke HM 08 Bermuda
T: 441 278 9250 F: 441 278 9255 archcapgroup.com