Document:

Exhibit 10.3

 

ARCH CAPITAL GROUP LTD.

Non-Qualified Stock Option Agreement

 

FOR GOOD AND
VALUABLE CONSIDERATION, receipt of which is hereby acknowledged, Arch Capital
Group Ltd. (the “Company”), a Bermuda company, hereby grants to Ralph E. Jones
III, an employee of a subsidiary of the Company on the date hereof (the “Option
Holder”), the option to purchase common shares, $0.01 par value per share, of
the Company (“Shares”), upon the following terms:

 

WHEREAS, the
Option Holder has been granted the following award in connection with his or
her retention as an employee and as compensation for services to be rendered;
and the following terms reflect the Company’s 2002 Long Term Incentive and
Share Award Plan (the “Plan”);

 

(a)   Grant.  The Option Holder is hereby granted an option (the “Option”) to
purchase 100,000 Shares (the “Option Shares”) pursuant to the Plan, the terms
of which are incorporated herein by reference. 
The Option is granted as of July 1, 2003 (the “Date of Grant”) and such
grant is subject to the terms and conditions herein and  the terms and conditions of the applicable
provisions of the Plan.  This Option
shall not be treated as an incentive stock option as defined in Section 422 of
the Internal Revenue Code of 1986, as amended. 
In the event of any conflict between this Agreement and the Plan, the
Plan shall control.

 

(b)   Status of Option Shares.  The Option Shares shall upon issue rank
equally in all respects with the other Shares.

 

(c)   Option Price.  The purchase price for the Option Shares
shall be, except as herein provided, $34.71 per Option Share, hereinafter
sometimes referred to as the “Option Price,” payable immediately in full upon
the exercise of the Option.

 

(d)   Term of Option.  The Option may be exercised only during the
period (the “Option Period”) set forth in paragraph (f) below and shall remain
exercisable until the tenth anniversary of the Date of Grant.  Thereafter, the Option Holder shall cease to
have any rights in respect thereof.  The
right to exercise the Option shall be subject to sooner termination as provided
in paragraph (j) below.

 

(e)   No Rights of Shareholder.  The Option Holder shall not, by virtue
hereof, be entitled to any rights of a shareholder in the Company, either at
law or in equity.

 

(f)    Exercisability.  Except as otherwise set forth in paragraph
(j) below, the Option shall become exercisable as to one third of the Option
Shares on the Date of Grant, as to an additional one-third of the Option Shares
on the first anniversary of the Date of Grant, and as to the final one-third of
the Option Shares on the second anniversary of the Date of Grant, in each case
subject to paragraph (j) below.  Subject
to paragraph (j) below, the Option may be exercised at any time or from time to
time during the Option Period in regard to all or any portion of the Option
which is then exercisable, as may be adjusted pursuant to paragraph (g) below.

 

 

(g)   Adjustments for Recapitalization and
Dividends.  In the event that, prior
to the expiration of the Option, any dividend in Shares, recapitalization,
Share split, reverse split, reorganization, merger, consolidation, spin-off,
combination, repurchase, or share exchange, or other such change affects the
Shares such that they are increased or decreased or changed into or exchanged for
a different number or kind of shares, other securities of the Company or of
another corporation or other consideration, then in order to maintain the
proportionate interest of the Option Holder and preserve the value of the
Option, (i) there shall automatically be substituted for each Share
subject to the unexercised Option the number and kind of shares, other
securities or other consideration (including cash) into which each outstanding
Share shall be changed or for which each such Share shall be exchanged, and
(ii) the exercise price shall be increased or decreased proportionately so
that the aggregate purchase price for the Shares subject to the unexercised
Option shall remain the same as immediately prior to such event.

 

(h)   Nontransferability.  The Option, or any interest therein, may not
be assigned or otherwise transferred, disposed of or encumbered by the Option
Holder, other than by will or by the laws of descent and distribution.  During the lifetime of the Option Holder,
the Option shall be exercisable only by the Option Holder or by his or her
guardian or legal representative. 
Notwithstanding the foregoing, the Option may be transferred by the
Option Holder to members of his or her “immediate family “ or to a trust or
other entity established for the exclusive benefit of solely one or more
members of the Option Holder’s “immediate family.”  Any Option held by the transferee will continue to be subject to
the same terms and conditions that were applicable to the Option immediately
prior to the transfer, except that the Option will be transferable by the
transferee only by will or the laws of descent and distribution.  For purposes hereof, “immediate family”
means the Option Holder’s children stepchildren, grandchildren, parents,
stepparents, grandparents, spouse, siblings (including half brother and
sisters), in laws, and relationships arising because of legal adoption.

 

(i)    Exercise of Option.  In order to exercise the Option, the Option
Holder shall submit to the Company an instrument in writing signed by the
Option Holder, specifying the whole number of Option Shares in respect of which
the Option is being exercised, accompanied by payment, in a manner acceptable
to the Company (which shall include a broker assisted exercise arrangement), of
the Option Price for the Option Shares for which the Option is being
exercised.  Payment to the Company in
cash or Shares already owned by the Option Holder (provided that the Option
Holder has owned such Shares for a minimum period of six months or has purchased
such Shares on the open market) and having a total Fair Market Value (as
defined below) equal to the exercise price, or in a combination of cash and
such Shares, shall be deemed acceptable for purposes hereof.  Option Shares will be issued accordingly by
the Company, and a share certificate dispatched to the Option Holder within 30
days.

 

The
Company shall not be required to issue fractional Shares upon the exercise of
the Option. If any fractional interest in a Share would be deliverable upon the
exercise of the Option in whole or in part but for the provisions of this
paragraph, the Company, in lieu of delivering any such fractional share
therefor, shall pay a cash adjustment therefor in an amount equal to their Fair
Market Value (or if any Shares are not publicly traded, an amount equal to the
book value per share at the end of the most recent fiscal quarter) multiplied
by the fraction of the fractional

 

2

 

share which would otherwise have been issued
hereunder.  Anything to the contrary
herein notwithstanding, the Company shall not be obligated to issue any Option
Shares hereunder if the issuance of such Option Shares would violate the
provision of any applicable law, in which event the Company shall, as soon as
practicable, take whatever action it reasonably can so that such Option Shares
may be issued without resulting in such violations of law.  For purposes hereof, Fair Market Value shall
mean the mean between the high and low selling prices per Share on the
immediately preceding date (or, if the Shares were not traded on that day, the
next preceding day that the Shares were traded) on the principal exchange on
which the Shares are traded, as such prices are officially quoted on such
exchange.

 

(j)    Termination of Service.  In the event the Option Holder ceases to be
an employee of the Company for any reason, except due to the Option Holder’s
death or Permanent Disability (as defined in the Employment Agreement between
the Option Holder and Arch Insurance Group Inc., dated as of June 4, 2003 (the
“Employment Agreement”)) or due to a termination of the Option Holder’s employment
by the Company for Cause (as defined in the Employment Agreement), the Option,
to the extent then exercisable, may be exercised for 90 days following
termination of employment (but not beyond the Option Period).  To the extent the Option is not exercisable
at the time of termination of employment, the Option shall be immediately
forfeited.  For purposes of this Option,
service with any of the Company’s Subsidiaries (as defined in the Plan) shall
be considered to be service with the Company. 
In the event of a termination of the Option Holder’s employment for
Cause, the Option shall immediately cease to be exercisable and shall be
immediately forfeited.  In the event the
Option Holder ceases to be an employee of the Company due to the Option
Holder’s death or Permanent Disability, the Option shall become immediately
exercisable in full and shall continue to be exercisable by the Option Holder
(or his or her Beneficiary in the event of death) for a period of three years
following such termination of employment (but not beyond the Option Period).

 

(k)   Obligations as to Capital.  The Company agrees that it will at all times
maintain authorized and unissued share capital sufficient to fulfill all of its
obligations under the Option.

 

(l)    Transfer of Shares.  The Option, the Option Shares, or any
interest in either, may be sold, assigned, pledged, hypothecated, encumbered,
or transferred or disposed of in any other manner, in whole or in part, only in
compliance with the terms, conditions and restrictions as set forth in the
governing instruments of the Company, applicable United States federal and
state securities laws and the terms and conditions hereof.

 

(m)  Expenses of Issuance of Option Shares.  The issuance of stock certificates upon the
exercise of the Option in whole or in part, shall be without charge to the
Option Holder.  The Company shall pay,
and indemnify the Option Holder from and against any issuance, stamp or
documentary taxes (other than transfer taxes) or charges imposed by any
governmental body, agency or official (other than income taxes) by reason of
the exercise of the Option in whole or in part or the resulting issuance of the
Option Shares.

 

(n)   Withholding.  No later than the date of exercise of the Option granted
hereunder, the Option Holder shall pay to the Company or make arrangements
satisfactory to the Committee regarding payment of any federal, state or local
taxes of any kind required by

 

3

 

law to be withheld upon
the exercise of such Option and the Company shall, to the extent permitted or
required by law, have the right to deduct from any payment of any kind otherwise
due to the Option Holder, federal, state and local taxes of any kind required
by law to be withheld upon the exercise of such Option.

 

(o)   References.  References herein to rights and obligations of the Option Holder
shall apply, where appropriate, to the Option Holder’s legal representative or
estate without regard to whether specific reference to such legal
representative or estate is contained in a particular provision of this Option.

 

(p)   Notices.  Any notice required or permitted to be given under this agreement
shall be in writing and shall be deemed to have been given when delivered
personally or by courier, or sent by certified or registered mail, postage
prepaid, return receipt requested, duly addressed to the party concerned at the
address indicated below or to such changed address as such party may
subsequently by similar process give notice of:

 

If to the Company:

 

Arch Capital Group
Ltd.:

Wessex House, 3rd
Floor 

45 Reid Street

Hamilton HM 12
Bermuda 

Attn:  Secretary

 

If to the Option Holder:

 

The last address
delivered to the Company by the Option Holder in the manner set forth herein.

 

(q)   Governing Law.  This agreement shall be governed by and
construed in accordance with the laws of New York, without giving effect to
principles of conflict of laws thereof.

 

(r)    Entire Agreement.  This agreement and the Plan constitute the
entire agreement among the parties relating to the subject matter hereof, and
any previous agreement or understanding among the parties with respect thereto
is superseded by this agreement and the Plan.

 

(s)   Counterparts.  This agreement may be executed in two
counterparts, each of which shall constitute one and the same instrument.

 

4

 

IN WITNESS
WHEREOF, the undersigned have executed this agreement as of the Date of Grant.

 

	
   

  	
  ARCH CAPITAL GROUP LTD.

  
	
   

  	
   

  
	
   

  	
   

  
	
   

  	
  By:

  	
  /s/ John D.
  Vollaro

  	
   

  
	
   

  	
   

  
	
   

  	
   

  
	
   

  	
  /s/ Ralph E.
  Jones III

  	
   

  
	
   

  	
  Ralph E. Jones III

  

 

5Exhibit
10.4

 

ARCH
CAPITAL GROUP LTD. INCENTIVE COMPENSATION PLAN

 

SECTION 1.  Purpose.

 

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

 

SECTION 2.  Definitions.

 

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

 

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

 

2.3                                 “Award”
means the amount of bonus compensation to which an Eligible Employee is
entitled for each Plan Year as determined by the Committee pursuant to Section
4 and 5 of the Plan, which may be paid in cash, restricted common shares of the
Company or stock options as provided in Section 5 of the Plan.

 

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

 

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

 

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

 

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

 

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

 

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

 

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

2

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

3

 

SECTION 3.                            Administration.

 

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

 

SECTION 4.                            Determination
of Awards.

 

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

 

4.2                                 Target
Bonus Approach.

 

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

 

4

 

contained in the
applicable management plan submitted to the Board for the Plan Year, peer group
performance and other measures deemed applicable by the Committee.

 

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

 

4.3                                 Formula
Approach.

 

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

 

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

 

(c)                                  Maximum
Formula Approach Pool; Carryforwards.  For any given Plan Year, the maximum Formula Approach Pool for
each of the Insurance Segment and the Reinsurance Segment shall equal 200% of
the applicable Aggregate Target Amount (each, a “Maximum Formula Approach
Pool”).  Amounts in excess of each
Maximum Formula Approach Pool up to an additional 200% of such Maximum Formula
Approach Pool (the “Maximum Carryforward Amount”) shall be carried
forward and made available in Plan Years where the applicable Maximum Formula Approach
Pool is not met,

 

5

 

provided that the amount
which may be carried forward to any subsequent Plan Year shall not exceed 25%
of the Maximum Carryforward Amount.

 

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

 

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

 

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

 

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

 

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

 

SECTION 5.                            Payment
of Awards.

 

5.1                                 Form
of Award.  The Committee in its sole
discretion shall determine for any Plan Year whether any Awards payable in that
year shall be paid in cash or in restricted common shares of the Company or
stock options.  Any Awards to be paid in
restricted common shares or

 

6

 

stock
options shall be made under the Company’s 2002 Long Term Incentive and Share
Award Plan (or any successor thereto).

 

5.2                                 Payout
Period.  For each Plan Year, and
subject to Section 5.3 hereof, unless otherwise determined by the Committee,
Awards under the Target Bonus Approach and the Formula Approach shall be paid
over a four-year period as follows:  40%
shall be paid within three months of the end of such Plan Year, and 20% shall
be paid within three months of the end of each of the next three calendar
years.  If, following such initial
four-year period relating to a given Plan Year, any additional amounts are owed
to Eligible Employees under the Formula Approach as a result of recalculation
of the applicable Formula Approach Pool, then such amounts shall be paid to
such Eligible Employees when bonuses are next paid hereunder.  Notwithstanding the foregoing, junior
employees subject to the Target Bonus Approach, as designated by senior management
of the applicable business segment or unit, shall receive 100% of their Awards
within three months following the end of each Plan Year, and the payment
schedule for junior employees subject to the Formula Approach shall be
determined by senior management.

 

5.3                                 Vesting.  Each Eligible Employee must be employed by
the Company at the time of each payment of an Award unless terminated by the
Company not for Cause or as a result of death or Permanent Disability.  In
the event an Eligible Employee ceases to be an employee of the Company prior to
the date an Award is paid (i) due to termination by the Company not for Cause
or (ii) as a result of death or Permanent Disability, the Award shall become
vested in full at the time of such termination of service and shall be paid when
bonuses are next paid hereunder following such termination of employment in the form determined by the
Committee.  If the Eligible Employee
ceases to be an employee of the Company for any other reason prior to the date
that an Award is paid, the Award shall be forfeited by the Eligible Employee
and become the property of the Company. 
For purposes hereof, service with any of the Subsidiaries shall be
considered to be service with the Company. 
Vested amounts shall reflect applicable carryforwards and
Deficits, and terminated employees unvested amounts shall be removed from the applicable
bonus pool.

 

SECTION 6.                            Non-Transferability.

 

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

 

SECTION 7.                            Amendments
and Termination.

 

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

 

7

 

SECTION 8.                            General
Provisions.

 

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

 

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

 

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

 

8.4                                 Excess Parachute Payments.

 

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

 

8

 

been reduced by more than the minimum amount required
under this Section 8.4, then an additional payment shall be promptly made
to the Eligible Employee in an amount equal to the excess reduction.

 

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

 

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

 

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

 

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

 

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

 

SECTION 9.                            Effective
Date of Plan.

 

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

 

9

 

Schedule I

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

 

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

 

I-2

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