Market Overview

Arch Capital Group Ltd. Reports 2018 Second Quarter Results

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Arch Capital Group Ltd. (NASDAQ:ACGL) announces its 2018 second quarter
results. The results included:

  • Net income available to Arch common shareholders of $233.2 million, or
    $0.56 per share, an 11.1% annualized return on average common equity,
    compared to $173.8 million, or $0.42 per share, and 8.7% for the 2017
    second quarter;
  • After-tax operating income available to Arch common shareholders, a
    non-GAAP measure, of $242.6 million, or $0.59 per share, an 11.6%
    annualized return on average common equity, compared to $168.9
    million, or $0.40 per share, and 8.5% for the 2017 second quarter;
  • Pre-tax current accident year catastrophic losses, net of reinsurance
    and reinstatement premiums(1), of $14.9 million;
  • Favorable development in prior year loss reserves, net of related
    adjustments(1), of $60.3 million;
  • Combined ratio excluding catastrophic activity and prior year
    development(1) of 84.0%;
  • Book value per common share of $20.68 at June 30, 2018, a 1.3%
    increase in the 2018 second quarter and a 4.1% increase for the
    trailing twelve months;
  • Share repurchases of $170.3 million.

All earnings per share amounts discussed in this release are on a
diluted basis. All share and per share amounts in this release reflect
the three-for-one share split of Arch Capital's common shares which
occurred in the 2018 second quarter.

The following table summarizes the Company's underwriting results, both
(i) on a consolidated basis and (ii) on a consolidated basis excluding
the ‘other' segment (i.e., results of Watford Re, as defined
below):

   
(U.S. dollars in thousands) Consolidated Consolidated Excluding ‘Other' Segment (1)
Three Months Ended June 30, Three Months Ended June 30,
2018   2017   % Change 2018   2017   % Change
Gross premiums written $ 1,696,544 $ 1,609,659 5.4 $ 1,591,202 $ 1,533,142 3.8
Net premiums written 1,298,896 1,248,695 4.0 1,158,310 1,108,292 4.5
Net premiums earned 1,336,763 1,240,874 7.7 1,177,245 1,090,120 8.0
Underwriting income 235,465 195,419 20.5 235,783 198,062 19.0
Underwriting Ratios

% Point
Change

% Point
Change

Loss ratio 54.3 % 55.6 % (1.3 ) 51.7 % 53.1 % (1.4 )
Underwriting expense ratio 28.4 % 29.0 % (0.6 ) 28.5 % 29.1 % (0.6 )
Combined ratio 82.7 % 84.6 % (1.9 ) 80.2 % 82.2 % (2.0 )
Combined ratio excluding catastrophic activity and prior year
development
84.0 % 86.3 % (2.3 )
 

(1) Excluding the ‘other' segment. See ‘Comments on Regulation G' for
further details.

Pursuant to GAAP, the Company consolidates the results of Watford
Holdings Ltd. in its financial statements, although it only owns
approximately 11% of Watford Holdings Ltd.'s common equity. Watford
Holdings Ltd. is the parent of Watford Re Ltd., a multi-line Bermuda
reinsurance company (together with Watford Holdings Ltd., "Watford Re").
See ‘Comments on Regulation G' for further details.

The following table summarizes the Company's 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 and related diluted per share results:

   
(U.S. dollars in thousands, except share data) Three Months Ended Six Months Ended
June 30, June 30,
2018   2017 2018   2017
Net income available to Arch common shareholders $ 233,243 $ 173,818 $ 370,519 $ 415,727
Net realized (gains) losses 61,426 (18,452 ) 173,190 (47,586 )
Net impairment losses recognized in earnings 470 1,730 632 3,537
Equity in net (income) loss of investment funds accounted for using
the equity method
(8,472 ) (32,706 ) (36,541 ) (80,794 )
Net foreign exchange (gains) losses (47,038 ) 38,012 (31,482 ) 57,808
UGC transaction costs and other 6,908 2,675 7,738 18,259
Loss on redemption of preferred shares 2,710
Income tax expense (benefit) (1) (3,941 ) 3,842   (9,027 ) (67 )
After-tax operating income available to Arch common shareholders $ 242,596   $ 168,919   $ 477,739   $ 366,884  
 

Diluted per common share results:

Net income available to Arch common shareholders $ 0.56 $ 0.42 $ 0.89 $ 1.00
Net realized (gains) losses 0.15 (0.05 ) 0.42 (0.12 )
Net impairment losses recognized in earnings 0.00 0.00 0.00 0.01
Equity in net (income) loss of investment funds accounted for using
the equity method
(0.02 ) (0.08 ) (0.09 ) (0.19 )
Net foreign exchange (gains) losses (0.11 ) 0.09 (0.08 ) 0.14
UGC transaction costs and other 0.02 0.01 0.02 0.04
Loss on redemption of preferred shares

0.01

Income tax expense (benefit) (1) (0.01 ) 0.01   (0.02 ) 0.00  
After-tax operating income available to Arch common shareholders $ 0.59   $ 0.40   $ 1.15   $ 0.88  
 
Weighted average common shares and common share equivalents
outstanding —diluted
413,111,205 417,733,938 415,460,756 417,421,896
 
Beginning common shareholders' equity $ 8,370,372 $ 7,833,289 $ 8,324,047 $ 7,481,163
Ending common shareholders' equity 8,383,755   8,126,332   8,383,755   8,126,332  
Average common shareholders' equity $ 8,377,064   $ 7,979,811   $ 8,353,901   $ 7,803,748  
 
Annualized return on average common equity 11.1 % 8.7 % 8.9 % 10.7 %
Annualized operating return on average common equity 11.6 % 8.5 % 11.4 % 9.4 %
 
(1)   Income tax expense on net realized gains or losses, net impairment
losses recognized in earnings, equity in net income (loss) of
investment funds accounted for using the equity method, net foreign
exchange gains or losses, UGC 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.
 

Each line item in the table above reflects the impact of the Company's
approximate 11% ownership of Watford Re's common equity. See ‘Comments
on Regulation G' for a discussion of non-GAAP financial measures.

Segment Information

The following section provides analysis on the Company's 2018 second
quarter performance by operating segment. For additional details
regarding the Company's operating segments, please refer to the
Company's Financial Supplement dated June 30, 2018. The Company's
segment information includes the use of underwriting income (loss) and a
combined ratio excluding catastrophic activity (if applicable for the
segment) and prior year development. Such items are non-GAAP financial
measures (see ‘Comments on Regulation G' for further details).

Insurance Segment

  Three Months Ended June 30,
(U.S. dollars in thousands) 2018   2017   % Change
 
Gross premiums written $ 769,372 $ 743,902 3.4
Net premiums written 524,107 496,456 5.6
Net premiums earned 546,449 517,574 5.6
 
Underwriting income (loss) $ 5,634 $ (4,504 ) n/m
 
Underwriting Ratios

% Point
Change

Loss ratio 65.4 % 67.8 % (2.4 )
Underwriting expense ratio 33.6 % 33.0 % 0.6  
Combined ratio 99.0 % 100.8 % (1.8 )
 
Catastrophic activity and prior year development:
Current accident year catastrophic events, net of reinsurance and
reinstatement premiums
1.4 % 1.6 % (0.2 )
Net (favorable) adverse development in prior year loss reserves, net
of related adjustments
(0.9 )% (0.2 )% (0.7 )
Combined ratio excluding catastrophic activity and prior year
development (1)
98.5 % 99.4 % (0.9 )
 

(1) See ‘Comments on Regulation G' for further discussion.

Gross premiums written by the insurance segment in the 2018 second
quarter were 3.4% higher than in the 2017 second quarter while net
premiums written were 5.6% higher than in the 2017 second quarter.
Changes in foreign currency exchange rates resulted in an increase in
net premiums written in the 2018 second quarter of $2.0 million, or
0.4%, compared to the 2017 second quarter. The increase in net premiums
written reflected growth in property, primarily due to new business and
rate increases, in travel, due to both new business and growth in
existing accounts, and in programs, reflecting rate increases and growth
in recently added programs. Net premiums earned by the insurance segment
in the 2018 second quarter were 5.6% higher than in the 2017 second
quarter, and reflect changes in net premiums written over the previous
five quarters.

The 2018 second quarter loss ratio reflected 1.4 points for current year
catastrophic activity, compared to 1.6 points in the 2017 second
quarter. Estimated net favorable development in prior year loss
reserves, before related adjustments, reduced the loss ratio by 1.1
points in the 2018 second quarter, compared to 0.4 points in the 2017
second quarter. The balance of the change in the 2018 second quarter
loss ratio resulted, in part, from a lower level of large attritional
losses and changes in mix of business.

The underwriting expense ratio was 33.6% in the 2018 second quarter,
compared to 33.0% in the 2017 second quarter, reflecting changes in the
mix and type of business.

Reinsurance Segment

  Three Months Ended June 30,
(U.S. dollars in thousands) 2018   2017   % Change
 
Gross premiums written $ 490,327 $ 453,186 8.2
Net premiums written 354,080 337,924 4.8
Net premiums earned 340,318 314,702 8.1
Other underwriting income (loss) (129 ) (279 ) (53.8 )
 
Underwriting income $ 24,413 $ 18,955 28.8
 
Underwriting Ratios

% Point
Change

Loss ratio 67.6 % 66.0 % 1.6
Underwriting expense ratio 25.2 % 28.0 % (2.8 )
Combined ratio 92.8 % 94.0 % (1.2 )
 
Catastrophic activity and prior year development:
Current accident year catastrophic events, net of reinsurance and
reinstatement premiums
2.2 % 5.2 % (3.0 )
Net (favorable) adverse development in prior year loss reserves, net
of related adjustments
(9.4 )% (12.3 )% 2.9  
Combined ratio excluding catastrophic activity and prior year
development (1)
100.0 % 101.1 % (1.1 )
 

(1) See ‘Comments on Regulation G' for further discussion.

Gross premiums written by the reinsurance segment in the 2018 second
quarter were 8.2% higher than in the 2017 second quarter, while net
premiums written were 4.8% higher than in the 2017 second quarter. The
lower level of growth in net premiums written primarily reflects an
increase in retrocessions on other specialty lines. Changes in foreign
currency exchange rates resulted in an increase in net premiums written
in the 2018 second quarter of $6.9 million, or 2.0%, compared to the
2017 second quarter. The increase in net premiums written reflected
growth in property excluding property catastrophe business, primarily
due to new accounts and rate increases. Net premiums earned reflect
changes in net premiums written over the previous five quarters.

The 2018 second quarter loss ratio contained 9.9 points, or $33.7
million, of property facultative loss activity, compared to 11.1 points,
or $34.8 million, in the 2017 second quarter. The 2018 second quarter
loss ratio included 2.2 points of current year catastrophic activity,
compared to 5.4 points of catastrophic activity in the 2017 second
quarter. Estimated net favorable development in prior year loss
reserves, before related adjustments, reduced the loss ratio by 9.7
points in the 2018 second quarter, compared to 12.6 points in the 2017
second quarter. The estimated net favorable development in the 2018
second quarter primarily resulted from better than expected claims
emergence in short-tail business from more recent underwriting years and
in longer-tail business across earlier underwriting years. The balance
of the change in the 2018 second quarter loss ratio resulted, in part,
from changes in mix of business.

The underwriting expense ratio was 25.2% in the 2018 second quarter,
compared to 28.0% in the 2017 second quarter, reflecting a higher level
of net premiums earned and changes in the mix and type of business. In
addition, the underwriting expense ratio benefited from a reduction in
federal excise taxes incurred of $2.6 million, or 0.8 points, as the
reinsurance agreements between the Company's U.S.-based insurance and
reinsurance subsidiaries and Arch Reinsurance Ltd. were not renewed as
of January 1, 2018.

Mortgage Segment

  Three Months Ended June 30,
(U.S. dollars in thousands) 2018   2017   % Change
 
Gross premiums written $ 330,990 $ 336,226 (1.6 )
Net premiums written 280,123 273,912 2.3
Net premiums earned 290,478 257,844 12.7
Other underwriting income 3,315 4,277 (22.5 )
 
Underwriting income $ 205,736 $ 183,611 12.0
 
Underwriting Ratios

% Point
Change

Loss ratio 7.4 % 8.0 % (0.6 )
Underwriting expense ratio 22.8 % 22.5 % 0.3  
Combined ratio 30.2 % 30.5 % (0.3 )
 
Prior year development:
Net (favorable) adverse development in prior year loss reserves, net
of related adjustments
(8.0 )% (11.5 )% 3.5  
Combined ratio excluding prior year development (1) 38.2 % 42.0 % (3.8 )
 

(1) See ‘Comments on Regulation G' for further discussion.

Gross premiums written by the mortgage segment in the 2018 second
quarter were 1.6% lower than in the 2017 second quarter, while net
premiums written were 2.3% higher than in the 2017 second quarter. The
reduction in gross premiums written primarily reflected lower level of
U.S. single premium business and a decrease in Australian mortgage
reinsurance business, partially offset by growth in U.S. monthly premium
business and government sponsored enterprise ("GSE") credit-risk sharing
transactions. Net premiums written for the 2018 second quarter reflected
a declining cession to AIG on the 50% quota share reinsurance agreement
covering 2014 to 2016 policy years of UGC business on a run-off basis,
while the 2017 second quarter also reflected higher retrocessions of
Australian mortgage reinsurance business. The increase in net premiums
earned for the 2018 second quarter primarily reflected the growth in
insurance in force over the last twelve months. Insurance in force
increased to $359.9 billion at June 30, 2018, compared to $332.9 billion
at June 30, 2017.

Arch MI U.S. generated $19.9 billion of new insurance written ("NIW") in
the 2018 second quarter, compared to $17.3 billion in the 2017 second
quarter, as a higher level of purchase market activity more than offset
a reduction in single premium business. Monthly premium policies
contributed 94.3% of NIW in the 2018 second quarter, compared to 85.7%
in the 2017 second quarter.

The loss ratio for the 2018 second quarter reflected $9.0 million, or
3.1 points, of favorable current year development on 2018 first quarter
delinquencies which cured in the period, and estimated net favorable
development in prior year loss reserves, before related adjustments, of
8.0 points, compared to 11.5 points in the 2017 second quarter. The
estimated net favorable development in the 2018 second quarter was
primarily driven by lower than expected claim rates on first lien
business and subrogation activity on second lien business. The ending
percentage of loans in default on first lien business decreased to 1.70%
at June 30, 2018, from 1.98% at March 31, 2018.

The mortgage segment's underwriting expense ratio was 22.8% in the 2018
second quarter, compared to 22.5% in the 2017 second quarter. The
underwriting expense ratio in the 2018 second quarter reflected an
increase in incentive compensation costs, partially offset by a higher
level of net premiums earned.

At June 30, 2018, the mortgage segment's risk-in-force (before
reinsurance) of $72.8 billion consisted of $67.3 billion from Arch MI
U.S. with the remainder from reinsurance and credit-risk sharing
operations. For additional information on the mortgage segment, please
refer to the Company's Financial Supplement dated June 30, 2018.

Corporate and Non-Underwriting

Corporate and non-underwriting results include net investment income,
other income (loss), corporate expenses, UGC transaction costs and
other, amortization of intangible assets, 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.

Pre-tax net investment income for the 2018 second quarter was $0.26 per
share, or $107.8 million, compared to $0.22 per share, or $92.5 million,
for the 2017 second quarter. The 2018 second quarter net investment
income reflected the reinvestment of fixed income securities at higher
available yields, a shift from municipal bonds to corporates and a
higher level of average investable assets than in the 2017 second
quarter. The annualized pre-tax investment income yield was 2.32% for
the 2018 second quarter, compared to 2.04% for the 2017 second quarter.

Corporate expenses were $15.6 million for the 2018 second quarter,
compared to $22.2 million for the 2017 second quarter, with the decrease
primarily due to lower incentive compensation costs. UGC transaction
costs and other were $6.9 million for the 2018 second quarter, compared
to $2.7 million for the 2017 second quarter. The 2018 second quarter
amount was primarily attributable to the write off of intangible assets
related to insurance licenses for a subsidiary of UGC which is being
merged with another subsidiary. Amortization of intangible assets for
the 2018 second quarter was $26.5 million, compared to $30.8 million for
the 2017 second quarter, with amounts in both periods primarily related
to intangible assets related to the UGC acquisition.

Interest expense for the 2018 second quarter was $26.1 million, compared
to $25.9 million for the 2017 second quarter while preferred dividends
for the 2018 second quarter were $10.4 million, compared to $11.3
million for the 2017 second quarter.

On a pre-tax basis, net foreign exchange gains for the 2018 second
quarter were $46.2 million, compared to net foreign exchange losses for
the 2017 second quarter of $37.8 million. For both periods, such amounts
were primarily unrealized and resulted from the effects of revaluing the
Company's net insurance liabilities required to be settled in foreign
currencies at each balance sheet date. Changes in the value of
available-for-sale investments held in foreign currencies due to foreign
currency rate movements are reflected as a direct increase or decrease
to shareholders' equity and are not included in the consolidated
statements of income. Although the Company generally attempts to match
the currency of its projected liabilities with investments in the same
currencies, the Company may elect to over or underweight one or more
currencies from time to time, which could increase the Company's
exposure to foreign currency fluctuations and increase the volatility of
the Company's shareholders' equity.

The Company's effective tax rate on income before income taxes (based on
the Company's annual effective tax rate) was 8.8% for the 2018 second
quarter, compared to 15.6% for the 2017 second quarter, while the
effective tax rate on pre-tax operating income available to Arch common
shareholders was 9.8% for the 2018 second quarter, compared to 14.4% for
the 2017 second quarter. The effective tax rates for the 2018 second
quarter included a discrete income tax benefit of $1.6 million related
to share-based compensation which had the effect of reducing the 2018
second quarter effective tax rate on operating income available to Arch
common shareholders by 0.6%. The change in the U.S. federal corporate
tax rate from 35% to 21% commencing on January 1, 2018 contributed to a
lower effective tax rate on operating income for the 2018 second quarter
as compared to the 2017 second quarter. The Company's effective tax rate
fluctuates from period to period based upon the relative mix of income
or loss reported by jurisdiction, the level of catastrophic loss
activity incurred, and the varying tax rates in each jurisdiction. The
Company currently expects that its annual effective tax rate on pre-tax
operating income available to Arch common shareholders for the year
ended December 31, 2018 will be in the range of 9% to 12%.

Capital Activity

During the 2018 second quarter, the Company repaid $250.0 million of
revolving credit agreement borrowings which reduced the overall debt and
preferred ratio to capital available to Arch to 23.9% at June 30, 2018.
In addition, the Company repurchased 6.4 million shares under its share
repurchase program with an aggregate purchase price of $170.3 million,
which reduced book value per share by $0.09 for the 2018 second quarter.
At June 30, 2018, $272.9 million of share repurchases were remaining and
available under the program, which may be effected from time to time in
open market or privately negotiated transactions through December 31,
2019. For additional information on the Company's capital structure,
please refer to the Financial Supplement dated June 30, 2018.

Conference Call

The Company will hold a conference call for investors and analysts at
11:00 a.m. Eastern Time on August 1, 2018. A live webcast of this call
will be available via the Investors section of the Company's website at http://www.archcapgroup.com.
A telephone replay of the conference call also will be available
beginning on August 1, 2018 at 2:00 p.m. Eastern Time until August 8,
2018 at midnight Eastern Time. To access the replay, domestic callers
should dial 855-859-2056, and international callers should dial
404-537-3406 (passcode 5782529 for all callers).

Please refer to the Company's Financial Supplement dated June 30, 2018,
which is available via the Investors section of the Company's website at http://www.archcapgroup.com.
The Financial Supplement provides additional detail regarding the
financial performance of the Company. From time to time, the Company
posts additional financial information and presentations to its website,
including information with respect to its subsidiaries. Investors and
other recipients of this information are encouraged to check the
Company's website regularly for additional information regarding the
Company.

Arch Capital Group Ltd., a Bermuda-based company with approximately
$11.02 billion in capital at June 30, 2018, provides insurance,
reinsurance and mortgage insurance on a worldwide basis through its
wholly owned subsidiaries.

Comments on Regulation G

Throughout this release, the Company presents its operations in the way
it believes will be the most meaningful and useful to investors,
analysts, rating agencies and others who use the Company's financial
information in evaluating the performance of the Company and that
investors and such other persons benefit from having a consistent basis
for comparison between quarters and for comparison with other companies
within the industry. These measures may not, however, be comparable to
similarly titled measures used by companies outside of the insurance
industry. Investors are cautioned not to place undue reliance on these
non-GAAP financial measures in assessing the Company's overall financial
performance.

This presentation includes the use of "after-tax operating income or
loss 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, UGC transaction costs and
other and loss on redemption of preferred shares, net of income taxes,
and the use of annualized operating return on average common equity. The
presentation of after-tax operating income available to Arch common
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 on the following page of this release.

The Company believes 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, UGC 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, the Company's business
performance. 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 the Company's
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 the Company's 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 the Company's investments represent other-than-temporary
declines in expected recovery values on securities without actual
realization. The use of the equity method on certain of the Company's
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 the Company's proportionate share of the
net income or loss of the funds (which include changes in the fair value
of the underlying securities in the funds). This method of accounting is
different from the way the Company accounts for its 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. UGC transaction costs and other include advisory,
financing, legal, severance, incentive compensation and other costs
related to the UGC acquisition. The Company believes that UGC
transaction costs and other, due to their non-recurring nature, are not
indicative of the performance of, or trends in, the Company's business
performance. The loss on redemption of preferred shares related to the
redemption of the Company's Series C preferred shares in January 2018
and had no impact on shareholders' equity or cash flows. Due to these
reasons, the Company excludes 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, UGC transaction costs and other and loss on
redemption of preferred shares from the calculation of after-tax
operating income or loss available to Arch common shareholders.

The Company believes that showing net income available to Arch common
shareholders exclusive of the items referred to above reflects the
underlying fundamentals of the Company's business since the Company
evaluates the performance of and manages its business to produce an
underwriting profit. In addition to presenting net income available to
Arch common shareholders, the Company believes that this presentation
enables investors and other users of the Company's financial information
to analyze the Company's performance in a manner similar to how the
Company's management analyzes performance. The Company also believes
that this measure follows industry practice and, therefore, allows the
users of the Company's financial information to compare the Company's
performance with its industry peer group. The Company believes that the
equity analysts and certain rating agencies which follow the Company and
the insurance industry as a whole generally exclude these items from
their analyses for the same reasons.

The Company's 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 its 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
the Company's individual underwriting operations. Underwriting income or
loss does not incorporate items included in the Company's corporate
(non-underwriting) segment. While these measures are presented in the
Segment Information footnote to the Company's 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 on the following pages.

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 and, accordingly, investment
income and other non-underwriting related items are not allocated to
each underwriting segment. As noted earlier, the ‘other' segment
includes the results of Watford Re. 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. 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 common and
preferred shares and counterparty credit risk (mitigated by collateral)
arising from reinsurance transactions.

Along with consolidated underwriting income, the Company provides a
subtotal of underwriting income or loss before the contribution from the
‘other' segment and believes that this presentation enables investors
and other users of the Company's financial information to analyze the
Company's underwriting performance in a manner similar to how the
Company's management analyzes performance.

In addition, the Company's segment information includes the use of a
combined ratio excluding catastrophic activity (if applicable for the
segment) and prior year development. These ratios are non-GAAP financial
measures as defined in Regulation G. The reconciliation of such measures
to the combined ratio (the most directly comparable GAAP financial
measure) in accordance with Regulation G are shown on the individual
segment pages. The Company's management utilizes the adjusted combined
ratio excluding current accident year catastrophic events and favorable
or adverse development in prior year loss reserves in its analysis of
the underwriting performance of each of its underwriting segments.

The following tables summarize the Company's results by segment for the
2018 second quarter and 2017 second quarter and a reconciliation of
underwriting income or loss to income or loss before income taxes and
net income or loss available to Arch common shareholders:

 
(U.S. Dollars in thousands) 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 (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 3,113 3,113
Corporate expenses (15,604 ) (15,604 )
UGC transaction costs and other (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 %
 
Net premiums written to gross premiums written 68.1 % 72.2 % 84.6 % 72.8 % 80.3 % 76.6 %
 
(1)   Certain amounts included in the gross premiums written of each
segment are related to intersegment transactions and are included in
the gross premiums written of each segment. 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.
 
 
(U.S. Dollars in thousands) Three Months Ended
June 30, 2017
Insurance   Reinsurance   Mortgage   Sub-total   Other   Total
Gross premiums written (1) $ 743,902 $ 453,186 $ 336,226 $ 1,533,142 $ 152,813 $ 1,609,659
Premiums ceded (247,446 ) (115,262 ) (62,314 ) (424,850 ) (12,410 ) (360,964 )
Net premiums written 496,456 337,924 273,912 1,108,292 140,403 1,248,695
Change in unearned premiums 21,118   (23,222 ) (16,068 ) (18,172 ) 10,351   (7,821 )
Net premiums earned 517,574 314,702 257,844 1,090,120 150,754 1,240,874
Other underwriting income (loss) (279 ) 4,277 3,998 824 4,822
Losses and loss adjustment expenses (350,939 ) (207,606 ) (20,694 ) (579,239 ) (110,621 ) (689,860 )
Acquisition expenses (78,872 ) (51,151 ) (25,666 ) (155,689 ) (34,747 ) (190,436 )
Other operating expenses (92,267 ) (36,711 ) (32,150 ) (161,128 ) (8,853 ) (169,981 )
Underwriting income (loss) $ (4,504 ) $ 18,955   $ 183,611   198,062 (2,643 ) 195,419
 
Net investment income 92,520 18,604 111,124
Net realized gains (losses) 18,046 3,689 21,735
Net impairment losses recognized in earnings (1,730 ) (1,730 )
Equity in net income (loss) of investment funds accounted for using
the equity method
32,706 32,706
Other income (loss) (1,994 ) (1,994 )
Corporate expenses (22,201 ) (22,201 )
UGC transaction costs and other (2,675 ) (2,675 )
Amortization of intangible assets (30,824 ) (30,824 )
Interest expense (25,912 ) (2,837 ) (28,749 )
Net foreign exchange gains (losses) (37,821 ) (1,722 ) (39,543 )
Income before income taxes 218,177 15,091 233,268
Income tax (expense) benefit (34,169 )   (34,169 )
Net income 184,008 15,091 199,099
Dividends attributable to redeemable noncontrolling interests (4,586 ) (4,586 )
Amounts attributable to nonredeemable noncontrolling interests   (9,346 ) (9,346 )
Net income available to Arch 184,008 1,159 185,167
Preferred dividends (11,349 )   (11,349 )
Net income available to Arch common shareholders $ 172,659   $ 1,159   $ 173,818  
 
Underwriting Ratios
Loss ratio 67.8 % 66.0 % 8.0 % 53.1 % 73.4 % 55.6 %
Acquisition expense ratio 15.2 % 16.3 % 10.0 % 14.3 % 23.0 % 15.3 %
Other operating expense ratio 17.8 % 11.7 % 12.5 % 14.8 % 5.9 % 13.7 %
Combined ratio 100.8 % 94.0 % 30.5 % 82.2 % 102.3 % 84.6 %
 
Net premiums written to gross premiums written 66.7 % 74.6 % 81.5 % 72.3 % 91.9 % 77.6 %
 
(1)   Certain amounts included in the gross premiums written of each
segment are related to intersegment transactions and are included in
the gross premiums written of each segment. 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.

Cautionary Note Regarding Forward-Looking Statements

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

  • the Company's ability to successfully implement its business strategy
    during "soft" as well as "hard" markets;
  • acceptance of the Company's business strategy, security and financial
    condition by rating agencies and regulators, as well as by brokers and
    its insureds and reinsureds;
  • the integration of any businesses the Company has acquired or may
    acquire into its existing operations;
  • the Company's ability to maintain or improve its ratings, which may be
    affected by its 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, 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 the Company operates;
  • 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 the
    Company's access to such markets;
  • the Company's ability to successfully enhance, integrate and maintain
    operating procedures (including information technology) to effectively
    support its current and new business;
  • the loss of key personnel;
  • accuracy of those estimates and judgments utilized in the preparation
    of the Company's 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 the Company, are even more
    difficult to make than those made in a mature company since relatively
    limited historical information has been reported to the Company
    through June 30, 2018;
  • greater than expected loss ratios on business written by the Company
    and adverse development on claim and/or claim expense liabilities
    related to business written by its insurance and reinsurance
    subsidiaries;
  • severity and/or frequency of losses;
  • claims resulting from natural or man-made catastrophic events in the
    Company's insurance, reinsurance and mortgage businesses could cause
    large losses and substantial volatility in our results of operations;
  • acts of terrorism, political unrest and other hostilities or other
    unforecasted and unpredictable events;
  • availability to the Company of reinsurance to manage its 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 the Company;
  • the timing of loss payments being faster or the receipt of reinsurance
    recoverables being slower than anticipated by the Company;
  • the Company's investment performance, including legislative or
    regulatory developments that may adversely affect the fair value of
    the Company's 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 the Company's
    business, financial condition and results of operations;
  • the volatility of the Company's shareholders' equity from foreign
    currency fluctuations, which could increase due to us not matching
    portions of the Company's projected liabilities in foreign currencies
    with investments in the same currencies;
  • losses relating to aviation business and business produced by a
    certain managing underwriting agency for which the Company may be
    liable to the purchaser of its prior reinsurance business or to others
    in connection with the May 5, 2000 asset sale described in the
    Company's periodic reports filed with the SEC;
  • changes in accounting principles or policies or in the Company's
    application of such accounting principles or policies;
  • changes in the political environment of certain countries in which the
    Company operates, underwrites business or invests;
  • statutory or regulatory developments, including as to tax policy
    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 the
    Company, its 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 the Company's Annual
    Report on Form 10-K, as well as the other factors set forth in the
    Company's 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 the Company or persons acting on its 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. The Company undertakes no obligation to publicly
update or revise any forward-looking statement, whether as a result of
new information, future events or otherwise.

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