Exhibit 10.7


 


SECOND AMENDED AND
RESTATED

ARCH CAPITAL GROUP LTD. INCENTIVE COMPENSATION PLAN


 


SECTION 1.         Purpose.


 


Arch Capital Group Ltd., a Bermuda company (the “Company”),
hereby establishes this Incentive Compensation Plan (as amended from time to
time, the “Plan”) in order to provide the Company’s employees with an
opportunity to earn annual bonus compensation as an incentive and reward for
their efforts to achieve the financial and strategic objectives of the Company.


 


SECTION 2.         Definitions.


 


2.1                                 “After-Tax Profit (Loss)” has the
meaning specified on Schedule I hereto.


 


2.2                                 “Aggregate Target Amount” has the
meaning specified in Section 4.3(a) hereof.


 


2.3                                 “Award” means the amount of bonus
compensation to which an Eligible Employee is entitled for each Plan Year as
determined by the Committee pursuant to Section 4 and 5 of the Plan.


 


2.4                                 “Board” means the Board of Directors
of the Company.


 


2.5                                 “Cash Flow” has the meaning specified
on Schedule I hereto.


 


2.6                                 “CAT Business” means business
classified by the Company as property catastrophe reinsurance.


 


2.7                                 “Cause”  means, with respect to an Eligible Employee, (a) theft
or embezzlement by the Eligible Employee with respect to the Company or its
Subsidiaries; (b) malfeasance or negligence in the performance of the
Eligible Employee’s duties; (c) the commission by the Eligible Employee of
any felony or any crime involving moral turpitude; (d) willful or
prolonged absence from work by the Eligible Employee (other than by reason of
disability due to physical or mental illness); (e) failure, neglect or
refusal by the Eligible Employee to adequately perform his or her duties and
responsibilities as determined by the Company; (f) continued and habitual
use of alcohol by the Eligible Employee to an extent which materially impairs
the Eligible Employee’s performance of his or her duties without the same being
corrected within ten (10) days after being given written notice thereof;
or (g) the Eligible Employee’s use of illegal drugs without the same being
corrected within ten (10) days after being given written notice thereof.


 


2.8                                 “Code” means the Internal Revenue Code
of 1986, as amended, including applicable regulations thereunder.


 


2.9                                 “Committee” means the Compensation
Committee of the Board, or such other Board committee or subcommittee (or the
entire Board) as may be designated by the Board to administer the Plan.


 

















 


2.10                           “Company” has the meaning specified in Section 1 hereof or
any successor.


 


2.11                           “Deficits” has the meaning specified in Section 4.3(d) hereof.


 


2.12                           “Development Period” has the meaning specified in Section 4.3(e) hereof.


 


2.13                           “Earned” has the meaning specified in Section 4.3(c) hereof.


 


2.14                           “Eligible Employee” means an employee of the Company or its
Subsidiaries, including any director who is an employee, who is selected to
participate in the Plan by the Committee.


 


2.15                           “Employer” means the Company, Arch
Reinsurance Ltd., Arch Reinsurance Company, Arch Capital Group (U.S.) Inc.,
Arch Insurance Group Inc. and its Subsidiaries, Arch Capital Services Inc., and
any other Subsidiary of the Company that becomes an Employer in accordance with
Section 8.1 hereof.


 


2.16                           “Equity” has the meaning specified on Schedule
I hereto.


 


2.17                           “Formula Approach” has the meaning
specified in Section 4.1 hereof.


 


2.18                           “Formula Approach Pool” has the
meaning specified in Section 4.3(a) hereof.


 


2.19                           “Hurdle ROE” has the meaning specified
in Section 4.3(b) hereof.


 


2.20                           “Insurance Segment” means the business
segment of the Company consisting of its core insurance Subsidiaries, including
Arch Insurance Group Inc. and its Subsidiaries, and any other insurance
Subsidiary of the Company that becomes an Employer in accordance with Section 8.1
hereof.


 


2.21                           “Investment Income” has the meaning specified on Schedule I
hereto.


 


2.22                           “Maximum Carryforward Amount” has the meaning specified in Section 4.3(c) hereof.


 


2.23                           “Maximum Formula Approach Pool” has the meaning specified in Section 4.3(c) hereof.


 


2.24                           “Operating Expenses” has the meaning
specified on Schedule I hereto.


 


2.25                           “Permanent Disability”  means, with respect to an Eligible
Employee, those circumstances where the Eligible Employee is unable to continue
to perform the usual customary duties of his or her assigned job for a period
of six (6) months in any twelve (12) month period because of physical,
mental or emotional incapacity resulting from injury, sickness or disease.  Any questions as to the existence of a
Permanent Disability shall be determined by a qualified, independent physician
selected by the Company and approved by the Eligible Employee (which 


 


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approval shall not be unreasonably
withheld).  The determination of any such
physician shall be final and conclusive for all purposes of this Plan.


 


2.26                           “Plan” has the meaning specified in Section 1
hereof.


 


2.27                           “Plan Year” means (i) with respect to the Target Bonus
Approach, a calendar year and (ii) with respect to the Formula Approach,
an underwriting (or policy) year commencing on January 1 and ending on December 31
during which an accounting shall be made for all Underwriting Profit (Loss)
attributable to Policies having an inception or renewal date during such
12-month period.


 


2.28                           “Policies” means policies, binders,
contracts or agreements of insurance or reinsurance.


 


2.29                           “Pre-Tax Profit” has the meaning
specified on Schedule I hereto.


 


2.30                           “Reinsurance Segment” means the
business segment of the Company consisting of its core reinsurance
Subsidiaries, including Arch Reinsurance Ltd. and Arch Reinsurance Company, and
any other reinsurance Subsidiary of the Company that becomes an Employer in
accordance with Section 8.1 hereof.


 


2.31                           “ROE” has the meaning specified on Schedule I hereto.


 


2.32                           “Senior Executives” has the meaning
set forth in Section 4.1 hereof.


 


2.33                           “Subsidiary” means any corporation
(other than the Company) in an unbroken chain of corporations beginning with
the Company if each of the corporations (other than the last corporation in the
unbroken chain) owns shares possessing 50% or more of the total combined voting
power of all classes of stock in one of the other corporations in the chain.


 


2.34                           “Target Bonus Approach” has the meaning specified in Section 4.1
hereof.


 


2.35                           “Target Bonus Approach Pool” has the meaning specified in Section 4.2(a) hereof.


 


2.36                           “Target Bonus Opportunity” means, with respect to each Eligible
Employee, a target bonus expressed as a percentage of his or her annual base
salary, which is intended as an approximation of the bonus payment that would
be paid if aggressive performance goals and other expectations are met by both
the Eligible Employee and the business segment or unit he or she is employed
by.  The Target Bonus Opportunity for
each Eligible Employee shall be periodically established (i) by senior
management of the applicable business segment or unit and (ii) by the
Committee, in the case of certain Senior Executives designated by the Committee
(subject to applicable employment agreements).


 


2.37                           “Underwriting Profit (Loss)” has the meaning specified on Schedule
I hereto.


 


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2.38                           “Retirement Age” means the later of an
Eligible Employee’s 55th birthday or the fifth anniversary of the first
day of the Plan Year in which such Eligible Employee’s participation in the
Plan commenced.


 


SECTION 3.         Administration.


 


The Plan shall be administered by the
Committee.  The Committee shall have the
authority, in its sole discretion, to administer the Plan and to exercise all
of the powers and authorities either specifically granted to it under the Plan
or necessary or advisable in the administration of the Plan, including, without
limitation, the authority to (i) establish performance goals for the
awarding of Awards for each Plan Year; (ii) determine the Eligible
Employees to whom Awards are to be made for each Plan Year; (iii) determine
whether performance goals for each Plan Year have been achieved; (iv) authorize
payment of Awards under the Plan; (v) adopt, alter and repeal such
administrative rules, guidelines and practices governing the Plan and make all
other determinations and judgments relating to the Plan as it shall deem
advisable; and (vi) interpret the terms and provisions of the Plan;
provided that neither the Committee nor the Board shall have any discretion to
reduce any previously determined Award. 
All determinations made by the Committee with respect to the Plan and
Awards thereunder shall be final and binding on all persons, including the
Company and all Eligible Employees.


 


SECTION 4.         Determination of Awards.


 


4.1                                 Performance Measures.  The
Plan combines two sets of performance measures: 
(i) a qualitative judgment about progress and performance each Plan
Year based on a number of factors, including the management plan for such Plan
Year and non-prescribed measures (the “Target Bonus Approach”), as set
forth in Section 4.2 hereof; and (ii) a quantitative, formula-based
measure (the “Formula Approach”), as set forth in Section 4.3
hereof.  The Target Bonus Approach shall
apply to certain senior executives (the “Senior Executives”) of each of
the insurance and reinsurance Subsidiaries of the Company designated by the
Committee from time to time.  The Formula
Approach shall apply to those Eligible Employees designated by the Senior
Executives.  All Eligible Employees of
Arch Capital Services Inc. and any non-designated Eligible Employees shall be
subject to the Target Bonus Approach. 
Awards under the Target Bonus Approach and the Formula Approach shall be
determined as set forth in Section 4.2 and Section 4.3, respectively,
and shall be payable as set forth in Section 5 hereof.


 


4.2                                 Target Bonus Approach.


 


(a)                                  Target Bonus Approach Pool.  Under
the Target Bonus Approach, a separate bonus pool shall be established for the
Company, the Insurance Segment, the Reinsurance Segment and Arch Capital
Services Inc. for each Plan Year (each, a “Target Bonus Approach Pool”).  The Target Bonus Approach Pool for each
segment for any given Plan Year shall initially equal the sum of the individual
Target Bonus Opportunities for each Eligible Employee included in such segment,
which amount shall be adjusted upward or downward to reflect the segment’s
actual performance as recommended by senior management of the applicable
business segment or unit but determined by the 


 


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Committee. 
Performance shall be judged against the achievement of the strategic and
financial objectives contained in the applicable management plan submitted to
the Board for the Plan Year, peer group performance and other measures deemed
applicable by the Committee.


 


(b)                                 Individual Participation.  At the individual level, actual performance bonuses for each Eligible
Employee shall reflect both individual and segment performance.  An Eligible Employee’s participation in the
applicable Target Bonus Approach Pool shall be initially based on his or her
Target Bonus Opportunity, which participation shall be adjusted based on his or
her performance.  Any such adjustments
(other than those for Senior Executives, as determined by the Committee) shall
be made in a zero sum manner and not affect the overall size of the Target
Bonus Approach Pool.  All performance
assessments shall include both objective and subjective elements, and the general
performance weighting guidelines between segment and individual performance to
be applied to an Eligible Employee’s Target Bonus Opportunity shall be
determined by senior management of the applicable business segment or unit.


 


4.3                                 Formula Approach.


 


(a)                                  Formula Approach Pool.  Under
the Formula Approach, a separate bonus pool shall be established for the
Insurance Segment and the Reinsurance Segment for each Plan Year and other
separate bonus pools may be established by the Committee (each, a “Formula
Approach Pool”).  Unless otherwise
determined by the Committee, any Underwriting Profit (Loss) generated from
business initially underwritten by the Insurance Segment and re-underwritten by
the Reinsurance Segment shall be applied solely to the Insurance Segment’s
Formula Approach Pool.  The Formula
Approach Pool for each of the Insurance Segment, the Reinsurance Segment and
any other segment pools for any given Plan Year shall initially equal the sum
of the individual Target Bonus Opportunities for each Eligible Employee
included in such segment (each, an “Aggregate Target Amount”).  The actual Formula Approach Pool will be a
percentage of the Aggregate Target Amount based upon the ROE achieved for such
Plan Year.  Schedule II sets forth
the size of the Formula Approach Pool based on various levels of ROE, which
schedule shall be reviewed and may be adjusted by the Committee for each Plan
Year.


 


(b)                                 Hurdle ROE.  With
respect to the Insurance Segment, the Reinsurance Segment and any other
segments, no Awards shall be payable for a given Plan Year unless a minimum ROE
of 8%, without taking into account any amounts carried forward pursuant to Section 5.3(c) hereof
(the “Hurdle ROE”), is achieved by such segment for such Plan Year.


 


(c)                                  Maximum Formula Approach
Pool; Carryforwards.  For any given Plan Year, the maximum Formula
Approach Pool for each of the Insurance Segment, the Reinsurance Segment and
any other segments shall equal 200% of the applicable Aggregate Target Amount
(each, a “Maximum Formula Approach Pool”).  For any given Plan Year, on and after the
third anniversary of the end of such Plan Year, Earned amounts in excess of
each Maximum Formula Approach Pool up to an additional 200% 


 


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of such applicable Aggregate Target Amount
(the “Maximum Carryforward Amount”) shall be carried forward and made
available, only to Eligible Employees who participated in such Plan Year, in
Plan Years subsequent to such Plan Year where the applicable Maximum Formula
Approach Pool is not expected to be Earned by the end of the applicable
Development Period, provided that the Earned amount which may be carried
forward to any subsequent Plan Year shall not exceed 25% of the Earned Maximum
Carryforward Amount.  Notwithstanding
anything set forth in the Plan, for a given Plan Year, amounts payable with
respect to each of the Insurance Segment, the Reinsurance Segment and any other
segment shall not exceed 15% of the Pre-Tax Profit for such segment,
respectively, for such Plan Year.  For
purposes hereof, with respect to a given amount, “Earned” means the
inception-to-date actual amount calculated for the applicable item through the
end of the period being calculated.


 


(d)                                 Deficits. 
After-Tax Losses (and not After-Tax Profit that is below the Hurdle ROE)
for a given Plan Year (“Deficits”) shall offset available After-Tax
Profit in subsequent Plan Years until all Deficits are eliminated.


 


(e)                                  Development Period.  For
each Plan Year, the Formula Approach Pool for each of the Insurance Segment,
the Reinsurance Segment and any other segment shall be calculated annually for
10 years (a “Development Period”). 
The first calculation shall be made within two and one half months
following the end of the initial 12-month calendar year period included in each
Plan Year, and the final calculation shall be made within two and one half
months following the end of the tenth year following the commencement of such
Plan Year, with losses and loss adjustment expenses (if any) projected to
ultimate and discounted to present value basis at such time.


 


(f)                                    CAT Business.  The
results of CAT Business shall be calculated over five-year periods based on
actual catastrophe experience (terrorism included).  Accordingly, at the end of (i) the fifth
Plan Year and (ii) each five-year period thereafter, Underwriting Profit
(Loss) and Cash Flow shall be initially determined for CAT Business for such
five-year period, and then such Underwriting Profit (Loss) and Cash Flow shall
be allocated to each Plan Year included in the five-year period based on net premiums
written attributable to CAT Business Policies having an inception or renewal
date within such Plan Year.  Following
such initial calculation, the results of CAT Business shall be part of the
annual recalculations of Underwriting Profit (Loss) and Cash Flow for the
remainder of the respective Development Period relating to each Plan Year.


 


(g)                                 Individual Participation. 
Individual participation in the applicable Formula Approach Pool shall
be initially determined based on the relative Target Bonus Opportunity of each
of the designated Eligible Employees and shall be subject to adjustment each
Plan Year by senior management of the applicable business segment or unit based
on criteria it deems appropriate, provided that any such adjustments shall be
made in a zero sum manner and not affect the overall size of the applicable
Formula Approach Pool.


 


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(h)                                 Board Review of Formula
Approach.  If the Board or the Committee determines that
the Formula Approach results in compensation levels that do not appropriately
reflect the Company’s underlying performance, then the Board or the Committee
may terminate the Formula Approach or make adjustments to it that it deems
appropriate.


 


SECTION 5.         Payment of Awards.


 


5.1                                 Form of Award. 
Except as otherwise provided in Section 8.9 below, any Awards
payable under this Plan shall be paid in cash.


 


5.2                                 Payout Period.  For
each Plan Year, and subject to Section 5.3 hereof, Awards under the Target
Bonus Approach shall be paid after the end of the Plan Year and no later than March 15
of the of the year immediately following the Plan Year.  For each Plan Year, and subject to Section 5.3
hereof, Awards under the Formula Approach shall be paid over a four-year period
as follows:  40% shall be paid after the
end of the Plan Year and no later than March 15 of the of the year
immediately following the Plan Year (based on Company performance determined
consistent with Section 4.3 above through the end of the Plan Year), and
20% shall be paid no earlier than January 1 and no later than March 15
of each of the years immediately following the end of each of the next three
calendar years, in each case based on Company performance determined consistent
with Section 4.3 above through the end of the calendar year immediately
preceding the year of payment.  If,
following such initial four-year period relating to a given Plan Year, any
additional amounts are owed to Eligible Employees under the Formula Approach as
a result of recalculation of the applicable Formula Approach Pool based on
Company performance through the end of a calendar year, then such amounts shall
be paid to such Eligible Employees no earlier than January 1 and no later
than March 15 of the immediately following calendar year.  Notwithstanding the foregoing, the payment
schedule for Eligible Employees subject to the Formula Approach who are junior
employees may be modified by senior management, but no such modification may
result in any amount being paid later than March 15 of the calendar year
immediately following the calendar year for which Company performance is used
to determine the amount of the payment.


 


5.3                                 Continued Service.  Each
Eligible Employee must be employed by the Company at the time of each payment
of an Award; provided, however, that, (x) in the event an Eligible
Employee ceases to be an employee of the Company after the Award for a Plan
Year is determined and communicated to the Eligible Employee but prior to the
date all payments under an Award are made (i) due to termination (A) by
the Company not for Cause or (B) with respect to an Eligible Employee
designated by the Committee, by the Eligible Employee for Good Reason (as
defined within such Eligible Employee’s employment agreement, unless otherwise
determined by the Committee), or (ii) as a result of death of the Eligible
Employee, the Award shall no longer be subject to the condition that the
Eligible Employee remain employed through the time of payment and payments
under the Award shall be made when such Award payments are regularly made
hereunder following such termination of employment (the amount of such
payments, if any, shall be as calculated herein and, in the case of Formula
Approach Awards, shall be based on the continued performance of the Company as
set forth in Section 4.3 hereof); and (y) in the event an Eligible
Employee ceases to be an employee of the Company prior to the 


 


7

















 


date all payments under an
Award are made (i) due to termination as a result of Permanent Disability
or (ii) due to termination of employment (other than by the Company for
Cause) after the attainment of Retirement Age, payments under such Award shall
continue to be made when the Award payments are normally made hereunder (the
amount of such payments, if any, shall be as calculated herein and, in the case
of Formula Approach Awards, be based on the continued performance of the
Company as set forth in Section 4.3 hereof), so long as, prior to the
applicable payment date, such Eligible Employee does not engage in any activity
in competition with any activity of the Company or any of its Subsidiaries
other than serving on the board of directors (or similar governing body) of
another company or as a consultant for no more than 26 weeks per calendar year;
provided that if the Eligible Employee does engage in such activity
after termination for such reasons, any unpaid portion of the Award shall be
forfeited by the Eligible Employee and become the property of the Company.  For purposes hereof, service with any of the
Company’s Subsidiaries shall be considered to be service with the Company.


 


If the Eligible Employee
ceases to be an employee of the Company for any other reason prior to the date
that all amounts under an Award are paid, the Award, including applicable
carryforwards, shall be forfeited by the Eligible Employee and become the
property of the Company.  For purposes
hereof, service with any of the Subsidiaries shall be considered to be service
with the Company.  In the case of Awards
made under the Formula Approach, the Awards shall include applicable
carryforwards and Deficits, and terminated employees’ forfeited Awards,
including applicable carryforwards, shall be removed from the applicable bonus
pool.


 


SECTION 6.         Non-Transferability.


 


No Award or rights under this Plan may be
transferred or assigned other than by will or by the laws of descent and
distribution.


 


SECTION 7.         Amendments and Termination.


 


The Board may terminate the Plan at any time and may
amend it from time to time, provided, however, that no termination or
amendment of the Plan shall adversely affect the rights of an Eligible Employee
or a beneficiary to a previously determined Award without the written consent
of such Eligible Employee or beneficiary.


 


SECTION 8.         General Provisions.


 


8.1                                 Subsidiaries.  Any
Subsidiary of the Company may, upon approval by the Committee, become an
Employer under the terms of the Plan. 
Notwithstanding any provision of the Plan to the contrary, benefits
payable under the Plan to an Eligible Employee or his or her beneficiary shall
be the obligation of the Employer who actually employs (or, in the case an
Eligible Employee who is no longer employed by an Employer, last employed) the
Eligible Employee; provided, however, that in the event the
Eligible Employee’s employer fails to make a payment of benefits to the
Eligible Employee or his or her beneficiary when due under the terms of the
Plan, the Company (the parent company of the Employers) shall be obligated to
make such benefit payments in accordance with the terms of the Plan.


 


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8.2                                 Unfunded Plan.  The
Plan shall be an unfunded incentive compensation arrangement.  Nothing contained in the Plan, and no action
taken pursuant to the Plan, shall create or be construed to create a trust of
any kind.  An Eligible Employee’s right
to receive a bonus shall be no greater than the right of an unsecured general
creditor of the Company.  All bonuses
shall be paid from the general funds of the Employers, and no segregation of
assets shall be made to ensure payment of bonuses.


 


8.3                                 Withholding.  The Company may provide for
the withholding from any benefits payable under this Plan all Federal, state,
city or other taxes as shall be required pursuant to any law or governmental
regulation or ruling.


 


8.4                                 Excess Parachute Payments.


 


(a)                                  Notwithstanding any other provision of the
Plan, in the event that the amount of payments or other benefits payable to any
Eligible Employee under the Plan (including, without limitation, the
acceleration of any payment or the accelerated vesting of any payment or other
benefit), together with any payments, awards or benefits payable under any
other plan, program, arrangement or agreement maintained by the Company or one
of its affiliates, would constitute an “excess parachute payment” (within the
meaning of Section 280G of the Code), the payments under this Plan shall
be reduced (by the minimum possible amounts) until no amount payable to the
Eligible Employee under the Plan constitutes an “excess parachute payment”
(within the meaning of Section 280G of the Code); provided, however,
that no such reduction shall be made if the net after-tax payment (after taking
into account Federal, state, local or other income, employment and excise
taxes) to which the Eligible Employee would otherwise be entitled without such
reduction would be greater than the net after-tax payment (after taking into
account Federal, state, local or other income, employment and excise taxes) to
the Eligible Employee resulting from the receipt of such payments with such
reduction.


 


(b)                                 All determinations required to be made under
this Section 8.4, including whether a payment would result in an “excess
parachute payment” and the assumptions to be utilized in arriving at such
determinations, shall be made by an accounting firm designated by the Company
(the “Accounting Firm”) which shall provide detailed supporting
calculations both to the Company and the Eligible Employee as requested by the
Company or the Eligible Employee.  All
fees and expenses of the Accounting Firm shall be borne solely by the Company
and shall be paid by the Company.  Absent
manifest error, all determinations made by the Accounting Firm under this Section 8.4
shall be final and binding upon the Company and the Eligible Employee.


 


(c)                                  In the event the Eligible Employee has an
employment agreement in effect with the Company or an affiliate providing for a
similar excess parachute payment cutback, the cutback calculations and
determinations under this Section 8.4 will be coordinated with the cutback
calculations and determinations under the employment agreement, resulting in
one calculation and one cutback determination. 
Any required 


 


9

















 


 


cutback shall be made first to payments as provided under the
employment agreement and then to payments under this Plan.


 


8.5                                 Hold Harmless.  No
member of the Board of the Committee, nor any officer or employee of the
Company acting on behalf of the Board or the Committee, shall be personally
liable for any action, determination or interpretation taken or made with
respect to the Plan, and all members of the Board or the Committee and all
officers or employees or the Company acting on their behalf shall, to the extent
permitted by law, be fully indemnified and protected by the Company in respect
of any such action, determination or interpretation.


 


8.6                                 Other Benefits; No Right of Employment. 
Nothing set forth in this Plan shall prevent the Board or the Committee from
adopting other or additional compensation arrangements.  Neither the adoption of the Plan or any Award
hereunder shall confer upon an Eligible Employee any right to continued
employment.


 


8.7                                 Captions.  The captions preceding the
sections and articles hereof have been inserted solely as a matter of
convenience and in no way define or limit the scope or intent of any provisions
of the Plan.


 


8.8                                 Governing Law.  The
Plan shall be interpreted, construed and administered in accordance with the
laws of the State of New York, without giving effect to principles of conflict
of laws.


 


8.9                                 Section 162(m). 
Payments under this Plan may be deferred by the Committee to the extent
that the Committee reasonably anticipates that, if the payment were made as
scheduled, the United States federal income tax deduction of any Subsidiary
that is subject to United States federal income tax would not be permitted for
the payment due to the application of Section 162(m) of the
Code.  Any payment deferred under this Section 8.9
shall be made, subject to the possible application of the delay provided for in
Section 8.10 below, as soon as reasonably practicable following the first
date on which the Company anticipates or reasonably should anticipate that, if
the payment were made on such date, the Subsidiary’s deduction with respect to
such payment would no longer be restricted due to the application of Section 162(m) of
the Code.  With respect to any amount
deferred under this Section 8.9, the Committee, in its discretion, may
credit notional earnings on the amount or substitute for the deferred payment,
restricted share units in respect of common shares of the Company having a fair
market value equal to the amount of the deferred payment, and common shares
subject to the restricted share units shall be distributed at the time payments
are to be made in accordance with this Section 8.9.  Any restricted share units shall be granted
under the Company’s 2007 Long Term Incentive and Share Award Plan (or any
successor plan).  If any scheduled
payment to an Eligible Employee in a calendar year is delayed in accordance
with this Section 8.9, all scheduled payments to that Eligible Employee
that could be delayed in accordance with Treas. Reg. § 1.409A-2(b)(7)(i) shall
also be delayed.  For purposes of any
deferral under this Section 8.9, the Company shall treat all payments to
similarly situated employees on a reasonably consistent basis.


 


8.10                           Sections 409A and 457A.  It is intended that the Plan will comply with
Sections 409A and 457A of the Code (and any regulations and guidelines issued
thereunder) to the extent 


 


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it is subject thereto, and
the Plan shall be interpreted on a basis consistent with such intent.  The Plan may be amended in any respect deemed
by the Board or the Committee to be necessary in order to preserve compliance
with Sections 409A and 457A of the Code. 
Notwithstanding any provision to the contrary in this Plan, if an
Eligible Employee is deemed on the date of his or her “separation from service”
(within the meaning of Treas. Reg. Section 1.409A-1(h)) with the Company
and its affiliates to be a “specified employee” (within the meaning of Treas.
Reg. Section 1.409A-1(i)), then with regard to any payment that is
considered deferred compensation under Section 409A payable on account of
a “separation from service” that is required to be delayed pursuant to Section 409A(a)(2)(B) of
the Code (after taking into account any applicable exceptions to such
requirement), such payment shall be made on the date that is the earlier of (i) the
expiration of the six (6)-month period measured from the date of the Eligible
Employee’s “separation from service,” or (ii) the date of the Eligible
Employee’s death (the “Delay Period”). 
Upon the expiration of the Delay Period, all payments delayed pursuant
to this Section shall be paid to the Eligible Employee in a lump sum. The
Company shall not have any obligation to indemnify or otherwise protect the
Eligible Employee from any obligation to pay any taxes, interest or penalties
pursuant to Sections 409A or 457A of the Code.


 


SECTION 9.         Effective Date of Plan.


 


The Plan became effective as of January 1,
2003, and shall remain in effect until such time as it may be terminated
pursuant to Section 7 hereof.


 


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Schedule
I


 


Unless otherwise indicated, all capitalized terms
used below have the meanings specified in the Plan.


 


“ROE” means, with respect to each of the
Insurance Segment and the Reinsurance Segment for a given Plan Year, After-Tax
Profit (Loss) divided by Equity.  For
each Plan Year, ROE shall be recalculated annually during the Development
Period relating to such Plan Year.


 


“After-Tax
Profit (Loss)” means, with respect to each of the Insurance Segment and the
Reinsurance Segment for a given Plan Year, the sum of (i) Underwriting
Profit (Loss) and (ii) Investment Income, taxed based upon the effective
tax rate of the Insurance Segment or Reinsurance Segment, as applicable.


 


“Cash
Flow” means, with respect to the Insurance Segment and the Reinsurance
Segment for a given Plan Year, net operating cash flow for such segment
reflecting premiums and fees collected, net of reinsurance, loss and loss
adjustment expenses paid, underwriting expenses paid and all other operating
expenses, including unallocated loss adjustment expenses, allocation of
expenses from the Company and Arch Capital Services Inc., federal excise taxes,
applicable income taxes and costs of letters of credit, but excluding bonuses payable
to Eligible Employees (“Operating Expenses”).  For such purposes, CAT Business shall be
reflected in the Formula Approach in the manner described in Section 4.3(f) of
the Plan.


 


“Equity”
means, with respect to each of the Insurance Segment and the Reinsurance
Segment for a given Plan Year, the amount of capital allocated to each such
segment as recommended by senior management and determined by the Committee.


 


“Investment
Income” means, with respect to the Insurance Segment and the Reinsurance
Segment for a given Plan Year, the sum of investment income, compounded as per
the applicable U.S. treasury security, on:


 


(i)                                     Equity, calculated at a rate equal to the
average rate earned on the investment portfolios of the Company and its
Subsidiaries during the initial 12-month calendar year period included in the
Plan Year, net of investment expenses relating to such portfolios; and


 


(ii)                                  Cash Flow, calculated at the following
rates:  (A) with respect to all
business other than property business, the average risk free rate equal to the
yield on a U.S. Treasury security with a duration equal to estimated weighted
average duration of the underwriting (or policy) year liabilities, net of
estimated investment expenses relating to a portfolio of U.S. Treasury securities,
and, (B) with respect to property business, the average risk free rate
equal to the yield on a U.S. Treasury security with a one year 


 

















 


duration, net of estimated investment expenses relating to a portfolio
of U.S. Treasury securities.


 


“Pre-Tax
Profit” means, with respect to each of the Insurance Segment and the
Reinsurance Segment for a given Plan Year, the sum of (i) Underwriting
Profit (Loss) and (ii) Investment Income.


 


 “Underwriting Profit (Loss)” reflects,
with respect to each of the Insurance Segment and the Reinsurance Segment for a
given Plan Year, (i) net premiums earned, fee income, losses and loss
adjustment expenses incurred and acquisition expenses attributable to Policies
having an inception or renewal date within the Plan Year and (ii) all
other Operating Expenses incurred during the initial 12-month calendar year
period included in the Plan Year.  For
such purposes, CAT Business shall be reflected in the Formula Approach in the
manner described in Section 4.3(f) of the Plan.


 


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