ARCH CAPITAL GROUP LTD. The following is a discussion and analysis of the financial condition and results of operations for the year endedDecember 31, 2022 and 2021. Comparisons between 2021 and 2020 have been omitted from this Form 10-K, but may be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of the Company's Annual Report on Form 10-K year endedDecember 31, 2021 filed with theSEC . This discussion and analysis contains forward-looking statements which involve inherent risks and uncertainties. All statements other than statements of historical fact are forward-looking statements. These statements are based on our current assessment of risks and uncertainties. Actual results may differ materially from those expressed or implied in these statements and, therefore, undue reliance should not be placed on them. Important factors that could cause actual events or results to differ materially from those indicated in such statements are discussed in this report, including the sections entitled " Cautionary Note Regarding Forward-Looking Statements ," and " Risk Factors ." This discussion and analysis should be read in conjunction with our audited consolidated financial statements and notes thereto presented under Item 8 . Tabular amounts are inU.S. Dollars in thousands, except share amounts, unless otherwise noted. Page No. Overview 62 Current Outlook 62 Financial Measures 63 Comments on Non-GAAP Measures 64 Results of Operations 66 Insurance Segment 67 Reinsurance Segment 68 Mortgage Segment 69 Corporate Segment 71 Summary of Critical Accounting Estimates 72 Financial Condition 80 Liquidity 83 Capital Resources 85 Contractual Obligations and Commitments 88 Ratings 89 Catastrophic Events and Severe Economic Events 89 Market Sensitive Instruments and Risk Management 91 ARCH CAPITAL 61 2022 FORM 10-K
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Table of Contents OVERVIEWArch Capital Group Ltd. ("Arch Capital " and, together with its subsidiaries, "we" or "us") is a publicly listedBermuda exempted company with approximately$15.6 billion in capital atDecember 31, 2022 and is part of the S&P 500 index. Through operations inBermuda ,the United States ,United Kingdom ,Europe ,Canada andAustralia , we write specialty lines of property and casualty insurance and reinsurance, as well as mortgage insurance and reinsurance, on a worldwide basis. It is our belief that our underwriting platform, our experienced management team and our strong capital base have enabled us to establish a strong presence in the insurance and reinsurance markets. The worldwide property casualty insurance and reinsurance industry is highly competitive and has traditionally been subject to an underwriting cycle. In that cycle, a "hard" market is evidenced by high premium rates, restrictive underwriting standards, narrow terms and conditions, and strong underwriting profits for insurers. A "hard" market typically attracts new capital and new entrants to the market and is eventually followed by a "soft" market, which has characteristics of low premium rates, relaxed underwriting standards, broader terms and conditions, and lower underwriting profits for insurers. Market conditions in the property and casualty arena may affect, among other things, the demand for our products, our ability to increase premium rates, the terms and conditions of the insurance policies we write, changes in the products offered by us or changes in our business strategy. The financial results of the property casualty insurance and reinsurance industry are influenced by factors such as the frequency and/or severity of claims and losses, including natural disasters or other catastrophic events, variations in interest rates and financial markets, changes in the legal, regulatory and judicial environments, inflationary pressures and general economic conditions. These factors influence, among other things, the demand for insurance or reinsurance, the supply of which is generally related to the total capital of competitors in the market.
Mortgage insurance and reinsurance is subject to similar cycles to property casualty except that they have historically been more dependent on macroeconomic conditions.
CURRENT OUTLOOK As we head into 2023, our objective remains the same, to deliver long term value for our shareholders. Underwriting discipline is core to our culture and we are committed to agile cycle management with a focus on risk-adjusted returns. 2022 was our third consecutive year of sustained premium and revenue growth, supporting stronger and more stable earnings power for the near term. Reinsurance segment's net premiums written grew 51% as the team seized on market dislocations while our insurance segment grew a robust 21%. We continue to see a broad array of opportunities to allocate capital where rates and terms and conditions allow for growth in attractive returns. We continue to execute our cycle management strategy by actively allocating capital across a diversified, specialty portfolio where rates allow for returns that are higher than our cost of capital. While we continue to allocate more capital to our property and casualty segments, it is important to note that we have capitalized on attractive returns from our mortgage segment with$1.3 billion of underwriting income in 2022. The catastrophic activity in 2022 has significantly increased pressure on property catastrophe markets, which could have a ripple effect across all property and casualty lines. As a result, we continue to show improved underwriting margins, partially due to the compounding of rate-on-rate increases and the rebalancing of our mix of business. We believe that this proven strategy of protecting capital through soft markets and increasing writings in hard markets gives us the best chance to generate superior risk adjusted returns over time. In reinsurance, pricing for theJanuary 1 renewals was strong. Property catastrophe pricing and terms both improved, leading to the effective rate changes in the 30% to 50% range. We anticipate that these trends will continue to the mid-year property catastrophe renewal period and should translate to strong property growth in 2023. As long as rate increases support returns above our required thresholds, we expect to continue to grow our writings. Rate improvements have enabled us to continue to expand writings in our property casualty segments. In insurance, underwriting conditions remain opportunistic as pricing discipline, terms and conditions, and limits management are stable across most lines. This stability, combined with the uncertainties in the insurance market, should keep the market disciplined and sustain rate increases in most lines of business. Our specialty business in theU.K. and theU.S. operations benefited from growth in professional liability, including cyber insurance, as well as travel where we believe relative returns are attractive.
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Table of Contents Inflation continues to be a focus for our industry. We proactively analyze available data and we incorporate emerging trends into our pricing and reserving. We believe that this discipline, coupled with increases in future investment returns and prudent reserving, helps us somewhat mitigate inflation's impact. In mortgage, we continue to be thoughtful in how we manage our portfolio and, because of our diversified model, we have the ability to take a measured view of the business as just one component of our diversified enterprise. Our mortgage business continues to deliver consistent underwriting results, once again demonstrating its sustainable earnings model. Although higher interest rates affected new loan origination volume, ourU.S. primary mortgage insurance in force grew to nearly$296 billion , reflecting a higher persistency rate. The credit quality of homebuyers remains excellent and we believe our portfolio is well positioned for a variety of economic scenarios. We remain 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 addition, we have entered into aggregate excess of loss mortgage reinsurance agreements with various special purpose reinsurance companies domiciled inBermuda and have issued mortgage insurance linked notes, increasing our protection for mortgage tail risk. The Bellemeade structures provided approximately$4.0 billion of aggregate reinsurance coverage atDecember 31, 2022 . FINANCIAL MEASURES
Management uses the following three key financial indicators in evaluating our
performance and measuring the overall growth in value generated for
Book Value per Share
Book value per share represents total common shareholders' equity available to Arch divided by the number of common shares and common share equivalents 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 ofArch 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$32.62 atDecember 31, 2022 , a 2.8% decrease from$33.56 atDecember 31, 2021 . The decline in 2022 reflected negative total return on investments driven by rising interest rates on fixed maturities.
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 average common shareholders' equity available to Arch during the
period. After-tax operating income available to Arch common shareholders, a
"non-GAAP measure" as defined in the SEC rules, represents net income available
to Arch common shareholders, excluding net realized gains or losses (which
includes changes in the allowance for credit losses on financial assets and net
impairment losses recognized in earnings), equity in net income or loss of
investments 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 Arch common shareholders. See "Comment on Non-GAAP Financial
Measures."
Our annualized net income return on average common equity was 11.6% for 2022,
compared to 16.7% for 2021, with the lower return in 2022 primarily resulting
from net realized losses and a lower level of income from equity method
investments. Our Operating ROAE was 14.8% for 2022, compared to 11.5% for 2021,
with the higher return in 2022 primarily resulting from strong underwriting
performance and growth in net investment income, reflecting higher yields
available on fixed income securities.
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Table of Contents Total Return on Investments Total return on investments includes investment income, equity in net income or loss of investments accounted for using the equity method, net realized gains or losses and the change in unrealized gains or losses generated by Arch's investment portfolio. Total return is calculated on a pre-tax basis before investment expenses, excluding amounts reflected in the 'other' segment, and reflects the effect of financial market conditions along with foreign currency fluctuations. Management uses total return on investments as a key measure of the return generated for Arch common shareholders on the capital held in the business, and compares the return generated by our investment portfolio against benchmark returns. See "Comment on Non-GAAP Financial Measures." The following table summarizes the pre-tax total return (before investment expenses) of investments held by Arch compared to the benchmark return (both based inU.S. Dollars) against which we measured our portfolio during the periods: Arch Benchmark Portfolio (1) Return Year Ended December 31, 2022 -6.45 % -9.60 % Year Ended December 31, 2021 1.90 % 1.20 %
(1) Our investment expenses were approximately 0.28% and 0.32%, respectively, of average invested assets in 2022 and 2021.
Total return for the 2022 period reflected rising interest rates on fixed maturities and weak equity markets. The overall position of our investment portfolio remains relatively unchanged as we remain cautious relative to duration, credit and equity risk.
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. AtDecember 31, 2022 , the benchmark return index had an average credit quality of "Aa3" by Moody's, an estimated duration of 3.16 years.
The benchmark return index included weightings to the following indices:
%
ICE BofAML US Corporates, A - AAA Rated 1-5 Yr Index 13.00 % ICE BofAML 1-5 Year US Treasury Index
12.00
ICE BofAML US Corporates, AAA-A 5-10 Year Index 11.00
ICE BofAML US Corporates, BBB Rated 1-10 Yr Index 5.00 JPM CLOIE Investment Grade
5.00
ICE BofAML 1-5 Year UK Gilt Index 4.25
ICE BofAML AAA US Fixed Rate CMBS Index 4.00
ICE BofAML US Mortgage Backed Securities Index 4.00
ICE BofAML German Government 1-10 Year Index 4.00
MSCI ACWI Net Total Return USD Index 4.00
Equity (MSCI ACWI) 3.30
ICE BofAML 0-3 Month US Treasury Bill Index 3.00
ICE BofAML 5-10 Year US Treasury Index 3.00
ICE BofAML 1-10 Year US Municipal Securities Index 3.00 Bloomberg Barclays ABS Aaa Total Return Index
3.00
ICE BofAML 1-5 Year Canada Government Index 2.50
ICE BofAML 1-5 Year Australia Government Index 2.50
Morningstar LSTA US Leveraged Loan TR USD 2.50
ICE BofAML US High Yield Constrained Index 2.50
Senior Lending (S&P Leveraged Loan) 2.48
Opportunistic Credit (Barclays Global HY) 1.38
Distressed (Ice BofA CCC and Lower) 1.38
Int'l Equity RE (DJ International RE) 0.83
US RE Mezz (FTSE NAREIT Mortgage Plus Capped Index) 0.83 US RE Senior (Barclays CMBS Erisa Eligible)
0.83
ICE BofAML 15+ Year Canada Government Index 0.50
ICE BofA 1-5 Year Japan Government Index 0.25
Total 100.0 %
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 (which includes changes in the allowance for credit losses on financial assets and net impairment losses recognized in earnings), equity in net income or loss of investments 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 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
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shareholders and annualized net income 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, equity in net income or loss of investments accounted for using the equity method, net foreign exchange gains or losses and transaction costs and other in any particular period are not indicative of the performance of, or trends in, our business. Although net realized gains or losses, equity in net income or loss of investments accounted for using the equity method and net foreign exchange gains or losses are an integral part of our operations, the decision to realize these items 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, changes in the allowance for credit losses and net impairment losses recognized in earnings on the Company's investments represent other-than-temporary declines in expected recovery values on securities without actual realization. The use of the equity method on certain of 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 investments and the timing of the recognition of equity in net income or loss of investments 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 the Company's preferred shares had no impact on shareholders' equity or cash flows.
Due to these reasons noted above, we exclude net realized gains or losses, equity in net income or loss of investments 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 that 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 segment. While these measures are presented in note 4, "Segment Information," to our consolidated financial statements in Item 8, 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 in Item 8. 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 intangible assets, and, accordingly, investment income, income from operating affiliates and other non-underwriting related items are not allocated to each underwriting segment. Along with consolidated underwriting income, we provide a subtotal of underwriting income or loss before the contribution from the 'other' segment. ThroughJune 30, 2021 , the 'other' segment included the results ofSomers Holdings Ltd. (formerlyWatford Holdings Ltd. ).Somers Holdings Ltd. is the parent ofSomers Re Ltd. , a multi-lineBermuda reinsurance company (together withSomers Holdings Ltd. , "Somers"). Pursuant to GAAP, Somers was
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Table of Contents considered a variable interest entity and we concluded that we were the primary beneficiary of Somers. As such, we consolidated the results of Somers in our consolidated financial statements throughJune 30, 2021 . In the 2020 fourth quarter,Arch Capital , Somers, andGreysbridge Ltd. , a wholly-owned subsidiary ofArch Capital , entered into an Agreement and Plan of Merger (as amended, the "Merger Agreement").Arch Capital assigned its rights under the Merger Agreement toGreysbridge Holdings Ltd. ("Greysbridge"). The merger and the related Greysbridge equity financing closed onJuly 1, 2021 . EffectiveJuly 1, 2021 , Somers is wholly owned by Greysbridge, and Greysbridge is owned 40% by Arch and 30% by certain funds managed by Kelso and 30% by certain funds managed by Warburg. Based on the governing documents of Greysbridge, we concluded that, while we retain significant influence over Greysbridge, Greysbridge does not constitute a variable interest entity. Accordingly, effectiveJuly 1, 2021 , we no longer consolidate the results of Somers in our consolidated financial statements and footnotes. See note 1 2 , "Variable Interest Entities and Noncontrolling Interests" and note 4, "Segment Information," to our consolidated financial statements for additional information on Somers. 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 investments accounted for using the equity method, net realized gains or losses (excluding changes in the allowance for credit losses on non-investment related financial assets) and the change in unrealized gains or 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 available to Arch common shareholders to after-tax operating income available to Arch common shareholders. See "Comment on Non-GAAP Financial Measures."
Year
Ended
2022 2021
Net income available to Arch common shareholders
$ 2,093,405 Net realized (gains) losses 662,735 (307,466)
Equity in net (income) loss of investments accounted for using the equity method
(115,856) (366,402)
Net foreign exchange (gains) losses (100,988) (42,743)
Transaction costs and other 1,092 1,199
Loss on redemption of preferred shares - 15,101
Income tax expense (benefit) (1) (42,791) 41,836
After-tax operating income available to Arch common shareholders
$ 1,840,389
Beginning common shareholders' equity$ 12,715,896 $ 12,325,886 Ending common shareholders' equity 12,080,073
12,715,896
Average common shareholders' equity$ 12,397,985
Annualized net income return on average common equity % 11.6 16.7 Annualized operating return on average common equity % 14.8 11.5 (1) Income tax on net realized gains or losses, equity in net income or loss of investments accounted for using the equity method, net foreign exchange gains or losses and transaction costs and other reflects the relative mix reported by jurisdiction and the varying tax rates in each jurisdiction.
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Table of Contents Segment Information We classify our businesses into three underwriting segments - insurance, reinsurance and mortgage - and two operating segments - corporate 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 Chief Executive Officer ofArch Capital , Chief Financial Officer and Treasurer ofArch Capital and the President and Chief Underwriting Officer ofArch 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:
Year Ended December 31,
2022 2021 % Change
Gross premiums written $ 6,930,864 $ 5,867,734 18.1
Premiums ceded (1,910,222) (1,719,541)
Net premiums written 5,020,642 4,148,193 21.0
Change in unearned premiums (461,307) (521,725)
Net premiums earned 4,559,335 3,626,468 25.7
Losses and loss adjustment expenses (2,782,945) (2,344,365)
Acquisition expenses (885,866) (606,265)
Other operating expenses (665,472) (558,906)
Underwriting income (loss) $ 225,052 $ 116,932 92.5
Underwriting Ratios % Point Change
Loss ratio 61.0 % 64.6 % (3.6)
Acquisition expense ratio 19.4 % 16.7 % 2.7
Other operating expense ratio 14.6 % 15.4 % (0.8)
Combined ratio 95.0 % 96.7 % (1.7)
The insurance segment consists of our insurance underwriting units which offer
specialty product lines on a worldwide basis, as described in note 4, "Segment
Information," to our consolidated financial statements in Item 8.
Net Premiums Written.
The following tables set forth our insurance segment's net premiums written by
major line of business:
Year Ended December 31,
2022 2021
Amount % Amount %
Professional lines $ 1,502,448 29.9 $ 1,177,144 28.4
Property, energy, marine and aviation 878,067 17.5 722,582 17.4
Programs 611,922 12.2 595,824 14.4
Travel, accident and health 484,847 9.7 305,390 7.4
Construction and national accounts 469,717 9.4 431,952 10.4
Excess and surplus casualty 460,798 9.2 359,458 8.7
Warranty and lenders solutions 139,247 2.8 146,984 3.5
Other 473,596 9.4 408,859 9.9
Total $ 5,020,642 100.0 $ 4,148,193 100.0
Net premiums written by the insurance segment were 21.0% higher in 2022 than in
2021. The increase in net premiums written reflected growth in professional
lines and in property, primarily due to rate increases, new business
opportunities and growth in existing accounts, and in travel, primarily due to
new business and growth in existing accounts.
Net Premiums Earned.
The following tables set forth our insurance segment's net premiums earned by
major line of business:
Year Ended December 31,
2022 2021
Amount % Amount %
Professional lines $ 1,314,236 28.8 $ 942,817 26.0
Property, energy, marine and aviation 772,388 16.9 667,892 18.4
Programs 589,860 12.9 506,867 14.0
Travel, accident and health 491,847 10.8 255,590 7.0
Construction and national accounts 432,020 9.5 416,107 11.5
Excess and surplus casualty 393,353 8.6 318,027 8.8
Warranty and lenders solutions 127,222 2.8 153,958 4.2
Other 438,409 9.6 365,210 10.1
Total $ 4,559,335 100.0 $ 3,626,468 100.0
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 by the
insurance segment were 25.7% higher in 2022 than in 2021, reflecting changes in
net premiums written over the previous five quarters.
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Table of Contents Losses and Loss Adjustment Expenses.
The table below shows the components of the insurance segment's loss ratio:
Year Ended December 31,
2022 2021
Current year 61.6 % 65.0 %
Prior period reserve development (0.6) % (0.4) %
Loss ratio 61.0 % 64.6 %
Current Year Loss Ratio.
The insurance segment's current year loss ratio was 3.4 points lower in 2022
than in 2021. The 2022 loss ratio included 5.2 points of current year
catastrophic event activity, primarily related to Hurricane Ian, Russia's
invasion of Ukraine and other natural catastrophes, compared to 5.6 points in
2021, primarily related to Hurricane Ida and winter storms Uri and Viola. The
balance of the change in the 2022 loss ratios resulted, in part, from changes in
mix of business.
Prior
The insurance segment's net favorable development was$25.3 million , or 0.6 points, for 2022, compared to$16.2 million , or 0.4 points, for 2021. See note 5, "Reserve for Losses and Loss Adjustment Expenses," to our consolidated financial statements in Item 8 for information about the insurance segment's prior year reserve development.
Underwriting Expenses.
The insurance segment's underwriting expense ratio was 34.0% in 2022, compared to 32.1% in 2021, with the increase primarily due to changing mix of business and growth in lines with higher acquisition costs.
Reinsurance Segment
The following tables set forth our reinsurance segment's underwriting results:
Year Ended December 31,
2022 2021 % Change
Gross premiums written $ 6,948,438 $ 5,093,930 36.4
Premiums ceded (2,024,462) (1,839,556)
Net premiums written 4,923,976 3,254,374 51.3
Change in unearned premiums (964,595) (413,931)
Net premiums earned 3,959,381 2,840,443 39.4
Other underwriting income (loss) 4,871 3,669
Losses and loss adjustment expenses (2,568,843) (1,924,719)
Acquisition expenses (813,555) (536,754)
Other operating expenses (267,531) (212,810)
Underwriting income $ 314,323 $ 169,829 85.1
Underwriting Ratios % Point Change
Loss ratio 64.9 % 67.8 % (2.9)
Acquisition expense ratio 20.5 % 18.9 % 1.6
Other operating expense ratio 6.8 % 7.5 % (0.7)
Combined ratio 92.2 % 94.2 % (2.0)
The reinsurance segment consists of our reinsurance underwriting units which
offer specialty product lines on a worldwide basis, as described in note 4,
"Segment Information," to our consolidated financial statements in Item 8.
Net Premiums Written.
The following tables set forth our reinsurance segment's net premiums written by
major line of business:
Year Ended December 31,
2022 2021
Amount % Amount %
Other specialty $ 1,982,594 40.3 $ 955,474 29.4
Property excluding property catastrophe 1,276,083 25.9 1,004,086 30.9
Casualty 973,948 19.8 808,164 24.8
Property catastrophe 415,725 8.4 233,260 7.2
Marine and aviation 166,933 3.4 171,753 5.3
Other 108,693 2.2 81,637 2.5
Total $ 4,923,976 100.0 $ 3,254,374 100.0
Net premiums written by the reinsurance segment were 51.3% higher in 2022 than
in 2021. The growth in net premiums written reflected increases in most lines of
business, primarily due to growth in existing accounts, new business, and rate
increases. The 2022 fourth quarter was affected by a few non-recurring
transactions, primarily impacting the other specialty line of business.
ARCH CAPITAL 68 2022 FORM 10-K
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Net Premiums Earned.
The following tables set forth our reinsurance segment's net premiums earned by
major line of business:
Year Ended December 31,
2022 2021
Amount % Amount %
Other specialty $ 1,377,880 34.8 $ 818,801 28.8
Property excluding property catastrophe 1,091,440 27.6 836,573 29.5
Casualty 854,543 21.6 666,754 23.5
Property catastrophe 366,991 9.3 280,738 9.9
Marine and aviation 159,401 4.0 152,955 5.4
Other 109,126 2.8 84,622 3.0
Total $ 3,959,381 100.0 $ 2,840,443 100.0
Net premiums earned in 2022 were 39.4% higher than in 2021, reflecting changes
in net premiums written over the previous five quarters, including the mix and
type of business written.
Other Underwriting Income (Loss).
Other underwriting income in 2022 was
Losses and Loss Adjustment Expenses.
The table below shows the components of the reinsurance segment's loss ratio:
Year Ended December 31,
2022 2021
Current year 69.7 % 74.1 %
Prior period reserve development (4.8) % (6.3) %
Loss ratio 64.9 % 67.8 %
Current Year Loss Ratio.
The reinsurance segment's current year loss ratio was 4.4 points lower in 2022
than in 2021. The 2022 loss ratio included 13.9 points for current year
catastrophic event activity, primarily related to Hurricane Ian, Russia's
invasion of Ukraine and other global events, compared to 16.5 points in 2021.
The balance of the change in the 2022 current year loss ratio resulted, in part,
from the effect of rate increases, changes in mix of business and the level of
attritional losses.
Prior
The reinsurance segment's net favorable development was
note 5, "Reserve for Losses and Loss Adjustment Expenses," to our consolidated financial statements in Item 8 for information about the reinsurance segment's prior year reserve development.
Underwriting Expenses.
The underwriting expense ratio for the reinsurance segment was 27.3% in 2022, compared to 26.4% in 2021, with the increase primarily resulting from changes in mix of business to lines with higher acquisition costs and expenses related to favorable development of prior year loss reserves.
Mortgage Segment
The following tables set forth our mortgage segment's underwriting results.
Year Ended December 31,
2022 2021 % Change
Gross premiums written $ 1,454,971 $ 1,507,825 (3.5)
Premiums ceded (322,400) (246,757)
Net premiums written 1,132,571 1,261,068 (10.2)
Change in unearned premiums 26,790 22,351
Net premiums earned 1,159,361 1,283,419 (9.7)
Other underwriting income 8,356 17,665
Losses and loss adjustment expenses 324,271 (56,677)
Acquisition expenses (40,159) (97,418)
Other operating expenses (195,172) (194,010)
Underwriting income $ 1,256,657 $ 952,979 31.9
Underwriting Ratios % Point Change
Loss ratio (28.0) % 4.4 % (32.4)
Acquisition expense ratio 3.5 % 7.6 % (4.1)
Other operating expense ratio 16.8 % 15.1 % 1.7
Combined ratio (7.7) % 27.1 % (34.8)
Premiums Written.
The following table sets forth our mortgage segment's net premiums written by underwriting location (i.e., where the business is underwritten):
Year Ended December 31,
2022 2021
Net premiums written by underwriting location
United States $ 780,256 $ 914,477
Other 352,315 346,591
Total $ 1,132,571 $ 1,261,068
Gross premiums written by the mortgage segment in 2022 were 3.5% lower than in
2021. The reduction in gross premiums written primarily reflected a lower U.S.
primary mortgage insurance single premium volume and a decrease in monthly
premiums. Net premiums written for 2022 were 10.2% lower than in the 2021
period. Net premiums written for the 2022 period reflected a higher level of
premiums ceded than in the 2021 period.
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Table of Contents The persistency rate of theU.S. primary portfolio of mortgage loans was 79.5% atDecember 31, 2022 compared to 62.4% atDecember 31, 2021 , with the increase primarily reflecting a lower level of refinancing activity due to a higher interest rate environment. The persistency rate 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.
Net Premiums Earned.
The following table sets forth our mortgage segment's net premiums earned by underwriting location (i.e., where the business is underwritten):
Year Ended December 31,
2022 2021
Net premiums earned by underwriting location
United States $ 815,519 $ 970,507
Other 343,842 312,912
Total $ 1,159,361 $ 1,283,419 Net premiums earned for 2022 were 9.7% lower than in 2021 and reflected a decline in monthly premiums and an increase in ceded premiums earned, partially offset by growth in credit risk transfer business.
Other Underwriting Income.
Other underwriting income, which is primarily related to GSE risk-sharing
transactions and our whole mortgage loan purchase and sell program, was
Losses and Loss Adjustment Expenses.
The table below shows the components of the mortgage segment's loss ratio:
Year Ended December 31,
2022 2021
Current year 19.8 % 17.6 %
Prior period reserve development (47.8) % (13.2) %
Loss ratio (28.0) % 4.4 %
Unlike property and casualty business for which we estimate ultimate losses on
premiums earned, losses on mortgage insurance business are only recorded at the
time a borrower is delinquent on their mortgage, in accordance with primary
mortgage insurance industry practice. Because our primary mortgage insurance
reserving process does not take into account the impact of future losses from
loans that are not delinquent, mortgage insurance loss reserves are not an
estimate of ultimate losses. In addition to establishing loss reserves for
delinquent loans, under GAAP, we are required to establish a premium deficiency
reserve for our mortgage
insurance products if the amount of expected future losses and maintenance costs
exceeds expected future premiums, existing reserves and the anticipated
investment income for such product. We assess the need for a premium deficiency
reserve on a quarterly basis and perform a full analysis annually. No such
reserve was established during 2022 or 2021.
Current Year Loss Ratio.
The mortgage segment's current year loss ratio was 2.2 points higher in 2022 compared to 2021. The higher current year loss ratio for the 2022 period reflected a lower level of premiums earned in theU.S. primary mortgage insurance business combined with an increase in new delinquencies as well as an increase in estimated claim rates.
The percentage of loans in default on
We insure mortgages for homes in areas that have been impacted by catastrophic events. Generally, mortgage insurance losses occur only when a credit event occurs and, following a physical damage event, when the home is restored to pre-storm condition. Our ultimate claims exposure will depend on the number of delinquency notices received and the ultimate claim rate related to such notices. In the event of natural disasters, cure rates are influenced by the adequacy of homeowners and flood insurance carried on a related property, and a borrower's access to aid from government entities and private organizations, in addition to other factors which generally impact cure rates in unaffected areas.
Prior
The mortgage segment's net favorable development was
note 5, "Reserve for Losses and Loss Adjustment Expenses," to our consolidated financial statements in Item 8 for information about the mortgage segment's prior year reserve development.
Underwriting Expenses.
The underwriting expense ratio for the mortgage segment was 20.3% for 2022, compared to 22.7% for 2021, with the decrease primarily due to lower acquisition expenses on Australian mortgage insurance following the acquisition of Westpac LMI in the 2021 third quarter and profit commissions adjustments related to favorable development of prior year loss reserves. Such amounts were partially offset by a lower level of net premiums earned in theU.S. primary mortgage insurance business. ARCH CAPITAL 70 2022 FORM 10-K
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Table of Contents
Corporate Segment
The corporate segment results include net investment income, net realized gains
or losses, equity in net income or loss of investments accounted for using the
equity method, other income (loss), corporate expenses, transaction costs and
other, amortization of intangible assets, interest expense, net foreign exchange
gains or losses, income taxes, income from operating affiliates and items
related to our non-cumulative preferred shares. Such amounts exclude the results
of the 'other' segment.
Net Investment Income.
The components of net investment income were derived from the following sources:
Year Ended December 31,
2022 2021
Fixed maturities $ 468,659 $ 307,536
Equity securities 22,497 42,094
Short-term investments 29,519 6,799
Other (1) 46,647 68,411
Gross investment income 567,322 424,840
Investment expenses (2) (70,775) (78,032)
Net investment income $ 496,547 $ 346,808
(1) Amounts include dividends and other distributions on investment funds, term
loan investments, funds held balances, cash balances and other.
(2) Investment expenses were approximately 0.28% of average invested assets for
2022, compared to 0.32% for 2021.
The pre-tax investment income yield was 1.99% for 2022, compared to 1.41% for 2021. The higher level of net investment income for 2022 compared to 2021 reflected higher yields available in the financial markets. The pre-tax investment income yields were calculated based on amortized cost. Yields on future investment income may vary based on financial market conditions, investment allocation decisions and other factors.
Net Realized Gains (Losses).
We recorded net realized losses of$662.7 million for 2022, compared to net realized gains of$299.2 million for 2021. 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 or losses as the portfolio is 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 changes in the allowance for credit losses on financial assets and net impairment losses recognized in earnings. See note 9, "Investment Information-Net Realized Gains (Losses)," and note 9, "Investment Information-Allowance for Credit Losses," to our consolidated financial statements for additional information.
Equity in Net Income (Loss) of Investments Accounted for Using the Equity Method.
We recorded$115.9 million of equity in net income related to investments accounted for using the equity method for 2022, compared to$366.4 million for 2021. Investments accounted for using the equity method totaled$3.8 billion atDecember 31, 2022 , compared to$3.1 billion atDecember 31, 2021 . See note 9, "Investment Information-Equity in Net Income (Loss) of Investments Accounted For Using the Equity Method," to our consolidated financial statements in Item 8 for additional information. Other Income (Loss) Other loss for the 2022 period was$26.2 million , compared to other income of$10.2 million for the 2021 period. Amounts in both periods primarily reflect changes in the cash surrender value of our investment in corporate-owned life insurance. Corporate Expenses. Corporate expenses were$94.4 million for 2022, compared to$77.1 million for 2021. Such amounts primarily represent certain holding company costs necessary to support our worldwide operations and costs associated with operating as a publicly traded company. Transaction Costs and Other. Transaction costs and other were$1.1 million for the 2022 period consistent with$1.1 million for 2021. Amounts in both periods are primarily related to acquisition activity.
Amortization of Intangible Assets.
Amortization of intangible assets for 2022 was$106.2 million , compared to$82.1 million for 2021. Amounts in 2022 and 2021 primarily related to amortization of finite-lived intangible assets. The increase in amortization of intangible assets expense was a result of acquisitions closed during the 2021 period. See note 2, "Acquisitions." Interest Expense. Interest expense was$130.3 million for 2022, compared to$131.1 million for 2021. Interest expense primarily reflects amounts related to our outstanding senior notes. ARCH CAPITAL 71 2022 FORM 10-K
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Table of Contents Net Foreign Exchange Gains or Losses. Net foreign exchange gains for 2022 were$100.9 million , compared to net foreign exchange gains for 2021 of$42.9 million . Amounts in such 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 before income taxes resulted in an expense of 5.1% for 2022, compared to an expense of 5.6% for 2021. The effective tax rate for the 2022 period included discrete income tax benefits of$40.6 million , compared to benefits of$39.3 million for 2021. The discrete tax items in both periods primarily related to the release of valuation allowances on certain deferred tax assets. Our effective tax rate fluctuates from year to year consistent with the relative mix of income or loss reported by jurisdiction and the varying tax rates in each jurisdiction. See note 15, "Income Taxes," to our consolidated financial statements in Item 8 for a reconciliation of the difference between the provision for income taxes and the expected tax provision at the weighted average statutory tax rate for 2022 and 2021.
Income (Loss) from Operating Affiliates.
We recorded$73.9 million of net income from our operating affiliates in the 2022 period, compared to income of$264.7 million in the 2021 period. Results for the 2021 period included a one-time gain of$95.7 million recognized from the Company's investment in Greysbridge and a one-time gain of$74.5 million recognized from the Company's investment in Coface SA ("Coface"), aFrance -based leader in the global trade credit insurance market.
Loss on Redemption of Preferred Shares.
In 2021, we redeemed all 5.25% Series E preferred shares and recorded a loss of$15.1 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.
SUMMARY OF CRITICAL ACCOUNTING ESTIMATES
The preparation of consolidated financial statements in accordance with GAAP requires us to make many estimates and judgments that affect the reported amounts of assets, liabilities (including reserves), revenues and expenses, and related disclosures of contingent liabilities. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, insurance and other reserves, reinsurance recoverables, allowance for current expected credit losses, investment valuations, goodwill and intangible assets, bad debts, income taxes, contingencies and litigation. We base our estimates on historical experience, where possible, and on various other assumptions that we believe to be reasonable under the circumstances, which form the basis for our judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results will differ from these estimates and such differences may be material. We believe that the following critical accounting policies affect significant estimates used in the preparation of our consolidated financial statements.
Loss Reserves
We are required by applicable insurance laws and regulations and GAAP to establish reserves for losses and loss adjustment expenses, or "Loss Reserves", that arise from the business we underwrite. Loss Reserves for our insurance, reinsurance and mortgage operations are balance sheet liabilities representing estimates of future amounts required to pay losses and loss adjustment expenses for insured or reinsured events which have occurred at or before the balance sheet date. Loss Reserves do not reflect contingency reserve allowances to account for future loss occurrences. Losses arising from future events will be estimated and recognized at the time the losses are incurred and could be substantial. See note 6, "Short Duration Contracts," to our consolidated financial statements in Item 8 for additional information on our reserving process. ARCH CAPITAL 72 2022 FORM 10-K
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Table of Contents AtDecember 31, 2022 and 2021, our Loss Reserves, net of unpaid losses and loss adjustment expenses recoverable, by type and by operating segment were as follows: December 31, 2022 2021 Insurance segment: Case reserves$ 2,397,881 $ 2,102,891 IBNR reserves 4,934,583 4,269,904 Total net reserves 7,332,464 6,372,795 Reinsurance segment: Case reserves 1,902,899 1,733,571 Additional case reserves 481,523 426,531 IBNR reserves 3,403,109 2,656,527 Total net reserves 5,787,531 4,816,629 Mortgage segment: Case reserves 447,018 741,897 IBNR reserves 186,105 226,604 Total net reserves 633,123 968,501 Total: Case reserves 4,747,798 4,578,359 Additional case reserves 481,523 426,531 IBNR reserves 8,523,797 7,153,035 Total net reserves$ 13,753,118 $ 12,157,925 AtDecember 31, 2022 and 2021, the insurance segment's Loss Reserves by major line of business, net of unpaid losses and loss adjustment expenses recoverable, were as follows: December 31, 2022 2021 Professional lines$ 2,069,912 $ 1,673,615
Construction and national accounts 1,558,466 1,490,206 Programs
843,094 793,187
Excess and surplus casualty 786,494 657,307
Property, energy, marine and aviation 763,531 599,093 Travel, accident and health
138,814 96,051
Warranty and lenders solutions 46,733 58,351
Other 1,125,420 1,004,985
Total net reserves $ 7,332,464 $ 6,372,795
At December 31, 2022 and 2021, the reinsurance segment's Loss Reserves by major
line of business, net of unpaid losses and loss adjustment expenses recoverable,
were as follows:
December 31,
2022 2021
Casualty $ 2,342,077 $ 2,123,360
Other specialty 1,475,702 1,113,766
Property excluding property catastrophe 993,454 711,859
Property catastrophe 535,844 486,911
Marine and aviation 291,548 246,861
Other 148,906 133,872
Total net reserves $ 5,787,531 $ 4,816,629
At December 31, 2022 and 2021, the mortgage segment's Loss Reserves by major
line of business, net of unpaid losses and loss adjustment expenses recoverable,
were as follows:
December 31,
2022 2021
U.S. primary mortgage insurance (1) $ 415,242 $ 710,708 Total net reserves$ 633,123 $ 968,501 (1) AtDecember 31, 2022 , 33.8% of total net reserves represent policy years 2012 and prior and the remainder from later policy years. AtDecember 31, 2021 , 27.9% of total net reserves represent policy years 2012 and prior and the remainder from later policy years.
Potential Variability in Loss Reserves
The following tables summarize the effect of reasonably likely scenarios on the
key actuarial assumptions used to estimate our Loss Reserves, net of unpaid
losses and loss adjustment expenses recoverable, at
The scenarios shown in the tables summarize the effect of (i) changes to the expected loss ratio selections used atDecember 31, 2022 , which represent loss ratio point increases or decreases to the expected loss ratios used, and (ii) changes to the loss development patterns used in our reserving process atDecember 31, 2022 , which represent claims reporting that is either slower or faster than the reporting patterns used. We believe that the illustrated sensitivities are indicative of the potential variability inherent in the estimation process of those parameters. The results show the impact of varying each key actuarial assumption using the chosen sensitivity on our IBNR reserves, on a net basis and across all accident years. ARCH CAPITAL 73 2022 FORM 10-K
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Table of Contents
Higher Expected Loss Slower Loss
INSURANCE SEGMENT Ratios Development Patterns
Reserving lines selected assumptions:
Property, energy, marine and aviation 5 points 3 months
Third party occurrence business 10 6
Third party claims-made business 10 6
Multi-line and other specialty 10 6
Increase (decrease) in Loss Reserves:
Property, energy, marine and aviation $ 44,139 $ 93,943
Third party occurrence business 209,293 100,645
Third party claims-made business 385,410 210,223
Multi-line and other specialty 235,811 104,475
Lower Expected Loss Faster Loss
INSURANCE SEGMENT Ratios Development Patterns
Reserving lines selected assumptions:
Property, energy, marine and aviation (5) points (3) months
Third party occurrence business (10) (6)
Third party claims-made business (10) (6)
Multi-line and other specialty (10) (6)
Increase (decrease) in Loss Reserves:
Property, energy, marine and aviation $ (44,139) $ (60,941)
Third party occurrence business (207,906) (82,490)
Third party claims-made business (382,587) (173,800)
Multi-line and other specialty (197,682) (71,891)
Higher Expected Loss Slower Loss
REINSURANCE SEGMENT Ratios Development Patterns
Reserving lines selected assumptions:
Casualty 10 points 6 months
Other specialty 5 3
Property excluding property catastrophe 5 3
Property catastrophe 5 3
Marine and aviation 5 3
Other 5 3
Increase (decrease) in Loss Reserves:
Casualty $ 192,747 $ 220,372
Other specialty 140,889 102,342
Property excluding property catastrophe 41,745 101,294
Property catastrophe 31,774 52,223
Marine and aviation 14,524 25,618
Other 8,541 5,591
Lower Expected Loss Faster Loss
REINSURANCE SEGMENT Ratios Development Patterns
Reserving lines selected assumptions:
Casualty (10) points (6) months
Other specialty (5) (3)
Property excluding property catastrophe (5) (3)
Property catastrophe (5) (3)
Marine and aviation (5) (3)
Other (5) (3)
Increase (decrease) in Loss Reserves:
Casualty $ (192,743) $ (167,558)
Other specialty (140,889) (147,647)
Property excluding property catastrophe (41,745) (99,642)
Property catastrophe (31,774) (32,967)
Marine and aviation (14,715) (27,465)
Other (8,541) (5,086)
It is not necessarily appropriate to sum the total impact for a specific factor
or the total impact for a specific business category as the business categories
are not perfectly correlated. In addition, the potential variability shown in
the tables above are reasonably likely scenarios of changes in our key
assumptions at December 31, 2022 and are not meant to be a "best case" or "worst
case" series of outcomes and therefore, it is possible that future variations
may be more or less than the amounts set forth above.
For our mortgage segment, we considered the sensitivity of loss reserve
estimates at December 31, 2022 by assessing the potential changes resulting from
a parallel shift in severity and default to claim rate. For example, assuming
all other factors remain constant, for every one percentage point change in
primary claim severity (which we estimate to be approximately 30% of the unpaid
principal balance at December 31, 2022 ), we estimated that our loss reserves
would change by approximately $21.0 million at December 31, 2022 . For every one
percentage point change in our primary net default to claim rate (which we
estimate to be approximately 37% at December 31, 2022 ), we estimated a $17.0
million change in our loss reserves at December 31, 2022 .
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Table of Contents Simulation Results In order to illustrate the potential volatility in our Loss Reserves, we used a Monte Carlo simulation approach to simulate a range of results based on various probabilities. Both the probabilities and related modeling are subject to inherent uncertainties. The simulation relies on a significant number of assumptions, such as the potential for multiple entities to react similarly to external events, and includes other statistical assumptions. The simulation results shown for each segment do not add to the total simulation results, as the individual segment simulation results do not reflect the diversification effects across our segments. AtDecember 31, 2022 , our recorded Loss Reserves by underwriting segment, net of unpaid losses and loss adjustment expenses recoverable, and the results of the simulation were as follows: Insurance Segment Reinsurance Segment Mortgage Segment Total Loss Reserves (1)$7,332,464 $5,787,531 $633,123 $13,753,118 Simulation results: 90th percentile (2)$8,611,623 $7,054,715 $757,900 $16,070,373 10th percentile (3)$6,091,636 $4,614,229 $517,006 $11,544,929 (1) Net of reinsurance recoverables. (2) Simulation results indicate that a 90% probability exists that the net reserves for losses and loss adjustment expenses will not exceed the indicated amount. (3) Simulation results indicate that a 10% probability exists that the net reserves for losses and loss adjustment expenses will be at or below the indicated amount. For informational purposes, based on the total simulation results, a change in our Loss Reserves to the amount indicated at the 90th percentile would result in a decrease in income before income taxes of approximately$2.3 billion , or$6.14 per diluted share, while a change in our Loss Reserves to the amount indicated at the 10th percentile would result in an increase in income before income taxes of approximately$2.2 billion , or$5.85 per diluted share. The simulation results noted above are informational only, and no assurance can be given that our ultimate losses will not be significantly different than the simulation results shown above, and such differences could directly and significantly impact earnings favorably or unfavorably in the period they are determined. We do not have significant exposure to pre-2002 liabilities, such as asbestos-related illnesses and other long-tail liabilities. It is difficult to provide meaningful trend information for certain liability/casualty coverages for which the claim-tail may be especially long, as claims are often reported and ultimately paid or settled years, or even decades, after the related loss events occur. Any estimates and assumptions made as part of the reserving process could prove to be inaccurate due to several factors, including the fact that for certain lines of business relatively limited historical information has been reported to us throughDecember 31, 2022 . Accordingly, the reserving for incurred losses in these lines of business could be subject to greater variability. See Item 1A, "Risk Factors - Risks Relating to Our Industry, Business & Operations - Underwriting risks and reserving for losses are based on probabilities and related modeling, which are subject to inherent uncertainties."
Mortgage Operations Supplemental Information
The mortgage segment's insurance in force ("IIF") and risk in force ("RIF") were
as follows at
(U.S. Dollars in millions) December 31,
2022 2021
Amount % Amount %
Insurance In Force (IIF) (1):
U.S. primary mortgage insurance $ 295,651 57.6 $ 280,945 61.0
U.S. credit risk transfer
(CRT) and other (2) 145,087 28.3 110,018 23.9
International mortgage
insurance/reinsurance (3) 72,315 14.1 69,655 15.1
Total $ 513,053 100.0 $ 460,618 100.0
Risk In Force (RIF) (4):
U.S. primary mortgage insurance $ 75,806 84.8 $ 70,619 84.3
U.S. credit risk transfer
(CRT) and other (2) 6,245 7.0 5,120 6.1
International mortgage
insurance/reinsurance (3) 7,369 8.2 7,983 9.5
Total $ 89,420 100.0 $ 83,722 100.0
(1) Represents the aggregate dollar amount of each insured mortgage loan's
current principal balance.
(2) Includes all CRT transactions, which are predominantly with GSEs, and other
U.S. reinsurance transactions.
(3) International mortgage insurance and reinsurance with risk primarily
located in Australia and to lesser extent Europe and Asia .
(4) 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 risk-sharing or reinsurance transactions.
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Table of Contents The insurance in force and risk in force for ourU.S. primary mortgage insurance business by policy year were as follows atDecember 31, 2022 : (U.S. Dollars in millions) IIF RIF Delinquency Amount % Amount % Rate (1) Policy year: 2012 and prior$ 9,931 3.4$ 2,424 3.2 8.41 % 2013 3,000 1.0 798 1.1 1.85 % 2014 3,696 1.3 1,012 1.3 2.61 % 2015 6,236 2.1 1,680 2.2 2.08 % 2016 10,225 3.5 2,744 3.6 2.66 % 2017 9,508 3.2 2,521 3.3 3.06 % 2018 10,260 3.5 2,625 3.5 4.11 % 2019 19,096 6.5 4,840 6.4 2.36 % 2020 65,141 22.0 16,414 21.7 1.20 % 2021 89,621 30.3 22,740 30.0 0.95 % 2022 68,937 23.3 18,008 23.8 0.20 % Total$ 295,651 100.0$ 75,806 100.0 1.77 %
(1)Represents the ending percentage of loans in default.
The insurance in force and risk in force for our
(U.S. Dollars in millions) IIF RIF Delinquency
Amount % Amount % Rate (1)
Policy year:
2012 and prior $ 13,030 4.6 $ 2,960 4.2 8.48 %
2013 4,206 1.5 1,148 1.6 2.63 %
2014 4,822 1.7 1,328 1.9 3.14 %
2015 8,703 3.1 2,340 3.3 2.67 %
2016 14,344 5.1 3,841 5.4 3.29 %
2017 13,128 4.7 3,436 4.9 4.09 %
2018 14,046 5.0 3,562 5.0 5.28 %
2019 25,841 9.2 6,467 9.2 3.13 %
2020 82,502 29.4 20,341 28.8 0.97 %
2021 100,323 35.7 25,196 35.7 0.29 %
Total $ 280,945 100.0 $ 70,619 100.0 2.36 %
(1)Represents the ending percentage of loans in default.
The following tables provide supplemental disclosures on risk in force for our
(U.S. Dollars in millions) December 31,
2022 2021
Amount % Amount %
Credit quality (FICO):
>=740 $ 46,812 61.8 $ 42,451 60.1
680-739 24,945 32.9 23,646 33.5
620-679 3,772 5.0 4,196 5.9
<620 277 0.4 326 0.5
Total $ 75,806 100.0 $ 70,619 100.0
Weighted average FICO score 750 746
Loan-to-Value (LTV):
95.01% and above $ 7,289 9.6 $ 7,538 10.7
90.01% to 95.00% 43,681 57.6 38,829 55.0
85.01% to 90.00% 20,851 27.5 20,006 28.3
85.00% and below 3,985 5.3 4,246 6.0
Total $ 75,806 100.0 $ 70,619 100.0
Weighted average LTV 92.8 % 92.8 %
Total RIF, net of external reinsurance $ 57,151 $ 54,574
(U.S. Dollars in millions) December 31,
2022 2021
Amount % Amount %
Total RIF by State:
California $ 6,341 8.4 $ 5,559 7.9
Texas 6,151 8.1 5,594 7.9
Florida 3,268 4.3 3,303 4.7
Georgia 3,169 4.2 2,902 4.1
North Carolina 3,160 4.2 2,921 4.1
Illinois 3,081 4.1 2,933 4.2
Minnesota 3,003 4.0 2,916 4.1
Massachusetts 2,809 3.7 2,537 3.6
Virginia 2,656 3.5 2,446 3.5
Michigan 2,618 3.5 2,492 3.5
Others 39,550 52.2 37,016 52.4
Total $ 75,806 100.0 $ 70,619 100.0
ARCH CAPITAL 76 2022 FORM 10-K
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Table of Contents The following table provides supplemental disclosures for ourU.S. primary mortgage insurance business related to insured loans and loss metrics for the years endedDecember 31, 2022 and 2021: (U.S. Dollars in thousands, except loan and claim Year Ended December 31, count) 2022 2021 Rollforward of insured loans in default: Beginning delinquent number of loans 27,645 52,234 New notices 36,396 35,554 Cures (42,789) (59,372) Paid claims (685) (771) Ending delinquent number of loans (1) 20,567 27,645 Ending number of policies in force (1) 1,160,219 1,171,835 Delinquency rate (1) 1.77 % 2.36 % Losses: Number of claims paid 685 771 Total paid claims $ 21,412 $ 30,979 Average per claim $ 31.3 $ 40.2 Severity (2) 73.2 % 80.8 % Average reserve per default (in thousands) (1) $ 21.1 $ 26.7
(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 MIU.S. was approximately 7.2 to 1 atDecember 31, 2022 , compared to 8 to 1 atDecember 31, 2021 .
Ceded Reinsurance
In the normal course of business, our insurance and mortgage insurance operations cede a portion of their premium on a quota share or excess of loss basis through treaty or facultative reinsurance agreements. Our reinsurance operations also obtain reinsurance whereby another reinsurer contractually agrees to indemnify it for all or a portion of the reinsurance risks underwritten by our reinsurance operations. Such arrangements, where one reinsurer provides reinsurance to another reinsurer, are usually referred to as "retrocessional reinsurance" arrangements. In addition, our reinsurance subsidiaries participate in "common account" retrocessional arrangements for certain pro rata treaties. Such arrangements reduce the effect of individual or aggregate losses to all companies participating on such treaties, including the reinsurers, such as our reinsurance operations, and the ceding company. Estimating reinsurance recoverables can be more subjective than estimating the underlying reserves for losses and loss adjustment expenses as discussed above in "-Loss Reserves." In particular, reinsurance recoverables may be affected by deemed inuring reinsurance, industry losses reported by various statistical reporting services, and other factors. Reinsurance recoverables are recorded as assets, predicated on the reinsurers' ability to meet their obligations under the reinsurance agreements. If the reinsurers are unable to satisfy their obligations under the agreements, our insurance or reinsurance operations would be liable for such defaulted amounts. The availability and cost of reinsurance and retrocessional protection is subject to market conditions, which are beyond our control. Although we believe that our insurance and reinsurance operations have been successful in obtaining adequate reinsurance and retrocessional protection, it is not certain that they will be able to continue to obtain adequate protection at cost effective levels. As a result of such market conditions and other factors, our insurance, reinsurance and mortgage operations may not be able to successfully mitigate risk through reinsurance and retrocessional arrangements and may lead to increased volatility in our results of operations in future periods. See "Risk Factors-Risks Relating to Our Industry, Business and Operations-The failure of any of the loss limitation methods we employ could have a material adverse effect on our financial condition or results of operations." For purposes of managing risk, we reinsure a portion of our exposures, paying to reinsurers a part of the premiums received on the policies we write, and we may also use retrocessional protection. On a consolidated basis, ceded premiums written represented 27.7% of gross premiums written for 2022, compared to 29.3% for 2021. We monitor the financial condition of our reinsurers and attempt to place coverages only with substantial, financially sound carriers. If the financial condition of our reinsurers or retrocessionaires deteriorates, resulting in an impairment of their ability to make payments, we will be responsible for probable losses resulting from our inability to collect amounts due from such parties, as appropriate. We evaluate the credit worthiness of all the reinsurers to which we cede business. We report reinsurance recoverables net of an allowance for expected credit loss. The allowance is based upon our ongoing review of amounts outstanding, the financial condition of our reinsurers, amounts and form of collateral obtained and other relevant factors. A ratings based probability-of-default and loss-given-default methodology is used to estimate the allowance for expected credit loss. See "Risk Factors-Risks Relating to Our Industry, Business and Operations-We are exposed to credit risk in certain of our business operations" and "Financial Condition, Liquidity and Capital Resources" for further details. We have entered into various aggregate excess of loss reinsurance agreements with various special purpose reinsurance companies domiciled inBermuda . These are special purpose variable interest entities that are not consolidated in our financial results because we do not have
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the unilateral power to direct those activities that are significant to its economic performance. As ofDecember 31, 2022 , our estimated off-balance sheet maximum exposure to loss from such entities was$26.8 million . See note 12, "Variable Interest Entity and Noncontrolling Interests," to our consolidated financial statements in Item 8 for additional information.
Premium Revenues and Related Expenses
Insurance premiums written are generally recorded at the policy inception and are primarily earned on a pro rata basis over the terms of the policies for all products, usually 12 months. Premiums written include estimates in our insurance operations' programs, specialty lines, collateral protection business and for participation in involuntary pools. Such premium estimates are derived from multiple sources which include the historical experience of the underlying business, similar business and available industry information. Unearned premium reserves represent the portion of premiums written that relates to the unexpired terms of in-force insurance policies. Reinsurance premiums written include amounts reported by brokers and ceding companies, supplemented by our own estimates of premiums where reports have not been received. The determination of premium estimates requires a review of our experience with the ceding companies, familiarity with each market, the timing of the reported information, an analysis and understanding of the characteristics of each line of business, and management's judgment of the impact of various factors, including premium or loss trends, on the volume of business written and ceded to us. On an ongoing basis, our underwriters review the amounts reported by these third parties for reasonableness based on their experience and knowledge of the subject class of business, taking into account our historical experience with the brokers or ceding companies. In addition, reinsurance contracts under which we assume business generally contain specific provisions which allow us to perform audits of the ceding company to ensure compliance with the terms and conditions of the contract, including accurate and timely reporting of information. Based on a review of all available information, management establishes premium estimates where reports have not been received. Premium estimates are updated when new information is received and differences between such estimates and actual amounts are recorded in the period in which estimates are changed or the actual amounts are determined. Premiums written are recorded based on the type of contracts we write. Premiums on our excess of loss and pro rata reinsurance contracts are estimated when the business is underwritten. For excess of loss contracts, premiums are recorded as written based on the terms of the contract. Estimates of premiums written under pro rata contracts are recorded in the period in which the underlying risks incept and are based on information provided by the brokers and the ceding companies. For multi-year reinsurance treaties which are payable in annual installments, generally, only the initial annual installment is included as premiums written at policy inception due to the ability of the reinsured to commute or cancel coverage during the term of the policy. The remaining annual installments are included as premiums written at each successive anniversary date within the multi-year term. Reinstatement premiums for our insurance and reinsurance operations are recognized at the time a loss event occurs, where coverage limits for the remaining life of the contract are reinstated under pre-defined contract terms. Reinstatement premiums, if obligatory, are fully earned when recognized. The accrual of reinstatement premiums is based on an estimate of losses and loss adjustment expenses, which reflects management's judgment, as described above in "-Loss Reserves." The amount of reinsurance premium estimates included in premiums receivable and the amount of related acquisition expenses by type of business were as follows atDecember 31, 2022 : December 31, 2022 Net Gross Amount Acquisition Expenses Amount Other specialty$ 1,211,598 $ (381,502)$ 830,096 Property excluding property catastrophe 390,612 (123,720) 266,892 Casualty 388,091 (114,028) 274,063 Marine and aviation 203,125 (43,922) 159,203 Property catastrophe 49,078 (5,850) 43,228 Other 69,297 (5,004) 64,293 Total$ 2,311,801 $ (674,026)$ 1,637,775 Premium estimates are reviewed by management at least quarterly. Such review includes a comparison of actual reported premiums to expected ultimate premiums along with a review of the aging and collection of premium estimates. Based on management's review, the appropriateness of the premium estimates is evaluated, and any adjustment to these estimates is recorded in the period in which it becomes known. Adjustments to premium estimates could be material and such adjustments could directly and significantly impact earnings favorably or unfavorably in the period they are determined because the estimated premium may be fully or substantially earned. A significant portion of amounts included as premiums receivable, which represent estimated premiums written, net of commissions, are not currently due based on the terms of the underlying contracts. Based on currently available information, we report premiums receivable net of an allowance for expected credit loss. We monitor credit risk associated with premiums receivable through our ongoing ARCH CAPITAL 78 2022 FORM 10-K
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Reinsurance premiums assumed, irrespective of the class of business, are generally earned on a pro rata basis over the terms of the underlying policies or reinsurance contracts. Contracts and policies written on a "losses occurring" basis cover claims that may occur during the term of the contract or policy, which is typically 12 months. Accordingly, the premium is earned evenly over the term. Contracts which are written on a "risks attaching" basis cover claims which attach to the underlying insurance policies written during the terms of such contracts. Premiums earned on such contracts usually extend beyond the original term of the reinsurance contract, typically resulting in recognition of premiums earned over a 24-month period. Certain of our reinsurance contracts include provisions that adjust premiums or acquisition expenses based upon the experience under the contracts. Premiums written and earned, as well as related acquisition expenses, are recorded based upon the projected experience under such contracts. Retroactive reinsurance reimburses a ceding company for liabilities incurred as a result of past insurable events covered by the underlying policies reinsured. In certain instances, reinsurance contracts cover losses both on a prospective basis and on a retroactive basis and, accordingly, we bifurcate the prospective and retrospective elements of these reinsurance contracts and accounts for each element separately where practical. Underwriting income generated in connection with retroactive reinsurance contracts is deferred and amortized into income over the settlement period while losses are charged to income immediately. Subsequent changes in estimated amount or timing of cash flows under such retroactive reinsurance contracts are accounted for by adjusting the previously deferred amount to the balance that would have existed had the revised estimate been available at the inception of the reinsurance transaction, with a corresponding charge or credit to income. Mortgage guaranty insurance policies are contracts that are generally non-cancelable by the insurer, are renewable at a fixed price, and provide for payment of premiums on a monthly, annual or single basis. Upon renewal, we are not able to re-underwrite or re-price our policies. Consistent with industry accounting practices, premiums written on a monthly basis are earned as coverage is provided. Premiums written on an annual basis are amortized on a monthly pro rata basis over the year of coverage. Primary mortgage insurance premiums written on policies covering more than one year are referred to as single premiums. A portion of the revenue from single premiums is recognized in premiums earned in the current period, and the remaining portion is deferred as unearned premiums and earned over the estimated expiration of risk of the policy. If single premium policies
related to insured loans are canceled for any reason and the policy is a non-refundable product, the remaining unearned premium related to each canceled policy is recognized as earned premium upon notification of the cancellation.
Unearned premiums represent the portion of premiums written that is applicable
to the estimated unexpired risk of insured loans. A portion of premium payments
may be refundable if the insured cancels coverage, which generally occurs when
the loan is repaid, the loan amortizes to a sufficiently low amount to trigger a
lender permitted or legally required cancellation, or the value of the property
has increased sufficiently in accordance with the terms of the contract. Premium
refunds reduce premiums earned in the consolidated statements of income.
Generally, only unearned premiums are refundable.
Acquisition costs that are directly related and incremental to the successful
acquisition or renewal of business are deferred and amortized based on the type
of contract. For property and casualty insurance and reinsurance contracts,
deferred acquisition costs are amortized over the period in which the related
premiums are earned. Consistent with mortgage insurance industry accounting
practice, amortization of acquisition costs related to the mortgage insurance
contracts for each underwriting year's book of business is recorded in
proportion to estimated gross profits. Estimated gross profits are comprised of
earned premiums and losses and loss adjustment expenses. For each underwriting
year, we estimate the rate of amortization to reflect actual experience and any
changes to persistency or loss development.
Acquisition expenses and other expenses related to our underwriting operations
that vary with, and are directly related to, the successful acquisition or
renewal of business are deferred and amortized based on the type of contract.
Our insurance and reinsurance operations capitalize incremental direct external
costs that result from acquiring a contract but do not capitalize salaries,
benefits and other internal underwriting costs. For our mortgage insurance
operations, which include a substantial direct sales force, both external and
certain internal direct costs are deferred and amortized. Deferred acquisition
costs are carried at their estimated realizable value and take into account
anticipated losses and loss adjustment expenses, based on historical and current
experience, and anticipated investment income.
A premium deficiency occurs if the sum of anticipated losses and loss adjustment
expenses, unamortized acquisition costs and maintenance costs and anticipated
investment income exceed unearned premiums. A premium deficiency reserve ("PDR")
is recorded by charging any unamortized acquisition costs to expense to the
extent required in order to eliminate the deficiency. If the premium deficiency
exceeds unamortized acquisition costs then a liability is accrued for the excess
deficiency.
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Table of Contents To assess the need for a PDR on our mortgage exposures, we develop loss projections based on modeled loan defaults related to our current policies in force. This projection is based on recent trends in default experience, severity and rates of defaulted loans moving to claim, as well as recent trends in the rate at which loans are prepaid, and incorporates anticipated interest income. Evaluating the expected profitability of our existing mortgage insurance business and the need for a PDR for our mortgage business involves significant reliance upon assumptions and estimates with regard to the likelihood, magnitude and timing of potential losses and premium revenues. The models, assumptions and estimates we use to evaluate the need for a PDR may prove to be inaccurate, especially during an extended economic downturn or a period of extreme market volatility and uncertainty.
No premium deficiency charges were recorded by us during 2022 or 2021.
Fair Value Measurements
We review our securities measured at fair value and discuss the proper classification of such investments with investment advisors and others. See
note 10, "Fair Value," to our consolidated financial statements in Item 8 for a summary of our financial assets and liabilities measured at fair value atDecember 31, 2022 by valuation hierarchy.
Reclassifications
We have reclassified the presentation of certain prior year information to conform to the current presentation. Such reclassifications had no effect on our net income, shareholders' equity or cash flows.
Significant Accounting Pronouncements
For all other significant accounting policies see note 3, "Significant Accounting Policies" and note 3(t), "Recent Accounting Pronouncements"
to
our consolidated financial statements in Item 8 for disclosures concerning our companies significant accounting policies and recent accounting pronouncements.
FINANCIAL CONDITION Investable Assets
At
Investable Assets Held by Arch
The Finance, Investment andRisk Committee ("FIR Committee") of our Board of Directors (the "Board") establishes our investment policies and sets the parameters for creating guidelines for our investment managers. The FIR reviews the implementation of the investment strategy on a regular basis. Our current approach stresses preservation of capital, market liquidity and diversification of risk. While maintaining our emphasis on preservation of capital and liquidity, we expect our portfolio to become more diversified and, as a result, we may expand into areas which are not currently part of our investment strategy. Our Chief Investment Officer administers the investment portfolio, oversees our investment managers and formulates investment strategy in conjunction with the FIR Committee. AtDecember 31, 2022 , approximately$18.8 billion , or 67%, of total investable assets held by Arch were internally managed, compared to$18.5 billion , or 67%, atDecember 31, 2021 . The following table summarizes the fair value of investable assets held by Arch: December 31, 2022 2021 Average effective duration (in years) 2.89 2.70 Average S&P/Moody's credit ratings (1) AA-/Aa3 AA-/Aa3
(1)Average credit ratings on our investment portfolio on securities with ratings
by
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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.
% of
Estimated Fair Value Total
December 31, 2022
U.S. government and gov't agencies (1) $ 5,829,279 28.8
AAA 3,616,537 17.9
AA 2,214,494 10.9
A 3,993,471 19.7
BBB 3,324,095 16.4
BB 560,213 2.8
B 377,462 1.9
Lower than B 12,029 0.1
Not rated 309,329 1.5
Total $ 20,236,909 100.0
December 31, 2021
U.S. government and gov't agencies (1) $ 5,063,191 27.5
AAA 3,783,386 20.5
AA 2,459,413 13.4
A 2,943,594 16.0
BBB 2,936,398 15.9
BB 501,588 2.7
B 371,747 2.0
Lower than B 43,756 0.2
Not rated 311,734 1.7
Total $ 18,414,807 100.0
(1)Includes
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:
% of
Gross Total Gross
Unrealized Unrealized
Severity of gross unrealized losses: Estimated Fair Value Losses Losses
December 31, 2022
0-10% $ 12,342,899 $ (579,958) 35.2
10-20% 5,331,223 (843,924) 51.3
20-30% 692,100 (198,778) 12.1
Greater than 30% 44,023 (23,739) 1.4
Total $ 18,410,245 $ (1,646,399) 100.0
December 31, 2021
0-10% $ 12,231,146 $ (166,867) 97.6
10-20% 16,884 (2,412) 1.4
20-30% 2,593 (759) 0.4
Greater than 30% 684 (916) 0.5
Total $ 12,251,307 $ (170,954) 100.0
The following table summarizes our top ten exposures to fixed income corporate
issuers by fair value at December 31, 2022 , excluding guaranteed amounts and
covered bonds:
Credit
Estimated Fair Value Rating (1)
Bank of America Corporation $ 430,071 A-/A2
JPMorgan Chase & Co. 296,901 A-/A1
Morgan Stanley 290,477 A-/A1
Citigroup Inc. 270,074 BBB+/A3
The Goldman Sachs Group, Inc. 249,547 BBB+/A2
Wells Fargo & Company 242,538 BBB+/A1
Blue Owl Capital Inc. 164,098 BBB-/Baa3
Blackstone Inc. 150,691 BBB-/Baa3
UBS Group AG 130,244 A/Aa3
Spring Funding II Llc 121,221 NA/NA
Total $ 2,345,862
(1)Average credit ratings as assigned by S&P and Moody's, respectively.
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The following table provides information on our structured securities, which
include residential mortgage-backed securities ("RMBS"), commercial
mortgage-backed securities ("CMBS") and asset backed securities ("ABS"):
Agencies Investment Grade Below Investment Grade Total
Dec. 31, 2022
RMBS $ 645,008 $ 133,958 $ 16,425 $ 795,391
CMBS 17,680 947,396 82,199 1,047,275
ABS - 1,787,684 140,785 1,928,469
Total $ 662,688 $ 2,869,038 $ 239,409 $ 3,771,135
Dec. 31, 2021
RMBS $ 268,229 $ 129,296 $ 10,952 $ 408,477
CMBS 22,198 926,302 97,984 1,046,484
ABS - 2,543,907 152,551 2,696,458
Total $ 290,427 $ 3,599,505 $ 261,487 $ 4,151,419 The following table summarizes our equity securities, which include investments in exchange traded funds:
December 31,
2022 2021
Equities (1) $ 569,239 $ 883,722
Exchange traded funds
Fixed income (2) 272,407 455,467
Equity and other (3) 32,115 491,474
Total $ 873,761 $ 1,830,663
(1)Primarily in healthcare, technology, consumer cyclical and non-cyclical and
industrials at December 31, 2022 .
(2)Primarily in corporate at December 31, 2022 .
(3)Primarily in large cap stocks, foreign equities, healthcare, technology and
consumer discretionary at December 31, 2022 .
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 11, "Derivative Instruments," to our
consolidated financial statements in Item 8 for additional disclosures
concerning 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 10, "Fair Value," to our
consolidated financial statements in Item 8 for a summary of our financial
assets and liabilities measured at fair value at December 31, 2022 and 2021
segregated by level in the fair value hierarchy.
Reinsurance Recoverables
The following table details our reinsurance recoverables atDecember 31, 2022 : A.M. Best % of Total Rating (1) Somers Re (2) 17.7 A- Hannover Rück SE 4.6 A+ Lloyd's syndicates (3) 3.6 A Swiss Reinsurance America Corporation 3.3 A+ Everest Reinsurance Company 3.2 A+ Munich Reinsurance America, Inc. 3.1 A+ Fortitude Reinsurance Company Ltd. 2.9 A Partner Reinsurance Company of the U.S. 2.9 A+ XL Re 2.5 A+ Berkley Insurance Company 2.0 A+ All other -- "A-" or better 23.0 All other -- rated carriers 0.1 All other -- not rated (4) 31.1 Total 100.0 (1) The financial strength ratings are as ofFebruary 6, 2023 and were assigned byA.M. Best based on its opinion of the insurer's financial strength as of such date. An explanation of the ratings listed in the table follows: the rating of "A+" is designated "Superior"; and the "A" rating is designated "Excellent." (2) See note 12, "Variable Interest Entity and Noncontrolling Interests" and note 16, " Transactions with Related Parties . " (3) TheA.M. Best group rating of "A" (Excellent) has been applied to all Lloyd's syndicates. (4) Over 95% of such amount is collateralized through reinsurance trusts, funds withheld arrangements, letters of credit or other.
See note 8, "Reinsurance," to our consolidated financial statements in Item 8 for further details.
Reserves for Losses and Loss Adjustment Expenses
We establish 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 costs of losses incurred. Estimating Loss Reserves is inherently difficult. 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. See "Management's Discussion and Analysis of Financial Condition and Results of Operations-Summary of Critical Accounting Estimates-Loss Reserves" and see Item 1 "Business-Reserves" for further details.
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Shareholders' Equity and Book Value per Share
Total shareholders' equity available to Arch was$12.9 billion atDecember 31, 2022 , compared to$13.5 billion atDecember 31, 2021 . The 2022 period primarily reflected the impact of rising interest rates on our fixed income portfolio and the elevated catastrophe activity we experienced during the year.
The following table presents the calculation of book value per share:
December 31,
(U.S. dollars in thousands, except share data) 2022 2021
Total shareholders' equity available to Arch $ 12,910,073 $ 13,545,896
Less preferred shareholders' equity 830,000 830,000
Common shareholders' equity available to Arch
$ 12,715,896 Common shares and common share equivalents outstanding, net of treasury shares (1) 370,345,997 378,923,894 Book value per share $ 32.62 $ 33.56 (1) Excludes the effects of 14,420,901 and 17,083,160 stock options and 557,003 and 729,636 restricted stock and performance units outstanding atDecember 31, 2022 and 2021, respectively.
LIQUIDITY
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. In 2022,Arch Capital received dividends of$0.7 billion fromArch Reinsurance Ltd. ("Arch Re Bermuda"), ourBermuda -based reinsurer and insurer which can pay approximately$3.7 billion toArch Capital in 2023 without providing an affidavit to theBermuda Monetary Authority ("BMA"). Our insurance and reinsurance operations provide liquidity in that premiums are received in advance, sometimes substantially in advance, of the time losses are paid. The period of time from the occurrence of a claim through the settlement of the liability may extend many years into the future. Sources of liquidity include cash flows from operations, financing arrangements or routine sales of investments. As part of our investment strategy, we seek to establish a level of cash and highly liquid short-term and intermediate-term securities which, combined with expected cash flow, is believed by us to be adequate to meet our foreseeable payment obligations. However, due to the nature of our operations, cash flows are affected by claim payments that may comprise large payments on a limited number of claims and which can fluctuate from year to year. We believe that our liquid investments and cash flow will provide us with sufficient liquidity in order to meet our claim payment obligations. However, the timing and amounts of actual claim payments related to recorded Loss Reserves vary based on many factors, including large individual losses, changes in the legal environment, as well as general market conditions. The ultimate amount of the claim payments could differ materially from our estimated amounts. Certain lines of business written by us, such as excess casualty, have loss experience characterized as low frequency and high severity. The foregoing may result in significant variability in loss payment patterns. The impact of this variability can be exacerbated by the fact that the timing of the receipt of reinsurance recoverables owed to us may be slower than anticipated by us. Therefore, the irregular timing of claim payments can create significant variations in cash flows from operations between periods and may require us to utilize other sources of liquidity to make these payments, which may include the sale of investments or utilization of existing or new credit facilities or capital market transactions. If the source of liquidity is the sale of investments, we may be forced to sell such investments at a loss, which may be material. We expect that our liquidity needs, including our anticipated insurance obligations and operating and capital expenditure needs, 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, for the next twelve months, at a minimum.
Dividend Restrictions
Arch Capital has no material restrictions on its ability to make distributions to shareholders. However, the ability of our regulated insurance and reinsurance subsidiaries to pay dividends or make distributions or other payments to us is limited by the applicable local laws and relevant regulations of the various countries and states in which we operate. See note 25, "Statutory Information," to our consolidated financial statements in Item 8 for additional information on dividend restrictions. The payment of dividends from Arch Re Bermuda is, under certain circumstances, limited underBermuda law, which requires ourBermuda operating subsidiary to maintain certain measures of solvency and liquidity.
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Table of Contents OurU.S. insurance and reinsurance subsidiaries are subject to insurance laws and regulations in the jurisdictions in which they operate. The ability of our regulated insurance subsidiaries to pay dividends or make distributions is dependent on their ability to meet applicable regulatory standards. These regulations include restrictions that limit the amount of dividends or other distributions, such as loans or cash advances, available to shareholders without prior approval of the insurance regulatory authorities. Each state requires prior regulatory approval of any payment of extraordinary dividends. We also have insurance subsidiaries that are the parent company for other insurance subsidiaries, which means that dividends and other distributions will be subject to multiple layers of regulations in order for our insurance subsidiaries to be able to dividend funds toArch Capital . The inability of the subsidiaries ofArch Capital to pay dividends and other permitted distributions could have a material adverse effect onArch Capital's cash requirements and our ability to make principal, interest and dividend payments on the senior notes, preferred shares and common shares.
In addition to meeting applicable regulatory standards, the ability of our
insurance and reinsurance subsidiaries to pay dividends is also constrained by
our dependence on the financial strength ratings of our insurance and
reinsurance subsidiaries from independent rating agencies. The ratings from
these agencies depend to a large extent on the capitalization levels of our
insurance and reinsurance subsidiaries. We believe that
Restricted Assets
Our insurance, reinsurance and mortgage insurance subsidiaries are required to maintain assets on deposit, which primarily consist of fixed maturities, with various regulatory authorities to support their operations. The assets on deposit are available to settle insurance and reinsurance liabilities to third parties. Our insurance and reinsurance subsidiaries maintain assets in trust accounts as collateral for insurance and reinsurance transactions with affiliated companies and also have investments in segregated portfolios primarily to provide collateral or guarantees for letters of credit to third parties. AtDecember 31, 2022 and 2021, such amounts approximated$8.7 billion and$8.2 billion , respectively. Our investments in certain securities, including certain fixed income and structured securities, investments in funds accounted for using the equity method, other alternative investments and investments in operating affiliates may be illiquid due to contractual provisions or investment market conditions. If we require significant amounts of cash on short notice in excess of anticipated cash requirements, then we may have difficulty selling these investments in a timely manner or may be forced to sell or terminate them at unfavorable values. Our unfunded investment commitments totaled approximately$2.9 billion atDecember 31, 2022 and are callable by our investment managers. The timing of the funding of investment commitments is uncertain and may require us to access cash on short notice.
Cash Flows
The following table summarizes our cash flows from operating, investing and financing activities, excluding amounts related to the 'other' segment:
Year Ended
2022 2021
Total cash provided by (used for): Operating activities$ 3,815,227 $ 3,380,700 Investing activities (3,102,055) (1,870,885) Financing activities (705,726) (1,243,613) Effects of exchange rate changes on foreign currency cash (48,889) (30,524) Increase (decrease) in cash$ (41,443) $ 235,678
Cash provided by operating activities for the 2022 period reflected a higher level of premiums collected than in the 2021 period.
Cash used for investing activities for the 2022 period reflected a higher level of purchases of fixed income securities than in the 2021 period, while the 2021 period reflected cash used for our investment in Coface and Somers.
Cash used for financing activities for the 2022 period primarily reflected
Investments AtDecember 31, 2022 , our investable assets were$28.1 billion . The primary goals of our asset liability management process are to meet our insurance liabilities, manage the interest rate risk embedded in those insurance liabilities and maintain sufficient liquidity to cover fluctuations in projected liability cash flows, including debt service obligations. Generally, the expected principal and interest payments produced by our fixed income portfolio adequately fund the estimated runoff of our insurance reserves. Although this is not an exact cash flow match in each period, the substantial degree by which the fair value of the fixed income portfolio exceeds the expected present value of the net insurance liabilities, as well as the positive cash flow from newly sold policies and the large amount of high quality liquid bonds, provide assurance of our ability to fund the payment of claims and to service our outstanding debt without having to ARCH CAPITAL 84 2022 FORM 10-K
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Table of Contents sell securities at distressed prices or access credit facilities. Please refer to Item 1A " Risk Factors " for a discussion of other risks relating to our business and investment portfolio.
CAPITAL RESOURCES
The following table provides an analysis of our capital structure:
(U.S. dollars in thousands, except December 31, share data) 2022 2021 Senior notes$ 2,725,410 $ 2,724,394
Shareholders' equity available to Arch:
Series F non-cumulative preferred shares 330,000 330,000 Series G non-cumulative preferred shares 500,000 500,000 Common shareholders' equity 12,080,073 12,715,896 Total $
12,910,073
Total capital available to Arch $
15,635,483
Senior notes to total capital (%) 17.4 16.7 Revolving credit agreement borrowings to total capital (%) - - Debt to total capital (%) 17.4 16.7 Preferred to total capital (%) 5.3 5.1 Debt and preferred to total capital (%) 22.7 21.8 See note 19, "Debt and Financing Arrangements" and note 21, "Shareholders' Equity" , to our consolidated financial statements in Item 8 for additional information on capital structure.
Capital Adequacy
We monitor our capital adequacy on a regular basis and will seek to adjust our capital base (up or down) according to the needs of our business. The future capital requirements of our business will depend on many factors, including our ability to write new business successfully and to establish premium rates and reserves at levels sufficient to cover losses. Our ability to underwrite is largely dependent upon the quality of our claims paying and financial strength ratings as evaluated by independent rating agencies. In particular, we require (1) sufficient capital to maintain our financial strength ratings, as issued by several ratings agencies, at a level considered necessary by management to enable our key operating subsidiaries to compete; (2) sufficient capital to enable our underwriting subsidiaries to meet the capital adequacy tests performed by statutory agencies in theU.S. and other key markets; and (3) our non-U.S. operating companies are required to post letters of credit and other forms of collateral that are necessary for them to operate as they are "non-admitted" underU.S. state insurance regulations. In addition, AMIC and UGRIC (together, "Arch MIU.S. ") are required to maintain compliance with the GSE requirements, known as 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 MIU.S. satisfied the PMIERs' financial requirements as ofDecember 31, 2022 with a PMIER sufficiency ratio of 236%, compared to 197% atDecember 31, 2021 . As part of our capital management program, we may seek to raise additional capital or may seek to return capital to our shareholders through share repurchases, cash dividends or other methods (or a combination of such methods). Any such determination will be at the discretion of the Board and will be dependent upon our profits, financial requirements and other factors, including legal restrictions, rating agency requirements and such other factors as our Board deems relevant. To the extent that our existing capital is insufficient to fund our future operating requirements or maintain such ratings, we may need to raise additional funds through financings or limit our growth. We can provide no assurance that, if needed, we would be able to obtain additional funds through financing on satisfactory terms or at all. Any adverse developments in the financial markets, such as disruptions, uncertainty or volatility in the capital and credit markets, may result in realized and unrealized capital losses that could have ARCH CAPITAL 85 2022 FORM 10-K
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Table of Contents a material adverse effect on our results of operations, financial position and our businesses, and may also limit our access to capital required to operate our business. In addition to common share capital, we depend on external sources of finance to support our underwriting activities, which can be in the form (or any combination) of debt securities, preference shares, common equity and bank credit facilities providing loans and/or letters of credit.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. Except as described in the above paragraph, or where express reinsurance, guarantee or other financial support contractual arrangements are in place, each ofArch Capital's subsidiaries or affiliates is solely responsible for its own liabilities and commitments (and no otherArch Capital subsidiary or affiliate is so responsible). Any reinsurance arrangements, guarantees or other financial support contractual arrangements that are in place are solely for the benefit of theArch Capital subsidiary or affiliate involved and third parties (creditors or insureds of such entity) are not express beneficiaries of such arrangements.
Share Repurchase Program
Our Board has authorized the investment inArch Capital's common shares through a share repurchase program. Since the inception of the share repurchase program throughDecember 31, 2022 ,Arch Capital has repurchased approximately 433.6 million common shares for an aggregate purchase price of$5.9 billion . AtDecember 31, 2022 ,$1.0 billion of share repurchases were available under the program. Repurchases under the program may be effected from time to time in open market or privately negotiated transactions throughDecember 31, 2024 . The timing and amount of the repurchase transactions under this program will depend on a variety of factors, including market conditions, the development of the economy, corporate and regulatory considerations. We will continue to monitor our share price and, depending upon results of operations, market conditions and the development of the economy, as well as other factors, we will consider share repurchases on an opportunistic basis.
GUARANTOR INFORMATION
The below table provides a description of our senior notes payable atDecember 31, 2022 : Interest Principal Carrying Issuer/Due (Fixed) Amount AmountArch Capital : May 1, 2034 7.350 %$ 300,000 $ 297,618 June 30, 2050 3.635 % 1,000,000 988,949 Arch-U.S.: Nov. 1, 2043 (1) 5.144 % 500,000 495,188 Arch Finance: Dec. 15, 2026 (1) 4.011 % 500,000 498,073 Dec. 15, 2046 (1) 5.031 % 450,000 445,582 Total$ 2,750,000 $ 2,725,410
(1) Fully and unconditionally guaranteed by
Our senior notes were issued byArch Capital ,Arch Capital Group (U.S.) Inc. ("Arch-U.S. ") andArch Capital Finance LLC ("Arch Finance"). Arch-U.S. is a wholly-owned subsidiary ofArch Capital and Arch Finance is a wholly-owned finance subsidiary of Arch-U.S. Our 2034 senior notes and 2050 senior notes issued byArch Capital are unsecured and unsubordinated obligations ofArch Capital and ranked equally with all of its existing and future unsecured and unsubordinated indebtedness. The 2043 senior notes issued by Arch-U.S. are unsecured and unsubordinated obligations of Arch-U.S. andArch Capital and rank equally and ratably with the other unsecured and unsubordinated indebtedness of Arch-U.S. andArch Capital . The 2026 senior notes and 2046 senior notes issued by Arch Finance are unsecured and unsubordinated obligations ofArch Finance andArch Capital and rank equally and ratably with the other unsecured and unsubordinated indebtedness ofArch Finance andArch Capital .Arch Capital and Arch-U.S. are each holding companies and, accordingly, they conduct substantially all of their operations through their operating subsidiaries. Arch Finance is a wholly owned subsidiary ofArch U.S. MI Holdings Inc. , aU.S. holding company. 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 and on their ability to distribute the earnings, loans or other payments from such subsidiaries toArch Capital , Arch-U.S. and Arch Finance, respectively. During 2022 and 2021, we made interest payments of$128.4 million and$131.0 million respectively, related to our senior notes and other financing arrangements. See note 19, "Debt and Financing Arrangements," to our consolidated financial statements in Item 8 for additional disclosures concerning our senior notes and revolving credit agreement borrowings. For additional information on our preferred shares, see note 21, "Shareholders' Equity," to our consolidated financial statements in Item 8.
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Table of Contents The following tables present condensed financial information forArch Capital (parent guarantor) and Arch-U.S. (subsidiary issuer):December 31, 2022
Arch Capital Arch-U.S. Arch Capital Arch-U.S.
Assets
Total investments $ 7,282 $ 78,766 $ 2,038 $ 137,124
Cash 11,393 9,542 16,317 18,392
Investment in operating affiliates 5,259 6,877
Due from subsidiaries and affiliates 1,554 2 11 26,000 Other assets 17,203 30,311 9,604 37,040 Total assets$ 42,691 $ 118,621 $ 34,847 $ 218,556 Liabilities Senior notes 1,286,567 495,188 1,286,208 495,063 Due to subsidiaries and affiliates - 991,070 - 521,839 Other liabilities 37,239 36,405 24,767 47,410 Total liabilities 1,323,806 1,522,663 1,310,975 1,064,312
Non-cumulative preferred shares
$ 830,000 $ - December 31, 2022 December 31, 2021 Year Ended Arch Capital Arch-U.S. Arch Capital Arch-U.S.
Revenues
Net investment income$ 2,058 $
1,341
29 (346) - 72,437
Equity in net income (loss) of
investments accounted for using the
equity method - 10,228 - 18,149
Total revenues 2,087 11,223 1,524 102,182
Expenses
Corporate expenses 85,997 12,502 71,818 5,875
Interest expense 58,759 48,199 58,741 47,292
Net foreign exchange (gains) losses (1) - 7 -
Total expenses 144,755 60,701 130,566 53,167
Income (loss) before income taxes (142,668) (49,478) (129,042) 49,015
Income tax (expense) benefit - 10,097 - (12,513)
Income (loss) from operating
affiliates (1,047) - (590) -
Net income available to Arch (143,715) (39,381) (129,632) 36,502
Preferred dividends (40,736) - (48,343) -
Loss on redemption of preferred
shares - - (15,101) -
Net income available to Arch common
shareholders $ (184,451) $ (39,381) $ (193,076) $ 36,502
ARCH CAPITAL 87 2022 FORM 10-K
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Table of Contents
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
Contractual Obligations
The following table provides an analysis of our contractual commitments at
Payment due by period
Total 2023 2024 and 2025 2026 and 2027 Thereafter
Operating activities Estimated gross payments for losses and loss adjustment expenses (1)$ 20,031,943 $
5,687,045
10,376 5,449 1,519 365 3,043
Contractholder payables (3) 1,733,984 549,050 602,897 239,833 342,204
Operating lease obligations 175,284 31,922 54,862 39,918 48,582 Purchase obligations 150,053 83,078 64,952 2,023 - Investing activities Unfunded investment commitments (4) 2,922,663 2,922,663 - -
-
Financing activities Senior notes (including interest payments) 5,166,889 126,815 253,629 733,574
4,052,871
Total contractual obligations and commitments$ 30,191,192 $ 9,406,022 $ 7,388,678 $ 4,046,503 $ 9,349,989 (1)The estimated expected contractual commitments related to the reserves for losses and loss adjustment expenses are presented on a gross basis (i.e., not reflecting any corresponding reinsurance recoverable amounts that would be due to us). It should be noted that until a claim has been presented to us, determined to be valid, quantified and settled, there is no known obligation on an individual transaction basis, and while estimable in the aggregate, the timing and amount contain significant uncertainty. (2)The estimated expected contractual commitments related to deposit accounting liabilities have been estimated using projected cash flows from the underlying contracts. It should be noted that, due to the nature of such liabilities, the timing and amount contain significant uncertainty. (3)Certain insurance policies written by our insurance operations feature large deductibles, primarily in construction and national accounts lines. Under such contracts, we are obligated to pay the claimant for the full amount of the claim and are subsequently reimbursed by the policyholder for the deductible amount. In the event we are unable to collect from the policyholder, we would be liable for such defaulted amounts. (4)Unfunded investment commitments are callable by our investment managers. We have assumed that such investments will be funded in the next year but the funding may occur over a longer period of time, due to market conditions and other factors.
Letter of Credit and Revolving Credit Facilities
In the normal course of its operations, the Company enters into agreements with financial institutions to obtain secured and unsecured credit facilities. OnApril 7, 2022 ,Arch Capital and certain of its subsidiaries amended its existing credit agreement into a$925.0 million facility (the "Credit Facility") with a syndication of lenders. The Credit Facility, as amended, consists of a$425.0 million secured facility for letters of credit (the "Secured Facility") and a$500.0 million unsecured facility for revolving loans and letters of credit (the "Unsecured Facility"). Obligations of each borrower under the Secured Facility for letters of credit are secured by cash and eligible securities of such borrower held in collateral accounts. Commitments under the Credit Facility may be increased up to, but not exceeding, an aggregate of$1.25 billion .Arch Capital has a one-time option to convert any or all outstanding revolving loans ofArch Capital and/or Arch-U.S. to term loans with the same terms as the revolving loans except that any prepayments may not be re-borrowed. Arch-U.S. guarantees the obligations ofArch Capital , andArch Capital guarantees the obligations of Arch-U.S. Borrowings of revolving loans may be made at a variable rate based on Secured Overnight Financing Rate ("SOFR"). Secured letters of credit are available for issuance on behalf of certainArch Capital subsidiaries. AtDecember 31, 2022 , the Secured Facility had$323.1 million of letters of credit outstanding and remaining capacity of$101.9 million , and the Unsecured Facility had no outstanding revolving loans or letters of credit, with remaining capacity of$500.0 million . The Credit Facility contains certain restrictive covenants customary for facilities of this type, including restrictions on indebtedness, consolidated tangible net worth, minimum shareholders' equity levels and minimum financial strength ratings.Arch Capital and its subsidiaries which are party to the agreement were in compliance with all covenants contained therein atDecember 31, 2022 .
See note 19, "Debt and Financing Arrangements," to our consolidated financial statements in Item 8 for additional disclosures concerning our senior notes and revolving credit agreement borrowings.
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Table of Contents RATINGS Our ability to underwrite business is affected by the quality of our claims paying ability and financial strength ratings as evaluated by independent agencies. Such ratings from third party internationally recognized statistical rating organizations or agencies are instrumental in establishing the financial security of companies in our industry. We believe that the primary users of such ratings include commercial and investment banks, policyholders, brokers, ceding companies and investors. Insurance ratings are also used by insurance and reinsurance intermediaries as an important means of assessing the financial strength and quality of insurers and reinsurers, and are often an important factor in the decision by an insured or intermediary of whether to place business with a particular insurance or reinsurance provider. Periodically, rating agencies evaluate us to confirm that we continue to meet their criteria for the ratings assigned to us by them. S&P, Moody's,A.M. Best Company and Fitch Ratings are ratings agencies which have assigned financial strength ratings to one or more ofArch Capital's subsidiaries. If we are not able to obtain adequate capital, our business, results of operations and financial condition could be adversely affected, which could include, among other things, the following possible outcomes: (1) potential downgrades in the financial strength ratings assigned by ratings agencies to our operating subsidiaries, which could place those operating subsidiaries at a competitive disadvantage compared to higher-rated competitors; (2) reductions in the amount of business that our operating subsidiaries are able to write in order to meet capital adequacy-based tests enforced by statutory agencies; and (3) any resultant ratings downgrades could, among other things, affect our ability to write business and increase the cost of bank credit and letters of credit. In addition, under certain of the reinsurance agreements assumed by our reinsurance operations, upon the occurrence of a ratings downgrade or other specified triggering event with respect to our reinsurance operations, such as a reduction in surplus by specified amounts during specified periods, our ceding company clients may be provided with certain rights, including, among other things, the right to terminate the subject reinsurance agreement and/or to require that our reinsurance operations post additional collateral. The ratings issued on our companies by these agencies are announced publicly and are available directly from the agencies. Our website www.archgroup.com (Investor Relations-Credit Ratings) contains information about our ratings, but such information on our website is not incorporated by reference into this report.
CATASTROPHIC EVENTS AND SEVERE ECONOMIC EVENTS
We have large aggregate exposures to natural and man-made catastrophic events, pandemic events like COVID-19 and severe economic events. Natural 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. We have substantial exposure to unexpected, large losses resulting from future man-made catastrophic events, such as acts of war, acts of terrorism and political instability. These risks are inherently unpredictable. It is difficult to predict the timing of such events with statistical certainty or estimate the amount of loss any given occurrence will generate. It is not possible to completely eliminate our exposure to unforecasted or unpredictable events and, to the extent that losses from such risks occur, our financial condition and results of operations could be materially adversely affected. Therefore, claims for natural and man-made catastrophic events could expose us to large losses and cause substantial volatility in our results of operations, which could cause the value of our common shares to fluctuate widely. In certain instances, we specifically insure and reinsure risks resulting from terrorism. Even in cases where we attempt to exclude losses from terrorism and certain other similar risks from some coverages written by us, we may not be successful in doing so. Moreover, irrespective of the clarity and inclusiveness of policy language, there can be no assurance that a court or arbitration panel will limit enforceability of policy language or otherwise issue a ruling adverse to us. We seek to limit our loss exposure by writing a number of our reinsurance contracts on an excess of loss basis, adhering to maximum limitations on reinsurance written in defined geographical zones, limiting program size for each client and prudent underwriting of each program written. In the case of proportional treaties, we may seek per occurrence limitations or loss ratio caps to limit the impact of losses from any one or series of events. In our insurance operations, we seek to limit our exposure through the purchase of reinsurance. We cannot be certain that any of these loss limitation methods will be effective. We also seek to limit our loss exposure by geographic diversification. Geographic zone limitations involve significant underwriting judgments, including the determination of the area of the zones and the inclusion of a particular policy within a particular zone's limits. There can ARCH CAPITAL 89 2022 FORM 10-K
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Table of Contents be no assurance that various provisions of our policies, such as limitations or exclusions from coverage or choice of forum, will be enforceable in the manner we intend. Disputes relating to coverage and choice of legal forum may also arise. Underwriting is inherently a matter of judgment, involving important assumptions about matters that are inherently unpredictable and beyond our control, and for which historical experience and probability analysis may not provide sufficient guidance. One or more catastrophic or other events could result in claims that substantially exceed our expectations, which could have a material adverse effect on our financial condition or our results of operations, possibly to the extent of eliminating our shareholders' equity. For our natural catastrophe exposed business, we seek to limit the amount of exposure we will assume from any one insured or reinsured and the amount of the exposure to catastrophe losses from a single event in any geographic zone. We monitor our exposure to catastrophic events, including earthquake and wind and periodically reevaluate the estimated probable maximum pre-tax loss for such exposures. Our estimated probable maximum pre-tax loss is determined through the use of modeling techniques, but such estimate does not represent our total potential loss for such exposures. 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 tangible shareholders' equity available to Arch (total shareholders' equity available to Arch less goodwill and intangible assets). We reserve the right to change this threshold at any time. Based on in-force exposure estimated as ofJanuary 1, 2023 , our modeled peak zone catastrophe exposure is a windstorm affecting the Florida Tri-County, with a net probable maximum pre-tax loss of$970 million , followed by windstorms affecting theNortheast U.S. , and theGulf of Mexico with net probable maximum pre-tax losses of$908 million and$903 million , respectively. As ofJanuary 1, 2023 , our modeled peak zone earthquake exposure (San Francisco area earthquake) represented approximately 60% of our peak zone catastrophe exposure, and our modeled peak zone international exposure (U.K. windstorm) was substantially less than both our peak zone windstorm and earthquake exposures.
We also have significant exposure to losses due to mortgage defaults resulting
from severe economic events in the future. For our
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. We reserve the right to change this threshold at any time. Based on in-force exposure estimated as ofJanuary 1, 2023 , our modeled RDS loss was 12.3% 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 before 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 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, Business and Operations" Depending on business opportunities and the mix of business that may comprise our insurance, reinsurance and mortgage portfolios, we may seek to adjust our self-imposed limitations on probable maximum pre-tax loss for catastrophe exposed business and mortgage default exposed business. See
"-Summary of Critical Accounting Estimates-Ceded Reinsurance" for a discussion of our catastrophe reinsurance programs.
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Table of Contents
MARKET SENSITIVE INSTRUMENTS AND RISK MANAGEMENT
Our investment results are subject to a variety of risks, including risks related to changes in the business, financial condition or results of operations of the entities in which we invest, as well as changes in general economic conditions and overall market conditions. We are also exposed to potential loss from various market risks, including changes in equity prices, interest rates and foreign currency exchange rates. In accordance with theSEC'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 ofDecember 31, 2022 . Market risk represents the risk of changes in the fair value of a financial instrument and consists of several components, including liquidity, basis and price risks. The sensitivity analysis performed as ofDecember 31, 2022 presents hypothetical losses in cash flows, earnings and fair values of market sensitive instruments which were held by us onDecember 31, 2022 and are sensitive to changes in interest rates and equity security prices. This risk management discussion and the estimated amounts generated from the following sensitivity analysis represent forward-looking statements of market risk assuming certain adverse market conditions occur. Actual results in the future may differ materially from these projected results due to actual developments in the global financial markets. The analysis methods used by us to assess and mitigate risk should not be considered projections of future events of losses. The focus of theSEC's market risk rules is on price risk. For purposes of specific risk analysis, we employ 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. The financial instruments included in the following sensitivity analysis consist of all of our investments and cash.
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, short-term investments and certain of our other investments, equity securities and investment funds accounted for using the equity method which invest in fixed income securities (collectively, "Fixed Income Securities ") and the corresponding change in unrealized appreciation. As interest rates rise, the fair value of ourFixed Income 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 inU.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 investment portfolio at
Interest Rate Shift in Basis Points
(U.S. dollars in billions) -100 -50 - +50 +100Dec. 31, 2022 Total fair value$ 27.19 $ 26.79 $ 26.42 $ 26.05 $ 25.71 Change from base 2.9 % 1.4 % (1.4) % (2.7) % Change in unrealized value$ 0.77 $ 0.37 $ (0.37) $ (0.71) Dec. 31, 2021 Total fair value$ 25.79 $ 25.44 $ 25.21 $ 24.75 $ 24.43 Change from base 2.3 % 0.9 % (1.8) % (3.1) % Change in unrealized value$ 0.58 $ 0.23 $
(0.45)
In addition, we consider the effect of credit spread movements on the market value of ourFixed Income Securities and the corresponding change in unrealized value. As credit spreads widen, the fair value of ourFixed Income Securities falls, and the converse is also true. In periods where the spreads on ourFixed Income Securities are much higher than their historical average due to short-term market dislocations, a parallel shift in credit spread levels would result in a much more pronounced change in unrealized value.
The following table summarizes the effect that an immediate, parallel shift in
credit spreads in a static interest rate environment would have had on the
portfolio at
Credit Spread Shift in Percentage
(U.S. dollars in billions) -100 -50 - +50 +100
Dec. 31, 2022
Total fair value $ 27.50 $ 26.95 $ 26.42 $ 25.89 $ 25.34
Change from base 4.1 % 2.0 % (2.0) % (4.1) %
Change in unrealized value $ 1.08 $ 0.53 $ (0.53) $ (1.08)
Dec. 31, 2021
Total fair value $ 26.17 $ 25.69 $ 25.21 $ 24.72 $ 24.24
Change from base 3.8 % 1.9 % (1.9) % (3.8) %
Change in unrealized value $ 0.97 $ 0.48 $ (0.48) $ (0.97) Another method that attempts to measure portfolio risk is Value-at-Risk ("VaR"). VaR measures the worst expected loss under normal market conditions over a specific time interval at a given confidence level. The 1-year 95th
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Table of Contents percentile parametric VaR reported herein estimates that 95% of the time, the portfolio loss in a one-year horizon would be less than or equal to the calculated number, stated as a percentage of the measured portfolio's initial value. The VaR is a variance-covariance based estimate, based on linear sensitivities of a portfolio to a broad set of systematic market risk factors and idiosyncratic risk factors mapped to the portfolio exposures. The relationships between the risk factors are estimated using historical data, and the most recent data points are generally given more weight. As ofDecember 31, 2022 , our portfolio's 95th percentile VaR was estimated to be 8.8%, compared to an estimated 4.8% atDecember 31, 2021 . In periods where the volatility of the risk factors mapped to our portfolio's exposures is higher due to market conditions, the resulting VaR is higher than in other periods.Equity Securities . AtDecember 31, 2022 and 2021, the fair value of our investments in equity securities and certain investments accounted for using the equity method with underlying equity strategies totaled$0.8 billion and$1.4 billion , 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$79.1 million and$137.5 million atDecember 31, 2022 and 2021, respectively, and would have decreased book value per share by approximately$0.21 and$0.36 , respectively. An immediate hypothetical 10% increase in the value of each position would increase the fair value of such investments by approximately$79.1 million and$137.5 million atDecember 31, 2022 and 2021, respectively, and would have increased book value per share by approximately$0.21 and$0.36 , respectively. Investment-Related Derivatives. AtDecember 31, 2022 , the notional value of all derivative instruments (excluding foreign currency forward contracts which are included in the foreign currency exchange risk analysis below) was$6.6 billion , compared to$6.4 billion atDecember 31, 2021 . If the underlying exposure of each investment-related derivative held atDecember 31, 2022 depreciated by 100 basis points, it would have resulted in a reduction in net income of approximately$66.3 million , and a decrease in book value per share of$0.18 , compared to$63.8 million and$0.17 , respectively, on investment-related derivatives held atDecember 31, 2021 . If the underlying exposure of each investment-related derivative held atDecember 31, 2022 appreciated by 100 basis points, it would have resulted in an increase in net income of approximately$66.3 million , and an increase in book value per share of$0.18 , compared to$63.8 million and$0.17 , respectively, on investment-related derivatives held at December 31, 2021. See note 11, "Derivative Instruments," to our consolidated financial statements in Item 8 for additional disclosures concerning derivatives.
For further discussion on investment activity, please refer to "-Financial Condition, Liquidity and Capital Resources-Financial Condition-Investable Assets."
ARCH CAPITAL 92 2022 FORM 10-K
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Table of Contents 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 theU.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 11, "Derivative Instruments," to our consolidated financial statements in Item 8 for additional information.
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 December 31, December 31, per share data) 2022 2021
Net assets (liabilities), denominated in foreign currencies, excluding shareholders' equity and derivatives
$ (396,305) $ (825,371) Shareholders' equity denominated in foreign currencies (1) 1,056,213 1,095,706 Net foreign currency forward contracts outstanding (2) 311,519 15,151 Net exposures denominated in foreign currencies $
971,427
Pre-tax impact of a hypothetical 10% appreciation of theU.S. Dollar against foreign currencies: Shareholders' equity$ (97,143) $ (28,549) Book value per share $ (0.26) $ (0.08) Pre-tax impact of a hypothetical 10% decline of theU.S. Dollar against foreign currencies: Shareholders' equity $ 97,143 $ 28,549 Book value per share $ 0.26 $ 0.08
(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 the Company generally attempts to match the currency of its projected liabilities with investments in the same currencies, from time to time the Company may elect to over or underweight one or more currencies, which could increase the Company's exposure to foreign currency fluctuations and increase the volatility of the Company's shareholders' equity. Historical observations indicate a low probability that all foreign currency exchange rates would shift against theU.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
General economic inflation has increased in recent quarters and may continue to remain at elevated levels for an extended period of time. The potential also exists, after a catastrophe loss or pandemic events like COVID-19, for the development of inflationary pressures in a local economy. This may have a material effect on the adequacy of our reserves for losses and loss adjustment expenses, especially in longer-tailed lines of business, and on the market value of our investment portfolio through rising interest rates. The anticipated effects of inflation are considered in our pricing models, reserving processes and exposure management, across all lines of business and types of loss including natural catastrophe events. The actual effects of inflation on our results cannot be accurately known until claims are ultimately settled and will vary by the specific type of inflation affecting each line of business.
ITEM 7A. 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 Operation," which information is hereby incorporated by reference.
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