10-QPeriod: Q3 FY2006

ARCH CAPITAL GROUP LTD. Quarterly Report for Q3 Ended Sep 30, 2006

Filed November 9, 2006For Securities:ACGLACGLNACGLO

Summary

Arch Capital Group Ltd. (ACGL) reported a strong third quarter and nine-month period ended September 30, 2006, demonstrating a significant turnaround from the prior year. Net income available to common shareholders reached $185.8 million for the quarter and $453.3 million for the nine months, a substantial improvement compared to a net loss in the same periods of 2005. This recovery was primarily driven by a lower incidence of catastrophic events and growth in investment income. The company's insurance and reinsurance segments both showed improved underwriting results, with combined ratios significantly better than in the prior year. The insurance segment reported underwriting income of $57.9 million and a combined ratio of 86.5%, while the reinsurance segment posted underwriting income of $62.3 million and a combined ratio of 81.5% for the third quarter. This reflects improved market conditions and effective risk management, particularly in property and marine lines of business, which have seen increased focus following the 2005 catastrophe events. Financially, ACGL's total assets grew to $13.95 billion, with total shareholders' equity reaching $3.35 billion. The company also successfully raised capital through preferred share offerings in February and May 2006, totaling $325 million, to support its underwriting operations. The company's liquidity remains strong, supported by robust operating cash flows and available credit facilities.

Key Highlights

  • 1Significant improvement in net income available to common shareholders, with $185.8 million in Q3 2006 and $453.3 million in the nine months ended Sept 30, 2006, compared to a net loss in 2005.
  • 2Both Insurance and Reinsurance segments experienced improved underwriting performance, evidenced by significantly lower combined ratios (86.5% and 81.5% respectively in Q3 2006) compared to the prior year.
  • 3Gross premiums written increased in the Insurance segment to $750.6 million in Q3 2006, driven by growth in property, professional liability, and construction/surety lines.
  • 4Reinsurance segment's gross premiums written saw a decrease to $366.8 million in Q3 2006, influenced by a higher cession to Flatiron Re Ltd. and adjustments on prior underwriting years.
  • 5Total investments grew to $8.72 billion as of September 30, 2006, with a strong credit quality rating (AA+).
  • 6Shareholders' equity increased substantially to $3.35 billion as of September 30, 2006, up from $2.48 billion at year-end 2005, supported by net income and preferred share issuances.
  • 7The company strengthened its capital base by issuing $325 million in non-cumulative preferred shares during 2006.

Frequently Asked Questions

The primary driver for the profit improvement was a substantial reduction in catastrophic events. The third quarter of 2005 was significantly impacted by major hurricanes, leading to large losses. In contrast, the third quarter of 2006 experienced a much lower incidence of such events, along with growth in investment income.

Following the significant weather-related catastrophic events in the second half of 2005, Arch Capital has focused on increasing its writings in property and marine business lines. This shift is supported by capital raised through preferred share offerings and a quota-share reinsurance treaty with Flatiron Re Ltd., allowing for increased participation without a proportional increase in risk.

Arch Capital maintains a strong liquidity position, supported by robust operating cash flows, significant investment assets, and available credit facilities. The company has actively managed its capital, including the successful issuance of preferred shares in 2006, and believes it has sufficient resources to meet its obligations and support future growth. The company also continuously monitors its capital adequacy and may adjust its capital base as needed.

Effective January 1, 2006, Arch Capital adopted the fair value method for share-based compensation under SFAS No. 123(R). This led to the recognition of compensation expense for stock options and restricted shares. Because a modified prospective method was used, prior period financial statements (2005) were not restated for stock option expense, making direct comparability of the impact of stock-based compensation between 2005 and 2006 challenging. The adoption resulted in pre-tax share-based compensation expense for stock options of $2.0 million in Q3 2006, compared to none in Q3 2005 under the previous accounting method.