01—Abstract
Summary
Summary of the 10-K filed March 10, 2004. Cited figures are marked; the original filing is the authoritative source.
Arch Capital Group Ltd. (ACGL) reported a transformative 2003 for its Bermuda-domiciled specialty insurance and reinsurance platform.
Net income rose to $280.6 milliona, or $4.14 diluted per share, from $59.0 million ($0.99 diluted) in 2002, and return on average equity improved to 18.0% from 4.9%. Net premiums written more than doubled to $2.74 billion from $1.26 billion, driven by both the reinsurance segment ($1.57 billion, up 77.5%) and the insurance segment ($1.17 billion, up from $379 million). The combined ratio improved to 90.0% from 90.9%, with the reinsurance segment at 89.2% and the insurance segment at 91.0%, down from 101.1% in 2002.
Net favorable reserve development of about $41.0 millionb on a net basis supported results, though the company recorded a gross deficiency of about $17.9 million tied to the Arch Specialty acquisition, which was largely reinsured by Sentry. The balance sheet expanded substantially, with total assets of $5.59 billion, cash and invested assets of $3.72 billion, and shareholders' equity of $1.71 billion. Book value per diluted share rose to $25.52 from $21.20.
Growth was financed partly by a $200 millionc borrowing under a $300 million 364-day revolving credit facility, which increased leverage (debt represented 10.5% of total capital). Investment quality is conservative: fixed maturities are about 91% of cash and invested assets, rated investment grade with an average S&P rating of AA+ and a 2.0-year average duration. Key risks for investors include the company's limited operating history (the underwriting initiative began in October 2001), reserves that rest largely on expected-loss estimates given sparse historical data, concentrated broker relationships (AON, Marsh and Willis supplied roughly 49% of gross premiums), and heavy catastrophe exposure.
Control is concentrated: Warburg Pincus and Hellman & Friedman funds own a majority of voting power through preference shares and a shareholders agreement. The company also said it may raise additional capital in the first half of 2004, which could dilute shareholders.
02—Key points
Key Highlights
- Net income of $280.6 million in 2003 versus $59.0 million in 2002; diluted EPS of $4.14 versus $0.99, and return on average equity of 18.0% versus 4.9%.
- Net premiums written of $2.74 billion, up 117% from $1.26 billion, with the reinsurance segment at $1.57 billion and the insurance segment at $1.17 billion.
- Combined ratio improved to 90.0% from 90.9%; the insurance segment swung from a 101.1% combined ratio in 2002 to 91.0% in 2003.
- Net favorable prior-year reserve development of $41.0 million, though a gross deficiency of $17.9 million was recorded, mostly related to the Arch Specialty acquisition and offset by Sentry's assumption of those liabilities.
- Book value per diluted share rose to $25.52 from $21.20, and total shareholders' equity reached $1.71 billion.
- Invested assets of $3.72 billion are conservatively positioned, with an average S&P rating of AA+ and an average duration of about 2.0 years.
- Leverage rose with a $200 million revolving credit borrowing, and the company plans to possibly raise additional debt or equity capital in the first half of 2004.
03—Questions
Frequently Asked Questions
What drove the large increase in ACGL's 2003 earnings?
Net income rose to $280.6 million from $59.0 million, mainly because underwriting results improved sharply as premiums earned grew to $2.21 billion from $655 million. Investment income also rose to $81.0 million, reflecting the investment of 2002 and 2003 operating cash flows, and realized gains were $25.3 million. Results were supported by favorable prior-year reserve development and a 2003 combined ratio of 90.0%.
How well is the company's reserving position supported, and what are the risks?
Net reserves for losses and loss adjustment expenses were $1.54 billion at year-end 2003. Management says it uses a conservative reserving philosophy and an expected-loss method, but it acknowledges that very limited historical loss data makes estimates highly uncertain. Reserves were redundant by $41.0 million on a net basis in 2003, while a gross deficiency of $17.9 million arose mainly from pre-acquisition business at Arch Specialty that Sentry has agreed to assume.
What are the main concentration and control risks for shareholders?
Three brokers (AON, Marsh & McLennan and Willis) generated about 49% of gross premiums written in 2003. Warburg Pincus and Hellman & Friedman funds hold majority voting influence and can nominate a majority of directors, and a shareholders agreement requires their designees' consent for transactions outside the ordinary course, including mergers. Bye-laws also contain anti-takeover provisions and limit voting power for U.S. persons to 9.9%.
Does the company face near-term capital or liquidity needs?
The company borrowed $200 million under a $300 million 364-day credit facility in September 2003 at a fixed rate of about 2.44% through March 2004, after which the rate resets. It said it may raise additional debt or equity in the first half of 2004 to support underwriting, and it filed a $500 million universal shelf registration in January 2004. Holding-company cash was only about $10.6 million, so dividends from regulated subsidiaries matter; the company does not intend to pay dividends and cannot pay them while preference-share obligations remain outstanding.
04—Continue