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Arch Capital Group Ltd. Reports 2009 First Quarter Results (Business Wire)

Tue, 28 Apr 2009 20:01:00 Etc/GM

The Company’s book value per common share increased by 6.3% to $54.61 at March 31, 2009, from $51.36 per share at December 31, 2008. The Company’s after-tax operating income available to common shareholders represented a 21.1% annualized return on average common equity for the 2009 first quarter, compared to 21.9% for the 2008 first quarter. After-tax operating income available to common shareholders, a non-GAAP measure, is defined as net income available to 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 page 7 for a further discussion of after-tax operating income available to common shareholders and Regulation G.

The following table summarizes the Company’s underwriting results:

  Three Months Ended
March 31,
(U.S. dollars in thousands) 2009   2008
 
Gross premiums written $ 1,024,971 $ 1,053,152
Net premiums written 822,863 811,342
Net premiums earned 700,564 708,234
Underwriting income 93,389 98,371
 
Combined ratio 86.7 % 86.2 %

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 common shareholders to net income available to common shareholders and related diluted per share results:

  Three Months Ended
March 31,
(U.S. dollars in thousands, except per share data) 2009   2008
 
After-tax operating income available to common shareholders $ 169,001 $ 201,983
Net realized gains (losses), net of tax (9,111 ) 45,782
Net impairment losses recognized in earnings, net of tax (36,134 ) (12,646 )
Equity in net income (loss) of investment funds accounted for using the equity method, net of tax (9,581 ) (22,313 )
Net foreign exchange gains (losses), net of tax   25,694     (23,384 )
Net income available to common shareholders $ 139,869   $ 189,422  
 
Diluted per common share results:
After-tax operating income available to common shareholders $ 2.70 $ 2.97
Net realized gains (losses), net of tax (0.14 ) 0.67
Net impairment losses recognized in earnings, net of tax (0.58 ) (0.19 )
Equity in net income (loss) of investment funds accounted for using the equity method, net of tax (0.15 ) (0.33 )
Net foreign exchange gains (losses), net of tax   0.41     (0.34 )
Net income available to common shareholders $ 2.24   $ 2.78  
 

Weighted average common shares and common share equivalents outstanding – diluted

  62,559,969     68,019,413  

The combined ratio represents a measure of underwriting profitability, excluding investment income, and is the sum of the loss ratio and expense ratio. A combined ratio under 100% represents an underwriting profit and a combined ratio over 100% represents an underwriting loss. For the 2009 first quarter, the combined ratio of the Company’s insurance and reinsurance subsidiaries consisted of a loss ratio of 57.2% and an underwriting expense ratio of 29.5%, compared to a loss ratio of 57.1% and an underwriting expense ratio of 29.1% for the 2008 first quarter. The loss ratio of 57.2% for the 2009 first quarter was comprised of 45.5 points of paid losses (including 5.0 points related to 2005 and 2008 named catastrophic events), 4.4 points related to reserves for reported losses and 7.3 points related to incurred but not reported reserves.

In establishing the reserves for losses and loss adjustment expenses, the Company has made various assumptions relating to the pricing of its reinsurance contracts and insurance policies and also has considered available historical industry experience and current industry conditions. The Company’s reserving method to date has been, to a large extent, the expected loss method, which is commonly applied when limited loss experience exists. Any estimates and assumptions made as part of the reserving process could prove to be inaccurate due to several factors, including the fact that relatively limited historical information has been reported to the Company through March 31, 2009. For a discussion of underwriting activities and a review of the Company’s results by operating segment, see “Segment Information” in the Supplemental Financial Information section of this release.

The Company’s investment portfolio continues to be comprised primarily of high quality fixed income securities, with no direct holdings of collateralized debt obligations (CDOs), collateralized loan obligations (CLOs) or credit default swaps (CDSs). The Company’s portfolio does not include ownership of common stock or preferred stock of any publicly-traded issuers and essentially includes no investments in hedge funds or private equity funds. The average credit quality rating of the portfolio remained at “AA+” at March 31, 2009 and the average effective duration was 3.02 years at March 31, 2009, compared to 3.62 years at December 31, 2008. Including the effects of foreign exchange, total return on the Company’s investment portfolio was approximately 1.09% for the 2009 first quarter, compared to 0.95% for the 2008 first quarter. Excluding foreign exchange, total return was 1.23% for the 2009 first quarter, compared to 0.71% for the 2008 first quarter.

Net investment income for the 2009 first quarter was $95.9 million, or $1.53 per share, compared to $111.7 million, or $1.79 per share, in the 2008 fourth quarter and $122.2 million, or $1.80 per share, in the 2008 first quarter. Contributing to the decrease in investment income compared to the 2008 fourth quarter were a decline in the portfolio’s book yield from 4.55% at year-end to 4.17%, due in part to lower available yields and a reduction in the portfolio’s effective duration. In addition, $3.0 million of the decrease from the 2008 fourth quarter related to reductions to the cost basis of treasury inflation protected securities (TIPS) in the 2009 first quarter which resulted from a decline in the consumer price index (CPI) during the period. Although TIPS investments negatively impacted net investment income, they generated a positive total return for the quarter. The Company has now reduced its exposure to TIPS as of March 31, 2009. Income from the Company’s securities lending program also declined by $2.4 million from the 2008 fourth quarter due to the increased supply of U.S. Treasuries and lower federal funds rates in effect during the 2009 first quarter. The comparability of net investment income during the 2009 and 2008 first quarters was also influenced by the Company’s share repurchase program described below. In addition, as previously disclosed, the 2008 amount included $3.4 million of interest income related to a favorable arbitration decision. The pre-tax investment income yield was 3.82% for the 2009 first quarter, compared to 4.50% for the 2008 fourth quarter and 4.88% (excluding the arbitration interest) for the 2008 first quarter.

During the 2009 first quarter, the Company adopted FASB Staff Position No. FAS 115-2, “Recognition and Presentation of Other-Than-Temporary Impairments” (“FSP 115-2”). The new accounting guidance revises the recognition and reporting requirements for other-than-temporary impairments (OTTI) on the Company’s debt securities. The Company reviewed OTTI provisions it had recorded through realized losses on securities held at December 31, 2008 ($171.1 million) and estimated the portion related to credit events (i.e., where the present value of cash flows expected to be collected are lower than the amortized cost basis of the security) and the portion related to all other factors (e.g., interest rates, market conditions, etc.). The Company determined that $109.1 million of the OTTI previously recorded related to specific credit events and $62.0 million related to all other factors. Under FSP 115-2, the Company increased the amortized cost basis of these debt securities by $62.0 million and recorded a cumulative effect adjustment, net of tax, in its shareholders’ equity section. The cumulative effect adjustment had no effect on total shareholders’ equity as it increased retained earnings and reduced accumulated other comprehensive income.

Under the new accounting guidance, the amount of the credit loss portion of OTTI is recorded through earnings while the portion attributable to all other factors is recorded as a component of other comprehensive income in the equity section. In the 2009 first quarter, the Company recorded $36.1 million of net impairment losses through earnings, while the portion of loss recognized as a component of other comprehensive income on these securities was approximately $56.9 million. The net impairment losses primarily resulted from changes to expected recovery values during the period on structured securities (mortgage and asset backed) along with the winding down and liquidation of a Euro-denominated bank loan fund for which limited recovery value is expected.

The Company recorded $9.6 million of net losses related to investment funds accounted for using the equity method for the 2009 first quarter, compared to net losses of $22.3 million for the 2008 first quarter. Due to the ownership structure of these investment funds, which invest in fixed maturity securities, the Company uses the equity method. 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 market 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. Investment funds accounted for using the equity method totaled $293.5 million at March 31, 2009, compared to $301.0 million at December 31, 2008. The Company’s portfolio includes $331.3 million of investments in U.S. and Euro-denominated bank loan funds, which are primarily reflected in the investment funds accounted for using the equity method shown above. Please refer to the Company’s Financial Supplement dated March 31, 2009, which is posted on the Company’s website at http://www.archcapgroup.bm/EarningsReleases.aspx for further information on the Company’s investment portfolio.

The Company’s effective tax rates on income before income taxes and pre-tax operating income for the 2009 first quarter were 6.1% and 3.3%, respectively, compared to 3.9% and 2.5% for the 2008 first quarter. The Company’s effective tax rates may fluctuate from period to period based on the relative mix of income reported by jurisdiction primarily due to the varying tax rates in each jurisdiction. The Company’s quarterly tax provision is adjusted to reflect changes in its expected annual effective tax rates, if any. The Company currently expects that its annual effective tax rate on pre-tax operating income available to common shareholders for the year ended December 31, 2009 will be in the range of 2.5% to 4.5%. In addition, the Company’s Bermuda-based reinsurer incurs federal excise taxes for premiums assumed on U.S. risks. The Company incurred $3.3 million of federal excise taxes in the 2009 and 2008 first quarters. Such amounts are reflected as acquisition expenses in the Company’s consolidated statements of income.

Net foreign exchange gains for the 2009 first quarter of $25.2 million consisted of net unrealized gains of $25.9 million and net realized losses of $0.7 million, compared to net foreign exchange losses for the 2008 first quarter of $23.6 million which consisted of net unrealized losses of $22.3 million and net realized losses of $1.3 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. The Company holds investments in foreign currencies which are intended to mitigate its exposure to foreign currency fluctuations in its net insurance liabilities. However, changes in the value of such investments due to foreign currency rate movements are reflected as a direct increase or decrease to shareholders’ equity and are not included in the statements of income.

Diluted weighted average common shares and common share equivalents outstanding, used in the calculation of after-tax operating income and net income per common share, were 62.6 million for the 2009 first quarter, compared to 68.0 million for the 2008 first quarter. The lower level of weighted average shares outstanding in the 2009 first quarter was primarily due to the impact of share repurchases as discussed below.

The board of directors of ACGL has authorized the investment of up to $1.5 billion in ACGL’s common shares through a share repurchase program. Repurchases under the program may be effected from time to time in open market or privately negotiated transactions through February 2010. In March 2009, ACGL purchased $1.6 million of common shares through the share repurchase program. Since the inception of the share repurchase program through March 31, 2009, ACGL has repurchased approximately 15.3 million common shares for an aggregate purchase price of $1.05 billion. At March 31, 2009, approximately $448.3 million of repurchases were available under the share repurchase program. As a result of the share repurchase transactions to date, book value per common share was reduced by $2.86 per share at March 31, 2009, compared to $3.52 at December 31, 2008, while weighted average shares outstanding were reduced by 15.3 million for the 2009 first quarter, compared to 9.4 million shares for the 2008 first quarter.

At March 31, 2009, the Company’s capital of $4.03 billion consisted of $300.0 million of senior notes, representing 7.4% of the total, $100.0 million of revolving credit agreement borrowings due in August 2011, representing 2.5% of the total, $325.0 million of preferred shares, representing 8.1% of the total, and common shareholders’ equity of $3.31 billion, representing the balance. At December 31, 2008, the Company’s capital of $3.83 billion consisted of $300.0 million of senior notes, representing 7.8% of the total, $100.0 million of revolving credit agreement borrowings due in August 2011, representing 2.6% of the total, $325.0 million of preferred shares, representing 8.5% of the total, and common shareholders’ equity of $3.11 billion, representing the balance. The increase in total capital during the 2009 first quarter was primarily attributable to net income during the period.

The Company will hold a conference call for investors and analysts at 11:00 a.m. Eastern Time on Wednesday, April 29, 2009. A live webcast of this call will be available via the Investor Relations – Events and Presentations section of the Company's website at http://www.archcapgroup.bm. A telephone replay of the conference call also will be available beginning on April 29 at 1:00 p.m. Eastern Time until May 6, 2009 at midnight Eastern Time. To access the replay, domestic callers should dial 888-286-8010 (passcode 14362334), and international callers should dial 617-801-6888 (passcode 14362334).

Please refer to the Company’s Financial Supplement dated March 31, 2009, which is posted on the Company’s website at http://www.archcapgroup.bm/EarningsReleases.aspx. The Financial Supplement provides additional detail regarding the financial performance of the Company.

Arch Capital Group Ltd., a Bermuda-based company with over $4.0 billion in capital at March 31, 2009, provides insurance and reinsurance on a worldwide basis through its wholly owned subsidiaries.

Cautionary Note Regarding Forward-Looking Statements

The Private Securities Litigation Reform Act of 1995 (“PLSRA”) 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 PLSRA 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:

  • the Company’s ability to successfully implement its business strategy during “soft” as well as “hard” markets;
  • acceptance of the Company’s business strategy, security and financial condition by rating agencies and regulators, as well as by brokers and its insureds and reinsureds;
  • the Company’s ability to maintain or improve its ratings, which may be affected by its ability to raise additional equity or debt financings, by ratings agencies’ existing or new policies and practices, as well as other factors described herein;
  • general economic and market conditions (including inflation, interest rates, foreign currency exchange rates and prevailing credit terms) and conditions specific to the reinsurance and insurance markets in which the Company operates;
  • competition, including increased competition, on the basis of pricing, capacity, coverage terms or other factors;
  • the Company’s ability to successfully integrate, establish and maintain operating procedures (including the implementation of improved computerized systems and programs to replace and support manual systems) to effectively support its underwriting initiatives and to develop accurate actuarial data;
  • the loss of key personnel;
  • the integration of businesses the Company has acquired or may acquire into its existing operations;
  • accuracy of those estimates and judgments utilized in the preparation of the Company’s financial statements, including those related to revenue recognition, insurance and other reserves, reinsurance recoverables, investment valuations, intangible assets, bad debts, income taxes, contingencies and litigation, and any determination to use the deposit method of accounting, which for a relatively new insurance and reinsurance company, like the Company, are even more difficult to make than those made in a mature company since relatively limited historical information has been reported to the Company through March 31, 2009;
  • greater than expected loss ratios on business written by the Company and adverse development on claim and/or claim expense liabilities related to business written by its insurance and reinsurance subsidiaries;
  • severity and/or frequency of losses;
  • claims for natural or man-made catastrophic events in the Company’s insurance or reinsurance business could cause large losses and substantial volatility in its results of operations;
  • acts of terrorism, political unrest and other hostilities or other unforecasted and unpredictable events;
  • losses relating to aviation business and business produced by a certain managing underwriting agency for which the Company may be liable to the purchaser of its prior reinsurance business or to others in connection with the May 5, 2000 asset sale described in the Company’s periodic reports filed with the SEC;
  • availability to the Company of reinsurance to manage its gross and net exposures and the cost of such reinsurance;
  • the failure of reinsurers, managing general agents, third party administrators or others to meet their obligations to the Company;
  • the timing of loss payments being faster or the receipt of reinsurance recoverables being slower than anticipated by the Company;
  • the Company’s investment performance;
  • material differences between actual and expected assessments for guaranty funds and mandatory pooling arrangements;
  • changes in accounting principles or policies or in the Company’s application of such accounting principles or policies;
  • changes in the political environment of certain countries in which the Company operates or underwrites business;
  • statutory or regulatory developments, including as to tax policy matters and insurance and other regulatory matters such as the adoption of proposed legislation that would affect Bermuda-headquartered companies and/or Bermuda-based insurers or reinsurers and/or changes in regulations or tax laws applicable to the Company, its subsidiaries, brokers or customers; and
  • the other matters set forth under Item 1A “Risk Factors”, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and other sections of the Company’s Annual Report on
    Form 10-K, as well as the other factors set forth in the Company’s other documents on file with the SEC, and management’s response to any of the aforementioned factors.

In addition, other general factors could affect the Company’s results, including developments in the world’s financial and capital markets and its access to such markets.

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 available to common shareholders, which is defined as net income available to common shareholders, excluding net realized gains or losses, net impairment losses included in earnings, equity in net income or loss of investment funds accounted for using the equity method and net foreign exchange gains or losses, net of income taxes. The presentation of after-tax operating income available to common shareholders is a “non-GAAP financial measure” as defined in Regulation G. The reconciliation of such measure to net income available to 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 included 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 included 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 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 included 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 market 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, 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 available to common shareholders.

The Company believes that showing net income available to 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 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.

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

SUPPLEMENTAL FINANCIAL INFORMATION

 

Book Value Per Common Share and Share Repurchases

   
March 31, December 31,
(U.S. dollars in thousands, except share data) 2009 2008
 
Calculation of book value per common share:
Total shareholders’ equity $ 3,630,396 $ 3,432,965
Less preferred shareholders’ equity   (325,000 )   (325,000 )
Common shareholders’ equity $ 3,305,396 $ 3,107,965
Common shares outstanding (1)   60,532,222     60,511,974  
Book value per common share $ 54.61   $ 51.36  
  Three Months Ended   Cumulative
March 31, March 31,
(U.S. dollars in thousands, except share data) 2009   2008 2009
 
Effect of share repurchases:
Aggregate purchase price of shares repurchased $ 1,552 $ 189,843 $ 1,051,748
Shares repurchased   33,305   2,749,909     15,289,594  
Average price per share repurchased $ 46.60 $ 69.04 $

source: http://biz.yahoo.com/bw/090428/20090428006441.html?.v=1

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