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Arch Capital Group Ltd. Reports 2016 Second Quarter ResultsArch Capital Group Ltd. (NASDAQ: ACGL) reports that net income available to Arch common shareholders for the 2016 second quarter was $205.6 million, or $1.65 per share, compared to $110.3 million, or $0.88 per share, for the 2015 second quarter. The Company's net income available to Arch common shareholders represented an annualized return on average common equity of 13.2% for the 2016 second quarter, compared to 7.5% for the 2015 second quarter. For the trailing twelve months ended June 30, 2016, net income available to Arch common shareholders produced a 7.9% return on average common equity. The Company's book value per common share was $52.04 at June 30, 2016, a 4.4% increase from $49.87 per share at March 31, 2016 and a 9.6% increase from $47.49 per share at June 30, 2015. All earnings per share amounts discussed in this release are on a diluted basis. The Company also reported after-tax operating income available to Arch common shareholders of $140.6 million, or $1.13 per share, for the 2016 second quarter, compared to $146.0 million, or $1.16 per share, for the 2015 second quarter. The Company's after-tax operating income available to Arch common shareholders represented an annualized return on average common equity of 9.0% for the 2016 second quarter, compared to 9.9% for the 2015 second quarter. For the trailing twelve months ended June 30, 2016, after-tax operating income available to Arch common shareholders produced a 9.1% return on average common equity. After-tax operating income or loss available to Arch common shareholders and the related return on average common equity are non-GAAP measures. See 'Comments on Regulation G' for further details. The Company's 2016 second quarter results included losses for current year catastrophic events of $36.3 million, net of reinsurance and the effects of reinstatement premiums, with $20.6 million from the insurance segment and $15.7 million from the reinsurance segment. Events in the 2016 second quarter included the Texas hailstorms and floods, Fort McMurray wildfires, earthquake events in Japan and Ecuador and other U.S. weather events. The following table summarizes the Company's consolidated underwriting results:
Please note that these amounts include the impact of the 'other' segment (i.e., results of Watford Re). See 'Comments on Regulation G' for a reconciliation of underwriting income or loss to income before income taxes and net income available to Arch common shareholders. The 'other' segment includes amounts related to Watford Re. Pursuant to generally accepted accounting principles, Watford Re is considered a variable interest entity and the Company concluded that it is the primary beneficiary of Watford Re. As such, the Company consolidates the results of Watford Re in its consolidated financial statements, although it only owns approximately 11% of Watford Re's common equity. Segment Information The following section provides analysis on the Company's 2016 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, 2016. The Company's segment information includes the use of underwriting income and a combined ratio excluding catastrophic activity and prior year development for the insurance segment and reinsurance segment and a combined ratio excluding prior year development for the mortgage segment. Such items are non-GAAP financial measures (see 'Comments on Regulation G' for further details).
Gross premiums written by the insurance segment in the 2016 second quarter were 2.3% higher than in the 2015 second quarter while net premiums written were 1.2% higher than in the 2015 second quarter. The increase in net premiums written reflected growth in travel, construction and national accounts, partially offset by a reduction in programs and property lines. The growth in travel reflected both new business and continued expansion in existing accounts. The increase in construction and national accounts primarily reflected new business and audit premiums. The reduction in program business primarily reflected the continued impact of the non-renewal of a large program in the latter part of 2015 while the lower level of net premiums written in property lines reflected continued weak market conditions. Net premiums earned by the insurance segment in the 2016 second quarter were 3.5% higher than in the 2015 second quarter, and reflect changes in net premiums written over the previous five quarters. The 2016 second quarter loss ratio reflected 3.9 points of current year catastrophic activity, compared to 1.2 points in the 2015 second quarter. Estimated net favorable development in prior year loss reserves, before related adjustments, reduced the loss ratio by 0.9 points in the 2016 second quarter, compared to 3.6 points in the 2015 second quarter. The estimated net favorable development in the 2016 second quarter primarily resulted from better than expected claims emergence in property lines from more recent accident years and in longer-tailed lines from earlier accident years, partially offset by a large energy casualty claim from the 2015 accident year. The balance of the change in the 2016 second quarter loss ratio resulted, in part, from changes in the mix of business. The underwriting expense ratio was 32.2% in the 2016 second quarter, compared to 32.5% in the 2015 second quarter. The comparison of the underwriting expense ratios and the underlying acquisition expense and other operating expense ratios reflected changes in the mix of business and the level of reinsurance ceded on a quota share basis.
Gross premiums written by the reinsurance segment in the 2016 second quarter were 20.4% higher than in the 2015 second quarter, while net premiums written were 15.6% higher than in the 2015 second quarter. The growth reflected the impact of a loss portfolio transfer which resulted in $52.1 million of gross premiums written and $40.2 million of net premiums written. Such premium was substantially earned in the period and resulted in a corresponding increase to losses and loss adjustment expenses. Excluding such transaction, net premiums written were flat, reflecting competitive market conditions and a higher level of ceded premiums. Other underwriting income for the 2016 second quarter included $19.1 million related to a contract which was commuted during the period. This contract had been reflected as a deposit accounting liability (i.e., a contract that, in accordance with GAAP, does not pass risk transfer) prior to the commutation. The 2016 second quarter loss ratio reflected 7.7 points related to the loss portfolio transfer noted above. In addition, the 2016 second quarter loss ratio included 6.1 points of current year catastrophic activity, compared to 3.7 points of catastrophic activity in the 2015 second quarter, and a higher level of attritional large loss activity than in the 2015 second quarter. Estimated net favorable development in prior year loss reserves, before related adjustments, reduced the loss ratio by 24.0 points in the 2016 second quarter, compared to 21.1 points in the 2015 second quarter. The estimated net favorable development in the 2016 second quarter primarily resulted from better than expected claims emergence in short-tail business from most underwriting years and in longer-tail business across earlier underwriting years. The underwriting expense ratio was 31.9% in the 2016 second quarter, compared to 35.5% in the 2015 second quarter. The loss portfolio transfer noted above improved the 2016 second quarter expense ratio by 5.0 points. The 2016 second quarter ratio reflected changes in the mix and type of business.
The mortgage segment includes the Company's U.S. and international mortgage insurance and reinsurance operations as well as government sponsored enterprise ("GSE") credit-risk sharing transactions. Arch Mortgage Insurance Company ("Arch MI U.S.") is approved as an eligible mortgage insurer by Fannie Mae and Freddie Mac. Gross premiums written by the mortgage segment in the 2016 second quarter were 72.7% higher than in the 2015 second quarter, while net premiums written were 80.7% higher than in the 2015 second quarter. Approximately two thirds of the increase was in Australian mortgage reinsurance business with the remainder split between U.S. primary business, primarily from banks and other non-credit union originators, and in GSE credit risk-sharing transactions receiving insurance accounting treatment. Net premiums earned for the 2016 second quarter were 26.8% higher than in the 2015 second quarter, reflecting the growth in insurance in force. Other underwriting income, which is primarily related to GSE risk-sharing transactions receiving derivative accounting treatment, was $4.1 million for the 2016 second quarter, compared to $3.7 million for the 2015 second quarter. The loss ratio for the 2016 second quarter reflected estimated net favorable development in prior year loss reserves, before related adjustments, of 16.6 points, compared to 2.1 points in the 2015 second quarter, driven primarily by continued lower than expected claim rates. As noted previously, the mortgage segment's underwriting expense ratio is expected to stay at an elevated level until Arch MI U.S. reaches scale. At June 30, 2016, the mortgage segment's risk-in-force consisted of $8.40 billion from Arch MI U.S. and an additional $4.56 billion through the mortgage segment's reinsurance and risk-sharing operations. Arch MI U.S. generated $6.42 billion of new insurance written ("NIW") during the 2016 second quarter, of which 76% was from banks and other non-credit union mortgage originators. For additional information on the mortgage segment, please refer to the Company's Financial Supplement. Corporate (Non-Underwriting) Segment The corporate (non-underwriting) segment results include net investment income, other income (loss), corporate expenses, interest expense, net realized gains or losses, net impairment losses included in earnings, equity in net income or loss of investment funds accounted for using the equity method, net foreign exchange gains or losses, income taxes and items related to the Company's non-cumulative preferred shares. Such amounts exclude the results of the 'other' segment. Net investment income for the 2016 second quarter was $0.57 per share, or $70.4 million, compared to $0.53 per share, or $67.2 million, for the 2015 second quarter, and $0.57 per share, or $70.4 million, for the 2016 first quarter. The 2016 second quarter net investment income reflected approximately $2.3 million related to inflation adjustments on U.S. Treasury Inflation-Protected Securities along with adjustments on structured securities, partially offset by lower returns from alternative investments. The annualized pre-tax investment income yield was 2.08% for the 2016 second quarter, compared to 2.05% for the 2015 second quarter and 2.13% for the 2016 first 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. Corporate expenses were $17.2 million for the 2016 second quarter, compared to $17.4 million for the 2015 second quarter. Such amounts primarily represent certain holding company costs necessary to support the Company's worldwide insurance, reinsurance and mortgage operations and costs associated with operating as a publicly traded company. Interest expense for the 2016 second quarter was $12.4 million, compared to $4.0 million for the 2015 second quarter. Such amounts reflected $12.4 million related to the Company's senior notes and other borrowings, while the 2015 second quarter was partially offset by an $8.4 million reduction in interest expense on the deposit accounting liability contract discussed above. On a pre-tax basis, net foreign exchange gains for the 2016 second quarter were $22.5 million, compared to net foreign exchange losses for the 2015 second quarter of $22.6 million. For both periods, such amounts were primarily unrealized and resulted 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. Although the Company generally attempts to match the currency of its projected liabilities with investments in the same currencies, from time to time the Company may elect to over or underweight one or more currencies, 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 (based on the Company's estimated annual effective tax rate) was 6.4% for the 2016 second quarter and 7.8% for the six months ended June 30, 2016, compared to 5.6% for the 2015 second quarter and 4.7% for the six months ended June 30, 2015. The Company's effective tax rate on pre-tax operating income available to Arch shareholders was 5.9% for the 2016 second quarter and 6.2% for the six months ended June 30, 2016, compared to 3.9% for the 2015 second quarter and 3.9% for the six months ended June 30, 2015. The Company's effective tax rate fluctuates from year to year based upon the relative mix of income or loss reported by jurisdiction and the varying tax rates in each jurisdiction. 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 2016 second quarter did not have a material impact on the Company's after-tax results. Capitalization and Shareholders' Equity At June 30, 2016, total capital available to Arch of $7.60 billion consisted of $791.4 million of senior notes, representing 10.4% of the total, $100.0 million of revolving credit agreement borrowings, representing 1.3% of the total, $325.0 million of preferred shares, representing 4.3% of the total, and common shareholders' equity of $6.38 billion, representing 84.0% of the total. At December 31, 2015, total capital available to Arch of $7.10 billion consisted of $791.3 million of senior notes, representing 11.2% of the total, $100.0 million of revolving credit agreement borrowings, representing 1.4% of the total, $325.0 million of preferred shares, representing 4.6% of the total, and common shareholders' equity of $5.88 billion, representing 82.9% of the total. Conference Call The Company will hold a conference call for investors and analysts at 11:00 a.m. Eastern Time on July 28, 2016. 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 July 28, 2016 at 2:00 p.m. Eastern Time until August 4, 2016 at midnight Eastern Time. To access the replay, domestic callers should dial 855-859-2056, and international callers should dial 404-537-3406 (passcode 38285511 for all callers). Please refer to the Company's Financial Supplement dated June 30, 2016, 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 $7.60 billion in capital at June 30, 2016, provides insurance and reinsurance on a worldwide basis through its wholly owned subsidiaries. Comments 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 and that investors and such other persons benefit from having a consistent basis for comparison between quarters and for comparison with other companies within the industry. These measures may not, however, be comparable to similarly titled measures used by companies outside of the insurance industry. Investors are cautioned not to place undue reliance on these non-GAAP financial measures in assessing the Company's overall financial performance. 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, net foreign exchange gains or losses 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 return on average common equity (the most directly comparable GAAP financial measures) in accordance with Regulation G is included on the following page 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. The following table summarizes the Company's consolidated financial data, including a reconciliation of net income available to Arch common shareholders to after-tax operating income available to Arch common shareholders and related diluted per share results. Each line item reflects the impact of the Company's approximate 11% ownership of Watford Re's common equity:
The Company's segment information includes the presentation of consolidated underwriting income or loss and a subtotal of underwriting income or loss before the contribution from the 'other' segment. Such measures represent the pre-tax profitability of its 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 the Company's individual underwriting operations. Underwriting income or loss does not incorporate items included in the Company's corporate (non-underwriting) segment. While these measures are presented in the Segment Information footnote to the Company's Consolidated Financial Statements, they are considered non-GAAP financial measures when presented elsewhere on a consolidated basis. The reconciliations of underwriting income or loss to income before income taxes (the most directly comparable GAAP financial measure) on a consolidated basis and a subtotal before the contribution from the 'other' segment, in accordance with Regulation G, is shown on pages 8 and 9. Management measures segment performance for its three underwriting segments based on underwriting income or loss. The Company does not manage its assets by underwriting segment, with the exception of goodwill and intangible assets, and, accordingly, investment income and other non-underwriting related items are not allocated to each underwriting segment. As noted earlier, the 'other' segment includes the results of Watford Re. Watford Re has its own management and board of directors that is responsible for the overall profitability of the 'other' segment. For the 'other' segment, performance is measured based on net income or loss. The Company does not guarantee or provide credit support for Watford Re, and the Company's financial exposure to Watford Re is limited to its investment in Watford Re's common and preferred shares and counterparty credit risk (mitigated by collateral) arising from reinsurance transactions. Along with consolidated underwriting income, the Company provides a subtotal of underwriting income or loss before the contribution from the 'other' segment and believes that this presentation enables investors and other users of the Company's financial information to analyze the Company's underwriting performance in a manner similar to how the Company's management analyzes performance. In addition, the Company's segment information includes the use of a combined ratio excluding catastrophic activity and prior year development for the insurance segment and reinsurance segment and a combined ratio excluding prior year development for the mortgage segment. These ratios are non-GAAP financial measures as defined in Regulation G. The reconciliation of such measures to the combined ratio (the most directly comparable GAAP financial measure) in accordance with Regulation G are shown on the individual segment pages. The Company's management utilizes the adjusted combined ratio excluding current accident year catastrophic events and favorable or adverse development in prior year loss reserves in its analysis of the underwriting performance of each of its underwriting segments. The following tables summarize the Company's results by segment for the 2016 second quarter and 2015 second quarter and a reconciliation of underwriting income or loss to income before income taxes and net income available to Arch common shareholders:
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.
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