Companies: 10,652     total market cap: $140.563 T
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Arch Capital
ACGL
#709
Rank
$35.67 B
Marketcap
๐Ÿ‡ง๐Ÿ‡ฒ
Country
$98.38
Share price
-1.47%
Change (1 day)
9.12%
Change (1 year)
๐Ÿฆ Insurance
Categories
  1. Arch Capital
  2. Quarterly Reports (10-Q)
  3. Financial Year FY2019 Q2

Arch Capital - 10-Q quarterly report FY2019 Q2


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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549
 
FORM 10-Q
☒
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
 
 
For the quarterly period ended June 30, 2019
 
 
 
Or
 
 
 
 
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number:  001-16209

 archlogorgbsolida36.jpg
ARCH CAPITAL GROUP LTD.
(Exact name of registrant as specified in its charter)
Bermuda
98-0374481
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
 
 
Waterloo House, Ground Floor
 
100 Pitts Bay Road,
Pembroke
HM 08,
Bermuda
(441)
278-9250
(Address of principal executive offices)
(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Exchange Act:
Title of each class
 
Trading Symbol (s)
 
Name of each exchange on which registered
Common shares, $0.0011 par value per share
 
ACGL
 
NASDAQ
 Stock Market
Depositary shares, each representing a 1/100th interest in a 5.25% Series E preferred share
 
ACGLP
 
NASDAQ
 Stock Market
Depositary shares, each representing a 1/100th interest in a 5.45% Series F preferred share
 
ACGLO
 
NASDAQ
 Stock Market
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ☑     No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☑     No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer ☑ Accelerated Filer ☐ Non-accelerated Filer ☐ Smaller reporting company ☐ Emerging growth company ☐
If an emerging growth company, indicate by check mark if the Registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐   No ☑

As of August 1, 2019, there were 404,987,803 common shares, $0.0011 par value per share, of the registrant outstanding.


ARCH CAPITAL GROUP LTD.
 
INDEX TO FORM 10-Q
 
 
 
 
Page No.
 
PART I
 
 
 
Financial Information
 
 2
Item 1.
Consolidated Financial Statements
 
 4
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
49
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
 
73
Item 4.
Controls and Procedures
 
74
 
 
 
 
 
PART II
 
 
 
Other Information
 
75 
Item 1.
Legal Proceedings
 
75
Item 1A.
Risk Factors
 
75 
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
 
75
Item 3.
Defaults Upon Senior Securities
 
76
Item 4.
Mine Safety Disclosures
 
76
Item 5.
Other Information
 
76
Item 6.
Exhibits
 
77
 
Signatures
 
78

ARCH CAPITAL
 1
2019 SECOND QUARTER FORM 10-Q

PART I.  FINANCIAL INFORMATION
Cautionary Note Regarding Forward-Looking Statements 
The Private Securities Litigation Reform Act of 1995 (“PSLRA”) provides a “safe harbor” for forward-looking statements. This report or any other written or oral statements made by or on behalf of us may include forward-looking statements, which reflect our current views with respect to future events and financial performance. All statements other than statements of historical fact included in or incorporated by reference in this report are forward-looking statements. Forward-looking statements, for purposes of the PSLRA or otherwise, can generally be identified by the use of forward-looking terminology such as “may,” “will,” “expect,” “intend,” “estimate,” “anticipate,” “believe” or “continue” and similar statements of a future or forward-looking nature or their negative or variations or similar terminology.
Forward-looking statements involve our 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 report and in our periodic reports filed with the Securities and Exchange Commission (the “SEC”), and include:
•
our ability to successfully implement our business strategy during “soft” as well as “hard” markets;
•
acceptance of our business strategy, security and financial condition by rating agencies and regulators, as well as by brokers and our insureds and reinsureds;
•
the integration of any businesses we have acquired or may acquire into our existing operations;
•
our ability to maintain or improve our ratings, which may be affected by our ability to raise additional equity or debt financings, by ratings agencies’ existing or new policies and practices, as well as other factors described herein;
•
general economic and market conditions (including inflation, interest rates, unemployment, housing prices, foreign currency exchange rates, prevailing credit terms and the depth and duration of a recession) and conditions specific to the reinsurance and insurance markets (including the length and magnitude of the current “soft” market) in which we operate;
•
competition, including increased competition, on the basis of pricing, capacity (including alternative sources of capital), coverage terms, or other factors;
•
developments in the world’s financial and capital markets and our access to such markets;
•
our ability to successfully enhance, integrate and maintain operating procedures (including information technology) to effectively support our current and new business;
•
the loss of key personnel;
•
accuracy of those estimates and judgments utilized in the preparation of our financial statements, including those related to revenue recognition, insurance and other reserves, reinsurance recoverables, investment valuations, intangible assets, bad debts, income taxes, contingencies and litigation, and any determination to use the deposit method of accounting, which for a relatively new insurance and reinsurance company, like our company, are even more difficult to make than those made in a mature company since relatively limited historical information has been reported to us through June 30, 2019;
•
greater than expected loss ratios on business written by us and adverse development on claim and/or claim expense liabilities related to business written by our insurance and reinsurance subsidiaries;
•
severity and/or frequency of losses;
•
claims for natural or man-made catastrophic events or severe economic events in our insurance, reinsurance and mortgage businesses could cause large losses and substantial volatility in our results of operations;
•
the effect of climate change on our business;
•
acts of terrorism, political unrest and other hostilities or other unforecasted and unpredictable events;
•
availability to us of reinsurance to manage our gross and net exposures and the cost of such reinsurance;
•
the failure of reinsurers, managing general agents, third party administrators or others to meet their obligations to us;
•
the timing of loss payments being faster or the receipt of reinsurance recoverables being slower than anticipated by us;

ARCH CAPITAL
 2
2019 SECOND QUARTER FORM 10-Q

•
our investment performance, including legislative or regulatory developments that may adversely affect the fair value of our investments;
•
changes in general economic conditions, including new or continued sovereign debt concerns in Eurozone countries or downgrades of U.S. securities by credit rating agencies, which could affect our business, financial condition and results of operations;
•
the volatility of our shareholders’ equity from foreign currency fluctuations, which could increase due to us not matching portions of our projected liabilities in foreign currencies with investments in the same currencies;
•
changes in accounting principles or policies or in our application of such accounting principles or policies;
•
changes in the political environment of certain countries in which we operate or underwrite business;
•
a disruption caused by cyber-attacks or other technology breaches or failures on us or our business partners and service providers, which could negatively impact our business and/or expose us to litigation;
•
statutory or regulatory developments, including as to tax matters and insurance and other regulatory matters such as the adoption of proposed legislation that would affect Bermuda-headquartered companies and/or Bermuda-based insurers or reinsurers and/or changes in regulations or tax laws applicable to us, our subsidiaries, brokers or customers, including the Tax Cuts and Jobs Act of 2017; and
•
the other matters set forth under Item 1A “Risk Factors”, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and other sections of our Annual Report on Form 10-K for the year ended December 31, 2018, as well as the other factors set forth in our other documents on file with the SEC, and management’s response to any of the aforementioned factors.
 
All subsequent written and oral forward-looking statements attributable to us or persons acting on our 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. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise. 


ARCH CAPITAL
 3
2019 SECOND QUARTER FORM 10-Q

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
 
 
Page No.
 
 
 
Report of Independent Registered Public Accounting Firm
 
5
 
 
 
Consolidated Balance Sheets
 
 
June 30, 2019 (unaudited) and December 31, 2018
 
6
 
 
 
Consolidated Statements of Income
 
 
For the three and six month periods ended June 30, 2019 and 2018 (unaudited)
 
7
 
 
 
Consolidated Statements of Comprehensive Income
 
 
For the three and six month periods ended June 30, 2019 and 2018 (unaudited)
 
8
 
 
 
Consolidated Statements of Changes in Shareholders’ Equity
 
 
For the three and six month periods ended June 30, 2019 and 2018 (unaudited)
 
9
 
 
 
Consolidated Statements of Cash Flows
 
 
For the six month periods ended June 30, 2019 and 2018 (unaudited)
 
10
 
 
 
Notes to Consolidated Financial Statements (unaudited)
 
 
Note 1 - Basis of Presentation and Recent Accounting Pronouncements
 
11 
Note 2 - Share Transactions
 
12
Note 3 - Earnings Per Common Share
 
13
Note 4 - Segment Information
 
14
Note 5 - Reserve for Losses and Loss Adjustment Expenses
 
19
Note 6 - Investment Information
 
22
Note 7 - Fair Value
 
28
Note 8 - Derivative Instruments
 
34
Note 9 - Commitments and Contingencies
 
35
Note 10 - Leases
 
35
Note 11 - Variable Interest Entities and Noncontrolling Interests
 
36
Note 12 - Other Comprehensive Income (Loss)
 
39
Note 13 - Guarantor Financial Information
 
40
Note 14 - Income Taxes
 
48
Note 15 - Legal Proceedings
 
48
Note 16 - Subsequent Events
 
48


ARCH CAPITAL
 4
2019 SECOND QUARTER FORM 10-Q

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholders of Arch Capital Group Ltd.

Results of Review of Interim Financial Statements

We have reviewed the accompanying consolidated balance sheet of Arch Capital Group Ltd. and its subsidiaries (the “Company”) as of June 30, 2019, and the related consolidated statements of income, comprehensive income, and changes in shareholders’ equity for each of the three-month and six-month periods ended June 30, 2019 and 2018, and the consolidated statements of cash flows for the six-month periods ended June 30, 2019 and 2018, including the related notes (collectively referred to as the “interim financial statements”). Based on our reviews, we are not aware of any material modifications that should be made to the accompanying interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of the Company as of December 31, 2018, and the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for the year then ended (not presented herein), and in our report dated February 28, 2019, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet as of December 31, 2018, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

Basis for Review Results

These interim financial statements are the responsibility of the Company’s management. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our review in accordance with the standards of the PCAOB. A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the PCAOB, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.



/s/ PricewaterhouseCoopers LLP

PricewaterhouseCoopers LLP
New York, NY
August 7, 2019

ARCH CAPITAL
 5
2019 SECOND QUARTER FORM 10-Q

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(U.S. dollars in thousands, except share data)
 
(Unaudited)
 
 
 
June 30,
2019
 
December 31,
2018
Assets
 

 
 

Investments:
 

 
 

Fixed maturities available for sale, at fair value (amortized cost: $15,584,662 and $14,829,902)
$
15,881,732

 
$
14,699,010

Short-term investments available for sale, at fair value (amortized cost: $822,157 and $956,238)
821,961

 
955,880

Collateral received under securities lending, at fair value (amortized cost: $450,312 and $274,125)
450,320

 
274,133

Equity securities, at fair value
670,943

 
338,899

Investments accounted for using the fair value option
3,721,035

 
3,983,571

Investments accounted for using the equity method
1,581,972

 
1,493,791

Total investments
23,127,963

 
21,745,284

 
 
 
 
Cash
605,316

 
646,556

Accrued investment income
119,252

 
114,641

Securities pledged under securities lending, at fair value (amortized cost: $436,699 and $266,786)
440,510

 
268,395

Premiums receivable
1,606,040

 
1,299,150

Reinsurance recoverable on unpaid and paid losses and loss adjustment expenses
3,171,257

 
2,919,372

Contractholder receivables
2,102,544

 
2,079,111

Ceded unearned premiums
1,136,728

 
975,469

Deferred acquisition costs
600,740

 
569,574

Receivable for securities sold
164,592

 
36,246

Goodwill and intangible assets
641,010

 
634,920

Other assets
1,135,718

 
929,611

Total assets
$
34,851,670

 
$
32,218,329

 
 
 
 
Liabilities
 
 
 
Reserve for losses and loss adjustment expenses
$
12,230,316

 
$
11,853,297

Unearned premiums
4,056,860

 
3,753,636

Reinsurance balances payable
531,990

 
393,107

Contractholder payables
2,102,544

 
2,079,111

Collateral held for insured obligations
237,056

 
236,630

Senior notes
1,733,865

 
1,733,528

Revolving credit agreement borrowings
491,006

 
455,682

Securities lending payable
450,312

 
274,125

Payable for securities purchased
294,109

 
90,034

Other liabilities
904,438

 
911,500

Total liabilities
23,032,496

 
21,780,650

 
 
 
 
Commitments and Contingencies


 


Redeemable noncontrolling interests
206,475

 
206,292

 
 
 
 
Shareholders' Equity
 
 
 
Non-cumulative preferred shares
780,000

 
780,000

Common shares ($0.0011 par, shares issued: 573,761,683 and 570,737,283)
638

 
634

Additional paid-in capital
1,847,949

 
1,793,781

Retained earnings
10,322,975

 
9,426,299

Accumulated other comprehensive income (loss), net of deferred income tax
206,827

 
(178,720
)
Common shares held in treasury, at cost (shares: 168,874,149 and 168,282,449)
(2,401,037
)
 
(2,382,167
)
Total shareholders' equity available to Arch
10,757,352

 
9,439,827

Non-redeemable noncontrolling interests
855,347

 
791,560

Total shareholders' equity
11,612,699

 
10,231,387

Total liabilities, noncontrolling interests and shareholders' equity
$
34,851,670

 
$
32,218,329



See Notes to Consolidated Financial Statements

ARCH CAPITAL
6
2019 SECOND QUARTER FORM 10-Q

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(U.S. dollars in thousands, except share data)
 
(Unaudited)
 
(Unaudited)
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2019
 
2018
 
2019
 
2018
Revenues
 

 
 

 
 

 
 

Net premiums written
$
1,444,898

 
$
1,298,896

 
$
2,970,157

 
$
2,711,440

Change in unearned premiums
18,829

 
37,867

 
(137,564
)
 
(139,778
)
Net premiums earned
1,463,727

 
1,336,763

 
2,832,593

 
2,571,662

Net investment income
155,038

 
135,668

 
311,987

 
262,392

Net realized gains (losses)
120,806

 
(76,611
)
 
262,371

 
(187,609
)
 
 
 
 
 
 
 
 
Other-than-temporary impairment losses
(49
)
 
(470
)
 
(1,358
)
 
(632
)
Less investment impairments recognized in other comprehensive income, before taxes
—

 
—

 
—

 
—

Net impairment losses recognized in earnings
(49
)
 
(470
)
 
(1,358
)
 
(632
)
 
 
 
 
 
 
 
 
Other underwriting income
5,953

 
3,874

 
14,778

 
9,223

Equity in net income of investment funds accounted for using the equity method
32,536

 
8,472

 
79,403

 
36,541

Other income
1,129

 
3,113

 
2,212

 
3,187

Total revenues
1,779,140

 
1,410,809

 
3,501,986

 
2,694,764

 
 
 
 
 
 
 
 
Expenses
 
 
 
 
 
 
 
Losses and loss adjustment expenses
767,543

 
726,153

 
1,486,075

 
1,363,013

Acquisition expenses
210,089

 
202,838

 
407,937

 
394,214

Other operating expenses
198,914

 
176,181

 
400,077

 
351,196

Corporate expenses
18,251

 
22,512

 
36,213

 
37,824

Amortization of intangible assets
19,794

 
26,472

 
40,211

 
53,208

Interest expense
29,280

 
30,344

 
58,345

 
60,980

Net foreign exchange (gains) losses
4,952

 
(53,706
)
 
1,427

 
(33,985
)
Total expenses
1,248,823

 
1,130,794

 
2,430,285

 
2,226,450

 
 
 
 
 
 
 
 
Income before income taxes
530,317

 
280,015

 
1,071,701

 
468,314

Income tax expense
(44,472
)
 
(23,668
)
 
(90,358
)
 
(45,583
)
Net income
$
485,845

 
$
256,347

 
$
981,343

 
$
422,731

Net (income) loss attributable to noncontrolling interests
(16,891
)
 
(12,701
)
 
(63,861
)
 
(28,662
)
Net income available to Arch
468,954

 
243,646

 
917,482

 
394,069

Preferred dividends
(10,403
)
 
(10,403
)
 
(20,806
)
 
(20,840
)
Loss on redemption of preferred shares
—

 
—

 
—

 
(2,710
)
Net income available to Arch common shareholders
$
458,551

 
$
233,243

 
$
896,676

 
$
370,519

 
 
 
 
 
 
 
 
Net income per common share and common share equivalent
 

 
 

 
 

 
 

Basic
$
1.14

 
$
0.58

 
$
2.24

 
$
0.91

Diluted
$
1.12

 
$
0.56

 
$
2.19

 
$
0.89

 
 
 
 
 
 
 
 
Weighted average common shares and common share equivalents outstanding
 
 
 
 
 

 
 

Basic
401,482,784

 
404,800,421

 
400,837,181

 
406,162,508

Diluted
410,899,483

 
413,111,205

 
409,755,250

 
415,460,756





See Notes to Consolidated Financial Statements

ARCH CAPITAL
7
2019 SECOND QUARTER FORM 10-Q

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(U.S. dollars in thousands)
 
(Unaudited)
 
(Unaudited)
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2019
 
2018
 
2019
 
2018
Comprehensive Income
 
 
 
 
 

 
 

Net income
$
485,845

 
$
256,347

 
$
981,343

 
$
422,731

Other comprehensive income (loss), net of deferred income tax
 
 
 
 
 
 
 
Unrealized appreciation (decline) in value of available-for-sale investments:
 
 
 
 
 
 
 
Unrealized holding gains (losses) arising during period
222,473

 
(85,271
)
 
448,360

 
(251,948
)
Reclassification of net realized (gains) losses, net of income taxes, included in net income (loss)
(55,345
)
 
36,643

 
(65,566
)
 
99,104

Foreign currency translation adjustments
4,267

 
(12,595
)
 
9,783

 
(11,313
)
Comprehensive income
657,240

 
195,124

 
1,373,920

 
258,574

Net (income) loss attributable to noncontrolling interests
(16,891
)
 
(12,701
)
 
(63,861
)
 
(28,662
)
Other comprehensive (income) loss attributable to noncontrolling interests
(2,891
)
 
1,077

 
(7,030
)
 
1,750

Comprehensive income available to Arch
$
637,458

 
$
183,500

 
$
1,303,029

 
$
231,662





See Notes to Consolidated Financial Statements

ARCH CAPITAL
8
2019 SECOND QUARTER FORM 10-Q

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(U.S. dollars in thousands)
 
(Unaudited)
 
(Unaudited)
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2019
 
2018
 
2019
 
2018
Non-cumulative preferred shares
 
 
 
 
 

 
 

Balance at beginning of period
$
780,000

 
$
780,000

 
$
780,000

 
$
872,555

Preferred shares redeemed
—

 
—

 
—

 
(92,555
)
Balance at end of period
780,000

 
780,000

 
780,000

 
780,000

 
 
 
 
 
 
 
 
Convertible non-voting common equivalent preferred shares
 
 
 
 
 
 
 
Balance at beginning of period
—

 
—

 
—

 
489,627

Preferred shares converted to common shares
—

 
—

 
—

 
(489,627
)
Balance at end of period
—

 
—

 
—

 
—

 
 
 
 
 
 
 
 
Common shares
 
 
 
 
 
 
 
Balance at beginning of period
636

 
630

 
634

 
611

Common shares issued, net
2

 
3

 
4

 
22

Balance at end of period
638

 
633

 
638

 
633

 
 
 
 
 
 
 
 
Additional paid-in capital
 
 
 
 
 

 
 

Balance at beginning of period
1,819,605

 
1,737,978

 
1,793,781

 
1,230,617

Preferred shares converted to common shares
—

 
—

 
—

 
489,608

Other changes
28,344


22,628


54,168


40,381

Balance at end of period
1,847,949

 
1,760,606

 
1,847,949

 
1,760,606

 
 
 
 
 
 
 
 
Retained earnings
 
 
 
 
 

 
 

Balance at beginning of period
9,864,424

 
8,849,959

 
9,426,299

 
8,562,889

Cumulative effect of an accounting change
—

 
—

 
—

 
149,794

Balance at beginning of period, as adjusted
9,864,424

 
8,849,959

 
9,426,299

 
8,712,683

Net income
485,845

 
256,347

 
981,343

 
422,731

Net (income) loss attributable to noncontrolling interests
(16,891
)
 
(12,701
)
 
(63,861
)
 
(28,662
)
Preferred share dividends
(10,403
)
 
(10,403
)
 
(20,806
)
 
(20,840
)
Loss on redemption of preferred shares
—

 
—

 
—

 
(2,710
)
Balance at end of period
10,322,975

 
9,083,202

 
10,322,975

 
9,083,202

 
 
 
 
 
 
 
 
Accumulated other comprehensive income (loss), net of deferred income tax
 
 
 
 
 
 
 
Balance at beginning of period
38,323

 
(134,009
)
 
(178,720
)
 
118,044

Unrealized appreciation (decline) in value of available-for-sale investments, net of deferred income tax:
 
 
 
 
 
 
 
Balance at beginning of period
97,202

 
(96,238
)
 
(114,178
)
 
157,400

Cumulative effect of an accounting change
—

 
—

 
—

 
(149,794
)
Balance at beginning of period, as adjusted
97,202

 
(96,238
)
 
(114,178
)
 
7,606

Unrealized holding gains (losses) during period, net of reclassification adjustment
167,128

 
(48,628
)
 
382,794

 
(152,844
)
Unrealized holding gains (losses) during period attributable to noncontrolling interests
(2,703
)
 
1,513

 
(6,989
)
 
1,885

Balance at end of period
261,627

 
(143,353
)
 
261,627

 
(143,353
)
Foreign currency translation adjustments, net of deferred income tax:
 
 
 
 
 
 
 
Balance at beginning of period
(58,879
)
 
(37,771
)
 
(64,542
)
 
(39,356
)
Foreign currency translation adjustments
4,267

 
(12,595
)
 
9,783

 
(11,313
)
Foreign currency translation adjustments attributable to noncontrolling interests
(188
)
 
(438
)
 
(41
)
 
(135
)
Balance at end of period
(54,800
)
 
(50,804
)
 
(54,800
)
 
(50,804
)
Balance at end of period
206,827

 
(194,157
)
 
206,827

 
(194,157
)
 
 
 
 
 
 
 
 
Common shares held in treasury, at cost
 
 
 
 
 
 
 
Balance at beginning of period
(2,388,392
)
 
(2,084,186
)
 
(2,382,167
)
 
(2,077,741
)
Shares repurchased for treasury
(12,645
)
 
(182,343
)
 
(18,870
)
 
(188,788
)
Balance at end of period
(2,401,037
)
 
(2,266,529
)
 
(2,401,037
)
 
(2,266,529
)
 
 
 
 
 
 
 
 
Total shareholders’ equity available to Arch
10,757,352

 
9,163,755

 
10,757,352

 
9,163,755

Non-redeemable noncontrolling interests
855,347

 
861,153

 
855,347

 
861,153

Total shareholders’ equity
$
11,612,699

 
$
10,024,908

 
$
11,612,699

 
$
10,024,908


See Notes to Consolidated Financial Statements

ARCH CAPITAL
9
2019 SECOND QUARTER FORM 10-Q

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(U.S. dollars in thousands)
 
(Unaudited)
 
Six Months Ended
 
June 30,
 
2019
 
2018
Operating Activities
 

 
 

Net income
$
981,343

 
$
422,731

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Net realized (gains) losses
(264,293
)
 
177,442

Net impairment losses recognized in earnings
1,358

 
632

Equity in net income or loss of investment funds accounted for using the equity method and other income or loss
(45,720
)
 
(13,543
)
Amortization of intangible assets
40,211

 
53,208

Share-based compensation
41,537

 
35,419

Changes in:
 
 
 
Reserve for losses and loss adjustment expenses, net of unpaid losses and loss adjustment expenses recoverable
154,396

 
(77,891
)
Unearned premiums, net of ceded unearned premiums
137,564

 
139,778

Premiums receivable
(302,050
)
 
(236,950
)
Deferred acquisition costs
(24,790
)
 
(35,111
)
Reinsurance balances payable
139,415

 
88,961

Other items, net
(146,447
)
 
(57,790
)
Net cash provided by (used for) operating activities
712,524

 
496,886

Investing Activities
 

 
 

Purchases of fixed maturity investments
(16,332,646
)
 
(16,867,570
)
Purchases of equity securities
(431,939
)
 
(679,663
)
Purchases of other investments
(677,063
)
 
(1,017,147
)
Proceeds from sales of fixed maturity investments
15,632,482

 
16,090,543

Proceeds from sales of equity securities
176,701

 
622,068

Proceeds from sales, redemptions and maturities of other investments
534,698

 
773,298

Proceeds from redemptions and maturities of fixed maturity investments
244,949

 
511,448

Net settlements of derivative instruments
87,701

 
4,498

Net sales of short-term investments
201,520

 
451,901

Change in cash collateral related to securities lending
7,590

 
176,304

Purchases of fixed assets
(16,359
)
 
(13,242
)
Other
(174,578
)
 
49,961

Net cash provided by (used for) investing activities
(746,944
)
 
102,399

Financing Activities
 

 
 

Redemption of preferred shares
—

 
(92,555
)
Purchases of common shares under share repurchase program
(2,871
)
 
(173,575
)
Proceeds from common shares issued, net
(557
)
 
(13,851
)
Proceeds from borrowings
62,800

 
130,579

Repayments of borrowings
(27,538
)
 
(373,000
)
Change in cash collateral related to securities lending
(7,590
)
 
(176,304
)
Dividends paid to redeemable noncontrolling interests
(8,994
)
 
(8,994
)
Other
(3,529
)
 
(4,489
)
Preferred dividends paid
(20,806
)
 
(20,840
)
Net cash provided by (used for) financing activities
(9,085
)
 
(733,029
)
 
 
 
 
Effects of exchange rate changes on foreign currency cash and restricted cash
1,937

 
(10,431
)
 
 
 
 
Increase (decrease) in cash and restricted cash
(41,568
)
 
(144,175
)
Cash and restricted cash, beginning of year
724,643

 
727,284

Cash and restricted cash, end of period
$
683,075

 
$
583,109




See Notes to Consolidated Financial Statements

ARCH CAPITAL
10
2019 SECOND QUARTER FORM 10-Q
Table of Contents
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 
1.    Basis of Presentation and Recent Accounting Pronouncements
General
Arch Capital Group Ltd. (“Arch Capital”) is a Bermuda public limited liability company which provides insurance, reinsurance and mortgage insurance on a worldwide basis through its wholly-owned subsidiaries. As used herein, the “Company” means Arch Capital and its subsidiaries. The Company’s consolidated financial statements include the results of Watford Holdings Ltd. and its wholly owned subsidiaries. See note 11.
On January 1, 2019, the Company’s U.K. insurance operations entered into a transaction with The Ardonagh Group to acquire renewal rights for a U.K. commercial lines book of business, consisting of commercial property, casualty, motor, professional liability, personal accident and travel business.
Basis of Presentation
The interim consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”). All significant intercompany transactions and balances have been eliminated in consolidation. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from those estimates and assumptions. In the opinion of management, the accompanying unaudited interim consolidated financial statements reflect all adjustments (consisting of normally recurring accruals) necessary for a fair statement of results on an interim basis. The results of any interim period are not necessarily indicative of the results for a full year or any future periods.
Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted; however, management believes that the disclosures are adequate to make the information presented not misleading. This report should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2018 (“2018 Form 10-K”), including the Company’s audited consolidated financial statements and related notes.
The Company has reclassified the presentation of certain prior year information to conform to the current presentation. Such reclassifications had no effect on the Company’s net income, comprehensive income, shareholders’ equity or cash flows.
 
Tabular amounts are in U.S. Dollars in thousands, except share amounts, unless otherwise noted.
Recent Accounting Pronouncements
Recently Issued Accounting Standards Adopted
The Company adopted ASU 2016-02, “Leases (Topic 842)”, which provides a new comprehensive model for lease accounting. Topic 842 requires a lessee to recognize a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. The Company adopted the modified retrospective approach of this standard, that resulted in the recognition of a right-of-use asset of  $147.9 million as part of other assets and a lease liability of $163.6 million as part of other liabilities in the consolidated balance sheet as of January 1, 2019. The Company de-recognized the liability for deferred rent that was required under the previous guidance.
In addition, the Company adopted ASU 2018-11, “Leases: Targeted Improvements (Topic 842),” which provides an additional (optional) transition method to adopt the new lease standard. The Company adopted the alternative transition method and elected to utilize a cumulative-effect adjustment to the opening balance of the retained earnings for the year of adoption. As such, the Company’s reporting for the comparative periods prior to the adoption continue to be presented in the financial statements in accordance with previous lease accounting guidance. The Company also adopted the practical expedients as a package which allows the Company to not reassess (1) whether any expired or existing contracts are or contain leases (2) the lease classification for any expired or existing leases (3) initial direct costs for any existing leases and (4) to account for the lease and non lease components as a single lease component. In addition to electing the practical expedients as a package, the Company elected to include hindsight to determine the lease term of existing leases, and made an accounting policy election to not apply the recognition requirements to short-term leases (lease term of less than twelve months). The cumulative effect adjustment to the opening balance of retained earnings was zero. The adoption of the updated guidance did not have a material effect on the Company’s results of operations or liquidity.
The Company adopted ASU 2018-07 “Improvements to Nonemployee Share-Based Payment Accounting,” which was issued in June 2018 to simplify the accounting for share-based payments granted to nonemployees for goods and services. Under this ASU, most of the guidance on such payments to nonemployees would be aligned with the requirements for share-based payments granted to employees. The ASU is effective for reporting periods beginning after December 15, 2018. This guidance and the adoption of this provision did not have a material effect on the Company's financial position, results of operations or cash flows.


ARCH CAPITAL
 11
2019 SECOND QUARTER FORM 10-Q
Table of Contents
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The Company adopted ASU 2018-02 “Income Statement-Reporting Comprehensive Income (Topic 220) - Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income,” which was issued in February 2018 to allow the reclassification of the stranded tax effects in accumulated other comprehensive income (“AOCI”) resulting from the Tax Cuts and Jobs Act of 2017 (“Tax Cuts Act”). Current guidance requires the effect of a change in tax laws or rates on deferred tax balances to be reported in income from continuing operations in the accounting period that includes the period of enactment, even if the related income tax effects were originally charged or credited directly to AOCI. The amount of the reclassification would include the effect of the change in the U.S. federal corporate income tax rate on the gross deferred tax amounts and related valuation allowances, if any, at the date of the enactment of the Tax Cuts Act related to items in AOCI. The updated guidance is effective for reporting periods beginning after December 15, 2018 and is to be applied retrospectively to each period in which the effect of the Tax Cuts Act related to items remaining in AOCI are recognized or at the beginning of the period of adoption. The adoption of this ASU did not have a material effect on the Company’s results of operations, financial position or liquidity.

The Company adopted ASU 2017-08 “Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20), Premium Amortization on Purchased Callable Debt Securities,” which was issued in March, 2017. This ASU shortens the amortization period for certain callable debt securities held at a premium and requires the premium to be amortized to the earliest call date. However, the new guidance does not require an accounting change for securities held at a discount whose discount continues to be amortized to maturity. The standard is effective for financial statements issued for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018, with early adoption permitted. The adoption of the guidance requires a modified retrospective approach with a cumulative-effect adjustment to retained earnings. The adoption of this ASU did not have a material effect on the Company’s consolidated financial statements.

Recently Issued Accounting Standards Not Yet Adopted
For information regarding additional accounting standards that the Company has not yet adopted, see note 3(q), “Significant Accounting Policies—Recent Accounting Pronouncements,” of the notes to consolidated financial statements in the Company’s 2018 Form 10-K.
2.    Share Transactions
Share Repurchases 
The board of directors of Arch Capital has authorized the investment in Arch Capital’s common shares through a share
 
repurchase program. Since the inception of the share repurchase program, Arch Capital has repurchased 386.3 million common shares for an aggregate purchase price of $3.97 billion. For the six months ended June 30, 2019, Arch Capital repurchased 0.1 million shares under the share repurchase program with an aggregate purchase price of $2.9 million. Arch Capital repurchased 6.5 million shares under the share repurchase program with an aggregate purchase price of $173.6 million during the six months ended June 30, 2018. At June 30, 2019, $160.9 million of share repurchases were available under the program, which may be effected from time to time in open market or privately negotiated transactions through December 31, 2019. The timing and amount of the repurchase transactions under this program will depend on a variety of factors, including market conditions and corporate and regulatory considerations.
Conversion of Convertible Non-Voting Common Equivalent Preferred Shares  
In March 2018, Arch Capital completed an underwritten public secondary offering of 17.0 million common shares (split adjusted) by American International Group, Inc. (“AIG”) following transfer of 0.6 million Series D convertible non-voting common equivalent preferred shares (“Series D Preferred Shares”). Proceeds from the sale of common shares pursuant to the public offering were received by AIG. At June 30, 2019, no Series D Preferred Shares were outstanding.
Series C Preferred Shares
On January 2, 2018, Arch Capital redeemed all outstanding 6.75% Series C non-cumulative preferred shares. The preferred shares were redeemed at a redemption price equal to $25 per share, plus all declared and unpaid dividends to (but excluding) the redemption date. In accordance with GAAP, following the redemption, original issuance costs related to such shares were removed from additional paid-in capital and recorded as a “loss on redemption of preferred shares.” Such adjustment had no impact on total shareholders’ equity or cash flows.

ARCH CAPITAL
 12
2019 SECOND QUARTER FORM 10-Q
Table of Contents
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

3.    Earnings Per Common Share
The following table sets forth the computation of basic and diluted earnings per common share:
 
Three Months Ended

Six Months Ended
 
June 30,
 
June 30,
 
2019
 
2018
 
2019
 
2018
Numerator:
 
 
 
 
 
 
 
Net income
$
485,845

 
$
256,347

 
$
981,343

 
$
422,731

Amounts attributable to noncontrolling interests
(16,891
)
 
(12,701
)
 
(63,861
)
 
(28,662
)
Net income available to Arch
468,954

 
243,646

 
917,482

 
394,069

Preferred dividends
(10,403
)
 
(10,403
)
 
(20,806
)
 
(20,840
)
Loss on redemption of preferred shares
—

 
—

 
—

 
(2,710
)
Net income available to Arch common shareholders
$
458,551

 
$
233,243

 
$
896,676

 
$
370,519

 
 
 
 
 
 
 
 
Denominator:
 
 
 
 
 
 
 
Weighted average common shares outstanding
401,482,784

 
404,800,421

 
400,837,181

 
399,485,135

Series D preferred shares (1)
—

 
—

 
—

 
6,677,373

Weighted average common shares and common share equivalents outstanding — basic
401,482,784

 
404,800,421

 
400,837,181

 
406,162,508

Effect of dilutive common share equivalents:
 
 
 
 
 
 
 
Nonvested restricted shares
1,937,626

 
1,575,749

 
1,720,417

 
1,837,356

Stock options (2)
7,479,073

 
6,735,035

 
7,197,652

 
7,460,892

Weighted average common shares and common share equivalents outstanding — diluted
410,899,483

 
413,111,205

 
409,755,250

 
415,460,756

 
 
 
 
 
 
 
 
Earnings per common share:
 
 
 
 
 
 
 
Basic
$
1.14

 
$
0.58

 
$
2.24

 
$
0.91

Diluted
$
1.12

 
$
0.56

 
$
2.19

 
$
0.89

(1)
Such shares are convertible non-voting common equivalent preferred shares issued in connection with the UGC acquisition. See note 2.
(2)
Certain stock options were not included in the computation of diluted earnings per share where the exercise price of the stock options exceeded the average market price and would have been anti-dilutive or where, when applying the treasury stock method to in-the-money options, the sum of the proceeds, including unrecognized compensation, exceeded the average market price and would have been anti-dilutive. For the 2019 second quarter and 2018 second quarter, the number of stock options excluded were 2,016,830 and 5,350,733, respectively. For the six months ended June 30, 2019 and 2018 period, the number of stock options excluded were 2,560,755 and 5,372,789, respectively.

ARCH CAPITAL
 13
2019 SECOND QUARTER FORM 10-Q
Table of Contents
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

4.    Segment Information
The Company classifies its businesses into three underwriting segments — insurance, reinsurance and mortgage — and two other operating segments — ‘other’ and corporate (non-underwriting). The Company determined its reportable segments using the management approach described in accounting guidance regarding disclosures about segments of an enterprise and related information. The accounting policies of the segments are the same as those used for the preparation of the Company’s consolidated financial statements. Intersegment business is allocated to the segment accountable for the underwriting results.
The Company’s insurance, reinsurance and mortgage segments each have managers who are responsible for the overall profitability of their respective segments and who are directly accountable to the Company’s chief operating decision makers, the President and Chief Executive Officer of Arch Capital, and the Chief Financial Officer of Arch Capital. The chief operating decision makers do not assess performance, measure return on equity or make resource allocation decisions on a line of business basis. Management measures segment performance for its three underwriting segments based on underwriting income or loss. The Company does not manage its assets by underwriting segment, with the exception of goodwill and intangible assets, and, accordingly, investment income is not allocated to each underwriting segment.
The insurance segment consists of the Company’s insurance underwriting units which offer specialty product lines on a worldwide basis. Product lines include: construction and national accounts; excess and surplus casualty; lenders products; professional lines; programs; property, energy, marine and aviation; travel, accident and health; and other (consisting of alternative markets, excess workers' compensation and surety business).
The reinsurance segment consists of the Company’s reinsurance underwriting units which offer specialty product lines on a worldwide basis. Product lines include: casualty; marine and aviation; other specialty; property catastrophe; property excluding property catastrophe (losses on a single risk, both excess of loss and pro rata); and other (consisting of life reinsurance, casualty clash and other).
The mortgage segment includes the Company’s U.S. and international mortgage insurance and reinsurance operations as well as government sponsored enterprise (“GSE”) credit-risk sharing transactions. Arch Mortgage Insurance Company and United Guaranty Residential Insurance Company (combined “Arch MI U.S.”) are approved as eligible mortgage insurers by Federal National Mortgage Association (“Fannie Mae”) and Federal Home Loan Mortgage Corporation (“Freddie Mac”), each a GSE.
The corporate (non-underwriting) segment results include net investment income, other income (loss), corporate expenses, transaction costs and other, interest expense, items related to the Company’s non-cumulative preferred shares, net realized gains or losses, net impairment losses included in earnings, equity in net income or loss of investment funds accounted for using the equity method, net foreign exchange gains or losses and income taxes. Such amounts exclude the results of the ‘other’ segment.
The ‘other’ segment includes the results of Watford Holdings Ltd. Watford Holdings Ltd. is the parent of Watford Re Ltd., a multi-line Bermuda reinsurance company (together with Watford Holdings Ltd., “Watford Re”) (see note 11). Watford Re has its own management and board of directors that is responsible for the overall profitability of the ‘other’ segment. For the ‘other’ segment, performance is measured based on net income or loss.

ARCH CAPITAL
 14
2019 SECOND QUARTER FORM 10-Q
Table of Contents
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following tables summarize the Company’s underwriting income or loss by segment, together with a reconciliation of underwriting income or loss to net income available to Arch common shareholders:
 
Three Months Ended
 
June 30, 2019
 
Insurance
 
Reinsurance
 
Mortgage
 
Sub-Total
 
Other
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
Gross premiums written (1)
$
919,925

 
$
545,547

 
$
364,465

 
$
1,829,829

 
$
161,978

 
$
1,937,809

Premiums ceded
(292,095
)
 
(169,457
)
 
(42,857
)
 
(504,301
)
 
(42,608
)
 
(492,911
)
Net premiums written
627,830

 
376,090

 
321,608

 
1,325,528

 
119,370

 
1,444,898

Change in unearned premiums
(35,388
)
 
(8,906
)
 
31,175

 
(13,119
)
 
31,948

 
18,829

Net premiums earned
592,442

 
367,184

 
352,783

 
1,312,409

 
151,318

 
1,463,727

Other underwriting income (loss)
—

 
1,224

 
4,056

 
5,280

 
673

 
5,953

Losses and loss adjustment expenses
(389,172
)
 
(240,958
)
 
(25,997
)
 
(656,127
)
 
(111,416
)
 
(767,543
)
Acquisition expenses
(91,094
)
 
(56,785
)
 
(32,654
)
 
(180,533
)
 
(29,556
)
 
(210,089
)
Other operating expenses
(109,523
)
 
(33,960
)
 
(39,819
)
 
(183,302
)
 
(15,612
)
 
(198,914
)
Underwriting income (loss)
$
2,653

 
$
36,705

 
$
258,369

 
297,727

 
(4,593
)
 
293,134

 
 
 
 
 
 
 
 
 
 
 
 
Net investment income
 
 
 
 
 
 
123,038

 
32,000

 
155,038

Net realized gains (losses)
 
 
 
 
 
 
125,112

 
(4,306
)
 
120,806

Net impairment losses recognized in earnings
 
 
 
 
 
 
(49
)
 
—

 
(49
)
Equity in net income (loss) of investment funds accounted for using the equity method
 
 
 
 
 
 
32,536

 
—

 
32,536

Other income (loss)
 
 
 
 
 
 
1,129

 
—

 
1,129

Corporate expenses (2)
 
 
 
 
 
 
(16,073
)
 
—

 
(16,073
)
Transaction costs and other (2)
 
 
 
 
 
 
(2,178
)
 
—

 
(2,178
)
Amortization of intangible assets
 
 
 
 
 
 
(19,794
)
 
—

 
(19,794
)
Interest expense
 
 
 
 
 
 
(23,375
)
 
(5,905
)
 
(29,280
)
Net foreign exchange gains (losses)
 
 
 
 
 
 
(6,190
)
 
1,238

 
(4,952
)
Income before income taxes
 
 
 
 
 
 
511,883

 
18,434

 
530,317

Income tax expense
 
 
 
 
 
 
(44,452
)
 
(20
)
 
(44,472
)
Net income
 
 
 
 
 
 
467,431

 
18,414

 
485,845

Dividends attributable to redeemable noncontrolling interests
 
 
 
 
 
 
—

 
(4,590
)
 
(4,590
)
Amounts attributable to nonredeemable noncontrolling interests
 
 
 
 
 
 
—

 
(12,301
)
 
(12,301
)
Net income available to Arch
 
 
 
 
 
 
467,431

 
1,523

 
468,954

Preferred dividends
 
 
 
 
 
 
(10,403
)
 
—

 
(10,403
)
Net income available to Arch common shareholders
 
 
 
 
 
 
$
457,028

 
$
1,523

 
$
458,551

 
 
 
 
 
 
 
 
 
 
 
 
Underwriting Ratios
 

 
 

 
 

 
 
 
 

 
 

Loss ratio
65.7
%
 
65.6
%
 
7.4
%
 
50.0
%
 
73.6
%
 
52.4
%
Acquisition expense ratio
15.4
%
 
15.5
%
 
9.3
%
 
13.8
%
 
19.5
%
 
14.4
%
Other operating expense ratio
18.5
%
 
9.2
%
 
11.3
%
 
14.0
%
 
10.3
%
 
13.6
%
Combined ratio
99.6
%
 
90.3
%
 
28.0
%
 
77.8
%
 
103.4
%
 
80.4
%
 
 
 
 
 
 
 
 
 
 
 
 
Goodwill and intangible assets
$
157,440

 
$
—

 
$
475,920

 
$
633,360

 
$
7,650

 
$
641,010


(1)
Certain amounts included in the gross premiums written of each segment are related to intersegment transactions. Accordingly, the sum of gross premiums written for each segment does not agree to the total gross premiums written as shown in the table above due to the elimination of intersegment transactions in the total.
(2)
Certain expenses have been excluded from ‘corporate expenses’ and reflected in ‘transaction costs and other.’


ARCH CAPITAL
 15
2019 SECOND QUARTER FORM 10-Q
Table of Contents
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 
Three Months Ended
 
June 30, 2018
 
Insurance
 
Reinsurance
 
Mortgage
 
Sub-Total
 
Other
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
Gross premiums written (1)
$
769,372

 
$
490,327

 
$
330,990

 
$
1,591,202

 
$
175,175

 
$
1,696,544

Premiums ceded
(245,265
)
 
(136,247
)
 
(50,867
)
 
(432,892
)
 
(34,589
)
 
(397,648
)
Net premiums written
524,107

 
354,080

 
280,123

 
1,158,310

 
140,586

 
1,298,896

Change in unearned premiums
22,342

 
(13,762
)
 
10,355

 
18,935

 
18,932

 
37,867

Net premiums earned
546,449

 
340,318

 
290,478

 
1,177,245

 
159,518

 
1,336,763

Other underwriting income (loss)
—

 
(129
)
 
3,315

 
3,186

 
688

 
3,874

Losses and loss adjustment expenses
(357,465
)
 
(229,956
)
 
(21,591
)
 
(609,012
)
 
(117,141
)
 
(726,153
)
Acquisition expenses
(90,670
)
 
(50,142
)
 
(27,737
)
 
(168,549
)
 
(34,289
)
 
(202,838
)
Other operating expenses
(92,680
)
 
(35,678
)
 
(38,729
)
 
(167,087
)
 
(9,094
)
 
(176,181
)
Underwriting income (loss)
$
5,634

 
$
24,413

 
$
205,736

 
235,783

 
(318
)
 
235,465

 
 
 
 
 
 
 
 
 
 
 
 
Net investment income
 
 
 
 
 
 
107,761

 
27,907

 
135,668

Net realized gains (losses)
 
 
 
 
 
 
(59,545
)
 
(17,066
)
 
(76,611
)
Net impairment losses recognized in earnings
 
 
 
 
 
 
(470
)
 
—

 
(470
)
Equity in net income (loss) of investment funds accounted for using the equity method
 
 
 
 
 
 
8,472

 
—

 
8,472

Other income (loss)
 
 
 
 
 
 
3,113

 
—

 
3,113

Corporate expenses (2)
 
 
 
 
 
 
(15,604
)
 
—

 
(15,604
)
Transaction costs and other (2)
 
 
 
 
 
 
(6,908
)
 
—

 
(6,908
)
Amortization of intangible assets
 
 
 
 
 
 
(26,472
)
 
—

 
(26,472
)
Interest expense
 
 
 
 
 
 
(26,058
)
 
(4,286
)
 
(30,344
)
Net foreign exchange gains (losses)
 
 
 
 
 
 
46,211

 
7,495

 
53,706

Income before income taxes
 
 
 
 
 
 
266,283

 
13,732

 
280,015

Income tax expense
 
 
 
 
 
 
(23,644
)
 
(24
)
 
(23,668
)
Net income
 
 
 
 
 
 
242,639

 
13,708

 
256,347

Dividends attributable to redeemable noncontrolling interests
 
 
 
 
 
 
—

 
(4,585
)
 
(4,585
)
Amounts attributable to nonredeemable noncontrolling interests
 
 
 
 
 
 
—

 
(8,116
)
 
(8,116
)
Net income available to Arch
 
 
 
 
 
 
242,639

 
1,007

 
243,646

Preferred dividends
 
 
 
 
 
 
(10,403
)
 
—

 
(10,403
)
Net income available to Arch common shareholders
 
 
 
 
 
 
$
232,236

 
$
1,007

 
$
233,243

 
 
 
 
 
 
 
 
 
 
 
 
Underwriting Ratios
 

 
 

 
 

 
 
 
 

 
 

Loss ratio
65.4
%
 
67.6
%
 
7.4
%
 
51.7
%
 
73.4
%
 
54.3
%
Acquisition expense ratio
16.6
%
 
14.7
%
 
9.5
%
 
14.3
%
 
21.5
%
 
15.2
%
Other operating expense ratio
17.0
%
 
10.5
%
 
13.3
%
 
14.2
%
 
5.7
%
 
13.2
%
Combined ratio
99.0
%
 
92.8
%
 
30.2
%
 
80.2
%
 
100.6
%
 
82.7
%
 
 
 
 
 
 
 
 
 
 
 
 
Goodwill and intangible assets
$
20,724

 
$
—

 
$
564,634

 
$
585,358

 
$
7,650

 
$
593,008


(1)
Certain amounts included in the gross premiums written of each segment are related to intersegment transactions. Accordingly, the sum of gross premiums written for each segment does not agree to the total gross premiums written as shown in the table above due to the elimination of intersegment transactions in the total.
(2)
Certain expenses have been excluded from ‘corporate expenses’ and reflected in ‘transaction costs and other.’


The following tables summarize the Company’s underwriting income or loss by segment, together with a reconciliation of underwriting income or loss to net income available to Arch common shareholders:

ARCH CAPITAL
 16
2019 SECOND QUARTER FORM 10-Q
Table of Contents
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 
Six Months Ended
 
June 30, 2019
 
Insurance
 
Reinsurance
 
Mortgage
 
Sub-Total
 
Other
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
Gross premiums written (1)
$
1,861,879

 
$
1,228,402

 
$
720,515

 
$
3,810,282

 
$
348,667

 
$
4,015,688

Premiums ceded
(612,717
)
 
(401,024
)
 
(91,655
)
 
(1,104,882
)
 
(83,910
)
 
(1,045,531
)
Net premiums written
1,249,162

 
827,378

 
628,860

 
2,705,400

 
264,757

 
2,970,157

Change in unearned premiums
(103,215
)
 
(113,829
)
 
46,825

 
(170,219
)
 
32,655

 
(137,564
)
Net premiums earned
1,145,947

 
713,549

 
675,685

 
2,535,181

 
297,412

 
2,832,593

Other underwriting income (loss)
—

 
5,601

 
7,912

 
13,513

 
1,265

 
14,778

Losses and loss adjustment expenses
(745,895
)
 
(480,768
)
 
(37,146
)
 
(1,263,809
)
 
(222,266
)
 
(1,486,075
)
Acquisition expenses
(173,918
)
 
(111,111
)
 
(64,326
)
 
(349,355
)
 
(58,582
)
 
(407,937
)
Other operating expenses
(222,919
)
 
(69,664
)
 
(79,694
)
 
(372,277
)
 
(27,800
)
 
(400,077
)
Underwriting income (loss)
$
3,215

 
$
57,607

 
$
502,431

 
563,253

 
(9,971
)
 
553,282

 
 
 
 
 
 
 
 
 
 
 
 
Net investment income
 
 
 
 
 
 
244,287

 
67,700

 
311,987

Net realized gains (losses)
 
 
 
 
 
 
237,545

 
24,826

 
262,371

Net impairment losses recognized in earnings
 
 
 
 
 
 
(1,358
)
 
—

 
(1,358
)
Equity in net income (loss) of investment funds accounted for using the equity method
 
 
 
 
 
 
79,403

 
—

 
79,403

Other income (loss)
 
 
 
 
 
 
2,212

 
—

 
2,212

Corporate expenses (2)
 
 
 
 
 
 
(32,845
)
 
—

 
(32,845
)
Transaction costs and other (2)
 
 
 
 
 
 
(3,368
)
 
—

 
(3,368
)
Amortization of intangible assets
 
 
 
 
 
 
(40,211
)
 
—

 
(40,211
)
Interest expense
 
 
 
 
 
 
(46,857
)
 
(11,488
)
 
(58,345
)
Net foreign exchange gains (losses)
 
 
 
 
 
 
(1,015
)
 
(412
)
 
(1,427
)
Income before income taxes
 
 
 
 
 
 
1,001,046

 
70,655

 
1,071,701

Income tax expense
 
 
 
 
 
 
(90,338
)
 
(20
)
 
(90,358
)
Net income
 
 
 
 
 
 
910,708

 
70,635

 
981,343

Dividends attributable to redeemable noncontrolling interests
 
 
 
 
 
 
—

 
(9,178
)
 
(9,178
)
Amounts attributable to nonredeemable noncontrolling interests
 
 
 
 
 
 
—

 
(54,683
)
 
(54,683
)
Net income available to Arch
 
 
 
 
 
 
910,708

 
6,774

 
917,482

Preferred dividends
 
 
 
 
 
 
(20,806
)
 
—

 
(20,806
)
Net income available to Arch common shareholders
 
 
 
 
 
 
$
889,902

 
$
6,774

 
$
896,676

 
 
 
 
 
 
 
 
 
 
 
 
Underwriting Ratios
 

 
 

 
 

 
 
 
 

 
 

Loss ratio
65.1
%
 
67.4
%
 
5.5
%
 
49.9
%
 
74.7
%
 
52.5
%
Acquisition expense ratio
15.2
%
 
15.6
%
 
9.5
%
 
13.8
%
 
19.7
%
 
14.4
%
Other operating expense ratio
19.5
%
 
9.8
%
 
11.8
%
 
14.7
%
 
9.3
%
 
14.1
%
Combined ratio
99.8
%
 
92.8
%
 
26.8
%
 
78.4
%
 
103.7
%
 
81.0
%
(1)
Certain amounts included in the gross premiums written of each segment are related to intersegment transactions. Accordingly, the sum of gross premiums written for each segment does not agree to the total gross premiums written as shown in the table above due to the elimination of intersegment transactions in the total.
(2)
Certain expenses have been excluded from ‘corporate expenses’ and reflected in ‘transaction costs and other.’


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 17
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Table of Contents
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 
Six Months Ended
 
June 30, 2018
 
Insurance
 
Reinsurance
 
Mortgage
 
Sub-Total
 
Other
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
Gross premiums written (1)
$
1,592,750

 
$
1,067,810

 
$
652,168

 
$
3,312,807

 
$
389,045

 
$
3,534,758

Premiums ceded
(492,445
)
 
(331,977
)
 
(97,004
)
 
(921,505
)
 
(68,907
)
 
(823,318
)
Net premiums written
1,100,305

 
735,833

 
555,164

 
2,391,302

 
320,138

 
2,711,440

Change in unearned premiums
(15,119
)
 
(116,343
)
 
15,556

 
(115,906
)
 
(23,872
)
 
(139,778
)
Net premiums earned
1,085,186

 
619,490

 
570,720

 
2,275,396

 
296,266

 
2,571,662

Other underwriting income (loss)
—

 
1,103

 
6,731

 
7,834

 
1,389

 
9,223

Losses and loss adjustment expenses
(711,195
)
 
(371,631
)
 
(65,057
)
 
(1,147,883
)
 
(215,130
)
 
(1,363,013
)
Acquisition expenses
(175,839
)
 
(98,461
)
 
(54,304
)
 
(328,604
)
 
(65,610
)
 
(394,214
)
Other operating expenses
(184,654
)
 
(71,249
)
 
(77,500
)
 
(333,403
)
 
(17,793
)
 
(351,196
)
Underwriting income (loss)
$
13,498

 
$
79,252

 
$
380,590

 
473,340

 
(878
)
 
472,462

 
 
 
 
 
 
 
 
 
 
 
 
Net investment income
 
 
 
 
 
 
208,004

 
54,388

 
262,392

Net realized gains (losses)
 
 
 
 
 
 
(171,404
)
 
(16,205
)
 
(187,609
)
Net impairment losses recognized in earnings
 
 
 
 
 
 
(632
)
 
—

 
(632
)
Equity in net income (loss) of investment funds accounted for using the equity method
 
 
 
 
 
 
36,541

 
—

 
36,541

Other income (loss)
 
 
 
 
 
 
3,187

 
—

 
3,187

Corporate expenses (2)
 
 
 
 
 
 
(30,086
)
 
—

 
(30,086
)
Transaction costs and other (2)
 
 
 
 
 
 
(7,738
)
 
—

 
(7,738
)
Amortization of intangible assets
 
 
 
 
 
 
(53,208
)
 
—

 
(53,208
)
Interest expense
 
 
 
 
 
 
(51,965
)
 
(9,015
)
 
(60,980
)
Net foreign exchange gains (losses)
 
 
 
 
 
 
31,172

 
2,813

 
33,985

Income before income taxes
 
 
 
 
 
 
437,211

 
31,103

 
468,314

Income tax expense
 
 
 
 
 
 
(45,556
)
 
(27
)
 
(45,583
)
Net income
 
 
 
 
 
 
391,655

 
31,076

 
422,731

Dividends attributable to redeemable noncontrolling interests
 
 
 
 
 
 
—

 
(9,170
)
 
(9,170
)
Amounts attributable to nonredeemable noncontrolling interests
 
 
 
 
 
 
—

 
(19,492
)
 
(19,492
)
Net income available to Arch
 
 
 
 
 
 
391,655

 
2,414

 
394,069

Preferred dividends
 
 
 
 
 
 
(20,840
)
 
—

 
(20,840
)
Loss on redemption of preferred shares
 
 
 
 
 
 
(2,710
)
 
—

 
(2,710
)
Net income available to Arch common shareholders
 
 
 
 
 
 
$
368,105

 
$
2,414

 
$
370,519

 
 
 
 
 
 
 
 
 
 
 
 
Underwriting Ratios
 

 
 

 
 

 
 
 
 

 
 

Loss ratio
65.5
%
 
60.0
%
 
11.4
%
 
50.4
%
 
72.6
%
 
53.0
%
Acquisition expense ratio
16.2
%
 
15.9
%
 
9.5
%
 
14.4
%
 
22.1
%
 
15.3
%
Other operating expense ratio
17.0
%
 
11.5
%
 
13.6
%
 
14.7
%
 
6.0
%
 
13.7
%
Combined ratio
98.7
%
 
87.4
%
 
34.5
%
 
79.5
%
 
100.7
%
 
82.0
%

(1)
Certain amounts included in the gross premiums written of each segment are related to intersegment transactions. Accordingly, the sum of gross premiums written for each segment does not agree to the total gross premiums written as shown in the table above due to the elimination of intersegment transactions in the total.
(2)
Certain expenses have been excluded from ‘corporate expenses’ and reflected in ‘transaction costs and other.’




ARCH CAPITAL
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Table of Contents
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

5.    Reserve for Losses and Loss Adjustment Expenses
The following table represents an analysis of losses and loss adjustment expenses and a reconciliation of the beginning and ending reserve for losses and loss adjustment expenses:
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2019
 
2018
 
2019
 
2018
Reserve for losses and loss adjustment expenses at beginning of period
$
12,010,041

 
$
11,496,205

 
$
11,853,297

 
$
11,383,792

Unpaid losses and loss adjustment expenses recoverable
2,970,159

 
2,446,990

 
2,814,291

 
2,464,910

Net reserve for losses and loss adjustment expenses at beginning of period
9,039,882

 
9,049,215

 
9,039,006

 
8,918,882

 
 
 
 
 
 
 
 
Net incurred losses and loss adjustment expenses relating to losses occurring in:
 
 
 
 
 
 
 
Current year
805,728

 
790,742

 
1,563,692

 
1,478,627

Prior years
(38,185
)
 
(64,589
)
 
(77,617
)
 
(115,614
)
Total net incurred losses and loss adjustment expenses
767,543

 
726,153

 
1,486,075

 
1,363,013

 
 
 
 
 
 
 
 
Retroactive reinsurance transactions (1)
—

 
(420,404
)
 
(225,500
)
 
(420,404
)
 
 
 
 
 
 
 
 
Net foreign exchange (gains) losses
(1,277
)
 
(120,292
)
 
(1,781
)
 
(76,278
)
 
 
 
 
 
 
 
 
Net paid losses and loss adjustment expenses relating to losses occurring in:
 
 
 
 
 
 
 
Current year
(61,148
)
 
(59,022
)
 
(125,488
)
 
(95,022
)
Prior years
(539,481
)
 
(403,062
)
 
(966,793
)
 
(917,603
)
Total net paid losses and loss adjustment expenses
(600,629
)
 
(462,084
)
 
(1,092,281
)
 
(1,012,625
)
 
 
 
 
 
 
 
 
Net reserve for losses and loss adjustment expenses at end of period
9,205,519

 
8,772,588

 
9,205,519

 
8,772,588

Unpaid losses and loss adjustment expenses recoverable
3,024,797

 
2,651,749

 
3,024,797

 
2,651,749

Reserve for losses and loss adjustment expenses at end of period
$
12,230,316

 
$
11,424,337

 
$
12,230,316

 
$
11,424,337


(1)
During the 2019 first quarter and 2018 second quarter, a subsidiary of the Company entered into two separate retroactive reinsurance transactions with third party reinsurers to reinsure run-off liabilities associated with certain U.S. exposures.
Development on Prior Year Loss Reserves

2019 Second Quarter

During the 2019 second quarter, the Company recorded net favorable development on prior year loss reserves of $38.2 million, which consisted of $2.6 million of favorable development from the insurance segment, $12.7 million from the reinsurance segment, $22.8 million from the mortgage segment and $0.1 million from the ‘other’ segment.
The insurance segment’s net favorable development of $2.6 million, or 0.4 loss ratio points, for the 2019 second quarter consisted of $8.0 million of net favorable development in short-tailed lines, $10.4 million of net adverse development in medium-tailed lines and $4.9 million of net favorable development in long-tailed lines. Net favorable development in short-tailed lines primarily resulted from property (including special risk other than marine) reserves across all accident years (i.e., the year in which a loss occurred). Net adverse development in medium-tailed lines primarily resulted from $15.5 million of adverse development on program business. Such amounts were partially offset by $5.1 million of net favorable development in other medium-tailed lines, including
 
surety business and professional liability, across most accident years. Net favorable development in long-tailed lines primarily resulted from reductions in executive assurance reserves of $5.1 million, primarily from the 2008 to 2014 accident years.
The reinsurance segment’s net favorable development of $12.7 million, or 3.5 loss ratio points, for the 2019 second quarter consisted of $1.8 million of net favorable development from short-tailed lines and $10.9 million of net favorable development from long-tailed and medium-tailed lines. Net favorable development in short-tailed lines primarily resulted from other specialty lines across most underwriting years (i.e., all premiums and losses attributable to contracts having an inception or renewal date within the given twelve-month period) and in property other than property catastrophe reserves from earlier underwriting years, partially offset by a small amount of adverse development from property catastrophe and property other than property catastrophe reserves in the 2015 and 2018 underwriting years. Favorable development in long-tailed and medium-tailed lines reflected reductions in casualty and marine reserves from most underwriting years.
The mortgage segment’s net favorable development was $22.8 million, or 6.5 loss ratio points, for the 2019 second quarter. The 2019 second quarter development was primarily driven by

ARCH CAPITAL
 19
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Table of Contents
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

continued favorable claim rates on first lien business and subrogation recoveries on second lien business.
2018 Second Quarter
During the 2018 second quarter, the Company recorded net favorable development on prior year loss reserves of $64.6 million, which consisted of $6.1 million from the insurance segment, $33.0 million from the reinsurance segment, $23.3 million from the mortgage segment and adverse development of $2.2 million from the ‘other’ segment.
The insurance segment’s net favorable development of $6.1 million, or 1.1 loss ratio points, for the 2018 second quarter consisted of $13.9 million of net favorable development in short-tailed lines and $14.3 million of net favorable development in long-tailed lines, partially offset by $22.1 million of net adverse development in medium-tailed lines. Net favorable development in short-tailed lines primarily resulted from property (including special risk other than marine) reserves from the 2010 to 2017 accident years while net favorable development in long-tailed lines primarily resulted from reductions in executive assurance reserves of $6.9 million, primarily from the 2007 to 2011 accident years, and in healthcare reserves of $4.9 million, primarily from the 2003 accident year. Net adverse development in medium-tailed lines reflected $11.6 million of adverse development in program business, primarily driven by a few inactive programs that were non-renewed in 2015 and early in 2016 and $18.0 million of adverse development on contract binding business, primarily from the 2014 to 2016 accident years. Such amounts were partially offset by $7.6 million of net favorable development in other medium-tailed lines, including professional liability and surety business, across most accident years.
The reinsurance segment’s net favorable development of $33.0 million, or 9.7 loss ratio points, for the 2018 second quarter consisted of $22.2 million from short-tailed lines and $10.8 million from long-tailed and medium-tailed lines. Favorable development in short-tailed lines included $19.3 million from property catastrophe and property other than property catastrophe reserves, across most underwriting years, reflecting lower levels of reported and paid claims activity than previously anticipated which led to decreases in certain loss ratio selections during the period. Favorable development in long-tailed and medium-tailed lines reflected reductions in marine reserves of $3.8 million, across most accident years, and in casualty reserves of $6.9 million based on varying levels of reported and paid claims activity, primarily from the 2003 to 2010 underwriting years.
The mortgage segment’s net favorable development was $23.3 million, or 8.0 loss ratio points, for the 2018 second quarter. The 2018 second quarter development was primarily driven by continued lower than expected claim rates on first lien business and subrogation recoveries on second lien business.
 
Six Months Ended June 30, 2019
During the six months ended June 30, 2019, the Company recorded net favorable development on prior year loss reserves of $77.6 million, which consisted of $7.0 million from the insurance segment, $11.0 million from the reinsurance segment, $59.4 million from the mortgage segment and $0.1 million from the ‘other’ segment.
The insurance segment’s net favorable development of $7.0 million, or 0.6 loss ratio points, for the 2019 period consisted of $17.7 million of net favorable development in short-tailed lines and $6.6 million of net favorable development in long-tailed lines, partially offset by $17.3 million of net adverse development in medium-tailed lines. Net favorable development in short-tailed lines primarily resulted from property (including special risk other than marine) reserves from the 2010 to 2018 accident years. Net favorable development in long-tailed lines reflected net reductions in executive assurance reserves of $5.7 million, primarily from the 2013 and 2015 accident years. Net adverse development in medium-tailed lines reflected $23.2 million of adverse development in program business, primarily from the 2018 accident year, and $9.7 million of adverse development on contract binding business, across most accident years. Such amounts were partially offset by $15.6 million of net favorable development in other medium-tailed lines, including professional liability, marine and surety business, across most accident years.
The reinsurance segment’s net favorable development of $11.0 million, or 1.5 loss ratio points, for the 2019 period consisted of $4.3 million of net adverse development from short-tailed lines, offset by $15.3 million of net favorable development from long-tailed and medium-tailed lines. Net adverse development in short-tailed lines reflected $17.9 million from property catastrophe and property other than property catastrophe reserves, reflecting an increase in reserves on Typhoon Jebi in the 2019 first quarter of $16.0 million following receipt of updated information from cedents and additional updated industry data. Such amounts were partially offset by $10.2 million of favorable development on other specialty lines, primarily from the 2016 to 2018 underwriting years. Favorable development in long-tailed and medium-tailed lines reflected reductions in casualty reserves of $9.1 million based on varying levels of reported and paid claims activity, primarily from the 2002 to 2007 underwriting years, and favorable development in marine reserves of $6.2 million, primarily from the 2015 to 2018 underwriting years.
The mortgage segment’s net favorable development was $59.4 million, or 8.8 loss ratio points, for the 2019 period. The 2019 development was primarily driven by continued lower than expected claim rates on first lien business and subrogation recoveries on second lien business.

ARCH CAPITAL
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Table of Contents
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Six Months Ended June 30, 2018

During the six months ended June 30, 2018, the Company recorded net favorable development on prior year loss reserves of $115.6 million, which consisted of $8.2 million from the insurance segment, $69.6 million from the reinsurance segment, $36.3 million from the mortgage segment and $1.6 million from the ‘other’ segment.
The insurance segment’s net favorable development of $8.2 million, or 0.8 loss ratio points, for the 2018 period consisted of $22.7 million of net favorable development in short-tailed lines and $17.2 million of net favorable development in long-tailed lines, partially offset by $31.7 million of net adverse development in medium-tailed lines. Net favorable development in short-tailed lines primarily resulted from property (including special risk other than marine) reserves from the 2010 and 2017 accident years. Net favorable development in long-tailed lines reflected net reductions in executive assurance reserves of $7.5 million, primarily from the 2008 to 2015 accident years, and in healthcare reserves of $7.0 million, primarily from the 2003 accident year. Net adverse development in medium-tailed lines reflected $21.9 million of adverse development in program business, primarily driven by a few inactive programs that were non-renewed in 2015 and early in 2016 and $25.6 million of adverse development on contract binding business, primarily from the 2014 to 2016 accident years. Such amounts were partially offset by $15.8 million of net favorable development in other medium-tailed lines, including professional liability and surety business, across most accident years.
 
The reinsurance segment’s net favorable development of $69.6 million, or 11.2 loss ratio points, for the 2018 period consisted of $51.1 million from short-tailed lines and $18.5 million from long-tailed and medium-tailed lines. Favorable development in short-tailed lines included $40.4 million from property catastrophe and property other than property catastrophe reserves, across most underwriting years, reflecting lower levels of reported and paid claims activity than previously anticipated which led to decreases in certain loss ratio selections during the period. Favorable development in long-tailed and medium-tailed lines reflected reductions in casualty reserves of $8.1 million based on varying levels of reported and paid claims activity, primarily from the 2002 to 2010 underwriting years, and favorable development in marine reserves of $10.0 million across most underwriting years.
The mortgage segment’s net favorable development was $36.3 million, or 6.4 loss ratio points, for the 2018 period. The 2018 development was primarily driven by continued lower than expected claim rates on first lien business and subrogation recoveries on second lien business.


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 21
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Table of Contents
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

6.    Investment Information

At June 30, 2019, total investable assets of $23.55 billion included $20.78 billion held by the Company and $2.77 billion attributable to Watford Re.
Available For Sale Investments
The following table summarizes the fair value and cost or amortized cost of the Company’s securities classified as available for sale:
 
Estimated
Fair
Value
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Cost or
Amortized
Cost
 
OTTI
Unrealized
Losses (2)
June 30, 2019
 
 
 
 
 
 
 
 
 
Fixed maturities (1):
 
 
 
 
 
 
 
 
 
Corporate bonds
$
6,044,081

 
$
166,372

 
$
(19,805
)
 
$
5,897,514

 
$
—

Mortgage backed securities
523,019

 
11,385

 
(187
)
 
511,821

 
(6
)
Municipal bonds
582,497

 
21,755

 
(58
)
 
560,800

 
—

Commercial mortgage backed securities
686,707

 
21,272

 
(228
)
 
665,663

 
—

U.S. government and government agencies
4,906,996

 
68,017

 
(2,051
)
 
4,841,030

 
—

Non-U.S. government securities
1,928,752

 
45,881

 
(36,125
)
 
1,918,996

 
—

Asset backed securities
1,636,897

 
28,133

 
(3,480
)
 
1,612,244

 
—

Total
16,308,949

 
362,815

 
(61,934
)
 
16,008,068

 
(6
)
Short-term investments
821,961

 
284

 
(480
)
 
822,157

 
—

Total
$
17,130,910

 
$
363,099

 
$
(62,414
)
 
$
16,830,225

 
$
(6
)
 
 
 
 
 
 
 
 
 
 
December 31, 2018
 
 
 
 
 
 
 
 
 
Fixed maturities (1):
 
 
 
 
 
 
 
 
 
Corporate bonds
$
5,537,548

 
$
14,476

 
$
(105,428
)
 
$
5,628,500

 
$
(69
)
Mortgage backed securities
541,193

 
3,991

 
(3,216
)
 
540,418

 
(6
)
Municipal bonds
1,013,395

 
5,380

 
(11,891
)
 
1,019,906

 
—

Commercial mortgage backed securities
729,442

 
2,650

 
(10,751
)
 
737,543

 
—

U.S. government and government agencies
3,758,698

 
27,189

 
(8,474
)
 
3,739,983

 
—

Non-U.S. government securities
1,771,338

 
14,477

 
(50,948
)
 
1,807,809

 
—

Asset backed securities
1,600,896

 
8,060

 
(14,798
)
 
1,607,634

 
—

Total
14,952,510

 
76,223

 
(205,506
)
 
15,081,793

 
(75
)
Short-term investments
955,880

 
36

 
(394
)
 
956,238

 
—

Total
$
15,908,390

 
$
76,259

 
$
(205,900
)
 
$
16,038,031

 
$
(75
)
(1)
In securities lending transactions, the Company receives collateral in excess of the fair value of the fixed maturities pledged. For purposes of this table, the Company has excluded the collateral received under securities lending, at fair value and included the securities pledged under securities lending, at fair value. See “—Securities Lending Agreements.”
(2)
Represents the total other-than-temporary impairments (“OTTI”) recognized in accumulated other comprehensive income (“AOCI”). It does not include the change in fair value subsequent to the impairment measurement date. At June 30, 2019 the net unrealized loss related to securities for which a non-credit OTTI was recognized in AOCI was $0.01 million, compared to net unrealized loss of $0.04 million at December 31, 2018.

ARCH CAPITAL
 22
2019 SECOND QUARTER FORM 10-Q
Table of Contents
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following table summarizes, for all available for sale securities in an unrealized loss position, the fair value and gross unrealized loss by length of time the security has been in a continual unrealized loss position:
 
Less than 12 Months
 
12 Months or More
 
Total
 
Estimated
Fair
Value
 
Gross
Unrealized
Losses
 
Estimated
Fair
Value
 
Gross
Unrealized
Losses
 
Estimated
Fair
Value
 
Gross
Unrealized
Losses
June 30, 2019
 
 
 
 
 
 
 
 
 
 
 
Fixed maturities (1):
 
 
 
 
 
 
 
 
 
 
 
Corporate bonds
$
259,361

 
$
(10,678
)
 
$
375,478

 
$
(9,127
)
 
$
634,839

 
$
(19,805
)
Mortgage backed securities
19,612

 
(169
)
 
261

 
(18
)
 
19,873

 
(187
)
Municipal bonds
—

 
—

 
12,489

 
(58
)
 
12,489

 
(58
)
Commercial mortgage backed securities
18,917

 
(106
)
 
23,198

 
(122
)
 
42,115

 
(228
)
U.S. government and government agencies
906,497

 
(1,711
)
 
104,692

 
(340
)
 
1,011,189

 
(2,051
)
Non-U.S. government securities
1,092,560

 
(33,985
)
 
124,466

 
(2,140
)
 
1,217,026

 
(36,125
)
Asset backed securities
312,033

 
(1,901
)
 
130,002

 
(1,579
)
 
442,035

 
(3,480
)
Total
2,608,980

 
(48,550
)
 
770,586

 
(13,384
)
 
3,379,566

 
(61,934
)
Short-term investments
53,431

 
(480
)
 
—

 
—

 
53,431

 
(480
)
Total
$
2,662,411

 
$
(49,030
)
 
$
770,586

 
$
(13,384
)
 
$
3,432,997

 
$
(62,414
)
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2018
 
 
 
 
 
 
 
 
 
 
 
Fixed maturities (1):
 
 
 
 
 
 
 
 
 
 
 
Corporate bonds
$
2,983,195

 
$
(68,910
)
 
$
1,234,865

 
$
(36,518
)
 
$
4,218,060

 
$
(105,428
)
Mortgage backed securities
84,296

 
(695
)
 
109,009

 
(2,521
)
 
193,305

 
(3,216
)
Municipal bonds
233,081

 
(2,074
)
 
408,155

 
(9,817
)
 
641,236

 
(11,891
)
Commercial mortgage backed securities
223,341

 
(2,831
)
 
193,956

 
(7,920
)
 
417,297

 
(10,751
)
U.S. government and government agencies
635,049

 
(1,354
)
 
391,102

 
(7,120
)
 
1,026,151

 
(8,474
)
Non-U.S. government securities
1,028,340

 
(35,524
)
 
389,671

 
(15,424
)
 
1,418,011

 
(50,948
)
Asset backed securities
533,592

 
(8,832
)
 
368,095

 
(5,966
)
 
901,687

 
(14,798
)
Total
5,720,894

 
(120,220
)
 
3,094,853

 
(85,286
)
 
8,815,747

 
(205,506
)
Short-term investments
122,878

 
(394
)
 
—

 
—

 
122,878

 
(394
)
Total
$
5,843,772

 
$
(120,614
)
 
$
3,094,853

 
$
(85,286
)
 
$
8,938,625

 
$
(205,900
)
(1)
In securities lending transactions, the Company receives collateral in excess of the fair value of the fixed maturities pledged. For purposes of this table, the Company has excluded the collateral received under securities lending, at fair value and included the securities pledged under securities lending, at fair value. See “—Securities Lending Agreements.”

At June 30, 2019, on a lot level basis, approximately 1,690 security lots out of a total of approximately 8,730 security lots were in an unrealized loss position and the largest single unrealized loss from a single lot in the Company’s fixed maturity portfolio was $3.1 million. At December 31, 2018, on a lot level basis, approximately 5,870 security lots out of a total of approximately 8,450 security lots were in an unrealized loss position and the largest single unrealized loss from a single lot in the Company’s fixed maturity portfolio was $2.6 million.

ARCH CAPITAL
 23
2019 SECOND QUARTER FORM 10-Q
Table of Contents
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The contractual maturities of the Company’s fixed maturities are shown in the following table. Expected maturities, which are management’s best estimates, will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
 
 
June 30, 2019
 
December 31, 2018
Maturity
 
Estimated
Fair
Value
 
Amortized
Cost
 
Estimated
Fair
Value
 
Amortized
Cost
Due in one year or less
 
$
414,736

 
$
413,481

 
$
276,682

 
$
279,135

Due after one year through five years
 
9,833,517

 
9,702,349

 
8,666,297

 
8,738,944

Due after five years through 10 years
 
3,028,435

 
2,923,881

 
2,919,232

 
2,951,582

Due after 10 years
 
185,638

 
178,629

 
218,768

 
226,537

 
 
13,462,326

 
13,218,340

 
12,080,979

 
12,196,198

Mortgage backed securities
 
523,019

 
511,821

 
541,193

 
540,418

Commercial mortgage backed securities
 
686,707

 
665,663

 
729,442

 
737,543

Asset backed securities
 
1,636,897

 
1,612,244

 
1,600,896

 
1,607,634

Total (1)
 
$
16,308,949

 
$
16,008,068

 
$
14,952,510

 
$
15,081,793


(1)
In securities lending transactions, the Company receives collateral in excess of the fair value of the securities pledged. For purposes of this table, the Company has excluded the collateral received under securities lending, at fair value and included the securities pledged under securities lending, at fair value. See “—Securities Lending Agreements.”
 
Securities Lending Agreements
The Company enters into securities lending agreements with financial institutions to enhance investment income whereby it loans certain of its securities to third parties, primarily major brokerage firms, for short periods of time through a lending agent. The Company maintains legal control over the securities it lends, retains the earnings and cash flows associated with the loaned securities and receives a fee from the borrower for the temporary use of the securities. An indemnification agreement with the lending agent protects the Company in the event a borrower becomes insolvent or fails to return any of the securities on loan from the Company.
The Company receives collateral in the form of cash or securities. Cash collateral primarily consists of short term investments. At June 30, 2019, the fair value of the cash collateral received on securities lending was $11.4 million and the fair value of security collateral received was $438.9 million. At December 31, 2018, the fair value of the cash collateral received on securities lending was $19.0 million, and the fair value of security collateral received was $255.1 million.
The Company’s securities lending transactions were accounted for as secured borrowings with significant investment categories as follows:
 
 
Remaining Contractual Maturity of the Agreements
 
 
Overnight and Continuous
 
Less than 30 Days
 
30-90 Days
 
90 Days or More
 
Total
June 30, 2019
 
 
 
 
 
 
 
 
 
 
U.S. government and government agencies
 
$
216,856

 
$
—

 
$
217,722

 
$
—

 
$
434,578

Corporate bonds
 
2,356

 
—

 
—

 
—

 
2,356

Equity securities
 
13,378

 
—

 
—

 
—

 
13,378

Total
 
$
232,590

 
$
—

 
$
217,722

 
$
—

 
$
450,312

Gross amount of recognized liabilities for securities lending in offsetting disclosure in note 8
 
$
—

Amounts related to securities lending not included in offsetting disclosure in note 8
 
$
450,312

 
 
 
 
 
 
 
 
 
 
 
December 31, 2018
 
 
 
 
 
 
 
 
 
 
U.S. government and government agencies
 
$
219,276

 
$
—

 
$
32,583

 
$
—

 
$
251,859

Corporate bonds
 
7,129

 
—

 
—

 
—

 
7,129

Equity securities
 
15,137

 
—

 
—

 
—

 
15,137

Total
 
$
241,542

 
$
—

 
$
32,583

 
$
—

 
$
274,125

Gross amount of recognized liabilities for securities lending in offsetting disclosure in note 8
 
$
—

Amounts related to securities lending not included in offsetting disclosure in note 8
 
$
274,125



ARCH CAPITAL
 24
2019 SECOND QUARTER FORM 10-Q
Table of Contents
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Equity Securities, at Fair Value
At June 30, 2019, the Company held $670.9 million of equity securities, at fair value, compared to $338.9 million at December 31, 2018. Such holdings include publicly traded common stocks in the natural resources, energy, consumer staples and other sectors and exchange-traded funds.
Other Investments
The following table summarizes the Company’s other investments which are included in investments accounted for using the fair value option, by strategy:
 
June 30,
2019
 
December 31,
2018
Term loan investments (par value: $1,427,330 and $1,369,216)
$
1,341,445

 
$
1,282,287

Lending
585,954

 
524,112

Credit related funds
166,673

 
202,123

Energy
123,547

 
117,509

Investment grade fixed income
86,808

 
101,902

Infrastructure
49,260

 
45,371

Private equity
23,925

 
24,383

Real estate
16,906

 
14,252

Total
$
2,394,518

 
$
2,311,939


Investments Accounted For Using the Equity Method
The following table summarizes the Company’s investments accounted for using the equity method, by strategy:
 
June 30,
2019
 
December 31,
2018
Credit related funds
$
436,118

 
$
429,402

Equities
324,525

 
375,273

Real estate
251,891

 
232,647

Lending
193,397

 
125,041

Private equity
131,863

 
114,019

Infrastructure
141,744

 
113,748

Energy
102,434

 
103,661

Total
$
1,581,972

 
$
1,493,791


Certain of the Company’s other investments are in investment funds for which the Company has the option to redeem at agreed upon values as described in each investment fund’s subscription agreement. Depending on the terms of the various subscription agreements, investments in investment funds may be redeemed daily, monthly, quarterly or on other terms. Two common redemption restrictions which may impact the Company’s ability to redeem these investment funds are gates and lockups. A gate is a suspension of redemptions which may be implemented by the general partner or investment manager of the fund in order to defer, in whole or in part, the redemption request in the event the aggregate amount of redemption requests exceeds a predetermined percentage of the investment fund’s net assets which may otherwise hinder the general
 
partner or investment manager’s ability to liquidate holdings in an orderly fashion in order to generate the cash necessary to fund extraordinarily large redemption payouts. A lockup period is the initial amount of time an investor is contractually required to hold the security before having the ability to redeem. If the investment funds are eligible to be redeemed, the time to redeem such fund can take weeks or months following the notification.
Fair Value Option 
The following table summarizes the Company’s assets which are accounted for using the fair value option:
 
June 30,
2019
 
December 31,
2018
Fixed maturities
$
965,161

 
$
1,245,562

Other investments
2,394,518

 
2,311,939

Short-term investments
257,465

 
322,177

Equity securities
103,891

 
103,893

Investments accounted for using the fair value option
$
3,721,035

 
$
3,983,571


Limited Partnership Interests
In the normal course of its activities, the Company invests in limited partnerships as part of its overall investment strategy. Such amounts are included in ‘investments accounted for using the equity method’ and ‘investments accounted for using the fair value option.’ The Company has determined that it is not required to consolidate these investments because it is not the primary beneficiary of the funds. The Company’s maximum exposure to loss with respect to these investments is limited to the investment carrying amounts reported in the Company’s consolidated balance sheet and any unfunded commitment.
The following table summarizes investments in limited partnership interests where the Company has a variable interest by balance sheet line item:
 
June 30,
2019
 
December 31,
2018
Investments accounted for using the equity method (1)
1,581,972

 
1,493,791

Investments accounted for using the fair value option (2)
178,977

 
162,398

Total
$
1,760,949

 
$
1,656,189

(1)
Aggregate unfunded commitments were $1.41 billion at June 30, 2019, compared to $1.22 billion at December 31, 2018.
(2)
Aggregate unfunded commitments were $63.6 million at June 30, 2019, compared to $117.5 million at December 31, 2018.

ARCH CAPITAL
 25
2019 SECOND QUARTER FORM 10-Q
Table of Contents
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Net Investment Income
The components of net investment income were derived from the following sources:
 
June 30,
 
2019
 
2018
Three Months Ended
 
 
 
Fixed maturities
$
125,018

 
$
115,110

Term loans
24,730

 
20,763

Equity securities
4,368

 
4,777

Short-term investments
3,859

 
4,392

Other (1)
18,523

 
17,405

Gross investment income
176,498

 
162,447

Investment expenses
(21,460
)
 
(26,779
)
Net investment income
$
155,038

 
$
135,668

 
 
 
 
Six Months Ended
 
 
 
Fixed maturities
$
254,817

 
$
222,997

Term loans
49,346

 
40,527

Equity securities
7,356

 
7,345

Short-term investments
8,038

 
9,252

Other (1)
39,719

 
35,015

Gross investment income
359,276

 
315,136

Investment expenses
(47,289
)
 
(52,744
)
Net investment income
$
311,987

 
$
262,392

(1)
Includes income distributions from investment funds and other items.
 
Net Realized Gains (Losses)
Net realized gains (losses) were as follows, excluding net impairment losses recognized in earnings:
 
June 30,
 
2019
 
2018
Three Months Ended
 
 
 
Available for sale securities:
 

 
 

Gross gains on investment sales
$
75,090

 
$
18,777

Gross losses on investment sales
(15,281
)
 
(57,711
)
Change in fair value of assets and liabilities accounted for using the fair value option:
 
 
 
Fixed maturities
11,429

 
(22,927
)
Other investments
(33,780
)
 
(254
)
Equity securities
6,414

 
1,230

Short-term investments
(1,392
)
 
(136
)
Equity securities, at fair value:
 
 
 
Net realized gains (losses) on sales during the period
(6,644
)
 
(5,918
)
Net unrealized gains (losses) on equity securities still held at reporting date
22,632

 
(7,278
)
Derivative instruments (1)
63,966

 
(2,146
)
Other (2)
(1,628
)
 
(248
)
Net realized gains (losses)
$
120,806

 
$
(76,611
)
 
 
 
 
Six Months Ended
 
 
 
Available for sale securities:
 
 
 
Gross gains on investment sales
$
118,455

 
$
33,742

Gross losses on investment sales
(46,937
)
 
(140,262
)
Change in fair value of assets and liabilities accounted for using the fair value option:
 
 
 
Fixed maturities
42,577

 
(40,478
)
Other investments
(15,585
)
 
(6,628
)
Equity securities
10,680

 
7,898

Short-term investments
(672
)
 
(287
)
Equity securities, at fair value:
 
 
 
Net realized gains (losses) on sales during the period
4,286

 
(11,286
)
Net unrealized gains (losses) on equity securities still held at reporting date
59,768

 
(14,861
)
Derivative instruments (1)
99,837

 
(6,109
)
Other (2)
(10,038
)
 
(9,338
)
Net realized gains (losses)
$
262,371

 
$
(187,609
)

(1)
See note 8 for information on the Company’s derivative instruments.
(2)
Includes the re-measurement of contingent consideration liability amounts.

Equity in Net Income (Loss) of Investment Funds Accounted for Using the Equity Method
The Company recorded $32.5 million of equity in net income related to investment funds accounted for using the equity method in the 2019 second quarter, compared to $8.5 million for the 2018 second quarter, and $79.4 million for the six months ended June 30, 2019, compared to $36.5 million for the 2018 period. In applying the equity method, investments are initially recorded at cost and are subsequently adjusted based on the Company’s proportionate share of the net income or loss of the

ARCH CAPITAL
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Table of Contents
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

funds (which include changes in the market value of the underlying securities in the funds). Such investments are generally recorded on a one to three month lag based on the availability of reports from the investment funds.
Net Impairment Losses Recognized in Earnings
The Company performs quarterly reviews of its available for sale investments in order to determine whether declines in fair value below the amortized cost basis were considered other-than-temporary in accordance with applicable guidance.
The following table details the net impairment losses recognized in earnings by asset class:
 
June 30,
 
2019
 
2018
Three Months Ended
 
 
 
Fixed maturities:
 

 
 

Mortgage backed securities
$
(24
)
 
$
(81
)
Corporate bonds
(25
)
 
(241
)
Asset backed securities
—

 
(148
)
Total
(49
)
 
(470
)
Net impairment losses recognized in earnings
$
(49
)
 
$
(470
)
 
 
 
 
Six Months Ended
 
 
 
Fixed maturities:
 
 
 
Mortgage backed securities
$
(555
)
 
$
(123
)
Corporate bonds
(590
)
 
(361
)
Asset backed securities
(213
)
 
(148
)
Total
(1,358
)
 
(632
)
Net impairment losses recognized in earnings
$
(1,358
)
 
$
(632
)
 
Net impairment losses recognized in earnings in the 2019 periods were primarily related to foreign currency fluctuations and other impairments on corporate bonds and other securities.
The Company believes that the minimal amount of OTTI included in accumulated other comprehensive income at June 30, 2019 on the securities which were considered by the Company to be impaired was due to market and sector-related factors (i.e., not credit losses). At June 30, 2019, the Company did not intend to sell these securities, or any other securities which were in an unrealized loss position, and determined that it is more likely than not that the Company will not be required to sell such securities before recovery of their cost basis.
 
The following table provides a roll forward of the amount related to credit losses recognized in earnings for which a portion of an OTTI was recognized in accumulated other comprehensive income:
 
June 30,
 
2019
 
2018
Three Months Ended
 
 
 
Balance at start of period
$
346

 
$
767

Credit loss impairments recognized on securities not previously impaired
—

 
—

Credit loss impairments recognized on securities previously impaired
—

 
—

Reductions for increases in cash flows expected to be collected that are recognized over the remaining life of the security
—

 
—

Reductions for securities sold during the period
—

 
(69
)
Balance at end of period
$
346

 
$
698

 
 
 
 
Six Months Ended
 
 
 
Balance at start of year
$
637

 
$
767

Credit loss impairments recognized on securities not previously impaired
—

 
—

Credit loss impairments recognized on securities previously impaired
—

 
—

Reductions for increases in cash flows expected to be collected that are recognized over the remaining life of the security
—

 
—

Reductions for securities sold during the period
(291
)
 
(69
)
Balance at end of period
$
346

 
$
698


Restricted Assets
The Company is required to maintain assets on deposit, which primarily consist of fixed maturities, with various regulatory authorities to support its underwriting operations. The Company’s subsidiaries maintain assets in trust accounts as collateral for transactions with affiliated companies and also have investments in segregated portfolios primarily to provide collateral or guarantees for letters of credit to third parties. See note 16, “Commitments and Contingencies,” of the notes to consolidated financial statements in the Company’s 2018 Form 10-K. The following table details the value of the Company’s restricted assets:
 
June 30,
2019
 
December 31,
2018
Assets used for collateral or guarantees:
 

 
 

Affiliated transactions
$
4,758,653

 
$
4,623,483

Third party agreements
2,612,380

 
2,181,682

Deposits with U.S. regulatory authorities
788,750

 
689,114

Deposits with non-U.S. regulatory authorities
62,449

 
59,624

Total restricted assets
$
8,222,232

 
$
7,553,903



ARCH CAPITAL
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Table of Contents
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

In addition, Watford Re maintains a secured credit facility to provide borrowing capacity for investment purposes and a total return swap agreement and maintains assets pledged as collateral for such purposes. The Company does not guarantee or provide credit support for Watford Re, and the Company’s financial exposure to Watford Re is limited to its investment in Watford Re’s senior notes, common and preferred shares and counterparty credit risk (mitigated by collateral) arising from reinsurance transactions. As of June 30, 2019 and December 31, 2018 Watford Re held $1.1 billion and $1.3 billion, respectively, in pledged assets to collateralize Watford Re’s credit facility mentioned above.
Reconciliation of Cash and Restricted Cash
The following table details reconciliation of cash and restricted cash within the Consolidated Balance Sheets:
 
June 30,
2019
 
December 31,
2018
Cash
$
605,316

 
$
646,556

Restricted cash (included in ‘other assets’)
$
77,759

 
$
78,087

Cash and restricted cash
$
683,075

 
$
724,643



7.    Fair Value
Accounting guidance regarding fair value measurements addresses how companies should measure fair value when they are required to use a fair value measure for recognition or disclosure purposes under GAAP and provides a common definition of fair value to be used throughout GAAP. It defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly fashion between market participants at the measurement date. In addition, it establishes a three-level valuation hierarchy for the disclosure of fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The level in the hierarchy within which a given fair value measurement falls is determined based on the lowest level input that is significant to the measurement (Level 1 being the highest priority and Level 3 being the lowest priority).
The levels in the hierarchy are defined as follows:
Level 1:
Inputs to the valuation methodology are observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets
Level 2:
Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly,
 
for substantially the full term of the financial instrument
Level 3:
Inputs to the valuation methodology are unobservable and significant to the fair value measurement
Following is a description of the valuation methodologies used for securities measured at fair value, as well as the general classification of such securities pursuant to the valuation hierarchy. The Company reviews its securities measured at fair value and discusses the proper classification of such investments with investment advisers and others.
The Company determines the existence of an active market based on its judgment as to whether transactions for the financial instrument occur in such market with sufficient frequency and volume to provide reliable pricing information. The independent pricing sources obtain market quotations and actual transaction prices for securities that have quoted prices in active markets. The Company uses quoted values and other data provided by nationally recognized independent pricing sources as inputs into its process for determining fair values of its fixed maturity investments. To validate the techniques or models used by pricing sources, the Company's review process includes, but is not limited to: (i) quantitative analysis (e.g., comparing the quarterly return for each managed portfolio to its target benchmark, with significant differences identified and investigated); (ii) a review of the average number of prices obtained in the pricing process and the range of resulting fair values; (iii) initial and ongoing evaluation of methodologies used by outside parties to calculate fair value; (iv) a comparison of the fair value estimates to the Company’s knowledge of the current market; (v) a comparison of the pricing services' fair values to other pricing services' fair values for the same investments; and (vi) periodic back-testing, which includes randomly selecting purchased or sold securities and comparing the executed prices to the fair value estimates from the pricing service. A price source hierarchy was maintained in order to determine which price source would be used (i.e., a price obtained from a pricing service with more seniority in the hierarchy will be used over a less senior one in all cases). The hierarchy prioritizes pricing services based on availability and reliability and assigns the highest priority to index providers. Based on the above review, the Company will challenge any prices for a security or portfolio which are considered not to be representative of fair value. The Company did not adjust any of the prices obtained from the independent pricing sources at June 30, 2019.
In certain circumstances, when fair values are unavailable from these independent pricing sources, quotes are obtained directly from broker-dealers who are active in the corresponding markets. Such quotes are subject to the validation procedures noted above. Of the $21.66 billion of financial assets and liabilities measured at fair value at June 30, 2019,

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

approximately $183.8 million, or 0.9%, were priced using non-binding broker-dealer quotes. Of the $20.41 billion of financial assets and liabilities measured at fair value at December 31, 2018, approximately $217.9 million, or 1.1%, were priced using non-binding broker-dealer quotes.
Fixed maturities
The Company uses the market approach valuation technique to estimate the fair value of its fixed maturity securities, when possible. The market approach includes obtaining prices from independent pricing services, such as index providers and pricing vendors, as well as to a lesser extent quotes from broker-dealers. The independent pricing sources obtain market quotations and actual transaction prices for securities that have quoted prices in active markets. Each source has its own proprietary method for determining the fair value of securities that are not actively traded. In general, these methods involve the use of “matrix pricing” in which the independent pricing source uses observable market inputs including, but not limited to, investment yields, credit risks and spreads, benchmarking of like securities, broker-dealer quotes, reported trades and sector groupings to determine a reasonable fair value.
The following describes the significant inputs generally used to determine the fair value of the Company’s fixed maturity securities by asset class:
•U.S. government and government agencies — valuations provided by independent pricing services, with all prices provided through index providers and pricing vendors. The Company determined that all U.S. Treasuries would be classified as Level 1 securities due to observed levels of trading activity, the high number of strongly correlated pricing quotes received on U.S. Treasuries and other factors. The fair values of U.S. government agency securities are generally determined using the spread above the risk-free yield curve. As the yields for the risk-free yield curve and the spreads for these securities are observable market inputs, the fair values of U.S. government agency securities are classified within Level 2.
•Corporate bonds — valuations provided by independent pricing services, substantially all through index providers and pricing vendors with a small amount through broker-dealers. The fair values of these securities are generally determined using the spread above the risk-free yield curve. These spreads are generally obtained from the new issue market, secondary trading and from broker-dealers who trade in the relevant security market. As the significant inputs used in the pricing process for corporate bonds are observable market inputs, the fair value of these securities are classified within Level 2. A small number of securities are included in Level 3 due to a low level of transparency on the inputs used in the pricing process. During the 2019 second quarter, the Company transferred $23.9 million of corporate bonds from Level 2 to Level 3 based on a review of the pricing of such securities, as described above.
 
•Mortgage-backed securities — valuations provided by independent pricing services, substantially all through pricing vendors and index providers with a small amount through broker-dealers. The fair values of these securities are generally determined through the use of pricing models (including Option Adjusted Spread) which use spreads to determine the expected average life of the securities. These spreads are generally obtained from the new issue market, secondary trading and from broker-dealers who trade in the relevant security market. The pricing services also review prepayment speeds and other indicators, when applicable. As the significant inputs used in the pricing process for mortgage-backed securities are observable market inputs, the fair value of these securities are classified within Level 2. A small number of securities are included in Level 3 due to a low level of transparency on the inputs used in the pricing process.
•Municipal bonds — valuations provided by independent pricing services, with all prices provided through index providers and pricing vendors. The fair values of these securities are generally determined using spreads obtained from broker-dealers who trade in the relevant security market, trade prices and the new issue market. As the significant inputs used in the pricing process for municipal bonds are observable market inputs, the fair value of these securities are classified within Level 2.
•Commercial mortgage-backed securities — valuations provided by independent pricing services, substantially all through index providers and pricing vendors with a small amount through broker-dealers. The fair values of these securities are generally determined through the use of pricing models which use spreads to determine the appropriate average life of the securities. These spreads are generally obtained from the new issue market, secondary trading and from broker-dealers who trade in the relevant security market. The pricing services also review prepayment speeds and other indicators, when applicable. As the significant inputs used in the pricing process for commercial mortgage-backed securities are observable market inputs, the fair value of these securities are classified within Level 2.
•Non-U.S. government securities — valuations provided by independent pricing services, with all prices provided through index providers and pricing vendors. The fair values of these securities are generally based on international indices or valuation models which include daily observed yield curves, cross-currency basis index spreads and country credit spreads. As the significant inputs used in the pricing process for non-U.S. government securities are observable market inputs, the fair value of these securities are classified within Level 2.
•Asset-backed securities — valuations provided by independent pricing services, substantially all through index providers and pricing vendors with a small amount through broker-dealers. The fair values of these securities are generally determined through the use of pricing models (including Option

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Adjusted Spread) which use spreads to determine the appropriate average life of the securities. These spreads are generally obtained from the new issue market, secondary trading and from broker-dealers who trade in the relevant security market. The pricing services also review prepayment speeds and other indicators, when applicable. As the significant inputs used in the pricing process for asset-backed securities are observable market inputs, the fair value of these securities are classified within Level 2.
Equity securities
The Company determined that exchange-traded equity securities would be included in Level 1 as their fair values are based on quoted market prices in active markets. Other equity securities are included in Level 2 of the valuation hierarchy. A small number of securities are included in Level 3 due to the lack of an available independent price source for such securities. As the significant inputs used to price these securities are unobservable, the fair value of such securities are classified as Level 3. During the 2019 second quarter, the Company transferred $107.4 million of equity securities from Level 2 to Level 3 based on a review of the pricing of such securities, as described above.
Other investments
The Company determined that exchange-traded investments in mutual funds would be included in Level 1 as their fair values are based on quoted market prices in active markets. Other investments also include term loan investments for which fair values are estimated by using quoted prices of term loan investments with similar characteristics, pricing models or matrix pricing. Such investments are generally classified within Level 2. The fair values for certain of the Company’s other investments are determined using net asset values as advised by external fund managers. The net asset value is based on the fund manager’s valuation of the underlying holdings in accordance with the fund’s governing documents. In accordance with applicable accounting guidance, certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been classified in the fair value hierarchy. A small number of
 
securities are included in Level 3 due to the lack of an available independent price source for such securities. During the 2019 second quarter, the Company transferred $44.6 million of other investments from Level 2 to Level 3 based on a review of the pricing of such securities, as described above.
Derivative instruments
The Company’s futures contracts, foreign currency forward contracts, interest rate swaps and other derivatives trade in the over-the-counter derivative market. The Company uses the market approach valuation technique to estimate the fair value for these derivatives based on significant observable market inputs from third party pricing vendors, non-binding broker-dealer quotes and/or recent trading activity. As the significant inputs used in the pricing process for these derivative instruments are observable market inputs, the fair value of these securities are classified within Level 2.
Short-term investments
The Company determined that certain of its short-term investments held in highly liquid money market-type funds, Treasury bills and commercial paper would be included in Level 1 as their fair values are based on quoted market prices in active markets. The fair values of other short-term investments are generally determined using the spread above the risk-free yield curve and are classified within Level 2.
Contingent consideration liabilities
Contingent consideration liabilities (included in ‘other liabilities’ in the consolidated balance sheets) include amounts related to the acquisition of CMG Mortgage Insurance Company and its affiliated mortgage insurance companies and other acquisitions. Such amounts are remeasured at fair value at each balance sheet date with changes in fair value recognized in ‘net realized gains (losses).’ To determine the fair value of contingent consideration liabilities, the Company estimates future payments using an income approach based on modeled inputs which include a weighted average cost of capital. The Company determined that contingent consideration liabilities would be included within Level 3.

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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following table presents the Company’s financial assets and liabilities measured at fair value by level at June 30, 2019:
 
 
 
Estimated Fair Value Measurements Using:
 
Estimated
Fair
Value
 
Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Assets measured at fair value (1):
 

 
 

 
 

 
 

Available for sale securities:
 

 
 

 
 

 
 

Fixed maturities:
 

 
 

 
 

 
 

Corporate bonds
$
6,044,081

 
$
—

 
$
6,036,439

 
$
7,642

Mortgage backed securities
523,019

 
—

 
522,729

 
290

Municipal bonds
582,497

 
—

 
582,497

 
—

Commercial mortgage backed securities
686,707

 
—

 
686,707

 
—

U.S. government and government agencies
4,906,996

 
4,746,260

 
160,736

 
—

Non-U.S. government securities
1,928,752

 
—

 
1,928,752

 
—

Asset backed securities
1,636,897

 
—

 
1,636,897

 
—

Total
16,308,949

 
4,746,260

 
11,554,757

 
7,932

 
 
 
 
 
 
 
 
Short-term investments
821,961

 
803,337

 
18,624

 
—

 
 
 
 
 
 
 
 
Equity securities, at fair value
684,236

 
620,508

 
12,516

 
51,212

 
 
 
 
 
 
 
 
Derivative instruments (4)
30,653

 
—

 
30,653

 
—

 
 
 
 
 
 
 
 
Fair value option:
 
 
 
 
 
 
 
Corporate bonds
673,431

 
—

 
647,328

 
26,103

Non-U.S. government bonds
56,416

 
—

 
56,416

 
—

Mortgage backed securities
16,076

 
—

 
16,076

 
—

Municipal bonds
6,731

 
—

 
6,731

 
—

Commercial mortgage backed securities
—

 
—

 
—

 
—

Asset backed securities
208,019

 
—

 
208,019

 
—

U.S. government and government agencies
4,488

 
4,378

 
110

 
—

Short-term investments
257,465

 
247,216

 
10,249

 
—

Equity securities
103,891

 
47,157

 
589

 
56,145

Other investments
1,394,344

 
41,176

 
1,257,895

 
95,273

Other investments measured at net asset value (2)
1,000,174

 
 
 
 
 
 
Total
3,721,035

 
339,927

 
2,203,413

 
177,521

 
 
 
 
 
 
 
 
Total assets measured at fair value
$
21,566,834

 
$
6,510,032

 
$
13,819,963

 
$
236,665

 
 
 
 
 
 
 
 
Liabilities measured at fair value:
 

 
 

 
 

 
 

Contingent consideration liabilities
$
(7,825
)
 
$
—

 
$
—

 
$
(7,825
)
Securities sold but not yet purchased (3)
(48,823
)
 
—

 
(48,823
)
 
—

Derivative instruments (4)
(38,363
)
 
—

 
(38,363
)
 
—

Total liabilities measured at fair value
$
(95,011
)
 
$
—

 
$
(87,186
)
 
$
(7,825
)

(1)
In securities lending transactions, the Company receives collateral in excess of the fair value of the securities pledged. For purposes of this table, the Company has excluded the collateral received under securities lending, at fair value and included the securities pledged under securities lending, at fair value. See note 6, “—Securities Lending Agreements.”
(2)
In accordance with applicable accounting guidance, certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been classified in the fair value hierarchy. The fair value amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the amounts presented in the consolidated balance sheets.
(3)
Represents the Company’s obligations to deliver securities that it did not own at the time of sale. Such amounts are included in “other liabilities” on the Company’s consolidated balance sheets.
(4)
See note 8.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following table presents the Company’s financial assets and liabilities measured at fair value by level at December 31, 2018:
 
 
 
Estimated Fair Value Measurements Using:
 
Estimated
Fair
Value
 
Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Assets measured at fair value (1):
 

 
 

 
 

 
 

Available for sale securities:
 

 
 

 
 

 
 

Fixed maturities:
 

 
 

 
 

 
 

Corporate bonds
$
5,537,548

 
$
—

 
$
5,529,407

 
$
8,141

Mortgage backed securities
541,193

 
—

 
540,884

 
309

Municipal bonds
1,013,395

 
—

 
1,013,395

 
—

Commercial mortgage backed securities
729,442

 
—

 
729,438

 
4

U.S. government and government agencies
3,758,698

 
3,657,181

 
101,517

 
—

Non-U.S. government securities
1,771,338

 
—

 
1,771,338

 
—

Asset backed securities
1,600,896

 
—

 
1,600,896

 
—

Total
14,952,510

 
3,657,181

 
11,286,875

 
8,454

 
 
 
 
 
 
 
 
Equity securities
353,794

 
321,927

 
31,867

 
—

 
 
 
 
 
 
 
 
Short-term investments
955,880

 
875,881

 
79,999

 
—

 
 
 
 
 
 
 
 
Derivative instruments (4)
73,893

 
—

 
73,893

 
—

 
 
 
 
 
 
 
 
Fair value option:
 
 
 
 
 
 
 
Corporate bonds
852,585

 
—

 
846,827

 
5,758

Non-U.S. government bonds
79,066

 
—

 
79,066

 
—

Mortgage backed securities
16,731

 
—

 
16,731

 
—

Municipal bonds
7,144

 
—

 
7,144

 
—

Commercial mortgage backed securities
—

 
—

 
—

 
—

Asset backed securities
178,790

 
—

 
178,790

 
—

U.S. government and government agencies
111,246

 
111,138

 
108

 
—

Short-term investments
322,177

 
278,579

 
43,598

 
—

Equity securities
103,893

 
48,827

 
55,066

 
—

Other investments
1,254,220

 
39,107

 
1,152,408

 
62,705

Other investments measured at net asset value (2)
1,057,719

 
 
 
 
 
 
Total
3,983,571

 
477,651

 
2,379,738

 
68,463

 
 
 
 
 
 
 
 
Total assets measured at fair value
$
20,319,648

 
$
5,332,640

 
$
13,852,372

 
$
76,917

 
 
 
 
 
 
 
 
Liabilities measured at fair value:
 

 
 

 
 

 
 

Contingent consideration liabilities
$
(66,665
)
 
$
—

 
$
—

 
$
(66,665
)
Securities sold but not yet purchased (3)
(7,790
)
 
—

 
(7,790
)
 
—

Derivative instruments (4)
(20,664
)
 
—

 
(20,664
)
 
—

Total liabilities measured at fair value
$
(95,119
)
 
$
—

 
$
(28,454
)
 
$
(66,665
)

(1)
In securities lending transactions, the Company receives collateral in excess of the fair value of the securities pledged. For purposes of this table, the Company has excluded the collateral received under securities lending, at fair value and included the securities pledged under securities lending, at fair value. See note 6, “—Securities Lending Agreements.”
(2)
In accordance with applicable accounting guidance, certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been classified in the fair value hierarchy. The fair value amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the amounts presented in the consolidated balance sheets.
(3)
Represents the Company’s obligations to deliver securities that it did not own at the time of sale. Such amounts are included in “other liabilities” on the Company’s consolidated balance sheets.
(4)
See note 8.


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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following table presents a reconciliation of the beginning and ending balances for all financial assets and liabilities measured at fair value on a recurring basis using Level 3 inputs:
 
Assets
Liabilities
s
Available For Sale
 
Fair Value Option
 
Fair Value
 
 
 
Structured Securities (1)
 
Corporate
Bonds
 
Corporate
Bonds
 
Other
Investments
 
Equity
Securities
 
Equity
Securities
 
Contingent Consideration Liabilities
Three Months Ended June 30, 2019
 
 
 

 
 
 
 
 
 
 
 

 
 
Balance at beginning of period
$
302

 
$
7,567

 
$
2,233

 
$
62,329

 
$
—

 
$
—

 
$
(68,121
)
Total gains or (losses) (realized/unrealized)
 
 
 
 
 
 
 
 
 
 


 
 
Included in earnings (2)
—

 
—

 
(49
)
 
(11,614
)
 
—

 
—

 
(423
)
Included in other comprehensive income
1

 
102

 
—

 
—

 
—

 
—

 
—

Purchases, issuances, sales and settlements
 
 
 
 
 
 
 
 
 
 


 
 
Purchases
—

 
429

 
—

 
—

 
—

 
—

 
—

Issuances
—

 
—

 
—

 
—

 
—

 
—

 
—

Sales
—

 
—

 
—

 
(74
)
 
—

 
—

 
—

Settlements
(13
)
 
(456
)
 
—

 
—

 
—

 
—

 
60,719

Transfers in and/or out of Level 3
—

 
—

 
23,919

 
44,632

 
56,145

 
51,212

 
—

Balance at end of period
$
290

 
$
7,642

 
$
26,103

 
$
95,273

 
$
56,145

 
$
51,212

 
$
(7,825
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended June 30, 2018
 
 
 

 
 
 
 
 
 
 
 

 
 
Balance at beginning of period
$
5,413

 
$
9,152

 
$
11,872

 
$
58,452

 
$
—

 
$
—

 
$
(62,449
)
Total gains or (losses) (realized/unrealized)
 
 
 
 
 
 
 
 
 
 


 
 
Included in earnings (2)
3

 
—

 
(537
)
 
336

 
—

 
—

 
(1,481
)
Included in other comprehensive income
(4
)
 
(316
)
 
—

 
—

 
—

 
—

 
—

Purchases, issuances, sales and settlements
 
 
 
 
 
 
 
 
 
 


 
 
Purchases
—

 
393

 
—

 
—

 
—

 
—

 
—

Issuances
—

 
—

 
—

 
—

 
—

 
—

 
—

Sales
(5,003
)
 
—

 
—

 
(74
)
 
—

 
—

 
—

Settlements
(33
)
 
(456
)
 
—

 
(500
)
 
—

 
—

 
—

Transfers in and/or out of Level 3
—

 
—

 
—

 
—

 
—

 
—

 
—

Balance at end of period
$
376

 
$
8,773

 
$
11,335

 
$
58,214

 
$
—

 
$
—

 
$
(63,930
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Six Months Ended June 30, 2019
 
 
 

 
 
 
 
 
 
 
 

 
 
Balance at beginning of year
$
313

 
$
8,141

 
$
5,758

 
$
62,705

 
$
—

 
$
—

 
$
(66,665
)
Total gains or (losses) (realized/unrealized)
 
 
 
 
 
 
 
 
 
 


 
 
Included in earnings (2)
1,757

 
—

 
(339
)
 
(11,316
)
 
—

 
—

 
(1,331
)
Included in other comprehensive income
5

 
(16
)
 
—

 
—

 
—

 
—

 
—

Purchases, issuances, sales and settlements
 
 
 
 
 
 
 
 
 
 


 
 
Purchases
—

 
429

 
—

 
—

 
—

 
—

 
—

Issuances
—

 
—

 
—

 
—

 
—

 
—

 
(548
)
Sales
(1,757
)
 
—

 
(3,235
)
 
(148
)
 
—

 
—

 
—

Settlements
(28
)
 
(912
)
 
—

 
(600
)
 
—

 
—

 
60,719

Transfers in and/or out of Level 3
—

 
—

 
23,919

 
44,632

 
56,145

 
51,212

 
—

Balance at end of period
$
290

 
$
7,642

 
$
26,103

 
$
95,273

 
$
56,145

 
$
51,212

 
$
(7,825
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Six Months Ended June 30, 2018
 
 
 

 
 
 
 
 
 
 
 

 
 
Balance at beginning of year
$
5,927

 
$
9,460

 
$
12,217

 
$
59,167

 
$
—

 
$
—

 
$
(60,996
)
Total gains or (losses) (realized/unrealized)
 
 
 
 
 
 
 
 
 
 


 
 
Included in earnings (2)
4

 
—

 
(612
)
 
(379
)
 
—

 
—

 
(2,934
)
Included in other comprehensive income
(8
)
 
(168
)
 
—

 
—

 
—

 
—

 
—

Purchases, issuances, sales and settlements
 
 
 
 
 
 
 
 
 
 


 
 
Purchases
—

 
393

 
—

 
—

 
—

 
—

 
—

Issuances
—

 
—

 
—

 
—

 
—

 
—

 
—

Sales
(5,003
)
 
—

 
—

 
(74
)
 
—

 
—

 
—

Settlements
(544
)
 
(912
)
 
(270
)
 
(500
)
 
—

 
—

 
—

Transfers in and/or out of Level 3
—

 
—

 
—

 
—

 
—

 
—

 
—

Balance at end of period
$
376

 
$
8,773

 
$
11,335

 
$
58,214

 
$
—

 
$
—

 
$
(63,930
)

(1)
Includes asset backed securities, mortgage backed securities and commercial mortgage backed securities.
(2)
Gains or losses were included in net realized gains (losses).

ARCH CAPITAL
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Table of Contents
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Financial Instruments Disclosed, But Not Carried, At Fair Value
The Company uses various financial instruments in the normal course of its business. The carrying values of cash, accrued investment income, receivable for securities sold, certain other assets, payable for securities purchased and certain other liabilities approximated their fair values at June 30, 2019, due to their respective short maturities. As these financial instruments are not actively traded, their respective fair values are classified within Level 2.
At June 30, 2019, the Company’s senior notes were carried at their cost, net of debt issuance costs, of $1.73 billion and had a fair value of $2.09 billion. At December 31, 2018, Company’s senior notes were carried at their cost, net of debt issuance costs, of $1.73 billion and had a fair value of $1.88 billion. The fair values of the senior notes were obtained from a third party pricing service and are based on observable market inputs. As such, the fair values of the senior notes are classified within Level 2.
8.    Derivative Instruments
The Company’s investment strategy allows for the use of derivative instruments. The Company’s derivative instruments are recorded on its consolidated balance sheets at fair value. The Company utilizes exchange traded U.S. Treasury note, Eurodollar and other futures contracts and commodity futures to manage portfolio duration or replicate investment positions in its portfolios and the Company routinely utilizes foreign currency forward contracts, currency options, index futures contracts and other derivatives as part of its total return objective. In addition, certain of the Company’s investments are managed in portfolios which incorporate the use of foreign currency forward contracts which are intended to provide an economic hedge against foreign currency movements. 
In addition, the Company purchases to-be-announced mortgage backed securities (“TBAs”) as part of its investment strategy. TBAs represent commitments to purchase a future issuance of agency mortgage backed securities. For the period between purchase of a TBA and issuance of the underlying security, the Company’s position is accounted for as a derivative. The Company purchases TBAs in both long and short positions to enhance investment performance and as part of its overall investment strategy.
 
The following table summarizes information on the fair values and notional values of the Company’s derivative instruments:
 
Estimated Fair Value
 
 
 
Asset Derivatives
 
Liability Derivatives
 
Notional
Value (1)
June 30, 2019
 
 
 
 
 
Futures contracts (2)
$
5,438

 
$
(1,586
)
 
$
4,354,852

Foreign currency forward contracts (2)
3,190

 
(10,352
)
 
939,940

TBAs (3)
15,509

 
—

 
14,846

Other (2)
22,025

 
(26,425
)
 
3,493,526

Total
$
46,162

 
$
(38,363
)
 
 
 
 
 
 
 
 
December 31, 2018
 
 
 
 
 
Futures contracts (2)
$
51,800

 
$
(2,115
)
 
$
3,153,518

Foreign currency forward contracts (2)
8,147

 
(7,796
)
 
1,008,907

TBAs (3)
8,292

 
—

 
8,132

Other (2)
13,946

 
(10,753
)
 
2,213,981

Total
$
82,185

 
$
(20,664
)
 
 
(1)
Represents the absolute notional value of all outstanding contracts, consisting of long and short positions.
(2)
The fair value of asset derivatives are included in ‘other assets’ and the fair value of liability derivatives are included in ‘other liabilities.’
(3)
The fair value of TBAs are included in ‘fixed maturities available for sale, at fair value.’
The Company did not hold any derivatives which were designated as hedging instruments at June 30, 2019 or December 31, 2018.
The Company’s derivative instruments can be traded under master netting agreements, which establish terms that apply to all derivative transactions with a counterparty. In the event of a bankruptcy or other stipulated event of default, such agreements provide that the non-defaulting party may elect to terminate all outstanding derivative transactions, in which case all individual derivative positions (loss or gain) with a counterparty are closed out and netted and replaced with a single amount, usually referred to as the termination amount, which is expressed in a single currency. The resulting single net amount, where positive, is payable to the party “in-the-money” regardless of whether or not it is the defaulting party, unless the parties have agreed that only the non-defaulting party is entitled to receive a termination payment where the net amount is positive and is in its favor. Contractual close-out netting reduces derivatives credit exposure from gross to net exposure. The remaining derivatives included in the table above were not subject to a master netting agreement.
At June 30, 2019, asset derivatives and liability derivatives of $46.2 million and $38.4 million, respectively, were subject to a master netting agreement, compared to $80.4 million and $18.9 million, respectively, at December 31, 2018. The remaining derivatives included in the preceding table were not subject to a master netting agreement.

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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Realized and unrealized contract gains and losses on the Company’s derivative instruments are reflected in ‘net realized gains (losses)’ in the consolidated statements of income, as summarized in the following table:
Derivatives not designated as
 
June 30,
hedging instruments:
 
2019
 
2018
 
 
 
 
 
Three Months Ended
 
 
 
 
Net realized gains (losses):
 
 
 
 
Futures contracts
 
$
66,973

 
$
(240
)
Foreign currency forward contracts
 
(5,365
)
 
(1,692
)
TBAs
 
48

 
—

Other
 
2,310

 
(214
)
Total
 
$
63,966

 
$
(2,146
)
 
 
 
 
 
Six Months Ended
 
 
 
 
Net realized gains (losses):
 
 
 
 
Futures contracts
 
$
94,309

 
$
4,790

Foreign currency forward contracts
 
(19,074
)
 
(7,616
)
TBAs
 
238

 
(97
)
Other
 
24,364

 
(3,186
)
Total
 
$
99,837

 
$
(6,109
)

9.    Commitments and Contingencies
Investment Commitments
The Company’s investment commitments, which are primarily related to agreements entered into by the Company to invest in funds and separately managed accounts when called upon, were approximately $1.92 billion at June 30, 2019, compared to $1.77 billion at December 31, 2018.
Interest Paid
Interest paid on the Company’s senior notes and other borrowings were $60.9 million for the six months ended June 30, 2019, consistent with $60.9 million for the 2018 period.
10.    Leases
In the ordinary course of business, the Company renews and enters into new leases for office property and equipment. At the lease inception date, the Company determines whether a contract contains a lease and its classification as a finance or operating lease. Primarily all of the Company’s leases are classified as operating leases. The Company’s operating leases have remaining lease terms of up to 12 years, some of which include options to extend the lease term. The Company considers these options when determining the lease term and measuring its lease liability and right-of-use asset. In addition, the Company’s lease agreements do not contain any material residual value guarantees or material restrictive covenants.
 
Short-term operating leases with an initial term of twelve months or less were excluded on the Company's consolidated balance sheet and represent an inconsequential amount of operating lease expense.
As most leases do not provide an implicit rate, the Company uses its incremental borrowing rate based on the information available at the lease commencement date in determining the present value of lease payments.
Additional information regarding the Company’s operating leases is as follows:
 
 
June 30,
 
 
2019
 
 
 
Three Months Ended
 
 
Operating lease costs
 
$
7,244

Cash payments included in the measurement of lease liabilities reported in operating cash flows
 
$
7,685

Right-of-use assets obtained in exchange for new lease liabilities
 
$
4,420

Right-of-use assets (1)
 
$
134,061

Operating lease liability (1)
 
$
150,341

Weighted average discount rate
 
3.9
%
Weighted average remaining lease term
 
6.5 years

 
 
 
Six Months Ended
 
 
Operating lease costs

 
$
14,860

Cash payments included in the measurement of lease liabilities reported in operating cash flows
 
$
14,585

Right-of-use assets obtained in exchange for new lease liabilities
 
$
4,420

Right-of-use assets (1)
 
$
134,061

Operating lease liability (1)
 
$
150,341

Weighted average discount rate
 
3.9
%
Weighted average remaining lease term
 
6.5 years

(1)
The right-of-use assets are included in ‘other assets’ while the operating lease liability is included in ‘other liabilities.’

The following table presents the contractual maturities of the Company's operating lease liabilities at June 30, 2019:
Years Ending December 31,
 
 
2019 (remainder)
 
$
9,985

2020
 
32,036

2021
 
30,673

2022
 
27,365

2023
 
22,667

2024 and thereafter
 
55,610

Total undiscounted lease liability
 
$
178,336

Less: present value adjustment
 
(27,995
)
Operating lease liability
 
$
150,341




ARCH CAPITAL
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Table of Contents
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

At December 31, 2018, the future minimum rental commitments, exclusive of escalation clauses and maintenance costs and net of rental income, for all of the Company’s operating leases was as follows:
2019
$
31,088

2020
30,491

2021
29,351

2022
26,068

2023
21,408

2024 and thereafter
54,745

Total
$
193,151


11.
Variable Interest Entities and Noncontrolling Interests
Watford Holdings Ltd.
In March 2014, the Company invested $100.0 million and acquired 2,500,000 common shares, approximately 11% of Watford Holdings Ltd.’s outstanding common equity, and a warrant to purchase up to 975,503 additional common shares. The warrants expire on March 31, 2020. The exercise price of the warrants is determined on the date of exercise based on certain targeted returns for existing common shareholders. Watford Holdings Ltd.’s common shares are listed on the Nasdaq Select Global Market under the ticker symbol “WTRE”.
Watford Re is considered a VIE and the Company concluded that it is the primary beneficiary of Watford Re. As such, the results of Watford Re are included in the Company’s consolidated financial statements.
The Company does not guarantee or provide credit support for Watford Re, and the Company’s financial exposure to Watford Re is limited to its investment in Watford Re’s senior notes, common and preferred shares and counterparty credit risk (mitigated by collateral) arising from reinsurance transactions.
 
The following table provides the carrying amount and balance sheet caption in which the assets and liabilities of Watford Re are reported:
 
June 30,
 
December 31,

 
2019
 
2018
Assets
 
 
 
Investments accounted for using the fair value option
$
1,972,947

 
$
2,312,003

Fixed maturities available for sale, at fair value
732,454

 
393,351

Equity securities, at fair value
64,703

 
32,206

Cash
68,977

 
63,529

Accrued investment income
16,916

 
19,461

Premiums receivable
228,588

 
227,301

Reinsurance recoverable on unpaid and paid losses and LAE
123,961

 
86,445

Ceded unearned premiums
79,513

 
61,587

Deferred acquisition costs
71,557

 
80,858

Receivable for securities sold
29,425

 
24,507

Goodwill and intangible assets
7,650

 
7,650

Other assets
71,837

 
63,959

Total assets of consolidated VIE
$
3,468,528

 
$
3,372,857

 
 
 
 
Liabilities
 
 
 
Reserve for losses and loss adjustment expenses
$
1,126,080

 
$
1,032,760

Unearned premiums
375,323

 
390,114

Reinsurance balances payable
23,312

 
21,034

Revolving credit agreement borrowings
491,006

 
455,682

Payable for securities purchased
51,216

 
60,142

Other liabilities (1)
219,120

 
302,524

Total liabilities of consolidated VIE
$
2,286,057

 
$
2,262,256

 
 
 
 
Redeemable noncontrolling interests
$
221,175

 
$
220,992


(1)
Includes certain borrowings related to investing activities.
For the six months ended June 30, 2019, Watford Re generated $115.9 million of cash provided by operating activities, $135.7 million of cash used for investing activities and $25.6 million of cash provided by financing activities, compared to $92.4 million of cash provided by operating activities, $168.0 million of cash used for investing activities and $2.1 million of cash used for financing activities for the six months ended June 30, 2018.
Non-redeemable noncontrolling interests
The Company accounts for the portion of Watford Re’s common equity attributable to third party investors in the shareholders’ equity section of its consolidated balance sheets. The noncontrolling ownership in Watford Re’s common shares was approximately 89% at June 30, 2019. The portion of Watford Re’s income or loss attributable to third party investors is recorded in the consolidated statements of income in ‘net (income) loss attributable to noncontrolling interests.’

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Table of Contents
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following table sets forth activity in the non-redeemable noncontrolling interests:
 
June 30,
 
2019
 
2018
Three Months Ended
 
 
 
Balance, beginning of period
$
838,081

 
$
854,112

Additional paid in capital attributable to noncontrolling interests
2,074

 
—

Amounts attributable to noncontrolling interests
12,301

 
8,116

Other comprehensive income (loss) attributable to noncontrolling interests
2,891

 
(1,075
)
Balance, end of period
$
855,347

 
$
861,153

 
 
 
 
Six Months Ended
 
 
 
Balance, beginning of year
$
791,560

 
$
843,411

Additional paid in capital attributable to noncontrolling interests
2,074

 
—

Amounts attributable to noncontrolling interests
54,683

 
19,492

Other comprehensive income (loss) attributable to noncontrolling interests
7,030

 
(1,750
)
Balance, end of period
$
855,347

 
$
861,153


Redeemable noncontrolling interests
The Company accounts for redeemable noncontrolling interests in the mezzanine section of its consolidated balance sheets in accordance with applicable accounting guidance. Such redeemable noncontrolling interests relate to the 9,065,200 cumulative redeemable preference shares (“Watford Preference Shares”) issued in late March 2014 with a par value of $0.01 per share and a liquidation preference of $25.00 per share. The Watford Preference Shares were issued at a discounted amount of $24.50 per share. Preferred dividends, including the accretion of the discount and issuance costs, are included in ‘net (income) loss attributable to noncontrolling interests’ in the Company’s consolidated statements of income.
The following table sets forth activity in the redeemable non-controlling interests:
 
June 30,
 
2019
 
2018
Three Months Ended
 
 
 
Balance, beginning of period
$
206,383

 
$
206,013

Accretion of preference share issuance costs
92

 
92

Balance, end of period
$
206,475

 
$
206,105

 
 
 
 
Six Months Ended
 
 
 
Balance, beginning of year
$
206,292

 
$
205,922

Accretion of preference share issuance costs
183

 
183

Balance, end of period
$
206,475

 
$
206,105


 
The portion of Watford Re’s income or loss attributable to third party investors, recorded in the Company’s consolidated statements of income in ‘net (income) loss attributable to noncontrolling interests,’ are summarized in the table below:
 
June 30,
 
2019
 
2018
Three Months Ended
 
 
 
Amounts attributable to non-redeemable noncontrolling interests
$
(12,301
)
 
$
(8,116
)
Dividends attributable to redeemable noncontrolling interests
(4,590
)
 
(4,585
)
Net (income) loss attributable to noncontrolling interests
$
(16,891
)
 
$
(12,701
)
 
 
 
 
Six Months Ended
 
 
 
Amounts attributable to non-redeemable noncontrolling interests
$
(54,683
)
 
$
(19,492
)
Dividends attributable to redeemable noncontrolling interests
(9,178
)
 
(9,170
)
Net (income) loss attributable to noncontrolling interests
$
(63,861
)
 
$
(28,662
)

Bellemeade Re
The Company has entered into various aggregate excess of loss mortgage reinsurance agreements with various special purpose reinsurance companies domiciled in Bermuda (the “Bellemeade Agreements”). At the time the Bellemeade Agreements were entered into, the applicability of the accounting guidance that addresses VIEs was evaluated. As a result of the evaluation of the Bellemeade Agreements, the Company concluded that these entities are VIEs. However, given that the ceding insurers do not have the unilateral power to direct those activities that are significant to their economic performance, the Company does not consolidate such entities in its consolidated financial statements.

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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following table presents the total assets of the Bellemeade entities, as well as the Company’s maximum exposure to loss associated with these VIEs, calculated as the maximum historical observable spread between the one month LIBOR, the basis for the contractual payments to bond holders, and short term invested trust asset yields.
 
 
 
Maximum Exposure to Loss
Bellemeade Entities (Issue Date)
Total VIE Assets
 
On-Balance Sheet (Asset) Liability
 
Off-Balance Sheet
 
Total
Jun 30, 2019
 
 
 
 
 
 
 
Bellemeade 2015-1 Ltd. (Jul-15)
$
19,103

 
$
(4
)
 
$
17

 
$
13

Bellemeade 2017-1 Ltd. (Oct-17)
277,554

 
(657
)
 
4,892

 
4,235

Bellemeade 2018-1 Ltd. (Apr-18)
374,460

 
(1,965
)
 
7,799

 
5,834

Bellemeade 2018-2 Ltd. (Aug-18)
571,129

 
(1,957
)
 
5,265

 
3,308

Bellemeade 2018-3 Ltd. (Oct-18)
506,110

 
(2,213
)
 
7,251

 
5,038

Bellemeade 2019-1 Ltd. (Mar-19)
329,085

 
(237
)
 
4,842

 
4,605

Bellemeade 2019-2 Ltd. (Apr-19)
621,022

 
(408
)
 
11,206

 
10,798

Total
$
2,698,463

 
$
(7,441
)
 
$
41,272

 
$
33,831

Dec 31, 2018
 
 
 
 
 
 
 
Bellemeade 2015-1 Ltd. (Jul-15)
$
43,246

 
$
112

 
$
498

 
$
610

Bellemeade 2017-1 Ltd. (Oct-17)
304,373

 
165

 
1,312

 
1,477

Bellemeade 2018-1 Ltd. (Apr-18)
374,460

 
132

 
3,539

 
3,671

Bellemeade 2018-2 Ltd. (Aug-18)
653,278

 
874

 
4,005

 
4,879

Bellemeade 2018-3 Ltd. (Oct-18)
506,110

 
469

 
1,836

 
2,305

Total
$
1,881,467

 
$
1,752

 
$
11,190

 
$
12,942


See note 16.

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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

12.    Other Comprehensive Income (Loss)

The following tables present details about amounts reclassified from accumulated other comprehensive income and the tax effects allocated to each component of other comprehensive income (loss):
 
 
 
 
Amounts Reclassified from AOCI
 
 
Consolidated Statement of Income
 
Three Months Ended
 
Six Months Ended
Details About
 
Line Item That Includes
 
June 30,
 
June 30,
AOCI Components
 
Reclassification
 
2019
 
2018
 
2019
 
2018
 
 
 
 
 
 
 
 
 
 
 
Unrealized appreciation on available-for-sale investments
 
 
 
 
 
 
 
 
 
 
Net realized gains (losses)
 
$
59,809

 
$
(38,935
)
 
$
71,518

 
$
(106,521
)
 
 
Other-than-temporary impairment losses
 
(49
)
 
(470
)
 
(1,358
)
 
(632
)
 
 
Total before tax
 
59,760

 
(39,405
)
 
70,160

 
(107,153
)
 
 
Income tax (expense) benefit
 
(4,415
)
 
2,762

 
(4,594
)
 
8,049

 
 
Net of tax
 
$
55,345

 
$
(36,643
)
 
$
65,566

 
$
(99,104
)

 
Before Tax Amount
 
Tax Expense (Benefit)
 
Net of Tax Amount
Three Months Ended June 30, 2019
 
 
 
 
 
Unrealized appreciation (decline) in value of investments:
 
 
 
 
 
Unrealized holding gains (losses) arising during period
$
248,074

 
$
25,601

 
$
222,473

Portion of other-than-temporary impairment losses recognized in other comprehensive income (loss)
—

 
—

 
—

Less reclassification of net realized gains (losses) included in net income
59,760

 
4,415

 
55,345

Foreign currency translation adjustments
4,409

 
142

 
4,267

Other comprehensive income (loss)
$
192,723

 
$
21,328

 
$
171,395

 
 
 
 
 
 
Three Months Ended June 30, 2018
 
 
 
 
 
Unrealized appreciation (decline) in value of investments:
 
 
 
 
 
Unrealized holding gains (losses) arising during period
$
(88,034
)
 
$
(2,763
)
 
$
(85,271
)
Portion of other-than-temporary impairment losses recognized in other comprehensive income (loss)
—

 
—

 
—

Less reclassification of net realized gains (losses) included in net income
(39,405
)
 
(2,762
)
 
(36,643
)
Foreign currency translation adjustments
(12,701
)
 
(106
)
 
(12,595
)
Other comprehensive income (loss)
$
(61,330
)
 
$
(107
)
 
$
(61,223
)
 
 
 
 
 
 
Six Months Ended June 30, 2019
 
 
 
 
 
Unrealized appreciation (decline) in value of investments:
 
 
 
 
 
Unrealized holding gains (losses) arising during period
$
503,064

 
$
54,704

 
$
448,360

Portion of other-than-temporary impairment losses recognized in other comprehensive income (loss)
—

 
—

 
—

Less reclassification of net realized gains (losses) included in net income
70,160

 
4,594

 
65,566

Foreign currency translation adjustments
10,053

 
270

 
9,783

Other comprehensive income (loss)
$
442,957

 
$
50,380

 
$
392,577

 
 
 
 
 
 
Six Months Ended June 30, 2018
 
 
 
 
 
Unrealized appreciation (decline) in value of investments:
 
 
 
 
 
Unrealized holding gains (losses) arising during period
$
(277,977
)
 
$
(26,029
)
 
$
(251,948
)
Portion of other-than-temporary impairment losses recognized in other comprehensive income (loss)
—

 
—

 
—

Less reclassification of net realized gains (losses) included in net income
(107,153
)
 
(8,049
)
 
(99,104
)
Foreign currency translation adjustments
(11,269
)
 
44

 
(11,313
)
Other comprehensive income (loss)
$
(182,093
)
 
$
(17,936
)
 
$
(164,157
)



ARCH CAPITAL
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Table of Contents
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

13.     Guarantor Financial Information
The following tables present condensed financial information for Arch Capital, Arch Capital Group (U.S.) Inc. (“Arch-U.S.”), a 100% owned subsidiary of Arch Capital, and Arch Capital’s other subsidiaries. The senior notes of Arch-U.S. due November 1, 2043 are fully and unconditionally guaranteed by Arch Capital.
 

June 30, 2019
Condensed Consolidating Balance Sheet
Arch Capital (Parent Guarantor)
 
Arch-U.S. (Subsidiary Issuer)
 
Other Arch Capital Subsidiaries
 
Consolidating Adjustments and Eliminations
 
Arch Capital Consolidated
Assets
 
 
 
 
 
 
 
 
 
Total investments
$
40

 
$
483,904

 
$
22,693,719

 
$
(49,700
)
 
$
23,127,963

Cash
10,750

 
47,875

 
546,691

 
—

 
605,316

Investments in subsidiaries
11,045,465

 
4,493,198

 
—

 
(15,538,663
)
 
—

Due from subsidiaries and affiliates
332

 
2

 
1,881,929

 
(1,882,263
)
 
—

Premiums receivable
—

 
—

 
2,291,360

 
(685,320
)
 
1,606,040

Reinsurance recoverable on unpaid and paid losses and loss adjustment expenses
—

 
—

 
8,618,279

 
(5,447,022
)
 
3,171,257

Contractholder receivables
—

 
—

 
2,102,544

 
—

 
2,102,544

Ceded unearned premiums
—

 
—

 
1,984,219

 
(847,491
)
 
1,136,728

Deferred acquisition costs
—

 
—

 
658,992

 
(58,252
)
 
600,740

Goodwill and intangible assets
—

 
—

 
641,010

 
—

 
641,010

Other assets
22,950

 
40,345

 
1,953,732

 
(156,955
)
 
1,860,072

 
Total assets
$
11,079,537

 
$
5,065,324

 
$
43,372,475

 
$
(24,665,666
)
 
$
34,851,670

 
 
 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
 
Reserve for losses and loss adjustment expenses
$
—

 
$
—

 
$
17,430,847

 
$
(5,200,531
)
 
$
12,230,316

Unearned premiums
—

 
—

 
4,904,351

 
(847,491
)
 
4,056,860

Reinsurance balances payable
—

 
—

 
1,217,310

 
(685,320
)
 
531,990

Contractholder payables
—

 
—

 
2,102,544

 
—

 
2,102,544

Collateral held for insured obligations
—

 
—

 
237,056

 

 
237,056

Senior notes
297,201

 
494,776

 
941,888

 
—

 
1,733,865

Revolving credit agreement borrowings
—

 
—

 
491,006

 
—

 
491,006

Due to subsidiaries and affiliates
9

 
536,747

 
1,345,507

 
(1,882,263
)
 
—

Other liabilities
24,975

 
64,956

 
2,055,626

 
(496,698
)
 
1,648,859

 
Total liabilities
322,185

 
1,096,479

 
30,726,135

 
(9,112,303
)
 
23,032,496

 
 
 
 
 
 
 
 
 
 
 
Redeemable noncontrolling interests
—

 
—

 
221,175

 
(14,700
)
 
206,475

 
 
 
 
 
 
 
 
 
 
 
Shareholders’ Equity
 
 
 
 
 
 
 
 
 
Total shareholders’ equity available to Arch
10,757,352

 
3,968,845

 
11,569,818

 
(15,538,663
)
 
10,757,352

Non-redeemable noncontrolling interests
—

 
—

 
855,347

 
—

 
855,347

 
Total shareholders’ equity
10,757,352

 
3,968,845

 
12,425,165

 
(15,538,663
)
 
11,612,699

 
 
 
 
 
 
 
 
 
 
 
Total liabilities, noncontrolling interests and shareholders’ equity
$
11,079,537

 
$
5,065,324

 
$
43,372,475

 
$
(24,665,666
)
 
$
34,851,670








ARCH CAPITAL
 40
2019 SECOND QUARTER FORM 10-Q
Table of Contents
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)


 
 
December 31, 2018
Condensed Consolidating Balance Sheet
Arch Capital (Parent Guarantor)
 
Arch-U.S. (Subsidiary Issuer)
 
Other Arch Capital Subsidiaries
 
Consolidating Adjustments and Eliminations
 
Arch Capital Consolidated
Assets
 
 
 
 
 
 
 
 
 
Total investments
$
104

 
$
452,674

 
$
21,307,206

 
$
(14,700
)
 
$
21,745,284

Cash
6,125

 
5,940

 
634,491

 
—

 
646,556

Investments in subsidiaries
9,735,256

 
3,999,243

 
—

 
(13,734,499
)
 
—

Due from subsidiaries and affiliates
9

 
2

 
1,802,686

 
(1,802,697
)
 
—

Premiums receivable
—

 
—

 
1,834,389

 
(535,239
)
 
1,299,150

Reinsurance recoverable on unpaid and paid losses and loss adjustment expenses
—

 
—

 
8,618,660

 
(5,699,288
)
 
2,919,372

Contractholder receivables
—

 
—

 
2,079,111

 
—

 
2,079,111

Ceded unearned premiums
—

 
—

 
1,730,262

 
(754,793
)
 
975,469

Deferred acquisition costs
—

 
—

 
618,535

 
(48,961
)
 
569,574

Goodwill and intangible assets
—

 
—

 
634,920

 
—

 
634,920

Other assets
12,588

 
80,949

 
1,466,438

 
(211,082
)
 
1,348,893

 
Total assets
$
9,754,082

 
$
4,538,808

 
$
40,726,698

 
$
(22,801,259
)
 
$
32,218,329

 
 
 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
 
Reserve for losses and loss adjustment expenses
$
—

 
$
—

 
$
17,345,142

 
$
(5,491,845
)
 
$
11,853,297

Unearned premiums
—

 
—

 
4,508,429

 
(754,793
)
 
3,753,636

Reinsurance balances payable
—

 
—

 
928,346

 
(535,239
)
 
393,107

Contractholder payables
—

 
—

 
2,079,111

 
—

 
2,079,111

Collateral held for insured obligations
—

 
—

 
236,630

 
—

 
236,630

Senior notes
297,150

 
494,723

 
941,655

 
—

 
1,733,528

Revolving credit agreement borrowings
—

 
—

 
455,682

 
—

 
455,682

Due to subsidiaries and affiliates
—

 
536,805

 
1,265,892

 
(1,802,697
)
 
—

Other liabilities
17,105

 
26,270

 
1,699,768

 
(467,484
)
 
1,275,659

 
Total liabilities
314,255

 
1,057,798

 
29,460,655

 
(9,052,058
)
 
21,780,650

 
 
 
 
 
 
 
 
 
 
 
Redeemable noncontrolling interests
—

 
—

 
220,992

 
(14,700
)
 
206,292

 
 
 
 
 
 
 
 
 
 
 
Shareholders’ Equity
 
 
 
 
 
 
 
 
 
Total shareholders’ equity available to Arch
9,439,827

 
3,481,010

 
10,253,491

 
(13,734,501
)
 
9,439,827

Non-redeemable noncontrolling interests
—

 
—

 
791,560

 
—

 
791,560

 
Total shareholders’ equity
9,439,827

 
3,481,010

 
11,045,051

 
(13,734,501
)
 
10,231,387

 
 
 
 
 
 
 
 
 
 
 
Total liabilities, noncontrolling interests and shareholders’ equity
$
9,754,082

 
$
4,538,808

 
$
40,726,698

 
$
(22,801,259
)
 
$
32,218,329



ARCH CAPITAL
 41
2019 SECOND QUARTER FORM 10-Q
Table of Contents
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)


 
 
Three Months Ended June 30, 2019
Condensed Consolidating Statement of Income and Comprehensive Income
Arch Capital (Parent Guarantor)
 
Arch-U.S. (Subsidiary Issuer)
 
Other Arch Capital Subsidiaries
 
Consolidating Adjustments and Eliminations
 
Arch Capital Consolidated
Revenues
 
 
 
 
 
 
 
 
 
Net premiums earned
$
—

 
$
—

 
$
1,463,727

 
$
—

 
$
1,463,727

Net investment income
38

 
2,847

 
174,738

 
(22,585
)
 
155,038

Net realized gains (losses)
—

 
5,825

 
115,620

 
(639
)
 
120,806

Net impairment losses recognized in earnings
—

 
—

 
(49
)
 
—

 
(49
)
Other underwriting income
—

 
—

 
5,953

 
—

 
5,953

Equity in net income (loss) of investment funds accounted for using the equity method
—

 
(64
)
 
32,600

 
—

 
32,536

Other income (loss)
(242
)
 
—

 
1,371

 
—

 
1,129

 
Total revenues
(204
)
 
8,608

 
1,793,960

 
(23,224
)
 
1,779,140

 
 
 
 
 
 
 
 
 
 
 
Expenses
 
 
 
 
 
 
 
 
 
Losses and loss adjustment expenses
—

 
—

 
767,543

 
—

 
767,543

Acquisition expenses
—

 
—

 
210,089

 
—

 
210,089

Other operating expenses
—

 
—

 
198,914

 
—

 
198,914

Corporate expenses
15,293

 
2,115

 
843

 
—

 
18,251

Amortization of intangible assets
—

 
—

 
19,794

 
—

 
19,794

Interest expense
5,538

 
11,996

 
34,012

 
(22,266
)
 
29,280

Net foreign exchange (gains) losses
—

 
—

 
(1,187
)
 
6,139

 
4,952

 
Total expenses
20,831

 
14,111

 
1,230,008

 
(16,127
)
 
1,248,823

 
 
 
 
 
 
 
 
 
 
 
Income (loss) before income taxes
(21,035
)
 
(5,503
)
 
563,952

 
(7,097
)
 
530,317

Income tax (expense) benefit
—

 
1,301

 
(45,773
)
 
—

 
(44,472
)
Income (loss) before equity in net income of subsidiaries
(21,035
)
 
(4,202
)
 
518,179

 
(7,097
)
 
485,845

Equity in net income of subsidiaries
489,989

 
148,747

 
—

 
(638,736
)
 
—

Net income
468,954

 
144,545

 
518,179

 
(645,833
)
 
485,845

Net (income) loss attributable to noncontrolling interests
—

 
—

 
(17,210
)
 
319

 
(16,891
)
Net income available to Arch
468,954

 
144,545

 
500,969

 
(645,514
)
 
468,954

Preferred dividends
(10,403
)
 
—

 
—

 
—

 
(10,403
)
Net income available to Arch common shareholders
$
458,551

 
$
144,545

 
$
500,969

 
$
(645,514
)
 
$
458,551

 
 
 
 
 
 
 
 
 
 
 
Comprehensive income available to Arch
$
637,458

 
$
231,120

 
$
663,685

 
$
(894,805
)
 
$
637,458



ARCH CAPITAL
 42
2019 SECOND QUARTER FORM 10-Q
Table of Contents
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)


 
 
Three Months Ended June 30, 2018
Condensed Consolidating Statement of Income and Comprehensive Income
Arch Capital (Parent Guarantor)
 
Arch-U.S. (Subsidiary Issuer)
 
Other Arch Capital Subsidiaries
 
Consolidating Adjustments and Eliminations
 
Arch Capital Consolidated
Revenues
 
 
 
 
 
 
 
 
 
Net premiums earned
$
—

 
$
—

 
$
1,336,763

 
$
—

 
$
1,336,763

Net investment income
15

 
560

 
157,532

 
(22,439
)
 
135,668

Net realized gains (losses)
—

 
—

 
(76,611
)
 
—

 
(76,611
)
Net impairment losses recognized in earnings
—

 
—

 
(470
)
 
—

 
(470
)
Other underwriting income
—

 
—

 
3,874

 
—

 
3,874

Equity in net income (loss) of investment funds accounted for using the equity method
—

 
—

 
8,472

 
—

 
8,472

Other income (loss)
2,339

 
—

 
774

 
—

 
3,113

 
Total revenues
2,354

 
560

 
1,430,334

 
(22,439
)
 
1,410,809

 
 
 
 
 
 
 
 
 
 
 
Expenses
 
 
 
 
 
 
 
 
 
Losses and loss adjustment expenses
—

 
—

 
726,153

 
—

 
726,153

Acquisition expenses
—

 
—

 
202,838

 
—

 
202,838

Other operating expenses
—

 
—

 
176,181

 
—

 
176,181

Corporate expenses
16,642

 
470

 
5,400

 
—

 
22,512

Amortization of intangible assets
—

 
—

 
26,472

 
—

 
26,472

Interest expense
5,537

 
12,013

 
34,911

 
(22,117
)
 
30,344

Net foreign exchange (gains) losses
—

 
—

 
(43,357
)
 
(10,349
)
 
(53,706
)
 
Total expenses
22,179

 
12,483

 
1,128,598

 
(32,466
)
 
1,130,794

 
 
 
 
 
 
 
 
 
 
 
Income (loss) before income taxes
(19,825
)
 
(11,923
)
 
301,736

 
10,027

 
280,015

Income tax (expense) benefit
—

 
2,477

 
(26,145
)
 
—

 
(23,668
)
Income (loss) before equity in net income of subsidiaries
(19,825
)
 
(9,446
)
 
275,591

 
10,027

 
256,347

Equity in net income of subsidiaries
263,471

 
86,727

 
—

 
(350,198
)
 
—

Net income (loss)
243,646

 
77,281

 
275,591

 
(340,171
)
 
256,347

Net (income) loss attributable to noncontrolling interests
—

 
—

 
(13,023
)
 
322

 
(12,701
)
Net income (loss) available to Arch
243,646

 
77,281

 
262,568

 
(339,849
)
 
243,646

Preferred dividends
(10,403
)
 
—

 
—

 
—

 
(10,403
)
Net income (loss) available to Arch common shareholders
$
233,243

 
$
77,281

 
$
262,568

 
$
(339,849
)
 
$
233,243

 
 
 
 
 
 
 
 
 
 
 
Comprehensive income available to Arch
$
183,500

 
$
70,066

 
$
212,802

 
$
(282,868
)
 
$
183,500




ARCH CAPITAL
 43
2019 SECOND QUARTER FORM 10-Q
Table of Contents
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 
 
Six Months Ended June 30, 2019
Condensed Consolidating Statement of Income and Comprehensive Income
Arch Capital (Parent Guarantor)
 
Arch-U.S. (Subsidiary Issuer)
 
Other Arch Capital Subsidiaries
 
Consolidating Adjustments and Eliminations
 
Arch Capital Consolidated
Revenues
 
 
 
 
 
 
 
 
 
Net premiums earned
$
—

 
$
—

 
$
2,832,593

 
$
—

 
$
2,832,593

Net investment income
84

 
6,526

 
350,410

 
(45,033
)
 
311,987

Net realized gains (losses)
—

 
14,343

 
253,673

 
(5,645
)
 
262,371

Net impairment losses recognized in earnings
—

 
—

 
(1,358
)
 
—

 
(1,358
)
Other underwriting income
—

 
—

 
14,778

 
—

 
14,778

Equity in net income (loss) of investment funds accounted for using the equity method
—

 
(64
)
 
79,467

 
—

 
79,403

Other income (loss)
(481
)
 
—

 
2,693

 
—

 
2,212

 
Total revenues
(397
)
 
20,805

 
3,532,256

 
(50,678
)
 
3,501,986

 
 
 
 
 
 
 
 
 
 
 
Expenses
 
 
 
 
 
 
 
 
 
Losses and loss adjustment expenses
—

 
—

 
1,486,075

 
—

 
1,486,075

Acquisition expenses
—

 
—

 
407,937

 
—

 
407,937

Other operating expenses
—

 
—

 
400,077

 
—

 
400,077

Corporate expenses
31,600

 
4,281

 
332

 
—

 
36,213

Amortization of intangible assets
—

 
—

 
40,211

 
—

 
40,211

Interest expense
11,076

 
23,947

 
67,718

 
(44,396
)
 
58,345

Net foreign exchange (gains) losses
2

 
—

 
(1,310
)
 
2,735

 
1,427

 
Total expenses
42,678

 
28,228

 
2,401,040

 
(41,661
)
 
2,430,285

 
 
 
 
 
 
 
 
 
 
 
Income (loss) before income taxes
(43,075
)
 
(7,423
)
 
1,131,216

 
(9,017
)
 
1,071,701

Income tax (expense) benefit
—

 
1,844

 
(92,202
)
 
—

 
(90,358
)
Income (loss) before equity in net income of subsidiaries
(43,075
)
 
(5,579
)
 
1,039,014

 
(9,017
)
 
981,343

Equity in net income of subsidiaries
960,557

 
285,301

 
—

 
(1,245,858
)
 
—

Net income
917,482

 
279,722

 
1,039,014

 
(1,254,875
)
 
981,343

Net (income) loss attributable to noncontrolling interests
—

 
—

 
(64,499
)
 
638

 
(63,861
)
Net income available to Arch
917,482

 
279,722

 
974,515

 
(1,254,237
)
 
917,482

Preferred dividends
(20,806
)
 
—

 
—

 
—

 
(20,806
)
Net income available to Arch common shareholders
$
896,676

 
$
279,722

 
$
974,515

 
$
(1,254,237
)
 
$
896,676

 
 
 
 
 
 
 
 
 
 
 
Comprehensive income available to Arch
$
1,303,029

 
$
469,276

 
$
1,352,225

 
$
(1,821,501
)
 
$
1,303,029



ARCH CAPITAL
 44
2019 SECOND QUARTER FORM 10-Q
Table of Contents
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)


 
 
Six Months Ended June 30, 2018
Condensed Consolidating Statement of Income and Comprehensive Income
Arch Capital (Parent Guarantor)
 
Arch-U.S. (Subsidiary Issuer)
 
Other Arch Capital Subsidiaries
 
Consolidating Adjustments and Eliminations
 
Arch Capital Consolidated
Revenues
 
 
 
 
 
 
 
 
 
Net premiums earned
$
—

 
$
—

 
$
2,571,662

 
$
—

 
$
2,571,662

Net investment income
35

 
818

 
306,299

 
(44,760
)
 
262,392

Net realized gains (losses)
29

 
(7
)
 
(187,631
)
 
—

 
(187,609
)
Net impairment losses recognized in earnings
—

 
—

 
(632
)
 
—

 
(632
)
Other underwriting income
—

 
—

 
9,223

 
—

 
9,223

Equity in net income (loss) of investment funds accounted for using the equity method
—

 
—

 
36,541

 
—

 
36,541

Other income (loss)
2,261

 
—

 
926

 
—

 
3,187

 
Total revenues
2,325

 
811

 
2,736,388

 
(44,760
)
 
2,694,764

 
 
 
 
 
 
 
 
 
 
 
Expenses
 
 
 
 
 
 
 
 
 
Losses and loss adjustment expenses
—

 
—

 
1,363,013

 
—

 
1,363,013

Acquisition expenses
—

 
—

 
394,214

 
—

 
394,214

Other operating expenses
—

 
—

 
351,196

 
—

 
351,196

Corporate expenses
32,811

 
759

 
4,254

 
—

 
37,824

Amortization of intangible assets
—

 
—

 
53,208

 
—

 
53,208

Interest expense
11,073

 
23,939

 
70,083

 
(44,115
)
 
60,980

Net foreign exchange (gains) losses
29

 
—

 
(26,921
)
 
(7,093
)
 
(33,985
)
 
Total expenses
43,913

 
24,698

 
2,209,047

 
(51,208
)
 
2,226,450

 
 
 
 
 
 
 
 
 
 
 
Income (loss) before income taxes
(41,588
)
 
(23,887
)
 
527,341

 
6,448

 
468,314

Income tax (expense) benefit
—

 
5,428

 
(51,011
)
 
—

 
(45,583
)
Income (loss) before equity in net income of subsidiaries
(41,588
)
 
(18,459
)
 
476,330

 
6,448

 
422,731

Equity in net income of subsidiaries
435,657

 
173,147

 
—

 
(608,804
)
 
—

Net income
394,069

 
154,688

 
476,330

 
(602,356
)
 
422,731

Net (income) loss attributable to noncontrolling interests
—

 
—

 
(29,307
)
 
645

 
(28,662
)
Net income available to Arch
394,069

 
154,688

 
447,023

 
(601,711
)
 
394,069

Preferred dividends
(20,840
)
 
—

 
—

 
—

 
(20,840
)
Loss on redemption of preferred shares
(2,710
)
 
—

 
—

 
—

 
(2,710
)
Net income available to Arch common shareholders
$
370,519

 
$
154,688

 
$
447,023

 
$
(601,711
)
 
$
370,519

 
 
 
 
 
 
 
 
 
 
 
Comprehensive income available to Arch
$
231,662

 
$
76,603

 
$
291,883

 
$
(368,486
)
 
$
231,662





ARCH CAPITAL
 45
2019 SECOND QUARTER FORM 10-Q
Table of Contents
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)


 
 
Six Months Ended June 30, 2019
Condensed Consolidating Statement
of Cash Flows
Arch Capital (Parent Guarantor)
 
Arch-U.S. (Subsidiary Issuer)
 
Other Arch Capital Subsidiaries
 
Consolidating Adjustments and Eliminations
 
Arch Capital Consolidated
Operating Activities
 
 
 
 
 
 
 
 
 
 
Net Cash Provided By (Used For) Operating Activities
$
30,946

 
$
24,059

 
$
749,885

 
$
(92,366
)
 
$
712,524

Investing Activities
 
 
 
 
 
 
 
 
 
Purchases of fixed maturity investments
—

 
(358,996
)
 
(15,973,650
)
 
—

 
(16,332,646
)
Purchases of equity securities
—

 
(56,441
)
 
(447,742
)
 
72,244

 
(431,939
)
Purchases of other investments
—

 
(17,891
)
 
(659,172
)
 
—

 
(677,063
)
Proceeds from the sales of fixed maturity investments
—

 
452,729

 
15,179,753

 
—

 
15,632,482

Proceeds from the sales of equity securities
—

 
—

 
248,945

 
(72,244
)
 
176,701

Proceeds from the sales, redemptions and maturities of other investments
—

 
391

 
534,307

 
—

 
534,698

Proceeds from redemptions and maturities of fixed maturity investments
—

 
100

 
244,849

 
—

 
244,949

Net settlements of derivative instruments
—

 
—

 
87,701

 
—

 
87,701

Net (purchases) sales of short-term investments
64

 
(2,015
)
 
203,471

 
—

 
201,520

Change in cash collateral related to securities lending
—

 
—

 
7,590

 
—

 
7,590

Contributions to subsidiaries
(2,121
)
 
—

 
(59,527
)
 
61,648

 
—

Issuance of intercompany loans
—

 
—

 
(53,828
)
 
53,828

 
—

Purchases of fixed assets
(32
)
 
—

 
(16,327
)
 
—

 
(16,359
)
Other
—

 
—

 
(174,578
)
 
—

 
(174,578
)
 
Net Cash Provided By (Used For) Investing Activities
(2,089
)
 
17,877

 
(878,208
)
 
115,476

 
(746,944
)
Financing Activities
 
 
 
 
 
 
 
 
 
Purchases of common shares under share repurchase program
(2,871
)
 
—

 
—

 
—

 
(2,871
)
Proceeds from common shares issued, net
(557
)
 
—

 
61,648

 
(61,648
)
 
(557
)
Proceeds from intercompany borrowings
—

 
—

 
53,828

 
(53,828
)
 
—

Proceeds from borrowings
—

 
—

 
62,800

 
—

 
62,800

Repayments of borrowings
—

 
—

 
(27,538
)
 
—

 
(27,538
)
Change in cash collateral related to securities lending
—

 
—

 
(7,590
)
 
—

 
(7,590
)
Dividends paid to redeemable noncontrolling interests
—

 
—

 
(9,632
)
 
638

 
(8,994
)
Dividends paid to parent (1)
—

 
—

 
(91,728
)
 
91,728

 
—

Other
—

 
—

 
(3,529
)
 
—

 
(3,529
)
Preferred dividends paid
(20,806
)
 
—

 
—

 
—

 
(20,806
)
 
Net Cash Provided By (Used For) Financing Activities
(24,234
)
 
—

 
38,259

 
(23,110
)
 
(9,085
)
Effects of exchange rates changes on foreign currency cash and restricted cash
—

 
—

 
1,937

 
—

 
1,937

Increase (decrease) in cash and restricted cash
4,623

 
41,936

 
(88,127
)
 
—

 
(41,568
)
Cash and restricted cash, beginning of year
6,159

 
5,940

 
712,544

 
—

 
724,643

Cash and restricted cash, end of period
$
10,782

 
$
47,876

 
$
624,417

 
$
—

 
$
683,075


(1)     Dividends received by parent are included in net cash provided by (used for) operating activities.


ARCH CAPITAL
 46
2019 SECOND QUARTER FORM 10-Q
Table of Contents
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)


 
 
Six Months Ended June 30, 2018
Condensed Consolidating Statement
of Cash Flows
Arch Capital (Parent Guarantor)
 
Arch-U.S. (Subsidiary Issuer)
 
Other Arch Capital Subsidiaries
 
Consolidating Adjustments and Eliminations
 
Arch Capital Consolidated
Operating Activities
 
 
 
 
 
 
 
 
 
 
Net Cash Provided By (Used For) Operating Activities
$
201,487

 
$
149,576

 
$
1,010,703

 
$
(864,880
)
 
$
496,886

Investing Activities
 
 
 
 
 
 
 
 
 
Purchases of fixed maturity investments
—

 
(125,440
)
 
(17,347,846
)
 
605,716

 
(16,867,570
)
Purchases of equity securities
—

 
—

 
(679,663
)
 
—

 
(679,663
)
Purchases of other investments
—

 
—

 
(1,017,147
)
 
—

 
(1,017,147
)
Proceeds from the sales of fixed maturity investments
—

 
33,793

 
16,662,466

 
(605,716
)
 
16,090,543

Proceeds from the sales of equity securities
—

 
—

 
622,068

 
—

 
622,068

Proceeds from the sales, redemptions and maturities of other investments
—

 
—

 
773,298

 
—

 
773,298

Proceeds from redemptions and maturities of fixed maturity investments
—

 
—

 
511,448

 
—

 
511,448

Net settlements of derivative instruments
—

 
—

 
4,498

 
—

 
4,498

Net (purchases) sales of short-term investments
96,446

 
(59,798
)
 
415,253

 
—

 
451,901

Change in cash collateral related to securities lending
—

 
—

 
176,304

 
—

 
176,304

Contributions to subsidiaries
—

 
(1,000
)
 
(22,595
)
 
23,595

 
—

Purchases of fixed assets
(71
)
 
—

 
(13,171
)
 
—

 
(13,242
)
Other
(4
)
 
—

 
49,965

 
—

 
49,961

 
Net Cash Provided By (Used For) Investing Activities
96,371

 
(152,445
)
 
134,878

 
23,595

 
102,399

Financing Activities
 
 
 
 
 
 
 
 
 
Redemption of preferred shares
(92,555
)
 
—

 
—

 
—

 
(92,555
)
Purchases of common shares under share repurchase program
(173,575
)
 
—

 
—

 
—

 
(173,575
)
Proceeds from common shares issued, net
(13,851
)
 
—

 
23,595

 
(23,595
)
 
(13,851
)
Proceeds from borrowings
—

 
—

 
130,579

 
—

 
130,579

Repayments of borrowings
—

 
—

 
(373,000
)
 
—

 
(373,000
)
Change in cash collateral related to securities lending
—

 
—

 
(176,304
)
 
—

 
(176,304
)
Dividends paid to redeemable noncontrolling interests
—

 
—

 
(9,632
)
 
638

 
(8,994
)
Dividends paid to parent (1)
—

 
—

 
(864,242
)
 
864,242

 
—

Other
—

 
—

 
(4,489
)
 
—

 
(4,489
)
Preferred dividends paid
(20,840
)
 
—

 
—

 
—

 
(20,840
)
 
Net Cash Provided By (Used For) Financing Activities
(300,821
)
 
—

 
(1,273,493
)
 
841,285

 
(733,029
)
Effects of exchange rates changes on foreign currency cash and restricted cash
—

 
—

 
(10,431
)
 
—

 
(10,431
)
Increase (decrease) in cash and restricted cash
(2,963
)
 
(2,869
)
 
(138,343
)
 
—

 
(144,175
)
Cash and restricted cash, beginning of year
10,048

 
30,380

 
686,856

 
—

 
727,284

Cash and restricted cash, end of period
$
7,085

 
$
27,511

 
$
548,513

 
$
—

 
$
583,109



(1)     Dividends received by parent are included in net cash provided by (used for) operating activities.




ARCH CAPITAL
 47
2019 SECOND QUARTER FORM 10-Q
Table of Contents
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

14.    Income Taxes
The Company’s income tax provision on income before income taxes resulted in an expense of 8.4% for the six months ended June 30, 2019, compared to an expense of 9.7% for the 2018 period. The Company’s effective tax rate, which is based upon the expected annual effective tax rate, may fluctuate from period to period based on the relative mix of income or loss reported by jurisdiction and the varying tax rates in each jurisdiction. For interim reporting purposes, the Company has calculated its annual effective tax rate for the full year of 2019 by treating excess tax benefits that arise from the accounting for stock based compensation as a discrete item. As such, this amount is not included when projecting the Company’s full year annual effective tax rate but rather is accounted for at the U.S. Federal statutory rate of 21% after applying the projected full year annual effective tax rate to actual six months results before the discrete item. The impact of the discrete item resulted in a benefit of 0.4% for the six months ended June 30, 2019.
The Company had a net deferred tax liability of $49.5 million at June 30, 2019, compared to a net deferred tax asset of $22.5 million at December 31, 2018. The change is primarily a result of the appreciation of the Company’s fixed maturities from December 31, 2018 to June 30, 2019. In addition, the Company paid $43.5 million and recovered $46.5 million of income taxes for the six months ended June 30, 2019 and 2018, respectively.
15.    Legal Proceedings
The Company, in common with the insurance industry in general, is subject to litigation and arbitration in the normal course of its business. As of June 30, 2019, the Company was not a party to any litigation or arbitration which is expected by management to have a material adverse effect on the Company’s results of operations and financial condition and liquidity.
16.    Subsequent Events

Bellemeade Re 2019-3 Ltd.
In July 2019, the Company’s first-lien U.S. mortgage insurance subsidiaries entered into an aggregate excess of loss reinsurance agreement with Bellemeade Re 2019-3 Ltd. (“Bellemeade 2019-3”), a special purpose reinsurance company domiciled in Bermuda. The Bellemeade 2019-3 agreement provides for up to $700.9 million of aggregate excess of loss reinsurance coverage at inception in excess of $232.1 million of aggregate losses for new delinquencies on a portfolio of in-force policies issued in 2016. The coverage amount decreases over a ten-year period as the underlying covered mortgages amortize.
Bellemeade 2019-3 financed the coverage through the issuance of mortgage insurance-linked notes in an aggregate amount of
 
approximately $700.9 million to unrelated investors (the “Notes”). The maturity date of the Notes is July 25, 2029. The Notes will be redeemed prior to maturity upon the occurrence of a mandatory termination event or if the ceding insurers trigger a termination of the reinsurance agreement following the occurrence of an optional termination event. All of the proceeds paid to Bellemeade 2019-3 from the sale of the Notes were deposited into a reinsurance trust as security for Bellemeade 2019-3’s obligations. At all times, funds in the reinsurance trust account are required to be invested in high credit quality money market funds.
Watford Re Capital Transactions
On July 2, 2019, Watford Holdings Ltd. completed an offering of $175.0 million in aggregate principal amount of its 6.5% senior notes, due July 2, 2029 (“Watford Senior Notes”). Interest on such notes will be paid semi-annually in arrears on each January 2 and July 2, commencing January 2, 2020. The $172.4 million net proceeds from the offering were used to redeem a portion of Watford Holdings Ltd.’s outstanding preference shares.
On August 1, 2019, Watford Holdings Ltd. redeemed 6,919,998 of its 9,065,200 total issued and outstanding Watford Preference Shares. The Watford Preference Shares were redeemed at a total redemption price of $25.19748 per share, inclusive of all declared and unpaid dividends, with accumulation of any undeclared dividends on or after June 30, 2019.
The Company purchased $35.0 million in aggregate principal amount of the Watford Senior Notes. In addition, the Company received $11.5 million pursuant to the redemption of Watford Preference Shares.
Business Acquisition
On July 30, 2019, the Company announced that it has entered into an agreement to purchase Barbican Group Holdings Limited from funds managed by Carlson Capital, a U.S. based alternative asset management firm. The acquisition includes Barbican Managing Agency Limited, Lloyd’s Syndicate 1955, Lloyd’s Syndicate 1856, Lloyd’s Special Purpose Arrangement 6132, Castel Underwriting Agencies Limited and other associated entities. The transaction is subject to regulatory approval and is expected to close in the late third or early fourth quarter of 2019.

ARCH CAPITAL
 48
2019 SECOND QUARTER FORM 10-Q

ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following is a discussion and analysis of our financial condition and results of operations. This should be read in conjunction with our consolidated financial statements included in Item 1 of this report and also our Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended December 31, 2018 (“2018 Form 10-K”). In addition, readers should review “Risk Factors” set forth in Item 1A of Part I of our 2018 Form 10-K. Tabular amounts are in U.S. Dollars in thousands, except share amounts, unless otherwise noted.
Arch Capital Group Ltd. (“Arch Capital” and, together with its subsidiaries, “Arch”, “we” or “us”) is a Bermuda public limited liability company with approximately $12.49 billion in capital at June 30, 2019 and, through operations in Bermuda, the United States, Europe, Canada and Australia, writes insurance, reinsurance and mortgage insurance on a worldwide basis.
CURRENT OUTLOOK
Our objective is to achieve an average operating return on average equity of 15% or greater over the insurance cycle, which we believe to be an attractive return to our common shareholders given the risks we assume. We continue to look for opportunities to find acceptable books of business to underwrite without sacrificing underwriting discipline and continue to write a portion of our overall book in catastrophe-exposed business which has the potential to increase the volatility of our operating results.
Market conditions in our property casualty segments continued to improve in the 2019 second quarter, with upward rate movement in property and select casualty lines, and we selectively increased our writings. Our underwriting teams continue to execute a disciplined strategy by emphasizing small and medium-sized accounts over large accounts, shrinking premiums in more commoditized lines such as general liability and by utilizing reinsurance purchases to reduce volatility on large account, high capacity business. We believe that the improvement in the markets reflects broader economic growth, particularly in the U.S. Across the property and casualty industry, we have seen several market opportunities where we have increased our capital deployment, notably in the London markets and excess and surplus lines in the U.S. However, the spread between rate changes and loss trend continues to be a key variable in assessing expected returns and can be difficult to quantify precisely, particularly in specialty lines. Writings in net property catastrophe-exposed business continued to remain low in the 2019 second quarter.
 
Our mortgage segment continues to experience generally favorable market conditions. Although pricing remains competitive in the U.S., borrower credit quality and the general economy remain strong. Our results continue to reflect our success in making high quality credit underwriting risk decisions and building customer relationships.
Arch remains committed to providing solutions across many offerings as the marketplace evolves, including the mortgage credit risk transfer programs initiated by government sponsored enterprises, or “GSEs,” in 2018. Such programs have continued to generate business. In addition, we completed three Bellemeade risk transfers in March, April and July 2019, increasing our protection for mortgage tail risk.
FINANCIAL MEASURES
Management uses the following three key financial indicators in evaluating our performance and measuring the overall growth in value generated for Arch Capital’s common shareholders:
Book Value per Share
Book value per share represents total common shareholders’ equity available to Arch divided by the number of common shares outstanding. Management uses growth in book value per share as a key measure of the value generated for our common shareholders each period and believes that book value per share is the key driver of Arch Capital’s share price over time. Book value per share is impacted by, among other factors, our underwriting results, investment returns and share repurchase activity, which has an accretive or dilutive impact on book value per share depending on the purchase price.
Book value per share was $24.64 at June 30, 2019, compared to $23.12 at March 31, 2019 and $20.68 at June 30, 2018. The 6.6% increase for the 2019 second quarter reflected strong underwriting results and the impact of a decrease in interest rates on our fixed income securities while the 19.2% increase over the trailing twelve months reflected strong underwriting results and investment returns.
Operating Return on Average Common Equity
Operating return on average common equity (“Operating ROAE”) represents annualized after-tax operating income available to Arch common shareholders divided by the average of beginning and ending common shareholders’ equity available to Arch during the period. After-tax operating income available to Arch common shareholders, a non-GAAP financial

ARCH CAPITAL
 49
2019 SECOND QUARTER FORM 10-Q

measure as defined in Regulation G, represents net income available to Arch common shareholders, excluding net realized gains or losses, net impairment losses recognized in earnings, equity in net income or loss of investment funds accounted for using the equity method, net foreign exchange gains or losses, transaction costs and other, loss on redemption of preferred shares and income taxes. Management uses Operating ROAE as a key measure of the return generated to common shareholders. See “Comment on Non-GAAP Financial Measures.”
Our Operating ROAE was 13.1% for the 2019 second quarter, compared to 11.6% for the 2018 second quarter, and 12.7% for the six months ended June 30, 2019, compared to 11.4% for the 2018 period. The 2019 and 2018 returns reflected favorable mortgage insurance underwriting performance, strong investment returns and a low level of catastrophic activity.
Total Return on Investments
Total return on investments includes investment income, equity in net income or loss of investment funds accounted for using the equity method, net realized gains and losses and the change in unrealized gains and losses generated by Arch’s investment portfolio. Total return is calculated on a pre-tax basis and before investment expenses, excludes amounts reflected in the ‘other’ segment, and reflects the effect of financial market conditions along with foreign currency fluctuations. In addition, total return incorporates the timing of investment returns during the periods. The following table summarizes our total return compared to the benchmark return against which we measured our portfolio during the periods. See “Comment on Non-GAAP Financial Measures.”
 
Arch
Portfolio
 
Benchmark
Return
Pre-tax total return (before investment expenses):
 
 
 
2019 Second Quarter
2.37
 %
 
2.17
 %
2018 Second Quarter
(0.19
)%
 
(0.21
)%
 
 
 
 
Six Months Ended June 30, 2019
5.14
 %
 
5.05
 %
Six Months Ended June 30, 2018
(0.51
)%
 
(0.89
)%
Total return for the 2019 periods reflected the impact of a decline in interest rates, which increased the total return on our investment grade fixed income portfolio, aided by favorable returns on equities.
The benchmark return index is a customized combination of indices intended to approximate a target portfolio by asset mix and average credit quality while also matching the approximate estimated duration and currency mix of our insurance and reinsurance liabilities. Although the estimated duration and average credit quality of this index will move as the duration and rating of its constituent securities change, generally we do not adjust the composition of the benchmark return index except
 
to incorporate changes to the mix of liability currencies and durations noted above. The benchmark return index should not be interpreted as expressing a preference for or aversion to any particular sector or sector weight. The index is intended solely to provide, unlike many master indices that change based on the size of their constituent indices, a relatively stable basket of investable indices. At June 30, 2019, the benchmark return index had an average credit quality of “Aa3” by Moody’s Investors Service (“Moody’s”), and an estimated duration of 3.06 years.
The benchmark return index included weightings to the following indices:
 
%
ICE BoAML 1-10 Year AAA - A U.S. Corporate Index
21.00
%
ICE BoAML 1-5 Year U.S. Treasury Index
15.00

ICE BoAML 3-5 Year Fixed Rate Asset Backed Securities Index
7.00

ICE BoAML 1-10 Year U.S. Municipal Securities Index
5.00

Bloomberg Barclays CMBS Invest Grade Aaa Total Return Index
5.00

MSCI ACWI Net Total Return USD Index
5.00

Hedge Fund Research HFRX Fixed Income Credit Index
5.00

Hedge Fund Research HFRX Equal Weighted Strategies
5.00

ICE BoAML 1-10 Year BBB U.S. Corporate Index
4.00

ICE BoAML German Government 1-10 Year Index
4.00

ICE BoAML U.S. Mortgage Backed Securities Index
4.00

ICE BoAML 0-3 Month U.S. Treasury Bill Index
4.00

ICE BoAML 1-5 Year U.K. Gilt Index
3.50

ICE BoAML 5-10 Year U.S. Treasury Index
3.00

ICE BoAML 1-5 Year Australian Governments Index
3.00

ICE BoAML U.S. High Yield Constrained Index
2.50

S&P Leveraged Loan Total Return Index
2.50

ICE BoAML 1-5 Year Canada Government Index
1.00

ICE BoAML 20+ Year Canada Government Index
0.50

Total
100.00
%
COMMENT ON NON-GAAP FINANCIAL MEASURES
Throughout this filing, we present our operations in the way we believe will be the most meaningful and useful to investors, analysts, rating agencies and others who use our financial information in evaluating the performance of our company. This presentation includes the use of after-tax operating income available to Arch common shareholders, which is defined as net income available to Arch common shareholders, excluding net realized gains or losses, net impairment losses recognized in earnings, equity in net income or loss of investment funds accounted for using the equity method, net foreign exchange gains or losses, transaction costs and other, loss on redemption of preferred shares and income taxes, and the use of annualized operating return on average common equity. The presentation of after-tax operating income available to Arch common

ARCH CAPITAL
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2019 SECOND QUARTER FORM 10-Q

shareholders and annualized operating return on average common equity are non-GAAP financial measures as defined in Regulation G. The reconciliation of such measures to net income available to Arch common shareholders and annualized return on average common equity (the most directly comparable GAAP financial measures) in accordance with Regulation G is included under “Results of Operations” below. 
We believe that net realized gains or losses, net impairment losses recognized in earnings, equity in net income or loss of investment funds accounted for using the equity method, net foreign exchange gains or losses, transaction costs and other and loss on redemption of preferred shares in any particular period are not indicative of the performance of, or trends in, our business. Although net realized gains or losses, net impairment losses recognized in earnings, equity in net income or loss of investment funds accounted for using the equity method and net foreign exchange gains or losses are an integral part of our operations, the decision to realize investment gains or losses, the recognition of the change in the carrying value of investments accounted for using the fair value option in net realized gains or losses, the recognition of net impairment losses, the recognition of equity in net income or loss of investment funds accounted for using the equity method and the recognition of foreign exchange gains or losses are independent of the insurance underwriting process and result, in large part, from general economic and financial market conditions. Furthermore, certain users of our financial information believe that, for many companies, the timing of the realization of investment gains or losses is largely opportunistic. In addition, net impairment losses recognized in earnings on our investments represent other-than-temporary declines in expected recovery values on securities without actual realization. The use of the equity method on certain of our investments in certain funds that invest in fixed maturity securities is driven by the ownership structure of such funds (either limited partnerships or limited liability companies). In applying the equity method, these investments are initially recorded at cost and are subsequently adjusted based on our proportionate share of the net income or loss of the funds (which include changes in the market value of the underlying securities in the funds). This method of accounting is different from the way we account for our other fixed maturity securities and the timing of the recognition of equity in net income or loss of investment funds accounted for using the equity method may differ from gains or losses in the future upon sale or maturity of such investments. Transaction costs and other include advisory, financing, legal, severance, incentive compensation and other transaction costs related to acquisitions. We believe that transaction costs and other, due to their non-recurring nature, are not indicative of the performance of, or trends in, our business performance. The loss on redemption of preferred shares related to the redemption of our Series C preferred shares in January 2018 and had no impact on shareholders' equity or cash flows. Due to these reasons, we exclude net realized gains or losses, net impairment losses recognized in earnings, equity
 
in net income or loss of investment funds accounted for using the equity method, net foreign exchange gains or losses, transaction costs and other and loss on redemption of preferred shares from the calculation of after-tax operating income available to Arch common shareholders. 
We believe that showing net income available to Arch common shareholders exclusive of the items referred to above reflects the underlying fundamentals of our business since we evaluate the performance of and manage our business to produce an underwriting profit. In addition to presenting net income available to Arch common shareholders, we believe that this presentation enables investors and other users of our financial information to analyze our performance in a manner similar to how management analyzes performance. We also believe that this measure follows industry practice and, therefore, allows the users of financial information to compare our performance with our industry peer group. We believe that the equity analysts and certain rating agencies which follow us and the insurance industry as a whole generally exclude these items from their analyses for the same reasons.
Our segment information includes the presentation of consolidated underwriting income or loss and a subtotal of underwriting income or loss before the contribution from the ‘other’ segment. Such measures represent the pre-tax profitability of our underwriting operations and include net premiums earned plus other underwriting income, less losses and loss adjustment expenses, acquisition expenses and other operating expenses. Other operating expenses include those operating expenses that are incremental and/or directly attributable to our individual underwriting operations. Underwriting income or loss does not incorporate items included in our corporate (non-underwriting) segment. While these measures are presented in note 4, “Segment Information,” of the notes accompanying our consolidated financial statements, they are considered non-GAAP financial measures when presented elsewhere on a consolidated basis. The reconciliations of underwriting income or loss to income before income taxes (the most directly comparable GAAP financial measure) on a consolidated basis and a subtotal before the contribution from the ‘other’ segment, in accordance with Regulation G, is shown in note 4, “Segment Information” to our consolidated financial statements.

We measure segment performance for our three underwriting segments based on underwriting income or loss. We do not manage our assets by underwriting segment, with the exception of goodwill and intangibles and, accordingly, investment income and other non-underwriting related items are not allocated to each underwriting segment. For the ‘other’ segment, performance is measured based on net income or loss.

Along with consolidated underwriting income, we provide a subtotal of underwriting income or loss before the contribution from the ‘other’ segment. The ‘other’ segment includes the

ARCH CAPITAL
 51
2019 SECOND QUARTER FORM 10-Q

results of Watford Holdings Ltd. Watford Holdings Ltd. is the parent of Watford Re Ltd., a multi-line Bermuda reinsurance company (together with Watford Holdings Ltd., “Watford Re”). Pursuant to generally accepted accounting principles, Watford Re is considered a variable interest entity and we concluded that we are the primary beneficiary of Watford Re. As such, we consolidate the results of Watford Re in our consolidated financial statements, although we only own approximately 11% of Watford Re’s common equity. Watford Re has its own management and board of directors that is responsible for its overall profitability. In addition, we do not guarantee or provide credit support for Watford Re. Since Watford Re is an independent company, the assets of Watford Re can be used only to settle obligations of Watford Re and Watford Re is solely responsible for its own liabilities and commitments. Our financial exposure to Watford Re is limited to our investment in Watford Re’s common and preferred shares and counterparty credit risk (mitigated by collateral) arising from the reinsurance transactions. We believe that presenting certain information excluding the ‘other’ segment enables investors and other users of our financial information to analyze our performance in a manner similar to how our management analyzes performance.

Our presentation of segment information includes the use of a current year loss ratio which excludes favorable or adverse development in prior year loss reserves. This ratio is a non-GAAP financial measure as defined in Regulation G. The reconciliation of such measure to the loss ratio (the most directly comparable GAAP financial measure) in accordance with Regulation G is shown on the individual segment pages. Management utilizes the current year loss ratio in its analysis of the underwriting performance of each of our underwriting segments.
Total return on investments includes investment income, equity in net income or loss of investment funds accounted for using the equity method, net realized gains and losses and the change in unrealized gains and losses generated by Arch’s investment portfolio. Total return is calculated on a pre-tax basis and before investment expenses, excludes amounts reflected in the ‘other’ segment, and reflects the effect of financial market conditions along with foreign currency fluctuations. In addition, total return incorporates the timing of investment returns during the periods. There is no directly comparable GAAP financial measure for total return. Management uses total return on investments as a key measure of the return generated to Arch common shareholders on the capital held in the business, and compares the return generated by our investment portfolio against benchmark returns which we measured our portfolio against during the periods.
 
RESULTS OF OPERATIONS
The following table summarizes our consolidated financial data, including a reconciliation of net income or loss available to Arch common shareholders to after-tax operating income or loss available to Arch common shareholders. Each line item reflects the impact of our approximate 11% ownership of Watford Re’s common equity.
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2019
 
2018
 
2019
 
2018
Net income available to Arch common shareholders
$
458,551

 
$
233,243

 
$
896,676

 
$
370,519

Net realized (gains) losses
(124,637
)
 
61,426

 
(240,281
)
 
173,190

Net impairment losses recognized in earnings
49

 
470

 
1,358

 
632

Equity in net (income) loss of investment funds accounted for using the equity method
(32,536
)
 
(8,472
)
 
(79,403
)
 
(36,541
)
Net foreign exchange (gains) losses
6,054

 
(47,038
)
 
1,060

 
(31,482
)
Transaction costs and other
2,178

 
6,908

 
3,368

 
7,738

Loss on redemption of preferred shares
—

 
—

 
—

 
2,710

Income tax expense (benefit) (1)
7,774

 
(3,941
)
 
10,552

 
(9,027
)
After-tax operating income available to Arch common shareholders
$
317,433

 
$
242,596

 
$
593,330

 
$
477,739

 
 
 
 
 
 
 
 
Beginning common shareholders’ equity
$
9,334,596

 
$
8,370,372

 
$
8,659,827

 
$
8,324,047

Ending common shareholders’ equity
9,977,352

 
8,383,755

 
9,977,352

 
8,383,755

Average common shareholders’ equity
$
9,655,974

 
$
8,377,064

 
$
9,318,590

 
$
8,353,901

 
 
 
 
 
 
 
 
Annualized return on average common equity %
19.0

 
11.1

 
19.2

 
8.9

Annualized operating return on average
common equity %
13.1

 
11.6

 
12.7

 
11.4

(1)
Income tax on net realized gains or losses, net impairment losses recognized in earnings, equity in net income or loss of investment funds accounted for using the equity method, net foreign exchange gains or losses, transaction costs and other and loss on redemption of preferred shares reflects the relative mix reported by jurisdiction and the varying tax rates in each jurisdiction.

ARCH CAPITAL
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2019 SECOND QUARTER FORM 10-Q

Segment Information
We classify our businesses into three underwriting segments — insurance, reinsurance and mortgage — and two other operating segments — corporate (non-underwriting) and ‘other.’ Our insurance, reinsurance and mortgage segments each have managers who are responsible for the overall profitability of their respective segments and who are directly accountable to our chief operating decision makers, the President and Chief Executive Officer of Arch Capital and the Chief Financial Officer of Arch Capital. The chief operating decision makers do not assess performance, measure return on equity or make resource allocation decisions on a line of business basis. Management measures segment performance for our three underwriting segments based on underwriting income or loss. We do not manage our assets by underwriting segment, with the exception of goodwill and intangible assets, and, accordingly, investment income is not allocated to each underwriting segment.
We determined our reportable segments using the management approach described in accounting guidance regarding disclosures about segments of an enterprise and related information. The accounting policies of the segments are the same as those used for the preparation of our consolidated financial statements. Intersegment business is allocated to the segment accountable for the underwriting results.
Insurance Segment
The following tables set forth our insurance segment’s underwriting results:
 
Three Months Ended June 30,
 
2019
 
2018
 
% Change
Gross premiums written
$
919,925

 
$
769,372

 
19.6

Premiums ceded
(292,095
)
 
(245,265
)
 
 
Net premiums written
627,830

 
524,107

 
19.8

Change in unearned premiums
(35,388
)
 
22,342

 
 
Net premiums earned
592,442

 
546,449

 
8.4

Losses and loss adjustment expenses
(389,172
)
 
(357,465
)
 
 

Acquisition expenses
(91,094
)
 
(90,670
)
 
 

Other operating expenses
(109,523
)
 
(92,680
)
 
 

Underwriting income
$
2,653

 
$
5,634

 
(52.9
)
 
 
 
 
 
 
Underwriting Ratios
 

 
 

 
% Point
Change
Loss ratio
65.7
%
 
65.4
%
 
0.3

Acquisition expense ratio
15.4
%
 
16.6
%
 
(1.2
)
Other operating expense ratio
18.5
%
 
17.0
%
 
1.5

Combined ratio
99.6
%
 
99.0
%
 
0.6

 
 
Six Months Ended June 30,
 
2019
 
2018
 
% Change
Gross premiums written
$
1,861,879

 
$
1,592,750

 
16.9

Premiums ceded
(612,717
)
 
(492,445
)
 
 
Net premiums written
1,249,162

 
1,100,305

 
13.5

Change in unearned premiums
(103,215
)
 
(15,119
)
 
 
Net premiums earned
1,145,947

 
1,085,186

 
5.6

Losses and loss adjustment expenses
(745,895
)
 
(711,195
)
 
 

Acquisition expenses
(173,918
)
 
(175,839
)
 
 

Other operating expenses
(222,919
)
 
(184,654
)
 
 

Underwriting income (loss)
$
3,215

 
$
13,498

 
(76.2
)
 
 
 
 
 
 
Underwriting Ratios
 

 
 

 
% Point
Change
Loss ratio
65.1
%
 
65.5
%
 
(0.4
)
Acquisition expense ratio
15.2
%
 
16.2
%
 
(1.0
)
Other operating expense ratio
19.5
%
 
17.0
%
 
2.5

Combined ratio
99.8
%
 
98.7
%
 
1.1

The insurance segment consists of our insurance underwriting units which offer specialty product lines on a worldwide basis. Product lines include:
•Construction and national accounts: primary and excess casualty coverages to middle and large accounts in the construction industry and a wide range of products for middle and large national accounts, specializing in loss sensitive primary casualty insurance programs (including large deductible, self-insured retention and retrospectively rated programs).
•Excess and surplus casualty: primary and excess casualty insurance coverages, including middle market energy business, and contract binding, which primarily provides casualty coverage through a network of appointed agents to small and medium risks.
•Lenders products: collateral protection, debt cancellation and service contract reimbursement products to banks, credit unions, automotive dealerships and original equipment manufacturers and other specialty programs that pertain to automotive lending and leasing.
•Professional lines: directors’ and officers’ liability, errors and omissions liability, employment practices liability, fiduciary liability, crime, professional indemnity and other financial related coverages for corporate, private equity, venture capital, real estate investment trust, limited partnership, financial institution and not-for-profit clients of all sizes and medical professional and general liability insurance coverages for the healthcare industry. The business is predominately written on a claims-made basis.
•Programs: primarily package policies, underwriting workers’ compensation and umbrella liability business in support of desirable package programs, targeting program managers with unique expertise and niche products offering

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general liability, commercial automobile, inland marine and property business with minimal catastrophe exposure.
•Property, energy, marine and aviation: primary and excess general property insurance coverages, including catastrophe-exposed property coverage, for commercial clients. Coverages for marine include hull, war, specie and liability. Aviation and stand alone terrorism are also offered.
•Travel, accident and health: specialty travel and accident and related insurance products for individual, group travelers, travel agents and suppliers, as well as accident and health, which provides accident, disability and medical plan insurance coverages for employer groups, medical plan members, students and other participant groups.
•Other: includes alternative market risks (including captive insurance programs), excess workers’ compensation and employer’s liability insurance coverages for qualified self-insured groups, associations and trusts, and contract and commercial surety coverages, including contract bonds (payment and performance bonds) primarily for medium and large contractors and commercial surety bonds for Fortune 1,000 companies and smaller transaction business programs.
Premiums Written.
The following tables set forth our insurance segment’s net premiums written by major line of business:
 
Three Months Ended June 30,
 
2019
 
2018
 
Amount
 
%
 
Amount
 
%
Professional Lines
$
121,679

 
19.4

 
$
108,298

 
20.7

Programs
108,671

 
17.3

 
100,178

 
19.1

Property, energy, marine and aviation
103,819

 
16.5

 
62,121

 
11.9

Travel, accident and health
76,537

 
12.2

 
63,222

 
12.1

Construction and national accounts
60,888

 
9.7

 
66,384

 
12.7

Excess and surplus casualty
58,466

 
9.3

 
40,042

 
7.6

Lenders products
22,373

 
3.6

 
22,290

 
4.3

Other
75,397

 
12.0

 
61,572

 
11.7

Total
$
627,830

 
100.0

 
$
524,107

 
100.0

2019 Second Quarter versus 2018 Second Quarter. Gross premiums written by the insurance segment in the 2019 second quarter were 19.6% higher than in the 2018 second quarter, while net premiums written were 19.8% higher. Approximately one third of the growth in net premiums written resulted from our acquisition of renewal rights of a U.K. commercial lines book of business on January 1, 2019. The remainder was due to growth in existing accounts and rate increases across most lines of business.
 
 
Six Months Ended June 30,
 
2019
 
2018
 
Amount
 
%
 
Amount
 
%
Professional Lines
$
250,913

 
20.1

 
$
228,087

 
20.7

Programs
209,843

 
16.8

 
196,734

 
17.9

Property, energy, marine and aviation
174,305

 
14.0

 
114,248

 
10.4

Travel, accident and health
164,641

 
13.2

 
143,746

 
13.1

Construction and national accounts
156,243

 
12.5

 
164,812

 
15.0

Excess and surplus casualty
103,631

 
8.3

 
81,964

 
7.4

Lenders products
44,788

 
3.6

 
44,274

 
4.0

Other
144,798

 
11.6

 
126,440

 
11.5

Total
$
1,249,162

 
100.0

 
$
1,100,305

 
100.0

Six Months Ended June 30, 2019 versus 2018 period. Gross premiums written by the insurance segment for the six months ended June 30, 2019 were 16.9% higher than in the 2018 period, while net premiums written were 13.5% higher than in the 2018 period. Growth in net premiums written resulted from our acquisition of renewal rights of a U.K. commercial lines book of business on January 1, 2019, growth in existing accounts and rate increases across most lines of business. The percentage increase in gross premiums written is higher than the increase in net premiums written due to a single large national account, for which the premium written in the quarter was substantially ceded.
Net Premiums Earned.
The following tables set forth our insurance segment’s net premiums earned by major line of business:
 
Three Months Ended June 30,
 
2019
 
2018
 
Amount
 
%
 
Amount
 
%
Professional Lines
$
115,667

 
19.5

 
$
112,226

 
20.5

Programs
102,687

 
17.3

 
97,333

 
17.8

Property, energy, marine and aviation
68,995

 
11.6

 
50,840

 
9.3

Travel, accident and health
83,636

 
14.1

 
74,754

 
13.7

Construction and national accounts
76,795

 
13.0

 
81,784

 
15.0

Excess and surplus casualty
47,858

 
8.1

 
40,049

 
7.3

Lenders products
23,570

 
4.0

 
23,161

 
4.2

Other
73,234

 
12.4

 
66,302

 
12.1

Total
$
592,442

 
100.0

 
$
546,449

 
100.0


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2019 SECOND QUARTER FORM 10-Q

 
Six Months Ended June 30,
 
2019
 
2018
 
Amount
 
%
 
Amount
 
%
Professional Lines
$
230,458

 
20.1

 
$
228,244

 
21.0

Programs
200,173

 
17.5

 
192,344

 
17.7

Property, energy, marine and aviation
128,633

 
11.2

 
99,443

 
9.2

Travel, accident and health
155,211

 
13.5

 
141,589

 
13.0

Construction and national accounts
152,726

 
13.3

 
158,996

 
14.7

Excess and surplus casualty
90,227

 
7.9

 
86,593

 
8.0

Lenders products
46,802

 
4.1

 
45,977

 
4.2

Other
141,717

 
12.4

 
132,000

 
12.2

Total
$
1,145,947

 
100.0

 
$
1,085,186

 
100.0

Net premiums written are primarily earned on a pro rata basis over the terms of the policies for all products, usually 12 months. Net premiums earned in the 2019 second quarter were 8.4% higher than in the 2018 second quarter. For the six months ended June 30, 2019, net premiums earned were 5.6% higher than in the 2018 period. Net premiums earned reflect changes in net premiums written over the previous five quarters.
Losses and Loss Adjustment Expenses.
The table below shows the components of the insurance segment’s loss ratio:
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2019
 
2018
 
2019
 
2018
Current year
66.1
 %
 
66.5
 %
 
65.7
 %
 
66.3
 %
Prior period reserve development
(0.4
)%
 
(1.1
)%
 
(0.6
)%
 
(0.8
)%
Loss ratio
65.7
 %
 
65.4
 %
 
65.1
 %
 
65.5
 %
Current Year Loss Ratio.
The insurance segment’s current year loss ratio in the 2019 second quarter was 0.4 points lower than in the 2018 second quarter and reflected 0.4 points of current year catastrophic activity, compared to 1.4 points in the 2018 second quarter. The insurance segment’s current year loss ratio for the six months ended June 30, 2019 was 0.6 points lower than in the 2018 period and reflected 0.2 points of current year catastrophic activity, compared to 0.8 points in the 2018 period. The balance of the change in the 2018 loss ratios resulted, in part, from changes in mix of business and the level of large attritional losses.
Prior Period Reserve Development.
The insurance segment’s net favorable development was $2.6 million, or 0.4 points, for the 2019 second quarter, compared to $6.1 million, or 1.1 points, for the 2018 second quarter, and
 
$7.0 million, or 0.6 points, for the six months ended June 30, 2019, compared to $8.2 million, or 0.8 points, for the 2018 period. See note 5, “Reserve for Losses and Loss Adjustment Expenses,” to our consolidated financial statements for information about the insurance segment’s prior year reserve development.
Underwriting Expenses.
2019 Second Quarter versus 2018 Second Quarter. The insurance segment’s underwriting expense ratio was 33.9% in the 2019 second quarter, compared to 33.6% in the 2018 second quarter. Operating expenses increased in the 2019 second quarter due to our recent acquisitions, as well as growth in headcount, primarily in the areas of underwriting and technology. The resulting increase in the expense ratio was partially offset by the growth in net premiums earned.
Six Months Ended June 30, 2019 versus 2018 period. The insurance segment’s underwriting expense ratio was 34.7% for the six months ended June 30, 2019, compared to 33.2% for the 2018 period. Operating expenses increased for the six months ended June 30, 2019 due to the recent acquisitions by the Company, as well as growth in headcount, primarily in the areas of underwriting and technology. The resulting increase in the expense ratio was partially offset by the growth in net premiums earned.
Reinsurance Segment 
The following tables set forth our reinsurance segment’s underwriting results:
 
Three Months Ended June 30,
 
2019
 
2018
 
% Change
Gross premiums written
$
545,547

 
$
490,327

 
11.3

Premiums ceded
(169,457
)
 
(136,247
)
 
 
Net premiums written
376,090

 
354,080

 
6.2

Change in unearned premiums
(8,906
)
 
(13,762
)
 
 
Net premiums earned
367,184

 
340,318

 
7.9

Other underwriting income
1,224

 
(129
)
 
 

Losses and loss adjustment expenses
(240,958
)
 
(229,956
)
 
 

Acquisition expenses
(56,785
)
 
(50,142
)
 
 

Other operating expenses
(33,960
)
 
(35,678
)
 
 

Underwriting income
$
36,705

 
$
24,413

 
50.4

 
 
 
 
 
 
Underwriting Ratios
 
 
 
 
% Point
Change
Loss ratio
65.6
%
 
67.6
%
 
(2.0
)
Acquisition expense ratio
15.5
%
 
14.7
%
 
0.8

Other operating expense ratio
9.2
%
 
10.5
%
 
(1.3
)
Combined ratio
90.3
%
 
92.8
%
 
(2.5
)

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2019 SECOND QUARTER FORM 10-Q

 
Six Months Ended June 30,
 
2019
 
2018
 
% Change
Gross premiums written
$
1,228,402

 
$
1,067,810

 
15.0

Premiums ceded
(401,024
)
 
(331,977
)
 
 
Net premiums written
827,378

 
735,833

 
12.4

Change in unearned premiums
(113,829
)
 
(116,343
)
 
 
Net premiums earned
713,549

 
619,490

 
15.2

Other underwriting income
5,601

 
1,103

 
 

Losses and loss adjustment expenses
(480,768
)
 
(371,631
)
 
 

Acquisition expenses
(111,111
)
 
(98,461
)
 
 

Other operating expenses
(69,664
)
 
(71,249
)
 
 

Underwriting income (loss)
$
57,607

 
$
79,252

 
(27.3
)
 
 
 
 
 
 
Underwriting Ratios
 
 
 
 
% Point
Change
Loss ratio
67.4
%
 
60.0
%
 
7.4

Acquisition expense ratio
15.6
%
 
15.9
%
 
(0.3
)
Other operating expense ratio
9.8
%
 
11.5
%
 
(1.7
)
Combined ratio
92.8
%
 
87.4
%
 
5.4

The reinsurance segment consists of our reinsurance underwriting units which offer specialty product lines on a worldwide basis. Product lines include:
•Casualty: provides coverage to ceding company clients on third party liability and workers’ compensation exposures from ceding company clients, primarily on a treaty basis. Exposures include, among others, executive assurance, professional liability, workers’ compensation, excess and umbrella liability, excess motor and healthcare business.
•Marine and aviation: provides coverage for energy, hull, cargo, specie, liability and transit, and aviation business, including airline and general aviation risks. Business written may also include space business, which includes coverages for satellite assembly, launch and operation for commercial space programs.
•Other specialty: provides coverage to ceding company clients for proportional motor and other lines, including surety, accident and health, workers’ compensation catastrophe, agriculture, trade credit and political risk.
•Property catastrophe: provides protection for most catastrophic losses that are covered in the underlying policies written by reinsureds, including hurricane, earthquake, flood, tornado, hail and fire, and coverage for other perils on a case-by-case basis. Property catastrophe reinsurance provides coverage on an excess of loss basis when aggregate losses and loss adjustment expense from a single occurrence or aggregation of losses from a covered peril exceed the retention specified in the contract.
•Property excluding property catastrophe: provides coverage for both personal lines and commercial property exposures and principally covers buildings, structures, equipment and contents. The primary perils in this business include fire, explosion, collapse, riot, vandalism, wind, tornado,
 
flood and earthquake. Business is assumed on both a proportional and excess of loss basis. In addition, facultative business is written which focuses on individual commercial property risks on an excess of loss basis.
•Other: includes life reinsurance business on both a proportional and non-proportional basis, casualty clash business and, in limited instances, non-traditional business which is intended to provide insurers with risk management solutions that complement traditional reinsurance.
Premiums Written.
The following tables set forth our reinsurance segment’s net premiums written by major line of business:
 
Three Months Ended June 30,
 
2019
 
2018
 
Amount
 
%
 
Amount
 
%
Other specialty
$
129,174

 
34.3

 
$
155,081

 
43.8

Casualty
78,025

 
20.7

 
68,113

 
19.2

Property excluding property catastrophe
96,050

 
25.5

 
77,876

 
22.0

Property catastrophe
46,594

 
12.4

 
35,045

 
9.9

Marine and aviation
15,619

 
4.2

 
10,061

 
2.8

Other
10,628

 
2.8

 
7,904

 
2.2

Total
$
376,090

 
100.0

 
$
354,080

 
100.0

2019 Second Quarter versus 2018 Second Quarter. Gross premiums written by the reinsurance segment in the 2019 second quarter were 11.3% higher than in the 2018 second quarter, while net premiums written were 6.2% higher. The increase in gross premiums written is primarily a result of growth in property business, with a significant amount being retroceded. The increase in net premiums written in the 2019 second quarter reflected growth from select new business opportunities across most lines of business. This was partially offset by a decline in other specialty business, primarily reflecting a reduction in U.K motor business with one cedent in the period.
 
Six Months Ended June 30,
 
2019
 
2018
 
Amount
 
%
 
Amount
 
%
Other specialty
$
269,651

 
32.6

 
$
294,073

 
40.0

Casualty
246,509

 
29.8

 
198,289

 
26.9

Property excluding property catastrophe
198,790

 
24.0

 
163,046

 
22.2

Property catastrophe
49,977

 
6.0

 
42,677

 
5.8

Marine and aviation
31,577

 
3.8

 
20,073

 
2.7

Other
30,874

 
3.7

 
17,675

 
2.4

Total
$
827,378

 
100.0

 
$
735,833

 
100.0

Six Months Ended June 30, 2019 versus 2018 period. Gross premiums written by the reinsurance segment for the six months ended June 30, 2019 were 15.0% higher than in the 2018 period, while net premiums written were 12.4% higher than in the 2018 period. The increase in gross premiums written is primarily a

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result of growth in property business, with a significant amount being retroceded. The increase in net premiums written for the six months ended June 30, 2019 reflected growth from select new business opportunities across most lines of business, partially offset by a decline in other specialty business, primarily reflecting a reduction in U.K motor business with one cedent in the period.
Net Premiums Earned.
The following tables set forth our reinsurance segment’s net premiums earned by major line of business:
 
Three Months Ended June 30,
 
2019
 
2018
 
Amount
 
%
 
Amount
 
%
Other specialty
$
136,573

 
37.2

 
$
149,648

 
44.0

Casualty
103,164

 
28.1

 
85,009

 
25.0

Property excluding property catastrophe
85,479

 
23.3

 
70,849

 
20.8

Property catastrophe
18,537

 
5.0

 
15,716

 
4.6

Marine and aviation
12,498

 
3.4

 
10,089

 
3.0

Other
10,933

 
3.0

 
9,007

 
2.6

Total
$
367,184

 
100.0

 
$
340,318

 
100.0

 
Six Months Ended June 30,
 
2019
 
2018
 
Amount
 
%
 
Amount
 
%
Other specialty
$
258,094

 
36.2

 
$
253,365

 
40.9

Casualty
194,788

 
27.3

 
154,381

 
24.9

Property excluding property catastrophe
169,271

 
23.7

 
139,603

 
22.5

Property catastrophe
37,269

 
5.2

 
34,103

 
5.5

Marine and aviation
23,557

 
3.3

 
19,478

 
3.1

Other
30,570

 
4.3

 
18,560

 
3.0

Total
$
713,549

 
100.0

 
$
619,490

 
100.0

Net premiums written, irrespective of the class of business, are generally earned on a pro rata basis over the terms of the underlying policies or reinsurance contracts. For the 2019 second quarter, net premiums earned were 7.9% higher than in the 2018 second quarter. For the six months ended June 30, 2019, net premiums earned were 15.2% higher than in the 2018 period.
Other Underwriting Income (Loss).
Other underwriting income (loss) for the 2019 second quarter was $1.2 million, compared to $(0.1) million for the 2018 second quarter, and $5.6 million for the six months ended June 30, 2019, compared to $1.1 million for the 2018 period.
 
Losses and Loss Adjustment Expenses.
The table below shows the components of the reinsurance segment’s loss ratio:
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2019
 
2018
 
2019
 
2018
Current year
69.1
 %
 
77.3
 %
 
68.9
 %
 
71.2
 %
Prior period reserve development
(3.5
)%
 
(9.7
)%
 
(1.5
)%
 
(11.2
)%
Loss ratio
65.6
 %
 
67.6
 %
 
67.4
 %
 
60.0
 %
Current Year Loss Ratio.
The reinsurance segment’s current year loss ratio in the 2019 second quarter was 8.2 points lower than in the 2018 second quarter and reflected 1.3 points of current year catastrophic activity, compared to 2.2 points in the 2018 second quarter. The reinsurance segment’s current year loss ratio for the six months ended June 30, 2019 was 2.3 points lower than in the 2018 period and reflected 1.7 points of current year catastrophic activity, compared to 1.4 points in the 2018 period. In addition, the current year loss ratio for the 2019 periods reflected a lower level of large attritional loss activity than in the 2018 periods.
Prior Period Reserve Development.
The reinsurance segment’s net favorable development was $12.7 million, or 3.5 points, for the 2019 second quarter, compared to $33.0 million, or 9.7 points, for the 2018 second quarter, and $11.0 million, or 1.5 points, for the six months ended June 30, 2019, compared to $69.6 million, or 11.2 points, for the 2018 period. See note 5, “Reserve for Losses and Loss Adjustment Expenses,” to our consolidated financial statements for information about the reinsurance segment’s prior year reserve development.
Underwriting Expenses.
2019 Second Quarter versus 2018 Second Quarter. The underwriting expense ratio for the reinsurance segment was 24.7% in the 2019 second quarter, compared to 25.2% in the 2018 second quarter, reflecting growth in net premiums earned and changes in mix of business.
Six Months Ended June 30, 2019 versus 2018 period. The underwriting expense ratio for the reinsurance segment was 25.4% for the six months ended June 30, 2019, compared to 27.4% for the 2018 period.
Mortgage Segment 
Our mortgage operations include U.S. and international mortgage insurance and reinsurance operations as well as participation in GSE credit risk-sharing transactions. Our mortgage group includes direct mortgage insurance in the U.S.

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2019 SECOND QUARTER FORM 10-Q

primarily through Arch Mortgage Insurance Company and United Guaranty Residential Insurance Company (together, “Arch MI U.S.”), mortgage reinsurance by Arch Reinsurance Ltd. (“Arch Re Bermuda”) to mortgage insurers on both a proportional and non-proportional basis globally; direct mortgage insurance in Europe through Arch Insurance (EU) Designated Activity Company (“Arch MI Europe”) and in Hong Kong through Arch MI Asia Limited (“Arch MI Asia”); and participation in various GSE credit risk-sharing products primarily through Arch Re Bermuda.
The following tables set forth our mortgage segment’s underwriting results.
 
Three Months Ended June 30,
 
2019
 
2018
 
% Change
Gross premiums written
$
364,465

 
$
330,990

 
10.1

Premiums ceded
(42,857
)
 
(50,867
)
 
 
Net premiums written
321,608

 
280,123

 
14.8

Change in unearned premiums
31,175

 
10,355

 
 
Net premiums earned
352,783

 
290,478

 
21.4

Other underwriting income
4,056

 
3,315

 
 

Losses and loss adjustment expenses
(25,997
)
 
(21,591
)
 
 

Acquisition expenses
(32,654
)
 
(27,737
)
 
 

Other operating expenses
(39,819
)
 
(38,729
)
 
 

Underwriting income
$
258,369

 
$
205,736

 
25.6

 
 
 
 
 
 
Underwriting Ratios
 

 
 

 
% Point
Change
Loss ratio
7.4
%
 
7.4
%
 
—

Acquisition expense ratio
9.3
%
 
9.5
%
 
(0.2
)
Other operating expense ratio
11.3
%
 
13.3
%
 
(2.0
)
Combined ratio
28.0
%
 
30.2
%
 
(2.2
)
 
Six Months Ended June 30,
 
2019
 
2018
 
% Change
Gross premiums written
$
720,515

 
$
652,168

 
10.5

Premiums ceded
(91,655
)
 
(97,004
)
 
 
Net premiums written
628,860

 
555,164

 
13.3

Change in unearned premiums
46,825

 
15,556

 
 
Net premiums earned
675,685

 
570,720

 
18.4

Other underwriting income
7,912

 
6,731

 
 

Losses and loss adjustment expenses
(37,146
)
 
(65,057
)
 
 

Acquisition expenses
(64,326
)
 
(54,304
)
 
 

Other operating expenses
(79,694
)
 
(77,500
)
 
 

Underwriting income
$
502,431

 
$
380,590

 
32.0

 
 
 
 
 
 
Underwriting Ratios
 

 
 

 
% Point
Change
Loss ratio
5.5
%
 
11.4
%
 
(5.9
)
Acquisition expense ratio
9.5
%
 
9.5
%
 
—

Other operating expense ratio
11.8
%
 
13.6
%
 
(1.8
)
Combined ratio
26.8
%
 
34.5
%
 
(7.7
)
 
Premiums Written.
The following tables set forth our mortgage segment’s net premiums written by underwriting location (i.e., where the business is underwritten):
 
Three Months Ended June 30,
 
2019
 
2018
 
Amount
 
%
 
Amount
 
%
Underwriting location:
 
 
 
 
 
 
 
United States
$
258,774

 
80.5

 
$
229,715

 
82.0

Other
62,834

 
19.5

 
50,408

 
18.0

Total
$
321,608

 
100.0

 
$
280,123

 
100.0

2019 Second Quarter versus 2018 Second Quarter. Gross premiums written by the mortgage segment in the 2019 second quarter were 10.1% higher than in the 2018 second quarter, while net premiums written were 14.8% higher. The growth in net premiums written primarily reflected an increase in monthly premium business due to growth in insurance in force, partially offset by higher ceded premiums related to Bellemeade transactions. In addition, net premiums written for the 2019 second quarter included $17.1 million due to the novation of a quota share reinsurance arrangement on international business.
 
Six Months Ended June 30,
 
2019
 
2018
 
Amount
 
%
 
Amount
 
%
Underwriting location:
 
 
 
 
 
 
 
United States
$
514,154

 
81.8

 
$
450,892

 
81.2

Other
114,706

 
18.2

 
104,272

 
18.8

Total
$
628,860

 
100.0

 
$
555,164

 
100.0

Six Months Ended June 30, 2019 versus 2018 period. Gross premiums written by the mortgage segment for the six months ended June 30, 2019 were 10.5% higher than in the 2018 period, while net premiums written were 13.3% higher. The growth in net premiums written primarily reflected an increase in monthly premium business due to growth in insurance in force, partially offset by higher ceded premiums related to Bellemeade transactions. In addition, net premiums written for the six months ended June 30, 2019 included $17.1 million due to the novation of a quota share reinsurance arrangement on international business.
The persistency rate, which represents the percentage of mortgage insurance in force at the beginning of a 12-month period that remains in force at the end of such period, of the Arch MI U.S. portfolio of mortgage loans was 80.9% at June 30, 2019, compared to 81.5% at December 31, 2018.

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2019 SECOND QUARTER FORM 10-Q

Arch MI U.S. generated $17.2 billion of new insurance written (“NIW”) in the 2019 second quarter, compared to $19.9 billion in the 2018 second quarter. NIW represents the original principal balance of all loans that received coverage during the period. Monthly premium policies contributed 92.9% of NIW in the 2019 second quarter, compared to 94.3% for the 2018 second quarter.
The following tables provide details on the NIW generated by Arch MI U.S.:
(U.S. Dollars in millions)
Three Months Ended June 30,
2019
 
2018
 
Amount
 
%
 
Amount
 
%
Total new insurance written (NIW) (1)
$
17,161

 
 
 
$
19,944

 
 
 
 
 
 
 
 
 
 
Credit quality (FICO):
 
 
 
 
 
 
 
>=740
$
9,862

 
57.5

 
$
11,308

 
56.7

680-739
6,139

 
35.8

 
7,182

 
36.0

620-679
1,160

 
6.8

 
1,454

 
7.3

Total
$
17,161

 
100.0

 
$
19,944

 
100.0

 
 
 
 
 
 
 
 
Loan-to-value (LTV):
 
 
 
 
 
 
 
95.01% and above
$
2,530

 
14.7

 
$
2,835

 
14.2

90.01% to 95.00%
7,497

 
43.7

 
9,205

 
46.2

85.01% to 90.00%
5,026

 
29.3

 
5,910

 
29.6

85.01% and below
2,108

 
12.3

 
1,994

 
10.0

Total
$
17,161

 
100.0

 
$
19,944

 
100.0

 
 
 
 
 
 
 
 
Monthly vs. single:
 
 
 
 
 
 
 
Monthly
$
15,935

 
92.9

 
$
18,814

 
94.3

Single
1,226

 
7.1

 
1,130

 
5.7

Total
$
17,161

 
100.0

 
$
19,944

 
100.0

 
 
 
 
 
 
 
 
Purchase vs. refinance:
 
 
 
 
 
 
 
Purchase
$
14,992

 
87.4

 
$
18,871

 
94.6

Refinance
2,169

 
12.6

 
1,073

 
5.4

Total
$
17,161

 
100.0

 
$
19,944

 
100.0

(1)
Represents the original principal balance of all loans that received coverage during the period.
 
(U.S. Dollars in millions)
Six Months Ended June 30,
2019
 
2018
 
Amount
 
%
 
Amount
 
%
Total new insurance written (NIW) (1)
$
28,368

 
 
 
$
31,317

 
 
 
 
 
 
 
 
 
 
Credit quality (FICO):
 
 
 
 
 
 
 
>=740
$
16,212

 
57.1

 
$
17,920

 
57.2

680-739
10,180

 
35.9

 
11,224

 
35.8

620-679
1,976

 
7.0

 
2,173

 
6.9

Total
$
28,368

 
100.0

 
$
31,317

 
100.0

 
 
 
 
 
 
 
 
Loan-to-value (LTV):
 
 
 
 
 
 
 
95.01% and above
$
4,338

 
15.3

 
$
4,097

 
13.1

90.01% to 95.00%
12,472

 
44.0

 
14,341

 
45.8

85.01% to 90.00%
8,175

 
28.8

 
9,553

 
30.5

85.01% and below
3,383

 
11.9

 
3,326

 
10.6

Total
$
28,368

 
100.0

 
$
31,317

 
100.0

 
 
 
 
 
 
 
 
Monthly vs. single:
 
 
 
 
 
 
 
Monthly
$
26,198

 
92.4

 
$
29,204

 
93.3

Single
2,170

 
7.6

 
2,113

 
6.7

Total
$
28,368

 
100.0

 
$
31,317

 
100.0

 
 
 
 
 
 
 
 
Purchase vs. refinance:
 
 
 
 
 
 
 
Purchase
$
25,281

 
89.1

 
$
29,159

 
93.1

Refinance
3,087

 
10.9

 
2,158

 
6.9

Total
$
28,368

 
100.0

 
$
31,317

 
100.0

(1)
Represents the original principal balance of all loans that received coverage during the period.
Net Premiums Earned.
The following tables set forth our mortgage segment’s net premiums earned by underwriting location:
 
Three Months Ended June 30,
 
2019
 
2018
 
Amount
 
%
 
Amount
 
%
Underwriting location:
 
 
 
 
 
 
 
United States
$
282,062

 
80.0

 
$
247,897

 
85.3

Other
70,721

 
20.0

 
42,581

 
14.7

Total
$
352,783

 
100.0

 
$
290,478

 
100.0

 
Six Months Ended June 30,
 
2019
 
2018
 
Amount
 
%
 
Amount
 
%
Underwriting location:
 
 
 
 
 
 
 
United States
$
556,535

 
82.4

 
$
486,038

 
85.2

Other
119,150

 
17.6

 
84,682

 
14.8

Total
$
675,685

 
100.0

 
$
570,720

 
100.0

Net premiums earned for the 2019 second quarter were 21.4% higher than in the 2018 second quarter. For the six months ended June 30, 2019, net premiums earned were 18.4% higher than in the 2018 period. The increases were primarily due to growth in U.S. insurance in force.

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2019 SECOND QUARTER FORM 10-Q

Other Underwriting Income.
Other underwriting income, which is primarily related to older GSE credit risk-sharing transactions receiving derivative accounting treatment, was $4.1 million for the 2019 second quarter, compared to $3.3 million for the 2018 second quarter. and $7.9 million for the six months ended June 30, 2019, compared to $6.7 million for the 2018 period.
Losses and Loss Adjustment Expenses.
The table below shows the components of the mortgage segment’s loss ratio:
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2019
 
2018
 
2019
 
2018
Current year
13.9
 %
 
15.4
 %
 
14.3
 %
 
17.8
 %
Prior period reserve development
(6.5
)%
 
(8.0
)%
 
(8.8
)%
 
(6.4
)%
Loss ratio
7.4
 %
 
7.4
 %
 
5.5
 %
 
11.4
 %
Current Year Loss Ratio.
The mortgage segment’s current year loss ratio was 1.5 points lower in the 2019 second quarter than in the 2018 second quarter. The mortgage segment’s current year loss ratio was 3.5 points lower for the six months ended June 30, 2019 than for the 2018 period. The lower current year loss ratios for the 2019 periods reflect the current favorable macroeconomic environment.
Prior Period Reserve Development.
The mortgage segment’s net favorable development was $22.8 million, or 6.5 points, for the 2019 second quarter, compared to $23.3 million, or 8.0 points, for the 2018 second quarter, and $59.4 million, or 8.8 points, for the six months ended June 30, 2019, compared to $36.3 million, or 6.4 points, for the 2018 period. See note 5, “Reserve for Losses and Loss Adjustment Expenses,” to our consolidated financial statements for information about the mortgage segment’s prior year reserve development.
Underwriting Expenses.
2019 Second Quarter versus 2018 Second Quarter. The underwriting expense ratio for the mortgage segment was 20.6% in the 2019 second quarter, compared to 22.8% in the 2018 second quarter. The lower ratio in the 2019 second quarter primarily resulted from the higher level of net premiums earned.
Six Months Ended June 30, 2019 versus 2018 period. The underwriting expense ratio for the mortgage segment was 21.3% for the six months ended June 30, 2019, compared to 23.1% for the 2018 period. The lower underwriting expense
 
ratio in the 2019 period primarily resulted from the higher level of net premiums earned.
Corporate (Non-Underwriting) Segment
The corporate (non-underwriting) segment results include net investment income, other income (loss), corporate expenses, transaction costs and other, amortization of intangible assets, interest expense, items related to our non-cumulative preferred shares, net realized gains or losses, net impairment losses included in earnings, equity in net income or loss of investment funds accounted for using the equity method, net foreign exchange gains or losses and income taxes. Such amounts exclude the results of the ‘other’ segment.
Net Investment Income.
The components of net investment income were derived from the following sources:
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2019
 
2018
 
2019
 
2018
Fixed maturities
$
111,335

 
$
98,968

 
$
221,986

 
$
191,406

Equity securities
3,494

 
4,232

 
5,740

 
6,982

Short-term investments
3,448

 
4,225

 
7,746

 
8,174

Other (1)
20,115

 
19,242

 
43,059

 
38,471

Gross investment income
138,392

 
126,667

 
278,531

 
245,033

Investment expenses (2)
(15,354
)
 
(18,906
)
 
(34,244
)
 
(37,029
)
Net investment income
$
123,038

 
$
107,761

 
$
244,287

 
208,004

(1)
Amounts include dividends and other distributions on investment funds, term loan investments, funds held balances, cash balances and other items.
(2)
Investment expenses were approximately 0.38% of average invested assets for the 2019 second quarter, compared to 0.40% for the 2018 second quarter, and 0.35% for the six months ended June 30, 2019, compared to 0.37% for the 2018 period.
The higher level of net investment income for the 2019 periods reflected growth in invested assets, the reinvestment of fixed income securities at higher available yields and the shift from municipal bonds to corporates. The pre-tax investment income yield, calculated based on amortized cost and on an annualized basis, was 2.62% for the 2019 second quarter, compare to 2.32% for the 2018 second quarter, and 2.64% for the six months ended June 30, 2019, compared to 2.23% for the 2018 period.
Corporate Expenses.
Corporate expenses were $16.1 million for the 2019 second quarter, compared to $15.6 million for the 2018 second quarter, and $32.8 million for the six months ended June 30, 2019, compared to $30.1 million for the 2018 period. The increase in corporate expenses in the 2019 periods primarily reflected higher incentive compensation costs.

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2019 SECOND QUARTER FORM 10-Q

Transaction Costs and Other.
Transaction costs and other were $2.2 million for the 2019 second quarter, compared to $6.9 million for the 2018 second quarter, and $3.4 million for the six months ended June 30, 2019, compared to $7.7 million for the 2018 period. Amounts in 2019 primarily related to recent acquisition activity while the 2018 activity primarily related to severance and related costs.
Amortization of Intangible Assets.
Amortization of intangible assets for the 2019 second quarter was $19.8 million, compared to $26.5 million for the 2018 second quarter, and $40.2 million for the six months ended June 30, 2019, compared to $53.2 million for the 2018 period. Such expenses primarily related to the UGC acquisition, while the 2019 periods also included amortization related to the previously announced acquisitions of (i) renewal rights of a U.K. commercial lines book of business on January 1, 2019; and (ii) McNeil &Co. on December 6, 2018. See the consolidated financial statements contained in our 2018 Form 10-K for disclosures on our amortization pattern.
Interest Expense.
Interest expense was $23.4 million for the 2019 second quarter, compared to the $26.1 million for the 2018 second quarter, and $46.9 million for the six months ended June 30, 2019, compared to $52.0 million for the 2018 period. The lower level in the 2019 periods reflected the paydown of revolving credit agreement borrowings in the second half of 2018.
Loss on Redemption of Preferred Shares.
In January 2018, we redeemed all remaining 6.75% Series C preferred shares and, in accordance with GAAP, recorded a loss of $2.7 million to remove original issuance costs related to the redeemed shares from additional paid-in capital. Such adjustment had no impact on total shareholders’ equity or cash flows.
Net Realized Gains or Losses.
We recorded net realized gains of $125.1 million for the 2019 second quarter, compared to net realized losses of $59.5 million for the 2018 second quarter, and net realized gains of $237.5 million for the six months ended June 30, 2019, compared to net realized losses of $171.4 million for the 2018 period. Currently, our portfolio is actively managed to maximize total return within certain guidelines. The effect of financial market movements on the investment portfolio will directly impact net realized gains and losses as the portfolio is adjusted and rebalanced. Net realized gains or losses from the sale of fixed maturities primarily results from our decisions to reduce credit exposure, to change duration targets, to rebalance our portfolios or due to relative value determinations. Net realized gains or losses also include realized and unrealized contract gains and losses on our derivative instruments, changes in the fair value
 
of assets accounted for using the fair value option and in the fair value of equities, along with re-measurement of contingent consideration liability amounts. See note 6, “Investment Information—Net Realized Gains (Losses),” to our consolidated financial statements for additional information.
Net Impairment Losses Recognized in Earnings.
We recorded minimal impairment losses for the 2019 second quarter, compared to $0.5 million for the 2018 second quarter, and $1.4 million for the six months ended June 30, 2019, compared to $0.6 million for the 2018 period. See note 6, “Investment Information—Other-Than-Temporary Impairments,” to our consolidated financial statements for additional information.
Equity in Net Income (Loss) of Investment Funds Accounted for Using the Equity Method.
We recorded $32.5 million of equity in net income related to investment funds accounted for using the equity method in the 2019 second quarter, compared to $8.5 million of income for the 2018 second quarter, and $79.4 million of income for the six months ended June 30, 2019, compared to $36.5 million for the 2018 period. Investment funds accounted for using the equity method totaled $1.58 billion at June 30, 2019, compared to $1.49 billion at December 31, 2018. See note 6, “Investment Information—Investments Accounted For Using the Equity Method,” to our consolidated financial statements for additional information.
Net Foreign Exchange Gains or Losses.
Net foreign exchange losses for the 2019 second quarter were $6.2 million, compared to net foreign exchange gains for the 2018 second quarter of $46.2 million. Net foreign exchange losses for the six months ended June 30, 2019 were $1.0 million, compared to net foreign exchange gains for the 2018 period of $31.2 million. Amounts in both periods were primarily unrealized and resulted from the effects of revaluing our net insurance liabilities required to be settled in foreign currencies at each balance sheet date.
Income Tax Expense.
Our income tax provision on income (loss) before income taxes resulted in an expense of 8.7% for the 2019 second quarter and 9.0% for the six months ended June 30, 2019, compared to 8.9% for the 2018 second quarter and 10.4% for the six months ended June 30, 2018 . The effective tax rates for the 2019 second quarter and six months ended June 30, 2019 included a discrete income tax benefit of $2.5 million and $4.3 million, respectively, related to share based compensation. Our effective tax rate, which is based upon the expected annual effective tax rate, may fluctuate from period to period based on the relative mix of income or loss reported by jurisdiction and the varying tax rates in each jurisdiction.

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2019 SECOND QUARTER FORM 10-Q

Other Segment 
The ‘other’ segment includes the results of Watford Re. Pursuant to generally accepted accounting principles, Watford Re is considered a variable interest entity and we concluded that we are the primary beneficiary of Watford Re. As such, we consolidate the results of Watford Re in our consolidated financial statements, although we only own approximately 11% of Watford Re’s common equity. See note 11, “Variable Interest Entities and Noncontrolling Interests,” and note 4, “Segment Information,” to our consolidated financial statements for additional information on Watford Re.
CRITICAL ACCOUNTING POLICIES,
ESTIMATES AND RECENT ACCOUNTING PRONOUNCEMENTS
Critical accounting policies, estimates and recent accounting pronouncements are discussed in Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our 2018 Form 10-K, updated where applicable in the notes accompanying our consolidated financial statements, including note 1, “Basis of Presentation and Recent Accounting Pronouncements.”
FINANCIAL CONDITION
Investable Assets 
At June 30, 2019, total investable assets held by Arch were $20.78 billion, excluding the $2.77 billion included in the ‘other’ segment (i.e., attributable to Watford Re).
 
Investable Assets Held by Arch 
The following table summarizes the fair value of the investable assets held by Arch:
Investable assets (1):
Estimated
Fair Value
 
% of
Total
June 30, 2019
 
 
 
Fixed maturities (2)
$
15,959,794

 
76.8

Short-term investments (2)
847,250

 
4.1

Cash
536,339

 
2.6

Equity securities (2)
666,900

 
3.2

Other investments (2)
1,327,134

 
6.4

Investments accounted for using the equity method
1,581,972

 
7.6

Securities transactions entered into but not settled at the balance sheet date
(142,726
)
 
(0.7
)
Total investable assets held by Arch
$
20,776,663

 
100.0

 
 
 
 
Average effective duration (in years)
3.52

 
 
Average S&P/Moody’s credit ratings (3)
AA/Aa2

 
 
Embedded book yield (4)
2.87
%
 
 
 
 
 
 
December 31, 2018
 
 
 
Fixed maturities (2)
$
14,881,902

 
76.1

Short-term investments (2)
995,926

 
5.1

Cash
583,027

 
3.0

Equity securities (2)
368,843

 
1.9

Other investments (2)
1,261,525

 
6.4

Investments accounted for using the equity method
1,493,791

 
7.6

Securities transactions entered into but not settled at the balance sheet date
(18,153
)
 
(0.1
)
Total investable assets held by Arch
$
19,566,861

 
100.0

 
 
 
 
Average effective duration (in years)
3.38

 
 
Average S&P/Moody’s credit ratings (3)
AA/Aa2

 
 
Embedded book yield (4)
2.89
%
 
 
(1)
In securities lending transactions, we receive collateral in excess of the fair value of the securities pledged. For purposes of this table, we have excluded the collateral received under securities lending, at fair value and included the securities pledged under securities lending, at fair value.
(2)
Includes investments carried at fair value under the fair value option.
(3)
Average credit ratings on our investment portfolio on securities with ratings by Standard & Poor’s Rating Services (“S&P”) and Moody’s Investors Service (“Moody’s”).
(4)
Before investment expenses.
At June 30, 2019, approximately $14.96 billion, or 72.0%, of total investable assets held by Arch were internally managed, compared to $14.08 billion, or 72.0%, at December 31, 2018.

ARCH CAPITAL
 62
2019 SECOND QUARTER FORM 10-Q

The following table summarizes our fixed maturities and fixed maturities pledged under securities lending agreements (“Fixed Maturities”) by type:
 
Estimated
Fair Value
 
% of
Total
June 30, 2019
 

 
 
Corporate bonds
$
6,281,897

 
39.4

Mortgage backed securities
513,760

 
3.2

Municipal bonds
581,378

 
3.6

Commercial mortgage backed securities
686,707

 
4.3

U.S. government and government agencies
4,545,169

 
28.5

Non-U.S. government securities
1,847,023

 
11.6

Asset backed securities
1,503,860

 
9.4

Total
$
15,959,794

 
100.0

 
 
 
 
December 31, 2018
 

 
 
Corporate bonds
$
5,735,526

 
38.5

Mortgage backed securities
535,763

 
3.6

Municipal bonds
1,012,308

 
6.8

Commercial mortgage backed securities
729,442

 
4.9

U.S. government and government agencies
3,601,269

 
24.2

Non-U.S. government securities
1,713,891

 
11.5

Asset backed securities
1,553,703

 
10.4

Total
$
14,881,902

 
100.0

The following table provides the credit quality distribution of our Fixed Maturities. For individual fixed maturities, S&P ratings are used. In the absence of an S&P rating, ratings from Moody’s are used, followed by ratings from Fitch Ratings.
 
Estimated Fair Value
 
% of
Total
June 30, 2019
 
 
 
U.S. government and gov’t agencies (1)
$
5,030,769

 
31.5

AAA
3,325,260

 
20.8

AA
1,831,265

 
11.5

A
3,439,690

 
21.6

BBB
1,465,219

 
9.2

BB
361,389

 
2.3

B
226,885

 
1.4

Lower than B
60,858

 
0.4

Not rated
218,459

 
1.4

Total
$
15,959,794

 
100.0

 
 
 
 
December 31, 2018
 
 
 
U.S. government and gov’t agencies (1)
$
4,194,676

 
28.2

AAA
3,551,039

 
23.9

AA
2,129,336

 
14.3

A
3,069,656

 
20.6

BBB
1,251,205

 
8.4

BB
275,201

 
1.8

B
183,614

 
1.2

Lower than B
61,271

 
0.4

Not rated
165,904

 
1.1

Total
$
14,881,902

 
100.0

(1)
Includes U.S. government-sponsored agency residential mortgage-backed securities and agency commercial mortgage-backed securities.
 
The following table provides information on the severity of the unrealized loss position as a percentage of amortized cost for all Fixed Maturities which were in an unrealized loss position:
Severity of gross unrealized losses:
Estimated Fair Value
 
Gross
Unrealized
Losses
 
% of
Total Gross
Unrealized
Losses
June 30, 2019
 
 
 
 
 
0-10%
$
3,323,262

 
$
(51,874
)
 
83.8

10-20%
54,735

 
(9,486
)
 
15.3

20-30%
1,496

 
(460
)
 
0.7

Greater than 30%
73

 
(114
)
 
0.2

Total
$
3,379,566

 
$
(61,934
)
 
100.0

 
 
 
 
 
 
December 31, 2018
 
 
 
 
 
0-10%
$
8,722,837

 
$
(190,170
)
 
92.5

10-20%
87,188

 
(13,012
)
 
6.3

20-30%
3,359

 
(1,058
)
 
0.5

Greater than 30%
2,363

 
(1,266
)
 
0.6

Total
$
8,815,747

 
$
(205,506
)
 
100.0

The following table summarizes our top ten exposures to fixed income corporate issuers by fair value at June 30, 2019, excluding guaranteed amounts and covered bonds:
 
Estimated Fair Value
 
Credit
Rating (1)
Bank of America Corporation
$
234,672

 
A-/A2
JPMorgan Chase & Co.
228,144

 
A-/A2
Wells Fargo & Company
216,814

 
A/A1
Citigroup Inc.
207,673

 
A/A1
Apple Inc.
144,498

 
AA+/Aa1
Morgan Stanley
117,638

 
BBB+/A3
Nestle S.A.
112,919

 
AA-/Aa2
American Express Company
112,584

 
BBB+/A3
BP P.L.C.
109,805

 
A-/A1
The Goldman Sachs Group, Inc.
108,946

 
BBB+/A3
Total
$
1,593,693

 
 
(1)
Average credit ratings as assigned by S&P and Moody’s, respectively.

ARCH CAPITAL
 63
2019 SECOND QUARTER FORM 10-Q

The following table provides information on our structured securities, which includes residential mortgage-backed securities (“RMBS”), commercial mortgage-backed securities (“CMBS”) and asset-backed securities (“ABS”):
 
Agencies
 
Investment Grade
 
Below Investment Grade
 
Total
Jun 30, 2019
 
 
 
 
 
 
 
RMBS
$
381,380

 
$
95,023

 
$
37,357

 
$
513,760

CMBS
104,220

 
560,602

 
21,885

 
686,707

ABS
—

 
1,431,312

 
72,548

 
1,503,860

Total
$
485,600

 
$
2,086,937

 
$
131,790

 
$
2,704,327

 
 
 
 
 
 
 
 
Dec 31, 2018
 
 
 
 
 
 
 
RMBS
$
488,862

 
$
15,410

 
$
31,491

 
$
535,763

CMBS
104,547

 
602,865

 
22,030

 
729,442

ABS
—

 
1,485,150

 
68,553

 
1,553,703

Total
$
593,409

 
$
2,103,425

 
$
122,074

 
$
2,818,908

At June 30, 2019, our structured securities included $41.0 million par value in sub-prime securities with a fair value of $34.2 million and average credit quality ratings from S&P/Moody’s of “CCC-/Caa3,” compared to $38.2 million par value with a fair value of $31.7 million and average credit quality ratings of “CCC-/Caa3” at December 31, 2018.
At June 30, 2019, our investment portfolio included $666.9 million of equity securities, compared to $368.8 million at December 31, 2018. Our equity portfolio includes publicly traded common stocks in the natural resources, energy, consumer staples and other sectors and exchange-traded funds.
The following table summarizes our other investments which are included in investments accounted for using the fair value option, by strategy:
 
June 30,
2019
 
December 31,
2018
Lending
$
585,954

 
$
524,112

Term loan investments
$
274,061

 
$
281,486

Energy
123,547

 
117,509

Credit related funds
166,673

 
152,510

Investment grade fixed income
86,808

 
101,902

Infrastructure
49,260

 
45,371

Private equity
23,925

 
24,383

Real estate
16,906

 
14,252

Total
$
1,327,134

 
$
1,261,525

For details on our investments accounted for using the equity method, see note 6, “Investment Information—Investments Accounted For Using the Equity Method,” to our consolidated financial statements.
Our investment strategy allows for the use of derivative instruments. We utilize various derivative instruments such as futures contracts to enhance investment performance, replicate investment positions or manage market exposures and duration
 
risk that would be allowed under our investment guidelines if implemented in other ways. See note 8, “Derivative Instruments,” to our consolidated financial statements for additional disclosures related to derivatives.
Accounting guidance regarding fair value measurements addresses how companies should measure fair value when they are required to use a fair value measure for recognition or disclosure purposes under GAAP and provides a common definition of fair value to be used throughout GAAP. See note 7, “Fair Value,” to our consolidated financial statements for a summary of our financial assets and liabilities measured at fair value, segregated by level in the fair value hierarchy.
Investable Assets in the ‘Other’ Segment
Investable assets in the ‘other’ segment are managed by Watford Re. The board of directors of Watford Re establishes its investment policies and guidelines. Watford Re’s investments are accounted for using the fair value option with changes in the carrying value of such investments recorded in net realized gains or losses.
The following table summarizes investable assets in the ‘other’ segment:
 
June 30,
2019
 
December 31,
2018
Investments accounted for using the fair value option:
 
 
 
Other investments
$
1,067,384

 
$
1,050,414

Fixed maturities
616,863

 
922,819

Short-term investments
232,176

 
282,131

Equity securities
56,524

 
56,638

Total
1,972,947

 
2,312,002

Fixed maturities available for sale, at fair value
697,453

 
393,351

Equity securities, at fair value
64,703

 
32,206

Cash
68,977

 
63,529

Securities sold but not yet purchased
(48,823
)
 
(7,790
)
Securities transactions entered into but not settled at the balance sheet date
13,209

 
(35,635
)
Total investable assets included in ‘other’ segment
$
2,768,466

 
$
2,757,663


ARCH CAPITAL
 64
2019 SECOND QUARTER FORM 10-Q

Reinsurance
The effects of reinsurance on written and earned premiums and losses and loss adjustment expenses (“LAE”) with unaffiliated reinsurers were as follows:
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2019
 
2018
 
2019
 
2018
Premiums written:
 
 
 
 
 
 
 
Direct
$
1,373,825

 
$
1,158,772

 
$
2,737,331

 
$
2,359,134

Assumed
563,984

 
537,772

 
1,278,357

 
1,175,624

Ceded
(492,911
)
 
(397,648
)
 
(1,045,531
)
 
(823,318
)
Net
$
1,444,898

 
$
1,298,896

 
$
2,970,157

 
$
2,711,440

 
 
 
 
 
 
 
 
Premiums earned:
 
 
 
 
 
 
 
Direct
$
1,335,558

 
$
1,174,372

 
$
2,601,621

 
$
2,322,048

Assumed
574,899

 
534,485

 
1,108,178

 
980,454

Ceded
(446,730
)
 
(372,094
)
 
(877,206
)
 
(730,840
)
Net
$
1,463,727

 
$
1,336,763

 
$
2,832,593

 
$
2,571,662

 
 
 
 
 
 
 
 
Losses and LAE:
 
 
 
 
 
 
 
Direct
$
705,235

 
$
520,473

 
$
1,321,297

 
$
1,088,939

Assumed
388,237

 
340,969

 
726,637

 
561,279

Ceded
(325,929
)
 
(135,289
)
 
(561,859
)
 
(287,205
)
Net
$
767,543

 
$
726,153

 
$
1,486,075

 
$
1,363,013

Reinsurance Recoverables
The following table summarizes our reinsurance recoverables on paid and unpaid losses (not including ceded unearned premiums) at June 30, 2019 and December 31, 2018:
 
June 30,
2019
 
December 31,
2018
Reinsurance recoverable on unpaid and paid losses and loss adjustment expenses
$
3,171,257

 
$
2,919,372

% due from carriers with A.M. Best rating of “A-” or better
58.7
%
 
63.0
%
% due from unrated fully collateralized reinsurers (1)
16.9
%
 
12.9
%
% due from all other carriers with no A.M. Best rating (2)
24.4
%
 
24.1
%
Largest balance due from any one carrier as % of total shareholders’ equity
1.9
%
 
2.7
%
(1)
Such amount is fully collateralized through reinsurance trusts.
(2)
Over 90% of such amount is collateralized through reinsurance trusts or letters of credit.
Growth in items not rated in 2019 is primarily due to recoverables from a third party reinsurer related to a retroactive reinsurance transaction to reinsure liabilities associated with certain U.S. insurance exposures. Such amounts are fully collateralized. See note 5, “Reserve for Losses and Loss
 
Adjustment Expenses,” to our consolidated financial statements for additional information.
Bellemeade Re
We have entered into various aggregate excess of loss mortgage reinsurance agreements with various special purpose reinsurance companies domiciled in Bermuda (the “Bellemeade Agreements”). For the respective coverage periods, we will retain the first layer of the respective aggregate losses and the special purpose reinsurance companies will provide second layer coverage up to the outstanding coverage amount. We will then retain losses in excess of the outstanding coverage limit. The aggregate excess of loss reinsurance coverage decreases over a ten-year period as the underlying covered mortgages amortize.
The following table summarizes the respective coverages and retentions at June 30, 2019:
 
Initial Coverage at Issuance
 
Coverage at Jun. 30, 2019
 
First Layer Retention
Bellemeade 2015-1 Ltd. (1)
$
300,000

 
$
19,103

 
$
129,900

Bellemeade 2017-1 Ltd. (2)
368,100

 
277,554

 
165,700

Bellemeade 2018-1 Ltd. (3)
374,460

 
374,460

 
168,510

Bellemeade 2018-2 Ltd. (4)
653,278

 
571,129

 
352,258

Bellemeade 2018-3 Ltd. (5)
506,110

 
506,110

 
179,331

Bellemeade 2019-1 Ltd. (6)
341,790

 
329,085

 
208,046

Bellemeade 2019-2 Ltd. (7)
621,022

 
621,022

 
221,794

(1)
Issued in July 2015, covering in-force policies issued between January 1, 2009 and March 31, 2013.
(2)
Issued in October 2017, covering in-force policies issued between January 1, 2017 and June 30, 2017.
(3)
Issued in April 2018, covering in-force policies issued between July 1, 2017 and December 31, 2017.
(4)
Issued in August 2018, covering in-force policies issued between April 1, 2013 and December 31, 2015.
(5)
Issued in October 2018, covering in-force policies issued between January 1, 2018 and June 30, 2018.
(6)
Issued in March 2019, covering in-force policies primarily issued between 2005-2008 under United Guaranty Residential Insurance Company (“UGRIC”); as well as policies issued through 2015 under both UGRIC and Arch Mortgage Insurance Company.
(7)
Issued in April 2019, covering in-force policies issued between July 1, 2018 and December 31, 2018.
In July 2019, we entered into an aggregate excess of loss reinsurance agreement with Bellemeade Re 2019-3 Ltd. Such agreement provides for up to $700.9 million of aggregate excess of loss reinsurance coverage at inception in excess of $232.1 million of aggregate losses for new delinquencies on a portfolio of in-force policies issued in 2016.
Reserve for Losses and Loss Adjustment Expenses 
We establish reserve for losses and loss adjustment expenses (“Loss Reserves”) which represent estimates involving actuarial and statistical projections, at a given point in time, of our expectations of the ultimate settlement and administration

ARCH CAPITAL
 65
2019 SECOND QUARTER FORM 10-Q

costs of losses incurred. Estimating Loss Reserves is inherently difficult, which is exacerbated by the fact that we have relatively limited historical experience upon which to base such estimates. We utilize actuarial models as well as available historical insurance industry loss ratio experience and loss development patterns to assist in the establishment of Loss Reserves. Actual losses and loss adjustment expenses paid will deviate, perhaps substantially, from the reserve estimates reflected in our financial statements.
At June 30, 2019 and December 31, 2018, our Loss Reserves, net of unpaid losses and loss adjustment expenses recoverable, by type and by operating segment were as follows:
 
June 30,
2019
 
December 31,
2018
Insurance segment:
 

 
 

Case reserves
$
1,481,510

 
$
1,489,644

IBNR reserves
3,242,209

 
3,266,796

Total net reserves
4,723,719

 
4,756,440

Reinsurance segment:
 
 
 
Case reserves
1,169,285

 
1,082,917

Additional case reserves
172,932

 
191,002

IBNR reserves
1,672,645

 
1,578,907

Total net reserves
3,014,862

 
2,852,826

Mortgage segment:
 
 
 
Case reserves
302,426

 
355,606

IBNR reserves
151,224

 
122,304

Total net reserves (1)
453,650

 
477,910

Other segment:
 
 
 
Case reserves
431,960

 
364,052

Additional case reserves
25,640

 
36,512

IBNR reserves
555,688

 
551,266

Total net reserves
1,013,288

 
951,830

Total:
 

 
 

Case reserves
3,385,181

 
3,292,219

Additional case reserves
198,572

 
227,514

IBNR reserves
5,621,766

 
5,519,273

Total net reserves
$
9,205,519

 
$
9,039,006

(1)
At June 30, 2019, total net reserves include $330.1 million from U.S. mortgage insurance business, of which 66.7% represents policy years 2009 and prior and the remainder from later policy years. At December 31, 2018, total net reserves include $375.8 million from U.S. mortgage insurance business, of which 73.4% represents policy years 2009 and prior and the remainder from later policy years.
 
At June 30, 2019 and December 31, 2018, the insurance segment’s Loss Reserves by major line of business, net of unpaid losses and loss adjustment expenses recoverable, were as follows:
 
June 30,
2019
 
December 31,
2018
Insurance segment:
 
 
 
Professional lines (1)
$
1,255,253

 
$
1,247,914

Construction and national accounts
1,200,490

 
1,166,143

Excess and surplus casualty (2)
508,926

 
631,370

Programs
527,190

 
482,045

Property, energy, marine and aviation
338,868

 
388,710

Travel, accident and health
88,704

 
83,836

Lenders products
49,447

 
52,007

Other (3)
754,841

 
704,415

Total net reserves
$
4,723,719

 
$
4,756,440

(1)
Includes professional liability, executive assurance and healthcare business.
(2)
Includes casualty and contract binding business.
(3)
Includes alternative markets, excess workers’ compensation and surety business.
At June 30, 2019 and December 31, 2018, the reinsurance segment’s Loss Reserves by major line of business, net of unpaid losses and loss adjustment expenses recoverable, were as follows:
 
June 30,
2019
 
December 31,
2018
Reinsurance segment:
 
 
 
Casualty (1)
$
1,589,727

 
$
1,551,550

Other specialty (2)
662,535

 
582,420

Property excluding property catastrophe
447,549

 
422,612

Marine and aviation
131,644

 
130,683

Property catastrophe
110,570

 
90,635

Other (3)
72,837

 
74,926

Total net reserves
$
3,014,862

 
$
2,852,826

(1)
Includes executive assurance, professional liability, workers’ compensation, excess motor, healthcare and other.
(2)
Includes non-excess motor, surety, accident and health, workers’ compensation catastrophe, agriculture, trade credit and other.
(3)
Includes life, casualty clash and other.

ARCH CAPITAL
 66
2019 SECOND QUARTER FORM 10-Q

Mortgage Operations Supplemental Information
The mortgage segment’s insurance in force (“IIF”) and risk in force (“RIF”) were as follows at June 30, 2019 and December 31, 2018:
(U.S. Dollars in millions)
June 30, 2019
 
December 31, 2018
Amount
 
%
 
Amount
 
%
Insurance In Force (IIF) (1):
 
 
 
 
 
 
 
U.S. primary mortgage insurance
$
279,297

 
69.1

 
$
276,538

 
72.1

Mortgage reinsurance
26,286

 
6.5

 
25,975

 
6.8

Other (2)
98,335

 
24.3

 
81,147

 
21.2

Total
$
403,918

 
100.0

 
$
383,660

 
100.0

 
 
 
 
 
 
 
 
Risk In Force (RIF) (3):
 
 
 
 
 
 
 
U.S. primary mortgage insurance
$
71,760

 
91.8

 
$
70,995

 
92.3

Mortgage reinsurance
2,182

 
2.8

 
2,217

 
2.9

Other (2)
4,260

 
5.4

 
3,728

 
4.8

Total
$
78,202

 
100.0

 
$
76,940

 
100.0

(1)
Represents the aggregate dollar amount of each insured mortgage loan’s current principal balance.
(2)
Includes GSE credit risk-sharing transactions and international insurance business.
(3)
Represents the aggregate dollar amount of each insured mortgage loan’s current principal balance multiplied by the insurance coverage percentage specified in the policy for insurance policies issued and after contract limits and/or loss ratio caps for credit risk-sharing or reinsurance transactions.
The insurance in force and risk in force for our U.S. primary mortgage insurance business by policy year were as follows at June 30, 2019:
(U.S. Dollars in millions)
IIF
 
RIF
 
Delinquency
Amount
 
%
 
Amount
 
%
 
Rate (1)
Policy year:
 
 
 
 
 
 
 
 
 
2009 and prior
$
19,182

 
6.9

 
$
4,397

 
6.1

 
8.23
%
2010
519

 
0.2

 
139

 
0.2

 
2.45
%
2011
2,091

 
0.7

 
582

 
0.8

 
1.59
%
2012
7,613

 
2.7

 
2,122

 
3.0

 
0.83
%
2013
14,800

 
5.3

 
4,125

 
5.7

 
0.84
%
2014
16,251

 
5.8

 
4,454

 
6.2

 
0.98
%
2015
30,289

 
10.8

 
8,003

 
11.2

 
0.73
%
2016
47,334

 
16.9

 
12,233

 
17.0

 
0.79
%
2017
50,603

 
18.1

 
12,918

 
18.0

 
0.65
%
2018
62,753

 
22.5

 
15,831

 
22.1

 
0.37
%
2019
27,862

 
10.0

 
6,956

 
9.7

 
0.05
%
Total
$
279,297

 
100.0

 
$
71,760

 
100.0

 
1.45
%
(1)
Represents the ending percentage of loans in default.
 
The insurance in force and risk in force for our U.S. primary mortgage insurance business by policy year were as follows at December 31, 2018:
(U.S. Dollars in millions)
IIF
 
RIF
 
Delinquency
Amount
 
%
 
Amount
 
%
 
Rate (1)
Policy year:
 
 
 
 
 
 
 
 
 
2009 and prior
$
21,210

 
7.7

 
$
4,900

 
6.9

 
8.90
%
2010
646

 
0.2

 
175

 
0.2

 
2.62
%
2011
2,530

 
0.9

 
701

 
1.0

 
1.57
%
2012
9,650

 
3.5

 
2,664

 
3.8

 
0.78
%
2013
16,823

 
6.1

 
4,676

 
6.6

 
0.89
%
2014
18,274

 
6.6

 
4,947

 
7.0

 
0.97
%
2015
33,781

 
12.2

 
8,849

 
12.5

 
0.69
%
2016
52,324

 
18.9

 
13,407

 
18.9

 
0.77
%
2017
54,287

 
19.6

 
13,793

 
19.4

 
0.55
%
2018
67,013

 
24.2

 
16,883

 
23.8

 
0.15
%
Total
$
276,538

 
100.0

 
$
70,995

 
100.0

 
1.60
%
(1)
Represents the ending percentage of loans in default.
The following tables provide supplemental disclosures on risk in force for our U.S. primary mortgage insurance business at June 30, 2019 and December 31, 2018:
(U.S. Dollars in millions)
June 30, 2019
 
December 31, 2018
Amount
 
%
 
Amount
 
%
Credit quality (FICO):
 
 
 
 
 
 
 
>=740
$
41,333

 
57.6

 
$
41,066

 
57.8

680-739
24,488

 
34.1

 
23,954

 
33.7

620-679
5,494

 
7.7

 
5,485

 
7.7

<620
445

 
0.6

 
490

 
0.7

Total
$
71,760

 
100.0

 
$
70,995

 
100.0

Weighted average FICO score
743

 
 
 
743

 
 
 
 
 
 
 
 
 
 
Loan-to-value (LTV):
 
 
 
 
 
 
 
95.01% and above
$
8,535

 
11.9

 
$
7,918

 
11.2

90.01% to 95.00%
39,777

 
55.4

 
39,370

 
55.5

85.01% to 90.00%
20,419

 
28.5

 
20,643

 
29.1

85.00% and below
3,029

 
4.2

 
3,064

 
4.3

Total
$
71,760

 
100.0

 
$
70,995

 
100.0

Weighted average LTV
93.1
%
 
 
 
93.0
%
 
 
 
 
 
 
 
 
 
 
Total RIF, net of external reinsurance
$
56,562

 
 
 
$
55,755

 
 

ARCH CAPITAL
 67
2019 SECOND QUARTER FORM 10-Q

(U.S. Dollars in millions)
June 30, 2019
 
December 31, 2018
Amount
 
%
 
Amount
 
%
Total RIF by State:
 
 
 
 
 
 
 
Texas
$
5,509

 
7.7

 
$
5,491

 
7.7

California
4,736

 
6.6

 
4,505

 
6.3

Florida
3,699

 
5.2

 
3,541

 
5.0

Virginia
2,916

 
4.1

 
2,931

 
4.1

Georgia
2,599

 
3.6

 
2,573

 
3.6

Illinois
2,536

 
3.5

 
2,482

 
3.5

North Carolina
2,462

 
3.4

 
2,505

 
3.5

Minnesota
2,434

 
3.4

 
2,400

 
3.4

Washington
2,421

 
3.4

 
2,408

 
3.4

Maryland
2,420

 
3.4

 
2,407

 
3.4

Others
40,028

 
55.8

 
39,752

 
56.0

Total
$
71,760

 
100.0

 
$
70,995

 
100.0

The following table provides supplemental disclosures for our U.S. primary mortgage insurance business related to insured loans and loss metrics:
(U.S. Dollars in thousands, except policy, loan and claim count)
Six Months Ended
June 30,
2019
 
2018
Roll-forward of insured loans in default:
 
 
 
Beginning delinquent number of loans
20,665

 
27,068

New notices
18,617

 
17,792

Cures
(18,907
)
 
(21,865
)
Paid claims
(1,614
)
 
(1,958
)
Ending delinquent number of loans (1)
18,761

 
21,037

 
 
 
 
Ending number of policies in force (1)
1,292,215

 
1,239,565

 
 
 
 
Delinquency rate (1)
1.45
%
 
1.70
%
 
 
 
 
Losses:
 
 
 
Number of claims paid
1,614

 
1,958

Total paid claims
$
65,519

 
$
83,534

Average per claim
$
40.6

 
$
42.7

Severity (2)
97.0
%
 
101.6
%
Average reserve per default (in thousands)
$
16.1

 
$
19.3

(1)
Includes first lien primary and pool policies.
(2)
Represents total paid claims divided by RIF of loans for which claims were paid.
The risk-to-capital ratio, which represents total current (non-delinquent) risk in force, net of reinsurance, divided by total statutory capital, for Arch MI U.S. was approximately 11.4 to 1 at June 30, 2019, compared to 13.0 to 1 at December 31, 2018.
Shareholders’ Equity and Book Value per Share
Total shareholders’ equity available to Arch was $10.76 billion at June 30, 2019, compared to $9.44 billion at December 31, 2018. The increase reflected strong underwriting and investment returns.
 
The following table presents the calculation of book value per share:
(U.S. dollars in thousands, except 
share data)
June 30,
2019
 
December 31,
2018
Total shareholders’ equity available to Arch
$
10,757,352

 
$
9,439,827

Less preferred shareholders’ equity
780,000

 
780,000

Common shareholders’ equity available to Arch
$
9,977,352

 
$
8,659,827

Common shares and common share equivalents outstanding, net of treasury shares (1)
404,887,534

 
402,454,834

Book value per share
$
24.64

 
$
21.52

(1)
Excludes the effects of 19,607,588 and 20,076,593 stock options and 1,693,203 and 1,307,304 restricted stock units outstanding at June 30, 2019 and December 31, 2018, respectively.
LIQUIDITY
This section does not include information specific to Watford Re. We do not guarantee or provide credit support for Watford Re, and our financial exposure to Watford Re is limited to our investment in Watford Re’s common and preferred shares and counterparty credit risk (mitigated by collateral) arising from reinsurance transactions with Watford Re.
Liquidity is a measure of our ability to access sufficient cash flows to meet the short-term and long-term cash requirements of our business operations.

Arch Capital is a holding company whose assets primarily consist of the shares in its subsidiaries. Generally, Arch Capital depends on its available cash resources, liquid investments and dividends or other distributions from its subsidiaries to make payments, including the payment of debt service obligations and operating expenses it may incur and any dividends or liquidation amounts with respect to our preferred and common shares.
For the six months ended June 30, 2019, Arch Capital received dividends of $67.1 million from Arch Re Bermuda, our Bermuda-based reinsurer and insurer, which can pay approximately $2.56 billion to Arch Capital during the remainder of 2019 without providing an affidavit to the Bermuda Monetary Authority (“BMA”).
We expect that our liquidity needs, including our anticipated (re)insurance obligations and operating and capital expenditure needs, for the next twelve months, at a minimum, will be met by funds generated from underwriting activities and investment income, as well as by our balance of cash, short-term investments, proceeds on the sale or maturity of our investments, and our credit facilities.

ARCH CAPITAL
 68
2019 SECOND QUARTER FORM 10-Q

Cash Flows
The following table summarizes our cash flows from operating, investing and financing activities, excluding amounts related to the ‘other’ segment (i.e., Watford Re). See note 11, “Variable Interest Entities and Noncontrolling Interests,” for cash flows related to Watford Re.
 
Six Months Ended
 
June 30,
 
2019
 
2018
Total cash provided by (used for):
 

 
 

Operating activities
$
597,276

 
$
404,451

Investing activities
(611,199
)
 
270,381

Financing activities
(35,352
)
 
(731,613
)
Effects of exchange rate changes on foreign currency cash
2,259

 
(9,024
)
Increase (decrease) in cash and restricted cash
$
(47,016
)
 
$
(65,805
)
•Cash provided by operating activities for the six months ended June 30, 2019 reflected a higher level of premiums collected than in the 2018 period.
•Cash used for investing activities for the six months ended June 30, 2019 was higher than in the 2018 period, reflecting a higher level of securities purchased.
•Cash used for financing activities for the six months ended June 30, 2019 was lower than in the 2018 period. The 2018 period reflected $250.0 million of paydowns on our revolving credit agreement borrowings, $173.6 million of repurchases under our share repurchase program and $92.6 million related to redemption of our Series C preferred shares in January 2018.
CAPITAL RESOURCES
This section does not include information specific to Watford Re. We do not guarantee or provide credit support for Watford Re, and our financial exposure to Watford Re is limited to our investment in Watford Re’s common and preferred shares and counterparty credit risk (mitigated by collateral) arising from reinsurance transactions with Watford Re.
 
The following table provides an analysis of our capital structure:
(U.S. dollars in thousands, except 
share data)
Jun 30,
2019
 
Dec 31,
2018
Debt:
 
 
 
Senior notes, due May 2034
$
300,000

 
$
300,000

Arch-U.S. senior notes, due Nov 2043 (1)
500,000

 
500,000

Arch Finance senior notes, due Dec 2026 (1)
500,000

 
500,000

Arch Finance senior notes, due Dec 2046 (1)
450,000

 
450,000

Deferred debt costs on senior notes
(16,135
)
 
(16,472
)
Revolving credit agreement borrowings due Oct 2021 (2)
—

 
—

Total
$
1,733,865

 
$
1,733,528

 
 
 
 
Shareholders’ equity available to Arch:
 
 
 
Series E non-cumulative preferred shares
$
450,000

 
$
450,000

Series F non-cumulative preferred shares
330,000

 
330,000

Common shareholders’ equity
9,977,352

 
8,659,827

Total
$
10,757,352

 
$
9,439,827

 
 
 
 
Total capital available to Arch
$
12,491,217

 
$
11,173,355

 
 
 
 
Debt to total capital (%)
13.9

 
15.5

Preferred to total capital (%)
6.2

 
7.0

Debt and preferred to total capital (%)
20.1

 
22.5

(1)
Fully and unconditionally guaranteed by Arch Capital.
(2)
$500 million unsecured facility for revolving loans and letters of credit.
Arch Capital and Arch-U.S. are each holding companies and, accordingly, they conduct substantially all of their operations through their operating subsidiaries. Arch Capital Finance LLC (“Arch Finance”) is a wholly owned subsidiary of Arch U.S. MI Holdings Inc. As a result, Arch Capital, Arch-U.S. and Arch Finance's cash flows and their ability to service their debt depends upon the earnings of their operating subsidiaries, or affiliates in the case of Arch Finance, and on their ability to distribute the earnings, loans or other payments from such subsidiaries or affiliates to Arch Capital, Arch-U.S. and Arch Finance, respectively.
In addition, Arch MI U.S. is required to maintain compliance with the GSEs requirements, known as the Private Mortgage Insurer Eligibility Requirements or “PMIERs.” The financial requirements require an eligible mortgage insurer’s available assets, which generally include only the most liquid assets of an insurer, to meet or exceed “minimum required assets” as of each quarter end. Minimum required assets are calculated from PMIERs tables with several risk dimensions (including origination year, original loan-to-value and original credit score of performing loans, and the delinquency status of non-performing loans) and are subject to a minimum amount. Arch MI U.S. satisfied the PMIERs’ financial requirements as of June 30, 2019 with an estimated PMIER sufficiency ratio of 163%, compared to 141% at December 31, 2018.


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Pursuant to our 2014 acquisition of the CMG Mortgage Insurance Company and its affiliated mortgage insurance companies, we made a contingent consideration payment of $61.5 million in April 2019. The maximum amount of remaining contingent consideration payments over the remaining earn-out period is $6.7 million.
Arch Capital, through its subsidiaries, provides financial support to certain of its insurance subsidiaries and affiliates, through certain reinsurance arrangements beneficial to the ratings of such subsidiaries. Historically, our insurance, reinsurance and mortgage insurance subsidiaries have entered into separate reinsurance arrangements with Arch Re Bermuda covering individual lines of business. The reinsurance agreements between our U.S.-based property casualty insurance and reinsurance subsidiaries and Arch Re Bermuda were canceled on a cutoff basis as of January 1, 2018. As a result, the level of subject business ceded to Arch Re Bermuda for the reported periods was substantially lower than in 2017 and prior periods.
SHARE REPURCHASE PROGRAM
The board of directors of Arch Capital has authorized the investment in Arch Capital’s common shares through a share repurchase program. For the six months ended June 30, 2019, Arch Capital repurchased 0.1 million shares under the share repurchase program with an aggregate purchase price of $2.9 million. Since the inception of the share repurchase program through June 30, 2019, Arch Capital has repurchased 386.3 million common shares for an aggregate purchase price of $3.97 billion. At June 30, 2019, approximately $160.9 million of share repurchases were available under the program, which may be effected from time to time in open market or privately negotiated transactions through December 31, 2019.
The timing and amount of the repurchase transactions under this program will depend on a variety of factors, including market conditions and corporate and regulatory considerations. We will continue to monitor our share price and, depending upon results of operations, market conditions and the development of the economy, as well as other factors, we will consider share repurchases on an opportunistic basis.
CATASTROPHIC EVENTS AND SEVERE ECONOMIC EVENTS
We have large aggregate exposures to natural and man-made catastrophic events and severe economic events. Catastrophes can be caused by various events, including hurricanes, floods, windstorms, earthquakes, hailstorms, tornadoes, explosions, severe winter weather, fires, droughts and other natural disasters. Catastrophes can also cause losses in non-property business such as mortgage insurance, workers’ compensation or general liability. In addition to the nature of property
 
business, we believe that economic and geographic trends affecting insured property, including inflation, property value appreciation and geographic concentration, tend to generally increase the size of losses from catastrophic events over time.
Our models employ both proprietary and vendor-based systems and include cross-line correlations for property, marine, offshore energy, aviation, workers compensation and personal accident. We seek to limit the probable maximum pre-tax loss to a specific level for severe catastrophic events. Currently, we seek to limit our 1-in-250 year return period net probable maximum loss from a severe catastrophic event in any geographic zone to approximately 25% of total shareholders’ equity available to Arch. We reserve the right to change this threshold at any time.
Based on in-force exposure estimated as of July 1, 2019, our modeled peak zone catastrophe exposure was a windstorm affecting the Northeastern U.S., with a net probable maximum pre-tax loss of $398 million, followed by windstorms affecting Florida Tri-County and the Gulf of Mexico regions with net probable maximum pre-tax losses of $368 million and $352 million, respectively. Our exposures to other perils, such as U.S. earthquake and international events, were less than the exposures arising from U.S. windstorms and hurricanes. As of July 1, 2019, our modeled peak zone earthquake exposure (San Francisco earthquake) represented approximately 69% of our peak zone catastrophe exposure, and our modeled peak zone international exposure (Japan earthquake) was substantially less than both our peak zone windstorm and earthquake exposures.
Effective July 1, 2019, our insurance operations had in effect a reinsurance program which provided coverage for certain property-catastrophe related losses equal to $275 million in excess of various retentions per occurrence.
We also have significant exposure to losses due to mortgage defaults resulting from severe economic events in the future. For our U.S. mortgage insurance business, we have developed a proprietary risk model (“Realistic Disaster Scenario” or “RDS”) that simulates the maximum loss resulting from a severe economic downturn impacting the housing market. The RDS models the collective impact of adverse conditions for key economic indicators, the most significant of which is a decline in home prices. The RDS model projects paths of future home prices, unemployment rates, income levels and interest rates and assumes correlation across states and geographic regions.  The resulting future performance of our in-force portfolio is then estimated under the economic stress scenario, reflecting loan and borrower information. 
Currently, we seek to limit our modeled RDS loss from a severe economic event to approximately 25% of total tangible shareholders’ equity available to Arch (total shareholders’ equity available to Arch less goodwill and intangible assets).

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2019 SECOND QUARTER FORM 10-Q

We reserve the right to change this threshold at any time. Based on in-force exposure estimated as of July 1, 2019, our modeled RDS loss was approximatly10% of tangible shareholders’ equity available to Arch.
Net probable maximum loss estimates are net of expected reinsurance recoveries, before income tax and before excess reinsurance reinstatement premiums. RDS loss estimates are net of expected reinsurance recoveries and after income tax. Catastrophe loss estimates are reflective of the zone indicated and not the entire portfolio. Since hurricanes and windstorms can affect more than one zone and make multiple landfalls, our catastrophe loss estimates include clash estimates from other zones. Our catastrophe loss estimates and RDS loss estimates do not represent our maximum exposures and it is highly likely that our actual incurred losses would vary materially from the modeled estimates. There can be no assurances that we will not suffer pre-tax losses greater than 25% of our total shareholders' equity or tangible shareholders’ equity from one or more catastrophic events or severe economic events due to several factors, including the inherent uncertainties in estimating the frequency and severity of such events and the margin of error in making such determinations resulting from potential inaccuracies and inadequacies in the data provided by clients and brokers, the modeling techniques and the application of such techniques or as a result of a decision to change the percentage of shareholders' equity exposed to a single catastrophic event or severe economic event. In addition, actual losses may increase if our reinsurers fail to meet their obligations to us or the reinsurance protections purchased by us are exhausted or are otherwise unavailable. See “Risk Factors—Risks Relating to Our Industry” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Catastrophic Events and Severe Economic Events” in our 2018 Form 10-K.
OFF-BALANCE SHEET ARRANGEMENTS
Off-balance sheet arrangements are discussed in Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our 2018 Form 10-K.
MARKET SENSITIVE INSTRUMENTS AND RISK MANAGEMENT
In accordance with the SEC’s Financial Reporting Release No. 48, we performed a sensitivity analysis to determine the effects that market risk exposures could have on the future earnings, fair values or cash flows of our financial instruments as of June 30, 2019. Market risk represents the risk of changes in the fair value of a financial instrument and is comprised of several components, including liquidity, basis and price risks. We have not included Watford Re in the following analyses as we do not guarantee or provide credit support for Watford Re, and our financial exposure to Watford Re is limited to our
 
investment in Watford Re’s common and preferred shares and counterparty credit risk (mitigated by collateral) arising from reinsurance transactions.
An analysis of material changes in market risk exposures at June 30, 2019 that affect the quantitative and qualitative disclosures presented in our 2018 Form 10-K (see section captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Market Sensitive Instruments and Risk Management”) were as follows: 
Investment Market Risk
Fixed Income Securities. We invest in interest rate sensitive securities, primarily debt securities. We consider the effect of interest rate movements on the fair value of our fixed maturities, fixed maturities pledged under securities lending agreements, short-term investments and certain of our other investments which invest in fixed income securities and the corresponding change in unrealized appreciation. As interest rates rise, the fair value of our interest rate sensitive securities falls, and the converse is also true. Based on historical observations, there is a low probability that all interest rate yield curves would shift in the same direction at the same time. Furthermore, at times interest rate movements in certain credit sectors exhibit a much lower correlation to changes in U.S. Treasury yields. Accordingly, the actual effect of interest rate movements may differ materially from the amounts set forth in the following tables.
The following table summarizes the effect that an immediate, parallel shift in the interest rate yield curve would have had on our fixed income securities:
(U.S. dollars in 
billions)
Interest Rate Shift in Basis Points
-100
 
-50
 
—
 
+50
 
+100
Jun 30, 2019
 

 
 

 
 

 
 

 
 

Total fair value
$
20.24

 
$
19.91

 
$
19.57

 
$
19.22

 
$
18.89

Change from base
3.4
%
 
1.7
%
 
 
 
(1.8
)%
 
(3.5
)%
Change in unrealized value
$
0.67

 
$
0.33

 
 
 
$
(0.35
)
 
$
(0.69
)
 
 
 
 
 
 
 
 
 
 
Dec 31, 2018
 
 
 
 
 
 
 
 
 
Total fair value
$
19.23

 
$
18.91

 
$
18.62

 
$
18.30

 
$
17.98

Change from base
3.3
%
 
1.6
%
 
 
 
(1.7
)%
 
(3.4
)%
Change in unrealized value
$
0.61

 
$
0.30

 
 
 
$
(0.32
)
 
$
(0.63
)
In addition, we consider the effect of credit spread movements on the market value of our fixed maturities, fixed maturities pledged under securities lending agreements, short-term investments and certain of our other investments and investment funds accounted for using the equity method which invest in fixed income securities and the corresponding change in unrealized appreciation. As credit spreads widen, the fair value of our fixed income securities falls, and the converse is also true.

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2019 SECOND QUARTER FORM 10-Q

The following table summarizes the effect that an immediate, parallel shift in credit spreads in a static interest rate environment would have had on our fixed income securities:
(U.S. dollars in 
billions)
Credit Spread Shift in Percentage Points
-100
 
-50
 
—
 
+50
 
+100
Jun 30, 2019
 

 
 

 
 

 
 

 
 

Total fair value
$
19.96

 
$
19.77

 
$
19.57

 
$
19.38

 
$
19.18

Change from base
2.0
%
 
1.0
%
 
 
 
(1.0
)%
 
(2.0
)%
Change in unrealized value
$
0.39

 
$
0.20

 
 
 
$
(0.20
)
 
$
(0.39
)
 
 
 
 
 
 
 
 
 
 
Dec 31, 2018
 
 
 
 
 
 
 
 
 
Total fair value
$
19.08

 
$
18.84

 
$
18.62

 
$
18.39

 
$
18.15

Change from base
2.5
%
 
1.2
%
 
 
 
(1.2
)%
 
(2.5
)%
Change in unrealized value
$
0.47

 
$
0.22

 
 
 
$
(0.22
)
 
$
(0.47
)
Another method that attempts to measure portfolio risk is Value-at-Risk (“VaR”). VaR attempts to take into account a broad cross-section of risks facing a portfolio by utilizing relevant securities volatility data skewed towards the most recent months and quarters. VaR measures the amount of a portfolio at risk for outcomes 1.65 standard deviations from the mean based on normal market conditions over a one year time horizon and is expressed as a percentage of the portfolio’s initial value. In other words, 95% of the time, should the risks taken into account in the VaR model perform per their historical tendencies, the portfolio’s loss in any one year period is expected to be less than or equal to the calculated VaR, stated as a percentage of the measured portfolio’s initial value. As of June 30, 2019, our portfolio’s VaR was estimated to be 3.31% compared to an estimated 3.02% at December 31, 2018.
Equity Securities. At June 30, 2019 and December 31, 2018, the fair value of our investments in equity securities totaled $666.9 million and $368.8 million, respectively. These investments are exposed to price risk, which is the potential loss arising from decreases in fair value. An immediate hypothetical 10% decline in the value of each position would reduce the fair value of such investments by approximately $66.7 million and $36.9 million at June 30, 2019 and December 31, 2018, respectively, and would have decreased book value per share by approximately $0.16 and $0.09, respectively. An immediate hypothetical 10% increase in the value of each position would increase the fair value of such investments by approximately $66.7 million and $36.9 million at June 30, 2019 and December 31, 2018, respectively, and would have increased book value per share by approximately $0.16 and $0.09, respectively.
Investment-Related Derivatives. At June 30, 2019, the notional value of all derivative instruments (excluding to-be-announced mortgage backed securities which are included in the fixed income securities analysis above and foreign currency forward contracts which are included in the foreign currency exchange risk analysis below) was $7.85 billion, compared to $4.95
 
billion at December 31, 2018. If the underlying exposure of each investment-related derivative held at June 30, 2019 depreciated by 100 basis points, it would have resulted in a reduction in net income of approximately $78.5 million, and a decrease in book value per share of approximately $0.19 per share, compared to $49.5 million and $0.12 per share, respectively, on investment-related derivatives held at December 31, 2018. If the underlying exposure of each investment-related derivative held at June 30, 2019 appreciated by 100 basis points, it would have resulted in an increase in net income of approximately $78.5 million, and an increase in book value per share of approximately $0.19 per share, compared to $49.5 million and $0.12 per share, respectively, on investment-related derivatives held at December 31, 2018. See note 8, “Derivative Instruments,” to our consolidated financial statements for additional disclosures concerning derivatives.
For further discussion on investment activity, please refer to “Financial Condition—Investable Assets.”
Foreign Currency Exchange Risk
Foreign currency rate risk is the potential change in value, income and cash flow arising from adverse changes in foreign currency exchange rates. Through our subsidiaries and branches located in various foreign countries, we conduct our insurance and reinsurance operations in a variety of local currencies other than the U.S. Dollar. We generally hold investments in foreign currencies which are intended to mitigate our exposure to foreign currency fluctuations in our net insurance liabilities. We may also utilize foreign currency forward contracts and currency options as part of our investment strategy. See note 8, “Derivative Instruments,” to our consolidated financial statements for additional information.

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2019 SECOND QUARTER FORM 10-Q

The following table provides a summary of our net foreign currency exchange exposures, as well as foreign currency derivatives in place to manage these exposures:
(U.S. dollars in thousands, except 
per share data)
June 30,
2019
 
December 31,
2018
Net assets (liabilities), denominated in foreign currencies, excluding shareholders’ equity and derivatives
$
(326,838
)
 
$
(561,311
)
Shareholders’ equity denominated in foreign currencies (1)
598,443

 
478,678

Net foreign currency forward contracts outstanding (2)
181,655

 
241,442

Net exposures denominated in foreign currencies
$
453,260

 
$
158,809

 
 
 
 
Pre-tax impact of a hypothetical 10% appreciation of the U.S. Dollar against foreign currencies:
 

 
 

Shareholders’ equity
$
(45,326
)
 
$
(15,881
)
Book value per share
$
(0.11
)
 
$
(0.04
)
 
 
 
 
Pre-tax impact of a hypothetical 10% decline of the U.S. Dollar against foreign currencies:
 

 
 

Shareholders’ equity
$
45,326

 
$
15,881

Book value per share
$
0.11

 
$
0.04

(1)
Represents capital contributions held in the foreign currencies of our operating units.
(2)
Represents the net notional value of outstanding foreign currency forward contracts.
Although we generally attempt to match the currency of our projected liabilities with investments in the same currencies, from time to time we may elect to over or underweight one or more currencies, which could increase our exposure to foreign currency fluctuations and increase the volatility of our shareholders’ equity. Historical observations indicate a low probability that all foreign currency exchange rates would shift against the U.S. Dollar in the same direction and at the same time and, accordingly, the actual effect of foreign currency rate movements may differ materially from the amounts set forth above. For further discussion on foreign exchange activity, please refer to “—Results of Operations.”
Effects of Inflation
We do not believe that inflation has had a material effect on our consolidated results of operations, except insofar as inflation may affect our reserve for losses and loss adjustment expenses and interest rates. The potential exists, after a catastrophe loss, for the development of inflationary pressures in a local economy. The anticipated effects of inflation on us are considered in our catastrophe loss models. The actual effects of inflation on our results cannot be accurately known until claims are ultimately settled.
 
OTHER FINANCIAL INFORMATION
The consolidated financial statements as of June 30, 2019 and for the three month and six month periods ended June 30, 2019 and 2018 have been reviewed by PricewaterhouseCoopers LLP, the registrant's independent public accountants, whose report is included as an exhibit to this filing. The report of PricewaterhouseCoopers LLP states that they did not audit and they do not express an opinion on that unaudited financial information. Accordingly, the degree of reliance on their report on such information should be restricted in light of the limited nature of the review procedures applied. PricewaterhouseCoopers LLP is not subject to the liability provisions of Section 11 of the Securities Act of 1933 for their report on the unaudited financial information because that report is not a "report" or a "part" of the registration statement prepared or certified by PricewaterhouseCoopers LLP within the meaning of Sections 7 and 11 of the Securities Act of 1933.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Reference is made to the information appearing above under the subheading “Market Sensitive Instruments and Risk Management” under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” which information is hereby incorporated by reference. 

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2019 SECOND QUARTER FORM 10-Q

ITEM 4. CONTROLS AND PROCEDURES
 
Evaluation of Disclosure Controls and Procedures
In connection with the filing of this Form 10-Q, our management, including the Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of disclosure controls and procedures pursuant to applicable Exchange Act Rules as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures were effective as of the end of and during the period covered by this report with respect to information being recorded, processed, summarized and reported within time periods specified in the SEC’s rules and forms and with respect to timely communication to them and other members of management responsible for preparing periodic reports of all material information required to be disclosed in this report as it relates to Arch Capital and its consolidated subsidiaries.
We continue to enhance our operating procedures and internal controls to effectively support our business and our regulatory and reporting requirements. Our management does not expect that our disclosure controls or our internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. As a result of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons or by collusion of two or more people. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. As a result of the inherent limitations in a cost-effective control system, misstatement due to error or fraud may occur and not be detected. Accordingly, our disclosure controls and procedures are designed to provide reasonable, not absolute, assurance that the disclosure controls and procedures are met.
 
Changes in Internal Controls Over Financial Reporting
There have been no changes in internal control over financial reporting that occurred during the quarter ended June 30, 2019 that have materially affected, or are reasonably likely to materially affect, internal control over financial reporting.

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2019 SECOND QUARTER FORM 10-Q

PART II.  OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We, in common with the insurance industry in general, are subject to litigation and arbitration in the normal course of our business. As of June 30, 2019, we were not a party to any litigation or arbitration which is expected by management to have a material adverse effect on our results of operations and financial condition and liquidity.
ITEM 1A. RISK FACTORS
There were no material changes from the risk factors previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2018.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The following table summarizes our purchases of common shares for the 2019 second quarter:
 
 
Issuer Purchases of Equity Securities
Period
 
Total Number of Shares
Purchased (1)
 
Average Price Paid per Share
 
Total Number of Shares Purchased as Part of
Publicly Announced
Plans or Programs
 
Approximate Dollar
Value of Shares that
 May Yet be Purchased
Under the Plan or
Programs (2)
4/1/2019 - 4/30/2019
 
17,802

 
$
32.62

 
—

 
$
160,867

5/1/2019 - 5/31/2019
 
333,431

 
33.71

 
—

 
$
160,867

6/1/2019 - 6/30/2019
 
23,317

 
35.42

 
—

 
$
160,867

Total
 
374,550

 
$
33.76

 
—

 
 
(1)
Represents repurchases by Arch Capital of shares, from time to time, from employees in order to facilitate the payment of withholding taxes on restricted shares granted and the exercise of stock appreciation rights. We purchased these shares at their fair value, as determined by reference to the closing price of our common shares on the day the restricted shares vested or the stock appreciation rights were exercised.
(2)
Remaining amount available at June 30, 2019 under Arch Capital’s share repurchase authorization, under which repurchases may be effected from time to time in open market or privately negotiated transactions through December 31, 2019.


ARCH CAPITAL
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2019 SECOND QUARTER FORM 10-Q

ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.

ITEM 5. OTHER INFORMATION
In accordance with Section 10a(i)(2) of the Securities Exchange Act of 1934, as amended, we are responsible for disclosing non-audit services to be provided by our independent auditor, PricewaterhouseCoopers LLP, which are approved by the Audit Committee of our board of directors. During the 2019 second quarter, the Audit Committee approved engagements of PricewaterhouseCoopers LLP for permitted non-audit services, which consisted of tax consulting services, tax compliance services and other accounting consulting services.
Disclosure of Certain Activities Under Section 13(r) of the Securities Exchange Act of 1934

Section 13(r) of the Securities Exchange Act of 1934, as amended, requires an issuer to disclose in its annual or quarterly reports whether it or an affiliate knowingly engaged in certain activities described in that section, including certain activities related to Iran during the period covered by the report.
Certain of our non-U.S. subsidiaries underwrite insurance and facultative reinsurance on a global basis to non-U.S. insureds and insurers, including for liability, marine, aviation and energy risks. Coverage provided to non-Iranian business may indirectly cover an exposure in Iran. For example, certain of our operations underwrite global marine hull and cargo policies that provide coverage for vessels navigating into and out of ports worldwide, including Iran. For the quarter ended June 30, 2019, there has been no material amount of premium allocated or apportioned to activities relating to Iran, and we are unable to attribute gross revenues or net profits from any such policies because they insure multiple voyages and fleets containing multiple ships. Such non-U.S. subsidiaries will continue to provide such coverage only to the extent permitted by applicable law.

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2019 SECOND QUARTER FORM 10-Q

ITEM 6. EXHIBITS
 
 
 
 
 
Incorporated by Reference
 
 
Exhibit Number
 
Exhibit Description
 
Form
 
Original Number
 
Date Filed
 
Filed Herewith
15
 
Accountants’ Awareness Letter (regarding unaudited interim financial information)
 
 
 
 
 
 
 
X
31.1
 
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
 
 
 
 
 
 
X
31.2
 
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
 
 
 
 
 
 
X
32.1
 
Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
 
 
 
 
 
X
32.2
 
Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
 
 
 
 
 
X
101.INS
 
XBRL Instance Document
 
 
 
 
 
 
 
 
101.SCH
 
XBRL Taxonomy Extension Schema Document
 
 
 
 
 
 
 
 
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase Document
 
 
 
 
 
 
 
 
101.DEF
 
XBRL Taxonomy Extension Definition Linkbase Document
 
 
 
 
 
 
 
 
101.LAB
 
XBRL Taxonomy Extension Label Linkbase Document
 
 
 
 
 
 
 
 
101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase Document
 
 
 
 
 
 
 
 

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2019 SECOND QUARTER FORM 10-Q

SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
ARCH CAPITAL GROUP LTD.
 
 
(REGISTRANT)
 
 
 
 
 
/s/ Marc Grandisson
Date: August 7, 2019
 
Marc Grandisson
 
 
President and Chief Executive Officer (Principal Executive Officer)
 
 
 
 
 
/s/ François Morin
Date: August 7, 2019
 
François Morin
 
 
Executive Vice President, Chief Financial Officer and Treasurer (Principal Financial and Accounting Officer)

ARCH CAPITAL
 78
2019 SECOND QUARTER FORM 10-Q

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