Arch Capital Group Ltd.
Earnings Release Supplement
As of June 30, 2002
INDEX TO SUPPLEMENT
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PAGE
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Earnings Release................................................ 1
Consolidated Statements of Income............................... 7
Consolidated Balance Sheets..................................... 8
Consolidated Statements of Changes in Shareholders' Equity...... 9
Consolidated Statements of Comprehensive Income................. 10
Consolidated Statements of Cash Flows........................... 11
Supplemental Financial Information.............................. 12
ARCH CAPITAL GROUP LTD. REPORTS SECOND QUARTER RESULTS
HAMILTON, BERMUDA, August 8, 2002 -- Arch Capital Group Ltd. (NASDAQ: ACGL)
reported that net premiums written for the 2002 second quarter were $223.0
million, of which the Company's reinsurance and insurance operations contributed
net premiums written of $176.6 million and $46.4 million, respectively. For the
six months ended June 30, 2002, net premiums written were $503.7 million, of
which the Company's reinsurance and insurance operations contributed net
premiums written of $441.5 million and $62.2 million, respectively. The Company
also reported that, for the period from January 1 to July 31, 2002, its
reinsurance subsidiaries have entered into reinsurance treaties and other
reinsurance arrangements that are expected to provide approximately $800 million
of annualized net reinsurance premiums, a substantial portion of which will be
recorded in calendar year 2002.
The following table summarizes the Company's financial performance for the three
and six month periods ended June 30, 2002 and 2001. Comparisons of 2002 and 2001
results of operations are not meaningful due to the changes in the Company's
business during 2001 resulting from the Company's new underwriting initiatives
and the related capital infusions. In addition, certain prior period information
has been reclassified to conform to the current presentation. After-tax
operating income is defined as net income, excluding net realized investment
gains or losses on investment sales, equity in net income or loss of investees,
non-cash compensation charges, and foreign exchange gains or losses. The
increase in diluted average shares outstanding from 2001 to 2002 was primarily
due to the issuance of convertible preference shares and Class A warrants in
connection with the Company's capital infusion in November 2001 and the issuance
of 7,475,000 common shares in connection with a public offering completed by the
Company in April 2002.
(Unaudited) (Unaudited)
Three Months Ended Six Months Ended
Summary of Results June 30, June 30,
----------------------------------- -----------------------------------
(in thousands) 2002 2001 2002 2001
----------------- --------------- ---------------- ----------------
Net premiums written..................... $223,025 $6,719 $503,736 $9,557
Net premiums earned...................... 113,459 5,565 180,986 7,198
Total revenues........................... 135,807 23,191 215,300 40,073
Components of Net Income:
Operating income....................... 15,514 3,079 23,882 4,635
Net realized investment gains 389 5,633 (773) 11,837
(losses)...............................
Provision for non-cash compensation.... (8,094) (270) (11,766) (577)
Reversal of deferred tax asset 7,421 -- 7,421 --
valuation allowance....................
Net foreign exchange gains............. 3,352 -- 3,244 --
Equity in net income (loss) of 644 (42) 1,184 498
investees..............................
----------------- --------------- ---------------- ----------------
Net income............................. $19,226 $8,400 $23,192 $16,393
================= =============== ================ ================
1
(Unaudited) (Unaudited)
Three Months Ended Six Months Ended
Summary of Results June 30, June 30,
----------------------------------- -----------------------------------
(continued) 2002 2001 2002 2001
----------------- --------------- ---------------- ----------------
Per Share Results:
Operating income....................... $0.27 $0.24 $0.43 $0.37
Net realized investment gains 0.01 0.43 (0.01) 0.92
(losses)...............................
Provision for non-cash compensation.... (0.14) (0.02) (0.21) (0.05)
Reversal of deferred tax asset 0.12 -- 0.13 --
valuation allowance....................
Net foreign exchange gains............. 0.06 -- 0.06 --
Equity in net income (loss) of 0.01 (0.00) 0.02 0.04
investees..............................
----------------- --------------- ---------------- ----------------
Net income............................. $0.33 $0.65 $0.42 $1.28
================= =============== ================ ================
Diluted average shares outstanding....... 58,877,515 12,844,000 54,981,185 12,818,160
As set forth in the above table, for the three months ended June 30, 2002, the
Company's after-tax operating income was $15.5 million, or $0.27 per share, and
for the six months ended June 30, 2002, after-tax operating income was $23.9
million, or $0.43 per share. Net income for the 2002 second quarter was $19.2
million, or $0.33 per share, and for the six months ended June 30, 2002, net
income was $23.2 million, or $0.42 per share. Net income for the 2002 second
quarter and for the six months ended June 30, 2002 included a benefit of $7.4
million, or $0.12 and $0.13 per diluted share, respectively, resulting from a
reversal of a valuation allowance on certain of the Company's deferred tax
assets. Such reversal was based on the Company's recently completed
restructuring of its U.S.-based insurance underwriting operations and its
business plan. In addition, the Company recorded an after-tax provision for
non-cash compensation in the 2002 second quarter and for the six months ended
June 30, 2002 of $8.1 million, or $0.14 per diluted share, and $11.8 million, or
$0.21 per diluted share, respectively, related to the vesting of restricted
common shares.
In the 2002 second quarter, net foreign exchange gains of $3,352,000 consisted
of an unrealized gain of $3,263,000 and a realized gain of $89,000. Net foreign
exchange gains for the six months ended June 30, 2002 of $3,244,000 consisted of
an unrealized gain of $3,263,000 and a realized loss of $19,000. The net
unrealized gain resulted from the translation of foreign denominated monetary
assets and liabilities at June 30, 2002 as required by generally accepted
accounting principles ("GAAP"). Under GAAP, accounts that are classified as
monetary assets and liabilities, such as premiums receivable and the reserve for
losses and loss adjustment expenses, are revalued at each balance sheet date.
Accounts that are classified as non-monetary are not revalued. Pursuant to GAAP,
the unearned premium reserve is classified as non-monetary and, accordingly, was
not revalued at June 30, 2002. If the unearned premium reserve was considered a
monetary asset under GAAP, the unrealized foreign exchange gain would have been
reduced by $3.3 million for the three and six month periods ended June 30, 2002.
In establishing the reserves for losses and loss adjustment expenses, the
Company made various assumptions relating to the pricing of its reinsurance
contracts and insurance policies, historical industry experience and current
industry conditions. In its reserving process, the Company recognized that there
is a possibility of adverse deviation from the assumptions made due to several
factors primarily related to
2
the Company's start-up nature, including the fact that very limited historical
information has been reported to the Company as of June 30, 2002.
Other operating expenses were $14.9 million for the 2002 second quarter,
compared to $4.8 million for the 2001 second quarter. For the first six months
of 2002, other operating expenses were $28.2 million, compared to $8.4 million
for the same prior year period. The increase in other operating expenses was due
to acquisitions completed by the Company in 2001 and the operating expenses
associated with the Company's new underwriting initiatives.
Net investment income for the 2002 second quarter was $11.6 million, compared to
$3.1 million in the 2001 second quarter. For the first six months of 2002, net
investment income was $20.8 million, compared to $6.2 million for the same prior
year period. The increase in net investment income was due to the significant
increase in the Company's invested assets resulting from (i) the capital
infusion completed in November 2001, (ii) the proceeds received from the public
offering of the Company's common shares in April 2002 and (iii) cash flow from
operations. The Company invested these funds in high quality fixed income
securities which had an average Standard & Poor's quality rating of "AA-" and an
average duration of 2.8 years at June 30, 2002.
Net realized investment gains for the 2002 second quarter on a pre-tax and
after-tax basis were $2.5 million and $389,000, respectively. The net realized
gain consisted of a $5.9 million gain on the sale of a privately held equity
investment, which was partially offset by the sale of certain fixed income
securities.
The following table details components of the combined ratio for the
reinsurance, insurance and total underwriting operations of the Company on both
a GAAP and statutory basis for the three and six month periods ended June 30,
2002. The difference between the GAAP and statutory ratios shown below results
from the difference in the expense ratios. The statutory expense ratios are
based on net premiums written, while the GAAP expense ratios are based on net
premiums earned. In calculating expenses incurred under GAAP, the Company is
deferring a portion of its underwriting expenses.
(Unaudited)
Three Months Ended
Operating Information by Segment June 30, 2002
----------------------------------------------------------
(in thousands) Reinsurance Insurance Total
----------------- ----------------- ----------------
Net premiums written.................................. $176,619 $46,406 $223,025
Net premiums earned................................... 96,330 17,129 113,459
GAAP underwriting income (loss)....................... 10,389 (3,425) 6,964
Combined Ratio:
Statutory Basis..................................... 92.5% 104.5% 94.6%
GAAP Basis.......................................... 89.2% 120.0% 93.9%
3
(Unaudited)
Six Months Ended
June 30, 2002
----------------------------------------------------------
Reinsurance Insurance Total
----------------- ----------------- ----------------
Net premiums written.................................. $441,480 $62,256 $503,736
Net premiums earned................................... 151,863 29,123 180,986
GAAP underwriting income (loss)....................... 14,238 (3,449) 10,789
Combined Ratio:
Statutory Basis..................................... 89.4% 102.5% 91.3%
GAAP Basis.......................................... 90.6% 111.8% 94.0%
Paul Ingrey, Chairman and Chief Executive Officer of Arch Reinsurance Ltd.,
stated, "We remain very pleased with the level and quality of the business
opportunities presented to us. We expect to continue to add to our current
portfolio of business, which is diversified across various classes of business,
in an insurance marketplace that continues to strengthen."
For the three and six month periods ended June 30, 2002, the statutory expense
ratios for the insurance segment were 27.4% and 24.1%, respectively. On a GAAP
basis, the expense ratios were 42.9% and 33.4%, respectively. The insurance
segment expenses are reflected net of certain policy-related fee income. The
statutory and GAAP combined ratios for the insurance operating segment reflect
"start-up" operating expenses of $2.1 million and $3.7 million, respectively,
for the three and six month periods ended June 30, 2002.
Commenting on the progress of the Company's insurance group, Constantine
Iordanou, President and Chief Executive Officer of Arch Insurance Group, said
"Our insurance activity continues to increase at a very rapid pace. Our
experienced and talented management team and strong financial position have
resulted in a very robust level of submissions. We expect that the progress we
have made during the last six months will produce an even higher level of future
activity."
At June 30, 2002 and December 31, 2001, the Company's consolidated shareholders'
equity was $1.25 billion and $1.02 billion, respectively. On a diluted basis,
the per share book value at June 30, 2002 increased to $20.27 from $19.59 at
December 31, 2001. The increase in diluted book value per share was primarily
attributable to the net effects of issuing 7,475,000 common shares at $25.50 per
share in the stock offering completed by the Company in April 2002, and an
increase in unrealized appreciation of investments of $10.9 million. These
increases were partially offset by the effects of the issuance on June 28, 2002
of 875,753 additional Series A convertible preference shares pursuant to a
post-closing purchase price adjustment mechanism under the Subscription
Agreement. The diluted per share book value reflects the Company's outstanding
convertible preference shares and Class A warrants, but does not take into
account certain potential adjustments. If such potential adjustments were
triggered, the diluted pro forma book value at June 30, 2002 would have been
reduced by $0.91 per share. The calculation of the Company's book value per
share amounts and the potential adjustments to book value per share are included
in (and described in) the accompanying supplemental financial information.
The Company will hold a conference call for investors and analysts at 10:00 a.m.
Eastern Time on August 9. A live webcast of this call will be available at
http://www.vcall.com/EventPage.asp?ID=82027 and will be archived on VCall's
website from 12:00 p.m. Eastern Time on August 9 through midnight Eastern Time
on September 9, 2002. A telephone replay of the conference call also will be
available beginning on August 9 at 12:00 p.m. Eastern Time until August 12 at
10:00 a.m. Eastern Time. To
4
access the replay, domestic callers should dial 877-660-6853, passcode 39793,
and international callers should dial 201-612-7415, passcode 39793.
Arch Capital Group Ltd., a Bermuda-based company with over $1.2 billion in
equity capital, provides insurance and reinsurance on a worldwide basis through
its wholly owned subsidiaries.
Cautionary Note Regarding Forward-Looking Statements
The Private Securities Litigation Reform Act of 1995 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 this release are forward-looking statements.
Forward-looking statements can generally be identified by the use of
forward-looking terminology such as "may," "will," "expect," "intend,"
"estimate," "anticipate," "believe" or "continue" 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 include:
o the Company's ability to successfully implement its business strategy,
including implementing procedures and internal controls to support the
value of the Company's business and its regulatory and reporting
requirements;
o acceptance of the Company's products and services and security by
brokers and insureds;
o acceptance of the Company's business strategy, security and financial
condition by rating agencies and regulators;
o general economic and market conditions (including as to inflation and
foreign currency exchange rates) and conditions specific to the
reinsurance and insurance markets in which the Company operates;
o competition, including increased competition, on the basis of pricing,
capacity, coverage terms or other factors;
o the Company's ability to successfully integrate new management and
operating personnel and to establish and maintain operating procedures
to effectively support the Company's new underwriting initiatives and
to develop accurate actuarial data and develop and implement actuarial
models and procedures;
o the loss of key personnel;
o the integration of businesses the Company has acquired or may acquire
into its existing operations;
o greater than expected loss ratios on business written by the Company's
insurance and reinsurance subsidiaries and adverse development on
claim and/or claim expense liabilities related to business written by
its insurance and reinsurance subsidiaries;
o severity and/or frequency of losses;
5
o claims for natural or man-made catastrophic events in the Company's
insurance or reinsurance business could cause large losses and
substantial volatility in the Company's results of operations;
o acts of terrorism, other hostilities or other unforecasted and
unpredictable events;
o 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;
o availability to the Company of reinsurance to manage its gross and net
exposures;
o the failure of reinsurers, managing general agents or others to meet
their obligations to the Company's insurance and reinsurance
subsidiaries;
o the timing of claims payments being faster or the receipt of
reinsurance recoverables being slower than anticipated by the Company;
o changes in the financial environment, including interest rates;
o changes in accounting principles or the application of such principles
by accounting firms or regulators;
o statutory or regulatory developments, including as to tax policy and
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 government provision or back-stopping of insurance
(including for acts of terrorism); and
o rating agency policies and practices.
In addition, other general factors could affect the Company's results,
including: (a) developments in the world's financial and capital markets and the
Company's access to such markets; (b) changes in regulation or tax laws
applicable to the Company, its subsidiaries, brokers or customers; and (c) the
effects of business disruption or economic contraction due to terrorism or other
hostilities.
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.
6
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except share data)
(Unaudited) (Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
2002 2001 2002 2001
----------------- --------------- --------------- ---------------
Revenues
Net premiums written.................................. $223,025 $6,719 $503,736 $9,557
Increase in unearned premiums......................... (109,566) (1,154) (322,750) (2,359)
----------------- --------------- --------------- ---------------
Net premiums earned................................... 113,459 5,565 180,986 7,198
Net investment income................................. 11,611 3,078 20,778 6,238
Net realized investment gains......................... 2,476 9,605 1,011 18,609
Equity in net income of investees..................... 778 33 1,576 921
Fee income............................................ 4,131 3,711 7,705 5,426
Net commission income................................. -- 1,199 -- 1,681
Net foreign exchange gains............................ 3,352 -- 3,244 --
----------------- --------------- --------------- ---------------
Total revenues........................................ 135,807 23,191 215,300 40,073
Expenses
Losses and loss adjustment expenses................... 80,304 5,526 130,844 7,071
Acquisition expenses.................................. 17,755 -- 25,065 --
Other operating expenses.............................. 14,854 4,761 28,178 8,440
Provision for non-cash compensation................... 8,636 275 12,764 634
----------------- --------------- --------------- ---------------
Total expenses........................................ 121,549 10,562 196,851 16,145
Income Before Income Taxes............................ 14,258 12,629 18,449 23,928
Income tax (benefit) expense.......................... (4,968) 4,229 (4,743) 7,535
----------------- --------------- --------------- ---------------
Net Income............................................ $19,226 $8,400 $23,192 $16,393
================= =============== =============== ===============
Net Income Per Share Data
Basic................................................. $0.95 $0.65 $1.39 $1.28
Diluted............................................... $0.33 $0.65 $0.42 $1.28
Average Shares Outstanding
Basic................................................. 20,323,114 12,832,261 16,691,051 12,809,572
Diluted............................................... 58,877,515 12,844,000 54,981,185 12,818,160
7
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
(Unaudited)
June 30, December 31,
2002 2001
------------------- -------------------
Assets
Investments:
Fixed maturities available for sale, at fair value (amortized cost:
2002, $1,043,700; 2001, $467,154).................................................... $1,056,780 $468,269
Short-term investments available for sale, at fair value (amortized cost: 2002,
$176,119; 2001, $477,058)............................................................ 175,720 476,820
Publicly traded equity securities available for sale, at fair value (cost: 2002,-- ;
2001, $960).......................................................................... -- 235
Securities held in escrow, at fair value (amortized cost: 2002,--; 2001, $22,156)... -- 22,156
Privately held securities (cost: 2002, $31,537; 2001, $41,587)...................... 31,571 41,608
------------------- -------------------
Total investments.................................................................... 1,264,071 1,009,088
------------------- -------------------
Cash................................................................................. 37,641 9,970
Accrued investment income............................................................ 13,681 7,572
Premiums receivable.................................................................. 330,086 59,463
Unpaid losses and loss adjustment expenses recoverable .............................. 137,051 90,442
Paid losses and loss adjustment expenses recoverable................................. 22,315 14,418
Prepaid reinsurance premiums......................................................... 56,430 58,961
Goodwill............................................................................. 28,823 26,336
Deferred income tax asset............................................................ 18,342 13,716
Deferred acquisition costs........................................................... 61,803 5,412
Other assets......................................................................... 37,493 18,323
------------------- -------------------
Total Assets......................................................................... $2,007,736 $1,313,701
=================== ===================
......................................................................................
Liabilities
Reserve for losses and loss adjustment expenses...................................... $266,590 $113,507
Unearned premiums.................................................................... 408,759 88,539
Reinsurance balances payable......................................................... 38,147 47,029
Reserve for loss of escrowed assets.................................................. -- 18,833
Other liabilities.................................................................... 48,193 25,424
------------------- -------------------
Total Liabilities.................................................................... 761,689 293,332
------------------- -------------------
Commitments and Contingencies
Shareholders' Equity
Preferred shares ($0.01 par value, 50,000,000 shares authorized, issued: 2002,
36,563,488, 2001, 35,687,735)........................................................ 366 357
Common shares ($0.01 par value, 200,000,000 shares authorized, issued: 2002,
23,795,740, 2001, 13,513,538)........................................................ 238 135
Additional paid-in capital........................................................... 1,282,401 1,039,887
Deferred compensation under share award plan......................................... (59,241) (8,230)
Retained earnings (deficit).......................................................... 11,582 (11,610)
Accumulated other comprehensive income consisting of unrealized
appreciation (decline) in value of investments, net of income tax.................... 10,701 (170)
------------------- -------------------
Total Shareholders' Equity........................................................... 1,246,047 1,020,369
-------------------
Total Liabilities & Shareholders' Equity............................................. $2,007,736 $1,313,701
=================== ===================
8
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(in thousands)
(Unaudited)
Six Months Ended
June 30,
2002 2001
------------------- -------------------
Preference Shares
Balance at beginning of year............................................. $357 --
Preference shares issued................................................. 9 --
------------------- -------------------
Balance at end of period................................................. 366 --
------------------- -------------------
Common Shares
Balance at beginning of year............................................. 135 $127
Common shares issued..................................................... 103 2
------------------- -------------------
Balance at end of period................................................. 238 129
------------------- -------------------
Additional Paid-in Capital
Balance at beginning of year............................................. 1,039,887 288,016
Common shares issued..................................................... 242,514 2,360
------------------- -------------------
Balance at end of period................................................. 1,282,401 290,376
------------------- -------------------
Deferred Compensation Under Share Award Plan
Balance at beginning of year............................................. (8,230) (341)
Restricted common shares issued.......................................... (63,615) (1,772)
Deferred compensation expense recognized................................. 12,604 634
------------------- -------------------
Balance at end of period................................................. (59,241) (1,479)
------------------- -------------------
Retained Earnings (Deficit)
Balance at beginning of year, as previously reported..................... (11,610) (30,916)
Adjustment to retroactively adopt the equity method of accounting
for the original investment in ART Services............................ -- (2,710)
------------------- -------------------
Balance at beginning of year, as adjusted................................ (11,610) (33,626)
Net income............................................................... 23,192 16,393
------------------- -------------------
Balance at end of period................................................. 11,582 (17,233)
------------------- -------------------
Accumulated Other Comprehensive Income
Unrealized Appreciation (Decline) in Value of Investments, Net of
Income Tax
Balance at beginning of year............................................. (170) 18,432
Adjustment to retroactively adopt the equity method of accounting for
the original investment in ART Services................................ -- (309)
------------------- -------------------
Balance at beginning of year, as adjusted................................ (170) 18,123
Change in unrealized appreciation (decline) in value of investments...... 10,871 (18,264)
------------------- -------------------
Balance at end of period................................................. 10,701 (141)
------------------- -------------------
Total Shareholders' Equity............................................... $1,246,047 $271,652
=================== ===================
9
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
(Unaudited)
Six Months Ended
June 30,
2002 2001
------------------- -------------------
Comprehensive Income (Loss)
Net income...................................................................... $23,192 $16,393
Other comprehensive income (loss), net of tax
Unrealized appreciation (decline) in value of investments:
Unrealized holding gains (losses) arising during period..................... 10,098 (6,427)
Reclassification of net realized losses (gains) included in net income...... 773 (11,837)
------------------- -------------------
Other comprehensive income (loss)............................................. 10,871 (18,264)
------------------- -------------------
Comprehensive Income (Loss)..................................................... $34,063 ($1,871)
=================== ===================
10
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
Six Months Ended,
June 30,
2002 2001
------------------- -------------------
Operating Activities
Net income........................................................................... $23,192 $16,393
Adjustments to reconcile net income to net cash provided
by operating activities:
Net realized investment gains................................................... (1,011) (18,610)
Provision for non-cash compensation............................................. 12,764 634
Net unrealized foreign exchange gains........................................... (3,263) --
Changes in:
Reserve for losses and loss adjustment expenses, net........................... 106,430 (253)
Unearned premiums.............................................................. 322,458 5,163
Premiums receivable............................................................ (267,316) (5,971)
Accrued investment income...................................................... (5,894) (326)
Reinsurance recoverables....................................................... (2,436) (2,668)
Reinsurance balances payable................................................... (9,490) 205
Deferred acquisition costs..................................................... (56,391) (473)
Deferred income tax asset...................................................... (4,626) 302
Other liabilities.............................................................. 16,801 (3,017)
Other items, net............................................................... (17,513) 8,329
------------------- -------------------
Net Cash Provided By (Used For) Operating Activities................................. 113,705 (292)
------------------- -------------------
Investing Activities
Purchases of fixed maturity investments.............................................. (885,654) (112,225)
Release of escrowed assets........................................................... (18,833) --
Sales of fixed maturity investments.................................................. 300,277 65,899
Purchases of equity securities....................................................... -- (19)
Sales of equity securities........................................................... 13,802 44,468
Net sales of short-term investments.................................................. 329,843 37,500
Acquisition of Rock River Insurance Company, net of cash and investments............. (2,513) --
Acquisition of ART Services, net of cash............................................. -- (34,159)
Acquisition of American Independent Insurance Holding Company, net of cash........... -- 224
Purchases of furniture, equipment and other.......................................... (2,073) (633)
------------------- -------------------
Net Cash (Used For) Provided By Investing Activities................................. (265,151) 1,055
------------------- -------------------
Financing Activities
Common stock issued.................................................................. 179,154 --
Purchase of treasury shares.......................................................... -- (48)
Debt retirement and other............................................................ (37) (73)
------------------- -------------------
Net Cash Provided By (Used For) Financing Activities................................. 179,117 (121)
------------------- -------------------
Increase in cash..................................................................... 27,671 642
Cash beginning of year............................................................... 9,970 11,481
------------------- -------------------
Cash end of period................................................................... $37,641 $12,123
=================== ===================
11
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
SUPPLEMENTAL FINANCIAL INFORMATION
(dollars in thousands, except per share data)
(Unaudited) (Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
2002 2001 2002 2001
================ =============== ============== ===============
Investment Portfolio Statistics
Investment income yield (at amortized cost):
Pre-tax.............................................. 4.1% 5.2% 3.6% 4.9%
After-tax............................................ 3.6% 4.6% 3.1% 4.5%
(Unaudited)
June 30, December 31,
2002 2001
---------------- ---------------
Average duration (in years).......................... 2.8 1.9
Average credit quality (Standard & Poors)............ AA- AA-
Segment Information
The Company classifies its businesses into two underwriting segments -
reinsurance and insurance - and a corporate segment (non-underwriting). Segment
performance is evaluated based on underwriting income or loss. Other revenue and
expense items are not evaluated by segment. The accounting policies of the
segments are the same as those used for the consolidated financial statements.
The reinsurance segment consists of the Company's reinsurance underwriting
subsidiaries, Arch Reinsurance Ltd., based in Bermuda, and Arch Reinsurance
Company, based in the United States. The reinsurance segment's strategy is to
write significant portions of business on a select number of specialty property
and casualty treaties. Classes of business focused on by the Company's
reinsurance subsidiaries include property catastrophe reinsurance; other
property business (losses on a single risk, both excess of loss and pro rata);
casualty; other specialty business (which includes non-standard auto, surety and
workers' compensation); marine, aviation and space; casualty clash; and
non-traditional business.
The insurance segment includes the Company's primary underwriting subsidiaries,
Arch Insurance Company (formerly known as First American Insurance Company),
Arch Specialty Insurance Company (formerly known as Rock River Insurance
Company), Arch Excess & Surplus Insurance Company (formerly known as Cross River
Insurance Company) and American Independent Insurance Company. The insurance
segment is comprised of six profit centers, including property, casualty,
executive assurance, healthcare, professional liability insurance, program
business, and other (currently identified as the non-standard auto business of
American Independent Insurance Company and the lenders business of Arch
Insurance Company).
The corporate segment (non-underwriting) includes net investment income and net
realized gains or losses and other corporate expenses incurred by the Company.
Other items of revenue and expenses of the Company are not evaluated at the
segment level. The corporate segment also includes the results of Hales &
Company Inc., the Company's merchant banking subsidiary.
The following tables set forth an analysis of the Company's underwriting income
or loss by segment for the three and six month periods ended June 30, 2002,
together with a reconciliation of underwriting income or loss to net income. Due
to the significant changes in the Company's operations due to the new
underwriting initiative, comparisons between 2002 and 2001 results are not
meaningful.
12
(Unaudited)
Three Months Ended
June 30, 2002
----------------------------------------------------------
Operating Information by Segment (in thousands) Reinsurance Insurance Total
----------------- ---------------- ----------------
Net premiums written......................................... $176,619 $46,406 $223,025
Net premiums earned.......................................... 96,330 17,129 113,459
Fee income................................................... -- 2,767 2,767
Losses and loss adjustment expenses.......................... (67,100) (13,204) (80,304)
Acquisition expenses......................................... (16,226) (1,529) (17,755)
Operating expenses........................................... (2,615) (8,588) (11,203)
----------------- ---------------- ----------------
GAAP underwriting income (loss).............................. $10,389 ($3,425) $6,964
================= ================
Net investment income........................................ 11,611
Net realized gains on investments............................ 2,476
Equity in net income of investees............................ 778
Net foreign exchange gains................................... 3,352
Other fee income............................................. 1,364
Other corporate expenses..................................... (3,651)
Provision for non-cash compensation.......................... (8,636)
Income tax benefit........................................... 4,968
----------------
Net income................................................... $19,226
================
Statutory Basis (1)
Loss ratio................................................... 69.7% 77.1% 70.8%
Acquisition expense ratio (2)................................ 19.0% 0.6% 15.3%
Other operating expense ratio................................ 3.8% 26.8% 8.5%
----------------- ---------------- ----------------
Combined ratio............................................... 92.5% 104.5% 94.6%
----------------- ---------------- ----------------
GAAP Basis (1)
Loss ratio.................................................. 69.7% 77.1% 70.8%
Acquisition expense ratio (2)............................... 16.8% (7.2%) 13.2%
Other operating expense ratio............................... 2.7% 50.1% 9.9%
----------------- ---------------- ----------------
Combined ratio.............................................. 89.2% 120.0% 93.8%
----------------- ---------------- ----------------
(1) The loss ratios for statutory and GAAP are based on earned premiums. The
statutory expense ratios are based on net premiums written, while the GAAP
expense ratios are based on net premiums earned.
(2) The acquisition expense ratio is adjusted to include certain policy-related
fee income.
13
(Unaudited)
Six Months Ended
June 30, 2002
----------------------------------------------------------
Operating Information by Segment (in thousands) Reinsurance Insurance Total
----------------- ---------------- ----------------
Net premiums written......................................... $441,480 $62,256 $503,736
Net premiums earned.......................................... 151,863 29,123 180,986
Fee income................................................... -- 3,935 3,935
Losses and loss adjustment expenses.......................... (108,005) (22,839) (130,844)
Acquisition expenses......................................... (23,487) (1,578) (25,065)
Operating expenses........................................... (6,133) (12,090) (18,223)
----------------- ---------------- ----------------
GAAP underwriting income (loss).............................. $14,238 ($3,449) $10,789
================= ================
Net investment income........................................ 20,778
Net realized gains on investments............................ 1,011
Equity in net income of investees............................ 1,576
Net foreign exchange gains................................... 3,244
Other fee income............................................. 3,770
Other corporate expenses..................................... (9,955)
Provision for non-cash compensation.......................... (12,764)
Income tax benefit........................................... 4,743
----------------
Net income................................................... $23,192
================
Statutory Basis (1)
Loss ratio................................................... 71.1% 78.4% 72.3%
Acquisition expense ratio (2)................................ 15.5% (2.9%) 13.2%
Other operating expense ratio................................ 2.8% 27.0% 5.8%
----------------- ---------------- ----------------
Combined ratio............................................... 89.4% 102.5% 91.3%
----------------- ---------------- ----------------
GAAP Basis (1)
Loss ratio.................................................. 71.1% 78.4% 72.3%
Acquisition expense ratio (2)............................... 15.5% (8.1%) 11.7%
Other operating expense ratio............................... 4.0% 41.5% 10.0%
----------------- ---------------- ----------------
Combined ratio.............................................. 90.6% 111.8% 94.0%
----------------- ---------------- ----------------
(1) The loss ratios for statutory and GAAP are based on earned premiums. The
statutory expense ratios are based on net premiums written, while the GAAP
expense ratios are based on net premiums earned.
(2) The acquisition expense ratio is adjusted to include certain policy-related
fee income.
14
Summary information about net premiums written produced by line of business for
the reinsurance segment for the three and six month periods ended June 30, 2002
is as follows:
(Unaudited) (Unaudited)
Three Months Ended Six Months Ended
June 30, 2002 June 30, 2002
---------------------------------- ----------------------------------
(in thousands) Premiums % Of Total Premiums % Of Total
Written Written
--------------- --------------- ---------------- --------------
Reinsurance Segment
Net Premiums Written by
Class of Business:
Property catastrophe...................... $28,315 16.0% $79,030 17.9%
Other property business................... 41,203 23.3% 83,875 19.0%
Casualty.................................. 16,128 9.1% 56,868 12.9%
Other specialty business.................. 71,194 40.3% 101,449 23.0%
Marine, aviation and space................ 9,639 5.5% 28,598 6.5%
Casualty clash............................ 1,779 1.0% 12,929 2.9%
Non-traditional business.................. 8,361 4.8% 78,731 17.8%
--------------- --------------- ---------------- --------------
Total..................................... $176,619 100.0% $441,480 100.0%
=============== =============== ================ ==============
Summary information about net premiums written produced by line of business for
the insurance segment for the three and six month periods ended June 30, 2002 is
as follows:
(Unaudited) (Unaudited)
Three Months Ended Six Months Ended
June 30, 2002 June 30, 2002
---------------------------------- ----------------------------------
(in thousands) Premiums % Of Total Premiums % Of Total
Written Written
--------------- --------------- ---------------- --------------
Insurance Segment
Net Premiums Written by
Class of Business:
Executive assurance....................... $10,871 23.4% $12,783 20.5%
Casualty.................................. 10,579 22.8% 10,579 17.0%
Program business.......................... 6,429 13.8% 8,696 14.0%
Property.................................. 5,130 11.1% 5,130 8.3%
Professional liability.................... 2,138 4.6% 2,138 3.4%
Other..................................... 11,259 24.3% 22,930 36.8%
--------------- --------------- ---------------- --------------
Total..................................... $46,406 100.0% $62,256 100.0%
=============== =============== ================ ==============
15
Calculation of Book Value Per Share
The following actual book value per share calculations are based on
shareholders' equity of $1,246,047 at June 30, 2002 (unaudited) and $1,020,369
at December 31, 2001 (audited).
(Unaudited)
June 30, 2002 December 31, 2001
--------------------------------- -----------------------------------
Common Shares Cumulative Common Shares Cumulative
and Potential Book Value and Potential Book Value
Common Shares Per Share Common Shares Per Share
--------------- -------------- --------------- ---------------
Per common share (1)............................... 23,795,740 $20.10 13,513,538 $20.05
Series A convertible preference shares (2)......... 36,563,488 $20.64 35,687,735 $20.74
Dilutive Class A warrants (3)...................... 1,112,468 $20.27 1,206,206 $20.24
Restricted common shares (4)....................... -- 1,689,629 $19.59
--------------- ---------------
Common shares and potential common shares.......... 61,471,696 52,097,108
=============== ===============
(1) Book value per common share at June 30, 2002 and December 31, 2001 was
determined by dividing (i) the difference between total shareholders' equity and
the aggregate liquidation preference of the Series A convertible preference
shares of $767.8 million and $749.4 million, respectively, by (ii) the number of
common shares outstanding.
(2) Includes preference shares that were issued by the Company on November 20,
2001 in exchange for $763.1 million of cash. The number of preference shares
issued was based on the estimated per share price of $21.38. The estimated per
share price was based on (i) the Company's total shareholders' equity as of June
30, 2001 (adjusted for certain amounts as described in the Subscription
Agreement entered in connection with the capital infusion (the "Subscription
Agreement")), divided by (ii) the total number of common shares outstanding as
of June 30, 2001, which was 12,863,079. In addition, the amount of preference
shares at June 30, 2002 includes 875,753 preference shares that were issued by
the Company on June 28, 2002 pursuant to a post-closing purchase price
adjustment mechanism under the Subscription Agreement. Each preference share is
convertible at any time and from time to time at the option of the holder
thereof into one fully paid and nonassessable common share, subject to possible
adjustment.
(3) Includes the net number of common shares that would be issued under the
Class A warrants, primarily issued in connection with the capital infusion
transaction, calculated using the treasury stock method. Class A warrants to
purchase an aggregate of 3,842,450 and 5,401,707 common shares were outstanding
as of June 30, 2002 and December 31, 2001, respectively. Class A warrants are
immediately exercisable at $20 per share and expire September 19, 2002. In April
2002, 1,559,257 Class A warrants were canceled in exchange for 446,608 newly
issued common shares.
(4) Represents restricted common shares issued in connection with the November
2001 capital infusion transaction. These restricted common shares are included
in common shares at June 30, 2002.
16
Potential Adjustments to Book Value Per Share
The following are potential adjustments to book value per share at June 30, 2002
and December 31, 2001, excluding the effects of stock options, that could be
made if certain future events described below occur.
(Unaudited)
June 30, 2002 December 31, 2001
--------------------------------- ----------------------------------
Cumulative Cumulative
Potential Potential
Contingently Adjustments Contingently Adjustments
Issuable to Book Value Issuable to Book Value
Common Shares Per Shares Common Shares Per Share
--------------- -------------- --------------- -- ---------------
Contingently issuable:
Series A convertible preference shares (1)....... -- -- 875,765 ($0.33)
Series A convertible preference shares (2)....... 2,831,174 ($0.89) 2,831,174 ($1.31)
Class B warrants (3)............................. 43,428 ($0.91) 33,495 ($1.32)
(1) Amount at December 31, 2001 represents an estimate of the amount of
additional Series A convertible preference shares that will be issued to the new
investors during the second quarter of 2002 pursuant to a post-closing purchase
price adjustment mechanism under the Subscription Agreement. The per share price
was based on (i) the Company's total shareholders' equity as of June 30, 2001 as
set forth on the audited balance sheet, adjusted for certain items as described
in the Subscription Agreement, divided by (ii) the total number of common shares
outstanding as of June 30, 2001. Consistent with such estimate, 875,753
preference shares were issued to the new investors on June 28, 2002 and are
reflected in the amount of preference shares at June 30, 2002.
(2) Represents an estimate of the amount of additional Series A preference
shares that would be issued under the Subscription Agreement in the event that
on or prior to September 19, 2005 (1) the closing price of the Company's common
shares is at least $30 per share for at least 20 out of 30 consecutive trading
days or (2) a change in control occurs (either case, a "Triggering Event").
Pursuant to the Subscription Agreement, the Company has agreed to issue to the
new investors additional Series A preference shares such that the audited per
share price is adjusted downward by $1.50 per preference share.
(3) Includes the number of common shares that would be issued under the Class B
warrants for purposes of calculating diluted book value per share under the
treasury stock method. Class B warrants to purchase an aggregate of 150,000
common shares were outstanding as of June 30, 2002 and December 31, 2001 and
expire September 19, 2005. Class B warrants are exercisable at $20 per share
when (1) the closing price of the Company's common shares is at least $30 per
share for at least 20 out of 30 consecutive trading days or (2) a change in
control occurs.
Pursuant to the Subscription Agreement, a post-closing purchase price adjustment
will be calculated in November 2003 (or such earlier date as agreed upon by the
Company and the investors thereunder) based on an adjustment basket. The
adjustment basket will be equal to (1) the difference between value realized
upon sale and the GAAP book value at the closing of the capital infusion
(November 2001) (as adjusted based on a pre-determined growth rate) of agreed
upon non-core businesses; plus (2) the difference between GAAP net book value of
the Company's insurance balances attributable to the Company's core insurance
operations with respect to any policy or contract written or having an effective
date prior to November 20, 2001 at the time of the final adjustment and those
balances at the closing; minus (3) reductions in book value arising from costs
and expenses relating to the transaction provided under the Subscription
Agreement, actual losses arising out of breach of representations under the
Subscription Agreement and certain other costs and expenses. If the adjustment
basket, which will be calculated by the Company's independent auditors, is less
than zero, the Company will issue additional preference shares to the investors
based on the decrease in value of the components of the adjustment basket. If
the adjustment basket is greater than zero, the Company is allowed to use cash
in an amount based on the increase in value of the components of the adjustment
basket to repurchase common shares (other than any common shares issued upon
conversion of the preference shares or exercise of the Class A warrants). If the
adjustment basket is less than zero and in the event that a Triggering Event
occurs, the Company agreed to issue additional preference shares to the
investors as a further adjustment. In addition, on the fourth anniversary of the
closing, there will be a calculation of a further adjustment basket based on (1)
liabilities owed to Folksamerica (if any) under the Asset Purchase Agreement,
dated as of January 10, 2000, between the Company and Folksamerica, and (2)
specified tax and ERISA matters under the Subscription Agreement.
17