We lease office space in Bermuda where our principal offices are located. Our reinsurance group leases space for offices in the U.S., Bermuda, Europe, Canada and Dubai. Our insurance group leases space for offices in the U.S., Canada, Bermuda, Europe, South Africa and Australia. Our mortgage group leases
space for offices in the U.S. 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 2017.
Amounts reflect a cumulative effect of an accounting change. See note 1, “General,” of the notes accompanying our consolidated financial statements for additional information.
Equals after-tax operating income available to Arch common shareholders divided by the average of beginning and ending common shareholders’ equity for each period presented. For the 2016 period, the return on average common shareholders’ equity reflects the weighted impact of the $1.10 billion of convertible non-voting common equivalent preferred shares, which were issued on December 31, 2016 as part of the UGC acquisition. For the 2015 and prior periods, the average common shareholders’ equity balances in each period reflect a cumulative effect of an accounting change. See note 1, “General,” of the notes accompanying our consolidated financial statements for additional information.
Balances for December 31, 2015 and prior periods reflect a cumulative effect of an accounting change. See note 1, “General,” of the notes accompanying our consolidated financial statements for additional information.
The financial results of the property casualty insurance and reinsurance industry are influenced by factors such as the frequency and/or severity of claims and losses, including natural disasters or other catastrophic events, variations in
interest rates and financial markets, changes in the legal, regulatory and judicial environments, inflationary pressures and general economic conditions. These factors influence, among other things, the demand for insurance or reinsurance, the supply of which is generally related to the total capital of competitors in the market.
The broad property casualty insurance market environment continues to be competitive in our property/casualty business, consistent with our view in prior quarters. In our insurance segment, we experienced a slight deterioration in rates across certain sectors, while there are signs that reinsurance terms, especially ceding commissions, have bottomed out. This has led us to continue to reduce writings in certain property casualty lines in 2016. With the continued low interest rate environment, additional price increases are needed in many lines in order for us to achieve our return requirements. Our underwriting teams continue to execute a disciplined strategy by emphasizing small and medium-sized accounts over large accounts and by utilizing reinsurance purchases to reduce volatility on large account, high capacity business.
Our mortgage operations continue to experience favorable market conditions. Within the U.S. mortgage insurance sector, we continued to expand into the marketplace. Our market share continued to increase, reflecting growth in the bank channel and the impact of RateStar, our risk-based pricing program, which has met with wide acceptance from bank and credit union clients. In addition, international business and credit risk-sharing transactions continue to provide growth opportunities for our mortgage operations.
In addition, on August 15, 2016, we entered into a Stock Purchase Agreement (the “Stock Purchase Agreement”) with American International Group, Inc. (“AIG”) pursuant to which we agreed to purchase from AIG all of the issued and outstanding shares of capital stock of United Guaranty Corporation, a North Carolina corporation (“UGC”). The acquisition under the Stock Purchase Agreement is referred to herein as the “UGC acquisition.”
costs. The aggregate purchase price paid by ACGL was approximately $3.26 billion, consisting of cash consideration of $2.16 billion and convertible non-voting common-equivalent preference shares of ACGL with a fair value of $1.10 billion.
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 investment funds accounted for using the equity method, net foreign exchange gains or losses and UGC transaction costs and other, net of income taxes. Management uses Operating ROAE as a key measure of the return generated to Arch common shareholders and has set an objective to achieve an average Operating ROAE of 15% or greater over the insurance cycle, as opposed to any one calendar year, which it believes to be an attractive return to common shareholders given the risks we assume. See “Comment on Non-GAAP Financial Measures.” Our Operating ROAE was 9.4% for 2016, compared to 9.7% for 2015 and 11.2% for 2014. The lower Operating ROAE for 2016 primarily reflected a higher level of average equity than in 2015, which more than offset a higher level of after-tax operating income.
Our investment expenses were approximately 0.34%, 0.35% and 0.28%, respectively, of average invested assets in 2016, 2015 and 2014.
Total return for our investment portfolio underperformed that of the benchmark return index in 2016 and primarily reflected low investment returns on our investment grade fixed income portfolio, partially offset by strong returns on non-investment grade fixed income and alternatives. Total return was impacted by strengthening of the U.S. Dollar against a number of major currencies which reduced total return on non-U.S. Dollar denominated investments during 2016. Excluding foreign exchange, total return was 2.35% for 2016, compared to 1.62% for 2015 and 4.26% for 2014.
The benchmark return index is a customized combination of indices intended to approximate a target portfolio by asset mix and average credit quality while also matching the approximate estimated duration and currency mix of our insurance and reinsurance liabilities. Although the estimated duration and average credit quality of this index will move as the duration and rating of its constituent securities change, generally we do not adjust the composition of the benchmark return index except to incorporate changes to the mix of liability currencies and durations noted above. The benchmark return index should not be interpreted as expressing a preference for or aversion to any particular sector or sector weight. The index is intended solely to provide, unlike many master indices that change based on the size of their constituent indices, a relatively stable basket of investable indices. At December 31, 2016, the benchmark return index had an average credit quality of “Aa2” by Moody’s Investors Service (“Moody’s”), an estimated duration of 3.57 years.
The benchmark return index included weightings to the following indices, which are primarily from The Bank of America Merrill Lynch (“BoAML”):
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 investment funds 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 investment funds accounted for using the equity method may differ from gains or losses in the future upon sale or maturity of such investments. UGC transaction costs and other include non-recurring advisory, financing, legal and other transaction costs related to the UGC acquisition and non-recurring expenses related to a change in our approach on the deferral of certain internal underwriting costs which are no longer being deferred. We believe that UGC transaction costs and other, due to their non-recurring nature, are not indicative of the performance of, or trends in, our business performance. Due to these reasons, we exclude net realized gains or losses, net impairment losses recognized in earnings, equity in net income or loss of investment funds accounted for using the equity method, net foreign exchange gains or losses and UGC transaction costs and other from the calculation of after-tax operating income available to Arch common shareholders.
We believe that showing net income available to Arch common shareholders exclusive of the items referred to above reflects the underlying fundamentals of our business since we evaluate the performance of and manage our business to produce an underwriting profit. In addition to presenting net income available to Arch common shareholders, we believe that this presentation enables investors and other users of our financial information to analyze our performance in a manner similar to how management analyzes performance. We also believe that this measure follows industry practice and, therefore, allows the users of financial information to compare our performance with our industry peer group. We believe that the equity analysts
and certain rating agencies which follow us and the insurance industry as a whole generally exclude these items from their analyses for the same reasons.
Our segment information includes the presentation of consolidated underwriting income or loss and a subtotal of underwriting income or loss before the contribution from the ‘other’ segment. Such measures represent the pre-tax profitability of our underwriting operations and include net premiums earned plus other underwriting income, less losses and loss adjustment expenses, acquisition expenses and other operating expenses. Other operating expenses include those operating expenses that are incremental and/or directly attributable to our individual underwriting operations. Underwriting income or loss does not incorporate items included in our corporate (non-underwriting) segment. While these measures are presented in Note 5, “Segment Information,” of the notes accompanying our consolidated financial statements, they are considered non-GAAP financial measures when presented elsewhere on a consolidated basis. The reconciliations of underwriting income or loss to income before income taxes (the most directly comparable GAAP financial measure) on a consolidated basis and a subtotal before the contribution from the ‘other’ segment, in accordance with Regulation G, is shown in Note 5, “Segment Information” of the notes accompanying our consolidated financial statements.
Along with consolidated underwriting income, we provide a subtotal of underwriting income or loss before the contribution from the ‘other’ segment. Pursuant to generally accepted accounting principles, Watford Re is considered a variable interest entity and we concluded that we are the primary beneficiary of Watford Re. As such, we consolidate the results of Watford Re in our consolidated financial statements, although we only own approximately 11% of Watford Re’s common equity. Watford Re has its own management and board of directors that is responsible for its overall profitability. In addition, we do not guarantee or provide credit support for Watford Re. Since Watford Re is an independent company, the assets of Watford Re can be used only to settle obligations of Watford Re and Watford Re is solely responsible for its own liabilities and commitments. Our financial exposure to Watford Re is limited to our investment in Watford Re’s common and preferred shares and counterparty credit risk (mitigated by collateral) arising from the reinsurance transactions. We believe that presenting certain information excluding the ‘other’ segment enables investors and other users of our financial
Total return on investments includes investment income, equity in net income or loss of investment funds accounted for using the equity method, net realized gains and losses and the change in unrealized gains and losses generated by Arch’s investment portfolio. Total return is calculated on a pre-tax basis and before investment expenses, excludes amounts reflected in the ‘other’ segment, and reflects the effect of financial market conditions along with foreign currency fluctuations. In addition, total return incorporates the timing of investment returns during the periods. There is no directly comparable GAAP financial measure for total return. Management uses total return on investments as a key measure of the return generated to Arch common shareholders on the capital held in the business, and compares the return generated by our investment portfolio against benchmark returns which we measured our portfolio against during the periods.
Results in all periods presented reflected the impact of current insurance and reinsurance market conditions and the impact of low interest yields on our investment portfolio.
2016 prior period reserve development: The insurance segment’s net favorable development of $33.1 million, or 1.6 points of net earned premium, consisted of $8.7 million of net favorable development from short-tailed lines and $24.4 million of net favorable development from medium-tailed and long-tailed lines. Favorable development in short-tailed lines predominantly consisted of $17.2 million of net favorable development in property lines, primarily from the 2008 to 2014 accident years (i.e., the year in which a loss occurred), partially offset by $11.1 million of adverse development on travel, accident and health business from the 2012 to 2015 accident years. Contained within the short tail release in property lines was favorable development of $11.3 million from named catastrophic events from prior accident years. Net favorable development in medium-tailed and long-tailed lines of $24.4 million included $53.8 million of net favorable development on professional lines, primarily from the 2008 to 2012 accident years, partially offset by $33.1 million of net adverse development in program business, primarily from the 2013 to 2015 accident years. The adverse development in program business was driven by a few inactive programs that were non-renewed in 2015 and early in 2016.
2015 prior period reserve development: The insurance segment’s net favorable development of $47.2 million, or 2.3 points of net earned premium, consisted of $27.3 million of net favorable development from short-tailed lines and $19.9 million of net favorable development from medium-tailed and long-tailed lines. Favorable development in short-tailed lines predominantly consisted of $32.4 million of net favorable development in property lines, primarily from the 2011 to 2014 accident years. Contained within this short tail release was favorable development of $5.7 million from named catastrophic events from prior accident years. Net favorable development in medium-tailed and long-tailed lines of $19.9 million included $29.7 million of net favorable development on professional lines, primarily from the 2005 to 2010 accident years, partially offset by $15.0 million of net adverse development in program business, primarily from the 2013 and 2014 accident years. The adverse development in program business was driven by a few
inactive programs that were non-renewed in 2015 and early in 2016.
2016 versus 2015: The insurance segment’s underwriting expense ratio was 31.8% in 2016, compared to 31.9% in 2015. The acquisition expense ratio was 14.7% for 2016, compared to 14.6% for 2015. The insurance segment’s other operating expense ratio was 17.1% for 2016, compared to 17.3% for 2015. The comparison of the underwriting expense ratios and the underlying acquisition expense and other operating expense ratios were generally flat in 2016 when compared to 2015.
Property catastrophe: provides protection for most catastrophic losses that are covered in the underlying policies written by reinsureds, including hurricane, earthquake, flood, tornado, hail and fire, and coverage for other perils on a case-by-case basis. Property catastrophe reinsurance provides coverage on an excess of loss basis when aggregate losses and loss adjustment expense from a single occurrence or aggregation of losses from a covered peril exceed the retention specified in the contract.
Property excluding property catastrophe: provides coverage for both personal lines and commercial property exposures and principally covers buildings, structures, equipment and contents. The primary perils in this business include fire, explosion, collapse, riot, vandalism, wind, tornado, flood and earthquake. Business is assumed on both a proportional and excess of loss basis. In addition, facultative business is written which focuses on individual commercial property risks on an excess of loss basis.
2016 versus 2015: Gross premiums written by the reinsurance segment in 2016 were 5.3% higher than in 2015, while net premiums written were 1.5% higher than in 2015. Premiums written reflects the 2016 second quarter loss portfolio transfer in the other specialty line which resulted in $52.1 million of gross premiums written and $40.2 million of net premiums written. Such premium was substantially earned in the period and resulted in a corresponding increase to losses and loss adjustment expenses. Excluding the loss portfolio transfer, net premiums written were lower by 2.4%, reflecting decreases in property (both catastrophe and non-catastrophe exposed) and marine and aviation lines, reflecting a higher level of ceded premiums and competitive market conditions.
2015 versus 2014: Gross premiums written by the reinsurance segment in 2015 were 7.1% lower than in 2014, while net premiums written were 18.0% lower than in 2014. The differential in gross versus net premiums written primarily reflects increased cessions to the ‘other’ segment (Watford Re) in 2015 compared to 2014. In addition, the decline in net premiums written reflected reductions in property lines and
other specialty business. The reduction in property catastrophe business reflected non-renewals and share decreases in response to current market conditions and a higher usage of retrocessional coverage. In addition, property excluding property catastrophe business in 2014 included an incoming unearned premium portfolio transfer of $50.2 million from Gulf Reinsurance Limited (“Gulf Re”) which we subsequently acquired in 2015. The decrease in other specialty business reflected non-renewals and share decreases in response to current market conditions, primarily in proportional motor contracts.
Other underwriting income in 2016 was $36.4 million, compared to $10.6 million in 2015 and $3.2 million in 2014. The 2016 period included $19.1 million related to a contract which was commuted during the 2016 second quarter. This contract had been reflected as a deposit accounting liability (i.e., a contract that, in accordance with GAAP, does not pass risk transfer) prior to the commutation.
2016 versus 2015: The reinsurance segment’s current year loss ratio was 3.9 points higher in 2016 than in 2015. The 2016 loss ratio included 4.1 points for current year catastrophic event activity, compared to 3.5 points in 2015. The 2016 current year loss ratio reflected a significantly lower contribution from property lines than in 2015. In addition, the loss ratio for 2016 reflects the impact of the loss portfolio transfer noted above (net premiums earned at a high loss ratio), which increased the current year loss ratio by 2.1 points.
2016 prior period reserve development: The reinsurance segment’s net favorable development of $218.8 million, or 20.7 points of net earned premium, consisted of $133.8 million from short-tailed lines and $85.0 million of net favorable development from medium-tailed and long-tailed lines. Favorable development in short-tailed lines included $113.6 million from property catastrophe and property other than property catastrophe reserves, primarily from the 2009 to 2015 underwriting years (i.e., losses attributable to contracts having an inception or renewal date within the given twelve-month period). Contained within this release was favorable development of $8.7 million from named catastrophic events from prior accident years. The net reduction of loss estimates for the reinsurance segment’s short-tailed lines primarily resulted from varying levels of reported and paid claims activity
2014 prior period reserve development: The reinsurance segment’s net favorable development of $267.3 million, or 20.9 points of net earned premium, consisted of $146.7 million from short-tailed lines and $120.6 million of net favorable development from medium-tailed and long-tailed lines. Favorable development in short-tailed lines included $107.6 million from property catastrophe and property other than property catastrophe reserves, primarily from the 2011 to 2013 underwriting years. Contained within this release was favorable development of $23.3 million from the named catastrophic events from prior accident years. The net reduction of loss estimates for the reinsurance segment’s short-tailed lines primarily resulted from varying levels of reported and paid claims activity than previously anticipated which led to decreases in certain loss ratio selections during 2014. Net favorable development of $120.6 million in medium-tailed and long-tailed lines included reductions in casualty reserves of $101.6 million, primarily from the 2003 to 2006 underwriting years and the 2009 and 2010 underwriting years, and marine and aviation reserves of $14.7 million, primarily from the 2008 to 2012 underwriting years. The balance of net favorable development was spread across various lines and underwriting years.
2015 versus 2014: The underwriting expense ratio for the reinsurance segment was 35.3% in 2015, compared to 32.0% in 2014. The acquisition expense ratio for 2015 was 20.8%, compared to 20.4% for 2014. The comparison of the 2015 and 2014 acquisition expense ratios is influenced by, among other things, the mix and type of business written and earned and the level of ceding commissions incurred. The operating expense ratio for 2015 of 14.5% was higher than the 2014 ratio of 11.6% primarily reflecting a lower level of net premiums earned.
AMIC, United Guaranty Residential Insurance Company and United Guaranty Mortgage Indemnity Company have each been approved as an eligible mortgage insurer by Fannie Mae and Freddie Mac, subject to maintaining certain ongoing requirements.
The UGC acquisition was completed on December 31, 2016. As such, the mortgage segment’s results for 2016 do not reflect UGC activity.
The persistency rate of the U.S. primary portfolio of mortgage loans (combined AMIC and UGC) was 76.1% at December 31, 2016. The persistency rate represents the percentage of mortgage insurance in force at the beginning of a 12-month period that remains in force at the end of such period. In addition, net premiums written in 2016 reflected an increase in GSE credit risk-sharing transactions accounted for under insurance accounting guidance.
2015 versus 2014: Net premiums written in 2015 included new Australian mortgage reinsurance business, which is primarily a single premium market, and an increase in business written by AMIC compared to 2014.
AMIC generated $26.87 billion of new insurance written (“NIW”) during 2016. NIW represents the original principal balance of all loans that received coverage during the period.
Net premiums earned for 2016 was substantially higher than in 2015, primarily due to the growth of AMIC’s business along with a higher earned contribution from the mortgage segment’s quota share reinsurance business. Growth from 2014 to 2015 primarily reflects growth of AMIC.
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 in default, mortgage insurance loss reserves are not an estimate of ultimate losses. In addition to establishing loss reserves for loans in default, 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 evaluate whether a premium deficiency exists quarterly. No such reserve was established during 2016.
The mortgage segment’s current year loss ratio was 7.0 points lower in 2016 compared to 2015 and 4.8 points lower in 2015 compared to 2014. The current year loss ratio for 2016 reflects changes in the mix of business earned, when compared to 2015, and the impact of a decrease in the number of delinquent loans and a lower claim rate on such loans. The lower current year loss ratio for 2015 compared to 2014 also reflected changes in the mix of business earned and a decrease in delinquent loans and claim rates.
The mortgage segment’s net favorable development was $21.2 million, or 7.4 points, for 2016, compared to $12.3 million, or 5.7 points, for 2015 and $0.9 million, or 0.5 points, for 2014.The mortgage segment’s net favorable development for 2016 included $18.5 million of favorable development on AMIC business, reflecting a decrease in the number of delinquent loans and a lower claim rate on such loans. Such development was primarily from the 2004 to 2008 and 2014 origination years. The mortgage segment also experienced net favorable development of $2.7 million on U.S. mortgage reinsurance business.
The corporate (non-underwriting) segment results include net investment income, other income (loss), corporate expenses, interest expense, net realized gains or losses, net impairment losses included in earnings, equity in net income or loss of investment funds accounted for using the equity method, net foreign exchange gains or losses, UGC transaction costs and
other, income taxes and items related to our non-cumulative preferred shares. Such amounts exclude the results of the ‘other’ segment.
Amounts include dividends and income distributions on investment funds and other items.
Investment expenses were approximately 0.34% of average invested assets for 2016, compared to 0.35% for 2015 and 0.28% for 2014.
The pre-tax investment income yield was 1.92% for 2016, compared to 2.06% for 2015 and 2.08% for 2014. The comparability of net investment income between the periods was influenced by our share repurchase program, as well as the decrease in the pre-tax investment income yield, due in part to the prevailing interest rate environment. 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.
We recorded net realized gains of $69.6 million for 2016, compared to net realized losses of $99.1 million for 2015 and net realized gains of $133.4 million for 2014. Currently, our 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 2016, we recorded $30.4 million of credit related impairments in earnings, compared to $20.1 million in 2015 and $30.2 million in 2014. The impairment losses recorded in 2016 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. In addition, impairment losses included reductions on certain corporate bonds, equities and other investments, with smaller contributions from other sectors. See note 9, “Investment Information-Other-Than-Temporary Impairments,” of the notes accompanying our consolidated financial statements for additional information.
Net foreign exchange gains for 2016 were $31.4 million, compared to net foreign exchange gains for 2015 of $62.6 million and net foreign exchange gains for 2014 of $82.7 million million. Amounts in such periods were primarily unrealized and resulted from the effects of revaluing our net insurance
liabilities required to be settled in foreign currencies at each balance sheet date.
recoverables, allowance for doubtful accounts, investment valuations, 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, 2016. 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.
We are required by applicable insurance laws and regulations and GAAP to establish reserves for losses and loss adjustment expenses (“Loss Reserves”) that arise from the business we underwrite. Loss Reserves for our insurance and reinsurance operations are balance sheet liabilities representing estimates of future amounts required to pay losses and loss adjustment expenses for insured or reinsured events which have occurred at or before the balance sheet date. Loss Reserves do not reflect contingency reserve allowances to account for future loss occurrences. Losses arising from future events will be estimated and recognized at the time the losses are incurred and could be substantial.
At December 31, 2016 and 2015, our Loss Reserves, net of unpaid losses and loss adjustment expenses recoverable, by type and by operating segment were as follows:
Net of reinsurance recoverables. Excludes amounts reflected in the ‘other’ segment.
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 $1.33 billion, or $10.64 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 $1.21 billion, or $9.72 per diluted share. The simulation results noted above are informational only, and no assurance can be given that our ultimate losses will not be significantly different than the simulation results shown above, and such differences could directly and significantly impact earnings favorably or unfavorably in the period they are determined. We do not have significant exposure to pre-2002 liabilities, such as asbestos-related illnesses and other long-tail liabilities. It is difficult to provide meaningful trend information for certain liability/casualty coverages for which the claim-tail may be especially long, as claims are often reported and ultimately paid or settled years, or even decades, after the related loss events occur. Any estimates and assumptions made as part of the reserving process could prove to be inaccurate due to several factors, including the fact that relatively limited historical information has been reported to us through December 31, 2016.
The aggregate dollar amount of each insured mortgage loan’s current principal balance.
For each quarter end in 2016, the following table provides supplemental disclosures for our U.S. mortgage insurance operations’ risk in force:
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 reinsurance whereby another reinsurer contractually agrees to indemnify it for all or a portion of the reinsurance risks underwritten by our reinsurance operations. Such arrangements, where one reinsurer provides reinsurance to another reinsurer, are usually referred to as “retrocessional reinsurance” arrangements. In addition, our reinsurance subsidiaries participate in “common account” retrocessional arrangements for certain pro rata treaties. Such arrangements reduce the effect of individual or aggregate losses to all
Our insurance operations had in effect during 2016 a reinsurance program which provided coverage for certain property-catastrophe related losses equal to $200 million in excess of a $150 million retention per occurrence, consistent with the program in place for 2015. In the 2017 first quarter, our insurance operations renewed its reinsurance program with the same limits.
A significant portion of amounts included as premiums receivable, which represent estimated premiums written, net of commissions, are not currently due based on the terms of the underlying contracts. Based on currently available information, management believes that the premium estimates included in premiums receivable will be collectible and, therefore, no provision for doubtful accounts has been recorded on the premium estimates at December 31, 2016.
Certain of our reinsurance contracts include provisions that adjust premiums or acquisition expenses based upon the experience under the contracts. Premiums written and earned,
Unearned premiums represent the portion of premiums written that is applicable to the estimated unexpired risk of insured loans. A portion of premium payments may be refundable if the insured cancels coverage, which generally occurs when the loan is repaid, the loan amortizes to a sufficiently low amount to trigger a lender permitted or legally required cancellation, or the value of the property has increased sufficiently in accordance with the terms of the contract. Premium refunds reduce premiums earned in the consolidated statements of income. Generally, only unearned premiums are refundable. However, when we pay a claim on a delinquent loan, all servicer paid premiums received on the delinquent loan covering any period after the default date will be refunded, in accordance with the terms of the contract.
No premium deficiency charges were recorded by us during 2016, 2015 and 2014.
We determine the existence of an active market based on our judgment as to whether transactions for the financial instrument occur in such market with sufficient frequency and volume to provide reliable pricing information. The independent pricing sources obtain market quotations and actual transaction prices for securities that have quoted prices in active markets. We use quoted values and other data provided by nationally recognized independent pricing sources as inputs into our process for determining fair values of our fixed maturity investments. To validate the techniques or models used by pricing sources, our review process includes, but is not limited to: quantitative analysis (e.g., comparing the quarterly return for each managed portfolio to their target benchmark, with significant differences identified and investigated); a review of the average number of prices obtained in the pricing process and the range of resulting fair values; initial and ongoing evaluation of methodologies used by outside parties to calculate fair value; comparing the fair value estimates to our knowledge of the current market; a comparison of the pricing services’ fair values to other pricing services’ fair values for the same investments; and back-testing, which includes randomly selecting purchased or sold securities and comparing the executed prices to the fair value estimates from the pricing service. Where multiple quotes or prices were obtained, a price source hierarchy was maintained in order to determine which price source would be used (i.e., a price obtained from a pricing service with more seniority in the hierarchy will be used from a less senior one in all cases). The hierarchy prioritizes pricing services based on availability and reliability and assigns the highest priority to index providers. Based on the above review, we will challenge any prices for a security or portfolio which are considered not to be representative of fair value.
On a quarterly basis, we perform reviews of our investments to determine whether declines in fair value below the cost basis are considered other-than-temporary in accordance with applicable accounting guidance regarding the recognition and presentation of OTTI. The process of determining whether a security is other-than-temporarily impaired requires judgment and involves analyzing many factors. These factors include: an analysis of the liquidity, business prospects and overall financial condition of the issuer; the time period in which there was a significant decline in value; the significance of the decline; and the analysis of specific credit events.
or loss. The amount of the credit loss of an impaired debt security is the difference between the amortized cost and the greater of (i) the present value of expected future cash flows and (ii) the fair value of the security. In instances where no credit loss exists but it is more likely than not that we will have to sell the debt security prior to the anticipated recovery, the decline in fair value below amortized cost is recognized as an OTTI in earnings. In periods after the recognition of an OTTI on debt securities, we account for such securities as if they had been purchased on the measurement date of the OTTI at an amortized cost basis equal to the previous amortized cost basis less the OTTI recognized in earnings. For debt securities for which OTTI were recognized in earnings, the difference between the new amortized cost basis and the cash flows expected to be collected will be accreted or amortized into net investment income.
For 2016, we recorded $30.4 million of credit related impairments in earnings, compared to $20.1 million in 2015 and $30.2 million in 2014. See note 9, “Investment Information-Other-Than-Temporary Impairments,” of the notes accompanying our consolidated financial statements for additional information.
On December 31, 2016, the UGC acquisition was completed. As such, our balance sheet reflects the acquisition of UGC while our results of operations for 2016 do not include UGC activity other than the impact of capital raising activity and transaction costs.
The following table summarizes the fair value of the investable assets held by Arch (i.e., excluding amounts in the ‘other’ segment):
At December 31, 2016, below-investment grade securities comprised approximately 5% of our Fixed Maturities, compared to 5% at December 31, 2015. In accordance with our investment strategy, we invest in high yield fixed income securities which are included in “Corporate bonds.” Upon issuance, these securities are typically rated below investment grade (i.e., rating assigned by the major rating agencies of “BB+” or less). At December 31, 2016, corporate bonds represented 51% of the total below investment grade securities at fair value, mortgage backed securities represented 5% of the total and 44% were in other classes. At December 31, 2015, corporate bonds represented 70% of the total below investment grade securities at fair value, mortgage backed securities represented 13% of the total and 17% were in other classes. Unrealized losses include the impact of foreign exchange movements on certain securities denominated in foreign currencies and, as such, the amount of securities in an unrealized loss position fluctuates due to foreign currency movements.
We determine estimated recovery values for our Fixed Maturities following a review of the business prospects, credit ratings, estimated loss given default factors and information received from asset managers and rating agencies for each security. For structured securities, we utilize underlying data, where available, for each security provided by asset managers and additional information from credit agencies in order to determine an expected recovery value for each security. The analysis provided by the asset managers includes expected cash flow projections under base case and stress case scenarios which modify expected default expectations and loss severities and slow down prepayment assumptions.
The following table summarizes our top ten exposures to fixed income corporate issuers by fair value at December 31, 2016, excluding guaranteed amounts and covered bonds:
backed securities (“RMBS”) amounted to approximately $504.7 million, or 2.7% of total investable assets held by Arch, compared to $812.6 million, or 5.5%, at December 31, 2015. As with other fixed income investments, the fair value of these securities fluctuates depending on market and other general economic conditions and the interest rate environment. Declines or flattening in residential property values may result in additional increases in delinquencies and losses on residential mortgage loans generally, especially with respect to any residential mortgage loans where the aggregate loan amounts (including any subordinate loans) are close to or greater than the related property values. Such developments may have a significant adverse effect on the prices of loans and securities, including those in our investment portfolio.
Our portfolio also includes commercial mortgage backed securities (“CMBS”). At December 31, 2016, CMBS constituted approximately $536.1 million, or 2.9% of total investable assets held by Arch, compared to $764.2 million, or 5.2%, at December 31, 2015. The commercial real estate market may experience price deterioration, which could lead to delinquencies and losses on commercial real estate mortgages.
The following table provides information on our non-agency RMBS and non-agency CMBS at December 31, 2016 by issuance year, excluding amounts guaranteed by U.S. government agencies. Non-agency RMBS and non-agency CMBS were 0.6% and 2.8% of total investable assets held by Arch, respectively.
The following table provides information on our asset backed securities (“ABS”) at December 31, 2016. ABS were 6.0% of total investable assets held by Arch, respectively.
The following table provides information on the fair value of our Eurozone investments at December 31, 2016:
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, 2016.
At December 31, 2016, our equity portfolio included $558.0 million of equity securities, compared to $630.0 million at
The following table provides information on the severity of the unrealized loss position as a percentage of cost for all equity securities classified as available for sale which were in an unrealized loss position:
On a quarterly basis, we evaluate the unrealized losses of our equity securities by issuer and forecast a reasonable period of time by which the fair value of the securities would increase and we would recover the cost basis. All of the unrealized losses on equity securities were on holdings which have been in a continual unrealized loss position for less than 12 months at December 31, 2016. We believe that a reasonable period of time exists to allow for recovery of the cost basis of our equity securities that are in an unrealized loss position at December 31, 2016.
Certain of our other investments are in investment funds for which we have the option to redeem at agreed upon values as described in each investment fund’s subscription agreement. Depending on the terms of the various subscription agreements, investments in investment funds may be redeemed daily, monthly, quarterly or on other terms. Two common redemption restrictions which may impact our ability to redeem these investment funds are gates and lockups. A gate is a suspension of redemptions which may be implemented by the general partner or investment manager of the fund in order to defer, in whole or in part, the redemption request in the event the aggregate amount of redemption requests exceeds a predetermined percentage of the investment fund’s net assets which may otherwise hinder the general partner or investment manager’s ability to liquidate holdings in an orderly fashion in order to generate the cash necessary to fund extraordinarily large redemption payouts. A lockup period is the initial amount of time an investor is contractually required to hold the security before having the ability to redeem. If our investment is eligible to be redeemed, the time to redeem such investment can take weeks or months following the notification.
Certain of our investment managers may use leverage to achieve a higher rate of return on their assets under management, primarily those included in “other investments available for sale, at fair value,” “investments accounted for using the fair value option” and “investments accounted for using the equity method” on our balance sheet. While leverage presents opportunities for increasing the total return of such investments, it may increase losses as well. Accordingly, any event that adversely affects the value of the underlying holdings would be magnified to the extent leverage is used and our potential losses would be magnified. In addition, the structures used to
Accounting guidance regarding fair value measurements addresses how companies should measure fair value when they are required to use a fair value measure for recognition or disclosure purposes under GAAP and provides a common definition of fair value to be used throughout GAAP. See note 10, “Fair Value,” of the notes accompanying our consolidated financial statements for a summary of our financial assets and liabilities measured at fair value at December 31, 2016 and December 31, 2015 segregated by level in the fair value hierarchy.
The following table details our reinsurance recoverables at December 31, 2016:
Total shareholders’ equity available to Arch was $8.25 billion at December 31, 2016, compared to $6.17 billion at December 31, 2015. The increase in 2016 was primarily attributable to the issuance of $1.10 billion of convertible non-voting common equivalent preferred shares (included in common shareholders’ equity) and $450 million of non-cumulative preferred shares (included in preferred shareholders’ equity), along with underwriting and investment returns.
Excludes the effects of 6,872,494 and 7,482,462 stock options and 381,461 and 413,364 restricted stock units outstanding at December 31, 2016 and December 31, 2015, respectively.
The ability of our regulated insurance and reinsurance subsidiaries to pay dividends or make distributions or other payments to us is dependent on their ability to meet applicable regulatory standards. Under Bermuda law, Arch Re Bermuda is required to maintain an enhanced capital requirement which must equal or exceed its minimum solvency margin (i.e., the amount by which the value of its general business assets must exceed its general business liabilities) equal to the greatest of (1) $100.0 million, (2) 50% of net premiums written (being gross premiums written less any premiums ceded by Arch Re Bermuda, but Arch Re Bermuda may not deduct more than 25% of gross premiums when computing net premiums written) and (3) 15% of net discounted aggregated losses and loss expense provisions and other insurance reserves. Arch Re Bermuda is prohibited from declaring or paying any dividends during any financial year if it is not in compliance with its enhanced capital requirement, minimum solvency margin or minimum liquidity ratio. In addition, 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 (“BMA”) an affidavit stating that it will continue to meet the required margins. In addition, Arch Re Bermuda is prohibited, without prior approval of the BMA, from reducing by 15% or more its total statutory capital, as set out in its previous year’s statutory financial statements. As a Class 4 insurer, Arch Re Bermuda is required to maintain available statutory capital and surplus pertaining to its general business at a level equal to or in excess of its enhanced capital requirement (“ECR”) which is established by reference to either the BSCR model (“BSCR”) or an approved internal capital model. At December 31, 2016, as determined under Bermuda law, Arch Re Bermuda had statutory capital and surplus of $7.88 billion ($5.43 billion at December 31, 2015), which amounts were in compliance with Arch Re Bermuda’s ECR at such date. Such amounts include ownership interests in U.S. insurance and reinsurance subsidiaries. Accordingly, Arch Re Bermuda can pay approximately $1.97 billion to ACGL during 2016 without providing an affidavit to the BMA, as discussed above. Under BMA guidelines, the value of the assets of our insurance group (i.e., the group of companies that conducts exclusively, or mainly, insurance business) must exceed the amount of the group’s liabilities by the aggregate minimum margin of solvency of each qualifying member of the group (the “Group MSM”). A member is a qualifying member of the insurance group if it is subject to solvency requirements in the jurisdiction in which it is registered. We were in compliance with the Group MSM at December 31, 2016.
The amount of assets required to satisfy the revised financial requirements of the PMIERs at any point in time will be affected by many factors, including macro-economic conditions, the size and composition of our eligible mortgage insurers’ mortgage insurance portfolio at the point in time, and the amount of risk ceded to reinsurers that may be deducted in our calculation of “minimum required assets.” Our eligible
mortgage insurers satisfied the PMIERs’ financial requirements as of December 31, 2016.
Under the PMIERs, AMIC was deemed to be a “newly-approved insurer.” As a result of this status, until January 2017, AMIC was subject to additional PMIER requirements, including restrictions on dividends to affiliates or making any investment, contribution or loan to any affiliate. Since January 2017, none of our eligible mortgage insurers are classified as a “newly-approved insurer” under PMIERs.
In conjunction with the acquisition of UGC and the related approval of the change of control by the GSEs, the GSEs imposed additional requirements on our eligible mortgage insurers, including maintaining capital in excess of PMIERs requirements on a consolidated basis and requiring notifications relating to certain integration activities.
our insurance and reinsurance subsidiaries. We believe that ACGL has sufficient cash resources and available dividend capacity to service its indebtedness and other current outstanding obligations.
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,
On December 31, 2016, we completed the acquisition of UGC pursuant to the Stock Purchase Agreement with AIG. The aggregate purchase price paid by ACGL was approximately $3.26 billion, consisting of cash consideration of $2.16 billion and convertible non-voting common-equivalent preference shares of ACGL with a fair value of approximately $1.10 billion.
In October 2016, we entered into a five-year agreement for a $500.0 million unsecured revolving loan and letter of credit facility and a $350.0 million secured letter of credit facility. We borrowed the full remaining capacity available from the unsecured revolving loan and letter of credit facility ($400.0 million) and used the proceeds to fund a portion of the UGC acquisition. At December 31, 2016, we had no remaining capacity under the unsecured revolving loan facility and $187.9 million of remaining capacity under the secured letter of credit facility. Refer to note 16, “Commitments and Contingencies-Letter of Credit and Revolving Credit Facilities,” of the notes accompanying our consolidated financial statements for a discussion of our available facilities, applicable covenants on such facilities and available capacity.
net proceeds from the offering of 2026 notes and 2046 notes of $940.7 million to fund a portion of the UGC acquisition.
The board of directors of ACGL has authorized the investment in ACGL’s common shares through a share repurchase program. Since the inception of the share repurchase program through December 31, 2016, ACGL has repurchased approximately 125.2 million common shares for an aggregate purchase price of $3.68 billion. At December 31, 2016, approximately $446.5 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.
In November 2016, ACGL, Arch-U.S. and Arch Finance filed a universal shelf registration statement with the SEC. This registration statement allows for the possible future offer and sale by us of various types of securities, including unsecured debt securities, preference shares, common shares, warrants, share purchase contracts and units and depositary shares. The shelf registration statement enables us to efficiently access the public debt and/or equity capital markets in order to meet our future capital needs. The shelf registration statement also allows selling shareholders to resell common shares that they own in one or more offerings from time to time. We will not receive any proceeds from any shares offered by the selling shareholders. This report is not an offer to sell or the solicitation of an offer to buy nor shall there be any sale of these securities in any state in which such offer, solicitation or sale would be unlawful prior to registration or qualification under the securities laws of any such state.
At December 31, 2016, total capital available to Arch of $10.49 billion consisted of $1.73 billion of senior notes, representing 16.5% of the total, $500.0 million of revolving credit agreement borrowings due in October 2021, representing 4.8% of the total, $772.6 million of preferred shares, representing 7.4% of the total, and common shareholders’ equity of $7.48 billion, representing 71.3% of the total. At December 31, 2015, total capital available to Arch of $7.06 billion consisted of $791.3 million of senior notes, representing 11.2% of the total, $100.0 million of revolving credit agreement borrowings, representing 1.4% of the total, $325.0 million of preferred shares, representing 4.6% of the total, and common shareholders’ equity of $5.84 billion, representing 82.8% of the total. The increase in total capital in 2016 was primarily attributable to capital raising activity related to the UGC acquisition and underwriting and investing returns.
We seek to limit our loss exposure by writing a number of our reinsurance contracts on an excess of loss basis, adhering to maximum limitations on reinsurance written in defined geographical zones, limiting program size for each client and prudent underwriting of each program written. In the case of proportional treaties, we may seek per occurrence limitations or loss ratio caps to limit the impact of losses from any one or series of events. In our insurance operations, we seek to limit our exposure through the purchase of reinsurance. We cannot be certain that any of these loss limitation methods will be effective. We also seek to limit our loss exposure by geographic diversification. Geographic zone limitations involve significant underwriting judgments, including the determination of the area of the zones and the inclusion of a particular policy within a particular zone's limits. There can be no assurance that various provisions of our policies, such as limitations or exclusions from coverage or choice of forum, will be enforceable in the manner we intend. Disputes relating to coverage and choice of legal forum may also arise. Underwriting is inherently a matter of judgment, involving important assumptions about matters that are inherently unpredictable and beyond our control, and for which historical experience and probability analysis may not provide sufficient guidance. One or more catastrophic or other events could result in claims that substantially exceed our expectations, which could have a material adverse effect on our financial condition or our results of operations, possibly to the extent of eliminating our shareholders' equity.
The following section does not include information specific to Watford Re. We do not guarantee or provide credit support for
As of December 31, 2016, ACGL and certain of its subsidiaries had a $350.0 million secured facility for letters of credit and a $500.0 million unsecured facility for revolving loans and letters of credit (the “Credit Agreement”). Obligations of each borrower under the secured facility for letters of credit are secured by cash and eligible securities of such borrower held in collateral accounts. Subject to the receipt of commitments, the secured facility may be increased by up to an aggregate of $350.0 million, and the unsecured facility may be increased to an amount not to exceed $750.0 million. ACGL has a one-time option to convert any or all outstanding revolving loans of ACGL and/or Arch-U.S. to term loans with the same terms as the revolving loans except that any prepayments may not be reborrowed. Arch-U.S. guarantees the obligations of ACGL, and ACGL 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 ACGL. Secured letters of credit are available for issuance on behalf of ACGL insurance and reinsurance subsidiaries. The Credit Agreement and related documents are structured such that each party that requests a letter of credit or borrowing does so only for itself and for only its own obligations.
The Credit Agreement contains customary representations, conditions to issuance of letters of credit and borrowings which include, among other things: (i) the maintenance of a debt to total capital ratio of not greater than 0.35 to 1; (ii) consolidated tangible net worth in excess of $5.63 billion plus 25% of future aggregate net income (not including any future net losses) for each quarterly period ending after December 31, 2016 plus 25% of future aggregate net cash proceeds from the issuance of common or preferred equity (other than the proceeds of which are used to fund the repurchase or redemption of our preferred securities (“Refinanced Preferred Securities”)), minus 70% of up to $750.0 million of the aggregate book value of any preferred securities of ACGL which are repurchased or redeemed by ACGL or its subsidiaries (other than Refinanced Preferred Securities); and (iii) that ACGL’s principal insurance and reinsurance subsidiaries that are borrowers under the Credit Agreement maintain a financial strength rating of at least a “B++” from A.M. Best or “BBB+” from S&P. In addition, certain of ACGL’s subsidiaries which are party to the Credit Agreement are required to maintain minimum shareholders’ equity levels. Commitments under the Amended Credit Agreement will expire on October 26, 2021, and all loans then outstanding under the Amended Credit Agreement must be repaid. Letters of credit issued under the Amended Credit Agreement will not have an expiration date later than October 26, 2022. ACGL and its subsidiaries which are party to the Credit Agreement were
ratably with the other unsecured and unsubordinated indebtedness of Arch-U.S. and ACGL, respectively. Interest payments on the 2043 notes are due on May 1st and November 1st of each year. Arch-U.S. may redeem the 2043 notes at any time and from time to time, in whole or in part, at a “make-whole” redemption price. The fair value of the 2043 notes at December 31, 2016 and 2015 was $521.6 million and $513.9 million, respectively.
On December 8, 2016, Arch Finance, a wholly-owned subsidiary of ACGL, completed a public offering of $500.0 million principal amount of 4.011% senior notes due December 15, 2026 (“2026 notes”), fully and unconditionally guaranteed by ACGL. The 2026 notes are unsecured and unsubordinated obligations of Arch Finance and ACGL, respectively, and rank equally and ratably with the other unsecured and unsubordinated indebtedness of Arch Finance and ACGL, 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 fair value of the 2026 notes at December 31, 2016 was $509.3 million.
On December 8, 2016, Arch Finance completed a public offering of $450.0 million principal amount of 5.031% senior notes due December 15, 2046 (“2046 notes”), fully and unconditionally guaranteed by ACGL. The 2046 notes are unsecured and unsubordinated obligations of Arch Finance and ACGL, respectively, and rank equally and ratably with the other unsecured and unsubordinated indebtedness of Arch Finance and ACGL, 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. The fair value of the 2046 notes at December 31, 2016 was $476.0 million.
ACGL and Arch-U.S. are each holding companies and, accordingly, they conduct substantially all of their operations through their operating subsidiaries. Arch Finance is a wholly owned subsidiary of Arch U.S. MI Holdings Inc., a U.S. holding company. As a result, ACGL, 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 ACGL, Arch-U.S. and Arch Finance, respectively.
The following table provides an analysis of our contractual commitments at December 31, 2016 (excluding amounts related to the ‘other’ segment’):
The estimated expected contractual commitments related to the reserves for losses and loss adjustment expenses are presented on a gross basis (i.e., not reflecting any corresponding reinsurance recoverable amounts that would be due to us). It should be noted that until a claim has been presented to us, determined to be valid, quantified and settled, there is no known obligation on an individual transaction basis, and while estimable in the aggregate, the timing and amount contain significant uncertainty. Approximately 63% of our reserves for losses and loss adjustment expenses were incurred but not reported at December 31, 2016.
Pursuant to our 2014 acquisition of the CMG Entities, we are required to make contingent consideration payments based on the closing book value of the pre-closing portfolio of the CMG Entities as re-calculated over an earn-out period and payable at the third, fifth and sixth anniversaries after closing (subject to a one time extension period of one to three years at the sellers’ discretion). The maximum amount of contingent consideration payments over the earn-out period is $136.9 million (or 150% of the closing book value of the CMG Entities less amounts paid at closing). For purposes of this table, the maximum exposure has been shown using an estimated payout pattern.
Amounts outstanding under credit facilities include $100 million borrowed by ACGL and $400 million borrowed by Arch U.S. MI Holdings Inc., its wholly owned subsidiary. Due to the variable nature of the interest payments on these borrowings and the ability to repay such borrowings at will, no interest payments have been reflected.
Bellemeade Re I Ltd. and Bellemeade Re II Ltd. are special purpose variable interest entities that are not consolidated in our financial results because we do not have the unilateral power to direct those activities that are significant to its economic performance. As of December 31, 2016, our estimated off-balance sheet maximum exposure to loss from Bellemeade Re was $2.4 million. See note 4, “Variable Interest Entities-Bellemeade Re I and II,” of the notes accompanying our consolidated financial statements for additional information.
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, 2016. 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.
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, 2016, our portfolio’s VaR was estimated to be 3.75%, compared to an estimated 3.01% at December 31, 2015.
$2.81 billion at December 31, 2015. If the underlying exposure of each investment-related derivative held at December 31, 2016 depreciated by 100 basis points, it would have resulted in a reduction in net income of approximately $21.2 million, and a decrease in book value per share of $0.16, compared to $28.1 million and $0.23, respectively, on investment-related derivatives held at December 31, 2015. If the underlying exposure of each investment-related derivative held at December 31, 2016 appreciated by 100 basis points, it would have resulted in an increase in net income of approximately $21.2 million, and an increase in book value per share of $0.16, compared to $28.1 million and $0.23, respectively, on investment-related derivatives held at December 31, 2015. See note 11, “Derivative Instruments,” of the notes accompanying our consolidated financial statements for additional disclosures concerning derivatives.
As described in Management’s Annual Report on Internal Control over Financial Reporting, management has excluded United Guaranty Corporation and its subsidiaries from its assessment of internal control over financial reporting as of December 31, 2016 because it was acquired by the Company in a purchase business combination during 2016. We have also excluded United Guaranty Corporation and its subsidiaries from our audit of internal control over financial reporting. United Guaranty Corporation and its subsidiaries are wholly-owned subsidiaries whose total assets and total revenues represent 15.8% and 0.0%, respectively, of the related consolidated financial statement amounts as of and for the year ended December 31, 2016.
The Company believes that this change in accounting principle is preferable as it will allow for consistency with peer insurance and reinsurance companies, which the Company believes do not capitalize certain salaries, benefits and other internal underwriting costs. We have retrospectively applied this change in accounting principle to all prior periods. As of January 1, 2014, the cumulative effect of the change resulted in a decrease of $38.3 million in retained earnings with a $50.6 million reduction in deferred acquisition costs and a $12.3 million increase in other assets related to deferred taxes. As of December 31, 2015, this resulted in a $57.3 million reduction
(1) Based upon a formula set forth in the Stock Purchase Agreement, AIG received 1,276,282 of ACGL’s convertible non-voting common equivalent preferred shares, each of which is convertible into 10 shares of ACGL fully paid non-assessable common stock. The Company has determined that, based on a review of the terms, features and rights of the Company’s non-voting common equivalent preferred shares compared to the rights of the Company’s common shareholders, the underlying 12,762,820 common shares that the convertible securities convert to were common share equivalents at the time of their issuance. See Note 19 for further details.
The Company recognized goodwill of $188.8 million that is primarily attributed to UGC’s assembled workforce, access to the mortgage insurance market and additional synergies to be realized in the future. Under U.S. tax principles, the UGC
The following table presents unaudited pro forma consolidated information for the years ended December 31, 2016 and 2015 and assumes the UGC acquisition occurred on January 1, 2015. The pro forma financial information is presented for informational purposes only and does not necessarily reflect the results that would have occurred had the acquisition taken place on January 1, 2015, nor is it necessarily indicative of future results. Significant adjustments used to determine the pro forma results below include amortization of intangible assets and financing adjustments related to the Company’s issuance of senior notes, revolving credit agreement borrowings and preferred shares, and the corresponding income tax effects. Non-recurring transaction costs have been included in the unaudited pro forma results in the 2015 period.
million through a transfer of fixed maturity investments. GIC continues to participate equally with the Company in the financial results of Gulf Re and have the ability to purchase shares in Gulf Re over seven years. The acquisition resulted in no goodwill or other intangible assets as the fair value of Gulf Re was equal to its book value at closing.
Mortgage. Mortgage guaranty insurance policies are contracts that are generally non-cancelable by the insurer, are renewable at a fixed price, and provide for payment of premiums on a monthly, annual or single basis. Upon renewal, the Company is not able to re-underwrite or re-price its policies. Consistent with industry accounting practices, premiums written on a monthly basis are earned as coverage is provided. Premiums written on an annual basis are amortized on a monthly pro rata basis over the year of coverage. Primary mortgage insurance premiums written on policies covering more than one year are 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.
No premium deficiency charges were recorded by the Company during 2016, 2015 or 2014.
The Company currently classifies substantially all of its fixed maturity investments, equity securities and short-term investments as “available for sale” and, accordingly, they are carried at estimated fair value (also known as fair value) with the changes in fair value recorded as an unrealized gain or loss component of accumulated other comprehensive income in shareholders’ equity. The fair value of fixed maturity securities and equity securities is generally determined from quotations received from nationally recognized pricing services, or when such prices are not available, by reference to broker or underwriter bid indications. Short-term investments comprise securities due to mature within one year of the date of issue. Short-term investments include certain cash equivalents which are part of investment portfolios under the management of external and internal investment managers.
The Company participates in a securities lending program as a mechanism for generating additional interest income on its fixed income portfolio. Under the security lending agreements, certain of its fixed income portfolio securities are loaned to third parties, primarily major brokerage firms, for short periods of time through a lending agent. Such securities have been reclassified as “Fixed maturities and short-term investments pledged under securities lending agreements, at fair value.” The Company maintains legal control over the securities it lends, retains the earnings and cash flows associated with the loaned securities and receives a fee from the borrower for the temporary use of the securities. Collateral received is required at a rate of 102% or greater of the fair value of the loaned securities including accrued investment income and is monitored and maintained by the lending agent. Such collateral is reflected as “Collateral received under securities lending agreements, at fair value.”
The Company performs quarterly reviews of its investments to determine whether declines in fair value below the cost basis are considered other-than-temporary in accordance with applicable accounting guidance regarding the recognition and presentation of other-than-temporary impairments (“OTTI”). The process of determining whether a security is other-than-temporarily impaired requires judgment and involves analyzing many factors. These factors include (i) an analysis of the liquidity, business prospects and overall financial condition of the issuer, (ii) the time period in which there was a significant decline in value, (iii) the significance of the decline and (iv) the analysis of specific credit events. The Company evaluates the
When there are credit-related losses associated with debt securities for which the Company does not have an intent to sell and it is more likely than not that it will not be required to sell the security before recovery of its cost basis, the amount of the OTTI related to a credit loss is recognized in earnings and the amount of the OTTI related to other factors (e.g., interest rates, market conditions, etc.) is recorded as a component of other comprehensive income (loss). The amount of the credit loss of an impaired debt security is the difference between the amortized cost and the greater of (i) the present value of expected future cash flows and (ii) the fair value of the security. In instances where no credit loss exists but it is more likely than not that the Company will have to sell the debt security prior to the anticipated recovery, the decline in fair value below amortized cost is recognized as an OTTI in earnings. In periods after the recognition of an OTTI on debt securities, the Company accounts for such securities as if they had been purchased on the measurement date of the OTTI at an amortized cost basis equal to the previous amortized cost basis less the OTTI recognized in earnings. For debt securities for which OTTI were recognized in earnings, the difference between the new amortized cost basis and the cash flows expected to be collected will be accreted or amortized into net investment income. See Note 9, “Investment Information-Other-Than-Temporary Impairments” for additional information.
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 2016, 2015, and 2014, the Company did not designate any derivative instruments as hedges under the relevant accounting guidance. See Note 11 for information on the Company’s derivative instruments.
its reserving process based on the continuing maturation of the Company’s reserves. Inherent in the estimates of ultimate losses and loss adjustment expenses are expected trends in claims severity and frequency and other factors which may vary significantly as claims are settled. Accordingly, ultimate losses and loss adjustment expenses may differ materially from the amounts recorded in the accompanying consolidated financial statements. Losses and loss adjustment expenses are recorded on an undiscounted basis, except for excess workers’ compensation and employers’ liability business written by the Company’s insurance operations.
Certain insurance policies written by the Company’s insurance operations feature large deductibles, primarily in its construction and national accounts lines of business. Under such contracts, the Company is obligated to pay the claimant for the full amount of the claim. The Company is subsequently reimbursed by the policyholder for the deductible amount. These amounts are included on a gross basis in the consolidated balance sheet in contractholder payables and contractholder receivables, respectively. In the event that the Company is unable to collect from the policyholder, the Company would be liable for such defaulted amounts. Collateral, primarily in the form of letters of credit, cash and trusts, is obtained from the
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. See Note 18 for information relating to the Company’s goodwill and intangible assets.
The Company adopted Financial Accounting Standards Board (“FASB”) Accounting Standard Update (“ASU”) 2015-02, “Consolidation (Topic 810) - Amendments to the Consolidation Analysis,” in the 2016 first quarter. This ASU provided targeted improvements to consolidation guidance for limited partnerships and other similarly structured entities. The adoption of this ASU resulted in the Company concluding that it no longer had a variable interest in Alternative Re Ltd. and, as a result, no longer is required to consolidate Alternative Re Ltd. in its financial statements. Alternative Re Ltd. is a Bermuda-domiciled company that provides collateralized segregated accounts to its clients. The Company applied this new standard on a modified retrospective basis as of January
1, 2016. Such adoption did not impact the Company’s shareholders’ equity or net income.
The adoption of this ASU also resulted in a review of certain funds within the Company’s investment portfolio where the Company has a limited partnership interest. See Note 9 for disclosures on limited partnership interests.
The Company adopted ASU 2015-09, “Financial Services - Insurance (Topic 944) - Disclosure about Short-Duration Contracts,” effective January 1, 2016. The amendments in this ASU enhance annual disclosures relating to reserves for losses and loss expenses by requiring the following: (1) net incurred and paid claims development information by accident year; (2) a reconciliation of incurred and paid claims development information to the aggregate carrying amount of the reserve for losses and loss expenses; (3) for each accident year presented, total IBNR plus expected development on case reserves included in the reserve for losses and loss expenses, accompanied by a description of reserving methodologies and any changes thereto; (4) for each accident year presented, quantitative information about claim frequency (unless impracticable) accompanied by a qualitative description of methodologies used for determining claim frequency information and any changes thereto; and (5) the average annual percentage payout of incurred claims by age for the same number of accident years presented. The amendments in this ASU became effective for the Company on January 1, 2016 and the required annual disclosures have been included in Note 7.
ASU 2014-09, “Revenue from Contracts with Customers (Topic 606),” was issued in the 2014 second quarter and will change the manner in which most companies recognize revenue. The ASU requires that revenue reflect the transfer of goods or services to customers based on the consideration or payment the company expects to be entitled to in exchange for those goods or services; however, the ASU does not change the accounting for insurance contracts or financial instruments. The ASU also requires enhanced disclosures about revenue. The ASU is effective in the 2018 first quarter and may be applied on a full retrospective or modified retrospective approach. The Company is currently assessing the impact the implementation of this ASU will have on its consolidated financial statements.
ASU 2016-01, “Financial Instruments - Overall (Subtopic 825-10) - Recognition and Measurement of Financial Assets and Financial Liabilities,” was issued in the 2016 first quarter to enhance the reporting model for financial instruments and to provide improved financial information to readers of the financial statements. Among other provisions focused on improving the recognition and measurement of financial instruments, the ASU requires that equity investments be measured at fair value on the balance sheet with changes in fair value reported in the income statement and that an exit price notion be used when measuring the fair value of financial instruments for disclosure purposes. The ASU is effective in the 2018 first quarter and, aside from limited situations, cannot be early adopted. The Company is currently assessing the impact the implementation of this ASU will have on its consolidated financial statements.
ASU 2016-09, “Compensation - Stock Compensation (Topic 718),” was issued in the 2016 first quarter to improve and simplify the accounting for employee share-based payment transactions. The ASU provides simplifications with respect to income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows for these types of transactions. The guidance is effective for annual and interim periods beginning after December 15, 2016. The Company has adopted the ASU effective January 1, 2017. The Company anticipates that the ASU will not have a material impact on the consolidated financial statements and expects the primary change to be the recognition of excess tax benefits or deficiencies on vesting or settlement of awards as an income tax benefit or expense within net income and the related cash flows classified within operating activities. With respect to the forfeiture accounting policy election, the Company has elected to account for forfeitures as they occur, which did not result in a material cumulative effect adjustment.
ASU 2016-15, “Statement of Cash Flows - Classification of Certain Cash Receipts and Cash Payments (Topic 230),” was issued in the 2016 third quarter. The ASU addresses several clarifications on the presentation and classification of certain cash receipts and cash payments in the statement of cash flows. Among several other cash flow issues, the ASU specifically
ASU 2016-16, “Income Taxes - Intra-Entity Transfers of Assets Other than Inventory (Topic 740),” was issued in the 2016 fourth quarter. The ASU will require companies to recognize the income tax effects of intercompany sales and transfers of assets other than inventory (e.g., intangible assets) in the period in which the transfer occurs. The ASU is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company is assessing the impact the implementation will have on its consolidated financial statements and disclosures.
million respectively. During 2015, Watford Re generated $293.7 million of cash provided by operating activities and $361.9 million of cash provided by financing activities, partially offset by $556.8 million of cash used for investing activities. During 2014, Watford Re generated $39.3 million of cash provided by operating activities and $1.16 billion of cash provided by financing activities, partially offset by $1.18 billion of cash used for investing activities.
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
the economic performance of Bellemeade Re I Ltd. and Bellemeade Re II Ltd., UGC did not consolidate Bellemeade Re I Ltd. and Bellemeade Re II Ltd. in its consolidated financial statements. The Company acquired UGC’s rights and obligations related to the Bellemeade Agreements at closing and agreed with the accounting conclusions related to Bellemeade Re I and Bellemeade Re II.
The following table presents total assets of Bellemeade Re I Ltd. and Bellemeade Re II Ltd. as well as the Company’s maximum exposure to loss associated with these VIEs:
The Company’s insurance, reinsurance and mortgage segments each have managers who are responsible for the overall profitability of their respective segments and who are directly accountable to the Company’s chief operating decision makers, the Chairman and Chief Executive Officer of ACGL, the President and Chief Operating Officer of ACGL and the Chief Financial Officer of ACGL. The chief operating decision makers do not assess performance, measure return on equity or
Programs: primarily package policies, underwriting workers’ compensation and umbrella liability business in support of desirable package programs, targeting program managers with unique expertise and niche products offering general liability, commercial automobile, inland marine and property business with minimal catastrophe exposure.
Travel, accident and health: specialty travel and accident and related insurance products for individual, group
The mortgage segment includes the results of AMIC, UGRIC and UGMIC, leading providers of mortgage insurance products and services to the U.S. market, and and Arch MI Europe, a leading provider of mortgage insurance products and services to the European market. AMIC, UGRIC and UGMIC are approved as eligible mortgage insurers by Federal National Mortgage Association (“Fannie Mae”) and Federal Home Loan Mortgage Corporation (“Freddie Mac”), each a government sponsored enterprise, or “GSE.” The mortgage segment also includes GSE credit risk-sharing transactions and mortgage reinsurance for the U.S. and Australian markets.
Certain expenses have been excluded from ‘corporate expenses’ and ‘other operating expenses’ totaling $32.3 million and $9.4 million, respectively, and reflected in ‘UGC transaction costs and other.’ See ‘Comments on Regulation G’ for a further discussion of the presentation of such items.
During 2016, the Company recorded estimated net favorable development on prior year loss reserves of $270.0 million, which consisted of $218.8 million from the reinsurance segment, $33.1 million from the insurance segment, $21.2 million from the mortgage segment less adverse development of $3.1 million from the ‘other’ segment.
of $85.0 million in medium-tailed and long-tailed lines included reductions in casualty reserves of $86.1 million, primarily from the 2002 to 2013 underwriting years.
The insurance segment’s net favorable development of $33.1 million, or 1.6 points of net earned premium, consisted of $8.7 million of net favorable development from short-tailed lines and $24.4 million of net favorable development from medium-tailed and long-tailed lines. Favorable development in short-tailed lines predominantly consisted of $17.2 million of net favorable development in property lines, primarily from the 2008 to 2014 accident years (i.e., the year in which a loss occurred), partially offset by $11.1 million of adverse development on travel, accident and health business from the 2012 to 2015 accident years. Contained within the short tail release in property lines was favorable development of $11.3 million from named catastrophic events from prior accident years. Net favorable development in medium-tailed and long-tailed lines of $24.4 million included $53.8 million of net favorable development on professional lines, primarily from the 2008 to 2012 accident years, partially offset by $33.1 million of net adverse development in program business, primarily from the 2013 to 2015 accident years. The adverse development in program business was primarily driven by a few inactive programs that were non-renewed in 2015 and early in 2016.
The insurance segment’s net favorable development of $47.2 million, or 2.3 points of net earned premium, consisted of $27.3 million of net favorable development from short-tailed lines and $19.9 million of net favorable development from medium-tailed and long-tailed lines. Favorable development in short-tailed lines predominantly consisted of $32.4 million of net favorable development in property lines, primarily from the 2011 to 2014 accident years (i.e., the year in which a loss occurred). Contained within this short tail release was favorable development of $5.7 million from 2005 to 2014 named catastrophic events. Net favorable development in medium-tailed and long-tailed lines of $19.9 million included $29.7 million of net favorable development on professional lines,
primarily from the 2005 to 2010 accident years, partially offset by $15.0 million of net adverse development in program business, primarily from the 2013 and 2014 accident years. The adverse development in program business was driven by a few programs that were non-renewed in 2015 and early in 2016.
was favorable development of $7.9 million from 2005 to 2013 named catastrophic events. Net adverse development in medium-tailed and long-tailed lines of $14.8 million included a net increase of $41.3 million in construction reserves, primarily from the 2009 to 2013 accident years. The adverse development in construction was largely driven by general liability claims involving New York labor law matters. In addition, the insurance segment experienced $26.2 million of net adverse development in program business, primarily from the 2011 and 2012 accident years. Such amounts were partially offset by $39.0 million of net favorable development on professional lines, primarily from the 2003 to 2011 accident years, and $7.8 million of net favorable development on surety business, primarily from the 2011 to 2013 accident years.
mortgage reinsurance and various GSE credit risk-sharing products; and (iii) certain reinsurance business, including casualty clash and non-traditional lines. Such amounts are included as reconciling items.
The Company is required to establish reserves for losses and loss adjustment expenses (“loss reserves”) that arise from the business the Company underwrites. Loss reserves for the insurance, reinsurance and mortgage segments represent estimates of future amounts required to pay losses and loss adjustment expenses for insured or reinsured events which have occurred at or before the balance sheet date. Loss reserves do not reflect contingency reserve allowances to account for future loss occurrences. Losses arising from future events will be estimated and recognized at the time the losses are incurred and could be substantial.
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 to persist into the future. In forecasting ultimate losses and loss adjustment expenses with respect to any line of business, past experience with respect to that line of business is the primary
resource, developed through both industry and company experience, but cannot be relied upon in isolation. Uncertainties in estimating ultimate losses and loss adjustment expenses are magnified by the length of the time lag between when a claim actually occurs and when it is reported and settled. This time lag is sometimes referred to as the “claim-tail.” During this period additional facts regarding coverages written in prior accident years, as well as about actual claims and trends, may become known and, as a result, may lead to adjustments of the related loss reserves. If the Company determines that an adjustment is appropriate, the adjustment is recorded in the accounting period in which such determination is made. Accordingly, should loss reserves need to be increased or decreased in the future from amounts currently established, future results of operations would be negatively or positively impacted respectively. The Company authorizes managing general agents, general agents and other producers to write program business on the Company’s behalf within prescribed underwriting authorities. This delegated authority process introduces additional complexity to the actuarial determination of unpaid future losses and loss adjustment expenses. In order to monitor adherence to the underwriting guidelines given to such parties, the Company periodically performs underwriting and claims due diligence reviews.
for loss reserves from more mature accident years (the year in which a loss occurred). Each quarter, as part of the reserving process, the segments’ actuaries reaffirm that the assumptions used in the reserving process continue to form a sound basis for the projection of liabilities. If actual loss activity differs substantially from expectations based on historical information, an adjustment to loss reserves may be supported. The Company places more or less reliance on a particular actuarial method based on the facts and circumstances at the time the estimates of loss reserves are made.
In the initial reserving process for short-tail insurance lines (consisting of property, energy, marine and aviation and other exposures including travel, accident and health and lenders products), the Company relies on a combination of the reserving methods discussed above. For catastrophe-exposed business, the reserving process also includes the usage of catastrophe models for known events and a heavy reliance on analysis of individual catastrophic events and management judgment. The development of losses on short-tail business can be unstable,
especially for policies characterized by high severity, low frequency losses. As time passes, for a given accident year, additional weight is given to the paid and incurred B-F loss development methods and historical paid and incurred loss development methods in the reserving process. The Company makes a number of key assumptions in their reserving process, including that historical paid and reported development patterns are stable, catastrophe models provide useful information about our exposure to catastrophic events that have occurred and underwriters’ judgment as to potential loss exposures can be relied on. The expected loss ratios used in the initial reserving process for short-tail business have varied over time due to changes in pricing, reinsurance structure, estimates of catastrophe losses, policy changes (such as attachment points, class and limits) and geographical distribution. As losses in short-tail lines are reported relatively quickly, expected loss ratios are selected for the current accident year based upon actual attritional loss ratios for earlier accident years, adjusted for rate changes, inflation, changes in reinsurance programs and expected attritional losses based on modeling. Furthermore, ultimate losses for short-tail business are known in a reasonably short period of time.
The following table presents the average annual percentage payout of incurred losses and allocated loss adjustment expenses by age, net of reinsurance, as of December 31, 2016:
Loss reserves for the Company’s reinsurance segment are comprised of (1) case reserves, (2) additional case reserves (“ACRs”) and (3) IBNR reserves. The Company receives reports of claims notices from ceding companies and records case reserves based upon the amount of reserves recommended by the ceding company. Case reserves may be supplemented by ACRs, which are often estimated by the Company’s claims personnel ahead of official notification from the ceding company, or when judgment regarding the size or severity of the known event differs from the ceding company. In certain instances, the Company establishes ACRs even when the ceding company does not report any liability on a known event. In addition, specific claim information reported by ceding companies or obtained through claim audits can alert the Company to emerging trends such as changing legal interpretations of coverage and liability, claims from unexpected sources or classes of business, and significant changes in the frequency or severity of individual claims. Such information is often used in the process of estimating IBNR reserves. IBNR reserves are established to provide for incurred claims which have not yet been reported at the balance sheet date as well as to adjust for any projected variance in case reserving. Actuaries estimate ultimate losses and loss adjustment expenses using various generally accepted actuarial methods applied to known losses and other relevant information. Like case reserves, IBNR reserves are adjusted as additional information becomes known or payments are made. The process of estimating reserves involves a considerable degree of judgment by management and, as of any given date, is inherently uncertain.
In the initial reserving process for medium-tail and long-tail reinsurance lines (consisting of casualty, other specialty, marine and aviation and other exposures), the Company primarily relies on the expected loss method. The development of medium-tail and long-tail business may be unstable, especially if there are high severity major events, with business written on an excess of loss basis typically having a longer tail than business written on a pro rata basis. As time passes, for a given underwriting year, additional weight is given to the paid and incurred B-F loss development methods and historical paid and incurred loss development methods in the reserving process. Our reinsurance operations make a number of key assumptions in reserving for medium-tail and long-tail lines, including that the pricing loss ratio is the best estimate of the ultimate loss ratio at the time the contract is entered into, historical paid and reported development patterns are stable and claims personnel and underwriters analyses of our exposure to major events are assumed to be our best estimate of our exposure to the known claims on those events. The expected loss ratios used in our reinsurance operations’ initial reserving process for medium-tail and long-tail contracts have varied over time due to changes in pricing, terms and conditions and reinsurance structure. As the credibility of historical experience for earlier underwriting years increases, the experience from these underwriting years will be used in the actuarial analysis to determine future underwriting year expected loss ratios, adjusted for changes in pricing, loss trends, terms and conditions and reinsurance structure.
The Company’s mortgage segment includes (1) direct mortgage insurance in the U.S., (2) direct mortgage insurance in Europe, (3) global mortgage reinsurance and (4) various GSE credit risk-sharing products, with the latter three categories excluded on the basis of insignificance for the purposes of presenting disclosures related to short duration contracts.
For direct mortgage insurance business, the Company establishes case reserves for loans that have been reported as delinquent by loan servicers as well as those that are delinquent but not reported (IBNR reserves). The Company’s U.S. mortgage insurance operations also reserve for the expenses of adjusting claims related to these delinquencies. The trigger that creates a case reserve estimate is that an insured loan is reported to us as being two payments in arrears. The actuarial reviews and documentation created in the reserving process are completed in accordance with generally accepted actuarial standards. The selected assumptions reflect the actuary’s
judgment based on historical data and experience combined with information concerning current underwriting, economic, judicial, regulatory and other influences on ultimate claim settlements.
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.
The tables below reflect 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 five accident years was sufficient for its current disclosures. The following table presents information on the mortgage segment’s short-duration insurance contracts:
Loss reserves for the ‘other’ segment (i.e., Watford Re) are comprised of case reserves, ACRs and IBNR reserves. For all business assumed by Watford Re, the Company acts as reinsurance underwriting manager, provides actuarial and risk management services and recommends a level of loss reserves to Watford Re. The Company does not guarantee or provide credit support for Watford Re, and the Company’s financial exposure to Watford Re is limited to its investment in Watford Re’s common and preferred shares and counterparty credit risk (mitigated by collateral) arising from the reinsurance transactions. The estimation of loss reserves for Watford Re is subject to the same risk factors as the estimation of loss reserves for the Company’s insurance, reinsurance and mortgage segments as described earlier. Watford Re performs its own reserve reviews and sets its loss reserves independently. As noted previously, the Company determined that amounts in the ‘other’ segment are insignificant for the purposes of these footnote disclosures.
For the year ended December 31, 2016, 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.
On July 29, 2015, UGC entered into an aggregate excess of loss reinsurance agreement with Bellemeade Re, a special purpose reinsurance company domiciled in Bermuda, at inception for new delinquencies on a portfolio of in-force policies issued between January 1, 2009 and March 31, 2013 through a mortgage insurance-linked notes offering by Bellemeade Re I Ltd. (“Bellemeade Re I”), a special purpose reinsurance company domiciled in Bermuda. The approximately $300 million of aggregate excess of loss reinsurance coverage decreases over a ten-year period as the underlying covered mortgages amortize and was $156.6 million as of December 31, 2016. For the coverage period, the ceding insurers will retain the first layer of $129.9 million of aggregate losses and Bellemeade Re will then provide second layer coverage up to the outstanding coverage amount. The ceding insurers will then retain losses in excess of the outstanding coverage limit.
At December 31, 2016, total investable assets of $20.49 billion included $18.64 billion held by the Company and $1.86 billion attributable to Watford Re.
In the normal course of its activities, the Company invests in limited partnerships as part of its overall investment strategy. Such amounts are included in ‘investments accounted for using the equity method’ and ‘investments accounted for using the fair value option.’ Based on the new accounting guidance for consolidation, the Company determined that these limited partnership interests represented variable interests in the funds because the general partner did not have a significant interest in the funds. The Company’s maximum exposure to loss with respect to these investments is limited to the investment carrying amounts reported in the Company’s consolidated balance sheet and any unfunded commitment.
Aggregate unfunded commitments were $776.6 million at December 31, 2016, compared to $535.4 million at December 31, 2015.
Aggregate unfunded commitments were $16.7 million at December 31, 2016, compared to $22.7 million at December 31, 2015.
value of the underlying securities in the funds). Such investments are generally recorded on a one month lag with some investments reported on a three month lag based on the availability of reports from the investment funds.
The following table details the net impairment losses recognized in earnings by asset class:
A description of the methodology and significant inputs used to measure the amount of net impairment losses recognized in earnings in 2016 is as follows:
Equity securities - the Company utilized information received from asset managers on common stocks, including the business prospects, recent events, industry and market data and other factors. Impairment losses were
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. See Note 16 for further details.
Inputs to the valuation methodology are observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets
The Company determines the existence of an active market based on its judgment as to whether transactions for the financial instrument occur in such market with sufficient frequency and volume to provide reliable pricing information. The independent pricing sources obtain market quotations and actual transaction prices for securities that have quoted prices in active markets. The Company uses quoted values and other data provided by nationally recognized independent pricing sources as inputs into its process for determining fair values of its fixed maturity investments. To validate the techniques or models used by pricing sources, the Company's review process includes, but is not limited to: (i) quantitative analysis (e.g., comparing the quarterly return for each managed portfolio to its target benchmark, with significant differences identified and investigated); (ii) a review of the average number of prices obtained in the pricing process and the range of resulting fair values; (iii) initial and ongoing evaluation of methodologies used by outside parties to calculate fair value; (iv) a comparison of the fair value estimates to the Company’s knowledge of the current market; (v) a comparison of the pricing services' fair values to other pricing services' fair values for the same investments; and (vi) periodic back-testing, which includes randomly selecting purchased or sold securities and comparing the executed prices to the fair value estimates from the pricing service. A price source hierarchy was maintained in order to determine which price source would be used (i.e., a price obtained from a pricing service with more seniority in the hierarchy will be used over a less senior one in all cases). The hierarchy prioritizes pricing services based on availability and reliability and assigns the highest priority to index providers. Based on the above review, the Company will challenge any prices for a security or portfolio which are considered not to be representative of fair value. For a limited number of securities, the Company substituted prices from the independent pricing sources at December 31, 2016 and utilized prices received from broker-dealers.
•U.S. government and government agencies - valuations provided by independent pricing services, with all prices provided through index providers and pricing vendors. The Company determined that all U.S. Treasuries would be classified as Level 1 securities due to observed levels of trading activity, the high number of strongly correlated pricing quotes received on U.S. Treasuries and other factors. The fair values of U.S. government agency securities are generally determined using the spread above the risk-free yield curve. As the yields for the risk-free yield curve and the spreads for these securities are observable market inputs, the fair values of U.S. government agency securities are classified within Level 2.
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
determined that contingent consideration liabilities would be included within Level 3.
The following table presents a reconciliation of the beginning and ending balances for all financial assets and liabilities measured at fair value on a recurring basis using Level 3 inputs for 2016 and 2015:
The calculation of basic earnings per common share is computed by dividing income available to Arch common shareholders by the weighted average number of Common Shares, including the weighted effect of 12,762,820 common shares that the Series D Preferred securities convert to. The following table sets forth the computation of basic and diluted earnings per common share:
The company has determined that, based on a review of the terms, features and rights of the Company’s non-voting common equivalent preferred shares compared to the rights of the Company’s common shareholders, the underlying 12,762,820 common shares that the convertible securities convert to were common share equivalents at the time of their issuance.
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 2016, 2015 and 2014, the number of stock options excluded were 722,729, 799,535 and 1,435,955, respectively.
ACGL and its non-U.S. subsidiaries will be subject to U.S. federal income tax only to the extent that they derive U.S. source income that is subject to U.S. withholding tax or income that is effectively connected with the conduct of a trade or business within the U.S. and is not exempt from U.S. tax under an applicable income tax treaty with the U.S. ACGL and its non-U.S. subsidiaries will be subject to a withholding tax on dividends from U.S. investments and interest from certain U.S. payors (subject to reduction by any applicable income tax treaty). ACGL and its non-U.S. subsidiaries intend to conduct their operations in a manner that will not cause them to be treated as engaged in a trade or business in the United States and, therefore, will not be required to pay U.S. federal income taxes (other than U.S. excise taxes on insurance and reinsurance premium and withholding taxes on dividends and certain other U.S. source investment income). However, because there is uncertainty as to the activities which constitute being engaged in a trade or business within the United States, there can be no
The expected tax provision computed on pre-tax income or loss at the weighted average tax rate has been calculated as the sum of the pre-tax income in each jurisdiction multiplied by that jurisdiction’s applicable statutory tax rate. The statutory tax rates by jurisdiction were as follows: Bermuda (0.0%), United States (35.0%), United Kingdom (20.00%), Ireland (12.5%), Denmark (22.0%), Canada (26.5%), Gibraltar (10.0%), Australia (30.0%) and the Netherlands (25.0%).
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, 2016, the Company’s valuation allowance was $17.0 million, compared to $13.8 million at December 31, 2015. The valuation allowance in both periods was primarily attributable to: (1) a full valuation allowance on the Company’s Canadian operations; (2) unutilized foreign tax credits; and (3) certain other deferred tax assets relating to carryforwards that have a limited use.
At December 31, 2016, the Company has net operating loss carryforwards in its U.K. operating subsidiaries of approximately $8.0 million. Additionally, the Company’s U.K. operations have a foreign tax credit carryforward of $6.4 million at December 31, 2016. These operating losses and foreign tax credits can be carried forward without expiration. Due to uncertainty surrounding their future utilization, a valuation
At December 31, 2016, net operating loss carryforwards in Ireland were approximately $9.2 million. Although these losses may be carried forward indefinitely, an offsetting valuation allowance of $1.0 million exists given management’s expectation that certain losses, which are specific to an individual Irish entity, will not be utilized in the future.
At December 31, 2016, net operating loss carryforwards in Australia were approximately $7.4 million. Although these losses may be carried forward indefinitely, subject to certain business and ownership continuity requirements, the associated net deferred tax asset of $2.2 million is fully offset by a valuation allowance of $2.2 million.
Kewsong Lee, a director of ACGL, is a Managing Director and Deputy Chief Investment Officer for Corporate Private Equity of The Carlyle Group (“Carlyle”). As part of its investment philosophy, the Company invests a portion of its investment portfolio in alternative investment funds. As of December 31, 2016, the total value of the Company’s investments in funds or other investments managed by Carlyle was approximately $215.2 million, and the Company had aggregate unfunded commitments to funds managed by Carlyle of $515.4 million. The Company may make additional commitments to funds managed by Carlyle from time to time. During 2016, 2015 and 2014, the Company made aggregate capital contributions to funds managed by Carlyle of $62.1 million, $116.5 million and $63.5 million, respectively. During 2016, 2015 and 2014, the Company received aggregate cash distributions from funds managed by Carlyle of $21.5 million, $44.6 million and $45.8 million, respectively.
accounts lines of business. Under such contracts, the Company is obligated to pay the claimant for the full amount of the claim. The Company is subsequently reimbursed by the policyholder for the deductible amount. These amounts are included on a gross basis in the consolidated balance sheet in contractholder payables and contractholder receivables, respectively. In the event that the Company is unable to collect from the policyholder, the Company would be liable for such defaulted amounts. Collateral, primarily in the form of letters of credit, cash and trusts, is obtained from the policyholder to mitigate the Company’s credit risk. In the instances where the company receives collateral in the form of cash, the Company records a related liability in “Collateral held for insured obligations.”
The Company’s investment commitments, which are primarily related to agreements entered into by the Company to invest in funds and separately managed accounts when called upon, were approximately $1.29 billion at December 31, 2016.
option to convert any or all outstanding revolving loans of ACGL and/or Arch-U.S. to term loans with the same terms as the revolving loans except that any prepayments may not be reborrowed. Arch-U.S. guarantees the obligations of ACGL, and ACGL 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 ACGL. Secured letters of credit are available for issuance on behalf of ACGL insurance and reinsurance subsidiaries. The Credit Agreement and related documents are structured such that each party that requests a letter of credit or borrowing does so only for itself and for only its own obligations.
In addition, certain of ACGL’s subsidiaries had outstanding letters of credit of $178.5 million, which were issued on a limited basis and for limited purposes (together with the secured portion of the Credit Agreement and these letter of credit facilities, the “LOC Facilities”). The principal purpose of the LOC Facilities is to issue, as required, evergreen standby letters of credit in favor of primary insurance or reinsurance counterparties with which certain of ACGL’s subsidiaries has entered into reinsurance arrangements. This is required to ensure that such counterparties are permitted to take credit for reinsurance obtained in United States jurisdictions where such subsidiaries are not licensed or otherwise admitted as an insurer, as required under insurance regulations in the United States,
Pursuant to the Company’s 2014 acquisition of the CMG Entities, the Company is required to make contingent consideration payments based on the closing book value of the pre-closing portfolio of the CMG Entities as re-calculated over an earn-out period and payable at the third, fifth and sixth anniversaries after closing (subject to a one time extension period of one to three years at the sellers’ discretion). The maximum amount of contingent consideration payments is $136.9 million over the earn-out period (or 150% of the closing book value of the CMG Entities less amounts paid at closing). 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.
At December 31, 2016, the future minimum rental commitments, exclusive of escalation clauses and maintenance costs and net of rental income, for all of the Company’s operating leases are as follows:
All of these leases are for the rental of office space, with expiration terms that range from 2017 to 2025. Rental expense, net of income from subleases, was approximately $24.2 million, $23.8 million and $23.1 million for 2016, 2015 and 2014, respectively.
At December 31, 2016, the Company has entered into capital lease agreements. The future lease payments for the Company’s capital leases are expected to be $10.8 million, $10.4 million and $4.2 million for 2017, 2018 and 2019, respectively.
At December 31, 2016, the Company has entered into employment agreements with certain of its executive officers for periods extending up to March 2018. Such employment arrangements provide for compensation in the form of base salary, annual bonus, share-based awards, participation in the Company’s employee benefit programs and the reimbursements of expenses.
On December 8, 2016, Arch Capital Finance LLC (“Arch Finance”), a wholly-owned finance subsidiary of ACGL, completed a public offering of $500.0 million principal amount of 4.011% senior notes due December 15, 2026 (“2026 notes”), fully and unconditionally guaranteed by ACGL. The 2026 notes are unsecured and unsubordinated obligations of Arch Finance and ACGL, respectively, and rank equally and ratably with the other unsecured and unsubordinated indebtedness of Arch Finance and ACGL, 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 Company used the net proceeds from the offering of $495.7 million to fund a portion of the UGC acquisition. The fair value of the 2026 notes at December 31, 2016 was $509.3 million.
The expected remaining amortization expense for intangible assets with a finite life is $124.5 million for 2017, $104.9 million for 2018, $73.7 million for 2019, $46.4 million for 2020 and $28.6 million for 2021. The estimated remaining useful lives of these assets range from one to twenty years at December 31, 2016.
The Company’s impairment reviews for goodwill and intangible assets did not result in the recognition of impairment losses for 2016, 2015 and 2014.
The authorized share capital of ACGL consists of 600 million Common Shares, par value of $0.0033 per share, and 50 million Preferred Shares, par value of $0.01 per share.
The following table presents a roll-forward of changes in ACGL’s issued and outstanding Common Shares:
The Company has determined that 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 12,762,820 common shares that the convertible securities convert to were common share equivalents at the time of their issuance.
On April 2, 2012, ACGL completed the underwritten public offering of $325.0 million of its 6.75% Series C non-cumulative preferred shares (“Series C preferred shares”). Except in specified circumstances relating to certain tax or corporate events, the Preferred Shares are not redeemable prior to April 2, 2017. The Series C preferred shares are on parity with the Series E preferred shares with respect to payment of dividends and the distribution of assets upon a liquidation, dissolution or winding-up of ACGL. Dividends on the Company’s Series C
The 2012 Long Term Incentive and Share Award Plan (the “2012 Plan”) became effective as of May 9, 2012 (the “Effective Date”) following approval by shareholders of the Company. The 2012 Plan is intended to provide for competitive compensation opportunities, to encourage long-term service, to
On May 11, 2007, following shareholder approval, the Company adopted the 2007 Employee Share Purchase Plan with 2,250,000 common shares available for issuance. Upon shareholder approval on May 6, 2016, the Amended and Restated Arch Capital Group Ltd. 2007 Employee Share Purchase Plan (the “ESPP”) became effective, which increased the number of shares available for issuance under the ESPP by 1,000,000 common shares. Prior to the amendment and restatement, 563,259 common shares remained available for issuance under the ESPP. After the amendment and restatement, a total of 1,563,259 common shares were reserved for issuance. The purpose of the ESPP is to give employees of ACGL and its subsidiaries an opportunity to purchase common shares through payroll deductions, thereby encouraging employees to share in the economic growth and success of ACGL and its subsidiaries. The ESPP is designed to qualify as an “employee share purchase plan” under Section 423 of the Code. At December 31, 2016, approximately 1,383,896 shares remain available for issuance.
With respect to certain subsidiaries, the Company may withhold, or require a participant to remit to the Company, an amount sufficient to satisfy any federal, state or local withholding tax requirements associated with awards under the Company’s share award plans. This includes the authority to withhold or receive shares or other property and to make cash payments in respect thereof.
For purposes of determining estimated market value, the Company has computed the estimated market values of share-based compensation related to stock options and SARs using
the Black-Scholes option valuation model and has applied the assumptions set forth in the following table. As described above, stock options and SARs generally vest over a three year period with one-third vesting on the first, second and third anniversaries of the grant date. The expected life assumption (i.e., the estimated period of time between the date an option or SAR is granted and the date the option or SAR is exercised) was based on an expected term analysis which incorporated the Company’s historical exercise experience. The Company based its estimate of expected volatility for stock options and SARs granted during 2016 on daily historical trading data of its common shares from September 20, 2002, the date marking the completion of the Company’s transition as a worldwide insurance and reinsurance company. For stock options and SARs granted during 2015 and 2014, the Company based its volatility estimate under the same method used for 2016, using the period from September 20, 2002 through the last day of the applicable period.
As of December 31, 2016, there was $32.0 million and $4.6 million, respectively, of unrecognized compensation costs related to unvested restricted share and unit awards, which are expected to be recognized over a weighted average period of 0.9 years and 0.9 years, respectively.
For purposes of providing employees with retirement benefits, the Company maintains defined contribution retirement plans. Contributions are based on the participants’ eligible compensation. For 2016, 2015 and 2014, the Company expensed $30.6 million, $29.7 million and $26.8 million, respectively, related to these retirement plans.
The Company, in common with the insurance industry in general, is subject to litigation and arbitration in the normal course of its business. As of December 31, 2016, the Company was not a party to any litigation or arbitration which is expected by management to have a material adverse effect on the Company’s results of operations and financial condition and liquidity.
The actual and required statutory capital and surplus for the Company’s principal operating subsidiaries at December 31, 2016 and 2015:
Statutory accounting differs from U.S. GAAP in the reporting of certain items such as acquisition costs, deferred income taxes and investments.
Watford Re is registered as a Class 4 insurer and is required to annually prepare and file statutory financial statements and a statutory financial return with the BMA. The Insurance Act also requires Watford Re to maintain minimum share capital and must ensure that the value of its general business assets exceeds the amount of its general business liabilities by an amount greater than the prescribed minimum solvency margins and enhanced capital requirement pertaining to its general business. At December 31, 2016, all such requirements were met.
The Company’s U.S. insurance and reinsurance subsidiaries are subject to insurance laws and regulations in the jurisdictions in which they operate. The ability of the Company’s regulated insurance subsidiaries to pay dividends or make distributions is dependent on their ability to meet applicable regulatory standards. These regulations include restrictions that limit the amount of dividends or other distributions, such as loans or cash advances, available to shareholders without prior approval of the insurance regulatory authorities. Dividends or distributions, if any, made by Arch Re U.S. would result in an increase in available capital at Arch-U.S., the Company’s U.S. holding company. Arch Re U.S. can declare a maximum of approximately $128.4 million of dividends during 2017 subject to the approval of the Commissioner of the Delaware Department of Insurance (“Commissioner”). In addition, with respect to dividends in excess of the $128.4 million (extraordinary dividend), no payment can be made until (1) 30 days after the Commissioner has received notice of the declaration thereof and has not within such period disapproved such payments; or (2) the Commissioner shall have approved the payment within the 30-day period. Delaware insurance laws also require that the statutory surplus of Arch Re U.S. following any dividend or distribution be reasonable in relation to its outstanding liabilities and adequate to its financial needs.
AMIC, United Guaranty Residential Insurance Company and United Guaranty Mortgage Indemnity Company have each been approved as an eligible mortgage insurer by Fannie Mae and Freddie Mac, subject to maintaining certain ongoing requirements (“eligible mortgage insurers”). In April 2015, the GSEs published comprehensive, revised requirements, known as the Private Mortgage Insurer Eligibility Requirements or “PMIERs.” As clarified and revised by the Guidance Letters issued by the GSEs in December 2016, the PMIERs apply to the Company’s eligible mortgage insurers, but do not apply to Arch Mortgage Guaranty Company, which is not GSE-approved.
Under Wisconsin and North Carolina law, as well as that of 14 other states, a mortgage insurer must maintain a minimum amount of statutory capital relative to its risk in force in order for the mortgage insurer to continue to write new business. While formulations of minimum capital vary in certain jurisdictions, the most common measure applied allows for a maximum risk-to-capital ratio of 25 to 1. Wisconsin and North Carolina both require a mortgage insurer to maintain a “minimum policyholder position” calculated in accordance with their respective regulations. Policyholders' position consists primarily of statutory policyholders' surplus plus the
Under U.K. law, all U.K. companies are restricted from declaring a dividend to their shareholders unless they have “profits available for distribution.” The calculation as to whether a company has sufficient profits is based on its accumulated realized profits minus its accumulated realized losses. U.K. insurance regulatory laws do not prohibit the payment of dividends, but the PRA or FCA, as applicable, requires that insurance companies and insurance intermediaries maintain certain solvency margins and may restrict the payment of a dividend by Arch Insurance Company Europe, AUAL and
Under the Insurance Companies Act (Canada), Arch Insurance Canada is required to maintain an adequate amount of capital in Canada, calculated in accordance with a test promulgated by OSFI called the Minimum Capital Test (“MCT”), and Arch Re Canada is required to maintain an adequate margin of assets over liabilities in Canada, calculated in accordance with a test promulgated by OSFI called the Branch Adequacy of Assets Test. Dividends or distributions, if any, made by Arch Insurance Canada would result in an increase in available capital at Arch Insurance Company (see “-United States” section).
Dividends paid are included in net cash provided by (used for) operating activities in the ACGL (Parent Guarantor) and/or Arch-U.S. (Subsidiary Issuer) columns.
In January 2017, the Company and Kelso & Company (“Kelso”) sponsored Premia Re, a newly-formed multi-line Bermuda reinsurance company. Premia Re’s strategy is to reinsure or acquire companies or reserve portfolios in the non-life property and casualty insurance and reinsurance run-off market. Arch Re Bermuda and certain Arch co-investors invested $100.0 million and acquired approximately 25% of Premia Re as well as warrants to purchase additional common equity. Affiliates of Kelso invested $300.0 million and acquired the balance of Premia Re as well as warrants to purchase additional common equity. Arch Re Bermuda will provide a 25% whole account quota share reinsurance treaty on business written by Premia Re, and subsidiaries of ACGL will provide certain administrative and support services to Premia Re, in each case pursuant to separate multi-year agreements. Arch Re Bermuda has appointed two directors to serve on the seven person board of directors of Premia Re. The Company has performed an analysis of Premia Re and concluded that it has significant influence over Premia Re and will therefore account for its investment in Premia Re under the equity method of accounting.