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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

 

FORM 10-Q

☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2019
Or
☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number:  001-16209

 

ARCH CAPITAL GROUP LTD.

(Exact name of registrant as specified in its charter)

Bermuda				98-0374481
(State or other jurisdiction of incorporation or organization)				(I.R.S. Employer Identification No.)
Waterloo House, Ground Floor
100 Pitts Bay Road,	Pembroke	HM 08,	Bermuda	(441)	278-9250
(Address of principal executive offices)				(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Exchange Act:

Title of each class		Trading Symbol (s)		Name of each exchange on which registered
Common shares, $0.0011 par value per share		ACGL		NASDAQ	Stock Market
Depositary shares, each representing a 1/100th interest in a 5.25% Series E preferred share		ACGLP		NASDAQ	Stock Market
Depositary shares, each representing a 1/100th interest in a 5.45% Series F preferred share		ACGLO		NASDAQ	Stock Market

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ☑     No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☑     No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer ☑ Accelerated Filer ☐ Non-accelerated Filer ☐ Smaller reporting company ☐ Emerging growth company ☐

If an emerging growth company, indicate by check mark if the Registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐   No ☑

As of August 1, 2019, there were 404,987,803 common shares, $0.0011 par value per share, of the registrant outstanding.

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ARCH CAPITAL GROUP LTD.

 

INDEX TO FORM 10-Q

 

			Page No.
	PART I
	Financial Information		2
Item 1.	Consolidated Financial Statements		4
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		49
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		73
Item 4.	Controls and Procedures		74
	PART II
	Other Information		75
Item 1.	Legal Proceedings		75
Item 1A.	Risk Factors		75
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		75
Item 3.	Defaults Upon Senior Securities		76
Item 4.	Mine Safety Disclosures		76
Item 5.	Other Information		76
Item 6.	Exhibits		77
	Signatures		78

ARCH CAPITAL	1	2019 SECOND QUARTER FORM 10-Q

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PART I.  FINANCIAL INFORMATION

Cautionary Note Regarding Forward-Looking Statements 

The Private Securities Litigation Reform Act of 1995 (“PSLRA”) provides a “safe harbor” for forward-looking statements. This report or any other written or oral statements made by or on behalf of us may include forward-looking statements, which reflect our 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 report 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 our 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 report and in our periodic reports filed with the Securities and Exchange Commission (the “SEC”), and include:

•	our ability to successfully implement our business strategy during “soft” as well as “hard” markets;

•	acceptance of our business strategy, security and financial condition by rating agencies and regulators, as well as by brokers and our insureds and reinsureds;

•	the integration of any businesses we have acquired or may acquire into our existing operations;

•	our ability to maintain or improve our ratings, which may be affected by our 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, unemployment, housing prices, foreign currency exchange rates, prevailing credit terms and the depth and duration of a recession) and conditions specific to the reinsurance and insurance markets (including the length and magnitude of the current “soft” market) in which we operate;

•	competition, including increased competition, on the basis of pricing, capacity (including alternative sources of capital), coverage terms, or other factors;

•	developments in the world’s financial and capital markets and our access to such markets;

•	our ability to successfully enhance, integrate and maintain operating procedures (including information technology) to effectively support our current and new business;

•	the loss of key personnel;

•

accuracy of those estimates and judgments utilized in the preparation of our 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 our company, are even more difficult to make than those made in a mature company since relatively limited historical information has been reported to us through June 30, 2019;

•	greater than expected loss ratios on business written by us and adverse development on claim and/or claim expense liabilities related to business written by our insurance and reinsurance subsidiaries;

•	severity and/or frequency of losses;

•	claims for natural or man-made catastrophic events or severe economic events in our insurance, reinsurance and mortgage businesses could cause large losses and substantial volatility in our results of operations;

•	the effect of climate change on our business;

•	acts of terrorism, political unrest and other hostilities or other unforecasted and unpredictable events;

•	availability to us of reinsurance to manage our 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 us;

•	the timing of loss payments being faster or the receipt of reinsurance recoverables being slower than anticipated by us;

ARCH CAPITAL	2	2019 SECOND QUARTER FORM 10-Q

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•	our investment performance, including legislative or regulatory developments that may adversely affect the fair value of our investments;

•	changes in general economic conditions, including new or continued sovereign debt concerns in Eurozone countries or downgrades of U.S. securities by credit rating agencies, which could affect our business, financial condition and results of operations;

•	the volatility of our shareholders’ equity from foreign currency fluctuations, which could increase due to us not matching portions of our projected liabilities in foreign currencies with investments in the same currencies;

•	changes in accounting principles or policies or in our application of such accounting principles or policies;

•	changes in the political environment of certain countries in which we operate or underwrite business;

•	a disruption caused by cyber-attacks or other technology breaches or failures on us or our business partners and service providers, which could negatively impact our business and/or expose us to litigation;

•	statutory or regulatory developments, including as to tax 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 us, our subsidiaries, brokers or customers, including the Tax Cuts and Jobs Act of 2017; 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 our Annual Report on Form 10-K for the year ended December 31, 2018, as well as the other factors set forth in our other documents on file with the SEC, and management’s response to any of the aforementioned factors.

 

All subsequent written and oral forward-looking statements attributable to us or persons acting on our 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. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise. 

ARCH CAPITAL	3	2019 SECOND QUARTER FORM 10-Q

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ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

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		Page No.
Report of Independent Registered Public Accounting Firm		5
Consolidated Balance Sheets
June 30, 2019 (unaudited) and December 31, 2018		6
Consolidated Statements of Income
For the three and six month periods ended June 30, 2019 and 2018 (unaudited)		7
Consolidated Statements of Comprehensive Income
For the three and six month periods ended June 30, 2019 and 2018 (unaudited)		8
Consolidated Statements of Changes in Shareholders’ Equity
For the three and six month periods ended June 30, 2019 and 2018 (unaudited)		9
Consolidated Statements of Cash Flows
For the six month periods ended June 30, 2019 and 2018 (unaudited)		10
Notes to Consolidated Financial Statements (unaudited)
Note 1 - Basis of Presentation and Recent Accounting Pronouncements		11
Note 2 - Share Transactions		12
Note 3 - Earnings Per Common Share		13
Note 4 - Segment Information		14
Note 5 - Reserve for Losses and Loss Adjustment Expenses		19
Note 6 - Investment Information		22
Note 7 - Fair Value		28
Note 8 - Derivative Instruments		34
Note 9 - Commitments and Contingencies		35
Note 10 - Leases		35
Note 11 - Variable Interest Entities and Noncontrolling Interests		36
Note 12 - Other Comprehensive Income (Loss)		39
Note 13 - Guarantor Financial Information		40
Note 14 - Income Taxes		48
Note 15 - Legal Proceedings		48
Note 16 - Subsequent Events		48

ARCH CAPITAL	4	2019 SECOND QUARTER FORM 10-Q

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Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholders of Arch Capital Group Ltd.

Results of Review of Interim Financial Statements

We have reviewed the accompanying consolidated balance sheet of Arch Capital Group Ltd. and its subsidiaries (the “Company”) as of June 30, 2019, and the related consolidated statements of income, comprehensive income, and changes in shareholders’ equity for each of the three-month and six-month periods ended June 30, 2019 and 2018, and the consolidated statements of cash flows for the six-month periods ended June 30, 2019 and 2018, including the related notes (collectively referred to as the “interim financial statements”). Based on our reviews, we are not aware of any material modifications that should be made to the accompanying interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of the Company as of December 31, 2018, and the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for the year then ended (not presented herein), and in our report dated February 28, 2019, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet as of December 31, 2018, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

Basis for Review Results

These interim financial statements are the responsibility of the Company’s management. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our review in accordance with the standards of the PCAOB. A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the PCAOB, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

/s/ PricewaterhouseCoopers LLP

PricewaterhouseCoopers LLP

New York, NY

August 7, 2019

ARCH CAPITAL	5	2019 SECOND QUARTER FORM 10-Q

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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (U.S. dollars in thousands, except share data)
	(Unaudited)
	June 30, 2019				December 31, 2018
Assets
Investments:
Fixed maturities available for sale, at fair value (amortized cost: $15,584,662 and $14,829,902)	$	15,881,732			$	14,699,010
Short-term investments available for sale, at fair value (amortized cost: $822,157 and $956,238)	821,961				955,880
Collateral received under securities lending, at fair value (amortized cost: $450,312 and $274,125)	450,320				274,133
Equity securities, at fair value	670,943				338,899
Investments accounted for using the fair value option	3,721,035				3,983,571
Investments accounted for using the equity method	1,581,972				1,493,791
Total investments	23,127,963				21,745,284
Cash	605,316				646,556
Accrued investment income	119,252				114,641
Securities pledged under securities lending, at fair value (amortized cost: $436,699 and $266,786)	440,510				268,395
Premiums receivable	1,606,040				1,299,150
Reinsurance recoverable on unpaid and paid losses and loss adjustment expenses	3,171,257				2,919,372
Contractholder receivables	2,102,544				2,079,111
Ceded unearned premiums	1,136,728				975,469
Deferred acquisition costs	600,740				569,574
Receivable for securities sold	164,592				36,246
Goodwill and intangible assets	641,010				634,920
Other assets	1,135,718				929,611
Total assets	$	34,851,670			$	32,218,329
Liabilities
Reserve for losses and loss adjustment expenses	$	12,230,316			$	11,853,297
Unearned premiums	4,056,860				3,753,636
Reinsurance balances payable	531,990				393,107
Contractholder payables	2,102,544				2,079,111
Collateral held for insured obligations	237,056				236,630
Senior notes	1,733,865				1,733,528
Revolving credit agreement borrowings	491,006				455,682
Securities lending payable	450,312				274,125
Payable for securities purchased	294,109				90,034
Other liabilities	904,438				911,500
Total liabilities	23,032,496				21,780,650
Commitments and Contingencies
Redeemable noncontrolling interests	206,475				206,292
Shareholders' Equity
Non-cumulative preferred shares	780,000				780,000
Common shares ($0.0011 par, shares issued: 573,761,683 and 570,737,283)	638				634
Additional paid-in capital	1,847,949				1,793,781
Retained earnings	10,322,975				9,426,299
Accumulated other comprehensive income (loss), net of deferred income tax	206,827				(178,720		)
Common shares held in treasury, at cost (shares: 168,874,149 and 168,282,449)	(2,401,037		)		(2,382,167		)
Total shareholders' equity available to Arch	10,757,352				9,439,827
Non-redeemable noncontrolling interests	855,347				791,560
Total shareholders' equity	11,612,699				10,231,387
Total liabilities, noncontrolling interests and shareholders' equity	$	34,851,670			$	32,218,329

See Notes to Consolidated Financial Statements

ARCH CAPITAL	6	2019 SECOND QUARTER FORM 10-Q

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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (U.S. dollars in thousands, except share data)
	(Unaudited)								(Unaudited)
	Three Months Ended								Six Months Ended
	June 30,								June 30,
	2019				2018				2019				2018
Revenues
Net premiums written	$	1,444,898			$	1,298,896			$	2,970,157			$	2,711,440
Change in unearned premiums	18,829				37,867				(137,564		)		(139,778		)
Net premiums earned	1,463,727				1,336,763				2,832,593				2,571,662
Net investment income	155,038				135,668				311,987				262,392
Net realized gains (losses)	120,806				(76,611		)		262,371				(187,609		)
Other-than-temporary impairment losses	(49		)		(470		)		(1,358		)		(632		)
Less investment impairments recognized in other comprehensive income, before taxes	—				—				—				—
Net impairment losses recognized in earnings	(49		)		(470		)		(1,358		)		(632		)
Other underwriting income	5,953				3,874				14,778				9,223
Equity in net income of investment funds accounted for using the equity method	32,536				8,472				79,403				36,541
Other income	1,129				3,113				2,212				3,187
Total revenues	1,779,140				1,410,809				3,501,986				2,694,764
Expenses
Losses and loss adjustment expenses	767,543				726,153				1,486,075				1,363,013
Acquisition expenses	210,089				202,838				407,937				394,214
Other operating expenses	198,914				176,181				400,077				351,196
Corporate expenses	18,251				22,512				36,213				37,824
Amortization of intangible assets	19,794				26,472				40,211				53,208
Interest expense	29,280				30,344				58,345				60,980
Net foreign exchange (gains) losses	4,952				(53,706		)		1,427				(33,985		)
Total expenses	1,248,823				1,130,794				2,430,285				2,226,450
Income before income taxes	530,317				280,015				1,071,701				468,314
Income tax expense	(44,472		)		(23,668		)		(90,358		)		(45,583		)
Net income	$	485,845			$	256,347			$	981,343			$	422,731
Net (income) loss attributable to noncontrolling interests	(16,891		)		(12,701		)		(63,861		)		(28,662		)
Net income available to Arch	468,954				243,646				917,482				394,069
Preferred dividends	(10,403		)		(10,403		)		(20,806		)		(20,840		)
Loss on redemption of preferred shares	—				—				—				(2,710		)
Net income available to Arch common shareholders	$	458,551			$	233,243			$	896,676			$	370,519
Net income per common share and common share equivalent
Basic	$	1.14			$	0.58			$	2.24			$	0.91
Diluted	$	1.12			$	0.56			$	2.19			$	0.89
Weighted average common shares and common share equivalents outstanding
Basic	401,482,784				404,800,421				400,837,181				406,162,508
Diluted	410,899,483				413,111,205				409,755,250				415,460,756

See Notes to Consolidated Financial Statements

ARCH CAPITAL	7	2019 SECOND QUARTER FORM 10-Q

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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (U.S. dollars in thousands)
	(Unaudited)								(Unaudited)
	Three Months Ended								Six Months Ended
	June 30,								June 30,
	2019				2018				2019				2018
Comprehensive Income
Net income	$	485,845			$	256,347			$	981,343			$	422,731
Other comprehensive income (loss), net of deferred income tax
Unrealized appreciation (decline) in value of available-for-sale investments:
Unrealized holding gains (losses) arising during period	222,473				(85,271		)		448,360				(251,948		)
Reclassification of net realized (gains) losses, net of income taxes, included in net income (loss)	(55,345		)		36,643				(65,566		)		99,104
Foreign currency translation adjustments	4,267				(12,595		)		9,783				(11,313		)
Comprehensive income	657,240				195,124				1,373,920				258,574
Net (income) loss attributable to noncontrolling interests	(16,891		)		(12,701		)		(63,861		)		(28,662		)
Other comprehensive (income) loss attributable to noncontrolling interests	(2,891		)		1,077				(7,030		)		1,750
Comprehensive income available to Arch	$	637,458			$	183,500			$	1,303,029			$	231,662

See Notes to Consolidated Financial Statements

ARCH CAPITAL	8	2019 SECOND QUARTER FORM 10-Q

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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (U.S. dollars in thousands)
	(Unaudited)								(Unaudited)
	Three Months Ended								Six Months Ended
	June 30,								June 30,
	2019				2018				2019				2018
Non-cumulative preferred shares
Balance at beginning of period	$	780,000			$	780,000			$	780,000			$	872,555
Preferred shares redeemed	—				—				—				(92,555		)
Balance at end of period	780,000				780,000				780,000				780,000
Convertible non-voting common equivalent preferred shares
Balance at beginning of period	—				—				—				489,627
Preferred shares converted to common shares	—				—				—				(489,627		)
Balance at end of period	—				—				—				—
Common shares
Balance at beginning of period	636				630				634				611
Common shares issued, net	2				3				4				22
Balance at end of period	638				633				638				633
Additional paid-in capital
Balance at beginning of period	1,819,605				1,737,978				1,793,781				1,230,617
Preferred shares converted to common shares	—				—				—				489,608
Other changes	28,344				22,628				54,168				40,381
Balance at end of period	1,847,949				1,760,606				1,847,949				1,760,606
Retained earnings
Balance at beginning of period	9,864,424				8,849,959				9,426,299				8,562,889
Cumulative effect of an accounting change	—				—				—				149,794
Balance at beginning of period, as adjusted	9,864,424				8,849,959				9,426,299				8,712,683
Net income	485,845				256,347				981,343				422,731
Net (income) loss attributable to noncontrolling interests	(16,891		)		(12,701		)		(63,861		)		(28,662		)
Preferred share dividends	(10,403		)		(10,403		)		(20,806		)		(20,840		)
Loss on redemption of preferred shares	—				—				—				(2,710		)
Balance at end of period	10,322,975				9,083,202				10,322,975				9,083,202
Accumulated other comprehensive income (loss), net of deferred income tax
Balance at beginning of period	38,323				(134,009		)		(178,720		)		118,044
Unrealized appreciation (decline) in value of available-for-sale investments, net of deferred income tax:
Balance at beginning of period	97,202				(96,238		)		(114,178		)		157,400
Cumulative effect of an accounting change	—				—				—				(149,794		)
Balance at beginning of period, as adjusted	97,202				(96,238		)		(114,178		)		7,606
Unrealized holding gains (losses) during period, net of reclassification adjustment	167,128				(48,628		)		382,794				(152,844		)
Unrealized holding gains (losses) during period attributable to noncontrolling interests	(2,703		)		1,513				(6,989		)		1,885
Balance at end of period	261,627				(143,353		)		261,627				(143,353		)
Foreign currency translation adjustments, net of deferred income tax:
Balance at beginning of period	(58,879		)		(37,771		)		(64,542		)		(39,356		)
Foreign currency translation adjustments	4,267				(12,595		)		9,783				(11,313		)
Foreign currency translation adjustments attributable to noncontrolling interests	(188		)		(438		)		(41		)		(135		)
Balance at end of period	(54,800		)		(50,804		)		(54,800		)		(50,804		)
Balance at end of period	206,827				(194,157		)		206,827				(194,157		)
Common shares held in treasury, at cost
Balance at beginning of period	(2,388,392		)		(2,084,186		)		(2,382,167		)		(2,077,741		)
Shares repurchased for treasury	(12,645		)		(182,343		)		(18,870		)		(188,788		)
Balance at end of period	(2,401,037		)		(2,266,529		)		(2,401,037		)		(2,266,529		)
Total shareholders’ equity available to Arch	10,757,352				9,163,755				10,757,352				9,163,755
Non-redeemable noncontrolling interests	855,347				861,153				855,347				861,153
Total shareholders’ equity	$	11,612,699			$	10,024,908			$	11,612,699			$	10,024,908

See Notes to Consolidated Financial Statements

ARCH CAPITAL	9	2019 SECOND QUARTER FORM 10-Q

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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (U.S. dollars in thousands)
	(Unaudited)
	Six Months Ended
	June 30,
	2019				2018
Operating Activities
Net income	$	981,343			$	422,731
Adjustments to reconcile net income to net cash provided by operating activities:
Net realized (gains) losses	(264,293		)		177,442
Net impairment losses recognized in earnings	1,358				632
Equity in net income or loss of investment funds accounted for using the equity method and other income or loss	(45,720		)		(13,543		)
Amortization of intangible assets	40,211				53,208
Share-based compensation	41,537				35,419
Changes in:
Reserve for losses and loss adjustment expenses, net of unpaid losses and loss adjustment expenses recoverable	154,396				(77,891		)
Unearned premiums, net of ceded unearned premiums	137,564				139,778
Premiums receivable	(302,050		)		(236,950		)
Deferred acquisition costs	(24,790		)		(35,111		)
Reinsurance balances payable	139,415				88,961
Other items, net	(146,447		)		(57,790		)
Net cash provided by (used for) operating activities	712,524				496,886
Investing Activities
Purchases of fixed maturity investments	(16,332,646		)		(16,867,570		)
Purchases of equity securities	(431,939		)		(679,663		)
Purchases of other investments	(677,063		)		(1,017,147		)
Proceeds from sales of fixed maturity investments	15,632,482				16,090,543
Proceeds from sales of equity securities	176,701				622,068
Proceeds from sales, redemptions and maturities of other investments	534,698				773,298
Proceeds from redemptions and maturities of fixed maturity investments	244,949				511,448
Net settlements of derivative instruments	87,701				4,498
Net sales of short-term investments	201,520				451,901
Change in cash collateral related to securities lending	7,590				176,304
Purchases of fixed assets	(16,359		)		(13,242		)
Other	(174,578		)		49,961
Net cash provided by (used for) investing activities	(746,944		)		102,399
Financing Activities
Redemption of preferred shares	—				(92,555		)
Purchases of common shares under share repurchase program	(2,871		)		(173,575		)
Proceeds from common shares issued, net	(557		)		(13,851		)
Proceeds from borrowings	62,800				130,579
Repayments of borrowings	(27,538		)		(373,000		)
Change in cash collateral related to securities lending	(7,590		)		(176,304		)
Dividends paid to redeemable noncontrolling interests	(8,994		)		(8,994		)
Other	(3,529		)		(4,489		)
Preferred dividends paid	(20,806		)		(20,840		)
Net cash provided by (used for) financing activities	(9,085		)		(733,029		)
Effects of exchange rate changes on foreign currency cash and restricted cash	1,937				(10,431		)
Increase (decrease) in cash and restricted cash	(41,568		)		(144,175		)
Cash and restricted cash, beginning of year	724,643				727,284
Cash and restricted cash, end of period	$	683,075			$	583,109

See Notes to Consolidated Financial Statements

ARCH CAPITAL	10	2019 SECOND QUARTER FORM 10-Q

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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

1.    Basis of Presentation and Recent Accounting Pronouncements

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General

Arch Capital Group Ltd. (“Arch Capital”) is a Bermuda public limited liability company which provides insurance, reinsurance and mortgage insurance on a worldwide basis through its wholly-owned subsidiaries. As used herein, the “Company” means Arch Capital and its subsidiaries. The Company’s consolidated financial statements include the results of Watford Holdings Ltd. and its wholly owned subsidiaries. See note 11.

On January 1, 2019, the Company’s U.K. insurance operations entered into a transaction with The Ardonagh Group to acquire renewal rights for a U.K. commercial lines book of business, consisting of commercial property, casualty, motor, professional liability, personal accident and travel business.

Basis of Presentation

The interim consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”). All significant intercompany transactions and balances have been eliminated in consolidation. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from those estimates and assumptions. In the opinion of management, the accompanying unaudited interim consolidated financial statements reflect all adjustments (consisting of normally recurring accruals) necessary for a fair statement of results on an interim basis. The results of any interim period are not necessarily indicative of the results for a full year or any future periods.

Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted; however, management believes that the disclosures are adequate to make the information presented not misleading. This report should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2018 (“2018 Form 10-K”), including the Company’s audited consolidated financial statements and related notes.

The Company has reclassified the presentation of certain prior year information to conform to the current presentation. Such reclassifications had no effect on the Company’s net income, comprehensive income, shareholders’ equity or cash flows.

 

Tabular amounts are in U.S. Dollars in thousands, except share amounts, unless otherwise noted.

Recent Accounting Pronouncements

Recently Issued Accounting Standards Adopted

The Company adopted ASU 2016-02, “Leases (Topic 842)”, which provides a new comprehensive model for lease accounting. Topic 842 requires a lessee to recognize a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. The Company adopted the modified retrospective approach of this standard, that resulted in the recognition of a right-of-use asset of  $147.9 million as part of other assets and a lease liability of $163.6 million as part of other liabilities in the consolidated balance sheet as of January 1, 2019. The Company de-recognized the liability for deferred rent that was required under the previous guidance.

In addition, the Company adopted ASU 2018-11, “Leases: Targeted Improvements (Topic 842),” which provides an additional (optional) transition method to adopt the new lease standard. The Company adopted the alternative transition method and elected to utilize a cumulative-effect adjustment to the opening balance of the retained earnings for the year of adoption. As such, the Company’s reporting for the comparative periods prior to the adoption continue to be presented in the financial statements in accordance with previous lease accounting guidance. The Company also adopted the practical expedients as a package which allows the Company to not reassess (1) whether any expired or existing contracts are or contain leases (2) the lease classification for any expired or existing leases (3) initial direct costs for any existing leases and (4) to account for the lease and non lease components as a single lease component. In addition to electing the practical expedients as a package, the Company elected to include hindsight to determine the lease term of existing leases, and made an accounting policy election to not apply the recognition requirements to short-term leases (lease term of less than twelve months). The cumulative effect adjustment to the opening balance of retained earnings was zero. The adoption of the updated guidance did not have a material effect on the Company’s results of operations or liquidity.

The Company adopted ASU 2018-07 “Improvements to Nonemployee Share-Based Payment Accounting,” which was issued in June 2018 to simplify the accounting for share-based payments granted to nonemployees for goods and services. Under this ASU, most of the guidance on such payments to nonemployees would be aligned with the requirements for share-based payments granted to employees. The ASU is effective for reporting periods beginning after December 15, 2018. This guidance and the adoption of this provision did not have a material effect on the Company's financial position, results of operations or cash flows.

ARCH CAPITAL	11	2019 SECOND QUARTER FORM 10-Q

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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The Company adopted ASU 2018-02 “Income Statement-Reporting Comprehensive Income (Topic 220) - Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income,” which was issued in February 2018 to allow the reclassification of the stranded tax effects in accumulated other comprehensive income (“AOCI”) resulting from the Tax Cuts and Jobs Act of 2017 (“Tax Cuts Act”). Current guidance requires the effect of a change in tax laws or rates on deferred tax balances to be reported in income from continuing operations in the accounting period that includes the period of enactment, even if the related income tax effects were originally charged or credited directly to AOCI. The amount of the reclassification would include the effect of the change in the U.S. federal corporate income tax rate on the gross deferred tax amounts and related valuation allowances, if any, at the date of the enactment of the Tax Cuts Act related to items in AOCI. The updated guidance is effective for reporting periods beginning after December 15, 2018 and is to be applied retrospectively to each period in which the effect of the Tax Cuts Act related to items remaining in AOCI are recognized or at the beginning of the period of adoption. The adoption of this ASU did not have a material effect on the Company’s results of operations, financial position or liquidity.

The Company adopted ASU 2017-08 “Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20), Premium Amortization on Purchased Callable Debt Securities,” which was issued in March, 2017. This ASU shortens the amortization period for certain callable debt securities held at a premium and requires the premium to be amortized to the earliest call date. However, the new guidance does not require an accounting change for securities held at a discount whose discount continues to be amortized to maturity. The standard is effective for financial statements issued for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018, with early adoption permitted. The adoption of the guidance requires a modified retrospective approach with a cumulative-effect adjustment to retained earnings. The adoption of this ASU did not have a material effect on the Company’s consolidated financial statements.

Recently Issued Accounting Standards Not Yet Adopted

For information regarding additional accounting standards that the Company has not yet adopted, see note 3(q), “Significant Accounting Policies—Recent Accounting Pronouncements,” of the notes to consolidated financial statements in the Company’s 2018 Form 10-K.

2.    Share Transactions

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Share Repurchases 

The board of directors of Arch Capital has authorized the investment in Arch Capital’s common shares through a share

 

repurchase program. Since the inception of the share repurchase program, Arch Capital has repurchased 386.3 million common shares for an aggregate purchase price of $3.97 billion. For the six months ended June 30, 2019, Arch Capital repurchased 0.1 million shares under the share repurchase program with an aggregate purchase price of $2.9 million. Arch Capital repurchased 6.5 million shares under the share repurchase program with an aggregate purchase price of $173.6 million during the six months ended June 30, 2018. At June 30, 2019, $160.9 million of share repurchases were available under the program, which may be effected from time to time in open market or privately negotiated transactions through December 31, 2019. 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.

Conversion of Convertible Non-Voting Common Equivalent Preferred Shares  

In March 2018, Arch Capital completed an underwritten public secondary offering of 17.0 million common shares (split adjusted) by American International Group, Inc. (“AIG”) following transfer of 0.6 million Series D convertible non-voting common equivalent preferred shares (“Series D Preferred Shares”). Proceeds from the sale of common shares pursuant to the public offering were received by AIG. At June 30, 2019, no Series D Preferred Shares were outstanding.

Series C Preferred Shares

On January 2, 2018, Arch Capital redeemed all outstanding 6.75% Series C non-cumulative preferred shares. The preferred shares were redeemed at a redemption price equal to $25 per share, plus all declared and unpaid dividends to (but excluding) the redemption date. In accordance with GAAP, following the redemption, original issuance costs related to such shares were removed from additional paid-in capital and recorded as a “loss on redemption of preferred shares.” Such adjustment had no impact on total shareholders’ equity or cash flows.

ARCH CAPITAL	12	2019 SECOND QUARTER FORM 10-Q

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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

3.    Earnings Per Common Share

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The following table sets forth the computation of basic and diluted earnings per common share:

	Three Months Ended								Six Months Ended
	June 30,								June 30,
	2019				2018				2019				2018
Numerator:
Net income	$	485,845			$	256,347			$	981,343			$	422,731
Amounts attributable to noncontrolling interests	(16,891		)		(12,701		)		(63,861		)		(28,662		)
Net income available to Arch	468,954				243,646				917,482				394,069
Preferred dividends	(10,403		)		(10,403		)		(20,806		)		(20,840		)
Loss on redemption of preferred shares	—				—				—				(2,710		)
Net income available to Arch common shareholders	$	458,551			$	233,243			$	896,676			$	370,519
Denominator:
Weighted average common shares outstanding	401,482,784				404,800,421				400,837,181				399,485,135
Series D preferred shares (1)	—				—				—				6,677,373
Weighted average common shares and common share equivalents outstanding — basic	401,482,784				404,800,421				400,837,181				406,162,508
Effect of dilutive common share equivalents:
Nonvested restricted shares	1,937,626				1,575,749				1,720,417				1,837,356
Stock options (2)	7,479,073				6,735,035				7,197,652				7,460,892
Weighted average common shares and common share equivalents outstanding — diluted	410,899,483				413,111,205				409,755,250				415,460,756
Earnings per common share:
Basic	$	1.14			$	0.58			$	2.24			$	0.91
Diluted	$	1.12			$	0.56			$	2.19			$	0.89

(1)	Such shares are convertible non-voting common equivalent preferred shares issued in connection with the UGC acquisition. See note 2.

(2)

Certain stock options were not included in the computation of diluted earnings per share where the exercise price of the stock options exceeded the average market price and would have been anti-dilutive or where, when applying the treasury stock method to in-the-money options, the sum of the proceeds, including unrecognized compensation, exceeded the average market price and would have been anti-dilutive. For the 2019 second quarter and 2018 second quarter, the number of stock options excluded were 2,016,830 and 5,350,733, respectively. For the six months ended June 30, 2019 and 2018 period, the number of stock options excluded were 2,560,755 and 5,372,789, respectively.

ARCH CAPITAL	13	2019 SECOND QUARTER FORM 10-Q

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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

4.    Segment Information

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The Company classifies its businesses into three underwriting segments — insurance, reinsurance and mortgage — and two other operating segments — ‘other’ and corporate (non-underwriting). The Company determined its 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 the Company’s consolidated financial statements. Intersegment business is allocated to the segment accountable for the underwriting results.

The Company’s 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 the Company’s chief operating decision makers, the President and Chief Executive Officer of Arch Capital, and the Chief Financial Officer of Arch 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 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 is not allocated to each underwriting segment.

The insurance segment consists of the Company’s insurance underwriting units which offer specialty product lines on a worldwide basis. Product lines include: construction and national accounts; excess and surplus casualty; lenders products; professional lines; programs; property, energy, marine and aviation; travel, accident and health; and other (consisting of alternative markets, excess workers' compensation and surety business).

The reinsurance segment consists of the Company’s reinsurance underwriting units which offer specialty product lines on a worldwide basis. Product lines include: casualty; marine and aviation; other specialty; property catastrophe; property excluding property catastrophe (losses on a single risk, both excess of loss and pro rata); and other (consisting of life reinsurance, casualty clash and other).

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 and United Guaranty Residential Insurance Company (combined “Arch MI U.S.”) are approved as eligible mortgage insurers by Federal National Mortgage Association (“Fannie Mae”) and Federal Home Loan Mortgage Corporation (“Freddie Mac”), each a GSE.

The corporate (non-underwriting) segment results include net investment income, other income (loss), corporate expenses, transaction costs and other, interest expense, items related to the Company’s non-cumulative preferred shares, 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 and income taxes. Such amounts exclude the results of the ‘other’ segment.

The ‘other’ segment includes the results of Watford Holdings Ltd. Watford Holdings Ltd. is the parent of Watford Re Ltd., a multi-line Bermuda reinsurance company (together with Watford Holdings Ltd., “Watford Re”) (see note 11). 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.

ARCH CAPITAL	14	2019 SECOND QUARTER FORM 10-Q

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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following tables summarize the Company’s underwriting income or loss by segment, together with a reconciliation of underwriting income or loss to net income available to Arch common shareholders:

	Three Months Ended
	June 30, 2019
	Insurance				Reinsurance				Mortgage				Sub-Total				Other				Total
Gross premiums written (1)	$	919,925			$	545,547			$	364,465			$	1,829,829			$	161,978			$	1,937,809
Premiums ceded	(292,095		)		(169,457		)		(42,857		)		(504,301		)		(42,608		)		(492,911		)
Net premiums written	627,830				376,090				321,608				1,325,528				119,370				1,444,898
Change in unearned premiums	(35,388		)		(8,906		)		31,175				(13,119		)		31,948				18,829
Net premiums earned	592,442				367,184				352,783				1,312,409				151,318				1,463,727
Other underwriting income (loss)	—				1,224				4,056				5,280				673				5,953
Losses and loss adjustment expenses	(389,172		)		(240,958		)		(25,997		)		(656,127		)		(111,416		)		(767,543		)
Acquisition expenses	(91,094		)		(56,785		)		(32,654		)		(180,533		)		(29,556		)		(210,089		)
Other operating expenses	(109,523		)		(33,960		)		(39,819		)		(183,302		)		(15,612		)		(198,914		)
Underwriting income (loss)	$	2,653			$	36,705			$	258,369			297,727				(4,593		)		293,134
Net investment income													123,038				32,000				155,038
Net realized gains (losses)													125,112				(4,306		)		120,806
Net impairment losses recognized in earnings													(49		)		—				(49		)
Equity in net income (loss) of investment funds accounted for using the equity method													32,536				—				32,536
Other income (loss)													1,129				—				1,129
Corporate expenses (2)													(16,073		)		—				(16,073		)
Transaction costs and other (2)													(2,178		)		—				(2,178		)
Amortization of intangible assets													(19,794		)		—				(19,794		)
Interest expense													(23,375		)		(5,905		)		(29,280		)
Net foreign exchange gains (losses)													(6,190		)		1,238				(4,952		)
Income before income taxes													511,883				18,434				530,317
Income tax expense													(44,452		)		(20		)		(44,472		)
Net income													467,431				18,414				485,845
Dividends attributable to redeemable noncontrolling interests													—				(4,590		)		(4,590		)
Amounts attributable to nonredeemable noncontrolling interests													—				(12,301		)		(12,301		)
Net income available to Arch													467,431				1,523				468,954
Preferred dividends													(10,403		)		—				(10,403		)
Net income available to Arch common shareholders													$	457,028			$	1,523			$	458,551
Underwriting Ratios
Loss ratio	65.7		%		65.6		%		7.4		%		50.0		%		73.6		%		52.4		%
Acquisition expense ratio	15.4		%		15.5		%		9.3		%		13.8		%		19.5		%		14.4		%
Other operating expense ratio	18.5		%		9.2		%		11.3		%		14.0		%		10.3		%		13.6		%
Combined ratio	99.6		%		90.3		%		28.0		%		77.8		%		103.4		%		80.4		%
Goodwill and intangible assets	$	157,440			$	—			$	475,920			$	633,360			$	7,650			$	641,010

(1)	Certain amounts included in the gross premiums written of each segment are related to intersegment transactions. Accordingly, the sum of gross premiums written for each segment does not agree to the total gross premiums written as shown in the table above due to the elimination of intersegment transactions in the total.

(2)	Certain expenses have been excluded from ‘corporate expenses’ and reflected in ‘transaction costs and other.’

ARCH CAPITAL	15	2019 SECOND QUARTER FORM 10-Q

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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

	Three Months Ended
	June 30, 2018
	Insurance				Reinsurance				Mortgage				Sub-Total				Other				Total
Gross premiums written (1)	$	769,372			$	490,327			$	330,990			$	1,591,202			$	175,175			$	1,696,544
Premiums ceded	(245,265		)		(136,247		)		(50,867		)		(432,892		)		(34,589		)		(397,648		)
Net premiums written	524,107				354,080				280,123				1,158,310				140,586				1,298,896
Change in unearned premiums	22,342				(13,762		)		10,355				18,935				18,932				37,867
Net premiums earned	546,449				340,318				290,478				1,177,245				159,518				1,336,763
Other underwriting income (loss)	—				(129		)		3,315				3,186				688				3,874
Losses and loss adjustment expenses	(357,465		)		(229,956		)		(21,591		)		(609,012		)		(117,141		)		(726,153		)
Acquisition expenses	(90,670		)		(50,142		)		(27,737		)		(168,549		)		(34,289		)		(202,838		)
Other operating expenses	(92,680		)		(35,678		)		(38,729		)		(167,087		)		(9,094		)		(176,181		)
Underwriting income (loss)	$	5,634			$	24,413			$	205,736			235,783				(318		)		235,465
Net investment income													107,761				27,907				135,668
Net realized gains (losses)													(59,545		)		(17,066		)		(76,611		)
Net impairment losses recognized in earnings													(470		)		—				(470		)
Equity in net income (loss) of investment funds accounted for using the equity method													8,472				—				8,472
Other income (loss)													3,113				—				3,113
Corporate expenses (2)													(15,604		)		—				(15,604		)
Transaction costs and other (2)													(6,908		)		—				(6,908		)
Amortization of intangible assets													(26,472		)		—				(26,472		)
Interest expense													(26,058		)		(4,286		)		(30,344		)
Net foreign exchange gains (losses)													46,211				7,495				53,706
Income before income taxes													266,283				13,732				280,015
Income tax expense													(23,644		)		(24		)		(23,668		)
Net income													242,639				13,708				256,347
Dividends attributable to redeemable noncontrolling interests													—				(4,585		)		(4,585		)
Amounts attributable to nonredeemable noncontrolling interests													—				(8,116		)		(8,116		)
Net income available to Arch													242,639				1,007				243,646
Preferred dividends													(10,403		)		—				(10,403		)
Net income available to Arch common shareholders													$	232,236			$	1,007			$	233,243
Underwriting Ratios
Loss ratio	65.4		%		67.6		%		7.4		%		51.7		%		73.4		%		54.3		%
Acquisition expense ratio	16.6		%		14.7		%		9.5		%		14.3		%		21.5		%		15.2		%
Other operating expense ratio	17.0		%		10.5		%		13.3		%		14.2		%		5.7		%		13.2		%
Combined ratio	99.0		%		92.8		%		30.2		%		80.2		%		100.6		%		82.7		%
Goodwill and intangible assets	$	20,724			$	—			$	564,634			$	585,358			$	7,650			$	593,008

(1)	Certain amounts included in the gross premiums written of each segment are related to intersegment transactions. Accordingly, the sum of gross premiums written for each segment does not agree to the total gross premiums written as shown in the table above due to the elimination of intersegment transactions in the total.

(2)	Certain expenses have been excluded from ‘corporate expenses’ and reflected in ‘transaction costs and other.’

The following tables summarize the Company’s underwriting income or loss by segment, together with a reconciliation of underwriting income or loss to net income available to Arch common shareholders:

ARCH CAPITAL	16	2019 SECOND QUARTER FORM 10-Q

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Table of Contents

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

	Six Months Ended
	June 30, 2019
	Insurance				Reinsurance				Mortgage				Sub-Total				Other				Total
Gross premiums written (1)	$	1,861,879			$	1,228,402			$	720,515			$	3,810,282			$	348,667			$	4,015,688
Premiums ceded	(612,717		)		(401,024		)		(91,655		)		(1,104,882		)		(83,910		)		(1,045,531		)
Net premiums written	1,249,162				827,378				628,860				2,705,400				264,757				2,970,157
Change in unearned premiums	(103,215		)		(113,829		)		46,825				(170,219		)		32,655				(137,564		)
Net premiums earned	1,145,947				713,549				675,685				2,535,181				297,412				2,832,593
Other underwriting income (loss)	—				5,601				7,912				13,513				1,265				14,778
Losses and loss adjustment expenses	(745,895		)		(480,768		)		(37,146		)		(1,263,809		)		(222,266		)		(1,486,075		)
Acquisition expenses	(173,918		)		(111,111		)		(64,326		)		(349,355		)		(58,582		)		(407,937		)
Other operating expenses	(222,919		)		(69,664		)		(79,694		)		(372,277		)		(27,800		)		(400,077		)
Underwriting income (loss)	$	3,215			$	57,607			$	502,431			563,253				(9,971		)		553,282
Net investment income													244,287				67,700				311,987
Net realized gains (losses)													237,545				24,826				262,371
Net impairment losses recognized in earnings													(1,358		)		—				(1,358		)
Equity in net income (loss) of investment funds accounted for using the equity method													79,403				—				79,403
Other income (loss)													2,212				—				2,212
Corporate expenses (2)													(32,845		)		—				(32,845		)
Transaction costs and other (2)													(3,368		)		—				(3,368		)
Amortization of intangible assets													(40,211		)		—				(40,211		)
Interest expense													(46,857		)		(11,488		)		(58,345		)
Net foreign exchange gains (losses)													(1,015		)		(412		)		(1,427		)
Income before income taxes													1,001,046				70,655				1,071,701
Income tax expense													(90,338		)		(20		)		(90,358		)
Net income													910,708				70,635				981,343
Dividends attributable to redeemable noncontrolling interests													—				(9,178		)		(9,178		)
Amounts attributable to nonredeemable noncontrolling interests													—				(54,683		)		(54,683		)
Net income available to Arch													910,708				6,774				917,482
Preferred dividends													(20,806		)		—				(20,806		)
Net income available to Arch common shareholders													$	889,902			$	6,774			$	896,676
Underwriting Ratios
Loss ratio	65.1		%		67.4		%		5.5		%		49.9		%		74.7		%		52.5		%
Acquisition expense ratio	15.2		%		15.6		%		9.5		%		13.8		%		19.7		%		14.4		%
Other operating expense ratio	19.5		%		9.8		%		11.8		%		14.7		%		9.3		%		14.1		%
Combined ratio	99.8		%		92.8		%		26.8		%		78.4		%		103.7		%		81.0		%

(1)	Certain amounts included in the gross premiums written of each segment are related to intersegment transactions. Accordingly, the sum of gross premiums written for each segment does not agree to the total gross premiums written as shown in the table above due to the elimination of intersegment transactions in the total.

(2)	Certain expenses have been excluded from ‘corporate expenses’ and reflected in ‘transaction costs and other.’

ARCH CAPITAL	17	2019 SECOND QUARTER FORM 10-Q

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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

	Six Months Ended
	June 30, 2018
	Insurance				Reinsurance				Mortgage				Sub-Total				Other				Total
Gross premiums written (1)	$	1,592,750			$	1,067,810			$	652,168			$	3,312,807			$	389,045			$	3,534,758
Premiums ceded	(492,445		)		(331,977		)		(97,004		)		(921,505		)		(68,907		)		(823,318		)
Net premiums written	1,100,305				735,833				555,164				2,391,302				320,138				2,711,440
Change in unearned premiums	(15,119		)		(116,343		)		15,556				(115,906		)		(23,872		)		(139,778		)
Net premiums earned	1,085,186				619,490				570,720				2,275,396				296,266				2,571,662
Other underwriting income (loss)	—				1,103				6,731				7,834				1,389				9,223
Losses and loss adjustment expenses	(711,195		)		(371,631		)		(65,057		)		(1,147,883		)		(215,130		)		(1,363,013		)
Acquisition expenses	(175,839		)		(98,461		)		(54,304		)		(328,604		)		(65,610		)		(394,214		)
Other operating expenses	(184,654		)		(71,249		)		(77,500		)		(333,403		)		(17,793		)		(351,196		)
Underwriting income (loss)	$	13,498			$	79,252			$	380,590			473,340				(878		)		472,462
Net investment income													208,004				54,388				262,392
Net realized gains (losses)													(171,404		)		(16,205		)		(187,609		)
Net impairment losses recognized in earnings													(632		)		—				(632		)
Equity in net income (loss) of investment funds accounted for using the equity method													36,541				—				36,541
Other income (loss)													3,187				—				3,187
Corporate expenses (2)													(30,086		)		—				(30,086		)
Transaction costs and other (2)													(7,738		)		—				(7,738		)
Amortization of intangible assets													(53,208		)		—				(53,208		)
Interest expense													(51,965		)		(9,015		)		(60,980		)
Net foreign exchange gains (losses)													31,172				2,813				33,985
Income before income taxes													437,211				31,103				468,314
Income tax expense													(45,556		)		(27		)		(45,583		)
Net income													391,655				31,076				422,731
Dividends attributable to redeemable noncontrolling interests													—				(9,170		)		(9,170		)
Amounts attributable to nonredeemable noncontrolling interests													—				(19,492		)		(19,492		)
Net income available to Arch													391,655				2,414				394,069
Preferred dividends													(20,840		)		—				(20,840		)
Loss on redemption of preferred shares													(2,710		)		—				(2,710		)
Net income available to Arch common shareholders													$	368,105			$	2,414			$	370,519
Underwriting Ratios
Loss ratio	65.5		%		60.0		%		11.4		%		50.4		%		72.6		%		53.0		%
Acquisition expense ratio	16.2		%		15.9		%		9.5		%		14.4		%		22.1		%		15.3		%
Other operating expense ratio	17.0		%		11.5		%		13.6		%		14.7		%		6.0		%		13.7		%
Combined ratio	98.7		%		87.4		%		34.5		%		79.5		%		100.7		%		82.0		%

(1)	Certain amounts included in the gross premiums written of each segment are related to intersegment transactions. Accordingly, the sum of gross premiums written for each segment does not agree to the total gross premiums written as shown in the table above due to the elimination of intersegment transactions in the total.

(2)	Certain expenses have been excluded from ‘corporate expenses’ and reflected in ‘transaction costs and other.’

ARCH CAPITAL	18	2019 SECOND QUARTER FORM 10-Q

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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

5.    Reserve for Losses and Loss Adjustment Expenses

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The following table represents an analysis of losses and loss adjustment expenses and a reconciliation of the beginning and ending reserve for losses and loss adjustment expenses:

	Three Months Ended								Six Months Ended
	June 30,								June 30,
	2019				2018				2019				2018
Reserve for losses and loss adjustment expenses at beginning of period	$	12,010,041			$	11,496,205			$	11,853,297			$	11,383,792
Unpaid losses and loss adjustment expenses recoverable	2,970,159				2,446,990				2,814,291				2,464,910
Net reserve for losses and loss adjustment expenses at beginning of period	9,039,882				9,049,215				9,039,006				8,918,882
Net incurred losses and loss adjustment expenses relating to losses occurring in:
Current year	805,728				790,742				1,563,692				1,478,627
Prior years	(38,185		)		(64,589		)		(77,617		)		(115,614		)
Total net incurred losses and loss adjustment expenses	767,543				726,153				1,486,075				1,363,013
Retroactive reinsurance transactions (1)	—				(420,404		)		(225,500		)		(420,404		)
Net foreign exchange (gains) losses	(1,277		)		(120,292		)		(1,781		)		(76,278		)
Net paid losses and loss adjustment expenses relating to losses occurring in:
Current year	(61,148		)		(59,022		)		(125,488		)		(95,022		)
Prior years	(539,481		)		(403,062		)		(966,793		)		(917,603		)
Total net paid losses and loss adjustment expenses	(600,629		)		(462,084		)		(1,092,281		)		(1,012,625		)
Net reserve for losses and loss adjustment expenses at end of period	9,205,519				8,772,588				9,205,519				8,772,588
Unpaid losses and loss adjustment expenses recoverable	3,024,797				2,651,749				3,024,797				2,651,749
Reserve for losses and loss adjustment expenses at end of period	$	12,230,316			$	11,424,337			$	12,230,316			$	11,424,337

(1)	During the 2019 first quarter and 2018 second quarter, a subsidiary of the Company entered into two separate retroactive reinsurance transactions with third party reinsurers to reinsure run-off liabilities associated with certain U.S. exposures.

Development on Prior Year Loss Reserves

2019 Second Quarter

During the 2019 second quarter, the Company recorded net favorable development on prior year loss reserves of $38.2 million, which consisted of $2.6 million of favorable development from the insurance segment, $12.7 million from the reinsurance segment, $22.8 million from the mortgage segment and $0.1 million from the ‘other’ segment.

The insurance segment’s net favorable development of $2.6 million, or 0.4 loss ratio points, for the 2019 second quarter consisted of $8.0 million of net favorable development in short-tailed lines, $10.4 million of net adverse development in medium-tailed lines and $4.9 million of net favorable development in long-tailed lines. Net favorable development in short-tailed lines primarily resulted from property (including special risk other than marine) reserves across all accident years (i.e., the year in which a loss occurred). Net adverse development in medium-tailed lines primarily resulted from $15.5 million of adverse development on program business. Such amounts were partially offset by $5.1 million of net favorable development in other medium-tailed lines, including

 

surety business and professional liability, across most accident years. Net favorable development in long-tailed lines primarily resulted from reductions in executive assurance reserves of $5.1 million, primarily from the 2008 to 2014 accident years.

The reinsurance segment’s net favorable development of $12.7 million, or 3.5 loss ratio points, for the 2019 second quarter consisted of $1.8 million of net favorable development from short-tailed lines and $10.9 million of net favorable development from long-tailed and medium-tailed lines. Net favorable development in short-tailed lines primarily resulted from other specialty lines across most underwriting years (i.e., all premiums and losses attributable to contracts having an inception or renewal date within the given twelve-month period) and in property other than property catastrophe reserves from earlier underwriting years, partially offset by a small amount of adverse development from property catastrophe and property other than property catastrophe reserves in the 2015 and 2018 underwriting years. Favorable development in long-tailed and medium-tailed lines reflected reductions in casualty and marine reserves from most underwriting years.

The mortgage segment’s net favorable development was $22.8 million, or 6.5 loss ratio points, for the 2019 second quarter. The 2019 second quarter development was primarily driven by

ARCH CAPITAL	19	2019 SECOND QUARTER FORM 10-Q

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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

continued favorable claim rates on first lien business and subrogation recoveries on second lien business.

2018 Second Quarter

During the 2018 second quarter, the Company recorded net favorable development on prior year loss reserves of $64.6 million, which consisted of $6.1 million from the insurance segment, $33.0 million from the reinsurance segment, $23.3 million from the mortgage segment and adverse development of $2.2 million from the ‘other’ segment.

The insurance segment’s net favorable development of $6.1 million, or 1.1 loss ratio points, for the 2018 second quarter consisted of $13.9 million of net favorable development in short-tailed lines and $14.3 million of net favorable development in long-tailed lines, partially offset by $22.1 million of net adverse development in medium-tailed lines. Net favorable development in short-tailed lines primarily resulted from property (including special risk other than marine) reserves from the 2010 to 2017 accident years while net favorable development in long-tailed lines primarily resulted from reductions in executive assurance reserves of $6.9 million, primarily from the 2007 to 2011 accident years, and in healthcare reserves of $4.9 million, primarily from the 2003 accident year. Net adverse development in medium-tailed lines reflected $11.6 million of adverse development in program business, primarily driven by a few inactive programs that were non-renewed in 2015 and early in 2016 and $18.0 million of adverse development on contract binding business, primarily from the 2014 to 2016 accident years. Such amounts were partially offset by $7.6 million of net favorable development in other medium-tailed lines, including professional liability and surety business, across most accident years.

The reinsurance segment’s net favorable development of $33.0 million, or 9.7 loss ratio points, for the 2018 second quarter consisted of $22.2 million from short-tailed lines and $10.8 million from long-tailed and medium-tailed lines. Favorable development in short-tailed lines included $19.3 million from property catastrophe and property other than property catastrophe reserves, across most underwriting years, reflecting lower levels of reported and paid claims activity than previously anticipated which led to decreases in certain loss ratio selections during the period. Favorable development in long-tailed and medium-tailed lines reflected reductions in marine reserves of $3.8 million, across most accident years, and in casualty reserves of $6.9 million based on varying levels of reported and paid claims activity, primarily from the 2003 to 2010 underwriting years.

The mortgage segment’s net favorable development was $23.3 million, or 8.0 loss ratio points, for the 2018 second quarter. The 2018 second quarter development was primarily driven by continued lower than expected claim rates on first lien business and subrogation recoveries on second lien business.

 

Six Months Ended June 30, 2019

During the six months ended June 30, 2019, the Company recorded net favorable development on prior year loss reserves of $77.6 million, which consisted of $7.0 million from the insurance segment, $11.0 million from the reinsurance segment, $59.4 million from the mortgage segment and $0.1 million from the ‘other’ segment.

The insurance segment’s net favorable development of $7.0 million, or 0.6 loss ratio points, for the 2019 period consisted of $17.7 million of net favorable development in short-tailed lines and $6.6 million of net favorable development in long-tailed lines, partially offset by $17.3 million of net adverse development in medium-tailed lines. Net favorable development in short-tailed lines primarily resulted from property (including special risk other than marine) reserves from the 2010 to 2018 accident years. Net favorable development in long-tailed lines reflected net reductions in executive assurance reserves of $5.7 million, primarily from the 2013 and 2015 accident years. Net adverse development in medium-tailed lines reflected $23.2 million of adverse development in program business, primarily from the 2018 accident year, and $9.7 million of adverse development on contract binding business, across most accident years. Such amounts were partially offset by $15.6 million of net favorable development in other medium-tailed lines, including professional liability, marine and surety business, across most accident years.

The reinsurance segment’s net favorable development of $11.0 million, or 1.5 loss ratio points, for the 2019 period consisted of $4.3 million of net adverse development from short-tailed lines, offset by $15.3 million of net favorable development from long-tailed and medium-tailed lines. Net adverse development in short-tailed lines reflected $17.9 million from property catastrophe and property other than property catastrophe reserves, reflecting an increase in reserves on Typhoon Jebi in the 2019 first quarter of $16.0 million following receipt of updated information from cedents and additional updated industry data. Such amounts were partially offset by $10.2 million of favorable development on other specialty lines, primarily from the 2016 to 2018 underwriting years. Favorable development in long-tailed and medium-tailed lines reflected reductions in casualty reserves of $9.1 million based on varying levels of reported and paid claims activity, primarily from the 2002 to 2007 underwriting years, and favorable development in marine reserves of $6.2 million, primarily from the 2015 to 2018 underwriting years.

The mortgage segment’s net favorable development was $59.4 million, or 8.8 loss ratio points, for the 2019 period. The 2019 development was primarily driven by continued lower than expected claim rates on first lien business and subrogation recoveries on second lien business.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Six Months Ended June 30, 2018

During the six months ended June 30, 2018, the Company recorded net favorable development on prior year loss reserves of $115.6 million, which consisted of $8.2 million from the insurance segment, $69.6 million from the reinsurance segment, $36.3 million from the mortgage segment and $1.6 million from the ‘other’ segment.

The insurance segment’s net favorable development of $8.2 million, or 0.8 loss ratio points, for the 2018 period consisted of $22.7 million of net favorable development in short-tailed lines and $17.2 million of net favorable development in long-tailed lines, partially offset by $31.7 million of net adverse development in medium-tailed lines. Net favorable development in short-tailed lines primarily resulted from property (including special risk other than marine) reserves from the 2010 and 2017 accident years. Net favorable development in long-tailed lines reflected net reductions in executive assurance reserves of $7.5 million, primarily from the 2008 to 2015 accident years, and in healthcare reserves of $7.0 million, primarily from the 2003 accident year. Net adverse development in medium-tailed lines reflected $21.9 million of adverse development in program business, primarily driven by a few inactive programs that were non-renewed in 2015 and early in 2016 and $25.6 million of adverse development on contract binding business, primarily from the 2014 to 2016 accident years. Such amounts were partially offset by $15.8 million of net favorable development in other medium-tailed lines, including professional liability and surety business, across most accident years.

 

The reinsurance segment’s net favorable development of $69.6 million, or 11.2 loss ratio points, for the 2018 period consisted of $51.1 million from short-tailed lines and $18.5 million from long-tailed and medium-tailed lines. Favorable development in short-tailed lines included $40.4 million from property catastrophe and property other than property catastrophe reserves, across most underwriting years, reflecting lower levels of reported and paid claims activity than previously anticipated which led to decreases in certain loss ratio selections during the period. Favorable development in long-tailed and medium-tailed lines reflected reductions in casualty reserves of $8.1 million based on varying levels of reported and paid claims activity, primarily from the 2002 to 2010 underwriting years, and favorable development in marine reserves of $10.0 million across most underwriting years.

The mortgage segment’s net favorable development was $36.3 million, or 6.4 loss ratio points, for the 2018 period. The 2018 development was primarily driven by continued lower than expected claim rates on first lien business and subrogation recoveries on second lien business.

ARCH CAPITAL	21	2019 SECOND QUARTER FORM 10-Q

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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

6.    Investment Information

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At June 30, 2019, total investable assets of $23.55 billion included $20.78 billion held by the Company and $2.77 billion attributable to Watford Re.

Available For Sale Investments

The following table summarizes the fair value and cost or amortized cost of the Company’s securities classified as available for sale:

	Estimated Fair Value				Gross Unrealized Gains				Gross Unrealized Losses				Cost or Amortized Cost				OTTI Unrealized Losses (2)
June 30, 2019
Fixed maturities (1):
Corporate bonds	$	6,044,081			$	166,372			$	(19,805	)		$	5,897,514			$	—
Mortgage backed securities	523,019				11,385				(187		)		511,821				(6		)
Municipal bonds	582,497				21,755				(58		)		560,800				—
Commercial mortgage backed securities	686,707				21,272				(228		)		665,663				—
U.S. government and government agencies	4,906,996				68,017				(2,051		)		4,841,030				—
Non-U.S. government securities	1,928,752				45,881				(36,125		)		1,918,996				—
Asset backed securities	1,636,897				28,133				(3,480		)		1,612,244				—
Total	16,308,949				362,815				(61,934		)		16,008,068				(6		)
Short-term investments	821,961				284				(480		)		822,157				—
Total	$	17,130,910			$	363,099			$	(62,414	)		$	16,830,225			$	(6	)
December 31, 2018
Fixed maturities (1):
Corporate bonds	$	5,537,548			$	14,476			$	(105,428	)		$	5,628,500			$	(69	)
Mortgage backed securities	541,193				3,991				(3,216		)		540,418				(6		)
Municipal bonds	1,013,395				5,380				(11,891		)		1,019,906				—
Commercial mortgage backed securities	729,442				2,650				(10,751		)		737,543				—
U.S. government and government agencies	3,758,698				27,189				(8,474		)		3,739,983				—
Non-U.S. government securities	1,771,338				14,477				(50,948		)		1,807,809				—
Asset backed securities	1,600,896				8,060				(14,798		)		1,607,634				—
Total	14,952,510				76,223				(205,506		)		15,081,793				(75		)
Short-term investments	955,880				36				(394		)		956,238				—
Total	$	15,908,390			$	76,259			$	(205,900	)		$	16,038,031			$	(75	)

(1)	In securities lending transactions, the Company receives collateral in excess of the fair value of the fixed maturities pledged. For purposes of this table, the Company has excluded the collateral received under securities lending, at fair value and included the securities pledged under securities lending, at fair value. See “—Securities Lending Agreements.”

(2)

Represents the total other-than-temporary impairments (“OTTI”) recognized in accumulated other comprehensive income (“AOCI”). It does not include the change in fair value subsequent to the impairment measurement date. At June 30, 2019 the net unrealized loss related to securities for which a non-credit OTTI was recognized in AOCI was $0.01 million, compared to net unrealized loss of $0.04 million at December 31, 2018.

ARCH CAPITAL	22	2019 SECOND QUARTER FORM 10-Q

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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following table summarizes, for all available for sale securities in an unrealized loss position, the fair value and gross unrealized loss by length of time the security has been in a continual unrealized loss position:

	Less than 12 Months								12 Months or More								Total
	Estimated Fair Value				Gross Unrealized Losses				Estimated Fair Value				Gross Unrealized Losses				Estimated Fair Value				Gross Unrealized Losses
June 30, 2019
Fixed maturities (1):
Corporate bonds	$	259,361			$	(10,678	)		$	375,478			$	(9,127	)		$	634,839			$	(19,805	)
Mortgage backed securities	19,612				(169		)		261				(18		)		19,873				(187		)
Municipal bonds	—				—				12,489				(58		)		12,489				(58		)
Commercial mortgage backed securities	18,917				(106		)		23,198				(122		)		42,115				(228		)
U.S. government and government agencies	906,497				(1,711		)		104,692				(340		)		1,011,189				(2,051		)
Non-U.S. government securities	1,092,560				(33,985		)		124,466				(2,140		)		1,217,026				(36,125		)
Asset backed securities	312,033				(1,901		)		130,002				(1,579		)		442,035				(3,480		)
Total	2,608,980				(48,550		)		770,586				(13,384		)		3,379,566				(61,934		)
Short-term investments	53,431				(480		)		—				—				53,431				(480		)
Total	$	2,662,411			$	(49,030	)		$	770,586			$	(13,384	)		$	3,432,997			$	(62,414	)
December 31, 2018
Fixed maturities (1):
Corporate bonds	$	2,983,195			$	(68,910	)		$	1,234,865			$	(36,518	)		$	4,218,060			$	(105,428	)
Mortgage backed securities	84,296				(695		)		109,009				(2,521		)		193,305				(3,216		)
Municipal bonds	233,081				(2,074		)		408,155				(9,817		)		641,236				(11,891		)
Commercial mortgage backed securities	223,341				(2,831		)		193,956				(7,920		)		417,297				(10,751		)
U.S. government and government agencies	635,049				(1,354		)		391,102				(7,120		)		1,026,151				(8,474		)
Non-U.S. government securities	1,028,340				(35,524		)		389,671				(15,424		)		1,418,011				(50,948		)
Asset backed securities	533,592				(8,832		)		368,095				(5,966		)		901,687				(14,798		)
Total	5,720,894				(120,220		)		3,094,853				(85,286		)		8,815,747				(205,506		)
Short-term investments	122,878				(394		)		—				—				122,878				(394		)
Total	$	5,843,772			$	(120,614	)		$	3,094,853			$	(85,286	)		$	8,938,625			$	(205,900	)

(1)	In securities lending transactions, the Company receives collateral in excess of the fair value of the fixed maturities pledged. For purposes of this table, the Company has excluded the collateral received under securities lending, at fair value and included the securities pledged under securities lending, at fair value. See “—Securities Lending Agreements.”

At June 30, 2019, on a lot level basis, approximately 1,690 security lots out of a total of approximately 8,730 security lots were in an unrealized loss position and the largest single unrealized loss from a single lot in the Company’s fixed maturity portfolio was $3.1 million. At December 31, 2018, on a lot level basis, approximately 5,870 security lots out of a total of approximately 8,450 security lots were in an unrealized loss position and the largest single unrealized loss from a single lot in the Company’s fixed maturity portfolio was $2.6 million.

ARCH CAPITAL	23	2019 SECOND QUARTER FORM 10-Q

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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The contractual maturities of the Company’s fixed maturities are shown in the following table. Expected maturities, which are management’s best estimates, will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

		June 30, 2019								December 31, 2018
Maturity		Estimated Fair Value				Amortized Cost				Estimated Fair Value				Amortized Cost
Due in one year or less		$	414,736			$	413,481			$	276,682			$	279,135
Due after one year through five years		9,833,517				9,702,349				8,666,297				8,738,944
Due after five years through 10 years		3,028,435				2,923,881				2,919,232				2,951,582
Due after 10 years		185,638				178,629				218,768				226,537
		13,462,326				13,218,340				12,080,979				12,196,198
Mortgage backed securities		523,019				511,821				541,193				540,418
Commercial mortgage backed securities		686,707				665,663				729,442				737,543
Asset backed securities		1,636,897				1,612,244				1,600,896				1,607,634
Total (1)		$	16,308,949			$	16,008,068			$	14,952,510			$	15,081,793

(1)	In securities lending transactions, the Company receives collateral in excess of the fair value of the securities pledged. For purposes of this table, the Company has excluded the collateral received under securities lending, at fair value and included the securities pledged under securities lending, at fair value. See “—Securities Lending Agreements.”

 

Securities Lending Agreements

The Company enters into securities lending agreements with financial institutions to enhance investment income whereby it loans certain of its securities to third parties, primarily major brokerage firms, for short periods of time through a lending agent. The Company maintains legal control over the securities it lends, retains the earnings and cash flows associated with the loaned securities and receives a fee from the borrower for the temporary use of the securities. An indemnification agreement with the lending agent protects the Company in the event a borrower becomes insolvent or fails to return any of the securities on loan from the Company.

The Company receives collateral in the form of cash or securities. Cash collateral primarily consists of short term investments. At June 30, 2019, the fair value of the cash collateral received on securities lending was $11.4 million and the fair value of security collateral received was $438.9 million. At December 31, 2018, the fair value of the cash collateral received on securities lending was $19.0 million, and the fair value of security collateral received was $255.1 million.

The Company’s securities lending transactions were accounted for as secured borrowings with significant investment categories as follows:

		Remaining Contractual Maturity of the Agreements
		Overnight and Continuous				Less than 30 Days				30-90 Days				90 Days or More				Total
June 30, 2019
U.S. government and government agencies		$	216,856			$	—			$	217,722			$	—			$	434,578
Corporate bonds		2,356				—				—				—				2,356
Equity securities		13,378				—				—				—				13,378
Total		$	232,590			$	—			$	217,722			$	—			$	450,312
Gross amount of recognized liabilities for securities lending in offsetting disclosure in note 8																		$	—
Amounts related to securities lending not included in offsetting disclosure in note 8																		$	450,312
December 31, 2018
U.S. government and government agencies		$	219,276			$	—			$	32,583			$	—			$	251,859
Corporate bonds		7,129				—				—				—				7,129
Equity securities		15,137				—				—				—				15,137
Total		$	241,542			$	—			$	32,583			$	—			$	274,125
Gross amount of recognized liabilities for securities lending in offsetting disclosure in note 8																		$	—
Amounts related to securities lending not included in offsetting disclosure in note 8																		$	274,125

ARCH CAPITAL	24	2019 SECOND QUARTER FORM 10-Q

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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Equity Securities, at Fair Value

At June 30, 2019, the Company held $670.9 million of equity securities, at fair value, compared to $338.9 million at December 31, 2018. Such holdings include publicly traded common stocks in the natural resources, energy, consumer staples and other sectors and exchange-traded funds.

Other Investments

The following table summarizes the Company’s other investments which are included in investments accounted for using the fair value option, by strategy:

	June 30, 2019				December 31, 2018
Term loan investments (par value: $1,427,330 and $1,369,216)	$	1,341,445			$	1,282,287
Lending	585,954				524,112
Credit related funds	166,673				202,123
Energy	123,547				117,509
Investment grade fixed income	86,808				101,902
Infrastructure	49,260				45,371
Private equity	23,925				24,383
Real estate	16,906				14,252
Total	$	2,394,518			$	2,311,939

Investments Accounted For Using the Equity Method

The following table summarizes the Company’s investments accounted for using the equity method, by strategy:

	June 30, 2019				December 31, 2018
Credit related funds	$	436,118			$	429,402
Equities	324,525				375,273
Real estate	251,891				232,647
Lending	193,397				125,041
Private equity	131,863				114,019
Infrastructure	141,744				113,748
Energy	102,434				103,661
Total	$	1,581,972			$	1,493,791

Certain of the Company’s other investments are in investment funds for which the Company has the option to redeem at agreed upon values as described in each investment fund’s subscription agreement. Depending on the terms of the various subscription agreements, investments in investment funds may be redeemed daily, monthly, quarterly or on other terms. Two common redemption restrictions which may impact the Company’s ability to redeem these investment funds are gates and lockups. A gate is a suspension of redemptions which may be implemented by the general partner or investment manager of the fund in order to defer, in whole or in part, the redemption request in the event the aggregate amount of redemption requests exceeds a predetermined percentage of the investment fund’s net assets which may otherwise hinder the general

 

partner or investment manager’s ability to liquidate holdings in an orderly fashion in order to generate the cash necessary to fund extraordinarily large redemption payouts. A lockup period is the initial amount of time an investor is contractually required to hold the security before having the ability to redeem. If the investment funds are eligible to be redeemed, the time to redeem such fund can take weeks or months following the notification.

Fair Value Option 

The following table summarizes the Company’s assets which are accounted for using the fair value option:

	June 30, 2019				December 31, 2018
Fixed maturities	$	965,161			$	1,245,562
Other investments	2,394,518				2,311,939
Short-term investments	257,465				322,177
Equity securities	103,891				103,893
Investments accounted for using the fair value option	$	3,721,035			$	3,983,571

Limited Partnership Interests

In the normal course of its activities, the Company invests in limited partnerships as part of its overall investment strategy. Such amounts are included in ‘investments accounted for using the equity method’ and ‘investments accounted for using the fair value option.’ The Company has determined that it is not required to consolidate these investments because it is not the primary beneficiary of the funds. The Company’s maximum exposure to loss with respect to these investments is limited to the investment carrying amounts reported in the Company’s consolidated balance sheet and any unfunded commitment.

The following table summarizes investments in limited partnership interests where the Company has a variable interest by balance sheet line item:

	June 30, 2019				December 31, 2018
Investments accounted for using the equity method (1)	1,581,972				1,493,791
Investments accounted for using the fair value option (2)	178,977				162,398
Total	$	1,760,949			$	1,656,189

(1)	Aggregate unfunded commitments were $1.41 billion at June 30, 2019, compared to $1.22 billion at December 31, 2018.

(2)	Aggregate unfunded commitments were $63.6 million at June 30, 2019, compared to $117.5 million at December 31, 2018.

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Net Investment Income

The components of net investment income were derived from the following sources:

	June 30,
	2019				2018
Three Months Ended
Fixed maturities	$	125,018			$	115,110
Term loans	24,730				20,763
Equity securities	4,368				4,777
Short-term investments	3,859				4,392
Other (1)	18,523				17,405
Gross investment income	176,498				162,447
Investment expenses	(21,460		)		(26,779		)
Net investment income	$	155,038			$	135,668
Six Months Ended
Fixed maturities	$	254,817			$	222,997
Term loans	49,346				40,527
Equity securities	7,356				7,345
Short-term investments	8,038				9,252
Other (1)	39,719				35,015
Gross investment income	359,276				315,136
Investment expenses	(47,289		)		(52,744		)
Net investment income	$	311,987			$	262,392

(1)	Includes income distributions from investment funds and other items.

 

Net Realized Gains (Losses)

Net realized gains (losses) were as follows, excluding net impairment losses recognized in earnings:

	June 30,
	2019				2018
Three Months Ended
Available for sale securities:
Gross gains on investment sales	$	75,090			$	18,777
Gross losses on investment sales	(15,281		)		(57,711		)
Change in fair value of assets and liabilities accounted for using the fair value option:
Fixed maturities	11,429				(22,927		)
Other investments	(33,780		)		(254		)
Equity securities	6,414				1,230
Short-term investments	(1,392		)		(136		)
Equity securities, at fair value:
Net realized gains (losses) on sales during the period	(6,644		)		(5,918		)
Net unrealized gains (losses) on equity securities still held at reporting date	22,632				(7,278		)
Derivative instruments (1)	63,966				(2,146		)
Other (2)	(1,628		)		(248		)
Net realized gains (losses)	$	120,806			$	(76,611	)
Six Months Ended
Available for sale securities:
Gross gains on investment sales	$	118,455			$	33,742
Gross losses on investment sales	(46,937		)		(140,262		)
Change in fair value of assets and liabilities accounted for using the fair value option:
Fixed maturities	42,577				(40,478		)
Other investments	(15,585		)		(6,628		)
Equity securities	10,680				7,898
Short-term investments	(672		)		(287		)
Equity securities, at fair value:
Net realized gains (losses) on sales during the period	4,286				(11,286		)
Net unrealized gains (losses) on equity securities still held at reporting date	59,768				(14,861		)
Derivative instruments (1)	99,837				(6,109		)
Other (2)	(10,038		)		(9,338		)
Net realized gains (losses)	$	262,371			$	(187,609	)

(1)	See note 8 for information on the Company’s derivative instruments.

(2)	Includes the re-measurement of contingent consideration liability amounts.

Equity in Net Income (Loss) of Investment Funds Accounted for Using the Equity Method

The Company recorded $32.5 million of equity in net income related to investment funds accounted for using the equity method in the 2019 second quarter, compared to $8.5 million for the 2018 second quarter, and $79.4 million for the six months ended June 30, 2019, compared to $36.5 million for the 2018 period. In applying the equity method, 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

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funds (which include changes in the market value of the underlying securities in the funds). Such investments are generally recorded on a one to three month lag based on the availability of reports from the investment funds.

Net Impairment Losses Recognized in Earnings

The Company performs quarterly reviews of its available for sale investments in order to determine whether declines in fair value below the amortized cost basis were considered other-than-temporary in accordance with applicable guidance.

The following table details the net impairment losses recognized in earnings by asset class:

	June 30,
	2019				2018
Three Months Ended
Fixed maturities:
Mortgage backed securities	$	(24	)		$	(81	)
Corporate bonds	(25		)		(241		)
Asset backed securities	—				(148		)
Total	(49		)		(470		)
Net impairment losses recognized in earnings	$	(49	)		$	(470	)
Six Months Ended
Fixed maturities:
Mortgage backed securities	$	(555	)		$	(123	)
Corporate bonds	(590		)		(361		)
Asset backed securities	(213		)		(148		)
Total	(1,358		)		(632		)
Net impairment losses recognized in earnings	$	(1,358	)		$	(632	)

 

Net impairment losses recognized in earnings in the 2019 periods were primarily related to foreign currency fluctuations and other impairments on corporate bonds and other securities.

The Company believes that the minimal amount of OTTI included in accumulated other comprehensive income at June 30, 2019 on the securities which were considered by the Company to be impaired was due to market and sector-related factors (i.e., not credit losses). At June 30, 2019, the Company did not intend to sell these securities, or any other securities which were in an unrealized loss position, and determined that it is more likely than not that the Company will not be required to sell such securities before recovery of their cost basis.

 

The following table provides a roll forward of the amount related to credit losses recognized in earnings for which a portion of an OTTI was recognized in accumulated other comprehensive income:

	June 30,
	2019				2018
Three Months Ended
Balance at start of period	$	346			$	767
Credit loss impairments recognized on securities not previously impaired	—				—
Credit loss impairments recognized on securities previously impaired	—				—
Reductions for increases in cash flows expected to be collected that are recognized over the remaining life of the security	—				—
Reductions for securities sold during the period	—				(69		)
Balance at end of period	$	346			$	698
Six Months Ended
Balance at start of year	$	637			$	767
Credit loss impairments recognized on securities not previously impaired	—				—
Credit loss impairments recognized on securities previously impaired	—				—
Reductions for increases in cash flows expected to be collected that are recognized over the remaining life of the security	—				—
Reductions for securities sold during the period	(291		)		(69		)
Balance at end of period	$	346			$	698

Restricted Assets

The Company is required to maintain assets on deposit, which primarily consist of fixed maturities, with various regulatory authorities to support its underwriting operations. The Company’s subsidiaries maintain assets in trust accounts as collateral for transactions with affiliated companies and also have investments in segregated portfolios primarily to provide collateral or guarantees for letters of credit to third parties. See note 16, “Commitments and Contingencies,” of the notes to consolidated financial statements in the Company’s 2018 Form 10-K. The following table details the value of the Company’s restricted assets:

	June 30, 2019				December 31, 2018
Assets used for collateral or guarantees:
Affiliated transactions	$	4,758,653			$	4,623,483
Third party agreements	2,612,380				2,181,682
Deposits with U.S. regulatory authorities	788,750				689,114
Deposits with non-U.S. regulatory authorities	62,449				59,624
Total restricted assets	$	8,222,232			$	7,553,903

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

In addition, Watford Re maintains a secured credit facility to provide borrowing capacity for investment purposes and a total return swap agreement and maintains assets pledged as collateral for such purposes. 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 senior notes, common and preferred shares and counterparty credit risk (mitigated by collateral) arising from reinsurance transactions. As of June 30, 2019 and December 31, 2018 Watford Re held $1.1 billion and $1.3 billion, respectively, in pledged assets to collateralize Watford Re’s credit facility mentioned above.

Reconciliation of Cash and Restricted Cash

The following table details reconciliation of cash and restricted cash within the Consolidated Balance Sheets:

	June 30, 2019				December 31, 2018
Cash	$	605,316			$	646,556
Restricted cash (included in ‘other assets’)	$	77,759			$	78,087
Cash and restricted cash	$	683,075			$	724,643

7.    Fair Value

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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. It defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly fashion between market participants at the measurement date. In addition, it establishes a three-level valuation hierarchy for the disclosure of fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The level in the hierarchy within which a given fair value measurement falls is determined based on the lowest level input that is significant to the measurement (Level 1 being the highest priority and Level 3 being the lowest priority).

The levels in the hierarchy are defined as follows:

Level 1:	Inputs to the valuation methodology are observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets

Level 2:	Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly,

 

for substantially the full term of the financial instrument

Level 3:	Inputs to the valuation methodology are unobservable and significant to the fair value measurement

Following is a description of the valuation methodologies used for securities measured at fair value, as well as the general classification of such securities pursuant to the valuation hierarchy. The Company reviews its securities measured at fair value and discusses the proper classification of such investments with investment advisers and others.

The Company determines the existence of an active market based on its judgment as to whether transactions for the financial instrument occur in such market with sufficient frequency and volume to provide reliable pricing information. The independent pricing sources obtain market quotations and actual transaction prices for securities that have quoted prices in active markets. The Company uses quoted values and other data provided by nationally recognized independent pricing sources as inputs into its process for determining fair values of its fixed maturity investments. To validate the techniques or models used by pricing sources, the Company's review process includes, but is not limited to: (i) quantitative analysis (e.g., comparing the quarterly return for each managed portfolio to its target benchmark, with significant differences identified and investigated); (ii) a review of the average number of prices obtained in the pricing process and the range of resulting fair values; (iii) initial and ongoing evaluation of methodologies used by outside parties to calculate fair value; (iv) a comparison of the fair value estimates to the Company’s knowledge of the current market; (v) a comparison of the pricing services' fair values to other pricing services' fair values for the same investments; and (vi) periodic back-testing, which includes randomly selecting purchased or sold securities and comparing the executed prices to the fair value estimates from the pricing service. A price source hierarchy was maintained in order to determine which price source would be used (i.e., a price obtained from a pricing service with more seniority in the hierarchy will be used over a less senior one in all cases). The hierarchy prioritizes pricing services based on availability and reliability and assigns the highest priority to index providers. Based on the above review, the Company will challenge any prices for a security or portfolio which are considered not to be representative of fair value. The Company did not adjust any of the prices obtained from the independent pricing sources at June 30, 2019.

In certain circumstances, when fair values are unavailable from these independent pricing sources, quotes are obtained directly from broker-dealers who are active in the corresponding markets. Such quotes are subject to the validation procedures noted above. Of the $21.66 billion of financial assets and liabilities measured at fair value at June 30, 2019,

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approximately $183.8 million, or 0.9%, were priced using non-binding broker-dealer quotes. Of the $20.41 billion of financial assets and liabilities measured at fair value at December 31, 2018, approximately $217.9 million, or 1.1%, were priced using non-binding broker-dealer quotes.

Fixed maturities

The Company uses the market approach valuation technique to estimate the fair value of its fixed maturity securities, when possible. The market approach includes obtaining prices from independent pricing services, such as index providers and pricing vendors, as well as to a lesser extent quotes from broker-dealers. The independent pricing sources obtain market quotations and actual transaction prices for securities that have quoted prices in active markets. Each source has its own proprietary method for determining the fair value of securities that are not actively traded. In general, these methods involve the use of “matrix pricing” in which the independent pricing source uses observable market inputs including, but not limited to, investment yields, credit risks and spreads, benchmarking of like securities, broker-dealer quotes, reported trades and sector groupings to determine a reasonable fair value.

The following describes the significant inputs generally used to determine the fair value of the Company’s fixed maturity securities by asset class:

•U.S. government and government agencies — valuations provided by independent pricing services, with all prices provided through index providers and pricing vendors. The Company determined that all U.S. Treasuries would be classified as Level 1 securities due to observed levels of trading activity, the high number of strongly correlated pricing quotes received on U.S. Treasuries and other factors. The fair values of U.S. government agency securities are generally determined using the spread above the risk-free yield curve. As the yields for the risk-free yield curve and the spreads for these securities are observable market inputs, the fair values of U.S. government agency securities are classified within Level 2.

•Corporate bonds — valuations provided by independent pricing services, substantially all through index providers and pricing vendors with a small amount through broker-dealers. The fair values of these securities are generally determined using the spread above the risk-free yield curve. These spreads are generally obtained from the new issue market, secondary trading and from broker-dealers who trade in the relevant security market. As the significant inputs used in the pricing process for corporate bonds are observable market inputs, the fair value of these securities are classified within Level 2. A small number of securities are included in Level 3 due to a low level of transparency on the inputs used in the pricing process. During the 2019 second quarter, the Company transferred $23.9 million of corporate bonds from Level 2 to Level 3 based on a review of the pricing of such securities, as described above.

 

•Mortgage-backed securities — valuations provided by independent pricing services, substantially all through pricing vendors and index providers with a small amount through broker-dealers. The fair values of these securities are generally determined through the use of pricing models (including Option Adjusted Spread) which use spreads to determine the expected average life of the securities. These spreads are generally obtained from the new issue market, secondary trading and from broker-dealers who trade in the relevant security market. The pricing services also review prepayment speeds and other indicators, when applicable. As the significant inputs used in the pricing process for mortgage-backed securities are observable market inputs, the fair value of these securities are classified within Level 2. A small number of securities are included in Level 3 due to a low level of transparency on the inputs used in the pricing process.

•Municipal bonds — valuations provided by independent pricing services, with all prices provided through index providers and pricing vendors. The fair values of these securities are generally determined using spreads obtained from broker-dealers who trade in the relevant security market, trade prices and the new issue market. As the significant inputs used in the pricing process for municipal bonds are observable market inputs, the fair value of these securities are classified within Level 2.

•Commercial mortgage-backed securities — valuations provided by independent pricing services, substantially all through index providers and pricing vendors with a small amount through broker-dealers. The fair values of these securities are generally determined through the use of pricing models which use spreads to determine the appropriate average life of the securities. These spreads are generally obtained from the new issue market, secondary trading and from broker-dealers who trade in the relevant security market. The pricing services also review prepayment speeds and other indicators, when applicable. As the significant inputs used in the pricing process for commercial mortgage-backed securities are observable market inputs, the fair value of these securities are classified within Level 2.

•Non-U.S. government securities — valuations provided by independent pricing services, with all prices provided through index providers and pricing vendors. The fair values of these securities are generally based on international indices or valuation models which include daily observed yield curves, cross-currency basis index spreads and country credit spreads. As the significant inputs used in the pricing process for non-U.S. government securities are observable market inputs, the fair value of these securities are classified within Level 2.

•Asset-backed securities — valuations provided by independent pricing services, substantially all through index providers and pricing vendors with a small amount through broker-dealers. The fair values of these securities are generally determined through the use of pricing models (including Option

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Adjusted Spread) which use spreads to determine the appropriate average life of the securities. These spreads are generally obtained from the new issue market, secondary trading and from broker-dealers who trade in the relevant security market. The pricing services also review prepayment speeds and other indicators, when applicable. As the significant inputs used in the pricing process for asset-backed securities are observable market inputs, the fair value of these securities are classified within Level 2.

Equity securities

The Company determined that exchange-traded equity securities would be included in Level 1 as their fair values are based on quoted market prices in active markets. Other equity securities are included in Level 2 of the valuation hierarchy. A small number of securities are included in Level 3 due to the lack of an available independent price source for such securities. As the significant inputs used to price these securities are unobservable, the fair value of such securities are classified as Level 3. During the 2019 second quarter, the Company transferred $107.4 million of equity securities from Level 2 to Level 3 based on a review of the pricing of such securities, as described above.

Other investments

The Company determined that exchange-traded investments in mutual funds would be included in Level 1 as their fair values are based on quoted market prices in active markets. Other investments also include term loan investments for which fair values are estimated by using quoted prices of term loan investments with similar characteristics, pricing models or matrix pricing. Such investments are generally classified within Level 2. The fair values for certain of the Company’s other investments are determined using net asset values as advised by external fund managers. The net asset value is based on the fund manager’s valuation of the underlying holdings in accordance with the fund’s governing documents. In accordance with applicable accounting guidance, certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been classified in the fair value hierarchy. A small number of

 

securities are included in Level 3 due to the lack of an available independent price source for such securities. During the 2019 second quarter, the Company transferred $44.6 million of other investments from Level 2 to Level 3 based on a review of the pricing of such securities, as described above.

Derivative instruments

The Company’s futures contracts, foreign currency forward contracts, interest rate swaps and other derivatives trade in the over-the-counter derivative market. The Company uses the market approach valuation technique to estimate the fair value for these derivatives based on significant observable market inputs from third party pricing vendors, non-binding broker-dealer quotes and/or recent trading activity. As the significant inputs used in the pricing process for these derivative instruments are observable market inputs, the fair value of these securities are classified within Level 2.

Short-term investments

The Company determined that certain of its short-term investments held in highly liquid money market-type funds, Treasury bills and commercial paper would be included in Level 1 as their fair values are based on quoted market prices in active markets. The fair values of other short-term investments are generally determined using the spread above the risk-free yield curve and are classified within Level 2.

Contingent consideration liabilities

Contingent consideration liabilities (included in ‘other liabilities’ in the consolidated balance sheets) include amounts related to the acquisition of CMG Mortgage Insurance Company and its affiliated mortgage insurance companies and other acquisitions. Such amounts are remeasured at fair value at each balance sheet date with changes in fair value recognized in ‘net realized gains (losses).’ To determine the fair value of contingent consideration liabilities, the Company estimates future payments using an income approach based on modeled inputs which include a weighted average cost of capital. The Company determined that contingent consideration liabilities would be included within Level 3.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following table presents the Company’s financial assets and liabilities measured at fair value by level at June 30, 2019:

					Estimated Fair Value Measurements Using:
	Estimated Fair Value				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Assets measured at fair value (1):
Available for sale securities:
Fixed maturities:
Corporate bonds	$	6,044,081			$	—			$	6,036,439			$	7,642
Mortgage backed securities	523,019				—				522,729				290
Municipal bonds	582,497				—				582,497				—
Commercial mortgage backed securities	686,707				—				686,707				—
U.S. government and government agencies	4,906,996				4,746,260				160,736				—
Non-U.S. government securities	1,928,752				—				1,928,752				—
Asset backed securities	1,636,897				—				1,636,897				—
Total	16,308,949				4,746,260				11,554,757				7,932
Short-term investments	821,961				803,337				18,624				—
Equity securities, at fair value	684,236				620,508				12,516				51,212
Derivative instruments (4)	30,653				—				30,653				—
Fair value option:
Corporate bonds	673,431				—				647,328				26,103
Non-U.S. government bonds	56,416				—				56,416				—
Mortgage backed securities	16,076				—				16,076				—
Municipal bonds	6,731				—				6,731				—
Commercial mortgage backed securities	—				—				—				—
Asset backed securities	208,019				—				208,019				—
U.S. government and government agencies	4,488				4,378				110				—
Short-term investments	257,465				247,216				10,249				—
Equity securities	103,891				47,157				589				56,145
Other investments	1,394,344				41,176				1,257,895				95,273
Other investments measured at net asset value (2)	1,000,174
Total	3,721,035				339,927				2,203,413				177,521
Total assets measured at fair value	$	21,566,834			$	6,510,032			$	13,819,963			$	236,665
Liabilities measured at fair value:
Contingent consideration liabilities	$	(7,825	)		$	—			$	—			$	(7,825	)
Securities sold but not yet purchased (3)	(48,823		)		—				(48,823		)		—
Derivative instruments (4)	(38,363		)		—				(38,363		)		—
Total liabilities measured at fair value	$	(95,011	)		$	—			$	(87,186	)		$	(7,825	)

(1)	In securities lending transactions, the Company receives collateral in excess of the fair value of the securities pledged. For purposes of this table, the Company has excluded the collateral received under securities lending, at fair value and included the securities pledged under securities lending, at fair value. See note 6, “—Securities Lending Agreements.”

(2)

In accordance with applicable accounting guidance, certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been classified in the fair value hierarchy. The fair value amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the amounts presented in the consolidated balance sheets.

(3)	Represents the Company’s obligations to deliver securities that it did not own at the time of sale. Such amounts are included in “other liabilities” on the Company’s consolidated balance sheets.

(4)	See note 8.

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The following table presents the Company’s financial assets and liabilities measured at fair value by level at December 31, 2018:

					Estimated Fair Value Measurements Using:
	Estimated Fair Value				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Assets measured at fair value (1):
Available for sale securities:
Fixed maturities:
Corporate bonds	$	5,537,548			$	—			$	5,529,407			$	8,141
Mortgage backed securities	541,193				—				540,884				309
Municipal bonds	1,013,395				—				1,013,395				—
Commercial mortgage backed securities	729,442				—				729,438				4
U.S. government and government agencies	3,758,698				3,657,181				101,517				—
Non-U.S. government securities	1,771,338				—				1,771,338				—
Asset backed securities	1,600,896				—				1,600,896				—
Total	14,952,510				3,657,181				11,286,875				8,454
Equity securities	353,794				321,927				31,867				—
Short-term investments	955,880				875,881				79,999				—
Derivative instruments (4)	73,893				—				73,893				—
Fair value option:
Corporate bonds	852,585				—				846,827				5,758
Non-U.S. government bonds	79,066				—				79,066				—
Mortgage backed securities	16,731				—				16,731				—
Municipal bonds	7,144				—				7,144				—
Commercial mortgage backed securities	—				—				—				—
Asset backed securities	178,790				—				178,790				—
U.S. government and government agencies	111,246				111,138				108				—
Short-term investments	322,177				278,579				43,598				—
Equity securities	103,893				48,827				55,066				—
Other investments	1,254,220				39,107				1,152,408				62,705
Other investments measured at net asset value (2)	1,057,719
Total	3,983,571				477,651				2,379,738				68,463
Total assets measured at fair value	$	20,319,648			$	5,332,640			$	13,852,372			$	76,917
Liabilities measured at fair value:
Contingent consideration liabilities	$	(66,665	)		$	—			$	—			$	(66,665	)
Securities sold but not yet purchased (3)	(7,790		)		—				(7,790		)		—
Derivative instruments (4)	(20,664		)		—				(20,664		)		—
Total liabilities measured at fair value	$	(95,119	)		$	—			$	(28,454	)		$	(66,665	)

(1)	In securities lending transactions, the Company receives collateral in excess of the fair value of the securities pledged. For purposes of this table, the Company has excluded the collateral received under securities lending, at fair value and included the securities pledged under securities lending, at fair value. See note 6, “—Securities Lending Agreements.”

(2)

In accordance with applicable accounting guidance, certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been classified in the fair value hierarchy. The fair value amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the amounts presented in the consolidated balance sheets.

(3)	Represents the Company’s obligations to deliver securities that it did not own at the time of sale. Such amounts are included in “other liabilities” on the Company’s consolidated balance sheets.

(4)	See note 8.

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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following table presents a reconciliation of the beginning and ending balances for all financial assets and liabilities measured at fair value on a recurring basis using Level 3 inputs:

	Assets																								Liabilities
s	Available For Sale								Fair Value Option												Fair Value
	Structured Securities (1)				Corporate Bonds				Corporate Bonds				Other Investments				Equity Securities				Equity Securities				Contingent Consideration Liabilities
Three Months Ended June 30, 2019
Balance at beginning of period	$	302			$	7,567			$	2,233			$	62,329			$	—			$	—			$	(68,121	)
Total gains or (losses) (realized/unrealized)
Included in earnings (2)	—				—				(49		)		(11,614		)		—				—				(423		)
Included in other comprehensive income	1				102				—				—				—				—				—
Purchases, issuances, sales and settlements
Purchases	—				429				—				—				—				—				—
Issuances	—				—				—				—				—				—				—
Sales	—				—				—				(74		)		—				—				—
Settlements	(13		)		(456		)		—				—				—				—				60,719
Transfers in and/or out of Level 3	—				—				23,919				44,632				56,145				51,212				—
Balance at end of period	$	290			$	7,642			$	26,103			$	95,273			$	56,145			$	51,212			$	(7,825	)
Three Months Ended June 30, 2018
Balance at beginning of period	$	5,413			$	9,152			$	11,872			$	58,452			$	—			$	—			$	(62,449	)
Total gains or (losses) (realized/unrealized)
Included in earnings (2)	3				—				(537		)		336				—				—				(1,481		)
Included in other comprehensive income	(4		)		(316		)		—				—				—				—				—
Purchases, issuances, sales and settlements
Purchases	—				393				—				—				—				—				—
Issuances	—				—				—				—				—				—				—
Sales	(5,003		)		—				—				(74		)		—				—				—
Settlements	(33		)		(456		)		—				(500		)		—				—				—
Transfers in and/or out of Level 3	—				—				—				—				—				—				—
Balance at end of period	$	376			$	8,773			$	11,335			$	58,214			$	—			$	—			$	(63,930	)
Six Months Ended June 30, 2019
Balance at beginning of year	$	313			$	8,141			$	5,758			$	62,705			$	—			$	—			$	(66,665	)
Total gains or (losses) (realized/unrealized)
Included in earnings (2)	1,757				—				(339		)		(11,316		)		—				—				(1,331		)
Included in other comprehensive income	5				(16		)		—				—				—				—				—
Purchases, issuances, sales and settlements
Purchases	—				429				—				—				—				—				—
Issuances	—				—				—				—				—				—				(548		)
Sales	(1,757		)		—				(3,235		)		(148		)		—				—				—
Settlements	(28		)		(912		)		—				(600		)		—				—				60,719
Transfers in and/or out of Level 3	—				—				23,919				44,632				56,145				51,212				—
Balance at end of period	$	290			$	7,642			$	26,103			$	95,273			$	56,145			$	51,212			$	(7,825	)
Six Months Ended June 30, 2018
Balance at beginning of year	$	5,927			$	9,460			$	12,217			$	59,167			$	—			$	—			$	(60,996	)
Total gains or (losses) (realized/unrealized)
Included in earnings (2)	4				—				(612		)		(379		)		—				—				(2,934		)
Included in other comprehensive income	(8		)		(168		)		—				—				—				—				—
Purchases, issuances, sales and settlements
Purchases	—				393				—				—				—				—				—
Issuances	—				—				—				—				—				—				—
Sales	(5,003		)		—				—				(74		)		—				—				—
Settlements	(544		)		(912		)		(270		)		(500		)		—				—				—
Transfers in and/or out of Level 3	—				—				—				—				—				—				—
Balance at end of period	$	376			$	8,773			$	11,335			$	58,214			$	—			$	—			$	(63,930	)

(1)	Includes asset backed securities, mortgage backed securities and commercial mortgage backed securities.

(2)	Gains or losses were included in net realized gains (losses).

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Table of Contents

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Financial Instruments Disclosed, But Not Carried, At Fair Value

The Company uses various financial instruments in the normal course of its business. The carrying values of cash, accrued investment income, receivable for securities sold, certain other assets, payable for securities purchased and certain other liabilities approximated their fair values at June 30, 2019, due to their respective short maturities. As these financial instruments are not actively traded, their respective fair values are classified within Level 2.

At June 30, 2019, the Company’s senior notes were carried at their cost, net of debt issuance costs, of $1.73 billion and had a fair value of $2.09 billion. At December 31, 2018, Company’s senior notes were carried at their cost, net of debt issuance costs, of $1.73 billion and had a fair value of $1.88 billion. The fair values of the senior notes were obtained from a third party pricing service and are based on observable market inputs. As such, the fair values of the senior notes are classified within Level 2.

8.    Derivative Instruments

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The Company’s investment strategy allows for the use of derivative instruments. The Company’s derivative instruments are recorded on its consolidated balance sheets at fair value. The Company utilizes exchange traded U.S. Treasury note, Eurodollar and other futures contracts and commodity futures to manage portfolio duration or replicate investment positions in its portfolios and the Company routinely utilizes foreign currency forward contracts, currency options, index futures contracts and other derivatives as part of its total return objective. In addition, certain of the Company’s investments are managed in portfolios which incorporate the use of foreign currency forward contracts which are intended to provide an economic hedge against foreign currency movements. 

In addition, the Company purchases to-be-announced mortgage backed securities (“TBAs”) as part of its investment strategy. TBAs represent commitments to purchase a future issuance of agency mortgage backed securities. For the period between purchase of a TBA and issuance of the underlying security, the Company’s position is accounted for as a derivative. The Company purchases TBAs in both long and short positions to enhance investment performance and as part of its overall investment strategy.

 

The following table summarizes information on the fair values and notional values of the Company’s derivative instruments:

	Estimated Fair Value
	Asset Derivatives				Liability Derivatives				Notional Value (1)
June 30, 2019
Futures contracts (2)	$	5,438			$	(1,586	)		$	4,354,852
Foreign currency forward contracts (2)	3,190				(10,352		)		939,940
TBAs (3)	15,509				—				14,846
Other (2)	22,025				(26,425		)		3,493,526
Total	$	46,162			$	(38,363	)
December 31, 2018
Futures contracts (2)	$	51,800			$	(2,115	)		$	3,153,518
Foreign currency forward contracts (2)	8,147				(7,796		)		1,008,907
TBAs (3)	8,292				—				8,132
Other (2)	13,946				(10,753		)		2,213,981
Total	$	82,185			$	(20,664	)

(1)	Represents the absolute notional value of all outstanding contracts, consisting of long and short positions.

(2)	The fair value of asset derivatives are included in ‘other assets’ and the fair value of liability derivatives are included in ‘other liabilities.’

(3)	The fair value of TBAs are included in ‘fixed maturities available for sale, at fair value.’

The Company did not hold any derivatives which were designated as hedging instruments at June 30, 2019 or December 31, 2018.

The Company’s derivative instruments can be traded under master netting agreements, which establish terms that apply to all derivative transactions with a counterparty. In the event of a bankruptcy or other stipulated event of default, such agreements provide that the non-defaulting party may elect to terminate all outstanding derivative transactions, in which case all individual derivative positions (loss or gain) with a counterparty are closed out and netted and replaced with a single amount, usually referred to as the termination amount, which is expressed in a single currency. The resulting single net amount, where positive, is payable to the party “in-the-money” regardless of whether or not it is the defaulting party, unless the parties have agreed that only the non-defaulting party is entitled to receive a termination payment where the net amount is positive and is in its favor. Contractual close-out netting reduces derivatives credit exposure from gross to net exposure. The remaining derivatives included in the table above were not subject to a master netting agreement.

At June 30, 2019, asset derivatives and liability derivatives of $46.2 million and $38.4 million, respectively, were subject to a master netting agreement, compared to $80.4 million and $18.9 million, respectively, at December 31, 2018. The remaining derivatives included in the preceding table were not subject to a master netting agreement.

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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Realized and unrealized contract gains and losses on the Company’s derivative instruments are reflected in ‘net realized gains (losses)’ in the consolidated statements of income, as summarized in the following table:

Derivatives not designated as		June 30,
hedging instruments:		2019				2018
Three Months Ended
Net realized gains (losses):
Futures contracts		$	66,973			$	(240	)
Foreign currency forward contracts		(5,365		)		(1,692		)
TBAs		48				—
Other		2,310				(214		)
Total		$	63,966			$	(2,146	)
Six Months Ended
Net realized gains (losses):
Futures contracts		$	94,309			$	4,790
Foreign currency forward contracts		(19,074		)		(7,616		)
TBAs		238				(97		)
Other		24,364				(3,186		)
Total		$	99,837			$	(6,109	)

9.    Commitments and Contingencies

---

Investment Commitments

The Company’s investment commitments, which are primarily related to agreements entered into by the Company to invest in funds and separately managed accounts when called upon, were approximately $1.92 billion at June 30, 2019, compared to $1.77 billion at December 31, 2018.

Interest Paid

Interest paid on the Company’s senior notes and other borrowings were $60.9 million for the six months ended June 30, 2019, consistent with $60.9 million for the 2018 period.

10.    Leases

---

In the ordinary course of business, the Company renews and enters into new leases for office property and equipment. At the lease inception date, the Company determines whether a contract contains a lease and its classification as a finance or operating lease. Primarily all of the Company’s leases are classified as operating leases. The Company’s operating leases have remaining lease terms of up to 12 years, some of which include options to extend the lease term. The Company considers these options when determining the lease term and measuring its lease liability and right-of-use asset. In addition, the Company’s lease agreements do not contain any material residual value guarantees or material restrictive covenants.

 

Short-term operating leases with an initial term of twelve months or less were excluded on the Company's consolidated balance sheet and represent an inconsequential amount of operating lease expense.

As most leases do not provide an implicit rate, the Company uses its incremental borrowing rate based on the information available at the lease commencement date in determining the present value of lease payments.

Additional information regarding the Company’s operating leases is as follows:

		June 30,
		2019
Three Months Ended
Operating lease costs		$	7,244
Cash payments included in the measurement of lease liabilities reported in operating cash flows		$	7,685
Right-of-use assets obtained in exchange for new lease liabilities		$	4,420
Right-of-use assets (1)		$	134,061
Operating lease liability (1)		$	150,341
Weighted average discount rate		3.9		%
Weighted average remaining lease term		6.5 years
Six Months Ended
Operating lease costs		$	14,860
Cash payments included in the measurement of lease liabilities reported in operating cash flows		$	14,585
Right-of-use assets obtained in exchange for new lease liabilities		$	4,420
Right-of-use assets (1)		$	134,061
Operating lease liability (1)		$	150,341
Weighted average discount rate		3.9		%
Weighted average remaining lease term		6.5 years

(1)	The right-of-use assets are included in ‘other assets’ while the operating lease liability is included in ‘other liabilities.’

The following table presents the contractual maturities of the Company's operating lease liabilities at June 30, 2019:

Years Ending December 31,
2019 (remainder)		$	9,985
2020		32,036
2021		30,673
2022		27,365
2023		22,667
2024 and thereafter		55,610
Total undiscounted lease liability		$	178,336
Less: present value adjustment		(27,995		)
Operating lease liability		$	150,341

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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

At December 31, 2018, the future minimum rental commitments, exclusive of escalation clauses and maintenance costs and net of rental income, for all of the Company’s operating leases was as follows:

2019	$	31,088
2020	30,491
2021	29,351
2022	26,068
2023	21,408
2024 and thereafter	54,745
Total	$	193,151

11.	Variable Interest Entities and Noncontrolling Interests

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Watford Holdings Ltd.

In March 2014, the Company invested $100.0 million and acquired 2,500,000 common shares, approximately 11% of Watford Holdings Ltd.’s outstanding common equity, and a warrant to purchase up to 975,503 additional common shares. The warrants expire on March 31, 2020. The exercise price of the warrants is determined on the date of exercise based on certain targeted returns for existing common shareholders. Watford Holdings Ltd.’s common shares are listed on the Nasdaq Select Global Market under the ticker symbol “WTRE”.

Watford Re is considered a VIE and the Company concluded that it is the primary beneficiary of Watford Re. As such, the results of Watford Re are included in the Company’s consolidated financial statements.

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 senior notes, common and preferred shares and counterparty credit risk (mitigated by collateral) arising from reinsurance transactions.

 

The following table provides the carrying amount and balance sheet caption in which the assets and liabilities of Watford Re are reported:

	June 30,				December 31,
	2019				2018
Assets
Investments accounted for using the fair value option	$	1,972,947			$	2,312,003
Fixed maturities available for sale, at fair value	732,454				393,351
Equity securities, at fair value	64,703				32,206
Cash	68,977				63,529
Accrued investment income	16,916				19,461
Premiums receivable	228,588				227,301
Reinsurance recoverable on unpaid and paid losses and LAE	123,961				86,445
Ceded unearned premiums	79,513				61,587
Deferred acquisition costs	71,557				80,858
Receivable for securities sold	29,425				24,507
Goodwill and intangible assets	7,650				7,650
Other assets	71,837				63,959
Total assets of consolidated VIE	$	3,468,528			$	3,372,857
Liabilities
Reserve for losses and loss adjustment expenses	$	1,126,080			$	1,032,760
Unearned premiums	375,323				390,114
Reinsurance balances payable	23,312				21,034
Revolving credit agreement borrowings	491,006				455,682
Payable for securities purchased	51,216				60,142
Other liabilities (1)	219,120				302,524
Total liabilities of consolidated VIE	$	2,286,057			$	2,262,256
Redeemable noncontrolling interests	$	221,175			$	220,992

(1)	Includes certain borrowings related to investing activities.

For the six months ended June 30, 2019, Watford Re generated $115.9 million of cash provided by operating activities, $135.7 million of cash used for investing activities and $25.6 million of cash provided by financing activities, compared to $92.4 million of cash provided by operating activities, $168.0 million of cash used for investing activities and $2.1 million of cash used for financing activities for the six months ended June 30, 2018.

Non-redeemable noncontrolling interests

The Company accounts for the portion of Watford Re’s common equity attributable to third party investors in the shareholders’ equity section of its consolidated balance sheets. The noncontrolling ownership in Watford Re’s common shares was approximately 89% at June 30, 2019. The portion of Watford Re’s income or loss attributable to third party investors is recorded in the consolidated statements of income in ‘net (income) loss attributable to noncontrolling interests.’

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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following table sets forth activity in the non-redeemable noncontrolling interests:

	June 30,
	2019				2018
Three Months Ended
Balance, beginning of period	$	838,081			$	854,112
Additional paid in capital attributable to noncontrolling interests	2,074				—
Amounts attributable to noncontrolling interests	12,301				8,116
Other comprehensive income (loss) attributable to noncontrolling interests	2,891				(1,075		)
Balance, end of period	$	855,347			$	861,153
Six Months Ended
Balance, beginning of year	$	791,560			$	843,411
Additional paid in capital attributable to noncontrolling interests	2,074				—
Amounts attributable to noncontrolling interests	54,683				19,492
Other comprehensive income (loss) attributable to noncontrolling interests	7,030				(1,750		)
Balance, end of period	$	855,347			$	861,153

Redeemable noncontrolling interests

The Company accounts for redeemable noncontrolling interests in the mezzanine section of its consolidated balance sheets in accordance with applicable accounting guidance. Such redeemable noncontrolling interests relate to the 9,065,200 cumulative redeemable preference shares (“Watford Preference Shares”) issued in late March 2014 with a par value of $0.01 per share and a liquidation preference of $25.00 per share. The Watford Preference Shares were issued at a discounted amount of $24.50 per share. Preferred dividends, including the accretion of the discount and issuance costs, are included in ‘net (income) loss attributable to noncontrolling interests’ in the Company’s consolidated statements of income.

The following table sets forth activity in the redeemable non-controlling interests:

	June 30,
	2019				2018
Three Months Ended
Balance, beginning of period	$	206,383			$	206,013
Accretion of preference share issuance costs	92				92
Balance, end of period	$	206,475			$	206,105
Six Months Ended
Balance, beginning of year	$	206,292			$	205,922
Accretion of preference share issuance costs	183				183
Balance, end of period	$	206,475			$	206,105

 

The portion of Watford Re’s income or loss attributable to third party investors, recorded in the Company’s consolidated statements of income in ‘net (income) loss attributable to noncontrolling interests,’ are summarized in the table below:

	June 30,
	2019				2018
Three Months Ended
Amounts attributable to non-redeemable noncontrolling interests	$	(12,301	)		$	(8,116	)
Dividends attributable to redeemable noncontrolling interests	(4,590		)		(4,585		)
Net (income) loss attributable to noncontrolling interests	$	(16,891	)		$	(12,701	)
Six Months Ended
Amounts attributable to non-redeemable noncontrolling interests	$	(54,683	)		$	(19,492	)
Dividends attributable to redeemable noncontrolling interests	(9,178		)		(9,170		)
Net (income) loss attributable to noncontrolling interests	$	(63,861	)		$	(28,662	)

Bellemeade Re

The Company has entered into various aggregate excess of loss mortgage reinsurance agreements with various special purpose reinsurance companies domiciled in Bermuda (the “Bellemeade Agreements”). At the time the Bellemeade Agreements were entered into, the applicability of the accounting guidance that addresses VIEs was evaluated. As a result of the evaluation of the Bellemeade Agreements, the Company concluded that these entities are VIEs. However, given that the ceding insurers do not have the unilateral power to direct those activities that are significant to their economic performance, the Company does not consolidate such entities in its consolidated financial statements.

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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following table presents the total assets of the Bellemeade entities, as well as the Company’s maximum exposure to loss associated with these VIEs, calculated as the maximum historical observable spread between the one month LIBOR, the basis for the contractual payments to bond holders, and short term invested trust asset yields.

					Maximum Exposure to Loss
Bellemeade Entities (Issue Date)	Total VIE Assets				On-Balance Sheet (Asset) Liability				Off-Balance Sheet				Total
Jun 30, 2019
Bellemeade 2015-1 Ltd. (Jul-15)	$	19,103			$	(4	)		$	17			$	13
Bellemeade 2017-1 Ltd. (Oct-17)	277,554				(657		)		4,892				4,235
Bellemeade 2018-1 Ltd. (Apr-18)	374,460				(1,965		)		7,799				5,834
Bellemeade 2018-2 Ltd. (Aug-18)	571,129				(1,957		)		5,265				3,308
Bellemeade 2018-3 Ltd. (Oct-18)	506,110				(2,213		)		7,251				5,038
Bellemeade 2019-1 Ltd. (Mar-19)	329,085				(237		)		4,842				4,605
Bellemeade 2019-2 Ltd. (Apr-19)	621,022				(408		)		11,206				10,798
Total	$	2,698,463			$	(7,441	)		$	41,272			$	33,831
Dec 31, 2018
Bellemeade 2015-1 Ltd. (Jul-15)	$	43,246			$	112			$	498			$	610
Bellemeade 2017-1 Ltd. (Oct-17)	304,373				165				1,312				1,477
Bellemeade 2018-1 Ltd. (Apr-18)	374,460				132				3,539				3,671
Bellemeade 2018-2 Ltd. (Aug-18)	653,278				874				4,005				4,879
Bellemeade 2018-3 Ltd. (Oct-18)	506,110				469				1,836				2,305
Total	$	1,881,467			$	1,752			$	11,190			$	12,942

See note 16.

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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

12.    Other Comprehensive Income (Loss)

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The following tables present details about amounts reclassified from accumulated other comprehensive income and the tax effects allocated to each component of other comprehensive income (loss):

				Amounts Reclassified from AOCI
		Consolidated Statement of Income		Three Months Ended								Six Months Ended
Details About		Line Item That Includes		June 30,								June 30,
AOCI Components		Reclassification		2019				2018				2019				2018
Unrealized appreciation on available-for-sale investments
		Net realized gains (losses)		$	59,809			$	(38,935	)		$	71,518			$	(106,521	)
		Other-than-temporary impairment losses		(49		)		(470		)		(1,358		)		(632		)
		Total before tax		59,760				(39,405		)		70,160				(107,153		)
		Income tax (expense) benefit		(4,415		)		2,762				(4,594		)		8,049
		Net of tax		$	55,345			$	(36,643	)		$	65,566			$	(99,104	)

	Before Tax Amount				Tax Expense (Benefit)				Net of Tax Amount
Three Months Ended June 30, 2019
Unrealized appreciation (decline) in value of investments:
Unrealized holding gains (losses) arising during period	$	248,074			$	25,601			$	222,473
Portion of other-than-temporary impairment losses recognized in other comprehensive income (loss)	—				—				—
Less reclassification of net realized gains (losses) included in net income	59,760				4,415				55,345
Foreign currency translation adjustments	4,409				142				4,267
Other comprehensive income (loss)	$	192,723			$	21,328			$	171,395
Three Months Ended June 30, 2018
Unrealized appreciation (decline) in value of investments:
Unrealized holding gains (losses) arising during period	$	(88,034	)		$	(2,763	)		$	(85,271	)
Portion of other-than-temporary impairment losses recognized in other comprehensive income (loss)	—				—				—
Less reclassification of net realized gains (losses) included in net income	(39,405		)		(2,762		)		(36,643		)
Foreign currency translation adjustments	(12,701		)		(106		)		(12,595		)
Other comprehensive income (loss)	$	(61,330	)		$	(107	)		$	(61,223	)
Six Months Ended June 30, 2019
Unrealized appreciation (decline) in value of investments:
Unrealized holding gains (losses) arising during period	$	503,064			$	54,704			$	448,360
Portion of other-than-temporary impairment losses recognized in other comprehensive income (loss)	—				—				—
Less reclassification of net realized gains (losses) included in net income	70,160				4,594				65,566
Foreign currency translation adjustments	10,053				270				9,783
Other comprehensive income (loss)	$	442,957			$	50,380			$	392,577
Six Months Ended June 30, 2018
Unrealized appreciation (decline) in value of investments:
Unrealized holding gains (losses) arising during period	$	(277,977	)		$	(26,029	)		$	(251,948	)
Portion of other-than-temporary impairment losses recognized in other comprehensive income (loss)	—				—				—
Less reclassification of net realized gains (losses) included in net income	(107,153		)		(8,049		)		(99,104		)
Foreign currency translation adjustments	(11,269		)		44				(11,313		)
Other comprehensive income (loss)	$	(182,093	)		$	(17,936	)		$	(164,157	)

ARCH CAPITAL	39	2019 SECOND QUARTER FORM 10-Q

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Table of Contents

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

13.     Guarantor Financial Information

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The following tables present condensed financial information for Arch Capital, Arch Capital Group (U.S.) Inc. (“Arch-U.S.”), a 100% owned subsidiary of Arch Capital, and Arch Capital’s other subsidiaries. The senior notes of Arch-U.S. due November 1, 2043 are fully and unconditionally guaranteed by Arch Capital.

		June 30, 2019
Condensed Consolidating Balance Sheet		Arch Capital (Parent Guarantor)				Arch-U.S. (Subsidiary Issuer)				Other Arch Capital Subsidiaries				Consolidating Adjustments and Eliminations				Arch Capital Consolidated
Assets
Total investments		$	40			$	483,904			$	22,693,719			$	(49,700	)		$	23,127,963
Cash		10,750				47,875				546,691				—				605,316
Investments in subsidiaries		11,045,465				4,493,198				—				(15,538,663		)		—
Due from subsidiaries and affiliates		332				2				1,881,929				(1,882,263		)		—
Premiums receivable		—				—				2,291,360				(685,320		)		1,606,040
Reinsurance recoverable on unpaid and paid losses and loss adjustment expenses		—				—				8,618,279				(5,447,022		)		3,171,257
Contractholder receivables		—				—				2,102,544				—				2,102,544
Ceded unearned premiums		—				—				1,984,219				(847,491		)		1,136,728
Deferred acquisition costs		—				—				658,992				(58,252		)		600,740
Goodwill and intangible assets		—				—				641,010				—				641,010
Other assets		22,950				40,345				1,953,732				(156,955		)		1,860,072
	Total assets	$	11,079,537			$	5,065,324			$	43,372,475			$	(24,665,666	)		$	34,851,670
Liabilities
Reserve for losses and loss adjustment expenses		$	—			$	—			$	17,430,847			$	(5,200,531	)		$	12,230,316
Unearned premiums		—				—				4,904,351				(847,491		)		4,056,860
Reinsurance balances payable		—				—				1,217,310				(685,320		)		531,990
Contractholder payables		—				—				2,102,544				—				2,102,544
Collateral held for insured obligations		—				—				237,056								237,056
Senior notes		297,201				494,776				941,888				—				1,733,865
Revolving credit agreement borrowings		—				—				491,006				—				491,006
Due to subsidiaries and affiliates		9				536,747				1,345,507				(1,882,263		)		—
Other liabilities		24,975				64,956				2,055,626				(496,698		)		1,648,859
	Total liabilities	322,185				1,096,479				30,726,135				(9,112,303		)		23,032,496
Redeemable noncontrolling interests		—				—				221,175				(14,700		)		206,475
Shareholders’ Equity
Total shareholders’ equity available to Arch		10,757,352				3,968,845				11,569,818				(15,538,663		)		10,757,352
Non-redeemable noncontrolling interests		—				—				855,347				—				855,347
	Total shareholders’ equity	10,757,352				3,968,845				12,425,165				(15,538,663		)		11,612,699
	Total liabilities, noncontrolling interests and shareholders’ equity	$	11,079,537			$	5,065,324			$	43,372,475			$	(24,665,666	)		$	34,851,670

ARCH CAPITAL	40	2019 SECOND QUARTER FORM 10-Q

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Table of Contents

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

		December 31, 2018
Condensed Consolidating Balance Sheet		Arch Capital (Parent Guarantor)				Arch-U.S. (Subsidiary Issuer)				Other Arch Capital Subsidiaries				Consolidating Adjustments and Eliminations				Arch Capital Consolidated
Assets
Total investments		$	104			$	452,674			$	21,307,206			$	(14,700	)		$	21,745,284
Cash		6,125				5,940				634,491				—				646,556
Investments in subsidiaries		9,735,256				3,999,243				—				(13,734,499		)		—
Due from subsidiaries and affiliates		9				2				1,802,686				(1,802,697		)		—
Premiums receivable		—				—				1,834,389				(535,239		)		1,299,150
Reinsurance recoverable on unpaid and paid losses and loss adjustment expenses		—				—				8,618,660				(5,699,288		)		2,919,372
Contractholder receivables		—				—				2,079,111				—				2,079,111
Ceded unearned premiums		—				—				1,730,262				(754,793		)		975,469
Deferred acquisition costs		—				—				618,535				(48,961		)		569,574
Goodwill and intangible assets		—				—				634,920				—				634,920
Other assets		12,588				80,949				1,466,438				(211,082		)		1,348,893
	Total assets	$	9,754,082			$	4,538,808			$	40,726,698			$	(22,801,259	)		$	32,218,329
Liabilities
Reserve for losses and loss adjustment expenses		$	—			$	—			$	17,345,142			$	(5,491,845	)		$	11,853,297
Unearned premiums		—				—				4,508,429				(754,793		)		3,753,636
Reinsurance balances payable		—				—				928,346				(535,239		)		393,107
Contractholder payables		—				—				2,079,111				—				2,079,111
Collateral held for insured obligations		—				—				236,630				—				236,630
Senior notes		297,150				494,723				941,655				—				1,733,528
Revolving credit agreement borrowings		—				—				455,682				—				455,682
Due to subsidiaries and affiliates		—				536,805				1,265,892				(1,802,697		)		—
Other liabilities		17,105				26,270				1,699,768				(467,484		)		1,275,659
	Total liabilities	314,255				1,057,798				29,460,655				(9,052,058		)		21,780,650
Redeemable noncontrolling interests		—				—				220,992				(14,700		)		206,292
Shareholders’ Equity
Total shareholders’ equity available to Arch		9,439,827				3,481,010				10,253,491				(13,734,501		)		9,439,827
Non-redeemable noncontrolling interests		—				—				791,560				—				791,560
	Total shareholders’ equity	9,439,827				3,481,010				11,045,051				(13,734,501		)		10,231,387
	Total liabilities, noncontrolling interests and shareholders’ equity	$	9,754,082			$	4,538,808			$	40,726,698			$	(22,801,259	)		$	32,218,329

ARCH CAPITAL	41	2019 SECOND QUARTER FORM 10-Q

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Table of Contents

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

		Three Months Ended June 30, 2019
Condensed Consolidating Statement of Income and Comprehensive Income		Arch Capital (Parent Guarantor)				Arch-U.S. (Subsidiary Issuer)				Other Arch Capital Subsidiaries				Consolidating Adjustments and Eliminations				Arch Capital Consolidated
Revenues
Net premiums earned		$	—			$	—			$	1,463,727			$	—			$	1,463,727
Net investment income		38				2,847				174,738				(22,585		)		155,038
Net realized gains (losses)		—				5,825				115,620				(639		)		120,806
Net impairment losses recognized in earnings		—				—				(49		)		—				(49		)
Other underwriting income		—				—				5,953				—				5,953
Equity in net income (loss) of investment funds accounted for using the equity method		—				(64		)		32,600				—				32,536
Other income (loss)		(242		)		—				1,371				—				1,129
	Total revenues	(204		)		8,608				1,793,960				(23,224		)		1,779,140
Expenses
Losses and loss adjustment expenses		—				—				767,543				—				767,543
Acquisition expenses		—				—				210,089				—				210,089
Other operating expenses		—				—				198,914				—				198,914
Corporate expenses		15,293				2,115				843				—				18,251
Amortization of intangible assets		—				—				19,794				—				19,794
Interest expense		5,538				11,996				34,012				(22,266		)		29,280
Net foreign exchange (gains) losses		—				—				(1,187		)		6,139				4,952
	Total expenses	20,831				14,111				1,230,008				(16,127		)		1,248,823
Income (loss) before income taxes		(21,035		)		(5,503		)		563,952				(7,097		)		530,317
Income tax (expense) benefit		—				1,301				(45,773		)		—				(44,472		)
Income (loss) before equity in net income of subsidiaries		(21,035		)		(4,202		)		518,179				(7,097		)		485,845
Equity in net income of subsidiaries		489,989				148,747				—				(638,736		)		—
Net income		468,954				144,545				518,179				(645,833		)		485,845
Net (income) loss attributable to noncontrolling interests		—				—				(17,210		)		319				(16,891		)
Net income available to Arch		468,954				144,545				500,969				(645,514		)		468,954
Preferred dividends		(10,403		)		—				—				—				(10,403		)
Net income available to Arch common shareholders		$	458,551			$	144,545			$	500,969			$	(645,514	)		$	458,551
Comprehensive income available to Arch		$	637,458			$	231,120			$	663,685			$	(894,805	)		$	637,458

ARCH CAPITAL	42	2019 SECOND QUARTER FORM 10-Q

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Table of Contents

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

		Three Months Ended June 30, 2018
Condensed Consolidating Statement of Income and Comprehensive Income		Arch Capital (Parent Guarantor)				Arch-U.S. (Subsidiary Issuer)				Other Arch Capital Subsidiaries				Consolidating Adjustments and Eliminations				Arch Capital Consolidated
Revenues
Net premiums earned		$	—			$	—			$	1,336,763			$	—			$	1,336,763
Net investment income		15				560				157,532				(22,439		)		135,668
Net realized gains (losses)		—				—				(76,611		)		—				(76,611		)
Net impairment losses recognized in earnings		—				—				(470		)		—				(470		)
Other underwriting income		—				—				3,874				—				3,874
Equity in net income (loss) of investment funds accounted for using the equity method		—				—				8,472				—				8,472
Other income (loss)		2,339				—				774				—				3,113
	Total revenues	2,354				560				1,430,334				(22,439		)		1,410,809
Expenses
Losses and loss adjustment expenses		—				—				726,153				—				726,153
Acquisition expenses		—				—				202,838				—				202,838
Other operating expenses		—				—				176,181				—				176,181
Corporate expenses		16,642				470				5,400				—				22,512
Amortization of intangible assets		—				—				26,472				—				26,472
Interest expense		5,537				12,013				34,911				(22,117		)		30,344
Net foreign exchange (gains) losses		—				—				(43,357		)		(10,349		)		(53,706		)
	Total expenses	22,179				12,483				1,128,598				(32,466		)		1,130,794
Income (loss) before income taxes		(19,825		)		(11,923		)		301,736				10,027				280,015
Income tax (expense) benefit		—				2,477				(26,145		)		—				(23,668		)
Income (loss) before equity in net income of subsidiaries		(19,825		)		(9,446		)		275,591				10,027				256,347
Equity in net income of subsidiaries		263,471				86,727				—				(350,198		)		—
Net income (loss)		243,646				77,281				275,591				(340,171		)		256,347
Net (income) loss attributable to noncontrolling interests		—				—				(13,023		)		322				(12,701		)
Net income (loss) available to Arch		243,646				77,281				262,568				(339,849		)		243,646
Preferred dividends		(10,403		)		—				—				—				(10,403		)
Net income (loss) available to Arch common shareholders		$	233,243			$	77,281			$	262,568			$	(339,849	)		$	233,243
Comprehensive income available to Arch		$	183,500			$	70,066			$	212,802			$	(282,868	)		$	183,500

ARCH CAPITAL	43	2019 SECOND QUARTER FORM 10-Q

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Table of Contents

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

		Six Months Ended June 30, 2019
Condensed Consolidating Statement of Income and Comprehensive Income		Arch Capital (Parent Guarantor)				Arch-U.S. (Subsidiary Issuer)				Other Arch Capital Subsidiaries				Consolidating Adjustments and Eliminations				Arch Capital Consolidated
Revenues
Net premiums earned		$	—			$	—			$	2,832,593			$	—			$	2,832,593
Net investment income		84				6,526				350,410				(45,033		)		311,987
Net realized gains (losses)		—				14,343				253,673				(5,645		)		262,371
Net impairment losses recognized in earnings		—				—				(1,358		)		—				(1,358		)
Other underwriting income		—				—				14,778				—				14,778
Equity in net income (loss) of investment funds accounted for using the equity method		—				(64		)		79,467				—				79,403
Other income (loss)		(481		)		—				2,693				—				2,212
	Total revenues	(397		)		20,805				3,532,256				(50,678		)		3,501,986
Expenses
Losses and loss adjustment expenses		—				—				1,486,075				—				1,486,075
Acquisition expenses		—				—				407,937				—				407,937
Other operating expenses		—				—				400,077				—				400,077
Corporate expenses		31,600				4,281				332				—				36,213
Amortization of intangible assets		—				—				40,211				—				40,211
Interest expense		11,076				23,947				67,718				(44,396		)		58,345
Net foreign exchange (gains) losses		2				—				(1,310		)		2,735				1,427
	Total expenses	42,678				28,228				2,401,040				(41,661		)		2,430,285
Income (loss) before income taxes		(43,075		)		(7,423		)		1,131,216				(9,017		)		1,071,701
Income tax (expense) benefit		—				1,844				(92,202		)		—				(90,358		)
Income (loss) before equity in net income of subsidiaries		(43,075		)		(5,579		)		1,039,014				(9,017		)		981,343
Equity in net income of subsidiaries		960,557				285,301				—				(1,245,858		)		—
Net income		917,482				279,722				1,039,014				(1,254,875		)		981,343
Net (income) loss attributable to noncontrolling interests		—				—				(64,499		)		638				(63,861		)
Net income available to Arch		917,482				279,722				974,515				(1,254,237		)		917,482
Preferred dividends		(20,806		)		—				—				—				(20,806		)
Net income available to Arch common shareholders		$	896,676			$	279,722			$	974,515			$	(1,254,237	)		$	896,676
Comprehensive income available to Arch		$	1,303,029			$	469,276			$	1,352,225			$	(1,821,501	)		$	1,303,029

ARCH CAPITAL	44	2019 SECOND QUARTER FORM 10-Q

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Table of Contents

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

		Six Months Ended June 30, 2018
Condensed Consolidating Statement of Income and Comprehensive Income		Arch Capital (Parent Guarantor)				Arch-U.S. (Subsidiary Issuer)				Other Arch Capital Subsidiaries				Consolidating Adjustments and Eliminations				Arch Capital Consolidated
Revenues
Net premiums earned		$	—			$	—			$	2,571,662			$	—			$	2,571,662
Net investment income		35				818				306,299				(44,760		)		262,392
Net realized gains (losses)		29				(7		)		(187,631		)		—				(187,609		)
Net impairment losses recognized in earnings		—				—				(632		)		—				(632		)
Other underwriting income		—				—				9,223				—				9,223
Equity in net income (loss) of investment funds accounted for using the equity method		—				—				36,541				—				36,541
Other income (loss)		2,261				—				926				—				3,187
	Total revenues	2,325				811				2,736,388				(44,760		)		2,694,764
Expenses
Losses and loss adjustment expenses		—				—				1,363,013				—				1,363,013
Acquisition expenses		—				—				394,214				—				394,214
Other operating expenses		—				—				351,196				—				351,196
Corporate expenses		32,811				759				4,254				—				37,824
Amortization of intangible assets		—				—				53,208				—				53,208
Interest expense		11,073				23,939				70,083				(44,115		)		60,980
Net foreign exchange (gains) losses		29				—				(26,921		)		(7,093		)		(33,985		)
	Total expenses	43,913				24,698				2,209,047				(51,208		)		2,226,450
Income (loss) before income taxes		(41,588		)		(23,887		)		527,341				6,448				468,314
Income tax (expense) benefit		—				5,428				(51,011		)		—				(45,583		)
Income (loss) before equity in net income of subsidiaries		(41,588		)		(18,459		)		476,330				6,448				422,731
Equity in net income of subsidiaries		435,657				173,147				—				(608,804		)		—
Net income		394,069				154,688				476,330				(602,356		)		422,731
Net (income) loss attributable to noncontrolling interests		—				—				(29,307		)		645				(28,662		)
Net income available to Arch		394,069				154,688				447,023				(601,711		)		394,069
Preferred dividends		(20,840		)		—				—				—				(20,840		)
Loss on redemption of preferred shares		(2,710		)		—				—				—				(2,710		)
Net income available to Arch common shareholders		$	370,519			$	154,688			$	447,023			$	(601,711	)		$	370,519
Comprehensive income available to Arch		$	231,662			$	76,603			$	291,883			$	(368,486	)		$	231,662

ARCH CAPITAL	45	2019 SECOND QUARTER FORM 10-Q

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Table of Contents

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

				Six Months Ended June 30, 2019
Condensed Consolidating Statement of Cash Flows				Arch Capital (Parent Guarantor)				Arch-U.S. (Subsidiary Issuer)				Other Arch Capital Subsidiaries				Consolidating Adjustments and Eliminations				Arch Capital Consolidated
Operating Activities
	Net Cash Provided By (Used For) Operating Activities			$	30,946			$	24,059			$	749,885			$	(92,366	)		$	712,524
Investing Activities
Purchases of fixed maturity investments				—				(358,996		)		(15,973,650		)		—				(16,332,646		)
Purchases of equity securities				—				(56,441		)		(447,742		)		72,244				(431,939		)
Purchases of other investments				—				(17,891		)		(659,172		)		—				(677,063		)
Proceeds from the sales of fixed maturity investments				—				452,729				15,179,753				—				15,632,482
Proceeds from the sales of equity securities				—				—				248,945				(72,244		)		176,701
Proceeds from the sales, redemptions and maturities of other investments				—				391				534,307				—				534,698
Proceeds from redemptions and maturities of fixed maturity investments				—				100				244,849				—				244,949
Net settlements of derivative instruments				—				—				87,701				—				87,701
Net (purchases) sales of short-term investments				64				(2,015		)		203,471				—				201,520
Change in cash collateral related to securities lending				—				—				7,590				—				7,590
Contributions to subsidiaries				(2,121		)		—				(59,527		)		61,648				—
Issuance of intercompany loans				—				—				(53,828		)		53,828				—
Purchases of fixed assets				(32		)		—				(16,327		)		—				(16,359		)
Other				—				—				(174,578		)		—				(174,578		)
	Net Cash Provided By (Used For) Investing Activities			(2,089		)		17,877				(878,208		)		115,476				(746,944		)
Financing Activities
Purchases of common shares under share repurchase program				(2,871		)		—				—				—				(2,871		)
Proceeds from common shares issued, net				(557		)		—				61,648				(61,648		)		(557		)
Proceeds from intercompany borrowings				—				—				53,828				(53,828		)		—
Proceeds from borrowings				—				—				62,800				—				62,800
Repayments of borrowings				—				—				(27,538		)		—				(27,538		)
Change in cash collateral related to securities lending				—				—				(7,590		)		—				(7,590		)
Dividends paid to redeemable noncontrolling interests				—				—				(9,632		)		638				(8,994		)
Dividends paid to parent (1)				—				—				(91,728		)		91,728				—
Other				—				—				(3,529		)		—				(3,529		)
Preferred dividends paid				(20,806		)		—				—				—				(20,806		)
	Net Cash Provided By (Used For) Financing Activities			(24,234		)		—				38,259				(23,110		)		(9,085		)
Effects of exchange rates changes on foreign currency cash and restricted cash				—				—				1,937				—				1,937
Increase (decrease) in cash and restricted cash				4,623				41,936				(88,127		)		—				(41,568		)
Cash and restricted cash, beginning of year				6,159				5,940				712,544				—				724,643
Cash and restricted cash, end of period				$	10,782			$	47,876			$	624,417			$	—			$	683,075

(1)     Dividends received by parent are included in net cash provided by (used for) operating activities.

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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

				Six Months Ended June 30, 2018
Condensed Consolidating Statement of Cash Flows				Arch Capital (Parent Guarantor)				Arch-U.S. (Subsidiary Issuer)				Other Arch Capital Subsidiaries				Consolidating Adjustments and Eliminations				Arch Capital Consolidated
Operating Activities
	Net Cash Provided By (Used For) Operating Activities			$	201,487			$	149,576			$	1,010,703			$	(864,880	)		$	496,886
Investing Activities
Purchases of fixed maturity investments				—				(125,440		)		(17,347,846		)		605,716				(16,867,570		)
Purchases of equity securities				—				—				(679,663		)		—				(679,663		)
Purchases of other investments				—				—				(1,017,147		)		—				(1,017,147		)
Proceeds from the sales of fixed maturity investments				—				33,793				16,662,466				(605,716		)		16,090,543
Proceeds from the sales of equity securities				—				—				622,068				—				622,068
Proceeds from the sales, redemptions and maturities of other investments				—				—				773,298				—				773,298
Proceeds from redemptions and maturities of fixed maturity investments				—				—				511,448				—				511,448
Net settlements of derivative instruments				—				—				4,498				—				4,498
Net (purchases) sales of short-term investments				96,446				(59,798		)		415,253				—				451,901
Change in cash collateral related to securities lending				—				—				176,304				—				176,304
Contributions to subsidiaries				—				(1,000		)		(22,595		)		23,595				—
Purchases of fixed assets				(71		)		—				(13,171		)		—				(13,242		)
Other				(4		)		—				49,965				—				49,961
	Net Cash Provided By (Used For) Investing Activities			96,371				(152,445		)		134,878				23,595				102,399
Financing Activities
Redemption of preferred shares				(92,555		)		—				—				—				(92,555		)
Purchases of common shares under share repurchase program				(173,575		)		—				—				—				(173,575		)
Proceeds from common shares issued, net				(13,851		)		—				23,595				(23,595		)		(13,851		)
Proceeds from borrowings				—				—				130,579				—				130,579
Repayments of borrowings				—				—				(373,000		)		—				(373,000		)
Change in cash collateral related to securities lending				—				—				(176,304		)		—				(176,304		)
Dividends paid to redeemable noncontrolling interests				—				—				(9,632		)		638				(8,994		)
Dividends paid to parent (1)				—				—				(864,242		)		864,242				—
Other				—				—				(4,489		)		—				(4,489		)
Preferred dividends paid				(20,840		)		—				—				—				(20,840		)
	Net Cash Provided By (Used For) Financing Activities			(300,821		)		—				(1,273,493		)		841,285				(733,029		)
Effects of exchange rates changes on foreign currency cash and restricted cash				—				—				(10,431		)		—				(10,431		)
Increase (decrease) in cash and restricted cash				(2,963		)		(2,869		)		(138,343		)		—				(144,175		)
Cash and restricted cash, beginning of year				10,048				30,380				686,856				—				727,284
Cash and restricted cash, end of period				$	7,085			$	27,511			$	548,513			$	—			$	583,109

(1)     Dividends received by parent are included in net cash provided by (used for) operating activities.

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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

14.    Income Taxes

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The Company’s income tax provision on income before income taxes resulted in an expense of 8.4% for the six months ended June 30, 2019, compared to an expense of 9.7% for the 2018 period. The Company’s 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. For interim reporting purposes, the Company has calculated its annual effective tax rate for the full year of 2019 by treating excess tax benefits that arise from the accounting for stock based compensation as a discrete item. As such, this amount is not included when projecting the Company’s full year annual effective tax rate but rather is accounted for at the U.S. Federal statutory rate of 21% after applying the projected full year annual effective tax rate to actual six months results before the discrete item. The impact of the discrete item resulted in a benefit of 0.4% for the six months ended June 30, 2019.

The Company had a net deferred tax liability of $49.5 million at June 30, 2019, compared to a net deferred tax asset of $22.5 million at December 31, 2018. The change is primarily a result of the appreciation of the Company’s fixed maturities from December 31, 2018 to June 30, 2019. In addition, the Company paid $43.5 million and recovered $46.5 million of income taxes for the six months ended June 30, 2019 and 2018, respectively.

15.    Legal Proceedings

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The Company, in common with the insurance industry in general, is subject to litigation and arbitration in the normal course of its business. As of June 30, 2019, the Company was not a party to any litigation or arbitration which is expected by management to have a material adverse effect on the Company’s results of operations and financial condition and liquidity.

16.    Subsequent Events

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Bellemeade Re 2019-3 Ltd.

In July 2019, the Company’s first-lien U.S. mortgage insurance subsidiaries entered into an aggregate excess of loss reinsurance agreement with Bellemeade Re 2019-3 Ltd. (“Bellemeade 2019-3”), a special purpose reinsurance company domiciled in Bermuda. The Bellemeade 2019-3 agreement provides for up to $700.9 million of aggregate excess of loss reinsurance coverage at inception in excess of $232.1 million of aggregate losses for new delinquencies on a portfolio of in-force policies issued in 2016. The coverage amount decreases over a ten-year period as the underlying covered mortgages amortize.

Bellemeade 2019-3 financed the coverage through the issuance of mortgage insurance-linked notes in an aggregate amount of

 

approximately $700.9 million to unrelated investors (the “Notes”). The maturity date of the Notes is July 25, 2029. The Notes will be redeemed prior to maturity upon the occurrence of a mandatory termination event or if the ceding insurers trigger a termination of the reinsurance agreement following the occurrence of an optional termination event. All of the proceeds paid to Bellemeade 2019-3 from the sale of the Notes were deposited into a reinsurance trust as security for Bellemeade 2019-3’s obligations. At all times, funds in the reinsurance trust account are required to be invested in high credit quality money market funds.

Watford Re Capital Transactions

On July 2, 2019, Watford Holdings Ltd. completed an offering of $175.0 million in aggregate principal amount of its 6.5% senior notes, due July 2, 2029 (“Watford Senior Notes”). Interest on such notes will be paid semi-annually in arrears on each January 2 and July 2, commencing January 2, 2020. The $172.4 million net proceeds from the offering were used to redeem a portion of Watford Holdings Ltd.’s outstanding preference shares.

On August 1, 2019, Watford Holdings Ltd. redeemed 6,919,998 of its 9,065,200 total issued and outstanding Watford Preference Shares. The Watford Preference Shares were redeemed at a total redemption price of $25.19748 per share, inclusive of all declared and unpaid dividends, with accumulation of any undeclared dividends on or after June 30, 2019.

The Company purchased $35.0 million in aggregate principal amount of the Watford Senior Notes. In addition, the Company received $11.5 million pursuant to the redemption of Watford Preference Shares.

Business Acquisition

On July 30, 2019, the Company announced that it has entered into an agreement to purchase Barbican Group Holdings Limited from funds managed by Carlson Capital, a U.S. based alternative asset management firm. The acquisition includes Barbican Managing Agency Limited, Lloyd’s Syndicate 1955, Lloyd’s Syndicate 1856, Lloyd’s Special Purpose Arrangement 6132, Castel Underwriting Agencies Limited and other associated entities. The transaction is subject to regulatory approval and is expected to close in the late third or early fourth quarter of 2019.

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ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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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 ended December 31, 2018 (“2018 Form 10-K”). In addition, readers should review “Risk Factors” set forth in Item 1A of Part I of our 2018 Form 10-K. Tabular amounts are in U.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 Bermuda public limited liability company with approximately $12.49 billion in capital at June 30, 2019 and, through operations in Bermuda, the United States, Europe, Canada and Australia, writes insurance, reinsurance and mortgage insurance on a worldwide basis.

CURRENT OUTLOOK

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Our objective is to achieve an average operating return on average equity of 15% or greater over the insurance cycle, which we believe to be an attractive return to our common shareholders given the risks we assume. We continue to look for opportunities to find acceptable books of business to underwrite without sacrificing underwriting discipline and continue to write a portion of our overall book in catastrophe-exposed business which has the potential to increase the volatility of our operating results.

Market conditions in our property casualty segments continued to improve in the 2019 second quarter, with upward rate movement in property and select casualty lines, and we selectively increased our writings. Our underwriting teams continue to execute a disciplined strategy by emphasizing small and medium-sized accounts over large accounts, shrinking premiums in more commoditized lines such as general liability and by utilizing reinsurance purchases to reduce volatility on large account, high capacity business. We believe that the improvement in the markets reflects broader economic growth, particularly in the U.S. Across the property and casualty industry, we have seen several market opportunities where we have increased our capital deployment, notably in the London markets and excess and surplus lines in the U.S. However, the spread between rate changes and loss trend continues to be a key variable in assessing expected returns and can be difficult to quantify precisely, particularly in specialty lines. Writings in net property catastrophe-exposed business continued to remain low in the 2019 second quarter.

 

Our mortgage segment continues to experience generally favorable market conditions. Although pricing remains competitive in the U.S., borrower credit quality and the general economy remain strong. Our results continue to reflect our success in making high quality credit underwriting risk decisions and building customer relationships.

Arch remains 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 2018. Such programs have continued to generate business. In addition, we completed three Bellemeade risk transfers in March, April and July 2019, increasing our protection for mortgage tail risk.

FINANCIAL MEASURES

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Management uses the following three key financial indicators in evaluating our performance and measuring the overall growth in value generated for Arch 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 of Arch 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 $24.64 at June 30, 2019, compared to $23.12 at March 31, 2019 and $20.68 at June 30, 2018. The 6.6% increase for the 2019 second quarter reflected strong underwriting results and the impact of a decrease in interest rates on our fixed income securities while the 19.2% increase over the trailing twelve months reflected strong underwriting results and investment returns.

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

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measure as defined in Regulation G, represents 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, 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 13.1% for the 2019 second quarter, compared to 11.6% for the 2018 second quarter, and 12.7% for the six months ended June 30, 2019, compared to 11.4% for the 2018 period. The 2019 and 2018 returns reflected favorable mortgage insurance underwriting performance, strong investment returns and a low level of catastrophic activity.

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 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. 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 Portfolio			Benchmark Return
Pre-tax total return (before investment expenses):
2019 Second Quarter	2.37	%		2.17	%
2018 Second Quarter	(0.19	)%		(0.21	)%
Six Months Ended June 30, 2019	5.14	%		5.05	%
Six Months Ended June 30, 2018	(0.51	)%		(0.89	)%

Total return for the 2019 periods reflected the impact of a decline in interest rates, which increased the total return on our investment grade fixed income portfolio, aided by favorable returns on equities.

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, 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. At June 30, 2019, the benchmark return index had an average credit quality of “Aa3” by Moody’s Investors Service (“Moody’s”), and an estimated duration of 3.06 years.

The benchmark return index included weightings to the following indices:

	%
ICE BoAML 1-10 Year AAA - A U.S. Corporate Index	21.00	%
ICE BoAML 1-5 Year U.S. Treasury Index	15.00
ICE BoAML 3-5 Year Fixed Rate Asset Backed Securities Index	7.00
ICE BoAML 1-10 Year U.S. Municipal Securities Index	5.00
Bloomberg Barclays CMBS Invest Grade Aaa Total Return Index	5.00
MSCI ACWI Net Total Return USD Index	5.00
Hedge Fund Research HFRX Fixed Income Credit Index	5.00
Hedge Fund Research HFRX Equal Weighted Strategies	5.00
ICE BoAML 1-10 Year BBB U.S. Corporate Index	4.00
ICE BoAML German Government 1-10 Year Index	4.00
ICE BoAML U.S. Mortgage Backed Securities Index	4.00
ICE BoAML 0-3 Month U.S. Treasury Bill Index	4.00
ICE BoAML 1-5 Year U.K. Gilt Index	3.50
ICE BoAML 5-10 Year U.S. Treasury Index	3.00
ICE BoAML 1-5 Year Australian Governments Index	3.00
ICE BoAML U.S. High Yield Constrained Index	2.50
S&P Leveraged Loan Total Return Index	2.50
ICE BoAML 1-5 Year Canada Government Index	1.00
ICE BoAML 20+ Year Canada Government Index	0.50
Total	100.00	%

COMMENT ON NON-GAAP FINANCIAL MEASURES

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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, 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

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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 under “Results of Operations” below. 

We believe 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, 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, 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 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, net impairment losses recognized in earnings on our 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 (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 our Series C preferred shares in January 2018 and had no impact on shareholders' equity or cash flows. Due to these reasons, we exclude 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, 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. 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 4, “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, in accordance with Regulation G, is shown in note 4, “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. For the ‘other’ segment, performance is measured based on net income or loss.

Along with consolidated underwriting income, we provide a subtotal of underwriting income or loss before the contribution from the ‘other’ segment. The ‘other’ segment includes the

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results of Watford Holdings Ltd. Watford Holdings Ltd. is the parent of Watford Re Ltd., a multi-line Bermuda reinsurance company (together with Watford Holdings Ltd., “Watford Re”). Pursuant to generally accepted accounting principles, Watford Re is considered a variable interest entity and we concluded that we are the primary beneficiary of Watford Re. As such, we consolidate the results of Watford Re in our consolidated financial statements, although we only own approximately 11% of Watford Re’s common equity. Watford Re has its own management and board of directors that is responsible for its overall profitability. In addition, we do not guarantee or provide credit support for Watford Re. Since Watford Re is an independent company, the assets of Watford Re can be used only to settle obligations of Watford Re and Watford Re is solely responsible for its own liabilities and commitments. Our financial exposure to Watford Re is limited to our investment in Watford Re’s common and preferred shares and counterparty credit risk (mitigated by collateral) arising from the reinsurance transactions. We believe that presenting certain information excluding the ‘other’ segment enables investors and other users of our financial information to analyze our performance in a manner similar to how our management analyzes performance.

Our presentation of segment information includes the use of a current year loss ratio which excludes favorable or adverse 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 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 on the capital held in the business, and compares the return generated by our investment portfolio against benchmark returns which we measured our portfolio against during the periods.

 

RESULTS OF OPERATIONS

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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. Each line item reflects the impact of our approximate 11% ownership of Watford Re’s common equity.

	Three Months Ended								Six Months Ended
	June 30,								June 30,
	2019				2018				2019				2018
Net income available to Arch common shareholders	$	458,551			$	233,243			$	896,676			$	370,519
Net realized (gains) losses	(124,637		)		61,426				(240,281		)		173,190
Net impairment losses recognized in earnings	49				470				1,358				632
Equity in net (income) loss of investment funds accounted for using the equity method	(32,536		)		(8,472		)		(79,403		)		(36,541		)
Net foreign exchange (gains) losses	6,054				(47,038		)		1,060				(31,482		)
Transaction costs and other	2,178				6,908				3,368				7,738
Loss on redemption of preferred shares	—				—				—				2,710
Income tax expense (benefit) (1)	7,774				(3,941		)		10,552				(9,027		)
After-tax operating income available to Arch common shareholders	$	317,433			$	242,596			$	593,330			$	477,739
Beginning common shareholders’ equity	$	9,334,596			$	8,370,372			$	8,659,827			$	8,324,047
Ending common shareholders’ equity	9,977,352				8,383,755				9,977,352				8,383,755
Average common shareholders’ equity	$	9,655,974			$	8,377,064			$	9,318,590			$	8,353,901
Annualized return on average common equity %	19.0				11.1				19.2				8.9
Annualized operating return on average common equity %	13.1				11.6				12.7				11.4

(1)	Income tax on 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, transaction costs and other and loss on redemption of preferred shares reflects the relative mix reported by jurisdiction and the varying tax rates in each jurisdiction.

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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 President and Chief Executive Officer of Arch Capital and the Chief Financial Officer of Arch 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 June 30,
	2019				2018				% Change
Gross premiums written	$	919,925			$	769,372			19.6
Premiums ceded	(292,095		)		(245,265		)
Net premiums written	627,830				524,107				19.8
Change in unearned premiums	(35,388		)		22,342
Net premiums earned	592,442				546,449				8.4
Losses and loss adjustment expenses	(389,172		)		(357,465		)
Acquisition expenses	(91,094		)		(90,670		)
Other operating expenses	(109,523		)		(92,680		)
Underwriting income	$	2,653			$	5,634			(52.9	)
Underwriting Ratios									% Point Change
Loss ratio	65.7		%		65.4		%		0.3
Acquisition expense ratio	15.4		%		16.6		%		(1.2	)
Other operating expense ratio	18.5		%		17.0		%		1.5
Combined ratio	99.6		%		99.0		%		0.6

 

	Six Months Ended June 30,
	2019				2018				% Change
Gross premiums written	$	1,861,879			$	1,592,750			16.9
Premiums ceded	(612,717		)		(492,445		)
Net premiums written	1,249,162				1,100,305				13.5
Change in unearned premiums	(103,215		)		(15,119		)
Net premiums earned	1,145,947				1,085,186				5.6
Losses and loss adjustment expenses	(745,895		)		(711,195		)
Acquisition expenses	(173,918		)		(175,839		)
Other operating expenses	(222,919		)		(184,654		)
Underwriting income (loss)	$	3,215			$	13,498			(76.2	)
Underwriting Ratios									% Point Change
Loss ratio	65.1		%		65.5		%		(0.4	)
Acquisition expense ratio	15.2		%		16.2		%		(1.0	)
Other operating expense ratio	19.5		%		17.0		%		2.5
Combined ratio	99.8		%		98.7		%		1.1

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 managers with unique expertise and niche products offering

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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 stand alone 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 June 30,
	2019							2018
	Amount				%			Amount				%
Professional Lines	$	121,679			19.4			$	108,298			20.7
Programs	108,671				17.3			100,178				19.1
Property, energy, marine and aviation	103,819				16.5			62,121				11.9
Travel, accident and health	76,537				12.2			63,222				12.1
Construction and national accounts	60,888				9.7			66,384				12.7
Excess and surplus casualty	58,466				9.3			40,042				7.6
Lenders products	22,373				3.6			22,290				4.3
Other	75,397				12.0			61,572				11.7
Total	$	627,830			100.0			$	524,107			100.0

2019 Second Quarter versus 2018 Second Quarter. Gross premiums written by the insurance segment in the 2019 second quarter were 19.6% higher than in the 2018 second quarter, while net premiums written were 19.8% higher. Approximately one third of the growth in net premiums written resulted from our acquisition of renewal rights of a U.K. commercial lines book of business on January 1, 2019. The remainder was due to growth in existing accounts and rate increases across most lines of business.

 

	Six Months Ended June 30,
	2019							2018
	Amount				%			Amount				%
Professional Lines	$	250,913			20.1			$	228,087			20.7
Programs	209,843				16.8			196,734				17.9
Property, energy, marine and aviation	174,305				14.0			114,248				10.4
Travel, accident and health	164,641				13.2			143,746				13.1
Construction and national accounts	156,243				12.5			164,812				15.0
Excess and surplus casualty	103,631				8.3			81,964				7.4
Lenders products	44,788				3.6			44,274				4.0
Other	144,798				11.6			126,440				11.5
Total	$	1,249,162			100.0			$	1,100,305			100.0

Six Months Ended June 30, 2019 versus 2018 period. Gross premiums written by the insurance segment for the six months ended June 30, 2019 were 16.9% higher than in the 2018 period, while net premiums written were 13.5% higher than in the 2018 period. Growth in net premiums written resulted from our acquisition of renewal rights of a U.K. commercial lines book of business on January 1, 2019, growth in existing accounts and rate increases across most lines of business. The percentage increase in gross premiums written is higher than the increase in net premiums written due to a single large national account, for which the premium written in the quarter was substantially ceded.

Net Premiums Earned.

The following tables set forth our insurance segment’s net premiums earned by major line of business:

	Three Months Ended June 30,
	2019							2018
	Amount				%			Amount				%
Professional Lines	$	115,667			19.5			$	112,226			20.5
Programs	102,687				17.3			97,333				17.8
Property, energy, marine and aviation	68,995				11.6			50,840				9.3
Travel, accident and health	83,636				14.1			74,754				13.7
Construction and national accounts	76,795				13.0			81,784				15.0
Excess and surplus casualty	47,858				8.1			40,049				7.3
Lenders products	23,570				4.0			23,161				4.2
Other	73,234				12.4			66,302				12.1
Total	$	592,442			100.0			$	546,449			100.0

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	Six Months Ended June 30,
	2019							2018
	Amount				%			Amount				%
Professional Lines	$	230,458			20.1			$	228,244			21.0
Programs	200,173				17.5			192,344				17.7
Property, energy, marine and aviation	128,633				11.2			99,443				9.2
Travel, accident and health	155,211				13.5			141,589				13.0
Construction and national accounts	152,726				13.3			158,996				14.7
Excess and surplus casualty	90,227				7.9			86,593				8.0
Lenders products	46,802				4.1			45,977				4.2
Other	141,717				12.4			132,000				12.2
Total	$	1,145,947			100.0			$	1,085,186			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 in the 2019 second quarter were 8.4% higher than in the 2018 second quarter. For the six months ended June 30, 2019, net premiums earned were 5.6% higher than in the 2018 period. Net premiums earned reflect changes in net premiums written over the previous five quarters.

Losses and Loss Adjustment Expenses.

The table below shows the components of the insurance segment’s loss ratio:

	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2019			2018			2019			2018
Current year	66.1	%		66.5	%		65.7	%		66.3	%
Prior period reserve development	(0.4	)%		(1.1	)%		(0.6	)%		(0.8	)%
Loss ratio	65.7	%		65.4	%		65.1	%		65.5	%

Current Year Loss Ratio.

The insurance segment’s current year loss ratio in the 2019 second quarter was 0.4 points lower than in the 2018 second quarter and reflected 0.4 points of current year catastrophic activity, compared to 1.4 points in the 2018 second quarter. The insurance segment’s current year loss ratio for the six months ended June 30, 2019 was 0.6 points lower than in the 2018 period and reflected 0.2 points of current year catastrophic activity, compared to 0.8 points in the 2018 period. The balance of the change in the 2018 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 $2.6 million, or 0.4 points, for the 2019 second quarter, compared to $6.1 million, or 1.1 points, for the 2018 second quarter, and

 

$7.0 million, or 0.6 points, for the six months ended June 30, 2019, compared to $8.2 million, or 0.8 points, for the 2018 period. See note 5, “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.

2019 Second Quarter versus 2018 Second Quarter. The insurance segment’s underwriting expense ratio was 33.9% in the 2019 second quarter, compared to 33.6% in the 2018 second quarter. Operating expenses increased in the 2019 second quarter due to our recent acquisitions, as well as growth in headcount, primarily in the areas of underwriting and technology. The resulting increase in the expense ratio was partially offset by the growth in net premiums earned.

Six Months Ended June 30, 2019 versus 2018 period. The insurance segment’s underwriting expense ratio was 34.7% for the six months ended June 30, 2019, compared to 33.2% for the 2018 period. Operating expenses increased for the six months ended June 30, 2019 due to the recent acquisitions by the Company, as well as growth in headcount, primarily in the areas of underwriting and technology. The resulting increase in the expense ratio was partially offset by the growth in net premiums earned.

Reinsurance Segment 

The following tables set forth our reinsurance segment’s underwriting results:

	Three Months Ended June 30,
	2019				2018				% Change
Gross premiums written	$	545,547			$	490,327			11.3
Premiums ceded	(169,457		)		(136,247		)
Net premiums written	376,090				354,080				6.2
Change in unearned premiums	(8,906		)		(13,762		)
Net premiums earned	367,184				340,318				7.9
Other underwriting income	1,224				(129		)
Losses and loss adjustment expenses	(240,958		)		(229,956		)
Acquisition expenses	(56,785		)		(50,142		)
Other operating expenses	(33,960		)		(35,678		)
Underwriting income	$	36,705			$	24,413			50.4
Underwriting Ratios									% Point Change
Loss ratio	65.6		%		67.6		%		(2.0	)
Acquisition expense ratio	15.5		%		14.7		%		0.8
Other operating expense ratio	9.2		%		10.5		%		(1.3	)
Combined ratio	90.3		%		92.8		%		(2.5	)

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	Six Months Ended June 30,
	2019				2018				% Change
Gross premiums written	$	1,228,402			$	1,067,810			15.0
Premiums ceded	(401,024		)		(331,977		)
Net premiums written	827,378				735,833				12.4
Change in unearned premiums	(113,829		)		(116,343		)
Net premiums earned	713,549				619,490				15.2
Other underwriting income	5,601				1,103
Losses and loss adjustment expenses	(480,768		)		(371,631		)
Acquisition expenses	(111,111		)		(98,461		)
Other operating expenses	(69,664		)		(71,249		)
Underwriting income (loss)	$	57,607			$	79,252			(27.3	)
Underwriting Ratios									% Point Change
Loss ratio	67.4		%		60.0		%		7.4
Acquisition expense ratio	15.6		%		15.9		%		(0.3	)
Other operating expense ratio	9.8		%		11.5		%		(1.7	)
Combined ratio	92.8		%		87.4		%		5.4

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 basis. In addition, facultative business is written which focuses on individual 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 June 30,
	2019							2018
	Amount				%			Amount				%
Other specialty	$	129,174			34.3			$	155,081			43.8
Casualty	78,025				20.7			68,113				19.2
Property excluding property catastrophe	96,050				25.5			77,876				22.0
Property catastrophe	46,594				12.4			35,045				9.9
Marine and aviation	15,619				4.2			10,061				2.8
Other	10,628				2.8			7,904				2.2
Total	$	376,090			100.0			$	354,080			100.0

2019 Second Quarter versus 2018 Second Quarter. Gross premiums written by the reinsurance segment in the 2019 second quarter were 11.3% higher than in the 2018 second quarter, while net premiums written were 6.2% higher. The increase in gross premiums written is primarily a result of growth in property business, with a significant amount being retroceded. The increase in net premiums written in the 2019 second quarter reflected growth from select new business opportunities across most lines of business. This was partially offset by a decline in other specialty business, primarily reflecting a reduction in U.K motor business with one cedent in the period.

	Six Months Ended June 30,
	2019							2018
	Amount				%			Amount				%
Other specialty	$	269,651			32.6			$	294,073			40.0
Casualty	246,509				29.8			198,289				26.9
Property excluding property catastrophe	198,790				24.0			163,046				22.2
Property catastrophe	49,977				6.0			42,677				5.8
Marine and aviation	31,577				3.8			20,073				2.7
Other	30,874				3.7			17,675				2.4
Total	$	827,378			100.0			$	735,833			100.0

Six Months Ended June 30, 2019 versus 2018 period. Gross premiums written by the reinsurance segment for the six months ended June 30, 2019 were 15.0% higher than in the 2018 period, while net premiums written were 12.4% higher than in the 2018 period. The increase in gross premiums written is primarily a

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result of growth in property business, with a significant amount being retroceded. The increase in net premiums written for the six months ended June 30, 2019 reflected growth from select new business opportunities across most lines of business, partially offset by a decline in other specialty business, primarily reflecting a reduction in U.K motor business with one cedent in the period.

Net Premiums Earned.

The following tables set forth our reinsurance segment’s net premiums earned by major line of business:

	Three Months Ended June 30,
	2019							2018
	Amount				%			Amount				%
Other specialty	$	136,573			37.2			$	149,648			44.0
Casualty	103,164				28.1			85,009				25.0
Property excluding property catastrophe	85,479				23.3			70,849				20.8
Property catastrophe	18,537				5.0			15,716				4.6
Marine and aviation	12,498				3.4			10,089				3.0
Other	10,933				3.0			9,007				2.6
Total	$	367,184			100.0			$	340,318			100.0

	Six Months Ended June 30,
	2019							2018
	Amount				%			Amount				%
Other specialty	$	258,094			36.2			$	253,365			40.9
Casualty	194,788				27.3			154,381				24.9
Property excluding property catastrophe	169,271				23.7			139,603				22.5
Property catastrophe	37,269				5.2			34,103				5.5
Marine and aviation	23,557				3.3			19,478				3.1
Other	30,570				4.3			18,560				3.0
Total	$	713,549			100.0			$	619,490			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. For the 2019 second quarter, net premiums earned were 7.9% higher than in the 2018 second quarter. For the six months ended June 30, 2019, net premiums earned were 15.2% higher than in the 2018 period.

Other Underwriting Income (Loss).

Other underwriting income (loss) for the 2019 second quarter was $1.2 million, compared to $(0.1) million for the 2018 second quarter, and $5.6 million for the six months ended June 30, 2019, compared to $1.1 million for the 2018 period.

 

Losses and Loss Adjustment Expenses.

The table below shows the components of the reinsurance segment’s loss ratio:

	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2019			2018			2019			2018
Current year	69.1	%		77.3	%		68.9	%		71.2	%
Prior period reserve development	(3.5	)%		(9.7	)%		(1.5	)%		(11.2	)%
Loss ratio	65.6	%		67.6	%		67.4	%		60.0	%

Current Year Loss Ratio.

The reinsurance segment’s current year loss ratio in the 2019 second quarter was 8.2 points lower than in the 2018 second quarter and reflected 1.3 points of current year catastrophic activity, compared to 2.2 points in the 2018 second quarter. The reinsurance segment’s current year loss ratio for the six months ended June 30, 2019 was 2.3 points lower than in the 2018 period and reflected 1.7 points of current year catastrophic activity, compared to 1.4 points in the 2018 period. In addition, the current year loss ratio for the 2019 periods reflected a lower level of large attritional loss activity than in the 2018 periods.

Prior Period Reserve Development.

The reinsurance segment’s net favorable development was $12.7 million, or 3.5 points, for the 2019 second quarter, compared to $33.0 million, or 9.7 points, for the 2018 second quarter, and $11.0 million, or 1.5 points, for the six months ended June 30, 2019, compared to $69.6 million, or 11.2 points, for the 2018 period. See note 5, “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.

2019 Second Quarter versus 2018 Second Quarter. The underwriting expense ratio for the reinsurance segment was 24.7% in the 2019 second quarter, compared to 25.2% in the 2018 second quarter, reflecting growth in net premiums earned and changes in mix of business.

Six Months Ended June 30, 2019 versus 2018 period. The underwriting expense ratio for the reinsurance segment was 25.4% for the six months ended June 30, 2019, compared to 27.4% for the 2018 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.

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primarily through Arch Mortgage Insurance Company and United Guaranty Residential Insurance 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 MI Europe”) and in Hong Kong through Arch MI Asia Limited (“Arch MI Asia”); 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 June 30,
	2019				2018				% Change
Gross premiums written	$	364,465			$	330,990			10.1
Premiums ceded	(42,857		)		(50,867		)
Net premiums written	321,608				280,123				14.8
Change in unearned premiums	31,175				10,355
Net premiums earned	352,783				290,478				21.4
Other underwriting income	4,056				3,315
Losses and loss adjustment expenses	(25,997		)		(21,591		)
Acquisition expenses	(32,654		)		(27,737		)
Other operating expenses	(39,819		)		(38,729		)
Underwriting income	$	258,369			$	205,736			25.6
Underwriting Ratios									% Point Change
Loss ratio	7.4		%		7.4		%		—
Acquisition expense ratio	9.3		%		9.5		%		(0.2	)
Other operating expense ratio	11.3		%		13.3		%		(2.0	)
Combined ratio	28.0		%		30.2		%		(2.2	)

	Six Months Ended June 30,
	2019				2018				% Change
Gross premiums written	$	720,515			$	652,168			10.5
Premiums ceded	(91,655		)		(97,004		)
Net premiums written	628,860				555,164				13.3
Change in unearned premiums	46,825				15,556
Net premiums earned	675,685				570,720				18.4
Other underwriting income	7,912				6,731
Losses and loss adjustment expenses	(37,146		)		(65,057		)
Acquisition expenses	(64,326		)		(54,304		)
Other operating expenses	(79,694		)		(77,500		)
Underwriting income	$	502,431			$	380,590			32.0
Underwriting Ratios									% Point Change
Loss ratio	5.5		%		11.4		%		(5.9	)
Acquisition expense ratio	9.5		%		9.5		%		—
Other operating expense ratio	11.8		%		13.6		%		(1.8	)
Combined ratio	26.8		%		34.5		%		(7.7	)

 

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 June 30,
	2019							2018
	Amount				%			Amount				%
Underwriting location:
United States	$	258,774			80.5			$	229,715			82.0
Other	62,834				19.5			50,408				18.0
Total	$	321,608			100.0			$	280,123			100.0

2019 Second Quarter versus 2018 Second Quarter. Gross premiums written by the mortgage segment in the 2019 second quarter were 10.1% higher than in the 2018 second quarter, while net premiums written were 14.8% higher. The growth in net premiums written primarily reflected an increase in monthly premium business due to growth in insurance in force, partially offset by higher ceded premiums related to Bellemeade transactions. In addition, net premiums written for the 2019 second quarter included $17.1 million due to the novation of a quota share reinsurance arrangement on international business.

	Six Months Ended June 30,
	2019							2018
	Amount				%			Amount				%
Underwriting location:
United States	$	514,154			81.8			$	450,892			81.2
Other	114,706				18.2			104,272				18.8
Total	$	628,860			100.0			$	555,164			100.0

Six Months Ended June 30, 2019 versus 2018 period. Gross premiums written by the mortgage segment for the six months ended June 30, 2019 were 10.5% higher than in the 2018 period, while net premiums written were 13.3% higher. The growth in net premiums written primarily reflected an increase in monthly premium business due to growth in insurance in force, partially offset by higher ceded premiums related to Bellemeade transactions. In addition, net premiums written for the six months ended June 30, 2019 included $17.1 million due to the novation of a quota share reinsurance arrangement on international business.

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, of the Arch MI U.S. portfolio of mortgage loans was 80.9% at June 30, 2019, compared to 81.5% at December 31, 2018.

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Arch MI U.S. generated $17.2 billion of new insurance written (“NIW”) in the 2019 second quarter, compared to $19.9 billion in the 2018 second quarter. NIW represents the original principal balance of all loans that received coverage during the period. Monthly premium policies contributed 92.9% of NIW in the 2019 second quarter, compared to 94.3% for the 2018 second quarter.

The following tables provide details on the NIW generated by Arch MI U.S.:

(U.S. Dollars in millions)	Three Months Ended June 30,
	2019							2018
	Amount				%			Amount				%
Total new insurance written (NIW) (1)	$	17,161						$	19,944
Credit quality (FICO):
>=740	$	9,862			57.5			$	11,308			56.7
680-739	6,139				35.8			7,182				36.0
620-679	1,160				6.8			1,454				7.3
Total	$	17,161			100.0			$	19,944			100.0
Loan-to-value (LTV):
95.01% and above	$	2,530			14.7			$	2,835			14.2
90.01% to 95.00%	7,497				43.7			9,205				46.2
85.01% to 90.00%	5,026				29.3			5,910				29.6
85.01% and below	2,108				12.3			1,994				10.0
Total	$	17,161			100.0			$	19,944			100.0
Monthly vs. single:
Monthly	$	15,935			92.9			$	18,814			94.3
Single	1,226				7.1			1,130				5.7
Total	$	17,161			100.0			$	19,944			100.0
Purchase vs. refinance:
Purchase	$	14,992			87.4			$	18,871			94.6
Refinance	2,169				12.6			1,073				5.4
Total	$	17,161			100.0			$	19,944			100.0

(1)	Represents the original principal balance of all loans that received coverage during the period.

 

(U.S. Dollars in millions)	Six Months Ended June 30,
	2019							2018
	Amount				%			Amount				%
Total new insurance written (NIW) (1)	$	28,368						$	31,317
Credit quality (FICO):
>=740	$	16,212			57.1			$	17,920			57.2
680-739	10,180				35.9			11,224				35.8
620-679	1,976				7.0			2,173				6.9
Total	$	28,368			100.0			$	31,317			100.0
Loan-to-value (LTV):
95.01% and above	$	4,338			15.3			$	4,097			13.1
90.01% to 95.00%	12,472				44.0			14,341				45.8
85.01% to 90.00%	8,175				28.8			9,553				30.5
85.01% and below	3,383				11.9			3,326				10.6
Total	$	28,368			100.0			$	31,317			100.0
Monthly vs. single:
Monthly	$	26,198			92.4			$	29,204			93.3
Single	2,170				7.6			2,113				6.7
Total	$	28,368			100.0			$	31,317			100.0
Purchase vs. refinance:
Purchase	$	25,281			89.1			$	29,159			93.1
Refinance	3,087				10.9			2,158				6.9
Total	$	28,368			100.0			$	31,317			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 June 30,
	2019							2018
	Amount				%			Amount				%
Underwriting location:
United States	$	282,062			80.0			$	247,897			85.3
Other	70,721				20.0			42,581				14.7
Total	$	352,783			100.0			$	290,478			100.0

	Six Months Ended June 30,
	2019							2018
	Amount				%			Amount				%
Underwriting location:
United States	$	556,535			82.4			$	486,038			85.2
Other	119,150				17.6			84,682				14.8
Total	$	675,685			100.0			$	570,720			100.0

Net premiums earned for the 2019 second quarter were 21.4% higher than in the 2018 second quarter. For the six months ended June 30, 2019, net premiums earned were 18.4% higher than in the 2018 period. The increases were primarily due to growth in U.S. insurance in force.

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Other Underwriting Income.

Other underwriting income, which is primarily related to older GSE credit risk-sharing transactions receiving derivative accounting treatment, was $4.1 million for the 2019 second quarter, compared to $3.3 million for the 2018 second quarter. and $7.9 million for the six months ended June 30, 2019, compared to $6.7 million for the 2018 period.

Losses and Loss Adjustment Expenses.

The table below shows the components of the mortgage segment’s loss ratio:

	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2019			2018			2019			2018
Current year	13.9	%		15.4	%		14.3	%		17.8	%
Prior period reserve development	(6.5	)%		(8.0	)%		(8.8	)%		(6.4	)%
Loss ratio	7.4	%		7.4	%		5.5	%		11.4	%

Current Year Loss Ratio.

The mortgage segment’s current year loss ratio was 1.5 points lower in the 2019 second quarter than in the 2018 second quarter. The mortgage segment’s current year loss ratio was 3.5 points lower for the six months ended June 30, 2019 than for the 2018 period. The lower current year loss ratios for the 2019 periods reflect the current favorable macroeconomic environment.

Prior Period Reserve Development.

The mortgage segment’s net favorable development was $22.8 million, or 6.5 points, for the 2019 second quarter, compared to $23.3 million, or 8.0 points, for the 2018 second quarter, and $59.4 million, or 8.8 points, for the six months ended June 30, 2019, compared to $36.3 million, or 6.4 points, for the 2018 period. See note 5, “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.

2019 Second Quarter versus 2018 Second Quarter. The underwriting expense ratio for the mortgage segment was 20.6% in the 2019 second quarter, compared to 22.8% in the 2018 second quarter. The lower ratio in the 2019 second quarter primarily resulted from the higher level of net premiums earned.

Six Months Ended June 30, 2019 versus 2018 period. The underwriting expense ratio for the mortgage segment was 21.3% for the six months ended June 30, 2019, compared to 23.1% for the 2018 period. The lower underwriting expense

 

ratio in the 2019 period primarily resulted from the higher level of net premiums earned.

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, 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 and income taxes. Such amounts exclude the results of the ‘other’ segment.

Net Investment Income.

The components of net investment income were derived from the following sources:

	Three Months Ended								Six Months Ended
	June 30,								June 30,
	2019				2018				2019				2018
Fixed maturities	$	111,335			$	98,968			$	221,986			$	191,406
Equity securities	3,494				4,232				5,740				6,982
Short-term investments	3,448				4,225				7,746				8,174
Other (1)	20,115				19,242				43,059				38,471
Gross investment income	138,392				126,667				278,531				245,033
Investment expenses (2)	(15,354		)		(18,906		)		(34,244		)		(37,029		)
Net investment income	$	123,038			$	107,761			$	244,287			208,004

(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 0.38% of average invested assets for the 2019 second quarter, compared to 0.40% for the 2018 second quarter, and 0.35% for the six months ended June 30, 2019, compared to 0.37% for the 2018 period.

The higher level of net investment income for the 2019 periods reflected growth in invested assets, the reinvestment of fixed income securities at higher available yields and the shift from municipal bonds to corporates. The pre-tax investment income yield, calculated based on amortized cost and on an annualized basis, was 2.62% for the 2019 second quarter, compare to 2.32% for the 2018 second quarter, and 2.64% for the six months ended June 30, 2019, compared to 2.23% for the 2018 period.

Corporate Expenses.

Corporate expenses were $16.1 million for the 2019 second quarter, compared to $15.6 million for the 2018 second quarter, and $32.8 million for the six months ended June 30, 2019, compared to $30.1 million for the 2018 period. The increase in corporate expenses in the 2019 periods primarily reflected higher incentive compensation costs.

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Transaction Costs and Other.

Transaction costs and other were $2.2 million for the 2019 second quarter, compared to $6.9 million for the 2018 second quarter, and $3.4 million for the six months ended June 30, 2019, compared to $7.7 million for the 2018 period. Amounts in 2019 primarily related to recent acquisition activity while the 2018 activity primarily related to severance and related costs.

Amortization of Intangible Assets.

Amortization of intangible assets for the 2019 second quarter was $19.8 million, compared to $26.5 million for the 2018 second quarter, and $40.2 million for the six months ended June 30, 2019, compared to $53.2 million for the 2018 period. Such expenses primarily related to the UGC acquisition, while the 2019 periods also included amortization related to the previously announced acquisitions of (i) renewal rights of a U.K. commercial lines book of business on January 1, 2019; and (ii) McNeil &Co. on December 6, 2018. See the consolidated financial statements contained in our 2018 Form 10-K for disclosures on our amortization pattern.

Interest Expense.

Interest expense was $23.4 million for the 2019 second quarter, compared to the $26.1 million for the 2018 second quarter, and $46.9 million for the six months ended June 30, 2019, compared to $52.0 million for the 2018 period. The lower level in the 2019 periods reflected the paydown of revolving credit agreement borrowings in the second half of 2018.

Loss on Redemption of Preferred Shares.

In January 2018, we redeemed all remaining 6.75% Series C preferred shares and, in accordance with GAAP, recorded a loss of $2.7 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 gains of $125.1 million for the 2019 second quarter, compared to net realized losses of $59.5 million for the 2018 second quarter, and net realized gains of $237.5 million for the six months ended June 30, 2019, compared to net realized losses of $171.4 million for the 2018 period. 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 re-measurement of contingent consideration liability amounts. See note 6, “Investment Information—Net Realized Gains (Losses),” to our consolidated financial statements for additional information.

Net Impairment Losses Recognized in Earnings.

We recorded minimal impairment losses for the 2019 second quarter, compared to $0.5 million for the 2018 second quarter, and $1.4 million for the six months ended June 30, 2019, compared to $0.6 million for the 2018 period. See note 6, “Investment Information—Other-Than-Temporary Impairments,” to our consolidated financial statements for additional information.

Equity in Net Income (Loss) of Investment Funds Accounted for Using the Equity Method.

We recorded $32.5 million of equity in net income related to investment funds accounted for using the equity method in the 2019 second quarter, compared to $8.5 million of income for the 2018 second quarter, and $79.4 million of income for the six months ended June 30, 2019, compared to $36.5 million for the 2018 period. Investment funds accounted for using the equity method totaled $1.58 billion at June 30, 2019, compared to $1.49 billion at December 31, 2018. See note 6, “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 losses for the 2019 second quarter were $6.2 million, compared to net foreign exchange gains for the 2018 second quarter of $46.2 million. Net foreign exchange losses for the six months ended June 30, 2019 were $1.0 million, compared to net foreign exchange gains for the 2018 period of $31.2 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 resulted in an expense of 8.7% for the 2019 second quarter and 9.0% for the six months ended June 30, 2019, compared to 8.9% for the 2018 second quarter and 10.4% for the six months ended June 30, 2018 . The effective tax rates for the 2019 second quarter and six months ended June 30, 2019 included a discrete income tax benefit of $2.5 million and $4.3 million, respectively, related to share based compensation. 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.

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Other Segment 

The ‘other’ segment includes the results of Watford Re. Pursuant to generally accepted accounting principles, Watford Re is considered a variable interest entity and we concluded that we are the primary beneficiary of Watford Re. As such, we consolidate the results of Watford Re in our consolidated financial statements, although we only own approximately 11% of Watford Re’s common equity. See note 11, “Variable Interest Entities and Noncontrolling Interests,” and note 4, “Segment Information,” to our consolidated financial statements for additional information on Watford Re.

CRITICAL ACCOUNTING POLICIES,

ESTIMATES AND RECENT ACCOUNTING PRONOUNCEMENTS

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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 2018 Form 10-K, updated where applicable in the notes accompanying our consolidated financial statements, including note 1, “Basis of Presentation and Recent Accounting Pronouncements.”

FINANCIAL CONDITION

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Investable Assets 

At June 30, 2019, total investable assets held by Arch were $20.78 billion, excluding the $2.77 billion included in the ‘other’ segment (i.e., attributable to Watford Re).

 

Investable Assets Held by Arch 

The following table summarizes the fair value of the investable assets held by Arch:

Investable assets (1):	Estimated Fair Value				% of Total
June 30, 2019
Fixed maturities (2)	$	15,959,794			76.8
Short-term investments (2)	847,250				4.1
Cash	536,339				2.6
Equity securities (2)	666,900				3.2
Other investments (2)	1,327,134				6.4
Investments accounted for using the equity method	1,581,972				7.6
Securities transactions entered into but not settled at the balance sheet date	(142,726		)		(0.7	)
Total investable assets held by Arch	$	20,776,663			100.0
Average effective duration (in years)	3.52
Average S&P/Moody’s credit ratings (3)	AA/Aa2
Embedded book yield (4)	2.87		%
December 31, 2018
Fixed maturities (2)	$	14,881,902			76.1
Short-term investments (2)	995,926				5.1
Cash	583,027				3.0
Equity securities (2)	368,843				1.9
Other investments (2)	1,261,525				6.4
Investments accounted for using the equity method	1,493,791				7.6
Securities transactions entered into but not settled at the balance sheet date	(18,153		)		(0.1	)
Total investable assets held by Arch	$	19,566,861			100.0
Average effective duration (in years)	3.38
Average S&P/Moody’s credit ratings (3)	AA/Aa2
Embedded book yield (4)	2.89		%

(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.

(2)	Includes investments carried at fair value under the fair value option.

(3)	Average credit ratings on our investment portfolio on securities with ratings by Standard & Poor’s Rating Services (“S&P”) and Moody’s Investors Service (“Moody’s”).

(4)	Before investment expenses.

At June 30, 2019, approximately $14.96 billion, or 72.0%, of total investable assets held by Arch were internally managed, compared to $14.08 billion, or 72.0%, at December 31, 2018.

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The following table summarizes our fixed maturities and fixed maturities pledged under securities lending agreements (“Fixed Maturities”) by type:

	Estimated Fair Value				% of Total
June 30, 2019
Corporate bonds	$	6,281,897			39.4
Mortgage backed securities	513,760				3.2
Municipal bonds	581,378				3.6
Commercial mortgage backed securities	686,707				4.3
U.S. government and government agencies	4,545,169				28.5
Non-U.S. government securities	1,847,023				11.6
Asset backed securities	1,503,860				9.4
Total	$	15,959,794			100.0
December 31, 2018
Corporate bonds	$	5,735,526			38.5
Mortgage backed securities	535,763				3.6
Municipal bonds	1,012,308				6.8
Commercial mortgage backed securities	729,442				4.9
U.S. government and government agencies	3,601,269				24.2
Non-U.S. government securities	1,713,891				11.5
Asset backed securities	1,553,703				10.4
Total	$	14,881,902			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.

	Estimated Fair Value				% of Total
June 30, 2019
U.S. government and gov’t agencies (1)	$	5,030,769			31.5
AAA	3,325,260				20.8
AA	1,831,265				11.5
A	3,439,690				21.6
BBB	1,465,219				9.2
BB	361,389				2.3
B	226,885				1.4
Lower than B	60,858				0.4
Not rated	218,459				1.4
Total	$	15,959,794			100.0
December 31, 2018
U.S. government and gov’t agencies (1)	$	4,194,676			28.2
AAA	3,551,039				23.9
AA	2,129,336				14.3
A	3,069,656				20.6
BBB	1,251,205				8.4
BB	275,201				1.8
B	183,614				1.2
Lower than B	61,271				0.4
Not rated	165,904				1.1
Total	$	14,881,902			100.0

(1)	Includes U.S. government-sponsored agency residential mortgage-backed securities and agency commercial mortgage-backed securities.

 

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:

Severity of gross unrealized losses:	Estimated Fair Value				Gross Unrealized Losses				% of Total Gross Unrealized Losses
June 30, 2019
0-10%	$	3,323,262			$	(51,874	)		83.8
10-20%	54,735				(9,486		)		15.3
20-30%	1,496				(460		)		0.7
Greater than 30%	73				(114		)		0.2
Total	$	3,379,566			$	(61,934	)		100.0
December 31, 2018
0-10%	$	8,722,837			$	(190,170	)		92.5
10-20%	87,188				(13,012		)		6.3
20-30%	3,359				(1,058		)		0.5
Greater than 30%	2,363				(1,266		)		0.6
Total	$	8,815,747			$	(205,506	)		100.0

The following table summarizes our top ten exposures to fixed income corporate issuers by fair value at June 30, 2019, excluding guaranteed amounts and covered bonds:

	Estimated Fair Value				Credit Rating (1)
Bank of America Corporation	$	234,672			A-/A2
JPMorgan Chase & Co.	228,144				A-/A2
Wells Fargo & Company	216,814				A/A1
Citigroup Inc.	207,673				A/A1
Apple Inc.	144,498				AA+/Aa1
Morgan Stanley	117,638				BBB+/A3
Nestle S.A.	112,919				AA-/Aa2
American Express Company	112,584				BBB+/A3
BP P.L.C.	109,805				A-/A1
The Goldman Sachs Group, Inc.	108,946				BBB+/A3
Total	$	1,593,693

(1)	Average credit ratings as assigned by S&P and Moody’s, respectively.

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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				Total
Jun 30, 2019
RMBS	$	381,380			$	95,023			$	37,357			$	513,760
CMBS	104,220				560,602				21,885				686,707
ABS	—				1,431,312				72,548				1,503,860
Total	$	485,600			$	2,086,937			$	131,790			$	2,704,327
Dec 31, 2018
RMBS	$	488,862			$	15,410			$	31,491			$	535,763
CMBS	104,547				602,865				22,030				729,442
ABS	—				1,485,150				68,553				1,553,703
Total	$	593,409			$	2,103,425			$	122,074			$	2,818,908

At June 30, 2019, our structured securities included $41.0 million par value in sub-prime securities with a fair value of $34.2 million and average credit quality ratings from S&P/Moody’s of “CCC-/Caa3,” compared to $38.2 million par value with a fair value of $31.7 million and average credit quality ratings of “CCC-/Caa3” at December 31, 2018.

At June 30, 2019, our investment portfolio included $666.9 million of equity securities, compared to $368.8 million at December 31, 2018. Our equity portfolio includes publicly traded common stocks in the natural resources, energy, consumer staples and other sectors and exchange-traded funds.

The following table summarizes our other investments which are included in investments accounted for using the fair value option, by strategy:

	June 30, 2019				December 31, 2018
Lending	$	585,954			$	524,112
Term loan investments	$	274,061			$	281,486
Energy	123,547				117,509
Credit related funds	166,673				152,510
Investment grade fixed income	86,808				101,902
Infrastructure	49,260				45,371
Private equity	23,925				24,383
Real estate	16,906				14,252
Total	$	1,327,134			$	1,261,525

For details on our investments accounted for using the equity method, see note 6, “Investment Information—Investments Accounted For Using the Equity Method,” to our consolidated financial statements.

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 8, “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 7, “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.

Investable Assets in the ‘Other’ Segment

Investable assets in the ‘other’ segment are managed by Watford Re. The board of directors of Watford Re establishes its investment policies and guidelines. Watford Re’s investments are accounted for using the fair value option with changes in the carrying value of such investments recorded in net realized gains or losses.

The following table summarizes investable assets in the ‘other’ segment:

	June 30, 2019				December 31, 2018
Investments accounted for using the fair value option:
Other investments	$	1,067,384			$	1,050,414
Fixed maturities	616,863				922,819
Short-term investments	232,176				282,131
Equity securities	56,524				56,638
Total	1,972,947				2,312,002
Fixed maturities available for sale, at fair value	697,453				393,351
Equity securities, at fair value	64,703				32,206
Cash	68,977				63,529
Securities sold but not yet purchased	(48,823		)		(7,790		)
Securities transactions entered into but not settled at the balance sheet date	13,209				(35,635		)
Total investable assets included in ‘other’ segment	$	2,768,466			$	2,757,663

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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								Six Months Ended
	June 30,								June 30,
	2019				2018				2019				2018
Premiums written:
Direct	$	1,373,825			$	1,158,772			$	2,737,331			$	2,359,134
Assumed	563,984				537,772				1,278,357				1,175,624
Ceded	(492,911		)		(397,648		)		(1,045,531		)		(823,318		)
Net	$	1,444,898			$	1,298,896			$	2,970,157			$	2,711,440
Premiums earned:
Direct	$	1,335,558			$	1,174,372			$	2,601,621			$	2,322,048
Assumed	574,899				534,485				1,108,178				980,454
Ceded	(446,730		)		(372,094		)		(877,206		)		(730,840		)
Net	$	1,463,727			$	1,336,763			$	2,832,593			$	2,571,662
Losses and LAE:
Direct	$	705,235			$	520,473			$	1,321,297			$	1,088,939
Assumed	388,237				340,969				726,637				561,279
Ceded	(325,929		)		(135,289		)		(561,859		)		(287,205		)
Net	$	767,543			$	726,153			$	1,486,075			$	1,363,013

Reinsurance Recoverables

The following table summarizes our reinsurance recoverables on paid and unpaid losses (not including ceded unearned premiums) at June 30, 2019 and December 31, 2018:

	June 30, 2019				December 31, 2018
Reinsurance recoverable on unpaid and paid losses and loss adjustment expenses	$	3,171,257			$	2,919,372
% due from carriers with A.M. Best rating of “A-” or better	58.7		%		63.0		%
% due from unrated fully collateralized reinsurers (1)	16.9		%		12.9		%
% due from all other carriers with no A.M. Best rating (2)	24.4		%		24.1		%
Largest balance due from any one carrier as % of total shareholders’ equity	1.9		%		2.7		%

(1)	Such amount is fully collateralized through reinsurance trusts.

(2)	Over 90% of such amount is collateralized through reinsurance trusts or letters of credit.

Growth in items not rated in 2019 is primarily due to recoverables from a third party reinsurer related to a retroactive reinsurance transaction to reinsure liabilities associated with certain U.S. insurance exposures. Such amounts are fully collateralized. See note 5, “Reserve for Losses and Loss

 

Adjustment Expenses,” to our consolidated financial statements for additional information.

Bellemeade Re

We have entered into various 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 decreases over a ten-year period as the underlying covered mortgages amortize.

The following table summarizes the respective coverages and retentions at June 30, 2019:

	Initial Coverage at Issuance				Coverage at Jun. 30, 2019				First Layer Retention
Bellemeade 2015-1 Ltd. (1)	$	300,000			$	19,103			$	129,900
Bellemeade 2017-1 Ltd. (2)	368,100				277,554				165,700
Bellemeade 2018-1 Ltd. (3)	374,460				374,460				168,510
Bellemeade 2018-2 Ltd. (4)	653,278				571,129				352,258
Bellemeade 2018-3 Ltd. (5)	506,110				506,110				179,331
Bellemeade 2019-1 Ltd. (6)	341,790				329,085				208,046
Bellemeade 2019-2 Ltd. (7)	621,022				621,022				221,794

(1)	Issued in July 2015, covering in-force policies issued between January 1, 2009 and March 31, 2013.

(2)	Issued in October 2017, covering in-force policies issued between January 1, 2017 and June 30, 2017.

(3)	Issued in April 2018, covering in-force policies issued between July 1, 2017 and December 31, 2017.

(4)	Issued in August 2018, covering in-force policies issued between April 1, 2013 and December 31, 2015.

(5)	Issued in October 2018, covering in-force policies issued between January 1, 2018 and June 30, 2018.

(6)	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.

(7)	Issued in April 2019, covering in-force policies issued between July 1, 2018 and December 31, 2018.

In July 2019, we entered into an aggregate excess of loss reinsurance agreement with Bellemeade Re 2019-3 Ltd. Such agreement provides for up to $700.9 million of aggregate excess of loss reinsurance coverage at inception in excess of $232.1 million of aggregate losses for new delinquencies on a portfolio of in-force policies issued in 2016.

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

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costs of losses incurred. Estimating Loss Reserves is inherently difficult, which is exacerbated by the fact that we have relatively limited historical experience upon which to base such estimates. 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 June 30, 2019 and December 31, 2018, our Loss Reserves, net of unpaid losses and loss adjustment expenses recoverable, by type and by operating segment were as follows:

	June 30, 2019				December 31, 2018
Insurance segment:
Case reserves	$	1,481,510			$	1,489,644
IBNR reserves	3,242,209				3,266,796
Total net reserves	4,723,719				4,756,440
Reinsurance segment:
Case reserves	1,169,285				1,082,917
Additional case reserves	172,932				191,002
IBNR reserves	1,672,645				1,578,907
Total net reserves	3,014,862				2,852,826
Mortgage segment:
Case reserves	302,426				355,606
IBNR reserves	151,224				122,304
Total net reserves (1)	453,650				477,910
Other segment:
Case reserves	431,960				364,052
Additional case reserves	25,640				36,512
IBNR reserves	555,688				551,266
Total net reserves	1,013,288				951,830
Total:
Case reserves	3,385,181				3,292,219
Additional case reserves	198,572				227,514
IBNR reserves	5,621,766				5,519,273
Total net reserves	$	9,205,519			$	9,039,006

(1)	At June 30, 2019, total net reserves include $330.1 million from U.S. mortgage insurance business, of which 66.7% represents policy years 2009 and prior and the remainder from later policy years. At December 31, 2018, total net reserves include $375.8 million from U.S. mortgage insurance business, of which 73.4% represents policy years 2009 and prior and the remainder from later policy years.

 

At June 30, 2019 and December 31, 2018, the insurance segment’s Loss Reserves by major line of business, net of unpaid losses and loss adjustment expenses recoverable, were as follows:

	June 30, 2019				December 31, 2018
Insurance segment:
Professional lines (1)	$	1,255,253			$	1,247,914
Construction and national accounts	1,200,490				1,166,143
Excess and surplus casualty (2)	508,926				631,370
Programs	527,190				482,045
Property, energy, marine and aviation	338,868				388,710
Travel, accident and health	88,704				83,836
Lenders products	49,447				52,007
Other (3)	754,841				704,415
Total net reserves	$	4,723,719			$	4,756,440

(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.

At June 30, 2019 and December 31, 2018, the reinsurance segment’s Loss Reserves by major line of business, net of unpaid losses and loss adjustment expenses recoverable, were as follows:

	June 30, 2019				December 31, 2018
Reinsurance segment:
Casualty (1)	$	1,589,727			$	1,551,550
Other specialty (2)	662,535				582,420
Property excluding property catastrophe	447,549				422,612
Marine and aviation	131,644				130,683
Property catastrophe	110,570				90,635
Other (3)	72,837				74,926
Total net reserves	$	3,014,862			$	2,852,826

(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.

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Mortgage Operations Supplemental Information

The mortgage segment’s insurance in force (“IIF”) and risk in force (“RIF”) were as follows at June 30, 2019 and December 31, 2018:

(U.S. Dollars in millions)	June 30, 2019							December 31, 2018
	Amount				%			Amount				%
Insurance In Force (IIF) (1):
U.S. primary mortgage insurance	$	279,297			69.1			$	276,538			72.1
Mortgage reinsurance	26,286				6.5			25,975				6.8
Other (2)	98,335				24.3			81,147				21.2
Total	$	403,918			100.0			$	383,660			100.0
Risk In Force (RIF) (3):
U.S. primary mortgage insurance	$	71,760			91.8			$	70,995			92.3
Mortgage reinsurance	2,182				2.8			2,217				2.9
Other (2)	4,260				5.4			3,728				4.8
Total	$	78,202			100.0			$	76,940			100.0

(1)	Represents the aggregate dollar amount of each insured mortgage loan’s current principal balance.

(2)	Includes GSE credit risk-sharing transactions and international insurance business.

(3)	Represents 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 credit risk-sharing or reinsurance transactions.

The insurance in force and risk in force for our U.S. primary mortgage insurance business by policy year were as follows at June 30, 2019:

(U.S. Dollars in millions)	IIF							RIF							Delinquency
	Amount				%			Amount				%			Rate (1)
Policy year:
2009 and prior	$	19,182			6.9			$	4,397			6.1			8.23	%
2010	519				0.2			139				0.2			2.45	%
2011	2,091				0.7			582				0.8			1.59	%
2012	7,613				2.7			2,122				3.0			0.83	%
2013	14,800				5.3			4,125				5.7			0.84	%
2014	16,251				5.8			4,454				6.2			0.98	%
2015	30,289				10.8			8,003				11.2			0.73	%
2016	47,334				16.9			12,233				17.0			0.79	%
2017	50,603				18.1			12,918				18.0			0.65	%
2018	62,753				22.5			15,831				22.1			0.37	%
2019	27,862				10.0			6,956				9.7			0.05	%
Total	$	279,297			100.0			$	71,760			100.0			1.45	%

(1)	Represents the ending percentage of loans in default.

 

The insurance in force and risk in force for our U.S. primary mortgage insurance business by policy year were as follows at December 31, 2018:

(U.S. Dollars in millions)	IIF							RIF							Delinquency
	Amount				%			Amount				%			Rate (1)
Policy year:
2009 and prior	$	21,210			7.7			$	4,900			6.9			8.90	%
2010	646				0.2			175				0.2			2.62	%
2011	2,530				0.9			701				1.0			1.57	%
2012	9,650				3.5			2,664				3.8			0.78	%
2013	16,823				6.1			4,676				6.6			0.89	%
2014	18,274				6.6			4,947				7.0			0.97	%
2015	33,781				12.2			8,849				12.5			0.69	%
2016	52,324				18.9			13,407				18.9			0.77	%
2017	54,287				19.6			13,793				19.4			0.55	%
2018	67,013				24.2			16,883				23.8			0.15	%
Total	$	276,538			100.0			$	70,995			100.0			1.60	%

(1)	Represents the ending percentage of loans in default.

The following tables provide supplemental disclosures on risk in force for our U.S. primary mortgage insurance business at June 30, 2019 and December 31, 2018:

(U.S. Dollars in millions)	June 30, 2019							December 31, 2018
	Amount				%			Amount				%
Credit quality (FICO):
>=740	$	41,333			57.6			$	41,066			57.8
680-739	24,488				34.1			23,954				33.7
620-679	5,494				7.7			5,485				7.7
<620	445				0.6			490				0.7
Total	$	71,760			100.0			$	70,995			100.0
Weighted average FICO score	743							743
Loan-to-value (LTV):
95.01% and above	$	8,535			11.9			$	7,918			11.2
90.01% to 95.00%	39,777				55.4			39,370				55.5
85.01% to 90.00%	20,419				28.5			20,643				29.1
85.00% and below	3,029				4.2			3,064				4.3
Total	$	71,760			100.0			$	70,995			100.0
Weighted average LTV	93.1		%					93.0		%
Total RIF, net of external reinsurance	$	56,562						$	55,755

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(U.S. Dollars in millions)	June 30, 2019							December 31, 2018
	Amount				%			Amount				%
Total RIF by State:
Texas	$	5,509			7.7			$	5,491			7.7
California	4,736				6.6			4,505				6.3
Florida	3,699				5.2			3,541				5.0
Virginia	2,916				4.1			2,931				4.1
Georgia	2,599				3.6			2,573				3.6
Illinois	2,536				3.5			2,482				3.5
North Carolina	2,462				3.4			2,505				3.5
Minnesota	2,434				3.4			2,400				3.4
Washington	2,421				3.4			2,408				3.4
Maryland	2,420				3.4			2,407				3.4
Others	40,028				55.8			39,752				56.0
Total	$	71,760			100.0			$	70,995			100.0

The following table provides supplemental disclosures for our U.S. primary mortgage insurance business related to insured loans and loss metrics:

(U.S. Dollars in thousands, except policy, loan and claim count)	Six Months Ended
	June 30,
	2019				2018
Roll-forward of insured loans in default:
Beginning delinquent number of loans	20,665				27,068
New notices	18,617				17,792
Cures	(18,907		)		(21,865		)
Paid claims	(1,614		)		(1,958		)
Ending delinquent number of loans (1)	18,761				21,037
Ending number of policies in force (1)	1,292,215				1,239,565
Delinquency rate (1)	1.45		%		1.70		%
Losses:
Number of claims paid	1,614				1,958
Total paid claims	$	65,519			$	83,534
Average per claim	$	40.6			$	42.7
Severity (2)	97.0		%		101.6		%
Average reserve per default (in thousands)	$	16.1			$	19.3

(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 11.4 to 1 at June 30, 2019, compared to 13.0 to 1 at December 31, 2018.

Shareholders’ Equity and Book Value per Share

Total shareholders’ equity available to Arch was $10.76 billion at June 30, 2019, compared to $9.44 billion at December 31, 2018. The increase reflected strong underwriting and investment returns.

 

The following table presents the calculation of book value per share:

(U.S. dollars in thousands, except  share data)	June 30, 2019				December 31, 2018
Total shareholders’ equity available to Arch	$	10,757,352			$	9,439,827
Less preferred shareholders’ equity	780,000				780,000
Common shareholders’ equity available to Arch	$	9,977,352			$	8,659,827
Common shares and common share equivalents outstanding, net of treasury shares (1)	404,887,534				402,454,834
Book value per share	$	24.64			$	21.52

(1)	Excludes the effects of 19,607,588 and 20,076,593 stock options and 1,693,203 and 1,307,304 restricted stock units outstanding at June 30, 2019 and December 31, 2018, respectively.

LIQUIDITY

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This section does not include information specific to Watford Re. We do not guarantee or provide credit support for Watford Re, and our financial exposure to Watford Re is limited to our investment in Watford Re’s common and preferred shares and counterparty credit risk (mitigated by collateral) arising from reinsurance transactions with Watford Re.

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 six months ended June 30, 2019, Arch Capital received dividends of $67.1 million from Arch Re Bermuda, our Bermuda-based reinsurer and insurer, which can pay approximately $2.56 billion to Arch Capital during the remainder of 2019 without providing an affidavit to the Bermuda Monetary Authority (“BMA”).

We expect that our liquidity needs, including our anticipated (re)insurance obligations and operating and capital expenditure needs, for the next twelve months, at a minimum, 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.

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Cash Flows

The following table summarizes our cash flows from operating, investing and financing activities, excluding amounts related to the ‘other’ segment (i.e., Watford Re). See note 11, “Variable Interest Entities and Noncontrolling Interests,” for cash flows related to Watford Re.

	Six Months Ended
	June 30,
	2019				2018
Total cash provided by (used for):
Operating activities	$	597,276			$	404,451
Investing activities	(611,199		)		270,381
Financing activities	(35,352		)		(731,613		)
Effects of exchange rate changes on foreign currency cash	2,259				(9,024		)
Increase (decrease) in cash and restricted cash	$	(47,016	)		$	(65,805	)

•Cash provided by operating activities for the six months ended June 30, 2019 reflected a higher level of premiums collected than in the 2018 period.

•Cash used for investing activities for the six months ended June 30, 2019 was higher than in the 2018 period, reflecting a higher level of securities purchased.

•Cash used for financing activities for the six months ended June 30, 2019 was lower than in the 2018 period. The 2018 period reflected $250.0 million of paydowns on our revolving credit agreement borrowings, $173.6 million of repurchases under our share repurchase program and $92.6 million related to redemption of our Series C preferred shares in January 2018.

CAPITAL RESOURCES

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This section does not include information specific to Watford Re. We do not guarantee or provide credit support for Watford Re, and our financial exposure to Watford Re is limited to our investment in Watford Re’s common and preferred shares and counterparty credit risk (mitigated by collateral) arising from reinsurance transactions with Watford Re.

 

The following table provides an analysis of our capital structure:

(U.S. dollars in thousands, except  share data)	Jun 30, 2019				Dec 31, 2018
Debt:
Senior notes, due May 2034	$	300,000			$	300,000
Arch-U.S. senior notes, due Nov 2043 (1)	500,000				500,000
Arch Finance senior notes, due Dec 2026 (1)	500,000				500,000
Arch Finance senior notes, due Dec 2046 (1)	450,000				450,000
Deferred debt costs on senior notes	(16,135		)		(16,472		)
Revolving credit agreement borrowings due Oct 2021 (2)	—				—
Total	$	1,733,865			$	1,733,528
Shareholders’ equity available to Arch:
Series E non-cumulative preferred shares	$	450,000			$	450,000
Series F non-cumulative preferred shares	330,000				330,000
Common shareholders’ equity	9,977,352				8,659,827
Total	$	10,757,352			$	9,439,827
Total capital available to Arch	$	12,491,217			$	11,173,355
Debt to total capital (%)	13.9				15.5
Preferred to total capital (%)	6.2				7.0
Debt and preferred to total capital (%)	20.1				22.5

(1)	Fully and unconditionally guaranteed by Arch Capital.

(2)	$500 million unsecured facility for revolving loans and letters of credit.

Arch Capital and Arch-U.S. are each holding companies and, accordingly, they conduct substantially all of their operations through their operating subsidiaries. Arch Capital Finance LLC (“Arch Finance”) is a wholly owned subsidiary of Arch U.S. MI Holdings Inc. As a result, Arch Capital, Arch-U.S. and Arch Finance's cash flows and their ability to service their debt depends upon the earnings of their operating subsidiaries, or affiliates in the case of Arch Finance, and on their ability to distribute the earnings, loans or other payments from such subsidiaries or affiliates to Arch Capital, Arch-U.S. and Arch Finance, respectively.

In addition, Arch MI U.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 MI U.S. satisfied the PMIERs’ financial requirements as of June 30, 2019 with an estimated PMIER sufficiency ratio of 163%, compared to 141% at December 31, 2018.

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Pursuant to our 2014 acquisition of the CMG Mortgage Insurance Company and its affiliated mortgage insurance companies, we made a contingent consideration payment of $61.5 million in April 2019. The maximum amount of remaining contingent consideration payments over the remaining earn-out period is $6.7 million.

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 our U.S.-based property casualty insurance and reinsurance subsidiaries and Arch Re Bermuda were canceled on a cutoff basis as of January 1, 2018. As a result, the level of subject business ceded to Arch Re Bermuda for the reported periods was substantially lower than in 2017 and prior periods.

SHARE REPURCHASE PROGRAM

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The board of directors of Arch Capital has authorized the investment in Arch Capital’s common shares through a share repurchase program. For the six months ended June 30, 2019, Arch Capital repurchased 0.1 million shares under the share repurchase program with an aggregate purchase price of $2.9 million. Since the inception of the share repurchase program through June 30, 2019, Arch Capital has repurchased 386.3 million common shares for an aggregate purchase price of $3.97 billion. At June 30, 2019, approximately $160.9 million of share repurchases were available under the program, which may be effected from time to time in open market or privately negotiated transactions through December 31, 2019.

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.

CATASTROPHIC EVENTS AND SEVERE ECONOMIC EVENTS

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We have large aggregate exposures to natural and man-made catastrophic events and severe economic events. Catastrophes can be caused by various events, including hurricanes, floods, windstorms, earthquakes, hailstorms, tornadoes, explosions, severe winter weather, fires, droughts and other natural disasters. 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 total shareholders’ equity available to Arch. We reserve the right to change this threshold at any time.

Based on in-force exposure estimated as of July 1, 2019, our modeled peak zone catastrophe exposure was a windstorm affecting the Northeastern U.S., with a net probable maximum pre-tax loss of $398 million, followed by windstorms affecting Florida Tri-County and the Gulf of Mexico regions with net probable maximum pre-tax losses of $368 million and $352 million, respectively. Our exposures to other perils, such as U.S. earthquake and international events, were less than the exposures arising from U.S. windstorms and hurricanes. As of July 1, 2019, our modeled peak zone earthquake exposure (San Francisco earthquake) represented approximately 69% of our peak zone catastrophe exposure, and our modeled peak zone international exposure (Japan earthquake) was substantially less than both our peak zone windstorm and earthquake exposures.

Effective July 1, 2019, our insurance operations had in effect a reinsurance program which provided coverage for certain property-catastrophe related losses equal to $275 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 our U.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 total tangible shareholders’ equity available to Arch (total shareholders’ equity available to Arch less goodwill and intangible assets).

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We reserve the right to change this threshold at any time. Based on in-force exposure estimated as of July 1, 2019, our modeled RDS loss was approximatly10% 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 after 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 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 total shareholders' equity or tangible shareholders’ equity from one or more catastrophic events or severe economic events due to several factors, including 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 2018 Form 10-K.

OFF-BALANCE SHEET ARRANGEMENTS

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Off-balance sheet arrangements are discussed in Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our 2018 Form 10-K.

MARKET SENSITIVE INSTRUMENTS AND RISK MANAGEMENT

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In accordance with the SEC’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 of June 30, 2019. 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. We have not included Watford Re in the following analyses as we do not guarantee or provide credit support for Watford Re, and our financial exposure to Watford Re is limited to our

 

investment in Watford Re’s common and preferred shares and counterparty credit risk (mitigated by collateral) arising from reinsurance transactions.

An analysis of material changes in market risk exposures at June 30, 2019 that affect the quantitative and qualitative disclosures presented in our 2018 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 Risk

Fixed 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 which invest in fixed income securities and the corresponding change in unrealized appreciation. As interest rates rise, the fair value of our interest rate sensitive 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 in U.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 our fixed income securities:

(U.S. dollars in  billions)	Interest Rate Shift in Basis Points
	-100				-50				—				+50				+100
Jun 30, 2019
Total fair value	$	20.24			$	19.91			$	19.57			$	19.22			$	18.89
Change from base	3.4		%		1.7		%						(1.8		)%		(3.5		)%
Change in unrealized value	$	0.67			$	0.33							$	(0.35	)		$	(0.69	)
Dec 31, 2018
Total fair value	$	19.23			$	18.91			$	18.62			$	18.30			$	17.98
Change from base	3.3		%		1.6		%						(1.7		)%		(3.4		)%
Change in unrealized value	$	0.61			$	0.30							$	(0.32	)		$	(0.63	)

In addition, we consider the effect of credit spread movements on the market value of our fixed maturities, fixed maturities pledged under securities lending agreements, short-term investments and certain of our other investments and investment funds accounted for using the equity method which invest in fixed income securities and the corresponding change in unrealized appreciation. As credit spreads widen, the fair value of our fixed income securities falls, and the converse is also true.

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The following table summarizes the effect that an immediate, parallel shift in credit spreads in a static interest rate environment would have had on our fixed income securities:

(U.S. dollars in  billions)	Credit Spread Shift in Percentage Points
	-100				-50				—				+50				+100
Jun 30, 2019
Total fair value	$	19.96			$	19.77			$	19.57			$	19.38			$	19.18
Change from base	2.0		%		1.0		%						(1.0		)%		(2.0		)%
Change in unrealized value	$	0.39			$	0.20							$	(0.20	)		$	(0.39	)
Dec 31, 2018
Total fair value	$	19.08			$	18.84			$	18.62			$	18.39			$	18.15
Change from base	2.5		%		1.2		%						(1.2		)%		(2.5		)%
Change in unrealized value	$	0.47			$	0.22							$	(0.22	)		$	(0.47	)

Another method that attempts to measure portfolio risk is Value-at-Risk (“VaR”). VaR attempts to take into account a broad cross-section of risks facing a portfolio by utilizing relevant securities volatility data skewed towards the most recent months and quarters. VaR measures the amount of a portfolio at risk for outcomes 1.65 standard deviations from the mean based on normal market conditions over a one year time horizon and is expressed as a percentage of the portfolio’s initial value. In other words, 95% of the time, should the risks taken into account in the VaR model perform per their historical tendencies, the portfolio’s loss in any one year period is expected to be less than or equal to the calculated VaR, stated as a percentage of the measured portfolio’s initial value. As of June 30, 2019, our portfolio’s VaR was estimated to be 3.31% compared to an estimated 3.02% at December 31, 2018.

Equity Securities. At June 30, 2019 and December 31, 2018, the fair value of our investments in equity securities totaled $666.9 million and $368.8 million, 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 $66.7 million and $36.9 million at June 30, 2019 and December 31, 2018, respectively, and would have decreased book value per share by approximately $0.16 and $0.09, respectively. An immediate hypothetical 10% increase in the value of each position would increase the fair value of such investments by approximately $66.7 million and $36.9 million at June 30, 2019 and December 31, 2018, respectively, and would have increased book value per share by approximately $0.16 and $0.09, respectively.

Investment-Related Derivatives. At June 30, 2019, 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 $7.85 billion, compared to $4.95

 

billion at December 31, 2018. If the underlying exposure of each investment-related derivative held at June 30, 2019 depreciated by 100 basis points, it would have resulted in a reduction in net income of approximately $78.5 million, and a decrease in book value per share of approximately $0.19 per share, compared to $49.5 million and $0.12 per share, respectively, on investment-related derivatives held at December 31, 2018. If the underlying exposure of each investment-related derivative held at June 30, 2019 appreciated by 100 basis points, it would have resulted in an increase in net income of approximately $78.5 million, and an increase in book value per share of approximately $0.19 per share, compared to $49.5 million and $0.12 per share, respectively, on investment-related derivatives held at December 31, 2018. See note 8, “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 8, “Derivative Instruments,” to our consolidated financial statements for additional information.

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The following table provides a summary of our net foreign currency exchange exposures, as well as foreign currency derivatives in place to manage these exposures:

(U.S. dollars in thousands, except  per share data)	June 30, 2019				December 31, 2018
Net assets (liabilities), denominated in foreign currencies, excluding shareholders’ equity and derivatives	$	(326,838	)		$	(561,311	)
Shareholders’ equity denominated in foreign currencies (1)	598,443				478,678
Net foreign currency forward contracts outstanding (2)	181,655				241,442
Net exposures denominated in foreign currencies	$	453,260			$	158,809
Pre-tax impact of a hypothetical 10% appreciation of the U.S. Dollar against foreign currencies:
Shareholders’ equity	$	(45,326	)		$	(15,881	)
Book value per share	$	(0.11	)		$	(0.04	)
Pre-tax impact of a hypothetical 10% decline of the U.S. Dollar against foreign currencies:
Shareholders’ equity	$	45,326			$	15,881
Book value per share	$	0.11			$	0.04

(1)	Represents capital contributions held in the foreign currencies of our operating units.

(2)	Represents the net notional value of outstanding foreign currency forward contracts.

Although we generally attempt to match the currency of our projected liabilities with investments in the same currencies, from time to time we may elect to over or underweight one or more currencies, which could increase our exposure to foreign currency fluctuations and increase the volatility of our shareholders’ equity. Historical observations indicate a low probability that all foreign currency exchange rates would shift against the U.S. Dollar in the same direction and at the same time and, accordingly, the actual effect of foreign currency rate movements may differ materially from the amounts set forth above. For further discussion on foreign exchange activity, please refer to “—Results of Operations.”

Effects of Inflation

We do not believe that inflation has had a material effect on our consolidated results of operations, except insofar as inflation may affect our reserve for losses and loss adjustment expenses and interest rates. The potential exists, after a catastrophe loss, for the development of inflationary pressures in a local economy. The anticipated effects of inflation on us are considered in our catastrophe loss models. The actual effects of inflation on our results cannot be accurately known until claims are ultimately settled.

 

OTHER FINANCIAL INFORMATION

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The consolidated financial statements as of June 30, 2019 and for the three month and six month periods ended June 30, 2019 and 2018 have been reviewed by PricewaterhouseCoopers LLP, the registrant's independent public accountants, whose report is included as an exhibit to this filing. The report of PricewaterhouseCoopers LLP states that they did not audit and they do not express an opinion on that unaudited financial information. Accordingly, the degree of reliance on their report on such information should be restricted in light of the limited nature of the review procedures applied. PricewaterhouseCoopers LLP is not subject to the liability provisions of Section 11 of the Securities Act of 1933 for their report on the unaudited financial information because that report is not a "report" or a "part" of the registration statement prepared or certified by PricewaterhouseCoopers LLP within the meaning of Sections 7 and 11 of the Securities Act of 1933.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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Reference is made to the information appearing above under the subheading “Market Sensitive Instruments and Risk Management” under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” which information is hereby incorporated by reference. 

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ITEM 4. CONTROLS AND PROCEDURES

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Evaluation of Disclosure Controls and Procedures

In connection with the filing of this Form 10-Q, our management, including the Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of disclosure controls and procedures pursuant to applicable Exchange Act Rules as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures were effective as of the end of and during the period covered by this report with respect to information being recorded, processed, summarized and reported within time periods specified in the SEC’s rules and forms and with respect to timely communication to them and other members of management responsible for preparing periodic reports of all material information required to be disclosed in this report as it relates to Arch Capital and its consolidated subsidiaries.

We continue to enhance our operating procedures and internal controls to effectively support our business and our regulatory and reporting requirements. Our management does not expect that our disclosure controls or our internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. As a result of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons or by collusion of two or more people. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. As a result of the inherent limitations in a cost-effective control system, misstatement due to error or fraud may occur and not be detected. Accordingly, our disclosure controls and procedures are designed to provide reasonable, not absolute, assurance that the disclosure controls and procedures are met.

 

Changes in Internal Controls Over Financial Reporting

There have been no changes in internal control over financial reporting that occurred during the quarter ended June 30, 2019 that have materially affected, or are reasonably likely to materially affect, internal control over financial reporting.

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PART II.  OTHER INFORMATION

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ITEM 1. LEGAL PROCEEDINGS

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We, in common with the insurance industry in general, are subject to litigation and arbitration in the normal course of our business. As of June 30, 2019, we were not a party to any litigation or arbitration which is expected by management to have a material adverse effect on our results of operations and financial condition and liquidity.

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ITEM 1A. RISK FACTORS

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There were no material changes from the risk factors previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2018.

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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

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The following table summarizes our purchases of common shares for the 2019 second quarter:

		Issuer Purchases of Equity Securities
Period		Total Number of Shares Purchased (1)			Average Price Paid per Share				Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs			Approximate Dollar Value of Shares that  May Yet be Purchased Under the Plan or Programs (2)
4/1/2019 - 4/30/2019		17,802			$	32.62			—			$	160,867
5/1/2019 - 5/31/2019		333,431			33.71				—			$	160,867
6/1/2019 - 6/30/2019		23,317			35.42				—			$	160,867
Total		374,550			$	33.76			—

(1)

Represents repurchases by Arch Capital of shares, from time to time, from employees in order to facilitate the payment of withholding taxes on restricted shares granted and the exercise of stock appreciation rights. We purchased these shares at their fair value, as determined by reference to the closing price of our common shares on the day the restricted shares vested or the stock appreciation rights were exercised.

(2)	Remaining amount available at June 30, 2019 under Arch Capital’s share repurchase authorization, under which repurchases may be effected from time to time in open market or privately negotiated transactions through December 31, 2019.

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ITEM 3. DEFAULTS UPON SENIOR SECURITIES

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None.

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ITEM 4. MINE SAFETY DISCLOSURES

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Not applicable.

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ITEM 5. OTHER INFORMATION

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In accordance with Section 10a(i)(2) of the Securities Exchange Act of 1934, as amended, we are responsible for disclosing non-audit services to be provided by our independent auditor, PricewaterhouseCoopers LLP, which are approved by the Audit Committee of our board of directors. During the 2019 second quarter, the Audit Committee approved engagements of PricewaterhouseCoopers LLP for permitted non-audit services, which consisted of tax consulting services, tax compliance services and other accounting consulting services.

Disclosure of Certain Activities Under Section 13(r) of the Securities Exchange Act of 1934

Section 13(r) of the Securities Exchange Act of 1934, as amended, requires an issuer to disclose in its annual or quarterly reports whether it or an affiliate knowingly engaged in certain activities described in that section, including certain activities related to Iran during the period covered by the report.

Certain of our non-U.S. subsidiaries underwrite insurance and facultative reinsurance on a global basis to non-U.S. insureds and insurers, including for liability, marine, aviation and energy risks. Coverage provided to non-Iranian business may indirectly cover an exposure in Iran. For example, certain of our operations underwrite global marine hull and cargo policies that provide coverage for vessels navigating into and out of ports worldwide, including Iran. For the quarter ended June 30, 2019, there has been no material amount of premium allocated or apportioned to activities relating to Iran, and we are unable to attribute gross revenues or net profits from any such policies because they insure multiple voyages and fleets containing multiple ships. Such non-U.S. subsidiaries will continue to provide such coverage only to the extent permitted by applicable law.

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ITEM 6. EXHIBITS

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				Incorporated by Reference
Exhibit Number		Exhibit Description		Form		Original Number		Date Filed		Filed Herewith
15		Accountants’ Awareness Letter (regarding unaudited interim financial information)								X
31.1		Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002								X
31.2		Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002								X
32.1		Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002								X
32.2		Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002								X
101.INS		XBRL Instance Document
101.SCH		XBRL Taxonomy Extension Schema Document
101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF		XBRL Taxonomy Extension Definition Linkbase Document
101.LAB		XBRL Taxonomy Extension Label Linkbase Document
101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

		ARCH CAPITAL GROUP LTD.
		(REGISTRANT)
		/s/ Marc Grandisson
Date: August 7, 2019		Marc Grandisson
		President and Chief Executive Officer (Principal Executive Officer)
		/s/ François Morin
Date: August 7, 2019		François Morin
		Executive Vice President, Chief Financial Officer and Treasurer (Principal Financial and Accounting Officer)

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