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Arch Capital Group Ltd. Reports 2014 Second Quarter ResultsHAMILTON, BERMUDA --(Business Wire)-- Arch Capital Group Ltd. (NASDAQ:ACGL) reports that net income available to Arch common shareholders for the 2014 second quarter was $202.5 million, or $1.48 per share, compared to $171.5 million, or $1.26 per share, for the 2013 second quarter. The Company also reported after-tax operating income available to Arch common shareholders of $160.7 million, or $1.17 per share, for the 2014 second quarter, compared to after-tax operating income available to Arch common shareholders of $135.0 million, or $0.99 per share, for the 2013 second quarter. The Company's after-tax operating income available to Arch common shareholders represented an annualized return on average common equity of 11.2% for the 2014 second quarter, compared to 10.9% for the 2013 second quarter. The Company's net income available to Arch common shareholders represented an annualized return on average common equity of 14.1% for the 2014 second quarter, compared to 13.8% for the 2013 second quarter. The Company's book value per common share was $43.73 at June 30, 2014, a 5.3% increase from $41.52 per share at March 31, 2014 and an 18.8% increase from $36.80 per share at June 30, 2013. After-tax operating income or loss available to Arch common shareholders, a non-GAAP measure, is defined as net income available to Arch common shareholders, excluding net realized gains or losses, net impairment losses recognized in earnings, equity in net income or loss of investment funds accounted for using the equity method and net foreign exchange gains or losses, net of income taxes. See 'Comments on Regulation G' for a further discussion of after-tax operating income or loss available to Arch common shareholders. All earnings per share amounts discussed in this release are on a diluted basis. In March 2014, the Company invested $100.0 million to acquire approximately 11% of Watford Holdings Ltd.'s common equity and a warrant to purchase additional common equity. Watford Holdings Ltd. is the parent of Watford Re Ltd., a multi-line Bermuda reinsurance company (together with Watford Holdings Ltd., "Watford"). Watford is considered a variable interest entity and the Company concluded that it is the primary beneficiary of Watford in accordance with GAAP. As such, 100% of the results of Watford are included in the Company's consolidated financial statements. Watford, which is included in the 'other' segment, reported $51.8 million of net premiums written and a net loss attributable to common shareholders of $1.4 million (net income less dividends attributable to redeemable noncontrolling interests) for the 2014 second quarter. For additional details regarding Watford, please refer to the Company's Financial Supplement dated June 30, 2014. All discussions of line items in this release exclude the 'other' segment amounts. The following table summarizes the Company's underwriting results (excluding the 'other' segment). For a discussion of underwriting activities and a review of the Company's results by operating segment, see the "Segment Information" section of this release.
The following table summarizes, on an after-tax basis, the Company's consolidated financial data, including a reconciliation of after-tax operating income available to Arch common shareholders to net income available to Arch common shareholders and related diluted per share results:
The Company's investment portfolio continues to be comprised primarily of high quality fixed income securities with an average credit quality of "AA/Aa2." The average effective duration of the Company's investment portfolio was 3.14 years at June 30, 2014, compared to 2.62 years at December 31, 2013. Including the effects of foreign exchange, total return on the Company's investment portfolio was 1.80% for the 2014 second quarter, compared to (1.59)% for the 2013 second quarter. Excluding the effects of foreign exchange, total return was 1.63% for the 2014 second quarter, compared to (1.56)% for the 2013 second quarter. Net investment income for the 2014 second quarter was $72.5 million, or 0.53 per share, compared to $67.0 million, or 0.49 per share, for the 2014 first quarter, and $68.4 million, or 0.50 per share, for the 2013 second quarter. Investment income for the 2014 second quarter included a $4.1 million interest income distribution received on a fund investment. The annualized pre-tax investment income yield was 2.05% for the 2014 second quarter, excluding the interest income distribution noted above, compared to 2.08% for the 2014 first quarter and 2.20% for the 2013 second quarter. Such yields reflect the effects of low prevailing interest rates available in the market and the Company's investment strategy, which puts an emphasis on total return. Consolidated cash flow provided by operating activities was $254.2 million for the 2014 second quarter, compared to $182.7 million for the 2013 second quarter, primarily reflecting an increase in premiums collected. The Company recorded after-tax net impairment losses on investments of $14.7 million in the 2014 second quarter. Such amount was primarily related to two fund investments and followed a review of various factors in accordance with GAAP, including the time period in which there was a significant decline in value. The Company also recorded $4.9 million of other income in the 2014 second quarter. Such amount was primarily due to a non-recurring income item. On a pre-tax basis, net foreign exchange losses for the 2014 second quarter were $2.8 million (net unrealized losses of $2.1 million and net realized losses of $0.7 million), compared to net foreign exchange gains for the 2013 second quarter of $13.8 million (net unrealized gains of $21.6 million and net realized losses of $7.8 million). Net unrealized foreign exchange gains or losses result from the effects of revaluing the Company's net insurance liabilities required to be settled in foreign currencies at each balance sheet date. Changes in the value of available-for-sale investments held in foreign currencies due to foreign currency rate movements are reflected as a direct increase or decrease to shareholders' equity and are not included in the consolidated statements of income. The Company has not matched a portion of its projected liabilities in foreign currencies with investments in the same currencies and may not match such amounts in future periods, which could increase the Company's exposure to foreign currency fluctuations and increase the volatility of the Company's shareholders' equity. The Company's effective tax rate on income before income taxes was 3.3% for the 2014 second quarter and 2.7% for the six months ended June 30, 2014, compared to 2.8% for the 2013 second quarter and 2.2% for the six months ended June 30, 2013. The Company's effective tax rate on pre-tax operating income available to Arch shareholders was 3.6% for the 2014 second quarter and 2.6% for the six months ended June 30, 2014, compared to 3.3% for the 2013 second quarter and 2.5% for the six months ended June 30, 2013. The Company's quarterly tax provision is adjusted to reflect changes in its estimated annual effective tax rate, if any. The adjustment to the estimated annual effective tax rate in the 2014 second quarter reduced the Company's after-tax results by $1.4 million, or $0.01 per share. At June 30, 2014, total capital available to Arch of $7.13 billion consisted of $800.0 million of senior notes, representing 11.2% of the total, $100.0 million of revolving credit agreement borrowings due in June 2019, representing 1.4% of the total, $325.0 million of preferred shares, representing 4.6% of the total, and common shareholders' equity of $5.90 billion, representing 82.8% of the total. At December 31, 2013, total capital available to Arch of $6.55 billion consisted of $800.0 million of senior notes, representing 12.2% of the total, $100.0 million of revolving credit agreement borrowings, representing 1.5% of the total, $325.0 million of preferred shares, representing 5.0% of the total, and common shareholders' equity of $5.32 billion, representing 81.3% of the total. The Company will hold a conference call for investors and analysts at 11:00 a.m. Eastern Time on August 1, 2014. A live webcast of this call will be available via the Investors section of the Company's website at http://www.archcapgroup.com. A telephone replay of the conference call also will be available beginning on August 1, 2014 at 3:00 p.m. Eastern Time until August 8, 2014 at midnight Eastern Time. To access the replay, domestic callers should dial 888-286-8010 (passcode 91603488), and international callers should dial 617-801-6888 (passcode 91603488). Please refer to the Company's Financial Supplement dated June 30, 2014, which is available via the Investors section of the Company's website at http://www.archcapgroup.com. The Financial Supplement provides additional detail regarding the financial performance of the Company. From time to time, the Company posts additional financial information and presentations to its website, including information with respect to its subsidiaries. Investors and other recipients of this information are encouraged to check the Company's website regularly for additional information regarding the Company. Arch Capital Group Ltd., a Bermuda-based company with approximately $7.13 billion in capital at June 30, 2014, provides insurance and reinsurance on a worldwide basis through its wholly owned subsidiaries.
Segment Information The following section provides analysis on the Company's 2014 second quarter performance by operating segment. For additional details regarding the Company's operating segments, please refer to the Company's Financial Supplement dated June 30, 2014, which is available via the Investors section of the Company's website at http://www.archcapgroup.com.
Gross premiums written by the insurance segment in the 2014 second quarter were 21.1% higher than in the 2013 second quarter, while net premiums written were 15.4% higher than in the 2013 second quarter. The differential in gross versus net premiums written primarily resulted from growth in alternative markets business which is subject to a high level of cessions, primarily to captives. The growth in net premiums written primarily resulted from increases in: alternative markets; excess and surplus casualty; travel, accident and health; and construction and national accounts. Such amounts were partially offset by a reduction in professional lines. The increase in alternative markets reflected new accounts written in the quarter resulting from a renewal rights agreement, while the growth in excess and surplus casualty primarily resulted from contract binding business along with rate increases. Growth in travel, accident and health primarily resulted from expansion in existing and new distribution channels while the increase in construction and national accounts primarily resulted from growth in existing accounts and rate increases. The decrease in professional lines was primarily due to a continued strategic reduction in exposure to international business. Net premiums earned by the insurance segment in the 2014 second quarter were 10.7% higher than in the 2013 second quarter, and reflect changes in net premiums written over the previous five quarters. The 2014 second quarter loss ratio reflected 0.7 points of current year catastrophic activity, compared to 1.5 points in the 2013 second quarter. Estimated net favorable development in prior year loss reserves, before related adjustments, reduced the loss ratio by 3.8 points in the 2014 second quarter, compared to 3.5 points in the 2013 second quarter. The estimated net favorable development in the 2014 second quarter primarily resulted from better than expected claims emergence in short-tail business from more recent accident years. The 2014 second quarter loss ratio also reflected the impact of rate improvement on net premiums earned over the previous five quarters and changes in the mix of business. The underwriting expense ratio was 31.9% in the 2014 second quarter, compared to 33.6% in the 2013 second quarter. The acquisition expense ratio was 15.0% in the 2014 second quarter, compared to 16.1% in the 2013 second quarter. The comparison of the 2014 second quarter and 2013 second quarter acquisition expense ratios is influenced by, among other things, the mix and type of business written and earned and the level of ceding commissions. The 2014 second quarter ratio was disproportionately impacted by ceding commissions on the alternative markets business noted above. In addition, the acquisition expense ratio was impacted by changes in development of prior year loss reserves which increased the 2014 second quarter commission expense ratio by 0.6 points, compared to a 0.5 point increase in the 2013 second quarter. The operating expense ratio was 16.9% in the 2014 second quarter, compared to 17.5% in the 2013 second quarter, primarily due to the higher level of net premiums earned.
Gross premiums written by the reinsurance segment in the 2014 second quarter were 9.7% higher than in the 2013 second quarter, while net premiums written were 0.2% higher than in the 2013 second quarter. The differential in gross versus net premiums written reflects the cession of premiums to the 'other' segment (Watford) in the 2014 second quarter and a higher level of other retrocessions than in the 2013 second quarter. The growth in net premiums written reflected increases in other specialty and casualty lines, partially offset by reductions in property catastrophe, property excluding property catastrophe and marine lines. Growth in other specialty premiums primarily reflected a higher level of accident and health business while the increase in casualty premiums reflected new international excess motor business as well as quota shares of U.S. professional liability business which were written after June 30, 2013. The reduction in property lines reflected market conditions, selected non-renewals and a higher usage of retrocessional coverage. Net premiums earned in the 2014 second quarter were 16.7% higher than in the 2013 second quarter, and primarily reflect changes in net premiums written over the previous five quarters, including the mix and type of business written. The 2014 second quarter loss ratio reflected 4.1 points of current year catastrophic activity, compared to 11.6 points of catastrophic activity in the 2013 second quarter. Estimated net favorable development in prior year loss reserves, before related adjustments, reduced the loss ratio by 20.6 points in the 2014 second quarter, compared to 18.6 points in the 2013 second quarter. The estimated net favorable development in the 2014 second quarter primarily resulted from better than expected claims emergence in short-tail business from more recent underwriting years and in longer-tail business, primarily from older underwriting years. The balance of the increase in the 2014 second quarter loss ratio primarily resulted from changes in the mix of net premiums earned, including a lower contribution from property catastrophe business than in the 2013 second quarter, and also resulted from a higher level of non-catastrophic large loss activity. The underwriting expense ratio was 30.9% in the 2014 second quarter, compared to 29.6% in the 2013 second quarter. The acquisition expense ratio for the 2014 second quarter was 19.7%, compared to 18.5% for the 2013 second quarter. The acquisition expense ratio was impacted by changes in development of prior year loss reserves which increased the 2014 second quarter commission expense ratio by 0.4 points, compared to a 0.6 point reduction in the 2013 second quarter. In addition, the comparison of the acquisition expense ratios is influenced by, among other things, the mix and type of business written and earned and the level of ceding commissions. The operating expense ratio for the 2014 second quarter was 11.2%, compared to 11.1% in the 2013 second quarter.
The mortgage segment includes the results of Arch MI U.S., a leading provider of mortgage insurance products and services to the U.S. marketplace, which was acquired in January 2014, along with the Company's other global mortgage insurance, reinsurance and risk-sharing products. Net premiums written in the 2014 second quarter included $24.6 million of business underwritten by Arch MI U.S., substantially all of which was for credit union clients. In addition, net premiums written included $9.3 million from a 100% quota share indemnity reinsurance agreement with PMI for all certificates of insurance that were issued by PMI between and including January 1, 2009 and December 31, 2011 that were not in default as of an agreed upon effective date. The mortgage segment's net premiums written also included other reinsurance treaties covering U.S. and international mortgages. The change on such business was minimal. Net premiums earned for the 2014 second quarter were substantially higher than in the 2013 second quarter, primarily due to the acquisition of Arch MI U.S. along with a higher earned contribution from the mortgage segment's quota share reinsurance business. As the mortgage segment's mix is expected to shift more towards U.S. mortgage insurance business, the underwriting expense ratio is expected to stay at an elevated rate until Arch MI U.S. reaches scale. At June 30, 2014, the mortgage segment's risk-in-force consisted of $5.3 billion from Arch MI U.S. (substantially all of which relates to credit union customers) and an additional $4.7 billion through the mortgage segment's reinsurance and risk-sharing operations. Arch MI U.S. generated $941 million of new insurance written ("NIW") during the 2014 second quarter, substantially all of which was to credit union clients. For additional information on the mortgage segment, please refer to the Company's Financial Supplement.
Cautionary Note Regarding Forward-Looking Statements The Private Securities Litigation Reform Act of 1995 ("PSLRA") provides a "safe harbor" for forward-looking statements. This release or any other written or oral statements made by or on behalf of the Company may include forward-looking statements, which reflect the Company's current views with respect to future events and financial performance. All statements other than statements of historical fact included in or incorporated by reference in this release are forward-looking statements. Forward-looking statements, for purposes of the PSLRA or otherwise, can generally be identified by the use of forward-looking terminology such as "may," "will," "expect," "intend," "estimate," "anticipate," "believe" or "continue" and similar statements of a future or forward-looking nature or their negative or variations or similar terminology. Forward-looking statements involve the Company's current assessment of risks and uncertainties. Actual events and results may differ materially from those expressed or implied in these statements. Important factors that could cause actual events or results to differ materially from those indicated in such statements are discussed below and elsewhere in this release and in the Company's periodic reports filed with the Securities and Exchange Commission (the "SEC"), and include:
All subsequent written and oral forward-looking statements attributable to the Company or persons acting on its behalf are expressly qualified in their entirety by these cautionary statements. The foregoing review of important factors should not be construed as exhaustive and should be read in conjunction with other cautionary statements that are included herein or elsewhere. The Company undertakes no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise. Comment on Regulation G Throughout this release, the Company presents its operations in the way it believes will be the most meaningful and useful to investors, analysts, rating agencies and others who use the Company's financial information in evaluating the performance of the Company. This presentation includes the use of after-tax operating income or loss available to Arch common shareholders, which is defined as net income available to Arch common shareholders, excluding net realized gains or losses, net impairment losses recognized in earnings, equity in net income or loss of investment funds accounted for using the equity method and net foreign exchange gains or losses, net of income taxes. The presentation of after-tax operating income or loss available to Arch common shareholders is a "non-GAAP financial measure" as defined in Regulation G. The reconciliation of such measure to net income available to Arch common shareholders (the most directly comparable GAAP financial measure) in accordance with Regulation G is included on page 2 of this release. The Company believes that net realized gains or losses, net impairment losses recognized in earnings, equity in net income or loss of investment funds accounted for using the equity method and net foreign exchange gains or losses in any particular period are not indicative of the performance of, or trends in, the Company's business performance. Although net realized gains or losses, net impairment losses recognized in earnings, equity in net income or loss of investment funds accounted for using the equity method and net foreign exchange gains or losses are an integral part of the Company's 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 the Company's financial information believe that, for many companies, the timing of the realization of investment gains or losses is largely opportunistic. In addition, net impairment losses recognized in earnings on 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 the Company's investments in certain funds that invest in fixed maturity securities is driven by the ownership structure of such funds (either limited partnerships or limited liability companies). In applying the equity method, these investments are initially recorded at cost and are subsequently adjusted based on the Company's proportionate share of the net income or loss of the funds (which include changes in the fair value of the underlying securities in the funds). This method of accounting is different from the way the Company accounts for its 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. Due to these reasons, the Company excludes net realized gains or losses, net impairment losses recognized in earnings, equity in net income or loss of investment funds accounted for using the equity method and net foreign exchange gains or losses from the calculation of after-tax operating income or loss available to Arch common shareholders. The Company believes that showing net income available to Arch common shareholders exclusive of the items referred to above reflects the underlying fundamentals of the Company's business since the Company evaluates the performance of and manages its business to produce an underwriting profit. In addition to presenting net income available to Arch common shareholders, the Company believes that this presentation enables investors and other users of the Company's financial information to analyze the Company's performance in a manner similar to how the Company's management analyzes performance. The Company also believes that this measure follows industry practice and, therefore, allows the users of the Company's financial information to compare the Company's performance with its industry peer group. The Company believes that the equity analysts and certain rating agencies which follow the Company and the insurance industry as a whole generally exclude these items from their analyses for the same reasons.
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