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ARCH CAPITAL GROUP LTD. – 10-Q – MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Edgar Glimpses
The following is a discussion and analysis of our financial condition and results of operations. This should be read in conjunction with our consolidated financial statements included in Item 1 of this report and also our Management's Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year endedDecember 31, 2020 ("2020 Form 10-K"). In addition, readers should review "Risk Factors" set forth in Item 1A of Part I of our 2020 Form 10-K and "ITEM 1A-Risk Factors" of this Form 10-Q. Tabular amounts are inU.S. Dollars in thousands, except share amounts, unless otherwise noted.Arch Capital Group Ltd. ("Arch Capital " and, together with its subsidiaries, "Arch", "we" or "us") is a publicly listedBermuda exempted company with approximately$16.1 billion in capital atSeptember 30, 2021 and, through operations inBermuda ,the United States ,Europe ,Canada ,Australia andHong Kong , writes insurance, reinsurance and mortgage insurance on a worldwide basis. CURRENT OUTLOOK As we approach the end of 2021, our three areas of focus during the year have remained constant. In our property and casualty segments of insurance and reinsurance, we continue our growth in the sectors where rates allow for returns that are substantially higher than our cost of capital. Our mortgage insurance segment has transitioned, for the most part, from forbearance to recovery and is producing results that made a significant contribution to our underwriting income in the third quarter. We have also been keenly focused on actively managing our investments and capital to enhance our returns over the long run. The 2021 third quarter reflected the benefits of attractive pricing in almost all of our insurance markets. As a result, we currently expect the next several quarters to continue to show improved underwriting margins, partially due to the compounding of rate-on-rate increases and the rebalancing of our mix of business. We believe that this time-tested strategy of protecting capital through soft markets and increasing our writings in hard markets gives us the best chance to generate superior risk adjusted returns over time. As long as rate increases support returns above our required thresholds, we expect to continue to grow our writings. The trajectory and market acceptance of rate increases reinforce why we remain optimistic that improved economics in the property casualty market will be sustainable for some time. The property casualty industry is facing many degrees of uncertainty, including heightened catastrophe activity, rising inflation, COVID's ongoing influence on the global economy and perennially low interest rates. Rate improvements have enabled us to continue to expand writings in our property casualty segments as we have been for two years now. Rate increases remain well above the long-term loss cost trends and have spread to more lines than last year. Overall, 2021 rates are up around 10% compared to 2020 and we currently expect that the benefit of higher premium levels will be reflected well into 2022 and beyond. Positive rate increases have accelerated in lower limit accounts which, until now, had lagged the increases in larger accounts. Our early focus on Lloyd's and business in theUK has improved our scale and our economics in this market. Some of our business lines that were most impacted by COVID, like travel, are recapturing some of the lost volume as both business and consumer travel increases. In reinsurance, strong growth was observed across most of our lines of business, but especially in our casualty and other specialty lines where strong rates increases and growth in new accounts helped increase the top line. At less than 6% of our tangible equity, we remained underweight in property catastrophe exposure and we will deploy more capital to the line if expected returns improve meaningfully above our target. Consistent with our insurance segment, we expect the ongoing rate improvements to be reflected in our underwriting results over the next several quarters. For ourU.S. primary mortgage operations, delinquencies continue to be better than our expectations at the beginning of the COVID-19 pandemic, as notices of default have declined to pre-pandemic levels atSeptember 30, 2021 , which is another indicator of improved conditions. Additionally, loans in forbearance continue to decline as federal programs conclude and we remain optimistic that most of these loans will ultimately cure. In the 2021 third quarter, insurance in force for ourU.S. primary mortgage operations remained steady at$280.4 billion , while insurance in force for the total mortgage segment was$457.7 billion . Overall, the market remains competitive but rational and our mortgage business continues to generate returns on capital in the mid teens. Mortgage originations continue at a pace similar to last year's record origination volume and credit quality remains excellent. Outside of theU.S. , we increased our writings inAustralia as a result of the housing market remaining strong and due to our acquisition of Westpac's LMI business. ARCH CAPITAL 42 2021 THIRD QUARTER FORM 10-Q -------------------------------------------------------------------------------- Table of Contents We remain committed to providing solutions across many offerings as the marketplace evolves, including the mortgage credit risk transfer programs initiated by government sponsored enterprises, or "GSEs." In addition, we enter into aggregate excess of loss mortgage reinsurance agreements with various special purpose reinsurance companies domiciled inBermuda and issue mortgage insurance linked notes, increasing our protection for mortgage tail risk. The Bellemeade structures provide approximately$5.1 billion of aggregate reinsurance coverage atSeptember 30, 2021 . FINANCIAL MEASURES Management uses the following three key financial indicators in evaluating our performance and measuring the overall growth in value generated forArch Capital's common shareholders: Book Value per Share Book value per share represents total common shareholders' equity available to Arch divided by the number of common shares outstanding. Management uses growth in book value per share as a key measure of the value generated for our common shareholders each period and believes that book value per share is the key driver ofArch Capital's share price over time. Book value per share is impacted by, among other factors, our underwriting results, investment returns and share repurchase activity, which has an accretive or dilutive impact on book value per share depending on the purchase price. Book value per share was$32.43 atSeptember 30, 2021 , compared to$32.02 atJune 30, 2021 and$28.75 atSeptember 30, 2020 . The 1.3% increase in book value per share for the 2021 third quarter reflected strong underwriting returns, which were impacted by a high level of losses from catastrophic events, along with flat total return on investments for the period. The 12.8% increase in book value per share over the trailing twelve months primarily reflected strong underwriting results. Operating Return on Average Common Equity Operating return on average common equity ("Operating ROAE") represents annualized after-tax operating income available to Arch common shareholders divided by the average of beginning and ending common shareholders' equity available to Arch during the period. After-tax operating income available to Arch common shareholders, a non-GAAP financial measure as defined in Regulation G, represents net income available to Arch common shareholders, excluding net realized gains or losses (which includes changes in the allowance for credit losses on financial assets and 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, transaction costs and other, loss on redemption of preferred shares and income taxes. Management uses Operating ROAE as a key measure of the return generated to common shareholders. See "Comment on Non-GAAP Financial Measures." Our Operating ROAE was 9.3% for the 2021 third quarter, compared to 4.2% for the 2020 third quarter, and 10.1% for the nine months endedSeptember 30, 2021 , compared to 3.9% for the 2020 period. Results for the 2021 third quarter reflected a one-time gain of$95.7 million recognized from the Company's previously disclosed acquisition of a 40% share of Greysbridge. Returns for the 2021 periods reflected strong underwriting returns and income from operating affiliates, while the 2020 period reflected the impact of COVID-19 on underwriting results. Total Return on Investments 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 (excluding changes in the allowance for credit losses on non-investment related financial assets) 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 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. The following table summarizes our total return compared to the benchmark return against which we measured our portfolio during the periods. See "Comment on Non-GAAP Financial Measures." Arch Benchmark Portfolio Return
Pre-tax total return (before investment expenses):
2021 Third Quarter
0.01 % (0.40) % 2020 Third Quarter 2.30 % 2.41 %
Nine Months Ended
Nine Months Ended
Total return for the 2021 third quarter reflected movements in interest rates and credit spreads on our fixed income portfolio. We continue to maintain a short duration on our portfolio of 2.68 years atSeptember 30, 2021 . 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, ARCH CAPITAL 43 2021 THIRD QUARTER FORM 10-Q -------------------------------------------------------------------------------- Table of Contents 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. AtSeptember 30, 2021 , the benchmark return index had an average credit quality of "Aa2" by Moody's Investors Service ("Moody's"), and an estimated duration of 3.18 years. The benchmark return index included weightings to the following indices: % ICE BoAML 1-5 Year A - AAA U.S. Corporate Index 13.00 % ICE BoAML 5-10 Year A - AAA U.S. Corporate Index 11.00 ICE BoAML 1-5 Year U.S. Treasury Index 11.00 MSCI ACWI Net Total Return USD Index 9.30 ICE BoAML 1-10 Year BBB U.S. Corporate Index 5.00 JPM CLOIE Investment Grade 5.00 S&P/LSTA Leveraged Loan Total Return Index 4.965 ICE BoAML U.S. Mortgage Backed Securities Index 4.00 ICE BoAML AAA US Fixed Rate CMBS 4.00 ICE BoAML 1-5 Year U.K. Gilt Index 4.00 ICE BoAML German Government 1-10 Year Index 3.50 ICE BoAML 0-3 Year U.S. Treasury Index 3.25 ICE BoAML 5-10 Year U.S. Treasury Index 3.00 ICE BoAML 1-10 Year U.S. Municipal Securities Index 3.00 Bloomberg Barclays ABS Aaa Index 3.00 ICE BoAML 1-5 Year Australia Government Index 2.75 ICE BoAML U.S. High Yield Constrained Index 2.50 ICE BoAML 1-5 Year Canada Government Index 2.00 ICE BofA CCC and Lower US High Yield Constrained Index 1.38 Bloomberg Barclays Global High Yield Index 1.38
S&P DJ Global ex-US Select Real Estate Securities Net Index 0.825
FTSE Nareit All Mortgage Capped Index Total Return USD
0.825 Bloomberg Barclays CMBS: Erisa Eligible Unhedged USD 0.825 ICE BoAML 15+ Year Canada Government Index 0.50 Total 100.00 %
COMMENT ON NON-GAAP FINANCIAL MEASURES
Throughout this filing, we present our operations in the way we believe will be the most meaningful and useful to investors, analysts, rating agencies and others who use our financial information in evaluating the performance of our company. This presentation includes the use of after-tax operating income available to Arch common shareholders, which is defined as net income available to Arch common shareholders, excluding net realized gains or losses (which includes changes in the allowance for credit losses on financial assets and 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, transaction costs and other, loss on redemption of preferred shares and income taxes, and the use of annualized operating return on average common equity. The presentation of after-tax operating income available to Arch common shareholders and annualized operating return on average common equity are non-GAAP financial measures as defined in Regulation G. The reconciliation of such measures to net income available to Arch common shareholders and annualized net income return on average common equity (the most directly comparable GAAP financial measures) in accordance with Regulation G is included under "Results of Operations" below. We believe that net realized gains or losses, equity in net income or loss of investment funds accounted for using the equity method, net foreign exchange gains or losses, transaction costs and other and loss on redemption of preferred shares in any particular period are not indicative of the performance of, or trends in, our business. Although net realized gains or losses, equity in net income or loss of investment funds accounted for using the equity method and net foreign exchange gains or losses are an integral part of our operations, the decision to realize investment gains or losses, the recognition of the change in the carrying value of investments accounted for using the fair value option in net realized gains or losses, the recognition of net impairment losses, the recognition of equity in net income or loss of 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, changes in the allowance for credit losses and net impairment losses recognized in earnings on the Company's 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 ARCH CAPITAL 44 2021 THIRD QUARTER FORM 10-Q -------------------------------------------------------------------------------- Table of Contents (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. Transaction costs and other include advisory, financing, legal, severance, incentive compensation and other transaction costs related to acquisitions. We believe that transaction costs and other, due to their non-recurring nature, are not indicative of the performance of, or trends in, our business performance. The loss on redemption of preferred shares related to the redemption of the Company's Series E preferred shares inSeptember 2021 and had no impact on shareholders' equity or cash flows. Due to these reasons, we exclude net realized gains or losses, equity in net income or loss of investment funds accounted for using the equity method, net foreign exchange gains or losses, transaction costs and other and loss on redemption of preferred shares 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, throughJune 30, 2021 . 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 throughJune 30, 2021 , in accordance with Regulation G, is shown in note 5, "Segment Information" to our consolidated financial statements. We measure segment performance for our three underwriting segments based on underwriting income or loss. We do not manage our assets by underwriting segment, with the exception of goodwill and intangibles and, accordingly, investment income and other non-underwriting related items are not allocated to each underwriting segment. The 'other' segment includes the results ofWatford throughJune 30, 2021 . Along with consolidated underwriting income, we provide a subtotal of underwriting income or loss before the contribution from the 'other' segment. ThroughJune 30, 2021 , the 'other' segment included the results ofWatford Holdings Ltd. Watford Holdings Ltd. is the parent ofWatford Re Ltd. , a multi-lineBermuda reinsurance company (together withWatford Holdings Ltd. , "Watford"). Pursuant to GAAP,Watford was considered a variable interest entity and we concluded that we were the primary beneficiary ofWatford . As such, we consolidated the results ofWatford in our consolidated financial statements throughJune 30, 2021 . In the 2020 fourth quarter,Arch Capital ,Watford , andGreysbridge Ltd. , a wholly-owned subsidiary ofArch Capital , entered into an Agreement and Plan of Merger (as amended, the "Merger Agreement").Arch Capital assigned its rights under the Merger Agreement toGreysbridge Holdings Ltd. ("Greysbridge"). The merger and the related Greysbridge equity financing closed onJuly 1, 2021 . EffectiveJuly 1, 2021 ,Watford is wholly owned by Greysbridge, and Greysbridge is owned 40% by Arch and 30% by certain funds managed by Kelso and 30% by certain funds managed by Warburg. Based on the governing documents of Greysbridge, we concluded that, while we retain significant influence over Greysbridge, Greysbridge does not constitute a variable interest entity. Accordingly, effectiveJuly 1, 2021 , we no longer consolidate the results of Watford in our consolidated financial statements and footnotes. See note 12, "Variable Interest Entities and Noncontrolling Interests" and note 5, "Segment Information," to our consolidated financial statements for additional information onWatford . Our presentation of segment information includes the use of a current year loss ratio which excludes favorable or adverse ARCH CAPITAL 45 2021 THIRD QUARTER FORM 10-Q -------------------------------------------------------------------------------- Table of Contents development in prior year loss reserves. This ratio is a non-GAAP financial measure as defined in Regulation G. The reconciliation of such measure to the loss ratio (the most directly comparable GAAP financial measure) in accordance with Regulation G is shown on the individual segment pages. Management utilizes the current year loss ratio in its analysis of the underwriting performance of each of our underwriting segments. Total return on investments includes investment income, equity in net income or loss of investment funds accounted for using the equity method, net realized gains and losses (excluding changes in the allowance for credit losses on non-investment related financial assets) 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, and compares the return generated by our investment portfolio against benchmark returns during the periods. RESULTS OF OPERATIONS
The following table summarizes our consolidated financial data, including a
reconciliation of net income or loss available to Arch common shareholders to
after-tax operating income or loss available to Arch common shareholders.
Three Months Ended Nine Months Ended
September 30, September 30,
2021 2020 2021 2020
Net income available to Arch
common shareholders $ 388,751 $ 408,636 $ 1,480,324 $ 830,768
Net realized (gains) losses 25,040 (219,726) (247,949) (517,007)
Equity in net (income) loss of
investment funds accounted for
using the equity method (105,398) (126,735) (299,270) (57,407)
Net foreign exchange (gains)
losses (36,078) 39,462 (39,522) 17,003
Transaction costs and other 1,036 1,674 889 5,246
Loss on redemption of preferred
shares 15,101 - 15,101 -
Income tax expense (1) 6,236 17,010 32,100 48,088
After-tax operating income
available to Arch common
shareholders $ 294,688 $ 120,321
Beginning common shareholders' equity$ 12,706,072 $ 11,211,825 $ 12,325,886 $ 10,717,371 Ending common shareholders' equity$ 12,557,526 $ 11,671,997 $ 12,557,526 $ 11,671,997 Average common shareholders' equity$ 12,631,799 $ 11,441,911
Annualized net income return on average common equity % 12.3 14.3 15.9 9.9 Annualized operating return on average common equity % 9.3 4.2 10.1 3.9 (1) Income tax expense on net realized gains or losses, equity in net income or loss of investment funds accounted for using the equity method, net foreign exchange gains or losses and transaction costs and other reflects the relative mix reported by jurisdiction and the varying tax rates in each jurisdiction. ARCH CAPITAL 46 2021 THIRD QUARTER FORM 10-Q -------------------------------------------------------------------------------- Table of Contents Segment Information We classify our businesses into three underwriting segments - insurance, reinsurance and mortgage - and two other operating segments - corporate (non-underwriting) and 'other.' Our insurance, reinsurance and mortgage segments each have managers who are responsible for the overall profitability of their respective segments and who are directly accountable to our chief operating decision makers, the Chief Executive Officer ofArch Capital , the Chief Financial Officer and Treasurer ofArch Capital and the President and Chief Underwriting Officer ofArch Capital . The chief operating decision makers do not assess performance, measure return on equity or make resource allocation decisions on a line of business basis. Management measures segment performance for our three underwriting segments based on underwriting income or loss. We do not manage our assets by underwriting segment, with the exception of goodwill and intangible assets, and, accordingly, investment income is not allocated to each underwriting segment. We determined our reportable segments using the management approach described in accounting guidance regarding disclosures about segments of an enterprise and related information. The accounting policies of the segments are the same as those used for the preparation of our consolidated financial statements. Intersegment business is allocated to the segment accountable for the underwriting results. Insurance Segment The following tables set forth our insurance segment's underwriting results:
Three Months Ended
%
2021 2020 Change
Gross premiums written $ 1,596,619 $ 1,206,328 32.4
Premiums ceded (442,806) (382,167)
Net premiums written 1,153,813 824,161 40.0
Change in unearned premiums (215,143) (105,007)
Net premiums earned 938,670 719,154 30.5
Other underwriting income (loss) - (31)
Losses and loss adjustment expenses (668,630) (525,321)
Acquisition expenses (152,467) (102,420)
Other operating expenses (138,931) (122,541)
Underwriting income (loss) $ (21,358) $ (31,159) 31.5
% Point
Underwriting Ratios Change
Loss ratio 71.2 % 73.0 % (1.8)
Acquisition expense ratio 16.2 % 14.2 % 2.0
Other operating expense ratio 14.8 % 17.0 % (2.2)
Combined ratio 102.2 % 104.2 % (2.0)
Nine Months Ended
2021 2020 % Change Gross premiums written$ 4,381,372 $ 3,444,335 27.2 Premiums ceded (1,269,165) (1,119,165) Net premiums written 3,112,207 2,325,170 33.8 Change in unearned premiums (488,636) (202,188) Net premiums earned 2,623,571 2,122,982 23.6 Other underwriting income - (31) Losses and loss adjustment expenses (1,750,257) (1,550,632) Acquisition expenses (417,541) (317,428) Other operating expenses (409,386) (370,947) Underwriting income (loss)$ 46,387 $ (116,056) 140.0 % Point Underwriting Ratios Change Loss ratio 66.7 % 73.0 % (6.3) Acquisition expense ratio 15.9 % 15.0 % 0.9 Other operating expense ratio 15.6 % 17.5 % (1.9) Combined ratio 98.2 % 105.5 % (7.3) The insurance segment consists of our insurance underwriting units which offer specialty product lines on a worldwide basis. Product lines include: •Construction and national accounts: primary and excess casualty coverages to middle and large accounts in the construction industry and a wide range of products for middle and large national accounts, specializing in loss sensitive primary casualty insurance programs (including large deductible, self-insured retention and retrospectively rated programs). •Excess and surplus casualty: primary and excess casualty insurance coverages, including middle market energy business, and contract binding, which primarily provides casualty coverage through a network of appointed agents to small and medium risks. •Lenders products: collateral protection, debt cancellation and service contract reimbursement products to banks, credit unions, automotive dealerships and original equipment manufacturers and other specialty programs that pertain to automotive lending and leasing. •Professional lines: directors' and officers' liability, errors and omissions liability, employment practices liability, fiduciary liability, crime, professional indemnity and other financial related coverages for corporate, private equity, venture capital, real estate investment trust, limited partnership, financial institution and not-for-profit clients of all sizes and medical professional and general liability insurance coverages for the healthcare industry. The business is predominately written on a claims-made basis. •Programs: primarily package policies, underwriting workers' compensation and umbrella liability business in support of desirable package programs, targeting program ARCH CAPITAL 47 2021 THIRD QUARTER FORM 10-Q
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managers with unique expertise and niche products offering general liability,
commercial automobile, inland marine and property business with minimal
catastrophe exposure.
•Property, energy, marine and aviation: primary and excess general property
insurance coverages, including catastrophe-exposed property coverage, for
commercial clients. Coverages for marine include hull, war, specie and
liability. Aviation and standalone terrorism are also offered.
•Travel, accident and health: specialty travel and accident and related
insurance products for individual, group travelers, travel agents and suppliers,
as well as accident and health, which provides accident, disability and medical
plan insurance coverages for employer groups, medical plan members, students and
other participant groups.
•Other: includes alternative market risks (including captive insurance
programs), excess workers' compensation and employer's liability insurance
coverages for qualified self-insured groups, associations and trusts, and
contract and commercial surety coverages, including contract bonds (payment and
performance bonds) primarily for medium and large contractors and commercial
surety bonds for Fortune 1,000 companies and smaller transaction business
programs.
Premiums Written.
The following tables set forth our insurance segment's net premiums written by
major line of business:
Three Months Ended September 30,
2021 2020
Amount % Amount %
Property, energy, marine and aviation $ 215,062 18.6 $ 152,193 18.5
Professional lines 310,185 26.9 199,163 24.2
Programs 196,048 17.0 123,768 15.0
Construction and national accounts 92,253 8.0 88,790 10.8
Excess and surplus casualty 98,320 8.5 78,889 9.6
Travel, accident and health 62,837 5.4 28,972 3.5
Lenders products 38,905 3.4 60,830 7.4
Other 140,203 12.2 91,556 11.1
Total $ 1,153,813 100.0 $ 824,161 100.0
2021 Third Quarter versus 2020 Period. Gross premiums written by the insurance
segment in the 2021 third quarter were 32.4% higher than in the 2020 third
quarter, while net premiums written were 40.0% higher. The higher level of net
premiums written reflected increases in most lines of business, due in part to
rate increases, new business opportunities and growth in existing accounts.
Nine Months Ended September 30,
2021 2020
Amount % Amount %
Property, energy, marine and aviation $ 593,322 19.1 $ 439,579 18.9
Professional Lines 803,392 25.8 526,180 22.6
Programs 503,822 16.2 341,230 14.7
Construction and national accounts 304,624 9.8 261,933 11.3
Excess and surplus casualty 258,259 8.3 209,011 9.0
Travel, accident and health 226,214 7.3 183,015 7.9
Lenders products 114,151 3.7 117,812 5.1
Other 308,423 9.9 246,410 10.6
Total $ 3,112,207 100.0 $ 2,325,170 100.0
Nine Months Ended September 30, 2021 versus 2020 Period. Gross premiums written
by the insurance segment for the nine months ended September 30, 2021 were 27.2%
higher than in the 2020 period, while net premiums written were 33.8% higher
than in the 2020 period. The increase in net premiums written reflected growth
across most lines of business, due in part to rate increases, new business
opportunities and growth in existing accounts.
Net Premiums Earned.
The following tables set forth our insurance segment's net premiums earned by
major line of business:
Three Months Ended September 30,
2021 2020
Amount % Amount %
Property, energy, marine and aviation $ 187,905 20.0 $ 133,827 18.6
Professional lines 249,007 26.5 168,502 23.4
Programs 137,299 14.6 104,861 14.6
Construction and national accounts 94,523 10.1 95,386 13.3
Excess and surplus casualty 84,048 9.0 69,978 9.7
Travel, accident and health 56,102 6.0 36,726 5.1
Lenders products 33,030 3.5 33,401 4.6
Other 96,756 10.3 76,473 10.6
Total $ 938,670 100.0 $ 719,154 100.0
ARCH CAPITAL 48 2021 THIRD QUARTER FORM 10-Q
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Nine Months Ended September 30,
2021 2020
Amount % Amount %
Property, energy, marine and aviation $ 512,880 19.5 $ 365,791 17.2
Professional Lines 662,776 25.3 475,014 22.4
Programs 369,113 14.1 322,203 15.2
Construction and national accounts 293,043 11.2 286,691 13.5
Excess and surplus casualty 232,314 8.9 196,041 9.2
Travel, accident and health 168,378 6.4 166,218 7.8
Lenders products 119,507 4.6 81,855 3.9
Other 265,560 10.1 229,169 10.8
Total $ 2,623,571 100.0 $ 2,122,982 100.0
Net premiums written are primarily earned on a pro rata basis over the terms of
the policies for all products, usually 12 months. Net premiums earned reflect
changes in net premiums written over the previous five quarters. Net premiums
earned in the 2021 third quarter were 30.5% higher than in the 2020 third
quarter. Net premiums earned for the nine months ended September 30, 2021 were
23.6% higher than in the 2020 period.
Losses and Loss Adjustment Expenses.
The table below shows the components of the insurance segment's loss ratio:
Three Months Ended Nine Months Ended
September 30, September 30,
2021 2020 2021 2020
Current year 71.7 % 73.3 % 67.2 % 73.3 %
Prior period reserve
development (0.5) % (0.3) % (0.5) % (0.3) %
Loss ratio 71.2 % 73.0 % 66.7 % 73.0 %
Current Year Loss Ratio.
2021 Third Quarter versus 2020 Period. The insurance segment's current year loss
ratio in the 2021 third quarter was 1.6 points lower than in the 2020 third
quarter. The 2021 third quarter loss ratio reflected 12.2 points of current year
catastrophic activity, primarily related to Hurricane Ida and other global
events, compared to 10.3 points of catastrophic activity for the 2020 third
quarter, which included exposure to the COVID-19 global pandemic. The insurance
segment's current year loss ratio for the nine months ended September 30, 2021
was 6.1 points lower than in the 2020 period and reflected 7.0 points of current
year catastrophic activity, compared to 9.9 points in the 2020 period. The
balance of the change in the 2021 loss ratios resulted, in part, from changes in
mix of business and the level of large attritional losses.
Prior Period Reserve Development .
The insurance segment's net favorable development was $5.1 million , or 0.5
points, for the 2021 third quarter, compared to $2.3 million , or 0.3 points, for
the 2020 third quarter, and $13.1 million , or 0.5 points for the nine months
ended September 30, 2021 , compared to $5.9 million , or 0.3 points, for the 2020
period. See note 6, "Reserve for Losses and Loss Adjustment Expenses," to
our consolidated financial statements for information about the insurance
segment's prior year reserve development.
Underwriting Expenses.
2021 Third Quarter versus 2020 Period. The insurance segment's underwriting
expense ratio was 31.0% in the 2021 third quarter, consistent with 31.2% in the
2020 third quarter.
Nine Months Ended September 30, 2021 versus 2020 Period. The insurance segment's
underwriting expense ratio was 31.5% for the nine months ended September 30,
2021 , compared to 32.5% for the 2020 period, with the decrease primarily due to
growth in net premiums earned.
Reinsurance Segment
The following tables set forth our reinsurance segment's underwriting results:
Three Months Ended September 30,
%
2021 2020 Change
Gross premiums written $ 1,251,760 $ 1,004,590 24.6
Premiums ceded (630,371) (400,388)
Net premiums written 621,389 604,202 2.8
Change in unearned premiums 57,313 (49,704)
Net premiums earned 678,702 554,498 22.4
Other underwriting income (loss) 3,293 298
Losses and loss adjustment expenses (545,846) (422,084)
Acquisition expenses (129,450) (85,388)
Other operating expenses (45,647) (41,818)
Underwriting income (loss) $ (38,948) $ 5,506 (807.4)
% Point
Underwriting Ratios Change
Loss ratio 80.4 % 76.1 % 4.3
Acquisition expense ratio 19.1 % 15.4 % 3.7
Other operating expense ratio 6.7 % 7.5 % (0.8)
Combined ratio 106.2 % 99.0 % 7.2
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Nine
Months Ended
2021 2020 % Change
Gross premiums written $ 4,080,840 $ 2,934,174 39.1
Premiums ceded (1,535,607) (967,698)
Net premiums written 2,545,233 1,966,476 29.4
Change in unearned premiums (484,607) (388,321)
Net premiums earned 2,060,626 1,578,155 30.6
Other underwriting income 3,148 1,767
Losses and loss adjustment expenses (1,494,539) (1,235,586)
Acquisition expenses (381,060) (255,516)
Other operating expenses (150,856) (125,831)
Underwriting income (loss) $ 37,319 $
(37,011) 200.8
% Point
Underwriting Ratios Change
Loss ratio 72.5 % 78.3 % (5.8)
Acquisition expense ratio 18.5 % 16.2 % 2.3
Other operating expense ratio 7.3 % 8.0 % (0.7)
Combined ratio 98.3 % 102.5 % (4.2)
The reinsurance segment consists of our reinsurance underwriting units which
offer specialty product lines on a worldwide basis. Product lines include:
•Casualty: provides coverage to ceding company clients on third party liability
and workers' compensation exposures from ceding company clients, primarily on a
treaty basis. Exposures include, among others, executive assurance, professional
liability, workers' compensation, excess and umbrella liability, excess motor
and healthcare business.
•Marine and aviation: provides coverage for energy, hull, cargo, specie,
liability and transit, and aviation business, including airline and general
aviation risks. Business written may also include space business, which includes
coverages for satellite assembly, launch and operation for commercial space
programs.
•Other specialty: provides coverage to ceding company clients for proportional
motor and other lines, including surety, accident and health, workers'
compensation catastrophe, agriculture, trade credit and political risk.
•Property catastrophe: provides protection for most catastrophic losses that are
covered in the underlying policies written by reinsureds, including hurricane,
earthquake, flood, tornado, hail and fire, and coverage for other perils on a
case-by-case basis. Property catastrophe reinsurance provides coverage on an
excess of loss basis when aggregate losses and loss adjustment expense from a
single occurrence or aggregation of losses from a covered peril exceed the
retention specified in the contract.
•Property excluding property catastrophe: provides coverage for both personal
lines and commercial property exposures and principally covers buildings,
structures, equipment and contents. The primary perils in this business
include fire, explosion, collapse, riot, vandalism, wind, tornado, flood and
earthquake. Business is assumed on both a proportional and excess of loss treaty
basis and on a facultative basis. In addition, facultative business is written
which focuses on commercial property risks on an excess of loss basis.
•Other: includes life reinsurance business on both a proportional and
non-proportional basis, casualty clash business and, in limited instances,
non-traditional business which is intended to provide insurers with risk
management solutions that complement traditional reinsurance.
Premiums Written.
The following tables set forth our reinsurance segment's net premiums written by
major line of business:
Three
Months Ended
2021 2020
Amount % Amount %
Property excluding property
catastrophe $ 237,025 38.1 $ 223,880 37.1
Property catastrophe (7,125) (1.1) 42,125 7.0
Other specialty 167,006 26.9 159,969 26.5
Casualty 187,066 30.1 142,401 23.6
Marine and aviation 19,159 3.1 27,839 4.6
Other 18,258 2.9 7,988 1.3
Total $ 621,389 100.0 $ 604,202 100.0
2021 Third Quarter versus 2020 Period. Gross premiums written by the reinsurance
segment in the 2021 third quarter were 24.6% higher than in the 2020 third
quarter, while net premiums written were 2.8% higher. The lower level of growth
in net premiums written compared to gross premiums written primarily reflected a
higher level of premiums ceded due to a one-time $161.2 million adjustment,
resulting from retrocessions to Watford following its ownership change on July
1, 2021 . Absent this item, the growth in net premiums written would have been
29.5%, consistent with the level of growth in gross premiums written, reflecting
increases in most lines of business, due in part to new business opportunities
and rate increases.
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Nine
Months Ended
2021 2020
Amount % Amount %
Property excluding property
catastrophe $ 778,959 30.6 $ 546,443 27.8
Property catastrophe 197,724 7.8 248,893 12.7
Other Specialty 747,662 29.4 562,296 28.6
Casualty 631,212 24.8 438,330 22.3
Marine and aviation 131,045 5.1 109,996 5.6
Other 58,631 2.3 60,518 3.1
Total $ 2,545,233 100.0 $ 1,966,476 100.0
Nine Months Ended September 30, 2021 versus 2020 Period. Gross premiums written
by the reinsurance segment for the nine months ended September 30, 2021 were
39.1% higher than in the 2020 period, while net premiums written were 29.4%
higher than in the 2020 period. The increase in net premiums written reflected
growth in property excluding property catastrophe, other specialty and casualty
primarily due to new business and rate increases.
Net Premiums Earned.
The following tables set forth our reinsurance segment's net premiums earned by
major line of business:
Three
Months Ended
2021 2020
Amount % Amount %
Property excluding property
catastrophe $ 210,280 31.0 $ 163,081 29.4
Property catastrophe 61,107 9.0 69,524 12.5
Other specialty 195,649 28.8 141,201 25.5
Casualty 159,697 23.5 136,421 24.6
Marine and aviation 29,818 4.4 26,744 4.8
Other 22,151 3.3 17,527 3.2
Total $ 678,702 100.0 $ 554,498 100.0
Nine
Months Ended
2021 2020
Amount % Amount %
Property excluding property
catastrophe $ 600,842 29.2 $ 399,752 25.3
Property catastrophe 225,285 10.9 177,750 11.3
Other Specialty 571,364 27.7 467,592 29.6
Casualty 492,574 23.9 404,248 25.6
Marine and aviation 112,699 5.5 76,562 4.9
Other 57,862 2.8 52,251 3.3
Total $ 2,060,626 100.0 $ 1,578,155 100.0
Net premiums written, irrespective of the class of business, are generally
earned on a pro rata basis over the terms of the underlying policies or
reinsurance contracts. Net premiums earned by the reinsurance segment in the
2021 third quarter were 22.4% higher than in the 2020 third quarter, and reflect
changes in net premiums written over the previous five quarters. For the nine
months ended September 30, 2021 , net premiums earned were 30.6% higher than in
the 2020 period.
Other Underwriting Income (Loss).
Other underwriting income for the 2021 third quarter was $3.3 million , compared
to an income of $0.3 million for the 2020 third quarter, and an income of $3.1
million for the nine months ended September 30, 2021 , compared to an income of
$1.8 million for the 2020 period.
Losses and Loss Adjustment Expenses.
The table below shows the components of the reinsurance segment's loss ratio:
Three Months Ended Nine Months Ended
September 30, September 30,
2021 2020 2021 2020
Current year 91.1 % 83.7 % 78.3 % 84.2 %
Prior period reserve development (10.7) % (7.6) % (5.8) % (5.9) %
Loss ratio 80.4 % 76.1 % 72.5 % 78.3 %
Current Year Loss Ratio.
2021 Third Quarter versus 2020 Period. The reinsurance segment's current year
loss ratio in the 2021 third quarter was 7.4 points higher than in the 2020
third quarter. The 2021 third quarter loss ratio reflected 34.6 points of
current year catastrophic activity, primarily related to Hurricane Ida, European
floods and other global events. The 2020 third quarter included 26.1 points of
catastrophic activity, which included exposure to the COVID-19 pandemic.
Nine Months Ended September 30, 2021 versus 2020 Period. The reinsurance
segment's current year loss ratio for the nine months ended September 30, 2021
was 5.9 points lower than in the 2020 period and reflected 20.1 points of
current year catastrophic activity, compared to 21.6 points in the 2020 period.
The 2020 period loss ratio included exposure to the COVID-19 pandemic.
Prior Period Reserve Development .
The reinsurance segment's net favorable development was $72.3 million , or 10.7
points, for the 2021 third quarter, compared to $42.0 million , or 7.6 points,
for the 2020 third quarter, and $119.6 million , or 5.8 points, for the nine
months ended September 30, 2021 , compared to $93.8 million , or 5.9 points, for
the 2020 period. See note 6, "Reserve for Losses and Loss Adjustment
Expenses," to our consolidated financial statements for information about the
reinsurance segment's prior year reserve development.
Underwriting Expenses.
2021 Third Quarter versus 2020 Period. The underwriting expense ratio for the
reinsurance segment was 25.8% in the
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2021 third quarter, compared to 22.9% in the 2020 third quarter, with the
increase primarily resulting from changes in mix of business to lines with
higher acquisition costs and a higher level of expenses related to favorable
development of prior year loss reserves.
Nine Months Ended September 30, 2021 versus 2020 Period. The underwriting
expense ratio for the reinsurance segment was 25.8% for the nine months ended
September 30, 2021 , compared to 24.2% for the 2020 period. The comparison of the
underwriting expense ratios also reflected changes in the mix and type of
business and a higher level of net premiums earned for the 2021 period.
Mortgage Segment
Our mortgage operations include U.S. and international mortgage insurance and
reinsurance operations as well as participation in GSE credit risk-sharing
transactions. Our mortgage group includes direct mortgage insurance in the U.S.
primarily through Arch Mortgage Insurance Company , United Guaranty Residential
Insurance Company and Arch Mortgage Guaranty Company (together, "Arch MI U.S. ");
mortgage reinsurance by Arch Reinsurance Ltd. ("Arch Re Bermuda") to mortgage
insurers on both a proportional and non-proportional basis globally; direct
mortgage insurance in Europe through Arch Insurance (EU) Designated Activity
Company ("Arch Insurance EU"); in Hong Kong through Arch MI Asia Limited ("Arch
MI Asia "); in Australia through Arch Lenders Mortgage Indemnity Limited ("ALMI")
and participation in various GSE credit risk-sharing products primarily through
Arch Re Bermuda.
The following tables set forth our mortgage segment's underwriting results.
Three Months Ended
2021 2020 % Change Gross premiums written$ 360,934 $ 346,248 4.2 Premiums ceded (60,207) (47,783) Net premiums written 300,727 298,465 0.8 Change in unearned premiums 11,238 52,944 Net premiums earned 311,965 351,409 (11.2) Other underwriting income 3,981 4,600 Losses and loss adjustment expenses (11,543) (153,055) Acquisition expenses (24,098) (35,716) Other operating expenses (46,254) (36,708) Underwriting income$ 234,051 $ 130,530 79.3 % Point Underwriting Ratios Change Loss ratio 3.7 % 43.6 % (39.9) Acquisition expense ratio 7.7 % 10.2 % (2.5) Other operating expense ratio 14.8 % 10.4 % 4.4 Combined ratio 26.2 % 64.2 % (38.0)
Nine Months Ended
2021 2020 % Change Gross premiums written$ 1,143,691 $ 1,084,337 5.5 Premiums ceded (171,923) (136,154) Net premiums written 971,768 948,183 2.5 Change in unearned premiums 10,735 113,965 Net premiums earned 982,503 1,062,148 (7.5) Other underwriting income 15,026 15,649 Losses and loss adjustment expenses (85,112) (444,721) Acquisition expenses (84,297) (108,304) Other operating expenses (143,697) (120,178) Underwriting income$ 684,423 $ 404,594 69.2 % Point Underwriting Ratios Change Loss ratio 8.7 % 41.9 % (33.2) Acquisition expense ratio 8.6 % 10.2 % (1.6) Other operating expense ratio 14.6 % 11.3 % 3.3 Combined ratio 31.9 % 63.4 % (31.5) Premiums Written. The following tables set forth our mortgage segment's net premiums written by underwriting location (i.e., where the business is underwritten): Three Months Ended September 30, 2021 2020 Amount % Amount % Underwriting location: United States $ 221,315 73.6$ 245,971 82.4 Other 79,412 26.4 52,494 17.6 Total $ 300,727 100.0$ 298,465 100.0 2021 Third Quarter versus 2020 Period. Gross premiums written by the mortgage segment in the 2021 third quarter were 4.2% higher than in the 2020 third quarter, while net premiums written were 0.8% higher. The increase in gross premiums written reflected growth in Australian single premium mortgage insurance partially as a result of the previously disclosed acquisition ofWestpac Lenders Mortgage Insurance Limited . The lower increase in net premiums written reflected a higher level of premiums ceded onU.S. primary mortgage insurance. Nine Months Ended September 30, 2021 2020 Amount % Amount % Underwriting location: United States$ 703,489 72.4$ 771,203 81.3 Other 268,279 27.6 176,980 18.7 Total$ 971,768 100.0$ 948,183 100.0 Nine Months EndedSeptember 30, 2021 versus 2020 Period. Gross premiums written by the mortgage segment for the nine months endedSeptember 30, 2021 were 5.5% higher than in the 2020 period, while net premiums written for the nine months endedSeptember 30, 2021 were 2.5% higher ARCH CAPITAL 52 2021 THIRD QUARTER FORM 10-Q -------------------------------------------------------------------------------- Table of Contents than in the 2020 period, primarily reflecting growth in Australian single premium mortgage insurance and the benefit of premiums received related to the exercise of early redemption options by GSEs for certain seasoned callable credit risk transfer contracts. This growth was partially offset by a lower level ofU.S. primary mortgage insurance in force on monthly premium policies, which resulted from the continued high level of refinancing activity. The persistency rate, which 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, was 57.7% for the Arch MIU.S. portfolio of mortgage insurance policies atSeptember 30, 2021 , reflecting the higher level of mortgage refinancing activity, compared to 58.7% atDecember 31, 2020 . The following tables provide details on the new insurance written ("NIW") generated by Arch MIU.S. NIW represents the original principal balance of all loans that received coverage during the period. (U.S. Dollars in millions) Three
Months Ended
2021 2020
Amount % Amount %
Total new insurance written (NIW)
(1) $ 27,841 $ 32,787
Credit quality (FICO):
>=740 $ 17,514 62.9 $ 21,160 64.5
680-739 9,012 32.4 10,562 32.2
620-679 1,315 4.7 1,065 3.2
Total $ 27,841 100.0 $ 32,787 100.0
Loan-to-value (LTV):
95.01% and above $ 1,554 5.6 $ 2,561 7.8
90.01% to 95.00% 14,240 51.1 13,967 42.6
85.01% to 90.00% 8,394 30.1 10,052 30.7
85.00% and below 3,653 13.1 6,207 18.9
Total $ 27,841 100.0 $ 32,787 100.0
Monthly vs. single:
Monthly $ 26,515 95.2 $ 31,928 97.4
Single 1,326 4.8 859 2.6
Total $ 27,841 100.0 $ 32,787 100.0
Purchase vs. refinance:
Purchase $ 25,711 92.3 $ 24,256 74.0
Refinance 2,130 7.7 8,531 26.0
Total $ 27,841 100.0 $ 32,787 100.0
(1)Represents the original principal balance of all loans that received coverage
during the period.
(U.S. Dollars in millions) Nine Months Ended September 30,
2021 2020
Amount % Amount %
Total new insurance written (NIW)
(1) $ 83,232 $ 74,116
Credit quality (FICO):
>=740 $ 54,572 65.6 $ 47,080 63.5
680-739 25,543 30.7 24,130 32.6
620-679 3,117 3.7 2,906 3.9
Total $ 83,232 100.0 $ 74,116 100.0
Loan-to-value (LTV):
95.01% and above $ 4,646 5.6 $ 6,177 8.3
90.01% to 95.00% 40,464 48.6 30,569 41.2
85.01% to 90.00% 25,381 30.5 23,521 31.7
85.01% and below 12,741 15.3 13,849 18.7
Total $ 83,232 100.0 $ 74,116 100.0
Monthly vs. single:
Monthly $ 78,229 94.0 $ 71,011 95.8
Single 5,003 6.0 3,105 4.2
Total $ 83,232 100.0 $ 74,116 100.0
Purchase vs. refinance:
Purchase $ 71,226 85.6 $ 51,511 69.5
Refinance 12,006 14.4 22,605 30.5
Total $ 83,232 100.0 $ 74,116 100.0
(1)Represents the original principal balance of all loans that received coverage
during the period.
Net Premiums Earned.
The following tables set forth our mortgage segment's net premiums earned by
underwriting location:
Three Months Ended September 30,
2021 2020
Amount % Amount %
Underwriting location:
United States $ 236,892 75.9 $ 290,451 82.7
Other 75,073 24.1 60,958 17.3
Total $ 311,965 100.0 $ 351,409 100.0
2021 Third Quarter versus 2020 Period. Net premiums earned for the 2021 third
quarter were 11.2% lower than in the 2020 third quarter, and reflected a lower
level of single premium policy terminations.
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Nine Months Ended September 30,
2021 2020
Amount % Amount %
Underwriting location:
United States $ 747,830 76.1 $ 884,265 83.3
Other 234,673 23.9 177,883 16.7
Total $ 982,503 100.0 $ 1,062,148 100.0
Nine Months Ended September 30, 2021 versus 2020 Period. Net premiums earned for
the nine months ended September 30, 2021 were 7.5% lower than in the 2020
period, primarily reflecting a lower level of single premiums earned, partially
offset by an increase in earnings from Australian single premium policy
terminations.
Other Underwriting Income.
Other underwriting income, which is primarily related to GSE credit risk-sharing
transactions was $4.0 million for the 2021 third quarter, compared to $4.6
million for the 2020 third quarter.
Losses and Loss Adjustment Expenses.
The table below shows the components of the mortgage segment's loss ratio:
Three Months Ended Nine Months Ended
September 30, September 30,
2021 2020 2021 2020
Current year 18.2 % 44.9 % 18.8 % 42.9 %
Prior period reserve development (14.5) % (1.3) % (10.1) % (1.0) %
Loss ratio 3.7 % 43.6 % 8.7 % 41.9 %
Current Year Loss Ratio.
2021 Third Quarter versus 2020 Period. The mortgage segment's current year loss
ratio was 26.7 points lower in the 2021 third quarter than in the 2020 third
quarter. The mortgage segment's current year loss ratio was 24.1 points lower
for the nine months ended September 30, 2021 than for the 2020 period. The lower
current year loss ratios for the 2021 period reflect decrease in loss
assumptions related to COVID-19 pandemic, primarily driven by lower
delinquencies.
For the 2020 periods, the increase in incurred losses was primarily due to, the
financial stress related to the COVID-19 pandemic. Segregating estimated losses
due to COVID-19 from the overall mortgage segment estimated losses would require
the number of delinquencies specifically attributable to COVID-19. As this
analysis cannot be performed accurately, the Company is not reporting COVID-19
provisions separately from its overall loss provisions.
Prior Period Reserve Development .
The mortgage segment's net favorable development was $45.1 million , or 14.5
points, for the 2021 third quarter, compared to $4.5 million , or 1.3 points, for
the 2020 third quarter, and $99.1 million , or 10.1 points, for the nine months
ended September 30, 2021 , compared to $10.8 million , or 1.0 points, for the 2020
period. See note 6, "Reserve for Losses and Loss Adjustment Expenses," to
our consolidated financial statements for information about the mortgage
segment's prior year reserve development.
Underwriting Expenses.
2021 Third Quarter versus 2020 Period. The underwriting expense ratio for the
mortgage segment was 22.5% in the 2021 third quarter, compared to 20.6% in the
2020 third quarter, with the increase primarily due to a lower level in net
premiums earned on U.S. primary mortgage insurance business.
Nine Months Ended September 30, 2021 versus 2020 Period. The underwriting
expense ratio for the mortgage segment was 23.2% for the nine months ended
September 30, 2021 , compared to 21.5% for the 2020 period, with the increase
primarily due to a lower level in net premiums earned on U.S. primary mortgage
insurance business.
Corporate (Non-Underwriting) Segment
The corporate (non-underwriting) segment results include net investment income,
other income (loss), corporate expenses, transaction costs and other,
amortization of intangible assets, interest expense, items related to our
non-cumulative preferred shares, net realized gains or losses (which includes
changes in the allowance for credit losses on financial assets and 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, income or loss from operating affiliates and income taxes. Such
amounts exclude the results of the 'other' segment. See note 1, "Basis of
Presentation and Recent Accounting Pronouncements," to our consolidated
financial statements for information about the change in presentation of income
or loss from operating affiliates.
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Net Investment Income.
The components of net investment income were derived from the following sources:
Three Months Ended Nine Months Ended
September 30, September 30,
2021 2020 2021 2020
Fixed maturities $ 75,964 $ 84,608 $ 232,690 $ 277,862
Equity securities 9,867 6,659 23,799 18,312
Short-term investments 1,858 1,162 3,474 5,444
Other (1) 19,114 24,594 55,699 62,898
Gross investment income 106,803 117,023 315,662 364,516
Investment expenses (2) (18,608) (17,166) (59,308) (50,600)
Net investment income $ 88,195 $ 99,857 $ 256,354 313,916
(1) Amounts include dividends and other distributions on investment funds, term
loan investments, funds held balances, cash balances and other items.
(2) Investment expenses were approximately 0.32% of average invested assets for
the 2021 third quarter, compared to 0.32% for the 2020 third quarter, and 0.32%
for the nine months ended September 30, 2021 , compared to 0.31% for the 2020
period.
The lower level of net investment income for the 2021 third quarter primarily
related to lower yields available in the financial market. The pre-tax
investment income yield, calculated based on amortized cost and on an annualized
basis, was 1.41% for the 2021 third quarter, compared to 1.76% for the 2020
third quarter, and 1.40% for the nine months ended September 30, 2021 , compared
to 1.94% for the 2020 period.
Corporate Expenses.
Corporate expenses were $18.6 million for the 2021 third quarter, compared to
$16.3 million for the 2020 third quarter, and $59.3 million for the nine months
ended September 30, 2021 , compared to $51.4 million for the 2020 period. The
increase in corporate expenses was primarily due to higher incentive
compensation costs.
Transaction Costs and Other.
Transaction costs and other were $1.0 million for the 2021 third quarter,
compared to $1.7 million for the 2020 third quarter, and $0.8 million for the
nine months ended September 30, 2021 , compared to $5.2 million for the 2020
period. Amounts in the 2021 and 2020 periods are primarily related to
acquisitions activity for the respective period.
Amortization of Intangible Assets.
Amortization of intangible assets for the 2021 third quarter was $20.1 million ,
compared to $16.7 million for the 2020 third quarter, and $48.9 million for the
nine months ended
September 30, 2021 , compared to $49.8 million for the 2020 period. Amounts in
2021 and 2020 primarily related to amortization of finite-lived intangible
assets. The increase in amortization of intangible assets expense was a result
of acquisitions closed during the 2021 third quarter.
Interest Expense.
Interest expense was $33.2 million for the 2021 third quarter, compared to the
$36.2 million for the 2020 third quarter, and $98.8 million for the nine months
ended September 30, 2021 , compared to $86.6 million for the 2020 period.The
higher level of interest expense in 2021 period mainly resulted from the
issuance of $1.0 billion of 3.635% senior notes on June 30, 2020 .
Loss on Redemption of Preferred Shares.
In September 2021 , we redeemed all 5.25% Series E preferred shares and, in
accordance with GAAP, we recorded a loss of $15.1 million to remove original
issuance costs related to the redeemed shares from additional paid-in capital.
Such adjustment had no impact on total shareholders' equity or cash flows.
Net Realized Gains or Losses.
We recorded net realized losses of $25.0 million for the 2021 third quarter,
compared to net realized gains of $211.0 million for the 2020 third quarter, and
net realized gains of $239.7 million for the nine months ended September 30,
2021 , compared to net realized gains of $524.0 million for the 2020 period. In
addition, 2021 third quarter included $33.1 million loss as a result of
deconsolidation of Watford in our financial statements following the close of
the transaction. 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 include realized and unrealized contract gains
and losses on our derivative instruments, changes in the fair value of assets
accounted for using the fair value option and in the fair value of equities,
along with changes in the allowance for credit losses on financial assets and
net impairment losses recognized in earnings. See note 8, "Investment
Information-Net Realized Gains (Losses)," to our consolidated financial
statements for additional information. See note 8, "Investment
Information-Allowance for Credit Losses," to our consolidated financial
statements for additional information.
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Equity in Net Income (Loss) of Investment Funds Accounted for Using the Equity
Method.
We recorded $105.4 million of equity in net income related to investment funds
accounted for using the equity method in the 2021 third quarter, compared to
income of $126.7 million for the 2020 third quarter, and $299.3 million of
income for the nine months ended September 30, 2021 , compared to income of $57.4
million for the 2020 period. Such investments are generally recorded on a one to
three month lag based on the availability of reports from the investment funds.
Investment funds accounted for using the equity method totaled $2.7 billion at
September 30, 2021, compared to $2.0 billion at December 31, 2020. See note 8,
"Investment Information-Investments Accounted For Using the Equity Method,"
to
our consolidated financial statements for additional information. Net Foreign Exchange Gains or Losses. Net foreign exchange gains for the 2021 third quarter were$36.1 million , compared to net foreign exchange losses for the 2020 third quarter of$38.7 million . Net foreign exchange gains for the nine months endedSeptember 30, 2021 were$39.7 million , compared to net foreign exchange losses for the 2020 period of$17.8 million . Amounts in both periods were primarily unrealized and resulted from the effects of revaluing our net insurance liabilities required to be settled in foreign currencies at each balance sheet date. Income Tax Expense. Our income tax provision on income (loss) before income taxes, including income (loss) from operating affiliates, resulted in an expense of 1.0% for the 2021 third quarter, compared to 5.4% for the 2020 third quarter, and 5.8% for the nine months endedSeptember 30, 2021 , compared to 8.3% for the 2020 period. The effective tax rates for the 2021 third quarter and nine months endedSeptember 30, 2021 included discrete income tax benefits of$25.3 million and$28.7 million , respectively. The discrete tax items primarily related to the partial release of a valuation allowance on certainU.K. deferred tax assets in the third quarter. Our effective tax rate, which is based upon the expected annual effective tax rate, may fluctuate from period to period based on the relative mix of income or loss reported by jurisdiction and the varying tax rates in each jurisdiction. Income (loss) from operating affiliates. We recorded$124.1 million of net income from our operating affiliates in the 2021 third quarter, compared to income of$0.9 million for the 2020 third quarter, and$224.1 million of income for the nine months endedSeptember 30, 2021 , compared to$6.3 million for the 2020 period. Results for the 2021 third quarter reflected a one-time gain of$95.7 million recognized from the Company's previously disclosed acquisition of a 40% share of Greysbridge. Results for 2021 period, primarily include income from our investment in Coface, Greysbridge and Premia. Other Segment ThroughJune 30, 2021 , the 'other' segment included the results ofWatford . Pursuant to GAAP,Watford was considered a variable interest entity and we concluded that we were the primary beneficiary ofWatford . As such, we consolidated the results ofWatford in our consolidated financial statements throughJune 30, 2021 . InJuly 2021 , we announced the completion of the previously disclosed acquisition ofWatford by Greysbridge. Based on the governing documents of Greysbridge, the Company has concluded that, while it retains significant influence overWatford ,Watford no longer constitutes a variable interest entity. Accordingly, effectiveJuly 1, 2021 , Arch no longer consolidates the results ofWatford in its consolidated financial statements. See note 12, "Variable Interest Entities and Noncontrolling Interests" and note 5, "Segment Information" to our consolidated financial statements for additional information onWatford . CRITICAL ACCOUNTING POLICIES, ESTIMATES AND RECENT ACCOUNTING PRONOUNCEMENTS Critical accounting policies, estimates and recent accounting pronouncements are discussed in Management's Discussion and Analysis of Financial Condition and Results of Operations contained in our 2020 Form 10-K, updated where applicable in the notes accompanying our consolidated financial statements, including
note 1, "Basis of Presentation and Recent Accounting Pronouncements."
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FINANCIAL CONDITION
Investable Assets Held by Arch
The following table summarizes the fair value of the investable assets held by
Arch:
Estimated % of
Investable assets (1): Fair Value Total
September 30, 2021
Fixed maturities (2) $ 17,182,370 63.0
Short-term investments (2) 3,185,646 11.7
Cash 1,137,721 4.2
Equity securities (2) 1,815,163 6.7
Other investments (2) 1,489,759 5.5
Other investable assets (3) - -
Investments accounted for using the equity method 2,741,293 10.0
Securities transactions entered into but not settled at
the balance sheet date
(273,512) (1.0) Total investable assets held by Arch$ 27,278,440 100.0 Average effective duration (in years) 2.68 Average S&P/Moody's credit ratings (4) AA-/Aa3 Embedded book yield (5) 1.54 % December 31, 2020 Fixed maturities (2)$ 18,771,296 69.9 Short-term investments (2) 2,063,240 7.7 Cash 694,997 2.6 Equity securities (2) 1,436,104 5.3 Other investments (2) 1,480,347 5.5 Other investable assets (3) 500,000 1.9 Investments accounted for using the equity method 2,047,889 7.6
Securities transactions entered into but not settled at
the balance sheet date
(137,578) (0.5) Total investable assets held by Arch$ 26,856,295 100.0 Average effective duration (in years) 3.01 Average S&P/Moody's credit ratings (4) AA/Aa2 Embedded book yield (5) 1.56 % (1)In securities lending transactions, we receive collateral in excess of the fair value of the securities pledged. For purposes of this table, we have excluded the collateral received under securities lending, at fair value and included the securities pledged under securities lending, at fair value. InSeptember 2021 , the Company terminated its securities lending program. (2)Includes investments carried as available for sale, at fair value and at fair value under the fair value option. (3)Represents participation interests in a receivable of a reverse repurchase agreement. (4)Average credit ratings on our investment portfolio on securities with ratings byStandard & Poor's Rating Services ("S&P") and Moody's Investors Service ("Moody's"). (5)Before investment expenses. AtSeptember 30, 2021 , approximately$18.4 billion , or 67.3%, of total investable assets held by Arch were internally managed, compared to$19.2 billion , or 71.4%, atDecember 31, 2020 . The following table summarizes our fixed maturities and fixed maturities pledged under securities lending agreements ("Fixed Maturities") by type: Estimated % of Fair Value Total September 30, 2021 Corporate bonds$ 6,777,943 39.4
Residential mortgage backed securities 405,797 2.4
Municipal bonds
382,722 2.2
Commercial mortgage backed securities 579,424 3.4
Non-
1,883,563 11.0 Asset backed securities 2,692,406 15.7 Total$ 17,182,370 100.0 December 31, 2020 Corporate bonds$ 8,039,745 42.8
Residential mortgage backed securities 616,619 3.3
Municipal bonds
492,734 2.6
Commercial mortgage backed securities 390,990 2.1
Non-
2,310,157 12.3 Asset backed securities 1,566,188 8.3 Total$ 18,771,296 100.0
The following table provides the credit quality distribution of our Fixed
Maturities. For individual fixed maturities, S&P ratings are used. In the
absence of an S&P rating, ratings from Moody's are used, followed by ratings
from Fitch Ratings.
% of
Estimated Fair Value Total
September 30, 2021
U.S. government and gov't agencies (1) $ 4,830,467 28.1
AAA 3,257,679 19.0
AA 2,217,452 12.9
A 2,773,104 16.1
BBB 2,807,788 16.3
BB 522,357 3.0
B 348,036 2.0
Lower than B 43,751 0.3
Not rated 381,736 2.2
Total $ 17,182,370 100.0
December 31, 2020
U.S. government and gov't agencies (1) $ 5,963,758 31.8
AAA 3,117,046 16.6
AA 2,063,738 11.0
A 3,760,280 20.0
BBB 2,699,201 14.4
BB 574,189 3.1
B 268,095 1.4
Lower than B 54,795 0.3
Not rated 270,194 1.4
Total $ 18,771,296 100.0
(1)Includes
securities and agency commercial mortgage-backed securities.
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The following table provides information on the severity of the unrealized loss
position as a percentage of amortized cost for all Fixed Maturities which were
in an unrealized loss position:
% of
Gross Total Gross
Unrealized Unrealized
Severity of gross unrealized losses: Estimated Fair Value Losses Losses
September 30, 2021
0-10% $ 9,287,536 $ (106,042) 93.6
10-20% 27,315 (4,173) 3.7
20-30% 8,233 (2,034) 1.8
Greater than 30% 993 (1,088) 1.0
Total $ 9,324,077 $ (113,337) 100.0
December 31, 2020
0-10% $ 3,583,981 $ (55,542) 79.4
10-20% 95,495 (12,183) 17.4
20-30% 1,061 (406) 0.6
Greater than 30% 1,249 (1,785) 2.6
Total $ 3,681,786 $ (69,916) 100.0
The following table summarizes our top ten exposures to fixed income corporate
issuers by fair value at September 30, 2021 , excluding guaranteed amounts and
covered bonds:
Credit
Estimated Fair Value Rating (1)
Bank of America Corporation $ 359,893 A-/A2
JPMorgan Chase & Co. 294,411 A-/A2
Citigroup Inc. 247,892 BBB+/A3
Wells Fargo & Company 231,542 BBB+/A1
Morgan Stanley 215,424 BBB+/A1
The Goldman Sachs Group, Inc. 180,324 BBB+/A2
Dai-ichi Life Holdings, Inc. 111,418 AA-/A1
Apple Inc. 111,280 AA+/Aa1
Westpac Banking Corporation 107,389 AA-/Aa3
Nestlé S.A. 83,838 AA-/Aa3
Total $ 1,943,411
(1)Average credit ratings as assigned by S&P and Moody's, respectively.
The following table provides information on our structured securities, which
includes residential mortgage-backed securities ("RMBS"), commercial
mortgage-backed securities ("CMBS") and asset-backed securities ("ABS"):
Agencies Investment Grade Below Investment Grade TotalSep 30, 2021 RMBS$ 345,175 $ 48,301 $ 12,321$ 405,797 CMBS 24,779 502,218 52,427 579,424 ABS - 2,374,981 317,425 2,692,406 Total$ 369,954 $ 2,925,500 $ 382,173$ 3,677,627 Dec 31, 2020 RMBS$ 584,499 $ 4,102 $ 28,018$ 616,619 CMBS 24,396 342,491 24,103 390,990 ABS - 1,403,137 163,051 1,566,188 Total$ 608,895 $ 1,749,730 $ 215,172$ 2,573,797
The following table summarizes our equity securities, which include investments
in exchange traded funds:
September 30, December 31,
2021 2020
Equities (1) $ 856,837 $ 676,437
Exchange traded funds
Fixed income (2) 348,613 341,139
Equity and other (3) 609,713 418,528
Total $ 1,815,163 $ 1,436,104
(1)Primarily in consumer non-cyclical, technology, communications financial and
consumer cyclical at September 30, 2021 .
(2)Primarily in corporate at September 30, 2021 .
(3)Primarily in large cap stocks, foreign equities, technology, financial and
utilities at September 30, 2021 .
The following table summarizes our other investments and other investable
assets:
September 30, December 31,
2021 2020
Lending $ 579,563 $ 572,636
Term loan investments 528,585 380,193
Energy 84,880 65,813
Credit related funds 56,997 90,780
Investment grade fixed income 131,910 138,646
Infrastructure 26,359 165,516
Private equity 81,465 48,750
Real estate - 18,013
Total fair value option $ 1,489,759 $ 1,480,347
Other investable assets - 500,000
Total other investments $ 1,489,759 $ 1,980,347
For details on our investments accounted for using the equity method, see note
8, "Investment Information-Investments Accounted For Using the Equity Method,"
to our consolidated financial statements.
ARCH CAPITAL 58 2021 THIRD QUARTER FORM 10-Q
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Our investment strategy allows for the use of derivative instruments. We utilize
various derivative instruments such as futures contracts to enhance investment
performance, replicate investment positions or manage market exposures and
duration risk that would be allowed under our investment guidelines if
implemented in other ways. See note 10, "Derivative Instruments," to our
consolidated financial statements for additional disclosures related to
derivatives.
Accounting guidance regarding fair value measurements addresses how companies
should measure fair value when they are required to use a fair value measure for
recognition or disclosure purposes under GAAP and provides a common definition
of fair value to be used throughout GAAP. See note 9, "Fair Value," to our
consolidated financial statements for a summary of our financial assets and
liabilities measured at fair value, segregated by level in the fair value
hierarchy.
Reinsurance
The effects of reinsurance on written and earned premiums and losses and loss
adjustment expenses ("LAE") with unaffiliated reinsurers were as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
2021 2020 2021 2020
Premiums written:
Direct $ 1,993,098 $ 1,667,449 $ 5,795,236 $ 4,841,874
Assumed 1,214,317 1,013,583 4,095,676 2,989,680
Ceded (1,131,486) (806,888) (2,907,002) (2,151,853)
Net $ 2,075,929 $ 1,874,144 $ 6,983,910 $ 5,679,701
Premiums earned:
Direct $ 1,754,462 $ 1,618,583 $ 5,263,286 $ 4,723,630
Assumed 1,129,434 880,024 3,169,016 2,387,286
Ceded (954,559) (727,515) (2,433,634) (1,930,026)
Net $ 1,929,337 $ 1,771,092 $ 5,998,668 $ 5,180,890
Losses and LAE:
Direct $ 1,101,793 $ 1,131,696 $ 3,134,305 $ 3,279,737
Assumed 961,285 635,199 2,182,852 1,689,176
Ceded (837,059) (550,622) (1,728,207) (1,406,699)
Net $ 1,226,019 $ 1,216,273 $ 3,588,950 $ 3,562,214
See note 7, "Allowance for Expected Credit Losses," to our consolidated
financial statements for information about our reinsurance recoverables and
related allowance for credit losses.
Bellemeade Re
We have entered into aggregate excess of loss mortgage reinsurance agreements
with various special purpose reinsurance companies domiciled in Bermuda (the
"Bellemeade Agreements"). For the respective coverage periods, we will retain
the first layer of the respective aggregate losses and the special purpose
reinsurance companies will provide second layer coverage up to the outstanding
coverage amount. We will then retain losses in excess of the outstanding
coverage limit. The aggregate excess of loss reinsurance coverage generally
decreases over a ten-year period as the underlying covered mortgages amortize,
unless provisional call options embedded within certain of the Bellemeade
Agreements are executed or if pre-defined delinquency triggering events occur.
The following table summarizes the respective coverages and retentions at
September 30, 2021 :
September 30, 2021
Initial Coverage Remaining
at Issuance Current Coverage Retention, Net
Bellemeade 2017-1 Ltd. (1) $ 368,114 $ 145,573 $ 124,777
Bellemeade 2018-1 Ltd. (2) 374,460 228,938 121,411
Bellemeade 2018-3 Ltd. (3) 506,110 302,563 126,578
Bellemeade 2019-1 Ltd. (4) 341,790 210,529 98,340
Bellemeade 2019-2 Ltd. (5) 621,022 398,316 156,085
Bellemeade 2019-3 Ltd. (6) 700,920 491,634 178,759
Bellemeade 2019-4 Ltd. (7) 577,267 468,737 113,674
Bellemeade 2020-2 Ltd. (8) 449,167 268,468 227,140
Bellemeade 2020-3 Ltd. (9) 451,816 405,881 159,615
Bellemeade 2020-4 Ltd. (10) 337,013 238,480 133,872
Bellemeade 2021-1 Ltd. (11) 643,577 643,577 157,685
Bellemeade 2021-2 Ltd. (12) 616,017 616,017 146,956
Bellemeade 2021-3 Ltd. (13) 639,391 639,391 145,790
Total $ 6,626,664 $ 5,058,104 $ 1,890,682
(1) Issued in October 2017 , covering in-force policies issued between January
1, 2017 and June 30, 2017 .
(2) Issued in April 2018 , covering in-force policies issued between July 1,
2017 and December 31, 2017 .
(3) Issued in October 2018 , covering in-force policies issued between January
1, 2018 and June 30, 2018 .
(4) Issued in March 2019 , covering in-force policies primarily issued between
2005-2008 under United Guaranty Residential Insurance Company ("UGRIC"); as well
as policies issued through 2015 under both UGRIC and Arch Mortgage Insurance
Company .
(5) Issued in April 2019 , covering in-force policies issued between July 1,
2018 and December 31, 2018 .
(6) Issued in July 2019 , covering in-force policies issued in 2016.
(7) Issued in October 2019 , covering in-force policies issued between January
1, 2019 and June 30, 2019 .
(8) Issued in September 2020 , covering in-force policies issued between January
1, 2020 and May 31, 2020 . $423 million was directly funded by Bellemeade 2020-2
Ltd. with an additional $26 million of capacity provided directly to Arch MI
U.S. by a separate panel of reinsurers.
ARCH CAPITAL 59 2021 THIRD QUARTER FORM 10-Q
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(9) Issued in November 2020 , covering in-force policies issued between June 1,
2020 and August 31, 2020 . $418 million was directly funded by Bellemeade 2020-3
Ltd. with an additional $34 million of capacity provided directly to Arch MI
U.S. by a separate panel of reinsurers.
(10) Issued in December 2020 , covering in-force policies issued between July 1,
2019 and December 31, 2019 . $321 million was directly funded by Bellemeade
2020-4 Ltd. with an additional $16 million of capacity provided directly to Arch
MI U.S. by a separate panel of reinsurers.
(11) Issued in March 2021 , covering in-force policies issued between September
1, 2020 and November 30, 2020 . $580 million was directly funded by Bellemeade Re
2021-1 Ltd. with an additional $64 million capacity provided directly to Arch MI
U.S. by a separate panel of reinsurers.
(12) Issued in June 2021 , covering in-force policies issued between December 1,
2020 and March 31, 2021 . $523 million was directly funded by Bellemeade Re
2021-2 Ltd. via insurance-linked notes, with an additional $93 million capacity
provided directly to Arch MI U.S. by a separate panel of reinsurers.
(13) Issued in September 2021 , covering in-force policies issued between April
1, 2021 and June 30, 2021 . $508 million was directly funded by Bellemeade Re
2021-3 Ltd. via insurance-linked notes, with an additional $131 million capacity
provided directly to Arch MI U.S. by a separate panel of reinsurers.
Reserve for Losses and Loss Adjustment Expenses
We establish reserve for losses and loss adjustment expenses ("Loss Reserves")
which represent estimates involving actuarial and statistical projections, at a
given point in time, of our expectations of the ultimate settlement and
administration costs of losses incurred. Estimating Loss Reserves is inherently
difficult. We utilize actuarial models as well as available historical insurance
industry loss ratio experience and loss development patterns to assist in the
establishment of Loss Reserves. Actual losses and loss adjustment expenses paid
will deviate, perhaps substantially, from the reserve estimates reflected in our
financial statements.
At September 30, 2021 and December 31, 2020 , our Loss Reserves, net of unpaid
losses and loss adjustment expenses recoverable, by type and by operating
segment were as follows:
September 30, December 31,
2021 2020
Insurance segment:
Case reserves $ 2,147,930 $ 2,051,640
IBNR reserves 4,341,016 3,889,823
Total net reserves 6,488,946 5,941,463
Reinsurance segment:
Case reserves 1,562,072 1,560,523
Additional case reserves 549,476 280,472
IBNR reserves 2,617,728 2,253,953
Total net reserves 4,729,276 4,094,948
Mortgage segment:
Case reserves 731,671 631,921
IBNR reserves 266,007 271,702
Total net reserves 997,678 903,623
Other segment:
Case reserves - 566,587
Additional case reserves - 32,321
IBNR reserves - 660,132
Total net reserves - 1,259,040
Total:
Case reserves 4,441,673 4,810,671
Additional case reserves 549,476 312,793
IBNR reserves 7,224,751 7,075,610
Total net reserves $ 12,215,900 $ 12,199,074
At
Reserves by major line of business, net of unpaid losses and loss adjustment
expenses recoverable, were as follows:
September 30, December 31,
2021 2020
Insurance segment:
Professional lines (1) $ 1,587,042 $ 1,482,820
Construction and national accounts 1,468,668 1,395,067
Excess and surplus casualty (2) 903,966 816,495
Programs 760,273 699,354
Property, energy, marine and aviation 599,431 517,692
Travel, accident and health 93,632 98,910
Lenders products 70,520 48,946
Other (3) 1,005,414 882,179
Total net reserves $ 6,488,946 $ 5,941,463
(1)Includes professional liability, executive assurance and healthcare business.
(2)Includes casualty and contract binding business.
(3)Includes alternative markets, excess workers' compensation and surety
business.
ARCH CAPITAL 60 2021 THIRD QUARTER FORM 10-Q
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At September 30, 2021 and December 31, 2020 , the reinsurance segment's Loss
Reserves by major line of business, net of unpaid losses and loss adjustment
expenses recoverable, were as follows:
September 30, December 31,
2021 2020
Reinsurance segment:
Casualty (1) $ 2,079,990 $ 1,995,849
Other specialty (2) 1,093,611 917,178
Property excluding property catastrophe 669,922 594,033
Marine and aviation 231,203 204,205
Property catastrophe 526,356 268,858
Other (3) 128,194 114,825
Total net reserves $ 4,729,276 $ 4,094,948
(1)Includes executive assurance, professional liability, workers' compensation,
excess motor, healthcare and other.
(2)Includes non-excess motor, surety, accident and health, workers' compensation
catastrophe, agriculture, trade credit and other.
(3)Includes life, casualty clash and other.
At September 30, 2021 and December 31, 2020 , the mortgage segment's Loss
Reserves by major line of business, net of unpaid losses and loss adjustment
expenses recoverable, were as follows:
September 30, December 31,
2021 2020
Other
271,042 253,875 Total net reserves$ 997,678 $ 903,623
(1) At
remainder from later policy years. At
reserves represent policy years 2011 and prior and the remainder from later
policy years.
Mortgage Operations Supplemental Information
The mortgage segment's insurance in force ("IIF") and risk in force ("RIF") were
as follows at September 30, 2021 and December 31, 2020 :
(U.S. Dollars in millions) September 30, 2021 December 31, 2020
Amount % Amount %
Insurance In Force (IIF) (1):
U.S. primary mortgage insurance $ 280,379 61.3 $ 280,579 66.2
U.S. credit risk transfer (CRT) and other
(2) 108,203 23.6 103,535 24.4
International mortgage
insurance/reinsurance (3) 69,127 15.1 39,425 9.3
Total $ 457,709 100.0 $ 423,539 100.0
Risk In Force (RIF) (4):
U.S. primary mortgage insurance $ 70,320 84.8 $ 70,522 90.5
U.S. credit risk transfer (CRT) and other
(2) 4,817 5.8 4,699 6.0
International mortgage
insurance/reinsurance (3) 7,803 9.4 2,673 3.4
Total $ 82,940 100.0 $ 77,894 100.0
(1)Represents the aggregate dollar amount of each insured mortgage loan's
current principal balance.
(2)Includes all CRT transactions, which are predominantly with GSEs, and other
U.S. reinsurance transactions.
(3)International mortgage insurance and reinsurance with risk primarily located
in Australia , which reflects WLMI acquisition in the 2021 third quarter and to
lesser extent Europe and Asia .
(4)The aggregate dollar amount of each insured mortgage loan's current principal
balance multiplied by the insurance coverage percentage specified in the policy
for insurance policies issued and after contract limits and/or loss ratio caps
for risk-sharing or reinsurance.
The IIF and RIF for our U.S. primary mortgage insurance business by policy year
were as follows at September 30, 2021 :
(U.S. Dollars in millions) IIF RIF Delinquency
Amount % Amount % Rate (1)
Policy year:
2011 and prior $ 11,888 4.2 $ 2,672 3.8 9.51 %
2012 1,974 0.7 505 0.7 2.76 %
2013 4,876 1.7 1,342 1.9 2.72 %
2014 5,454 1.9 1,501 2.1 3.37 %
2015 9,810 3.5 2,637 3.8 2.92 %
2016 16,150 5.8 4,324 6.1 3.64 %
2017 15,001 5.4 3,910 5.6 4.50 %
2018 16,193 5.8 4,105 5.8 5.75 %
2019 29,860 10.6 7,463 10.6 3.58 %
2020 88,737 31.6 21,777 31.0 0.91 %
2021 80,436 28.7 20,084 28.6 0.19 %
Total $ 280,379 100.0 $ 70,320 100.0 2.67 %
(1)Represents the ending percentage of loans in default.
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Table of Contents The IIF and RIF for ourU.S. primary mortgage insurance business by policy year were as follows atDecember 31, 2020 : (U.S. Dollars in millions) IIF RIF Delinquency Amount % Amount % Rate (1) Policy year: 2011 and prior$ 14,588 5.2$ 3,327 4.7 11.36 % 2012 3,651 1.3 992 1.4 2.98 % 2013 7,546 2.7 2,107 3.0 3.30 % 2014 8,261 2.9 2,273 3.2 4.06 % 2015 15,032 5.4 4,048 5.7 3.72 % 2016 24,958 8.9 6,648 9.4 4.77 % 2017 24,748 8.8 6,413 9.1 5.52 % 2018 27,304 9.7 6,918 9.8 6.76 % 2019 48,304 17.2 12,001 17.0 4.61 % 2020 106,187 37.8 25,795 36.6 0.76 % Total$ 280,579 100.0$ 70,522 100.0 4.19 % (1)Represents the ending percentage of loans in default. The following tables provide supplemental disclosures on risk in force for ourU.S. primary mortgage insurance business atSeptember 30, 2021 andDecember 31, 2020 : (U.S. Dollars in millions) September 30, 2021 December 31, 2020 Amount % Amount % Credit quality (FICO): >=740 $ 41,927 59.6 $ 40,774 57.8 680-739 23,732 33.7 24,498 34.7 620-679 4,323 6.1 4,837 6.9 <620 338 0.5 413 0.6 Total $ 70,320 100.0 $ 70,522 100.0 Weighted average FICO score 745 743 Loan-to-value (LTV): 95.01% and above $ 7,708 11.0 $ 8,643 12.3 90.01% to 95.00% 38,378 54.6 37,877 53.7 85.01% to 90.00% 19,980 28.4 20,013 28.4 85.00% and below 4,254 6.0 3,989 5.7 Total $ 70,320 100.0 $ 70,522 100.0 Weighted average LTV 92.8 % 92.8 % Total RIF, net of external reinsurance $ 54,847 $ 56,658 (U.S. Dollars in millions) September 30, 2021 December 31, 2020 Amount % Amount % Total RIF by State: Texas $ 5,590 7.9 $ 5,636 8.0 California 5,451 7.8 5,261 7.5 Florida 3,344 4.8 3,632 5.2 Minnesota 2,936 4.2 2,520 3.6 North Carolina 2,921 4.2 2,622 3.7 Illinois 2,920 4.2 2,762 3.9 Georgia 2,908 4.1 2,959 4.2 Massachusetts 2,519 3.6 2,464 3.5 Virginia 2,412 3.4 2,526 3.6 Ohio 2,263 3.2 2,264 3.2 Other 37,056 52.7 37,876 53.7 Total $ 70,320 100.0 $ 70,522 100.0
The following table provides supplemental disclosures for our
mortgage insurance business related to insured loans and loss metrics:
(
Nine Months Ended
claim count) September 30,
2021 2020
Roll-forward of insured loans in default:
Beginning delinquent number of loans 52,234 20,163
New notices 26,483 87,760
Cures (46,334) (48,234)
Paid claims (613) (1,327)
Ending delinquent number of loans (1) 31,770 58,362
Ending number of policies in force (1) 1,188,768 1,245,408
Delinquency rate (1) 2.67 % 4.69 %
Losses:
Number of claims paid 613 1,327
Total paid claims $ 22,848 $ 55,559
Average per claim $ 37.3 $ 41.9
Severity (2) 80.2 % 93.3 %
Average case reserve per default (in thousands) $ 23.5 $ 10.1
(1)Includes first lien primary and pool policies.
(2)Represents total paid claims divided by RIF of loans for which claims were
paid.
The risk to capital ratio, which represents total current (non-delinquent) risk
in force, net of reinsurance, divided by total statutory capital, for Arch MI
U.S. was approximately 8.6 to 1 at September 30, 2021 , compared to 9.3 to 1 at
December 31, 2020 .
ARCH CAPITAL 62 2021 THIRD QUARTER FORM 10-Q
-------------------------------------------------------------------------------- Table of Contents Shareholders' Equity and Book Value per Share The following table presents the calculation of book value per share: (U.S. dollars in thousands, except September 30, December 31, share data) 2021 2020 Total shareholders' equity available to Arch$ 13,387,526 $ 13,105,886 Less preferred shareholders' equity 830,000 780,000 Common shareholders' equity available to Arch$ 12,557,526 $ 12,325,886 Common shares and common share equivalents outstanding, net of treasury shares (1) 387,257,752 406,720,642 Book value per share $ 32.43 $ 30.31
(1)Excludes the effects of 17,419,530 and 17,839,333 stock options and 739,407
and 1,153,784 restricted stock units outstanding at
LIQUIDITY
Liquidity is a measure of our ability to access sufficient cash flows to meet the short-term and long-term cash requirements of our business operations.Arch Capital is a holding company whose assets primarily consist of the shares in its subsidiaries. Generally,Arch Capital depends on its available cash resources, liquid investments and dividends or other distributions from its subsidiaries to make payments, including the payment of debt service obligations and operating expenses it may incur and any dividends or liquidation amounts with respect to our preferred and common shares. For the nine months endedSeptember 30, 2021 ,Arch Capital received dividends of$1.4 billion from Arch Re Bermuda, ourBermuda -based reinsurer and insurer, which can pay approximately$2.3 billion toArch Capital during the remainder of 2021 without providing an affidavit to theBermuda Monetary Authority ("BMA"). For the nine months endedSeptember 30, 2021 , Arch-U.S. received$200.0 million of dividends fromArch U.S. MI Holdings Inc. , a subsidiary of Arch-U.S. , which received a total of$300.0 million of ordinary and extraordinary dividends,$140 million fromUnited Guaranty Residential Insurance Company ("UGRIC") and$160 million fromArch Mortgage Insurance Company ("AMIC"). UGRIC and AMIC have minimal ordinary dividend capacity remaining for the remainder of 2021. InJune 2021 ,Arch Capital completed a$500.0 million underwritten public offering of 20.0 million depositary shares, each of which represents a 1/1,000th interest in a share of its 4.550% Non-Cumulative Preferred Shares. See note 3, "Share Transactions." We expect that our liquidity needs, including our anticipated (re)insurance obligations and operating and capital expenditure needs, for the next twelve months, will be met by funds generated from underwriting activities and investment income, as well as by our balance of cash, short-term investments, proceeds on the sale or maturity of our investments, and our credit facilities. Cash Flows The following table summarizes our cash flows from operating, investing and financing activities. Nine Months Ended September 30, 2021 2020 Total cash provided by (used for): Operating activities$ 2,580,697 $ 2,198,037 Investing activities (1,184,436) (2,850,392) Financing activities (895,943) 845,612
Effects of exchange rate changes on foreign currency cash (30,501)
(2,878)
Increase (decrease) in cash and restricted cash$ 469,817
•Cash provided by operating activities for the nine months endedSeptember 30, 2021 reflected a higher level of premiums collected than in the 2020 period. •Cash used for investing activities for the nine months endedSeptember 30, 2021 was lower than in the 2020 period. Activity for the nine months endedSeptember 30, 2021 reflected cash used to purchase our non-controlling interest in Coface andWatford , while the 2020 period reflected a higher level of securities purchased, and the investing of proceeds from our issuance of the senior notes. •Cash used for financing activities for the nine months endedSeptember 30, 2021 reflected$485.8 million inflow from issuance of preferred shares,$450.0 million related to redemption of our Series E preferred shares and$872.2 million of repurchases under our share repurchase program. Activity for the 2020 period primarily reflected the issuance of$1.0 billion of our senior notes and$75.5 million of repurchases under our share repurchase program. ARCH CAPITAL 63 2021 THIRD QUARTER FORM 10-Q -------------------------------------------------------------------------------- Table of Contents CAPITAL RESOURCES
The following table provides an analysis of our capital structure:
(
Sep 30, Dec 31, share data) 2021 2020 Senior notes$ 2,724,149 $ 2,723,423
Shareholders' equity available to Arch:
Series E non-cumulative preferred shares $ -
Series F non-cumulative preferred shares 330,000
330,000 Series G non-cumulative preferred shares 500,000 - Common shareholders' equity 12,557,526 12,325,886 Total$ 13,387,526 $ 13,105,886 Total capital available to Arch$ 16,111,675 $ 15,829,309 Debt to total capital (%) 16.9 17.2 Preferred to total capital (%) 5.2 4.9 Debt and preferred to total capital (%) 22.1 22.1 Arch MIU.S. is required to maintain compliance with the GSEs requirements, known as the Private Mortgage Insurer Eligibility Requirements or "PMIERs." The financial requirements require an eligible mortgage insurer's available assets, which generally include only the most liquid assets of an insurer, to meet or exceed "minimum required assets" as of each quarter end. Minimum required assets are calculated from PMIERs tables with several risk dimensions (including origination year, original loan-to-value and original credit score of performing loans, and the delinquency status of non-performing loans) and are subject to a minimum amount. Arch MIU.S. satisfied the PMIERs' financial requirements as ofSeptember 30, 2021 with an estimated PMIER sufficiency ratio of 195%, compared to 173% atDecember 31, 2020 .Arch Capital , through its subsidiaries, provides financial support to certain of its insurance subsidiaries and affiliates, through certain reinsurance arrangements beneficial to the ratings of such subsidiaries. Historically, our insurance, reinsurance and mortgage insurance subsidiaries have entered into separate reinsurance arrangements with Arch Re Bermuda covering individual lines of business. The reinsurance agreements between ourU.S. -based property casualty insurance and reinsurance subsidiaries and Arch ReBermuda were canceled on a cutoff basis as ofJanuary 1, 2018 . In 2019, certain reinsurance agreements between our insurance subsidiaries and Arch Re Bermuda were reinstated. GUARANTOR INFORMATION The below table provides a description of our senior notes payable atSeptember 30, 2021 : Interest Principal Carrying Issuer/Due (Fixed) Amount Amount Arch Capital: May 1, 2034 7.350 %$ 300,000 $ 297,457 June 30, 2050 3.635 % 1,000,000 988,665 Arch-U.S.: Nov. 1, 2043 (1) 5.144 % 500,000 495,033 Arch Finance: Dec. 15, 2026 (1) 4.011 % 500,000 497,527 Dec. 15, 2046 (1) 5.031 % 450,000 445,467 Total$ 2,750,000 $ 2,724,149 (1)Fully and unconditionally guaranteed byArch Capital . Our senior notes were issued byArch Capital ,Arch Capital Group (U.S.) Inc. ("Arch-U.S. ") andArch Capital Finance LLC ("Arch Finance"). Arch-U.S. is a wholly-owned subsidiary ofArch Capital and Arch Finance is a wholly-owned finance subsidiary of Arch-U.S. Our 2034 senior notes and 2050 senior notes issued byArch Capital are unsecured and unsubordinated obligations ofArch Capital and ranked equally with all of its existing and future unsecured and unsubordinated indebtedness. The 2043 senior notes issued by Arch-U.S. are unsecured and unsubordinated obligations of Arch-U.S. andArch Capital and rank equally and ratably with the other unsecured and unsubordinated indebtedness of Arch-U.S. andArch Capital . The 2026 senior notes and 2046 senior notes issued by Arch Finance are unsecured and unsubordinated obligations ofArch Finance andArch Capital and rank equally and ratably with the other unsecured and unsubordinated indebtedness ofArch Finance andArch Capital . Arch-U.S. and Arch Finance depend on their available cash resources, liquid investments and dividends or other distributions from their subsidiaries or affiliates to make payments, including the payment of debt service obligations and operating expenses they may incur. ARCH CAPITAL 64 2021 THIRD QUARTER FORM 10-Q
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Table of Contents
The following tables present condensed financial information for
(parent guarantor) and Arch-
September 30, 2021 December 31, 2020
Arch Capital Arch-U.S. Arch Capital Arch-U.S.
Assets
Total investments $ 135 $ 565,314 $ 172 $ 396,547
Cash 10,796 10,386 18,932 11,368
Investment in operating affiliates 7,099 - 7,731 -
Due from subsidiaries and affiliates - 200,786 - 201,515
Other assets 10,281 36,601 10,659 34,405
Total assets $ 28,311 $ 813,087 $ 37,494 $ 643,835
Liabilities
Senior notes 1,286,122 495,033 1,285,867 494,944
Due to subsidiaries and affiliates 4 507,103 - 586,805
Other liabilities 37,226 55,132 23,270 41,876
Total liabilities $ 1,323,352 $ 1,057,268 $ 1,309,137 $ 1,123,625
Non-cumulative preferred shares $ 830,000 - $ 780,000 -
Nine Months Ended Year Ended
September 30, 2021 December 31, 2020
Arch Capital Arch-U.S. Arch Capital Arch-U.S.
Revenues
Net investment income $ 1,160 $ 9,392 $ 53 $ 18,084
Net realized gains (losses) - 66,147 (2,110) 26,096
Equity in net income (loss) of investments
accounted for using the equity method - 13,726 - 2,507
Total revenues 1,160 89,265 (2,057) 46,687
Expenses
Corporate expenses 54,726 4,438 65,566 7,227
Interest expense 44,055 35,455 40,445 47,566
Net foreign exchange (gains) losses 7 - 3 -
Total expenses 98,788 39,893 106,014 54,793
Income (loss) before income taxes and income
(loss) from operating affiliates (97,628) 49,372 (108,071) (8,106)
Income tax (expense) benefit - (12,843) - 2,689
Income (loss) from operating affiliates (443) - (437) -
Net income available to Arch (98,071) 36,529 (108,508) (5,417)
Preferred dividends (38,159) - (41,612) -
Loss on redemption of preferred shares (15,101) - - -
Net income (loss) available to Arch common
shareholders $ (151,331) $ 36,529 $ (150,120) $ (5,417)
ARCH CAPITAL 65 2021 THIRD QUARTER FORM 10-Q
--------------------------------------------------------------------------------
Table of Contents SHARE REPURCHASE PROGRAM The board of directors ofArch Capital has authorized the investment inArch Capital's common shares through a share repurchase program. For the nine months endedSeptember 30, 2021 ,Arch Capital repurchased 22.8 million shares under the share repurchase program with an aggregate purchase price of$872.2 million . Since the inception of the share repurchase program throughSeptember 30, 2021 ,Arch Capital has repurchased 412.0 million common shares for an aggregate purchase price of$4.92 billion . AtSeptember 30, 2021 , approximately$44.3 million of share repurchases were available under the program. OnOctober 8, 2021 , the board of directors of ACGL increased the aggregate purchase amount authorized under the share repurchase program to$1.5 billion , which may be effected from time to time in open market or privately negotiated transactions throughDecember 31, 2022 . 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. See note 17, "Subsequent Event." CATASTROPHIC EVENTS AND SEVERE ECONOMIC EVENTS We have large aggregate exposures to natural and man-made catastrophic events, pandemic events like COVID-19 and severe economic events. Natural catastrophes can be caused by various events, including hurricanes, floods, windstorms, earthquakes, hailstorms, tornadoes, explosions, severe winter weather, fires, droughts and other natural disasters. Man-made catastrophic events may include acts of war, acts of terrorism and political instability. Catastrophes can also cause losses in non-property business such as mortgage insurance, workers' compensation or general liability. In addition to the nature of property business, we believe that economic and geographic trends affecting insured property, including inflation, property value appreciation and geographic concentration, tend to generally increase the size of losses from catastrophic events over time. Our models employ both proprietary and vendor-based systems and include cross-line correlations for property, marine, offshore energy, aviation, workers compensation and personal accident. We seek to limit the probable maximum pre-tax loss to a specific level for severe catastrophic events. Currently, we seek to limit our 1-in-250 year return period net probable maximum loss from a severe catastrophic event in any geographic zone to approximately 25% of tangible shareholders' equity available to Arch (total shareholders' equity available to Arch less goodwill and intangible assets). We reserve the right to change this threshold at any time. Based on in-force exposure estimated as ofOctober 1, 2021 , our modeled peak zone catastrophe exposure was a windstorm affecting the Florida Tri-County, with a net probable maximum pre-tax loss of$671 million , followed by windstorms affecting theNortheastern U.S. and theGulf of Mexico regions with net probable maximum pre-tax losses of$650 and$661 million , respectively. Our exposures to other perils, such asU.S. earthquake and international events, were less than the exposures arising fromU.S. windstorms and hurricanes. As ofOctober 1, 2021 , our modeled peak zone earthquake exposure (San Francisco earthquake) represented approximately 75% of our peak zone catastrophe exposure, and our modeled peak zone international exposure (UK windstorm) was substantially less than both our peak zone windstorm and earthquake exposures. EffectiveJuly 1, 2021 , our insurance operations had in effect a reinsurance program which provided coverage for certain property-catastrophe related losses equal to$276 million in excess of various retentions per occurrence. We also have significant exposure to losses due to mortgage defaults resulting from severe economic events in the future. For ourU.S. mortgage insurance business, we have developed a proprietary risk model ("Realistic Disaster Scenario" or "RDS") that simulates the maximum loss resulting from a severe economic downturn impacting the housing market. The RDS models the collective impact of adverse conditions for key economic indicators, the most significant of which is a decline in home prices. The RDS model projects paths of future home prices, unemployment rates, income levels and interest rates and assumes correlation across states and geographic regions. The resulting future performance of our in-force portfolio is then estimated under the economic stress scenario, reflecting loan and borrower information. Currently, we seek to limit our modeled RDS loss from a severe economic event to approximately 25% of tangible shareholders' equity available to Arch. We reserve the right to change this threshold at any time. Based on in-force exposure estimated as ofOctober 1, 2021 , our modeled RDS loss was approximately 6% of tangible shareholders' equity available to Arch. Net probable maximum loss estimates are net of expected reinsurance recoveries, before income tax and before excess reinsurance reinstatement premiums. RDS loss estimates are net of expected reinsurance recoveries and before income tax. Catastrophe loss estimates are reflective of the zone indicated and not the entire portfolio. Since hurricanes and windstorms can affect more than one zone and make multiple landfalls, our catastrophe loss estimates include clash estimates from ARCH CAPITAL 66 2021 THIRD QUARTER FORM 10-Q -------------------------------------------------------------------------------- Table of Contents other zones. Our catastrophe loss estimates and RDS loss estimates do not represent our maximum exposures and it is highly likely that our actual incurred losses would vary materially from the modeled estimates. There can be no assurances that we will not suffer pre-tax losses greater than 25% of our tangible shareholders' equity from one or more catastrophic events or severe economic events due to several factors. These factors include the inherent uncertainties in estimating the frequency and severity of such events and the margin of error in making such determinations resulting from potential inaccuracies and inadequacies in the data provided by clients and brokers, the modeling techniques and the application of such techniques or as a result of a decision to change the percentage of shareholders' equity exposed to a single catastrophic event or severe economic event. In addition, actual losses may increase if our reinsurers fail to meet their obligations to us or the reinsurance protections purchased by us are exhausted or are otherwise unavailable. See "Risk Factors-Risks Relating to Our Industry" and "Management's Discussion and Analysis of Financial Condition and Results of Operations-Catastrophic Events and Severe Economic Events" in our 2020 Form 10-K. OFF-BALANCE SHEET ARRANGEMENTS Off-balance sheet arrangements are discussed in Management's Discussion and Analysis of Financial Condition and Results of Operations contained in our 2020 Form 10-K. MARKET SENSITIVE INSTRUMENTS AND RISK MANAGEMENT In accordance with theSEC'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 ofSeptember 30, 2021 . Market risk represents the risk of changes in the fair value of a financial instrument and is comprised of several components, including liquidity, basis and price risks. An analysis of material changes in market risk exposures atSeptember 30, 2021 that affect the quantitative and qualitative disclosures presented in our 2020 Form 10-K (see section captioned "Management's Discussion and Analysis of Financial Condition and Results of Operations-Market Sensitive Instruments and Risk Management") were as follows: Investment Market RiskFixed Income Securities . We invest in interest rate sensitive securities, primarily debt securities. We consider the effect of interest rate movements on the fair value of our fixed maturities, fixed maturities pledged under securities lending agreements, short-term investments and certain of our other investments, equity securities and investment funds accounted for using the equity method which invest in fixed income securities (collectively, "Fixed Income Securities ") and the corresponding change in unrealized appreciation. As interest rates rise, the fair value of ourFixed Income Securities falls, and the converse is also true. Based on historical observations, there is a low probability that all interest rate yield curves would shift in the same direction at the same time. Furthermore, at times interest rate movements in certain credit sectors exhibit a much lower correlation to changes inU.S. Treasury yields. Accordingly, the actual effect of interest rate movements may differ materially from the amounts set forth in the following tables. The following table summarizes the effect that an immediate, parallel shift in the interest rate yield curve would have had on ourFixed Income Securities : (U.S. dollars in Interest Rate Shift in Basis Points billions) -100 -50 - +50 +100 Sept. 30, 2021 Total fair value$ 25.29 $ 25.00 $ 24.67 $ 24.35 $ 24.06 Change from base 2.5 % 1.3 % (1.3) % (2.5) % Change in unrealized value$ 0.62 $ 0.32 $ (0.32) $ (0.62) Dec. 31, 2020 Total fair value$ 25.82 $ 25.44 $ 25.07 $ 24.69 $ 24.31 Change from base 3.0 % 1.5 % (1.5) % (3.0) % Change in unrealized value$ 0.75 $ 0.38 $ (0.38) $ (0.75) In addition, we consider the effect of credit spread movements on the market value of ourFixed Income Securities and the corresponding change in unrealized value. As credit spreads widen, the fair value of ourFixed Income Securities falls, and the converse is also true. In periods where the spreads on ourFixed Income Securities are much higher than their historical average due to short-term market dislocations, a parallel shift in credit spread levels would result in a much more pronounced change in unrealized value. ARCH CAPITAL 67 2021 THIRD QUARTER FORM 10-Q -------------------------------------------------------------------------------- Table of Contents The following table summarizes the effect that an immediate, parallel shift in credit spreads in a static interest rate environment would have had on ourFixed Income Securities : (U.S. dollars in Credit Spread Shift in Percentage Points billions) -100 -50 - +50 +100 Sept. 30, 2021 Total fair value$ 25.24 $ 24.97 $ 24.67 $ 24.38 $ 24.11 Change from base 2.3 % 1.2 % (1.2) % (2.3) % Change in unrealized value$ 0.57 $ 0.30 $ (0.30) $ (0.57) Dec. 31, 2020 Total fair value$ 25.54 $ 25.32 $ 25.07 $ 24.82 $ 24.59 Change from base 1.9 % 1.0 % (1.0) % (1.9) % Change in unrealized value$ 0.48 $ 0.25 $
(0.25)
Another method that attempts to measure portfolio risk is Value-at-Risk ("VaR").
VaR measures the worst expected loss under normal market conditions over a
specific time interval at a given confidence level. The 1-year 95th percentile
parametric VaR reported herein estimates that 95% of the time, the portfolio
loss in a one-year horizon would be less than or equal to the calculated number,
stated as a percentage of the measured portfolio's initial value. The VaR is a
variance-covariance based estimate, based on linear sensitivities of a portfolio
to a broad set of systematic market risk factors and idiosyncratic risk factors
mapped to the portfolio exposures. The relationships between the risk factors
are estimated using historical data, and the most recent data points are
generally given more weight. As of September 30, 2021 , our portfolio's VaR was
estimated to be 3.2% compared to an estimated 4.3% at December 31, 2020 . In
periods where the volatility of the risk factors mapped to our portfolio's
exposures is higher due to market conditions, the resulting VaR is higher than
in other periods.
Equity Securities . At September 30, 2021 and December 31, 2020 , the fair value
of our investments in equity securities (excluding securities included in Fixed
Income Securities above) totaled $1.5 billion and $1.1 billion , respectively.
These investments are exposed to price risk, which is the potential loss arising
from decreases in fair value. An immediate hypothetical 10% decline in the value
of each position would reduce the fair value of such investments by
approximately $146.7 million and $109.5 million at September 30, 2021 and
December 31, 2020 , respectively, and would have decreased book value per share
by approximately $0.38 and $0.27 , respectively. An immediate hypothetical 10%
increase in the value of each position would increase the fair value of such
investments by approximately $146.7 million and $109.5 million at September 30,
2021 and December 31, 2020 , respectively, and would have increased book value
per share by approximately $0.38 and $0.27 , respectively.
Investment-Related Derivatives. At September 30, 2021 , the notional value of all
derivative instruments (excluding to-be-announced mortgage backed securities
which are included in the fixed income securities analysis above and foreign
currency forward contracts which are included in the foreign currency exchange
risk analysis below) was $6.8 billion , compared to $8.6 billion at December 31,
2020 . If the underlying exposure of each investment-related derivative held at
September 30, 2021 depreciated by 100 basis points, it would have resulted in a
reduction in net income of approximately $68.2 million , and a decrease in book
value per share of approximately $0.18 per share, compared to $85.7 million and
$0.21 per share, respectively, on investment-related derivatives held at
December 31, 2020 . If the underlying exposure of each investment-related
derivative held at September 30, 2021 appreciated by 100 basis points, it would
have resulted in an increase in net income of approximately $68.2 million , and
an increase in book value per share of approximately $0.18 per share, compared
to $85.7 million and $0.21 per share, respectively, on investment-related
derivatives held at December 31, 2020 . See note 10, "Derivative
Instruments," to our consolidated financial statements for additional
disclosures concerning derivatives.
For further discussion on investment activity, please refer to "Financial
Condition-Investable Assets."
Foreign Currency Exchange Risk
Foreign currency rate risk is the potential change in value, income and cash
flow arising from adverse changes in foreign currency exchange rates. Through
our subsidiaries and branches located in various foreign countries, we conduct
our insurance and reinsurance operations in a variety of local currencies other
than the U.S. Dollar. We generally hold investments in foreign currencies which
are intended to mitigate our exposure to foreign currency fluctuations in our
net insurance liabilities. We may also utilize foreign currency forward
contracts and currency options as part of our investment strategy. See note
10, "Derivative Instruments," to our consolidated financial statements for
additional information.
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