01—Abstract
Summary
Summary of the 10-K filed February 29, 2008. Cited figures are marked; the original filing is the authoritative source.
Arch Capital Group Ltd. (ACGL) closed 2007 as a strong year: net income available to common shareholders rose to $832.1 milliona from $692.6 million, diluted EPS reached $11.28 (vs. $9.08), and return on average common equity was 23.9%.
Diluted book value per share grew 25.4% to $55.12b, helped by a benign catastrophe year and $185.4 million of net favorable reserve development. Net premiums written were $2.90 billion, roughly flat versus 2006, as the reinsurance segment shrank while the insurance segment grew, and total cash and invested assets reached $10.13 billion. The quality of 2007 earnings warrants scrutiny.
The combined ratio improved to 84.1% largely because of a low catastrophe load and favorable prior-year development, and the reinsurance segment's combined ratio of 74.5% benefited from $172.7 millionc of net favorable development. Management itself warns that the company is relatively new, so loss reserves ($5.48 billion net) rely on limited historical data. Pricing softened across most lines in 2007, the Flatiron Treaty expired at year-end 2007 without renewal, and the reinsurance catastrophe program was not renewed, which raises the company's retained catastrophe exposure going into 2008.
The effective tax rate of 1.8% is unusually low, reflecting Bermuda domicile and the geographic mix of income. Capital management was a major theme. ACGL repurchased about 7.8 million shares for $537.1 milliond under a $1 billion authorization running through February 2009, and it had repurchased an additional 2.1 million shares for $144.8 million by February 25, 2008.
Shareholders' equity rose to $4.04 billion, supported by $300 million of 7.35% senior notes and $325 million of preferred shares. Ratings are solid (A.M. Best "A", S&P "A", Moody's "A2"), and the company's ability to write business depends on keeping them.
02—Key points
Key Highlights
- Net income available to common shareholders was $832.1 million in 2007, up 20% from $692.6 million in 2006; diluted EPS was $11.28 versus $9.08, with a 23.9% return on average common equity.
- Diluted book value per share increased 25.4% to $55.12 at year-end 2007, from $43.97, after an estimated $1.45 per share dilution from share repurchases.
- Net premiums written were $2.90 billion, roughly flat versus $3.02 billion in 2006: insurance grew to $1.72 billion while reinsurance fell to $1.18 billion from $1.37 billion.
- The reinsurance segment's combined ratio improved to 74.5% from 80.7%, helped by $172.7 million of net favorable prior-year reserve development and a low catastrophe load (about 4.3 points).
- The Flatiron Re quota share treaty expired on December 31, 2007 and was not renewed, and the 2008 catastrophe reinsurance program was reduced to 70% of $275 million above a $75 million retention, increasing net exposure.
- Cash and invested assets totaled $10.13 billion, with about 85% in fixed maturities rated approximately 98% investment grade and an average credit rating of AA+.
- ACGL repurchased $537.1 million of common shares in 2007, with a further $144.8 million through February 25, 2008, under a $1 billion program expiring February 2009.
03—Questions
Frequently Asked Questions
Did the 2007 earnings improvement come from underwriting or from investments and reserve releases?
Both contributed, but the underwriting gain was flattered by reserve releases. Net favorable prior-year development was $185.4 million in total, and the insurance segment's combined ratio actually worsened to 91.2% from 89.9%. Net investment income rose to $463.1 million from $380.2 million, driven by a higher invested asset base and a higher yield of 4.88%. Investors should expect lower reserve releases in the future.
How exposed is ACGL to catastrophe losses in 2008?
Exposure increased. The Flatiron Treaty, which had ceded 45% of certain property and marine business, expired at year-end 2007, and the reinsurance group's catastrophe program was not renewed. The insurance group's 2008 catastrophe program covers 70% of the first $275 million in excess of a $75 million retention. The company targets a probable maximum pre-tax loss of about 25% of shareholders' equity for a 1-in-250-year event in any zone.
Is the company's capital position sufficient to support growth and buybacks?
Management says yes, citing about $933 million of dividend capacity from Arch Re Bermuda to ACGL in 2008 without regulatory affidavit, and a $300 million unsecured revolving facility plus a $1.0 billion secured letter of credit facility. Covenants require a debt-to-equity ratio of no more than 0.35 to 1 and maintenance of an A.M. Best B++ rating. Debt was $300 million, about 6.9% of total capital, and preferred shares were $325 million. Buybacks reduced book value per share by $1.45 in 2007.
What are the main risks to ACGL's credit ratings and business model?
Ratings (A.M. Best and S&P 'A', Moody's 'A2') drive the company's ability to win business, and downgrades could trigger reinsurance contract termination or collateral rights for ceding clients. Other key risks include a soft pricing environment (prices declined generally across lines in 2007), reliance on brokers (Marsh and Aon together generated about 36% of gross premiums), and reserve estimates that rest on limited historical data for a relatively new company.
04—Continue