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.
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.
addition, we completed multiple Bellemeade risk transfers to the capital markets throughout 2018, increasing our protection for mortgage tail risk.
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.
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.
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.
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.
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, net impairment losses recognized in earnings on our investments represent other-than-temporary declines 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
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.
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.
• 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.
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.
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 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.
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.
The insurance segment’s net favorable development was $24.4 million, or 1.1 points, for 2018, compared to $8.6 million, or
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.
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.
•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.
•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.
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 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.
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.
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.
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.
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):
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.
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.
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.
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
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.
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.
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 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.
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.
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.
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.
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.
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
critical accounting policies affect significant estimates used in the preparation of our consolidated financial statements.
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:
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:
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
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:
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
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, 2017:
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:
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.
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.
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
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
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.
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:
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.
mortgage business involves significant 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.
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.
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”).
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.
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.
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.
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 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:
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.
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.
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.
The following table details our reinsurance recoverables at December 31, 2018:
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.
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.
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.
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, reinsurance and mortgage 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
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 timing of the funding of investment commitments is uncertain and may require us to access cash on short notice.
•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.
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.
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.
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
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
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.
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.
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.
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.
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
have assigned financial strength ratings to one or more of Arch Capital’s subsidiaries.
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
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.
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.
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.
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 these projected results due 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.
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:
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.
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.
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.”
Represents capital contributions held in the foreign currencies of our operating units.
To the Board of Directors and Shareholders of Arch Capital Group Ltd.
We have served as the Company’s or its predecessor’s auditor since 1995.
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.
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.
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
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.
No premium deficiency charges were recorded by the Company during 2018, 2017 or 2016.
The Company recognizes all derivative instruments, including embedded derivative instruments, at fair value in its 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
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.
Assets and liabilities of foreign operations whose functional currency is not the U.S. Dollar are translated at the prevailing
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.
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.
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.
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.
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 instruments and provides improved financial information to readers of the financial statements. Among other provisions focused on improving the recognition and 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
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.
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.
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.
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.
Other segment results include premiums assumed through intersegment transactions and exclude premiums ceded through intersegment transactions.
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
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 from medium-tailed lines. 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
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
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.
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
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
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.
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
In 2018, the Company entered into a loss portfolio transfer and adverse development cover reinsurance agreement accounted
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.
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.
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
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.
The following tables present information on the reinsurance segment’s short-duration insurance contracts:
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.
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:
‘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.
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.
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”). 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
Issued in October 2018, covering in-force policies issued between January 1, 2018 and June 30, 2018.
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.
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.
The following table summarizes the Company’s other investments, including available for sale and fair value option components:
Aggregate unfunded commitments were $1.22 billion at December 31, 2018, compared to $1.02 billion at December 31, 2017.
Includes income distributions from investment funds, term loan investments and other items.
Pursuant to new accounting guidance (see Note 3), changes in fair value on equity securities are recorded through net income effective January 1, 2018.
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.
•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.
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.
Contingent consideration liabilities (included 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 (losses).’ To determine the fair value of contingent consideration liabilities, the Company estimates future 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.
The following table presents the Company’s financial assets and liabilities measured at fair value by level at December 31, 2018:
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.
Includes asset backed securities, mortgage backed securities and commercial mortgage backed securities.
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:
The following table summarizes information on the fair values and notional values of the Company’s derivative instruments:
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
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.
Subsidiaries of the Company act as Watford Re’s reinsurance and insurance underwriting managers.
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
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.
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.
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.
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:
(1) Includes $4.6 million net operating loss carryforwards from Watford Re.
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.
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:
As of December 31, 2018, the Company’s current income tax recoverable (included in “Other assets”) was $21.2 million.
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.
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.
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
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.
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.
(1) Senior notes of Arch Capital issued on May 4, 2004 and due May 1, 2034 (“2034 notes”).
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 2026 notes are unsecured and unsubordinated obligations of Arch Finance and Arch Capital, respectively, and rank equally and ratably with the other unsecured 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 equally and ratably with the other unsecured 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
redeem the 2046 notes at any time and from time to time, in whole or in part, at a “make-whole” redemption price.
credit were secured by investments with a fair value of $362.0 million.
(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.
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
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 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.
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.
(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.
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 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.
A summary of stock option and SAR activity under the Company’s Long Term Incentive and Share Award Plans during 2018 is presented below:
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:
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.
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.
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.
required to maintain a minimum level of capital. At December 31, 2018 and 2017, these requirements were met.
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.
Included in net cash provided by (used for) operating activities in the Arch Capital (Parent Guarantor) and/or Arch-U.S. (Subsidiary Issuer) columns.
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.