01—Abstract
Summary
Summary of the 10-K filed February 26, 2010. Cited figures are marked; the original filing is the authoritative source.
Arch Capital Group Ltd. (ACGL) closed 2009 as a strong year rebounding from 2008.
Net income available to common shareholders was $851.1 milliona (diluted EPS $13.74), versus $265.1 million in 2008, driven by a much lighter catastrophe year (no major catastrophe activity in 2009 versus Hurricanes Gustav and Ike in 2008), favorable prior-year reserve development of $189.2 million, and a sharp rebound in investment-related results, including $167.8 million of equity-method fund income and $143.6 million of net realized gains. Diluted book value per common share rose 42.2% to $73.01, and after-tax operating ROAE was 18.3%, above management's 15% target. Underwriting was solid but mixed by segment.
Net premiums written were $2.76 billionb, down about 1.5%. The insurance segment ran a 98.1% combined ratio (near breakeven), while the reinsurance segment was considerably more profitable at 73.7%. Total company combined ratio was 88.1%.
Management flagged that reinsurance net premiums earned will decline in 2010 because of a sharp fourth-quarter 2009 drop in written premium, and that the pricing environment is basically unchanged, with rate improvement moderating in the second half of 2009. The balance sheet is strong, with total shareholders' equity of $4.32 billionc and cash and invested assets of $11.3 billion, about 95% of fixed maturities rated investment grade, and an average credit rating of AA+. Risks include a 2.87-year portfolio duration, growing exposure to mortgage- and asset-backed securities (MBS and CMBS about 23% of invested assets), reliance on Marsh & McLennan (15.6% of gross premiums) and AON (21.4%), exposure to U.S. hurricanes (modeled Florida peak-zone net PML of $750 million), and ongoing share repurchases of $458 million in 2009, with $844.6 million of authorization remaining as of February 23, 2010.
02—Key points
Key Highlights
- Net income available to common shareholders of $851.1 million for 2009, up from $265.1 million in 2008, with diluted EPS of $13.74 versus $4.09.
- Diluted book value per common share grew 42.2% to $73.01 (from $51.36), and after-tax operating ROAE was 18.3%, above the company's 15% target.
- Favorable prior-year reserve development of $189.2 million (reinsurance $142.1M, insurance $47.1M) and no significant catastrophe losses in 2009 drove a much better underwriting result than 2008.
- Reinsurance segment combined ratio of 73.7% and underwriting income of $303.2 million, versus an insurance segment combined ratio of 98.1% and underwriting income of only $32.9 million.
- Net premiums written fell about 1.5% to $2.76 billion, and reinsurance net premiums written fell 7.8%, with management warning that reinsurance net premiums earned will decline further in 2010.
- Repurchased 6.7 million shares for $458.4 million in 2009 and 2.1 million more through February 23, 2010; $844.6 million of authorization remained.
- Strong capital base: $4.32 billion of shareholders' equity, $11.3 billion of cash and invested assets, and a portfolio averaging AA+ with about 95% investment grade, though MBS/CMBS concentration and a 2.87-year duration are notable risk factors.
03—One dollar
04—Financials
Financial Highlights
Figures from 10-KFY2009filed February 26, 2010Financial Statements
FY2009 against FY2008
| Line item | FY2009FY2008 | Change |
|---|---|---|
| Revenue | $3.50B$2.97B | +18.0% |
| Interest Expense | $24.44M$23.84M | +2.5% |
| Net Income | $876.95M$290.97M | +201.4% |
| EPS (Basic) | $1.59$0.47 | +234.4% |
| EPS (Diluted) | $1.53$0.45 | +235.9% |
| Shares Outstanding (Basic) | 536.04M558.91M | −4.1% |
| Shares Outstanding (Diluted) | 557.34M583.10M | −4.4% |
05—Questions
Frequently Asked Questions
Why did ACGL's earnings rebound so sharply in 2009 compared with 2008?
The 2008 results were depressed by Hurricanes Gustav and Ike, which cost about $287 million after tax, and by large investment-related losses, including $178.6 million of equity-method losses and $181.2 million of other-than-temporary impairments. In 2009, the company had no significant catastrophe activity, equity-method investments recovered to $167.8 million of income, and realized gains were $143.6 million. Combined with $189.2 million of favorable reserve development, these factors drove net income to $876.9 million from $291.0 million.
Is the reinsurance business or the insurance business the stronger earnings driver?
The reinsurance segment is clearly stronger. Its 2009 combined ratio was 73.7% and its underwriting income was $303.2 million, against an insurance combined ratio of 98.1% and underwriting income of just $32.9 million. Insurance faces a much higher loss ratio (67.5% versus 44.6% for reinsurance) and a higher expense load, and its earnings are thin relative to its premium base.
What are the main risks to ACGL's balance sheet and future earnings?
Key risks include catastrophe exposure, with the modeled peak zone being a Florida hurricane net PML of $750 million (about 25% of equity is the stated tolerance); investment risk, since MBS and CMBS make up roughly 23% of invested assets and the portfolio is sensitive to credit spreads and interest rates; broker concentration, with Marsh & McLennan and AON providing 15.6% and 21.4% of gross premiums; and the possibility that reinsurance recoverables from counterparties fail. Ratings downgrades could also hurt the company, since several reinsurance contracts give ceding clients termination or collateral rights after a downgrade.
How much capital does ACGL have available for shareholder returns?
The company had $4.32 billion of total shareholders' equity at December 31, 2009, including $325 million of preferred shares. Arch Re Bermuda, the main operating subsidiary, can pay approximately $1.07 billion in dividends to ACGL during 2010 without a regulatory affidavit. ACGL's parent-only cash and short-term investments were modest at about $25.7 million, so holding-company liquidity depends on those upstream dividends. The company had $844.6 million of remaining buyback authorization as of February 23, 2010, and $300 million of senior notes plus $100 million of revolver borrowings due August 2011.
Does ACGL pay a common dividend, and what does its tax position look like?
ACGL has not paid cash dividends on its common shares; it has instead returned capital through share repurchases. Preferred share dividends of $25.8 million were paid annually on its series A and series B non-cumulative preferred shares. ACGL is a Bermuda company with no current Bermuda income or capital gains tax, under an assurance that runs until March 28, 2016. Its effective tax rate was just 2.3% in 2009, and management expects roughly 3% to 5% in 2010. Its U.S. operations are structured to avoid being engaged in a U.S. trade or business, but that position depends on IRS interpretation and remains a disclosed risk.
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