<Page>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K/A
Current Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
June 22, 2001
- --------------------------------------------------------------------------------
Date of Report (Date of earliest event reported)
Arch Capital Group Ltd.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Bermuda 0-26456 N/A
- --------------------------------------------------------------------------------
(State or other jurisdiction (Commission File (I.R.S. Employer
of incorporation or Number) Identification No.)
organization)
20 Horseneck Lane, Greenwich, Connecticut 06830
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code:
(203) 862-4300
Not Applicable
- --------------------------------------------------------------------------------
(Former name or former address, if changed since last report)
<Page>
ITEM 2. ACQUISITION OR DISPOSITION OF ASSETS
On June 22, 2001, Arch Capital Group Ltd., a Bermuda company ("ACGL"),
acquired all of the capital stock of Altus Holdings, Ltd. ("Altus"), a Cayman
Islands company, that it did not already own, pursuant to a reorganization
agreement (the "Reorganization Agreement") dated as of March 23, 2001, by and
among Altus, ACGL and the other shareholders of Altus, for a purchase price of
approximately $38.8 million. The purchase price consisted of approximately $38.4
million in cash and 24,200 ACGL Common Shares issued to employee shareholders
continuing in management positions. Prior to the acquisition, ACGL owned a
minority interest in Altus' common stock which was previously accounted for
under "fair value".
Following the acquisition, Altus' name was changed to Arch Risk
Transfer Services Ltd. Arch Risk Transfer Services Ltd., through its
wholly-owned subsidiaries, including First American Insurance Company, an
admitted insurer with licenses in 49 states, provides insurance and alternative
risk transfer services through rent-a-captive and other facilities. The
conformed executed copy of the Reorganization Agreement and the press releases
relating to the transaction are filed as exhibits to ACGL's report on Form 8-K
filed with the SEC on July 6, 2001, and are incorporated herein by reference.
1
<Page>
ITEM 7. FINANCIAL STATEMENTS, PRO FORMA FINANCIAL INFORMATION AND EXHIBITS
(a) FINANCIAL STATEMENTS OF BUSINESS ACQUIRED.
Audited Consolidated Financial Statements of Altus:
Independent Auditors' Report
Consolidated Balance Sheets - December 31, 2000 and 1999
Consolidated Statements of Operations - Years Ended December 31,
2000 and 1999
Consolidated Statements of Shareholders' Equity - Years Ended
December 31, 2000 and 1999
Consolidated Statements of Cash Flows - Years Ended December 31,
2000 and 1999
Notes to Consolidated Financial Statements - Years Ended
December 31, 2000 and 1999
Unaudited Consolidated Financial Statements of Altus:
Unaudited Consolidated Balance Sheets - March 31, 2001 and 2000
Unaudited Consolidated Statements of Operations - For the Three Months
Ended March 31, 2001 and 2000
Unaudited Consolidated Statements of Cash Flows - For the Three Months
Ended March 31, 2001 and 2000
Notes to the Unaudited Consolidated Financial Statements - For the Three
Months Ended March 31, 2001 and 2000
(b) PRO FORMA FINANCIAL INFORMATION.
Unaudited Pro Forma Condensed Combined Financial Statements of ACGL
and Altus:
Unaudited Pro Forma Condensed Combined Balance Sheet - March 31, 2001
Unaudited Pro Forma Condensed Combined Statement of Income - For the Three
Months Ended March 31, 2001
Unaudited Pro Forma Condensed Combined Statement of Income - For the Year
Ended December 31, 2000
Notes to the Unaudited Pro Forma Condensed Combined Financial Statements
(c) EXHIBITS.
10.1. Reorganization Agreement, dated as of March 23, 2001, by and
among Altus Holdings, Ltd., The Trident Partnership, L.P.,
TRYCO II, Ltd., Marsh & McLennan Risk Capital Holdings, Ltd.,
Glenn L. Ballew, David G. May and Arch Capital Group Ltd.
("ACGL") (filed as an exhibit to ACGL's Report on Form 8-K, as
filed with the SEC on July 6, 2001, and incorporated by
reference).
23(a) Consent of Independent Accountants.
99.1. Press Release, dated March 23, 2001 (filed as an exhibit to
ACGL's Report on Form 8-K, as filed with the Securities and
Exchange Commission on July 6, 2001, and incorporated by
reference).
99.2. Press Release, dated June 22, 2001 (filed as an exhibit to
ACGL's Report on Form 8-K, as filed with the Securities and
Exchange Commission on July 6, 2001, and incorporated by
reference).
2
<Page>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
ARCH CAPITAL GROUP LTD.
Date: August 7, 2001 By: /s/ Debra M. O'Connor
----------------------
Debra M. O'Connor
Senior Vice President, Controller and Treasurer
3
<Page>
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
INDEX
<Table>
<Caption>
Page
-------------
FINANCIAL STATEMENTS OF BUSINESS ACQUIRED.
AUDITED CONSOLIDATED FINANCIAL STATEMENTS OF ALTUS:
Independent Auditors' Report 5
Consolidated Balance Sheets - December 31, 2000 and 1999 6-7
Consolidated Statements of Operations - Years Ended December 31, 2000 and 1999 8
Consolidated Statements Shareholders' Equity - Years Ended December 31, 2000 and 1999 9-10
Consolidated Statements of Cash Flows - Years Ended December 31, 2000 and 1999 11
Notes to Consolidated Financial Statements - Years Ended December 31, 2000 and 1999 12-23
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS OF ALTUS:
Unaudited Consolidated Balance Sheet - March 31, 2001 and 2000 24
Unaudited Consolidated Statement of Operations - For the Three Months Ended March 31, 2001 and 2000 25
Unaudited Consolidated Statement of Cash Flows - For the Three Months Ended March 31, 2001 and 2000 26
Notes to the Unaudited Consolidated Financial Statements - For the Three Months Ended March 31, 2001
and 2000 27
PRO FORMA FINANCIAL INFORMATION.
Unaudited Pro Forma Condensed Combined Financial Statements of ACGL and Altus:
Unaudited Pro Forma Condensed Combined Balance Sheet - March 31, 2001 29
Unaudited Pro Forma Condensed Combined Statement of Income - For the Three Months Ended March 31, 2001 30
Unaudited Pro Forma Condensed Combined Statement of Income - For the Year Ended December 31, 2000 31
Notes to the Unaudited Pro Forma Condensed Combined Financial Statements 32-33
</Table>
4
<Page>
ITEM 7. FINANCIAL STATEMENTS, PRO FORMA FINANCIAL INFORMATION AND EXHIBITS
(a) FINANCIAL STATEMENTS OF BUSINESS ACQUIRED.
Audited Consolidated Financial Statements of Altus:
INDEPENDENT AUDITORS' REPORT
To the Shareholders
of Altus Holdings, Ltd.
We have audited the accompanying consolidated balance sheets of Altus Holdings,
Ltd. (the "Company") as of December 31, 2000 and 1999, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
the years then ended. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of the Company as of December 31, 2000
and 1999, and the results of its operations and its cash flows for the years
then ended in conformity with accounting principles generally accepted in the
United States of America.
/s/ Deloitte & Touche LLP
May 18, 2001
5
<Page>
ALTUS HOLDINGS, LTD.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2000 AND 1999
(IN THOUSANDS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
ASSETS 2000 1999
-------- --------
Investments:
Securities available-for-sale, at fair value -
Fixed maturities (amortized cost: 2000 - $49,868; 1999 - $46,914) $ 50,272 $ 45,859
Equities (cost: 1999 - $597) -- 633
Certificates of deposit 3,325 1,078
-------- --------
Total investments 53,597 47,570
Cash and cash equivalents 13,204 10,576
Receivables - less allowance of $1,371 and $1,266 17,235 4,022
Reinsurance assets:
Paid losses and loss adjustment expenses recoverable 2,977 989
Unpaid losses and loss adjustment expenses recoverable 21,874 1,924
Prepaid reinsurance premiums 31,942 1,166
Deferred acquisition costs 3,244 2,437
Furniture and equipment - at cost, less accumulated
depreciation of $793 and $462 1,078 693
Accrued investment income 815 982
Other assets 305 277
Assets held in separate accounts 2,552 1,057
-------- --------
TOTAL $148,823 $ 71,693
======== ========
</Table>
See notes to consolidated financial statements.
6
<Page>
ALTUS HOLDINGS, LTD.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2000 AND 1999
(IN THOUSANDS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
LIABILITIES AND SHAREHOLDERS' EQUITY 2000 1999
--------- ---------
LIABILITIES:
Unearned premiums $ 47,817 $ 11,934
Losses and loss adjustment expenses 25,505 5,092
Claims payable 2,277 1,054
Reinsurance balances payable 17,239 356
Other liabilities 6,907 5,110
Liabilities related to separate accounts 2,552 1,057
--------- ---------
Total liabilities 102,297 24,603
--------- ---------
Commitments and contingencies
SHAREHOLDERS' EQUITY:
Class A common shares, $.01 par value:
Authorized: 200,000,000 Class A and B shares; issued
and outstanding: 67,469,902 and 72,250,376 674 722
Class B common shares, $.01 par value: issued and
outstanding: 1,002,000 10 10
Additional paid-in capital 63,330 63,081
Accumulated other comprehensive income (loss), net 295 (1,019)
Accumulated deficit (17,635) (15,509)
Deferred compensation (148) (195)
--------- ---------
Total shareholders' equity 46,526 47,090
--------- ---------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 148,823 $ 71,693
========= =========
</Table>
See notes to consolidated financial statements.
7
<Page>
ALTUS HOLDINGS, LTD.
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2000 AND 1999
(IN THOUSANDS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
2000 1999
-------- --------
REVENUES:
Premiums earned $ 19,136 $ 21,473
Finance and service charges 74 214
Commissions -- 362
Net investment income 3,280 3,090
Realized gains (losses) on investments 62 (242)
Other -- 375
-------- --------
Total revenues 22,552 25,272
-------- --------
LOSSES AND EXPENSES:
Losses and loss adjustment expenses 10,986 12,785
Underwriting, acquisition and insurance expenses 12,170 22,111
Provision for bad debt 459 895
Write-off of goodwill -- 1,887
Loss on disposal of furniture and equipment -- 2,299
Corporate and other expense 1,227 197
-------- --------
Total losses and expenses 24,842 40,174
-------- --------
Loss from continuing operations before income taxes (2,290) (14,902)
Income tax (expense) benefit 92 (116)
-------- --------
Loss from continuing operations (2,198) (15,018)
Gain from discontinued operations 72 189
-------- --------
Net loss $ (2,126) $(14,829)
======== ========
</Table>
See notes to consolidated financial statements.
8
<Page>
ALTUS HOLDINGS, LTD.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2000 AND 1999
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
COMMON STOCK
---------------------------------------------------------- ACCUMULATED
CLASS A CLASS B ADDITIONAL OTHER
-------------------------- ------------------------- PAID-IN COMPREHENSIVE
SHARES AMOUNT SHARES AMOUNT CAPITAL INCOME (LOSS)
---------- ---------- --------- ---------- --------- ----------
BALANCE, DECEMBER 31, 1998 63,085,709 $ 514 1,000,000 $ 10 $ 45,074 $ 298
Comprehensive loss:
Net loss
Other comprehensive loss (1,317)
Comprehensive loss
Repurchase of Class A and B
common shares (4,777,000) (31) (223,000) (2) (3,300)
Call on capital commitment - 100 - 9,900
Issuance of class A and B
common shares 13,941,667 139 225,000 2 14,025
Amortization of deferred
compensation
Repurchase of FAFC shares of
terminated officer (500)
Cancellation of FAFC deferred
compensation (2,118)
BALANCE, DECEMBER 31, 1999 72,250,376 722 1,002,000 10 63,081 (1,019)
<Caption>
TOTAL
ACCUMULATED DEFERRED SHAREHOLDERS'
DEFICIT COMPENSATION EQUITY
---------- ---------- ----------
BALANCE, DECEMBER 31, 1998 $ (680) $ (2,375) $ 42,841
Comprehensive loss:
Net loss (14,829) (14,829)
Other comprehensive loss (1,317)
----------
Comprehensive loss (16,146)
Repurchase of Class A and B
common shares (3,333)
Call on capital commitment 10,000
Issuance of class A and B
common shares 14,166
Amortization of deferred
compensation 62 62
Repurchase of FAFC shares of
terminated officer (500)
Cancellation of FAFC deferred
compensation 2,118 --
BALANCE, DECEMBER 31, 1999 (15,509) (195) 47,090
</Table>
See notes to consolidated financial statements.
9
<Page>
ALTUS HOLDINGS, LTD.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (CONTINUED)
YEARS ENDED DECEMBER 31, 2000 AND 1999
(DOLLARS IN THOUSANDS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
COMMON STOCK
---------------------------------------------------------------
CLASS A CLASS B ADDITIONAL
---------------------------- -------------------------- PAID-IN
SHARES AMOUNT SHARES AMOUNT CAPITAL
---------- ----------- --------- ----------- -----------
BALANCE, DECEMBER 31, 1999 72,250,376 $ 722 1,002,000 $ 10 $ 63,081
Comprehensive loss:
Net loss
Other comprehensive income
Comprehensive loss
Issuance of common stock and Warrants 193,156 2 173
Cancellation of common stock (5,000,000) (50) 50
Issuance of Class A common Shares award 26,370 * 26
Amortization of deferred Compensation
BALANCE, DECEMBER 31, 2000 67,469,902 $ 674 1,002,000 $ 10 $ 63,330
========== =========== ========= =========== ===========
<Caption>
ACCUMULATED
OTHER TOTAL
COMPREHENSIVE ACCUMULATED DEFERRED SHAREHOLDERS'
INCOME (LOSS) DEFICIT COMPENSATION EQUITY
------------- ----------- ------------ -----------
BALANCE, DECEMBER 31, 1999 $ (1,019) $ (15,509) $ (195) $ 47,090
Comprehensive loss:
Net loss (2,126) (2,126)
Other comprehensive income 1,314 1,314
----------- -----------
Comprehensive loss (812)
Issuance of common stock and Warrants 175
Cancellation of common stock --
Issuance of Class A common Shares award (26) --
Amortization of deferred Compensation 73 73
----------- -----------
BALANCE, DECEMBER 31, 2000 $ 295 $ (17,635) $ (148) $ 46,526
=========== =========== =========== ===========
</Table>
* amount not shown due to rounding
See notes to consolidated financial statements.
10
<Page>
ALTUS HOLDINGS, LTD.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2000 AND 1999
(IN THOUSANDS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
2000 1999
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (2,126) $(14,829)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation, amortization and other 498 971
Realized (gains) losses on investments (62) 242
Deferred income tax expense (benefit) (109) 116
Loss on disposition of furniture and equipment -- 2,299
Write-off of goodwill -- 1,887
Changes in assets and liabilities:
Receivables (13,318) 671
Reinsurance assets (52,714) 1,593
Deferred policy acquisition costs (807) 859
Unearned premiums 35,883 (7,579)
Losses and loss adjustment expenses 20,413 (3,453)
Claims payable 1,223 99
Reinsurance balances payable 16,883 391
Other assets and liabilities 1,936 (729)
-------- --------
Net cash provided by (used in) operating activities 7,700 (17,462)
-------- --------
INVESTING ACTIVITIES:
Proceeds from securities available-for-sale, fixed
maturities sold or matured 31,870 33,270
Proceeds from securities available-for-sale, equities 644 494
Purchases of securities available-for-sale, fixed maturities (34,782) (34,387)
Purchases of securities available-for-sale, equities -- (64)
Net maturities (purchases) of certificates of deposits (2,247) 2,455
Proceeds from sale of furniture and equipment -- 39
Purchase of furniture and equipment (732) (1,713)
-------- --------
Net cash provided by (used in) investing activities (5,247) 94
-------- --------
FINANCING ACTIVITIES:
Issuance of common stock and capital contributions 175 24,166
Payments on repurchase of common stock -- (3,333)
Proceeds from borrowings -- 15,078
Payments on borrowings -- (17,437)
Repurchased shares of terminated officer -- (500)
-------- --------
Net cash provided by financing activities 175 17,974
-------- --------
Net increase in cash and cash equivalents 2,628 606
Cash and cash equivalents, beginning of year 10,576 9,970
-------- --------
Cash and cash equivalents, end of year $ 13,204 $ 10,576
======== ========
SUPPLEMENTAL DISCLOSURES:
Interest paid $ -- $ 197
======== ========
Taxes paid $ 7 $ --
======== ========
Non-cash financing activities - Cancellation of FAFC deferred compensation $ -- $ 2,118
======== ========
</Table>
11
<Page>
ALTUS HOLDINGS, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2000 AND 1999
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION AND NATURE OF OPERATIONS - The accompanying
consolidated financial statements include the accounts and operations of
Altus Holdings, Ltd. ("Altus"), a corporation organized in the Cayman
Islands, and its wholly owned subsidiaries (the "Company").
During 1999, Altus acquired First American Financial Corporation
("FAFC"), a Missouri corporation through an exchange of shares. The
acquisition has been accounted for as a pooling of interests under
accounting principles generally accepted in the United States of America
("U.S. GAAP"). Under pooling of interests accounting, it is assumed that
Altus and FAFC have been merged from the date of incorporation of the
Company.
Altus and its wholly owned subsidiaries, Alternative Re Holdings Limited
("ARHL"), Alternative Re Limited ("ARL"), Alternative Insurance Company
Limited ("AICL"), Altrisc Services, Inc. ("ASI") and Alternative
Underwriting Services ("AUS") provide insurance, reinsurance, and
alternative reinsurance solutions through rent a captive and other
facilities.
FAFC and its wholly owned subsidiaries, First American Insurance Agency,
Inc. ("FAIA"), American First Insurance Agency II, Inc., First American
Service Corporation, First American Warranty Corporation of Florida and
First American Insurance Company ("FAIC") and its subsidiary, First
American General Agency, Inc. ("FAGA"), underwrite program business,
which is comprised primarily of insurance products for lending
institutions, workers compensation, commercial auto, personal auto and
general liability. FAFC's products are distributed through general
agents.
All significant intercompany accounts and transactions have been
eliminated in consolidation.
BASIS OF PRESENTATION - The accompanying consolidated financial
statements have been prepared in accordance with U.S. GAAP. The
significant accounting policies followed by the Company that materially
affect financial reporting are summarized in this note. They include the
acquisition of FAFC, which occurred in July 1999, and which has been
accounted for as a pooling of interests under U.S. GAAP. The consolidated
financial statements include FAFC as though it had always been a part of
the Company.
USE OF ESTIMATES - The preparation of consolidated financial statements
of insurance companies requires management to make estimates and
assumptions that affect amounts reported in the consolidated financial
statements and accompanying notes. Such estimates and assumptions could
change in the future, as more information becomes known that could impact
the amounts reported and disclosed therein.
INVESTMENTS - Investment securities are classified as held-to-maturity,
available-for-sale or trading. Currently, all of the Company's securities
are classified as available-for-sale. Securities classified as
available-for-sale are carried at fair value, and changes in fair value,
net of deferred income taxes, are reported as a component of accumulated
other comprehensive income or loss and, accordingly, have no effect on
the Company's net loss. Fair values for fixed maturities and equities
(see Note 3) are based on quoted market prices. Certificates of deposit
are reported at cost, which approximates fair value.
12
<Page>
The amortized cost of fixed maturities classified as available-for-sale
or held-to-maturity is adjusted for amortization of premiums and
accretion of discounts to maturity. Such amortization is included in net
investment income. Realized gains and losses on sales of investments and
declines in value judged to be other-than-temporary are recognized on the
specific identification basis.
PREMIUMS - Premiums are recognized as revenue principally pro rata over
the terms of the policies. Certain warranty premiums are earned based on
exposure patterns that increase over time. In addition, GAP premiums,
which cover the difference between automobile loan values and underlying
collateral, are earned in an accelerated manner based on a modified rule
of 78ths method to reflect the increased initial exposure on these
policies.
DEFERRED ACQUISITION COSTS - Acquisition costs consisting of commissions,
premium taxes and other underwriting expenses are deferred and amortized
ratably over the term of the related policies. The method followed in
computing deferred acquisition costs limits the amount of such costs to
their expected realizable value. In determining expected realizable
value, the computation gives effect to the premium to be earned, related
investment income, losses, loss adjustment expenses and certain other
costs expected to be incurred as the premium is earned.
LOSSES AND LOSS ADJUSTMENT EXPENSES - Losses and loss adjustment expenses
represent the estimated ultimate net cost of all reported and unreported
losses incurred and are estimated using case-basis evaluations and
statistical analyses, and are not discounted. Those estimates are subject
to the effects of trends in loss severity and frequency, and variability
is inherent in such estimates. Changes in estimates are reflected in
current operations.
REINSURANCE - Reinsurance premiums and losses and loss adjustment
expenses recoverable are accounted for on bases consistent with those
used in accounting for the original policies issued and the terms of the
reinsurance contracts. The accompanying consolidated statements of
operations reflect premiums, losses and loss adjustment expenses, and
acquisition costs, net of reinsurance ceded (see Note 5). Those
reinsurance arrangements provide for greater diversification of business,
allow management to control exposure to potential losses arising from
large risks and provide additional capacity for growth. The Company uses
quota-share, surplus share and excess-of-loss reinsurance contracts.
FAIR VALUE OF FINANCIAL INSTRUMENTS - The estimated fair value of
financial instruments held by the Company approximates carrying value.
EXCESS OF COST OVER NET TANGIBLE ASSETS ACQUIRED - In 1999 management
reevaluated the carrying value of goodwill within the requirements of
SFAS No. 121, "ACCOUNTING FOR IMPAIRMENT OF LONG-LIVED ASSETS AND
LONG-LIVED ASSETS TO BE DISPOSED OF," and determined that it no longer
had any value. As such, management reduced the carrying value of all
goodwill to zero. The result was a loss of $1,887,000 recorded in the
statement of operations in 1999.
STATEMENTS OF CASH FLOWS - Cash and cash equivalents in the consolidated
statements of cash flows represent cash balances and investments with
initial maturities of three months or less.
COMMISSION INCOME - The Company's active insurance agencies, ASI, FAIA
and FAGA, record commissions as income when the related policies are
written.
INCOME TAXES - U.S. deferred taxes are determined based on the
differences between the financial reporting and tax bases of assets and
liabilities and are measured using enacted tax rates.
13
<Page>
Under current Cayman Islands law, Altus is not required to pay taxes in
the Cayman Islands on either income or capital gains. Altus has received
an undertaking from the Cayman Islands government that, in the event of
income or capital gains taxes being imposed, the Company will be exempted
from such taxes until the year 2018.
Under current Bermuda law, ARHL, ARL, AICL, and AUS are not required to
pay taxes in Bermuda on either income or capital gains. They have
received an undertaking from the Bermuda government that, in the event of
income or capital gains taxes being imposed, they will be exempted from
such taxes until the year 2016.
AICL has made the election under Internal Revenue Code Section 953(d) to
be subject to U.S. income taxes as a domestic U.S. insurance company.
AICL and ASI file separate U.S. federal income tax returns. FAFC files a
consolidated U.S. federal income tax return.
FURNITURE AND EQUIPMENT - Furniture and equipment are recorded at cost
and are depreciated using the straight-line method over three to five
years.
SEPARATE ACCOUNTS - Under rent a captive arrangement, ARL maintains
segregated cells in separate accounts for companies ("Program Holders"),
whereby the Program Holder assumes investment, underwriting and exposure
risk and ARL receives an administration fee for managing the program. The
Program Holder owns preferred shares in ARHL under a Preferred
Shareholders Agreement ("the Agreement"). The Agreement provides for the
payment of dividends to the preferred shareholders based on the balance
of net profits calculated from earned reinsurance premiums, investment
income, expenses paid and losses and loss adjustment expenses incurred in
each Program Holder's account. Any profits are to be paid to the
preferred shareholders based upon a percentage of total profits to date,
calculated on an annual basis, commencing after the third year of the
Agreement. If the balance is a deficit at any time, additional letters of
credit, cash or indemnifications will be due to ARL. The preferred shares
are redeemable after five years. AICL is also permitted to maintain
segregated cells.
ACCOUNTING PRONOUNCEMENT - The Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities" in 2001. The Company does not engage
in hedging activities or invest in derivative instruments, including
derivatives embedded in other contracts. Accordingly, adoption of SFAS
No. 133 did not affect the financial statements.
RECLASSIFICATIONS - Certain 1999 amounts have been reclassified to
conform to the 2000 presentation.
2. BUSINESS COMBINATION
On June 18, 1999, Altus acquired FAFC in an all-stock transaction.
Shareholders of FAFC (the Trident Partnership, L.P. ("Trident") and Risk
Capital Reinsurance Company ("Risk Capital") (which, in May, 2000 was
renamed Arch Reinsurance Company) received 28,780,476 newly issued Class
A common shares. Trident was and remains a majority shareholder in Altus
and was also a majority shareholder in FAFC. In connection with the
acquisition by Altus, FAFC received a capital infusion of $28,000,000.
Also as a result of the purchase, all Class A, $7 par, common stock of
FAFC was retired and 1,000 shares of Class A, $.10 par, common stock was
reissued to Altus. Proceeds from the capital infusion were used to make a
capital contribution of $15,000,000 to FAIC and to repay note borrowings
of $11,000,000. The remaining proceeds of $2,000,000 were retained by
FAFC for internal operating and investing purposes. The transaction has
been accounted for as a pooling of interest under U.S. GAAP. No
adjustments were necessary to conform FAFC's accounting policies.
14
<Page>
The following table presents the revenues and loss for the combining
companies and subsidiaries for the period from the beginning of 1999 to
the date the acquisition was consummated (in thousands): All significant
intercompany transactions have been eliminated.
ALTUS FAFC
Revenues $ 167 $ 6,334
Loss $ (903) $(2,675)
A post closing adjustment to the acquisition related to losses required
that effective December 31, 1999 up to 5,000,000 of the Company's Class A
common shares issued as part of the acquisition be cancelled on a pro
rata basis between the individual shareholders. One Class A common share
of the Company was cancelled for every $1 of defined losses subject to a
$5,000,000 maximum.
Defined losses were the sum of the operating losses or expenses incurred
or reserved during the period from April 1, 1999 to December 31, 1999
primarily related to portions of FAIC's cancelled or exited business.
These losses exceeded $5,000,000, and therefore 5,000,000 Class A common
shares were cancelled in 2000 on a pro rata basis between the individual
shareholders and the related par value of $50,000 was transferred to
additional paid-in-capital.
3. INVESTMENTS
Investments are summarized as follows (in thousands):
<Table>
<Caption>
COST/ GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- --------- ---------- -------
December 31, 2000:
U.S. government bonds $34,741 $ 236 $ 79 $34,898
Industrial bonds 10,648 184 85 10,747
U.S. mortgage backed bonds 4,479 148 -- 4,627
------- ------- ------- -------
Total fixed maturities $49,868 $ 568 $ 164 $50,272
======= ======= ======= =======
<Caption>
COST/ GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- --------- ---------- -------
December 31, 1999:
U.S. government bonds $43,326 $ 7 $ 814 $42,519
Industrial bonds 3,146 -- 245 2,901
U.S. mortgage backed bonds 442 -- 3 439
------- ------- ------- -------
Total fixed maturities 46,914 7 1,062 45,859
Equities 597 36 -- 633
------- ------- ------- -------
$47,511 $ 43 $ 1,062 $46,492
======= ======= ======= =======
</Table>
15
<Page>
The following amounts were included in accumulated other comprehensive
income (loss) for the years ended December 31, 2000 and 1999 (in
thousands):
<Table>
<Caption>
2000 1999
------- -------
Unrealized holding gains (losses) arising during the year $ 1,485 $(1,671)
Less realized gains (losses) 62 (242)
------- -------
Other comprehensive (loss) income, before deferred taxes 1,423 (1,429)
Deferred income tax (expense) benefit (109) 118
Other -- (6)
------- -------
Other comprehensive income (loss), net $ 1,314 $(1,317)
======= =======
</Table>
Contractual maturities of fixed maturities at December 31, 2000 are
summarized as follows (in thousands):
<Table>
<Caption>
AMORTIZED FAIR
COST VALUE
--------- -------
Due within one year $13,081 $13,124
Due after one through five years 25,155 25,237
Due after five through ten years 11,156 11,424
Due after ten years 476 487
------- -------
$49,868 $50,272
======= =======
</Table>
The expected maturities in the foregoing table will differ from
contractual maturities because certain issuers may have the right to call
or prepay obligations with or without call or prepayment penalties.
Major sources of the Company's investment income are summarized as
follows (in thousands):
<Table>
<Caption>
2000 1999
------- -------
Fixed maturities $ 3,024 $ 2,460
Equities -- 63
Certificates of deposit and other 346 675
------- -------
3,370 3,198
Investment expenses (90) (54)
------- -------
Net investment income 3,280 3,144
Less investment income from discontinued operations -- (54)
------- -------
Net investment income from continuing operations $ 3,280 $ 3,090
======= =======
</Table>
16
<Page>
Proceeds from the sale of equity securities were $645,000 and $494,000 in
2000 and 1999, respectively. The Company had gross realized gains of
$47,000 in 2000 and gross realized losses of $61,000 in 1999 on those
sales.
Proceeds from sales, maturities and redemptions of investments in bonds
during 2000 and 1999 were $31,869,000 and $33,270,000, respectively. In
2000 and 1999, the Company had gross realized gains of $162,000 and
$36,000, respectively and gross realized losses of $147,000 and $217,000,
respectively.
At December 31, 2000, cash and cash equivalents of $646,000 and fixed
maturity securities with a carrying amount of $5,325,000 were on deposit
with state insurance departments to satisfy regulatory requirements. Also
at December 31, 2000, fixed maturity securities and cash and cash
equivalents with a carrying amount of $3,784,000 and $254,000,
respectively, were on deposit in various trusts securing unearned premium
reserves and loss reserves on insurance assumed from other companies.
4. INCOME TAXES
For financial reporting purposes, loss from continuing operations before
income taxes includes the following components (in thousands):
<Table>
<Caption>
2000 1999
-------- --------
Income (loss) from continuing operations:
United States $ (2,442) $(11,935)
Puerto Rico 392 (2,545)
Other countries (240) (422)
-------- --------
$ (2,290) $(14,902)
======== ========
</Table>
The components of income tax (expense) benefit are as follows (in
thousands):
<Table>
<Caption>
2000 1999
----- -----
Current - Federal (10) 2
Current - State (7) --
Deferred - Federal 109 (118)
----- -----
$ 92 $(116)
===== =====
</Table>
U.S. deferred income taxes at December 31 consist of the following
amounts (in thousands):
<Table>
<Caption>
2000 1999
-------- --------
Deferred tax asset $ 10,877 $ 9,896
Deferred tax liability (1,220) (859)
Valuation allowance (9,657) (9,037)
-------- --------
Net deferred tax asset $ -- $ --
======== ========
</Table>
17
<Page>
The deferred tax asset relates principally to net operating loss ("NOL")
carryforwards, alternative minimum tax ("AMT") credit carryforwards,
unearned premium reserves, loss reserve discounting and depreciation
expense. The deferred tax liability relates principally to deferred
policy acquisition costs. The Company maintains a full valuation
allowance in respect of the net deferred tax asset since it is more
likely than not that the benefit will not be utilized.
The income tax benefit in 2000 and expense in 1999 is not proportional to
loss before federal income taxes principally due to the change in the
valuation allowance, as discussed above.
FAFC has NOL carryforwards of $20,442,000 that expire beginning in 2011
and an AMT credit carryforward of $307,000 that has an unlimited
carryforward period. ASI has NOL carryforwards of $4,334,000 that expire
beginning in 2012. AICL has an AMT credit carryforward of $7,000.
5. REINSURANCE
Premiums written and earned are summarized as follows (in thousands):
<Table>
<Caption>
2000 1999
WRITTEN EARNED WRITTEN EARNED
-------- -------- -------- --------
Direct and assumed $ 87,571 $ 51,685 $ 16,265 $ 23,844
Ceded (63,328) (32,549) (2,156) (2,371)
-------- -------- -------- --------
Net premiums $ 24,243 $ 19,136 $ 14,109 $ 21,473
======== ======== ======== ========
</Table>
Losses and loss adjustment expenses are summarized as follows (in
thousands):
<Table>
<Caption>
2000 1999
-------- --------
Direct and assumed $ 38,724 $ 14,333
Ceded (27,810) (1,682)
-------- --------
Total losses and loss adjustment expenses 10,914 12,651
Decrease in losses and loss adjustment expenses
from discontinued operations 72 134
-------- --------
Losses and loss adjustment expenses from continuing operations $ 10,986 $ 12,785
======== ========
</Table>
Reinsurance ceded contracts do not relieve the Company from its
obligations to policyholders. In the unlikely event that any reinsurer
does not meet its obligations under the reinsurance agreements, the
Company remains liable to its policyholders for the portion reinsured. At
December 31, 2000 and 1999, all amounts recoverable by FAIC under
agreements with unauthorized reinsurers are fully secured by letters of
credit, except for $463,000 and $113,000 of unsecured balances at those
respective dates.
18
<Page>
6. FURNITURE AND EQUIPMENT
Furniture and equipment are summarized as follows (in thousands):
<Table>
<Caption>
2000 1999
------ ------
Furniture and fixtures $ 497 $ 660
Information systems 581 33
------ ------
$1,078 $ 693
====== ======
</Table>
7. LOSSES AND LOSS ADJUSTMENT EXPENSES
The following table provides a reconciliation of the beginning and ending
reserve balances, net of reinsurance, for the years ended December 31 (in
thousands):
<Table>
<Caption>
2000 1999
-------- --------
Reserve for losses and loss adjustment expenses ("LAE"), net of
reinsurance, at January 1 $ 3,168 $ 4,821
-------- --------
Add incurred related to:
Current year 11,178 13,167
Prior years (192) (516)
-------- --------
Total incurred 10,986 12,651
-------- --------
Deduct paid related to:
Current year 8,292 10,373
Prior years 2,231 3,931
-------- --------
Total paid 10,523 14,304
-------- --------
Reserve for losses and LAE, net of reinsurance, at December 31 3,631 3,168
Reinsurance recoverable on unpaid losses and LAE, at December 31 21,874 1,924
-------- --------
Reserve for unpaid losses and LAE, gross of reinsurance, at
December 31 $ 25,505 $ 5,092
======== ========
</Table>
The incurred amounts for prior years' claims relate to changes in
estimates of loss reserves. Such amounts are the result of using
actuarial data and other information in establishing loss reserves and
will vary from year to year.
19
<Page>
8. SHARE CAPITAL
On March 19, 1998, warrants to purchase a total of 3,500,000 shares of
the Company's Class A common shares at $1.00 per share were issued to
certain shareholders. These warrants are exercisable immediately, and
include 3,000,000 that expire on March 19, 2008. The 500,000 balance of
warrants were redistributed among certain shareholders and expire on
March 5, 2008. During 2000, warrants on 7,500 Class A common shares
expiring on December 29, 2010 were purchased by a senior executive
officer. Together with warrants discussed in Note 9, warrants for
3,538,023 and 3,530,523 were outstanding at December 31, 2000 and 1999,
respectively.
In the event that the Company enters into an initial public offering, or
a change in control, these warrants are callable by the Company, in their
entirety, or partially. The Company can redeem these warrants for $.01
each. Any partial redemption by the Company will be made on a pro rata
basis on the total outstanding warrants at the time of redemption.
See Note 18 - Subsequent Event.
9. STOCK COMPENSATION
The Company has elected to follow Accounting Principles Board ("APB")
Opinion No. 25, "ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES," in accounting
for its employee stock awards, employee stock options and stock
appreciation rights.
Pursuant to APB Opinion No. 25, compensation expense for stock awards,
options and grants is recognized as follows: (1) nonperformance awards -
measured at the fair value of the shares at the date of grant and
recognized as the awards vest; (2) performance-based stock awards and
stock options - periodically remeasured based on the fair value of the
stock and recognized only when it is probable that an amount will be
earned; and (3) stock options - recognized only if the exercise price of
the stock options is below the market price of the underlying stock on
the date of grant.
1998 STOCK OPTION PLAN - During 1998, the Company adopted the Management
Share Option Plan (the "Plan"), which permits the Board of Directors of
the Company to grant stock options to employees, officers and directors
of the Company. A total of 2,543,605 shares were authorized under the
Plan. Generally, the Company grants stock options with an exercise price
equal to the fair market value of the common share on the date of the
grant, as determined by the Company's Board of Directors. Stock options
generally vest ratably over a five-year period, and expire in March 2008.
Options to purchase 300,000 and 450,000 Class A common shares were
granted for $1.00 per share in 2000 and 1999, respectively. No options
were exercised in 2000 or 1999. Options forfeited or cancelled totaled
250,000 and nil in 2000 and 1999, respectively. At December 31, 2000 and
1999, options outstanding totaled 2,072,674 and 2,022,674, respectively,
of which 1,048,449 and 524,225, respectively were vested.
WARRANT AWARDS - During 1998, in consideration for entering into an
employment agreement with the Company, a senior executive of the Company
was granted warrants to purchase 30,523 Class A common shares for $1.00
per share. These warrants are exercisable by the holder from March 19,
1998 until they expire on March 19, 2008. These warrants are subject to
the same terms and conditions as the 1998 Stock Option Plan discussed
previously in this note.
20
<Page>
1998 AND 1999 STOCK AWARDS - During 1998, the Company entered into an
employment agreement with a senior executive that provided for stock
awards. Nonperformance awards for 305,233 Class A common shares under a
restricted share grant were granted to the senior executive. The shares
vest equally over a five-year period. In addition, as part of the
acquisition of FAFC, 26,370 non-performance common shares were awarded to
an officer. These shares vest equally over three years. The Company has
charged expenses of $73,000 and $62,000 in 2000 and 1999, respectively,
relating to compensation on these restricted share grants.
During 1999, the Company entered into a consulting agreement with a
senior non-executive that provided for stock options. The individual
agreed to purchase 250,000 Class A common shares for $1.00 per share by
January 1, 2001. Pursuant to this purchase, options to purchase by
January 1, 2001, 750,000 Class A common shares were granted for $1.00 per
share, under the same terms and conditions as the Plan. The
aforementioned purchase did not occur and, accordingly, the related
options were forfeited.
See Note 18 - Subsequent Event.
Certain performance-based stock awards and stock options issued in
conjunction with investments in FAFC by Trident and Risk Capital were
cancelled in 1999 as part of the acquisition of FAFC by the Company.
PRO FORMA NET INCOME - Pro forma information regarding net income is
required by SFAS No. 123, "ACCOUNTING FOR STOCK-BASED COMPENSATION," as
if the Company had accounted for its employee stock options, stock
warrants, and stock awards under the fair value method of that statement.
Had compensation cost for the Company's employee stock options, stock
warrants, and stock awards been determined based upon the fair value, as
determined by the board of directors, at the grant date for awards under
these plans consistent with the methodology prescribed under SFAS No.
123, the Company's loss for the years ended December 31, 2000 and 1999
would have been as follows (in thousands):
<Table>
<Caption>
2000 1999
------- -------
Net loss as reported $ 2,126 $14,829
======= =======
SFAS No. 123 proforma loss $ 2,229 $15,080
======= =======
</Table>
The Black-Scholes Option Pricing Model was used to estimate the fair
values of options granted during 2000 and 1999. The assumptions used for
these grants included the following:
Volatility factor of expected market price of the
Company's shares 0%
Dividend yield 0%
Weighted average expected life of stock options 10 years
Risk free interest rate 6%
10. CREDIT AGREEMENTS
As part of the acquisition of FAFC by Altus, all outstanding debt was
repaid in 1999 and an existing line-of-credit was cancelled. No debt was
outstanding at December 31, 2000 and 1999.
21
<Page>
11. RESTRUCTURING
During 1999, FAFC restructured its operations, which resulted in a charge
of $2,227,000 consisting of severance costs, lease termination penalties
and moving expenses. These expenses are included in underwriting,
acquisition and insurance expenses in the consolidated statement of
operations. Additionally, FAFC wrote off $2,299,000 of assets primarily
related to information systems as a result of the restructuring. The
restructuring was a result of the acquisition.
12. CANCELLATION OF BUSINESS
Prior to August 31, 1999 FAIC wrote vendors' single interest insurance
policies in Puerto Rico through the Jose Baldrich Jr. Inc. Agency (the
"Agency"). The Agency was FAIC's exclusive agency for business in Puerto
Rico. FAIC granted the Agency processing, claims adjudication and claims
payment authority as it related to these policies.
FAIC ceased writing business in Puerto Rico and cancelled all business in
effect as of August 31, 1999. An unrelated domestic insurance company
already doing business in Puerto Rico rewrote this in force business.
Unearned premiums refunded due to the cancellation, net of agent
commissions, totaled $7,857,000. In addition, FAIC made a final
termination payment to the agent of $463,000 in 1999.
13. DISCONTINUED OPERATIONS
In October 1995, FAIC adopted a plan to dispose of its commercial auto
line of business. Accordingly, the consolidated financial statements
report separately the operating results of this line of business, which
is treated as a discontinued operation. There was no gain or loss
associated with the disposal of this business.
A summary of balances and operating results of the discontinued
operations for the years ended December 31 is as follows (in thousands):
<Table>
<Caption>
2000 1999
------- -------
Reserve for losses and loss adjustment expenses:
Direct $ 1,423 $ 1,960
Ceded (1,019) (1,417)
Investment income -- 54
Gain 72 189
</Table>
14. STATUTORY AND REGULATORY MATTERS
The Company's ability to pay dividends is subject to certain regulatory
restrictions on the payment of dividends by ARL, AICL and FAIC.
Under the Insurance Act 1978 of Bermuda, amendments thereto and related
regulations, ARL and AICL are required to maintain certain measures of
solvency and liquidity. At December 31, 2000 these requirements were met.
Declaration of dividends from retained earnings and distributions from
additional paid-in-capital is subject to these requirements being met.
As of December 31, 2000, FAIC had statutory capital and surplus of
$36,478,000 and statutory net income of $727,000 for the year then ended.
Payment of dividends by FAIC to the Company, its ultimate parent, is
limited to the lesser of 10% of surplus or 100% of net investment income.
At December 31, 2000, FAIC can pay $2,679,000 in dividends to FAFC
without prior approval of the Missouri Department of Insurance ("MDI").
22
<Page>
FAIC's statutory-basis financial statements are prepared in accordance
with accounting practices prescribed or permitted by MDI. In 1998, the
National Association of Insurance Commissioners adopted codified
statutory accounting principles ("Codification"). Codification will
change, to some extent, prescribed statutory accounting practices. The
State of Missouri adopted Codification as the prescribed basis of
accounting on which domestic insurers must report their statutory-basis
results to MDI, effective the first quarter of 2001. Adoption of
Codification in the first quarter of 2001 did not have a material effect
on FAIC's statutory surplus or statutory net income.
15. BENEFIT PLANS
ASI has a 401(k) plan for which substantially all employees are eligible.
ASI's contributions to the plan were $101,000 and $50,000 during 2000 and
1999, respectively. ASI also has a deferred compensation plan. ASI's
contributions to the plan were $25,000 in 2000 and nil in 1999. Effective
January 1, 2001 the ASI 401(k) plan was renamed the ASI/FAFC 401(k). All
employees of FAFC are eligible to join the plan.
Through December 31, 2000, FAFC had a defined benefit plan for which
substantially all employees were eligible. FAFC's contributions to the
plan were $31,000 and $46,000 during 2000 and 1999, respectively. The
plan was terminated on December 31, 2000.
FAFC also had an employee stock ownership plan for which all shares in
the plan were sold when Altus purchased FAFC. The plan assets consist
entirely of cash. No contributions were made to the plan during 2000 and
1999. The plan terminated on December 31, 2000.
16. LEASE COMMITMENTS
The Company and its subsidiaries lease building space and certain office
equipment under noncancellable leases. Future minimum payments for these
leases are: 2001 - $422,000; 2002 - $382,000; 2003 - $175,000 and 2004
and later years - $80,000. The Company entered into an assignment
agreement with an unrelated company effective January 1, 2000 with
respect to certain of its leases. Payment of the lease expenses by the
unrelated company will reduce the payments for 2001 by $68,000. Total
rent expense was $428,000 and $725,000 for 2000 and 1999, respectively.
17. CONTINGENCIES
The Company is subject to litigation of disputes in the normal course of
its business. Management does not believe that any pending litigation or
arbitration to which it is a party, or of which any of its assets are
subject, is likely to have a material adverse effect on its current
financial position or results of operations.
18. SUBSEQUENT EVENT
On March 23, 2001, Arch Capital Group Ltd., ("Arch Capital") (formerly
Risk Capital Holdings, Inc.) announced that it had entered into a
definitive agreement to acquire all of the capital stock of the Company.
Arch Capital is a Bermuda-based diversified financial services holding
company with an emphasis on the insurance sector. Arch Capital is a
publicly held company listed on the NASDAQ Exchange and currently owns a
minority interest in the Company.
Upon closing, all warrants and stock options on the Company's common
shares will be permanently cancelled and retired.
23
<Page>
ITEM 7. FINANCIAL STATEMENTS, PRO FORMA FINANCIAL INFORMATION AND EXHIBITS
(a) FINANCIAL STATEMENTS OF BUSINESS ACQUIRED.
Unaudited Consolidated Financial Statements of Altus:
ALTUS HOLDINGS, LTD.
UNAUDITED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<Table>
<Caption>
MARCH 31,
------------------------
2001 2000
-------- --------
ASSETS
Investments:
Fixed maturities $ 56,197 $ 47,614
Equities 620
Short-term investments 525 567
-------- --------
Total investments 56,722 48,801
-------- --------
Cash 7,864 10,257
Accrued investment income 688 588
Premiums receivable 15,461 3,975
Unpaid losses and loss expenses recoverable 33,147 2,460
Prepaid reinsurance premiums 31,777 5,867
Reinsurance balances receivable 3,153 358
Deferred policy acquisition costs 2,505 2,397
Other assets 3,945 2,798
-------- --------
TOTAL ASSETS $155,262 $ 77,501
======== ========
LIABILITIES
Claims and claims expenses $ 37,585 $ 5,757
Unearned premiums 46,378 16,298
Reinsurance balances payable 15,855 3,447
Other liabilities 9,038 5,865
-------- --------
TOTAL LIABILITIES 108,856 31,367
-------- --------
SHAREHOLDERS' EQUITY 46,406 46,134
-------- --------
TOTAL LIABILITIES & SHAREHOLDERS' EQUITY $155,262 $ 77,501
======== ========
</Table>
See notes to the unaudited consolidated financial statements.
24
<Page>
ALTUS HOLDINGS, LTD.
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS)
<Table>
<Caption>
FOR THE THREE MONTHS ENDED
MARCH 31,
-------------------------
2001 2000
------- -------
REVENUES
Net premiums written $ 4,495 $ 3,854
Decrease in unearned premiums 1,274 340
------- -------
Net premiums earned 5,769 4,194
Net investment income 973 766
Net investment gains (losses) 279 (24)
Fee income 1,078 194
------- -------
Total revenues 8,099 5,130
------- -------
OPERATING COSTS AND EXPENSES
Claims and claims expenses 4,637 2,287
Commissions and brokerage 2,024 1,412
Other operating expenses 2,145 2,383
------- -------
Total operating costs and expenses 8,806 6,082
------- -------
Income (Loss) Before Income Taxes (707) (952)
------- -------
Income taxes:
Current
Deferred (178)
------- -------
Income tax expense (benefit) (178) 0
------- -------
Net Income (Loss) ($ 529) ($ 952)
======= =======
</Table>
See notes to the unaudited consolidated financial statements.
25
<Page>
ALTUS HOLDINGS, LTD.
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<Table>
<Caption>
FOR THE THREE MONTHS ENDED
MARCH 31,
-----------------------
2001 2000
-------- --------
OPERATING ACTIVITIES
Net income (loss) $ (529) $ (952)
Adjustments to reconcile net income (loss) to net cash
provided by (used for) operating activities:
Unpaid claims and claims expenses 12,080 664
Unearned premiums (1,439) 4,362
Premiums receivable 1,586 (807)
Accrued investment income 127 394
Prepaid reinsurance premiums 165 (4,703)
Reinsurance balances recoverable (11,449) 95
Reinsurance balances payable (1,384) 2,844
Deferred policy acquisition costs 739 41
Net realized investment (gains)/losses (230) 25
Other liabilities (2,696) (683)
Other items, net 39 (365)
-------- --------
NET CASH PROVIDED BY (USED FOR) OPERATING ACTIVITIES (2,991) 915
-------- --------
INVESTING ACTIVITIES
Investment activity, net (2,296) (1,207)
Property and equipment activity, net (53) (105)
-------- --------
NET CASH PROVIDED BY (USED FOR) INVESTING ACTIVITIES (2,349) (1,312)
-------- --------
NET CASH PROVIDED BY (USED FOR) FINANCING ACTIVITIES 0 0
-------- --------
Increase (decrease) in cash (5,340) (397)
Cash beginning of period 13,204 10,654
-------- --------
Cash end of period $ 7,864 $ 10,257
======== ========
</Table>
See notes to the unaudited consolidated financial statements.
26
<Page>
ALTUS HOLDINGS, LTD.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(1) The consolidated financial statements have been prepared by Altus
Holdings, Ltd. ("Altus") without audit, in accordance with generally
accepted accounting principles and pursuant to the rules and regulations
of the Securities and Exchange Commission. In the opinion of the
management of Altus, the accompanying financial statements include all
adjustments which are necessary for a fair presentation of the results
for the interim periods presented, such adjustments being of a normal
recurring nature. Certain information and footnote disclosures have been
condensed or omitted pursuant to such rules and regulations. It is
suggested that these consolidated financial statements and the notes
thereto be read in conjunction with the financial statements and notes
thereto of Altus as of December 31, 2000 and 1999 and for the years then
ended included in this Form 8-K/A. Results of operations in interim
periods are not necessarily indicative of results to be expected for a
full year.
(2) On June 22, 2001, Arch Capital Group Ltd. ("ACGL") acquired all of the
capital stock of Altus that it did not already own, pursuant to the
Reorganization Agreement dated as of March 23, 2001, by and among Altus,
ACGL and the other shareholders of Altus. Prior to the acquisition, ACGL
owned a 27.9% minority interest in Altus' common stock. Following the
acquisition, Altus' name was changed to Arch Risk Transfer Services Ltd.
27
<Page>
ITEM 7. FINANCIAL STATEMENTS, PRO FORMA FINANCIAL INFORMATION AND EXHIBITS
(b) PRO FORMA FINANCIAL INFORMATION.
OVERVIEW
On June 22, 2001, ACGL acquired all of the capital stock of Altus, a
Cayman Islands company, that it did not already own, pursuant to the
Reorganization Agreement dated as of March 23, 2001, by and among Altus, ACGL
and the other shareholders of Altus, for a purchase price of approximately $38.8
million. The purchase price consisted of approximately $38.4 million in cash and
24,200 ACGL Common Shares issued to employee shareholders continuing in
management positions. Prior to the acquisition, ACGL owned a 27.9% minority
interest in Altus' common stock. Following the acquisition, Altus' name was
changed to Arch Risk Transfer Services Ltd.
Upon the closing of ACGL's acquisition of Altus, ACGL was required under
generally accepted accounting principles governing a "step acquisition" of an
investee company to retroactively adopt the equity method of accounting for its
original 27.9% ownership interest in Altus for the periods prior to the
acquisition and to restate its historical financial results. Such restatement
resulted in a reduction in ACGL's book value at March 31, 2001 in the amount of
$3.1 million, or $0.24 per share. After ACGL's acquisition of its initial 27.9%
ownership interest in Altus in March 1998, the investment was carried at its
estimated fair value from the initial purchase through March 31, 2001 in
accordance with generally accepted accounting principles. ACGL accounted for its
initial interest in Altus under "fair value" because ACGL did not have the
ability to exercise significant influence over this investment due to ACGL's
limited voting and consent rights.
Subsequent to this Form 8-K/A report, ACGL will file with the Securities
and Exchange Commission ("SEC") an amended Form 10-K (10-K/A) for the year ended
December 31, 2000 and an amended Form 10-Q (10-Q/A) for the quarter ended March
31, 2001 to reflect the required restatement. See note 5 to the unaudited pro
forma financial statements contained in this report.
The following unaudited pro forma condensed combined financial statements
as of and for the quarter ended March 31, 2001 and for the year ended December
31, 2000 are based on the historical financial statements of Altus included
elsewhere in this Form 8-K/A, and the historical financial statements of ACGL
included in its Annual Report on Form 10-K for the year ended December 31, 2000
and its Quarterly Report on Form 10-Q for the quarter ended March 31, 2001 (See
note 5 to the unaudited pro forma financial statements). The unaudited pro forma
financial statements give effect to the transactions consummated pursuant to the
Reorganization Agreement.
The unaudited pro forma condensed combined statements of income have been
prepared to reflect the acquisition of Altus by ACGL as if the acquisition had
occurred as of January 1, 2000. The unaudited pro forma condensed combined
statement of financial condition reflects the acquisition as if it had occurred
on March 31, 2001. The pro forma adjustments made in connection with the
development of the pro forma information are preliminary and have been made
solely for the purposes of developing such pro forma information. The final
allocation may be different from these estimates and there can be no assurances
that such differences, if any, will not be material.
The pro forma information does not purport to be indicative of the
results of operations that would have occurred had the transaction been
consummated on the assumed dates, nor is the information intended to be a
projection for any future period. The unaudited pro forma financial information
should be read in conjunction with the related notes thereto and the historical
financial statements of Altus included herein, and the historical financial
statements of ACGL.
28
<Page>
UNAUDITED PRO FORMA CONDENSED COMBINED BALANCE SHEET
(IN THOUSANDS)
<Table>
<Caption>
MARCH 31, 2001
-----------------------------------------------------------------
PRO FORMA
----------------------------------
ACGL ALTUS ADJUSTMENTS COMBINED
-------- -------- ----------- --------
ASSETS
Investments:
Fixed maturities $90,400 $56,197 $146,597
Publicly traded equity securities 28,224 28,224
Privately held securities 52,080 ($16,000) (2) 36,080
Securities held in escrow 21,373 21,373
Short-term investments 72,421 525 (38,398) (3) 34,548
-------- -------- -------- --------
Total investments 264,498 56,722 (54,398) 266,822
-------- -------- -------- --------
Cash 20,290 7,864 28,154
Accrued investment income 2,405 688 3,093
Premiums receivable 39,459 15,461 54,920
Unpaid claims and claims expenses recoverable 34,520 33,147 67,667
Prepaid reinsurance premiums 31,735 31,777 63,512
Reinsurance balances receivable 9,654 3,153 12,807
Goodwill 20,381 5,343 (1), (4) 25,724
Deferred income tax asset 7,980 7,980
Deferred policy acquisition costs 2,485 2,505 4,990
Other assets 6,829 3,945 10,774
-------- -------- -------- --------
TOTAL ASSETS $440,236 $155,262 ($49,055) $546,443
======== ======== ======== ========
LIABILITIES
Claims and claims expenses $53,413 $37,585 $90,998
Unearned premiums 44,133 46,378 90,511
Reinsurance balances payable 34,282 15,855 50,137
Reserve for contingent loss of escrowed assets 15,000 15,000
Investment accounts payable 5,792 5,792
Other liabilities 15,135 9,038 24,173
-------- -------- -------- --------
TOTAL LIABILITIES 167,755 108,856 276,611
-------- -------- -------- --------
SHAREHOLDERS' EQUITY 272,481 46,406 (49,055) (5) 269,832
-------- -------- -------- --------
TOTAL LIABILITIES & SHAREHOLDERS' EQUITY $440,236 $155,262 ($49,055) $546,443
======== ======== ======== ========
</Table>
The accompanying notes are an integral part of the unaudited pro forma
condensed combined financial statements.
29
<Page>
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<Table>
<Caption>
FOR THE THREE MONTHS ENDED MARCH 31, 2001
---------------------------------------------------------
PRO FORMA
------------------------------
ACGL ALTUS ADJUSTMENTS COMBINED
-------- -------- ----------- --------
REVENUES
Net premiums written $2,837 $4,495 $7,332
(Increase) decrease in unearned premiums (1,204) 1,274 70
-------- -------- -------- --------
Net premiums earned 1,633 5,769 7,402
Net investment income 3,160 973 4,133
Net investment gains 9,004 279 9,283
Equity in net income of investees 1,036 1,036
Fee income 1,715 1,078 2,793
Net commission income 482 482
-------- -------- -------- --------
Total revenues 17,030 8,099 25,129
-------- -------- -------- --------
OPERATING COSTS AND EXPENSES
Claims and claims expenses 1,545 4,637 6,182
Commissions and brokerage 2,024 2,024
Other operating expenses 4,038 2,145 $89 (7) 6,272
-------- -------- -------- --------
Total operating costs and expenses 5,583 8,806 89 14,478
-------- -------- -------- --------
Income (Loss) Before Income Taxes 11,447 (707) (89) 10,651
-------- -------- -------- --------
Income taxes:
Current 201 201
Deferred 3,105 (178) (8) 2,927
-------- -------- -------- --------
Income tax expense (benefit) 3,306 (178) 3,128
-------- -------- -------- --------
Net Income (Loss) $8,141 ($529) ($89) $7,523
======== ======== ======== ========
AVERAGE SHARES OUTSTANDING
Basic 12,787 24 (9) 12,811
Diluted 12,792 24 (9) 12,816
PER SHARE DATA
Net Income - Basic $0.64 $0.59
Net Income - Diluted $0.64 $0.59
</Table>
The accompanying notes are an integral part of the unaudited pro forma
condensed combined financial statements.
30
<Page>
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<Table>
<Caption>
FOR THE YEAR ENDED DECEMBER 31, 2000
---------------------------------------------------------
PRO FORMA
------------------------------
ACGL ALTUS ADJUSTMENTS COMBINED
-------- -------- ----------- --------
REVENUES
Net premiums written ($10,604) $24,243 $13,639
(Increase) decrease in unearned premiums 98,134 (5,107) 93,027
-------- -------- -------- --------
Net premiums earned 87,530 19,136 106,666
Net investment income 15,923 3,280 19,203
Gain on sale of reinsurance operations 2,191 2,191
Net investment gains 16,872 62 $3,173 (6) 20,107
Equity in net income of investees 2,539 2,539
Fee income 74 74
-------- -------- -------- --------
Total revenues 125,055 22,552 3,173 150,780
-------- -------- -------- --------
OPERATING COSTS AND EXPENSES
Claims and claims expenses 76,263 10,986 87,249
Commissions and brokerage 26,756 12,170 38,926
Reserve for contingent loss of escrowed assets 15,000 15,000
Other operating expenses 7,953 1,686 356 (7) 9,995
Foreign exchange loss 1,159 1,159
-------- -------- -------- --------
Total operating costs and expenses 127,131 24,842 356 152,329
-------- -------- -------- --------
Income (Loss) Before Income Taxes and
Discontinued Operations (2,076) (2,290) 2,817 (1,549)
-------- -------- -------- --------
Income taxes:
Current 17 17
Deferred 6,665 (109) (8) 6,556
-------- -------- -------- --------
Income tax expense (benefit) 6,665 (92) 6,573
-------- -------- -------- --------
Loss From Continuing Operations ($8,741) ($2,198) $2,817 ($8,122)
======== ======== ======== ========
AVERAGE SHARES OUTSTANDING
Basic 13,198 24 (9) 13,222
Diluted 13,198 24 (9) 13,222
PER SHARE DATA
Net Loss - Basic ($0.66) ($0.61)
Net Loss - Diluted ($0.66) ($0.61)
</Table>
The accompanying notes are an integral part of the unaudited pro forma
condensed combined financial statements.
31
<Page>
NOTES TO THE UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS
The acquisition of Altus has been accounted for as a business combination
using the purchase method. The purchase price for this acquisition is the sum of
consideration paid and the transaction costs incurred by ACGL. Under the
purchase method of accounting for business combinations, the purchase price is
allocated to the assets and liabilities based on their fair values, with the
excess of the acquisition costs over the fair value of the net assets recorded
as goodwill.
(1) Preliminary analyses have been performed in order to identify intangible
assets and to allocate purchase price to identifiable assets and
liabilities, with the excess of purchase price over net tangible and
intangible assets recorded as goodwill. The fair values of reserves for
claims and claims expenses and related reinsurance recoverables for
Altus' subsidiary, First American Insurance Company, were estimated based
on the present value of the expected underlying cash flows of the
reserves and reinsurance recoverables using a risk free interest rate,
and include an adjustment for a risk factor and a profit margin. The
following table summarizes the calculation and allocation of purchase
price of the most recent acquisition:
<Table>
<Caption>
(in thousands) ALTUS
-------
PURCHASE PRICE:
Consideration paid in cash $37,985
Consideration paid in stock 404
Transaction costs 413
-------
Total Purchase Price 38,802
Original ACGL 27.9% investment (after adjustment described in notes 2
and 5) 12,947
-------
Total Investment $51,749
=======
PURCHASE PRICE ALLOCATION:
Fair value of net assets acquired 33,459
Goodwill 5,343
-------
Total Allocation of Purchase Price 38,802
Original ACGL 27.9% investment (after adjustment described in notes 2
and 5) 12,947
-------
Total Investment $51,749
=======
</Table>
(2) To eliminate ACGL's original minority investment in Altus, which was
carried at estimated fair value prior to the closing of the acquisition
on June 22, 2001.
(3) To record consideration paid to Altus' shareholders of $38.0 million and
acquisition expenses, consisting primarily of transaction fees and
professional services in the amount of $0.4 million.
(4) To record the value of goodwill (as described in note 1) of $5.3 million.
32
<Page>
(5) To reflect the elimination of Altus' shareholders' equity of $46.4
million, the issuance of 24,200 shares of ACGL Common Shares valued at
$0.4 million, and ACGL's 27.9% portion of equity in the net loss of Altus
occurring prior to March 31, 2001 in the amount of $3.1 million.
Upon the closing of ACGL's acquisition of Altus, ACGL was required under
generally accepted accounting principles governing a "step acquisition"
of an investee company to retroactively adopt the equity method of
accounting for its original 27.9% ownership interest in Altus for the
periods prior to the acquisition and to restate its historical financial
results. Such restatement resulted in a reduction in ACGL's book value at
March 31, 2001 in the amount of $3.1 million, or $0.24 per share. After
ACGL's acquisition of its initial 27.9% ownership interest in Altus in
March 1998, the investment was carried at its estimated fair value from
the initial purchase through March 31, 2001 in accordance with generally
accepted accounting principles. ACGL accounted for its initial interest
in Altus under "fair value" because ACGL did not have the ability to
exercise significant influence over this investment due to ACGL's limited
voting and consent rights.
Subsequent to this Form 8-K/A report, ACGL will file with the Securities
and Exchange Commission ("SEC") an amended Form 10-K (10-K/A) for the
year ended December 31, 2000 and an amended Form 10-Q (10-Q/A) for the
quarter ended March 31, 2001 to reflect the required restatement. ACGL's
historical financial statements have not been restated herein. However,
the cumulative result of retroactively adopting the equity method of
accounting for the original investment in Altus is included as a pro
forma adjustment to shareholders' equity as follows:
<Table>
Elimination of Altus' shareholders' equity ($46,406)
Issuance of ACGL Common Shares to employee shareholders of Altus 404
Cumulative net result of retroactively adopting the equity method of accounting (3,053)
--------
Pro Forma Adjustment ($49,055)
========
</Table>
(6) To eliminate the $3.2 million realized loss recorded in the first quarter
2000 historical financial statements as an adjustment to the fair value
of ACGL's investment in Altus. This item would not be recorded under the
equity method. See note 5 above regarding the step acquisition.
(7) To record the amortization of goodwill related to the acquisition of
Altus as if the transaction occurred on January 1, 2000. Goodwill in
relation to the acquisition was $5.3 million (see note 1) and will be
amortized on a straight-line basis over fifteen years.
(8) The amortization of goodwill related to the Altus acquisition is not
deductible for tax purposes; therefore, no tax effect has been included.
(9) Weighted average shares used to calculate pro forma basic and diluted net
income (loss) per share for the periods presented are computed using the
historical weighted average number of common shares outstanding for the
period presented and the shares issued in conjunction with the
acquisition of Altus as if such issued shares were outstanding as of
January 1, 2000.
33
<Page>
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
- ----------- ---------------------------------------------
23(a) Consent of Deloitte & Touche LLP