ARCH CAPITAL GROUP LTD. The following is a discussion and analysis of the financial condition and results of operations for the year endedDecember 31, 2021 and 2020. Comparisons between 2020 and 2019 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, 2020 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 in
GENERAL OverviewArch Capital Group Ltd. ("Arch Capital " and, together with its subsidiaries, "we" or "us") is a publicly listedBermuda exempted company with approximately$16.3 billion in capital atDecember 31, 2021 . Through operations inBermuda ,the United States ,United Kingdom ,Europe ,Canada ,Australia andHong Kong , 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, favorable terms and conditions, and underwriting gains. A hard market is eventually followed by a "soft" market which has the opposite characteristics of low premium rates, relaxed underwriting standards, broader terms and conditions, and underwriting losses. 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 Our three areas of focus during the year have remained constant. In our property and casualty segments we continued to focus and grow in sectors where rates allow for returns that are substantially higher than our cost of capital. Our mortgage insurance segment has transitioned, for the most part, from forbearance to recovery and produced results that made a significant contribution to our underwriting income. We have also continued to focus on actively managing our investments and capital to enhance our returns. In keeping with our longstanding underwriting approach, we look for acceptable books of business to underwrite without sacrificing discipline. Our corporate culture of being patient in soft markets while maintaining an agile mindset is a key to our success and allows us to seize opportunities when the odds for success are more in our favor. The 2021 year reflected the benefits of attractive pricing in almost all of our insurance markets. As a result, we currently expect favorable market conditions to continue in 2022, partially due to the compounding of rate-on-rate increases and the rebalancing of our mix of business. We believe that this time-tested strategy of protecting capital through soft markets and increasing our writings in hard markets gives us the best chance to generate superior risk adjusted returns over time. As long as rate increases support returns above our required thresholds, we expect to continue to grow our writings.
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Table of Contents The property casualty industry is facing many degrees of uncertainty, including heightened catastrophe activity, rising inflation, COVID's ongoing influence on the global economy and perennially low interest rates. These factors continue to influence the trajectory and market acceptance of rate increases and reinforce why we remain optimistic that improved economics in the property casualty market will be sustainable for some time. Rate improvements have enabled us to continue to expand writings in our property casualty segments as we have been for two years now. Rate momentum remained healthy and rate increases were well above the long-term loss cost trends and have spread to more lines than last year. Our early focus on Lloyd's and business in theU.K. has improved our scale and our economics in this market. Some of our business lines that were most impacted by COVID, like travel, are recapturing some of the lost volume as both business and consumer travel increases. In reinsurance, strong growth was observed across most of our lines of business, a reflection of our diversified specialty mix of business and our larger participation in quota share reinsurance which allows us to participate in the improved premium rates of cedents more directly. We continue to write a portion of our overall book in catastrophe exposed business, which has the potential to increase the volatility of our operating results. While property catastrophe rates were up broadly atJanuary 1, 2022 renewals, the increases were not enough for us to deploy more capital into our peak zones. However, we found many opportunities to grow in the other 93% of our reinsurance business that is specialty in nature, including property excluding property catastrophe. For ourU.S. primary mortgage operations, delinquencies continue to be lower than our expectations at the beginning of the COVID-19 pandemic. Overall, the U.S. market remains competitive but rational and our mortgage business continues to generate returns on capital in the mid teens. Outside of theU.S. , we increased our writings inAustralia as a result of the housing market remaining strong and due to our acquisition of Westpac's LMI business. 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 ("GSEs"). In addition, we enter into aggregate excess of loss mortgage reinsurance agreements with various special purpose reinsurance companies domiciled inBermuda and issue mortgage insurance linked notes, increasing our protection for mortgage tail risk. The Bellemeade structures provide approximately$4.6 billion of aggregate reinsurance coverage atDecember 31, 2021 .
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$33.56 atDecember 31, 2021 , a 10.7% increase from$30.31 atDecember 31, 2020 . The growth in 2021 reflected strong underwriting returns and income from operating affiliates.
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, 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, net of 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
Operating ROAE was 11.5% for 2021, compared to 4.8% for 2020. Returns for the
2021 period reflected strong underwriting returns and income from operating
affiliates, while the 2020 period reflected the impact of COVID-19 on
underwriting results.
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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 and losses and the change in unrealized gains and losses generated by Arch's investment portfolio. Total return is calculated on a pre-tax basis 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.
The following table summarizes the pre-tax total return (before investment
expenses) of investments held by Arch compared to the benchmark return (both
based in
Arch Benchmark
Portfolio (1) Return
Pre-tax total return (before investment expenses): Year Ended December 31, 2021 1.90 % 1.20 % Year Ended December 31, 2020 7.77 % 7.16 %
(1) Our investment expenses were approximately 0.32% and 0.31%, respectively, of average invested assets in 2021 and 2020.
Total return for our investment portfolio outperformed the benchmark return index in 2021 and reflected the impact of strong returns on alternatives and equities, partially offset by low returns on our fixed income portfolio.
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, 2021 , the benchmark return index had an average credit quality of "Aa3" by Moody's, an estimated duration of 3.14 years.
The benchmark return index included weightings to the following indices:
%
ICE BoAML 1-10 Year A -AAA U.S. Corporate Index 21.00 % ICE BoAML 1-5 YearU.S. Treasury Index 15.00 MSCI ACWI Net Total Return USD Index 8.60 ICE BoAML 3-5 Year Fixed Rate Asset Backed Securities Index 7.00 S&P Leveraged Loan Total Return Index 5.20 Bloomberg Barclays CMBS Invest Grade Aaa Total Return Index 5.00 ICE BoAML 1-10 Year BBBU.S. Corporate Index 4.00 ICE BoAMLU.S. Mortgage Backed Securities Index 4.00 ICE BoAML 1-5 YearU.K. Gilt Index 4.00 ICE BoAML German Government 1-10 Year Index 3.50 ICE BoAML 0-3 MonthU.S. Treasury Bill Index 3.25 ICE BoAML 1-10 YearU.S. Municipal Securities Index 3.00 ICE BoAML 5-10 YearU.S. Treasury Index 3.00 ICE BoAML 1-5 Year Australia Government Index 2.75 ICE BoAMLU.S. High Yield Constrained Index 2.50 ICE BoAML 1-5 Year Canada Government Index 2.00 Bloomberg Barclays Global High Yield Total Return Index 1.50
Hedge Fund Research HFRX ED Distressed Restructuring Index (Flagship Funds)
1.50
Dow Jones Global ex-US Select Real Estate Securities Total Return Net Index
0.90
FTSE Nareit All Mortgage Capped Index Total Return USD 0.90
Bloomberg Barclays CMBS: Erisa Eligible Unhedged USD 0.90
ICE BoAML 20+ Year Canada Government Index 0.50
Total 100.00 %
COMMENT ON NON-GAAP FINANCIAL MEASURES
Throughout this filing, we present our operations in the way we believe will be the most meaningful and useful to investors, analysts, rating agencies and others who use our financial information in evaluating the performance of our company. This presentation includes the use of after-tax operating income available to Arch common shareholders, which is defined as net income available to Arch common shareholders, excluding net realized gains or losses, 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 income taxes, and the use of annualized operating return on average common equity. The presentation of after-tax operating income available to Arch common shareholders and annualized operating return on average common equity are non-GAAP financial measures as defined in Regulation G. The reconciliation of such measures to net income available to Arch common shareholders and annualized 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. ARCH CAPITAL 59 2021 FORM 10-K
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Table of Contents 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 investment gains or losses, the recognition of the change in the carrying value of investments accounted for using the fair value option in net realized gains or losses, the recognition of net impairment losses, the recognition of equity in net income or loss of investments accounted for using the equity method and the recognition of foreign exchange gains or losses are independent of the insurance underwriting process and result, in large part, from general economic and financial market conditions. Furthermore, certain users of our financial information believe that, for many companies, the timing of the realization of investment gains or losses is largely opportunistic. In addition, changes in 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 fixed maturity securities 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 Series E preferred shares inSeptember 2021 had no impact on shareholders' equity or cash flows. Due to these reasons, 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 which follow us and the insurance industry as a whole generally exclude these items from their analyses for the same reasons. Our segment information includes the presentation of consolidated underwriting income or loss and a subtotal of underwriting income or loss before the contribution from the 'other' segment. Such measures represent the pre-tax profitability of our underwriting operations and include net premiums earned plus other underwriting income, less losses and loss adjustment expenses, acquisition expenses and other operating expenses. Other operating expenses include those operating expenses that are incremental and/or directly attributable to our individual underwriting operations. Underwriting income or loss does not incorporate items included in our corporate 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. 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 and losses and the change in unrealized gains and losses generated by Arch's investment portfolio. Total return is calculated on a pre-tax basis and before investment expenses, excludes amounts reflected in the 'other' segment, and reflects the effect of financial market conditions along with foreign currency fluctuations. In addition, total return incorporates the timing of investment returns during the periods. There is no directly comparable GAAP financial measure for total return. Management uses total return on investments as a key measure of the return generated to Arch common shareholders on the capital held in the business, and compares the return generated by our investment portfolio against benchmark returns which we measured our portfolio against during the periods. RESULTS OF OPERATIONS
The following table summarizes our consolidated financial data, including a reconciliation of net income available to Arch common shareholders to after-tax operating income available to Arch common shareholders.
Year
Ended
2021 2020
Net income available to Arch common shareholders
$ 1,363,909 Net realized (gains) losses (307,466) (814,808)
Equity in net (income) loss of investments accounted for using the equity method
(366,402) (146,693)
Net foreign exchange (gains) losses (42,743) 80,591
Transaction costs and other 1,199 9,964
Loss on redemption of preferred shares 15,101 -
Income tax expense (benefit) (1) 41,836 64,145
After-tax operating income available to Arch common shareholders
$ 1,434,930
Beginning common shareholders' equity$ 12,325,886 $ 10,717,371 Ending common shareholders' equity 12,715,896
12,325,886
Average common shareholders' equity$ 12,520,891
Annualized net income return on average common equity % 16.7 11.8 Annualized operating return on average common equity % 11.5 4.8 (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.
Results in all periods presented reflected the impact of current insurance and reinsurance market conditions and the impact of low interest yields on our investment portfolio.
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 ARCH CAPITAL 61 2021 FORM 10-K
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Table of Contents 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,
2021 2020 % Change
Gross premiums written $ 5,867,734 $ 4,688,562 25.1
Premiums ceded (1,719,541) (1,525,655)
Net premiums written 4,148,193 3,162,907 31.2
Change in unearned premiums (521,725) (291,487)
Net premiums earned 3,626,468 2,871,420 26.3
Other underwriting income - (31)
Losses and loss adjustment expenses (2,344,365) (2,092,453)
Acquisition expenses (606,265) (418,483)
Other operating expenses (558,906) (489,153)
Underwriting income (loss) $ 116,932 $ (128,700) 190.9
Underwriting Ratios % Point Change
Loss ratio 64.6 % 72.9 % (8.3)
Acquisition expense ratio 16.7 % 14.6 % 2.1
Other operating expense ratio 15.4 % 17.0 % (1.6)
Combined ratio 96.7 % 104.5 % (7.8)
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.
Premiums Written.
The following tables set forth our insurance segment's net premiums written by
major line of business:
Year Ended December 31,
2021 2020
Amount % Amount %
Professional lines $ 1,177,144 28.4 $ 743,486 23.5
Property, energy, marine and aviation 770,954 18.6 619,034 19.6
Programs 595,824 14.4 437,973 13.8
Construction and national accounts 383,580 9.2 364,104 11.5
Excess and surplus casualty 359,458 8.7 297,330 9.4
Travel, accident and health 305,390 7.4 212,974 6.7
Lenders products 146,984 3.5 156,119 4.9
Other 408,859 9.9 331,887 10.5
Total $ 4,148,193 100.0 $ 3,162,907 100.0
Net premiums written by the insurance segment were 31.2% higher in 2021 than in
2020. The higher level of net premiums written reflected increases across most
lines of business, due in part to new business opportunities, rate increases 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,
2021 2020
Amount % Amount %
Professional lines $ 942,817 26.0 $ 655,872 22.8
Property, energy, marine and aviation 702,693 19.4 517,247 18.0
Programs 506,867 14.0 432,854 15.1
Construction and national accounts 381,306 10.5 387,934 13.5
Excess and surplus casualty 318,027 8.8 270,620 9.4
Travel, accident and health 255,590 7.0 190,944 6.6
Lenders products 153,958 4.2 114,687 4.0
Other 365,210 10.1 301,262 10.5
Total $ 3,626,468 100.0 $ 2,871,420 100.0
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 26.3% higher in 2021 than in 2020, 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,
2021 2020
Current year 65.0 % 73.2 %
Prior period reserve development (0.4) % (0.3) %
Loss ratio 64.6 % 72.9 %
Current Year Loss Ratio.
The insurance segment's current year loss ratio was 8.2 points lower in 2021
than in 2020. The 2021 loss ratio included 5.6 points of current year
catastrophic event activity, primarily related to Hurricane Ida and winter
storms Uri and Viola, compared to 9.5 points in 2020, which included exposure to
the COVID-19 global pandemic. The balance of the change in the 2021 loss ratio
resulted, in part, from the effect of rate increases, changes in mix of business
and the level of attritional losses.
Prior
The insurance segment's net favorable development was$16.2 million , or 0.4 points, for 2021, compared to$7.8 million , or 0.3 points, for 2020. 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 32.1% in 2021, compared to 31.6% in 2020, with the increase primarily reflected growth in lines of business with higher acquisition costs, partially offset by growth in net premiums earned.
Reinsurance Segment
The following tables set forth our reinsurance segment's underwriting results:
Year Ended December 31,
2021 2020 % Change
Gross premiums written $ 5,093,930 $ 3,472,086 46.7
Premiums ceded (1,839,556) (1,014,716)
Net premiums written 3,254,374 2,457,370 32.4
Change in unearned premiums (413,931) (295,141)
Net premiums earned 2,840,443 2,162,229 31.4
Other underwriting income (loss) 3,669 4,454
Losses and loss adjustment expenses (1,924,719) (1,628,320)
Acquisition expenses (536,754) (354,048)
Other operating expenses (212,810) (168,011)
Underwriting income $ 169,829 $ 16,304 941.6
Underwriting Ratios % Point Change
Loss ratio 67.8 % 75.3 % (7.5)
Acquisition expense ratio 18.9 % 16.4 % 2.5
Other operating expense ratio 7.5 % 7.8 % (0.3)
Combined ratio 94.2 % 99.5 % (5.3)
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.
Premiums Written.
The following tables set forth our reinsurance segment's net premiums written by
major line of business:
Year Ended December 31,
2021 2020
Amount % Amount %
Property excluding property catastrophe $ 1,004,086 30.9 $ 697,086 28.4
Other Specialty 955,474 29.4 709,308 28.9
Casualty 808,164 24.8 542,319 22.1
Property catastrophe 233,260 7.2 286,210 11.6
Marine and aviation 171,753 5.3 141,414 5.8
Other 81,637 2.5 81,033 3.3
Total $ 3,254,374 100.0 $ 2,457,370 100.0
Gross premiums written by the reinsurance segment in 2021 were 46.7% higher than
in 2020, while net premiums written were 32.4% higher than in 2020. 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.
ARCH CAPITAL 63 2021 FORM 10-K
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Table of Contents
Net Premiums Earned.
The following tables set forth our reinsurance segment's net premiums earned by
major line of business:
Year Ended December 31,
2021 2020
Amount % Amount %
Property excluding property catastrophe $ 836,573 29.5 $ 562,208 26.0
Other Specialty 818,801 28.8 626,409 29.0
Casualty 666,754 23.5 549,056 25.4
Property catastrophe 280,738 9.9 237,736 11.0
Marine and aviation 152,955 5.4 109,624 5.1
Other 84,622 3.0 77,196 3.6
Total $ 2,840,443 100.0 $ 2,162,229 100.0
Net premiums earned in 2021 were 31.4% higher than in 2020, 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 2021 was
Losses and Loss Adjustment Expenses.
The table below shows the components of the reinsurance segment's loss ratio:
Year Ended December 31,
2021 2020
Current year 74.1 % 81.5 %
Prior period reserve development (6.3) % (6.2) %
Loss ratio 67.8 % 75.3 %
Current Year Loss Ratio.
The reinsurance segment's current year loss ratio was 7.4 points lower in 2021
than in 2020. The 2021 loss ratio included 16.5 points for current year
catastrophic event activity, primarily related to Hurricane Ida and winter
storms Uri and Viola, as well as other minor global events, compared to 20.1
points in 2020. The 2020 period loss ratio included exposure to the COVID-19
pandemic. The balance of the change in the 2021 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 26.4% in 2021, compared to 24.2% in 2020, 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,
2021 2020 % Change
Gross premiums written $ 1,507,825 $ 1,473,999 2.3
Premiums ceded (246,757) (194,149)
Net premiums written 1,261,068 1,279,850 (1.5)
Change in unearned premiums 22,351 118,085
Net premiums earned 1,283,419 1,397,935 (8.2)
Other underwriting income 17,665 20,316
Losses and loss adjustment expenses (56,677) (528,344)
Acquisition expenses (97,418) (134,240)
Other operating expenses (194,010) (162,202)
Underwriting income $ 952,979 $ 593,465 60.6
Underwriting Ratios % Point Change
Loss ratio 4.4 % 37.8 % (33.4)
Acquisition expense ratio 7.6 % 9.6 % (2.0)
Other operating expense ratio 15.1 % 11.6 % 3.5
Combined ratio 27.1 % 59.0 % (31.9)
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,
2021 2020
Net premiums written by underwriting location
United States $ 914,477 $ 1,021,950
Other 346,591 257,900
Total $ 1,261,068 $ 1,279,850
Gross premiums written by the mortgage segment in 2021 were 2.3% higher than in
2020, primarily reflecting growth in Australian single premium mortgage
insurance and due to the acquisition of Westpac Lenders Mortgage Insurance
Limited in 2021, which was partially offset by a lower level of U.S. primary
mortgage insurance monthly and single premium volume. Net premiums written for
2021 were 1.5% lower than in the 2020 period. Net premiums written for the 2021
period reflected a higher level of premiums ceded than in the 2020 period.
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Table of Contents The persistency rate of theU.S. primary portfolio of mortgage loans was 62.4% atDecember 31, 2021 compared to 58.7% atDecember 31, 2020 , 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,
2021 2020
Net premiums earned by underwriting location
United States $ 970,507 $ 1,158,563
Other 312,912 239,372
Total $ 1,283,419 $ 1,397,935 Net premiums earned for 2021 were 8.2% lower than in 2020, primarily reflecting a lower level of earnings from single premium policy terminations.
Other Underwriting Income.
Other underwriting income, which is primarily related to GSE risk-sharing
transactions, was
Losses and Loss Adjustment Expenses.
The table below shows the components of the mortgage segment's loss ratio:
Year Ended December 31,
2021 2020
Current year 17.6 % 39.2 %
Prior period reserve development (13.2) % (1.4) %
Loss ratio 4.4 % 37.8 %
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 2021 or
2020.
Current Year Loss Ratio.
The mortgage segment's current year loss ratio was 21.6 points lower in 2021
compared to 2020. The percentage of loans in default on U.S. primary mortgage
insurance decreased from 4.19% at December 31, 2020 to 2.36% at December 31,
2021 .
Incurred losses for the 2020 periods reflected elevated delinquency rates due,
in part, to financial stress from the COVID-19 pandemic. Segregating estimated
losses due to COVID-19 from the overall mortgage segment estimated losses would
require knowledge of the number of delinquencies specifically attributable to
COVID-19. As this exercise cannot be performed accurately, the Company is not
reporting COVID-19 provisions separately from its overall loss provisions.
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$169.6 million , or 13.2 points, for 2021, compared to$19.0 million , or 1.4 points, for 2020. See 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 22.7% for 2021, in line with 21.2% for 2020, with the increase primarily due to a lower level of net premiums earned in theU.S. primary mortgage insurance business.
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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,
2021 2020
Fixed maturities $ 307,536 $ 358,804
Equity securities 42,094 28,007
Short-term investments 6,799 6,573
Other (1) 68,411 77,951
Gross investment income 424,840 471,335
Investment expenses (2) (78,032) (69,427)
Net investment income $ 346,808 $ 401,908
(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 0.32% of average invested assets for
2021, compared to 0.31% for 2020.
The pre-tax investment income yield was 1.41% for 2021, compared to 1.78% for 2020. The lower level of net investment income for 2021 compared to 2020 reflected lower 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 gains of$299.2 million for 2021, compared to net realized gains of$813.8 million for 2020. Currently, our portfolio is actively managed to maximize total return within certain guidelines. The effect of financial market movements on the investment portfolio will directly impact net realized gains and losses as the portfolio is adjusted and rebalanced. Net realized gains or losses from the sale of fixed maturities primarily results from our decisions to reduce credit exposure, to change duration targets, to rebalance our portfolios or due to relative value determinations. Net realized gains or losses also include realized and unrealized contract gains and losses on our derivative instruments, changes in the fair value of assets accounted for using the fair value option and in the fair value of equities, along with 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$366.4 million of equity in net income related to investments accounted for using the equity method for 2021, compared to$146.7 million for 2020. Investments accounted for using the equity method totaled$3.1 billion atDecember 31, 2021 , compared to$2.0 billion atDecember 31, 2020 . 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 income of
Corporate Expenses.
Corporate expenses were$77.1 million for 2021, compared to$68.5 million for 2020. 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
Amortization of Intangible Assets.
Amortization of intangible assets for 2021 was$82.1 million , compared to$69.0 million for 2020. Amounts in 2021 and 2020 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."
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Table of Contents Interest Expense. Interest expense was$131.1 million for 2021, compared to$120.2 million for 2020. Interest expense primarily reflects amounts related to our outstanding senior notes. The higher level of interest expense mainly resulted from the issuance of$1.0 billion of 3.635% senior notes inJune 2020 .
Net Foreign Exchange Gains or Losses.
Net foreign exchange gains for 2021 were
Income Tax Expense.
Our income tax provision on income before income taxes resulted in an expense of 5.6% for 2021, compared to an expense of 7.4% for 2020. The effective tax rate for 2021 period included discrete income tax benefits of$39.3 million , compared to a benefit of$2.5 million for 2020. The discrete tax items in the 2021 period primarily relate to the release of valuation allowances on certain international 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 2021 and 2020.
Income (Loss) from Operating Affiliates.
We recorded$264.7 million of net income from our operating affiliates in the 2021 period, compared to income of$16.8 million in the 2020 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.
Other Segment
ThroughJune 30, 2021 , the 'other' segment included the results of Somers. Pursuant to GAAP, Somers was 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 . InJuly 2021 , we announced the completion of the previously disclosed acquisition of Somers by Greysbridge. Based on the governing documents of Greysbridge, the Company has concluded that, while it retains significant influence over Somers, Somers no longer constitutes a variable interest entity. Accordingly, effectiveJuly 1, 2021 , Arch no longer consolidates the results of Somers in its consolidated financial statements. See note 12, "Variable Interest Entity and Noncontrolling Interests," and note 4, "Segment Information," to our consolidated financial statements in Item 8 for additional information.
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.
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Table of Contents 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. AtDecember 31, 2021 and 2020, our Loss Reserves, net of unpaid losses and loss adjustment expenses recoverable, by type and by operating segment were as follows: December 31, 2021 2020 Insurance segment: Case reserves$ 2,102,891 $ 2,051,640 IBNR reserves 4,269,904 3,889,823 Total net reserves 6,372,795 5,941,463 Reinsurance segment: Case reserves 1,733,571 1,560,523 Additional case reserves 426,531 280,472 IBNR reserves 2,656,527 2,253,953 Total net reserves 4,816,629 4,094,948 Mortgage segment: Case reserves 741,897 631,921 IBNR reserves 226,604 271,702 Total net reserves 968,501 903,623 Other segment: Case reserves - 566,587 Additional case reserves - 32,321 IBNR reserves - 660,132 Total net reserves - 1,259,040 Total: Case reserves 4,578,359 4,810,671 Additional case reserves 426,531 312,793 IBNR reserves 7,153,035 7,075,610 Total net reserves$ 12,157,925 $ 12,199,074 AtDecember 31, 2021 and 2020, 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, 2021 2020 Professional lines (1)$ 1,673,615 $ 1,482,820
Construction and national accounts 1,490,206 1,395,067 Excess and surplus casualty (2)
657,307 816,495
Programs 793,187 699,354
Property, energy, marine and aviation 599,093 517,692
Travel, accident and health 96,051 98,910
Lenders products 58,351 48,946
Other (3) 1,004,985 882,179
Total net reserves $ 6,372,795 $ 5,941,463 (1) Includes professional liability, executive assurance and healthcare business. (2) Includes casualty and contract binding business. (3) Includes alternative markets, excess workers' compensation and surety business.
AtDecember 31, 2021 and 2020, 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, 2021 2020 Casualty (1)$ 2,123,360 $ 1,995,849 Other specialty (2) 1,113,766 917,178 Property excluding property catastrophe (3) 711,859 594,033 Marine and aviation 246,861 204,205 Property catastrophe 486,911 268,858 Other (4) 133,872 114,825 Total net reserves$ 4,816,629 $ 4,094,948 (1) Includes executive assurance, professional liability, workers' compensation, excess motor, healthcare and other. (2) Includes non-excess motor, surety, accident and health, workers' compensation catastrophe, agriculture, trade credit and other. (3) Includes property facultative business. (4) Includes life, casualty clash and other. AtDecember 31, 2021 and 2020, 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, 2021 2020 U.S. primary mortgage insurance (1)$ 710,708 $ 649,748
Total net reserves$ 968,501 $ 903,623 (1) AtDecember 31, 2021 , 27.0% of total net reserves represent policy years 2011 and prior and the remainder from later policy years. AtDecember 31, 2020 , 28.3% of total net reserves represent policy years 2011 and prior and the remainder from later policy years.
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Table of Contents Potential Variability in Loss Reserves The tables below 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, atDecember 31, 2021 by underwriting segment. The scenarios shown in the tables summarize the effect of (i) changes to the expected loss ratio selections used atDecember 31, 2021 , 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, 2021 , 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. 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 $ 44,245 $ 73,192 Third party occurrence business 317,483 165,701 Third party claims-made business 149,689 148,642 Multi-line and other specialty 145,365 132,792 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 $ (41,610) $ (35,731) Third party occurrence business (316,771) (144,688) Third party claims-made business (149,618) (118,728) Multi-line and other specialty (141,854) (89,390) 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 $ 159,539 $ 184,503 Other specialty 86,426 79,244 Property excluding property catastrophe 30,662 77,092 Property catastrophe 28,532 46,563 Marine and aviation 13,801 21,679 Other 7,253 4,901 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 $ (159,539) $ (142,727) Other specialty (86,397) (98,539) Property excluding property catastrophe (30,662) (70,358) Property catastrophe (28,532) (30,353) Marine and aviation (13,924) (22,699) Other (7,253) (4,688) 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 atDecember 31, 2021 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 atDecember 31, 2021 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 34% of the unpaid principal balance atDecember 31, 2021 ), we estimated that our loss reserves would change by approximately$28.0 million atDecember 31, 2021 . For every one percentage point change in our primary net default to claim rate (which we estimate to ARCH CAPITAL 69 2021 FORM 10-K
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Table of Contents be approximately 39% atDecember 31, 2021 ), we estimated a$24.0 million change in our loss reserves atDecember 31, 2021 .
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, 2021 , 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)$6,372,795 $4,816,629 $968,501 $12,157,925 Simulation results: 90th percentile (2)$7,670,396 $5,851,277 $1,159,743 $14,001,252 10th percentile (3)$5,128,642 $3,903,565 $791,504 $10,398,665 (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$1.8 billion , or$4.60 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$1.8 billion , or$4.39 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, 2021 . 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,
2021 2020
Amount % Amount %
Insurance In Force (IIF) (1):
U.S. primary mortgage insurance $ 280,945 61.0 $ 280,579 66.2
U.S. credit risk transfer
(CRT) and other (2) 110,018 23.9 103,535 24.4
International mortgage
insurance/reinsurance (3) 69,655 15.1 39,425 9.3
Total $ 460,618 100.0 $ 423,539 100.0
Risk In Force (RIF) (4):
U.S. primary mortgage insurance $ 70,619 84.3 $ 70,522 90.5
U.S. credit risk transfer
(CRT) and other (2) 5,120 6.1 4,699 6.0
International mortgage
insurance/reinsurance (3) 7,983 9.5 2,673 3.4
Total $ 83,722 100.0 $ 77,894 100.0
(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) Includes risks primarily located in Australia .
(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.
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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, 2021 : (U.S. Dollars in millions) IIF RIF Delinquency Amount % Amount % Rate (1) Policy year: 2011 and prior$ 11,245 4.0$ 2,509 3.6 9.24 % 2012 1,785 0.6 451 0.6 2.33 % 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 insurance in force and risk in force for our
(U.S. Dollars in millions) IIF RIF Delinquency
Amount % Amount % Rate (1)
Policy year:
2011 and prior $ 14,588 5.2 $ 3,327 4.7 11.36 %
2012 3,651 1.3 992 1.4 2.98 %
2013 7,546 2.7 2,107 3.0 3.30 %
2014 8,261 2.9 2,273 3.2 4.06 %
2015 15,032 5.4 4,048 5.7 3.72 %
2016 24,958 8.9 6,648 9.4 4.77 %
2017 24,748 8.8 6,413 9.1 5.52 %
2018 27,304 9.7 6,918 9.8 6.76 %
2019 48,304 17.2 12,001 17.0 4.61 %
2020 106,187 37.8 25,795 36.6 0.76 %
Total $ 280,579 100.0 $ 70,522 100.0 4.19 %
(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,
2021 2020
Amount % Amount %
Credit quality (FICO):
>=740 $ 42,451 60.1 $ 40,774 57.8
680-739 23,646 33.5 24,498 34.7
620-679 4,196 5.9 4,837 6.9
<620 326 0.5 413 0.6
Total $ 70,619 100.0 $ 70,522 100.0
Weighted average FICO score 746 743
Loan-to-Value (LTV):
95.01% and above $ 7,538 10.7 $ 8,643 12.3
90.01% to 95.00% 38,829 55.0 37,877 53.7
85.01% to 90.00% 20,006 28.3 20,013 28.4
85.00% and below 4,246 6.0 3,989 5.7
Total $ 70,619 100.0 $ 70,522 100.0
Weighted average LTV 92.8 % 92.8 %
Total RIF, net of external reinsurance $ 54,574 $ 56,658
(U.S. Dollars in millions) December 31,
2021 2020
Amount % Amount %
Total RIF by State:
Texas $ 5,594 7.9 $ 5,636 8.0
California 5,559 7.9 5,261 7.5
Florida 3,303 4.7 3,632 5.2
Illinois 2,933 4.2 2,762 3.9
North Carolina 2,921 4.1 2,622 3.7
Minnesota 2,916 4.1 2,520 3.6
Georgia 2,902 4.1 2,959 4.2
Massachusetts 2,537 3.6 2,464 3.5
Michigan 2,492 3.5 2,073 2.9
Virginia 2,446 3.5 2,526 3.6
Others 37,016 52.4 38,067 54.0
Total $ 70,619 100.0 $ 70,522 100.0
The following table provides supplemental disclosures for our
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Table of Contents
(U.S. Dollars in thousands, except loan and claim Year Ended December 31, count) 2021 2020 Rollforward of insured loans in default: Beginning delinquent number of loans 52,234 20,163 New notices 35,554 102,324 Cures (59,372) (68,691) Paid claims (771) (1,562) Ending delinquent number of loans (1) 27,645 52,234 Ending number of policies in force (1) 1,171,835 1,245,771 Delinquency rate (1) 2.36 % 4.19 % Losses: Number of claims paid 771 1,562 Total paid claims $ 30,979 $ 64,903 Average per claim $ 40.2 $ 41.6 Severity (2) 80.8 % 92.4 % Average reserve per default (in thousands) (1) $ 26.7 $ 12.6
(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 8 to 1 atDecember 31, 2021 , compared to 9.3 to 1 atDecember 31, 2020 .
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 under the heading "Loss Reserves" above. 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 29.3% of gross premiums written for 2021, compared to 26.3% for 2020. 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 the unilateral power to direct those activities that are significant to its economic performance. As ofDecember 31, 2021 , our estimated off-balance sheet maximum exposure to loss from such entities was$42.2 million . See note 12, "Variable Interest Entity and Noncontrolling Interests," to
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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, 2021 : December 31, 2021 Net Gross Amount Acquisition Expenses Amount Other specialty$ 421,504 $ (118,878)$ 302,626 Property excluding property catastrophe 288,622 (88,745) 199,877 Casualty 275,889 (76,342) 199,547 Marine and aviation 149,161 (34,338) 114,823 Property catastrophe 25,097 (2,723) 22,374 Other 48,733 (4,142) 44,591 Total$ 1,209,006 $ (325,168)$ 883,838 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 review of amounts outstanding, aging of the receivable, historical data and counterparty financial strength measures.
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.
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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.
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
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Table of Contents 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 2021 or 2020.
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, 2021 by valuation hierarchy.
Reclassifications
We have reclassified the presentation of certain prior year information to conform to the current presentation, including the correct presentation of 'income (loss) from operating affiliates' on its consolidated statements of income for all periods presented to reclass such item from 'other income (loss)'. We also changed the presentation of 'investment in operating affiliates' on our consolidated balance sheet for all periods presented to reclass such item from 'other assets'. 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-(s), "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") of our board of directors 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. OurChief Investment Officer administers the investment portfolio, oversees our investment managers and formulates investment strategy in conjunction with the FIR. AtDecember 31, 2021 , approximately$18.5 billion , or 67%, of total investable assets held by Arch were internally managed, compared to$19.2 billion , or 71%, atDecember 31, 2020 . ARCH CAPITAL 75 2021 FORM 10-K
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The following table summarizes the fair value of investable assets held by Arch:
Estimated % of
Investable assets (1): Fair Value Total
December 31, 2021
Fixed maturities (2) $ 18,414,807 67.1
Short-term investments (2) 1,832,522 6.7
Cash 858,668 3.1
Equity securities (2) 1,830,663 6.7
Other investments (2) 1,432,553 5.2
Investments accounted for using the equity method 3,077,611 11.2
Securities transactions entered into but not settled at the balance sheet date
(4,671) -
Total investable assets held by Arch $ 27,442,153 100.0
Average effective duration (in years) 2.70
Average S&P/Moody's credit ratings (4) AA-/Aa3
Embedded book yield (5) 1.63 %
December 31, 2020
Fixed maturities (2) $ 18,771,296 69.9
Short-term investments (2) 2,063,240 7.7
Cash 694,997 2.6
Equity securities (2) 1,436,104 5.3
Other investments (2) 1,480,347 5.5
Other investable assets (3) 500,000 1.9
Investments accounted for using the equity method 2,047,889 7.6
Securities transactions entered into but not settled at the balance sheet date
(137,578) (0.5)
Total investable assets held by Arch $ 26,856,295 100.0
Average effective duration (in years) 3.01
Average S&P/Moody's credit ratings (4) AA/Aa2
Embedded book yield (5) 1.56 %
(1)In securities lending transactions, we receive collateral in excess of the
fair value of the securities pledged. For purposes of this table, we have
excluded the collateral received under securities lending, at fair value and
included the securities pledged under securities lending, at fair value.
(2)Includes investments carried as available for sale, at fair value and at fair
value under the fair value option.
(3)Participation interests in a receivable of a reverse repurchase agreement.
(4)Average credit ratings on our investment portfolio on securities with ratings
by Standard & Poor's Rating Services ("S&P") and Moody's Investors Service
("Moody's").
(5)Before investment expenses.
The following table summarizes our fixed maturities and fixed maturities pledged under securities lending agreements ("Fixed Maturities") by type:
Estimated % of
Fair Value Total
December 31, 2021
Corporate bonds $ 6,941,879 37.7
Mortgage backed securities 408,477 2.2
Municipal bonds 404,666 2.2
Commercial mortgage backed securities 1,046,484 5.7
2,144,079 11.6
Asset backed securities 2,696,458 14.6
Total $ 18,414,807 100.0
December 31, 2020
Corporate bonds $ 8,039,745 42.8
Mortgage backed securities 616,619 3.3
Municipal bonds 492,734 2.6
Commercial mortgage backed securities 390,990 2.1
2,310,157 12.3
Asset backed securities 1,566,188 8.3
Total $ 18,771,296 100.0
The following table provides the credit quality distribution of our Fixed Maturities. For individual fixed maturities, S&P ratings are used. In the absence of an S&P rating, ratings from Moody's are used, followed by ratings from Fitch Ratings.
% of
Estimated Fair Value Total
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
December 31, 2020
U.S. government and gov't agencies (1) $ 5,963,758 31.8
AAA 3,117,046 16.6
AA 2,063,738 11.0
A 3,760,280 20.0
BBB 2,699,201 14.4
BB 574,189 3.1
B 268,095 1.4
Lower than B 54,795 0.3
Not rated 270,194 1.4
Total $ 18,771,296 100.0
(1)Includes
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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, 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
December 31, 2020
0-10% $ 3,583,981 $ (55,542) 79.4
10-20% 95,495 (12,183) 17.4
20-30% 1,061 (406) 0.6
Greater than 30% 1,249 (1,785) 2.6
Total $ 3,681,786 $ (69,916) 100.0
The following table summarizes our top ten exposures to fixed income corporate
issuers by fair value at December 31, 2021 , excluding guaranteed amounts and
covered bonds:
Credit
Estimated Fair Value Rating (1)
Bank of America Corporation $ 406,807 A-/A2
JPMorgan Chase & Co. 338,647 A-/A2
The Goldman Sachs Group, Inc. 237,628 BBB+/A2
Citigroup Inc. 220,915 BBB+/A3
Morgan Stanley 198,106 BBB+/A1
Wells Fargo & Company 183,261 BBB+/A1
Blackstone Inc. 128,138 NA/Baa3
Dai-ichi Life Holdings, Inc. 109,924 AA-/A1
Apple Inc. 109,008 AA+/Aaa
Westpac Banking Corporation 107,678 AA-/Aa3
Total $ 2,040,112
(1)Average credit ratings as assigned by S&P and Moody's, respectively.
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, 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
Dec. 31, 2020
RMBS $ 584,499 $ 4,102 $ 28,018 $ 616,619
CMBS 24,396 342,491 24,103 390,990
ABS - 1,403,137 163,051 1,566,188
Total $ 608,895 $ 1,749,730 $ 215,172 $ 2,573,797
The following table summarizes our equity securities, which include investments
in exchange traded funds:
December 31,
2021 2020
Equities (1) $ 883,722 $ 676,437
Exchange traded funds
Fixed income (2) 455,467 341,139
Equity and other (3) 491,474 418,528
Total $ 1,830,663 $ 1,436,104
(1)Primarily in consumer non-cyclical, technology, communications, consumer
cyclical and financial at December 31, 2021 .
(2)Primarily in corporate and MBS at December 31, 2021 .
(3)Primarily in large cap stocks, foreign equities, technology and utilities at
December 31, 2021 .
The following table summarizes our other investments and other investable
assets:
December 31,
2021 2020
Lending 536,345 572,636
Term loan investments 484,950 380,193
Investment grade fixed income 147,810 138,646
Private equity 91,126 48,750
Energy 81,692 65,813
Credit related funds 70,278 90,780
Infrastructure 20,352 165,516
Real estate - 18,013
Total fair value option 1,432,553 1,480,347
Other investable assets - 500,000
Total other investments $ 1,432,553 $ 1,980,347
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The following table summarizes our investments accounted for using the equity
method, by strategy:
December 31,
2021 2020
Credit related funds $ 1,022,334 $ 740,060
Private equity 436,042 235,289
Real estate 396,395 258,518
Equities 395,090 343,058
Lending 376,649 179,629
Infrastructure 230,070 175,882
Energy 119,141 115,453
Fixed income 101,890 -
Total $ 3,077,611 $ 2,047,889
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, 2021 and 2020
segregated by level in the fair value hierarchy.
Reinsurance Recoverables
The following table details our reinsurance recoverables atDecember 31, 2021 : A.M. Best % of Total Rating (1) Somers Re 6.7 A- Fortitude Reinsurance Company Ltd. 2.4 A Hannover Rück SE 1.8 A+ Swiss Reinsurance America Corporation 1.7 A+ Partner Reinsurance Company of the U.S. 1.4 A+ Everest Reinsurance Company 1.4 A+ Munich Reinsurance America, Inc. 1.3 A+ XL Re 1.2 A+ Lloyd's syndicates (2) 1.1 A Berkley Insurance Company 1.0 A+ All other -- "A-" or better 49.7 All other -- rated carriers 0.1 All other -- not rated (3) 30.2 Total 100.0 (1) The financial strength ratings are as ofFebruary 4, 2022 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) TheA.M. Best group rating of "A" (Excellent) has been applied to all Lloyd's syndicates. (3) Over 91% 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$13.5 billion atDecember 31, 2021 , compared to$13.1 billion atDecember 31, 2020 . The increase in 2021 primarily reflected the impact of underwriting returns and income from operating affiliates, partially offset by the impact of a higher level of catastrophic activity on underwriting returns.
The following table presents the calculation of book value per share:
December 31,
(U.S. dollars in thousands, except share data) 2021 2020
Total shareholders' equity available to Arch $ 13,545,896 $ 13,105,886
Less preferred shareholders' equity 830,000 780,000
Common shareholders' equity available to Arch
$ 12,325,886 Common shares and common share equivalents outstanding, net of treasury shares (1) 378,923,894 406,720,642 Book value per share $ 33.56 $ 30.31 (1) Excludes the effects of 17,083,160 and 17,839,333 stock options and 729,636 and 1,153,784 restricted stock and performance units outstanding atDecember 31, 2021 and 2020, 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. In 2021,Arch Capital completed a$500.0 million underwritten public offering of 20.0 million depositary shares, each of which represents a 1/1,000th interest in a share of its 4.55% Non-Cumulative Series G Preferred Shares. See note
2 1 , "Share holder ' s Equity ."
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 2021,Arch Capital received dividends of$1.8 billion fromArch Reinsurance Ltd. ("Arch Re Bermuda"), ourBermuda -based reinsurer and insurer which can pay approximately$3.8 billion toArch Capital in 2022 without providing an affidavit to theBermuda Monetary Authority ("BMA"). In 2021, Arch-U.S. received$200.0 million of dividends fromArch U.S. MI Holdings Inc. , a subsidiary of Arch-U.S. , which received a total of$300.0 million of ordinary and extraordinary dividends,$140 million from United Guaranty
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, for the next twelve months, at a minimum, will be met by funds generated from underwriting activities and investment income, as well as by our balance of cash, short-term investments, proceeds on the sale or maturity of our investments, and our credit facilities. ARCH CAPITAL 79 2021 FORM 10-K
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Table of Contents Dividend RestrictionsArch 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. 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, 2021 and 2020, such amounts approximated$8.2 billion and$7.7 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$3.0 billion atDecember 31, 2021 and are callable by our investment managers. The timing of the funding of investment commitments is uncertain and may require us to access cash on short notice.
Cash Flows
The following table summarizes our cash flows from operating, investing and financing activities, excluding amounts related to the 'other' segment:
Year Ended
2021 2020
Total cash provided by (used for): Operating activities$ 3,380,700 $ 2,705,054 Investing activities (1,870,885) (3,301,816) Financing activities (1,243,613) 856,771 Effects of exchange rate changes on foreign currency cash (30,524) 17,822 Increase (decrease) in cash$ 235,678 $ 277,831
Cash provided by operating activities for 2021 was higher than in 2020, primarily reflected a higher level of premiums collected than in the 2020 period.
Cash used for investing activities for 2021 was lower than in 2020. Activity for 2021 period reflected cash used to invest in Coface and Somers, while the 2020 period reflected a higher level of securities purchased, and the investing of proceeds from our issuance of the senior notes. Cash used for financing activities for 2021 was higher than in 2020. Activity for 2021 period, primarily reflected$485.8 million inflow from issuance of preferred shares,$450.0 million related to redemption of our Series E preferred shares and$1.2 billion of repurchases under our share repurchase program. Activity for the 2020 period primarily reflected the
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Table of Contents issuance of$1.0 billion of our senior notes and$83.5 million of repurchases under our share repurchase program.
Investments
AtDecember 31, 2021 , our investable assets were$27.4 billion . The primary goals of our asset liability management process are to meet our insurance liabilities, manage the interest rate risk embedded in those insurance liabilities and maintain sufficient liquidity to cover fluctuations in projected liability cash flows, including debt service obligations. Generally, the expected principal and interest payments produced by our fixed income portfolio adequately fund the estimated runoff of our insurance reserves. Although this is not an exact cash flow match in each period, the substantial degree by which the fair value of the fixed income portfolio exceeds the expected present value of the net insurance liabilities, as well as the positive cash flow from newly sold policies and the large amount of high quality liquid bonds, provide assurance of our ability to fund the payment of claims and to service our outstanding debt without having to sell securities at distressed prices or access credit facilities. Please refer to Item 1A " Risk Factors " for a discussion of other risks relating to our business and investment portfolio.
CAPITAL RESOURCES
The following table provides an analysis of our capital structure:
(U.S. dollars in thousands, except December 31, share data) 2021 2020 Senior notes$ 2,724,394 $ 2,723,423 Shareholders' equity available to Arch: Series E non-cumulative preferred shares - 450,000 Series F non-cumulative preferred shares 330,000 330,000 Series G non-cumulative preferred shares 500,000 - Common shareholders' equity 12,715,896 12,325,886 Total$ 13,545,896 $ 13,105,886 Total capital available to Arch$ 16,270,290 $ 15,829,309 Debt to total capital (%) 16.7 17.2 Preferred to total capital (%) 5.1 4.9 Debt and preferred to total capital (%) 21.8 22.1
See note 19, "Debt and Financing Arrangement" and note 21,
" Shareholder ' s 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 GSEs 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, 2021 with a PMIER sufficiency ratio of 197%, compared to 173% atDecember 31, 2020 . 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 our board of directors 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 of directors 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 81 2021 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, ourU.S. -based 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
The board of directors ofArch Capital has authorized the investment inArch Capital's common shares through a share repurchase program. Since the inception of the share repurchase program throughDecember 31, 2021 ,Arch Capital has repurchased approximately 420.7 million common shares for an aggregate purchase price of$5.3 billion . AtDecember 31, 2021 ,$1.2 billion of share repurchases were available under the program. Repurchases under the program may be effected from time to time in open market or privately negotiated transactions throughDecember 31, 2022 . The timing and amount of the repurchase transactions under this program will depend on a variety of factors, including market conditions, the development of the economy, corporate and regulatory considerations. We will continue to monitor our share price and, depending upon results of operations, market conditions and the development of the economy, as well as other factors, we will consider share repurchases on an opportunistic basis.
GUARANTOR INFORMATION
The below table provides a description of our senior notes payable atDecember 31, 2021 : Interest Principal Carrying Issuer/Due (Fixed) Amount AmountArch Capital : May 1, 2034 7.350 %$ 300,000 $ 297,488 June 30, 2050 3.635 % 1,000,000 988,720 Arch-U.S.: Nov. 1, 2043 (1) 5.144 % 500,000 495,063 Arch Finance: Dec. 15, 2026 (1) 4.011 % 500,000 497,633 Dec. 15, 2046 (1) 5.031 % 450,000 445,490 Total$ 2,750,000 $ 2,724,394
(1) Fully and unconditionally guaranteed by
Our senior notes were issued by
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. 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 During 2021 and 2020, we made interest payments of$131.0 million and$110.5 million respectively, related to our senior notes and other financing arrangements.
The following tables present condensed financial information for
December 31, 2021 December 31, 2020
Arch Capital Arch-U.S. Arch Capital Arch-U.S.
Assets
Total investments $ 2,038 $ 137,124 $ 172 $ 396,547
Cash 16,317 18,392 18,932 11,368
Investment in operating affiliates 6,877 7,731 -
Due from subsidiaries and affiliates - 26,000 - 201,515
Other assets 9,615 37,040 10,659 34,405
Total assets $ 34,847 $ 218,556 $ 37,494 $ 643,835
Liabilities
Senior notes 1,286,208 495,063 1,285,867 494,944
Due to subsidiaries and affiliates - 521,839 - 586,805
Other liabilities 24,767 47,410 23,270 41,876
Total liabilities 1,310,975 1,064,312 1,309,137 1,123,625
Non-cumulative preferred shares $ 830,000 $ - $ 780,000 $ -
Year Ended Year Ended
December 31, 2021 December 31, 2020
Arch Capital Arch-U.S. Arch Capital Arch-U.S.
Revenues
Net investment income $ 1,524 $ 11,596 $ 53 $ 18,084
Net realized gains (losses) - 72,437 (2,110) 26,096
Equity in net income (loss) of investments accounted for
using the equity method - 18,149 - 2,507
Total revenues 1,524 102,182 (2,057) 46,687
Expenses
Corporate expenses 71,818 5,875 65,566 7,227
Interest expense 58,741 47,292 40,445 47,566
Net foreign exchange (gains) losses 7 - 3 -
Total expenses 130,566 53,167 106,014 54,793
Income (loss) before income taxes (129,042) 49,015 (108,071) (8,106)
Income tax (expense) benefit - (12,513) - 2,689
Income (loss) from operating affiliates (590) - (437) -
Net income available to Arch (129,632) 36,502 (108,508) (5,417)
Preferred dividends (48,343) - (41,612) -
Loss on redemption of preferred shares (15,101) - - -
Net income available to Arch common shareholders $ (193,076) $ 36,502 $ (150,120) $ (5,417)
ARCH CAPITAL 83 2021 FORM 10-K
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CONTRACTUAL OBLIGATIONS AND COMMITMENTS
Contractual Obligations
The following table provides an analysis of our contractual commitments at
Payment due by period
Total 2022 2023 and 2024 2025 and 2026 Thereafter
Operating activities Estimated gross payments for losses and loss adjustment expenses (1)$ 17,757,156 $
4,893,981
11,838 6,167 2,043 382 3,246
Contractholder payables (3) 1,832,127 584,992 632,551 252,498 362,086
Operating lease obligations 148,598 32,064 48,837 31,275 36,422 Purchase obligations 114,143 58,191 50,991 4,961 - Investing activities Unfunded investment commitments (4) 2,973,492 2,973,492 - -
-
Financing activities
Senior notes (including interest payments) 5,290,334 126,815 253,629 251,958
4,657,932
Total contractual obligations and commitments$ 28,127,688 $ 8,675,702 $ 6,818,116 $ 3,252,802 $ 9,381,068 (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.
OnDecember 17, 2019 Arch Capital and certain of its subsidiaries entered into an$750.0 million five-year credit facility (the "Credit Facility") with a syndication of lenders. The Credit Facility consists of a$250.0 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$1.3 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 LIBOR or an alternative base rate at the option ofArch Capital .Arch Capital and its lenders may agree on a LIBOR successor rate at the appropriate time to address the replacement of LIBOR. Secured letters of credit are available for issuance on behalf ofArch Capital insurance and reinsurance subsidiaries. The Credit Facility is structured such that each party that requests a letter of credit or borrowing does so only for itself and for only its own obligations. 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, 2021 .
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 85 2021 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, 2022 , our modeled peak zone catastrophe exposure is a windstorm affecting theNortheast U.S. , with a net probable maximum pre-tax loss of$748 million , followed by windstorms affecting Florida Tri-County and theGulf of Mexico with net probable maximum pre-tax losses of$727 million and$649 million , respectively. Our exposures to other perils, such asU.S. earthquake and international events, were less than the exposures arising fromU.S. windstorms and hurricanes in both periods. As ofJanuary 1, 2022 , our modeled peak zone earthquake exposure (San Francisco area earthquake) represented approximately 78% 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 ourU.S. mortgage insurance business, we have developed a proprietary risk model ("Realistic Disaster Scenario" or "RDS") that simulates the maximum loss resulting from a severe economic downturn impacting the housing market. The RDS models the collective impact of adverse conditions for key economic indicators, the most significant of which is a decline in home prices. The RDS model projects paths of future home prices, unemployment rates, income levels and interest rates and assumes correlation across states and geographic regions. The resulting future performance of our in-force portfolio is then estimated under the economic stress scenario, reflecting loan and borrower information. Currently, we seek to limit our modeled RDS loss from a severe economic event to approximately 25% of total tangible shareholders' equity available to Arch. We reserve the right to change this threshold at any time. Based on in-force exposure estimated as ofJanuary 1, 2022 , our modeled RDS loss was 6.3% 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
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-Ceded Reinsurance" for a discussion of our catastrophe reinsurance programs.
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, 2021 . 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, 2021 presents hypothetical losses in cash flows, earnings and fair values of market sensitive instruments which were held by us onDecember 31, 2021 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, fixed maturities pledged under securities lending agreements, 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, 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) $ (0.78) Dec. 31, 2020 Total fair value$ 25.82 $ 25.44 $ 25.07 $ 24.69 $ 24.31 Change from base 3.0 % 1.5 % (1.5) % (3.0) % Change in unrealized value$ 0.75 $ 0.38 $
(0.38)
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, 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)
Dec. 31, 2020
Total fair value $ 25.54 $ 25.32 $ 25.07 $ 24.82 $ 24.59
Change from base 1.9 % 1.0 % (1.0) % (1.9) %
Change in unrealized value $ 0.48 $ 0.25 $ (0.25) $ (0.48)
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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 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 of December 31, 2021 , our portfolio's VaR was
estimated to be 4.83%, compared to an estimated 4.30% at December 31, 2020 .
Equity Securities . At December 31, 2021 and 2020, the fair value of our
investments in equity securities (excluding securities included in Fixed Income
Securities above) totaled $1.4 billion and $1.1 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
$137.5 million and $109.5 million at December 31, 2021 and 2020, respectively,
and would have decreased book value per share by approximately $0.36 and $0.27 ,
respectively. An immediate hypothetical 10% increase in the value of each
position would increase the fair value of such investments by approximately
$137.5 million and $109.5 million at December 31, 2021 and 2020, respectively,
and would have increased book value per share by approximately $0.36 and $0.27 ,
respectively.
Investment-Related Derivatives. At December 31, 2021 , the notional value of all
derivative instruments (excluding foreign currency forward contracts which are
included in the foreign currency exchange risk analysis below) was $6.4 billion ,
compared to $8.6 billion at December 31, 2020 . If the underlying exposure of
each investment-related derivative held at December 31, 2021 depreciated by 100
basis points, it would have resulted in a reduction in net income of
approximately $63.8 million , and a decrease in book value per share of $0.17 ,
compared to $85.7 million and $0.21 , respectively, on investment-related
derivatives held at December 31, 2020 . If the underlying exposure of each
investment-related derivative held at December 31, 2021 appreciated by 100 basis
points, it would have resulted in an increase in net income of approximately
$63.8 million , and an increase in book value per share of $0.17 , compared to
$85.7 million and $0.21 , respectively, on investment-related derivatives held at
December 31, 2020. 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."
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) 2021 2020
Net assets (liabilities), denominated in foreign currencies, excluding shareholders' equity and derivatives
$ (825,371) $ (309,968) Shareholders' equity denominated in foreign currencies (1) 1,095,706 695,355 Net foreign currency forward contracts outstanding (2) 15,151 1,108,161 Net exposures denominated in foreign currencies $
285,486
Pre-tax impact of a hypothetical 10% appreciation of theU.S. Dollar against foreign currencies: Shareholders' equity$ (28,549) $ (149,355) Book value per share $ (0.08) $ (0.37) Pre-tax impact of a hypothetical 10% decline of theU.S. Dollar against foreign currencies: Shareholders' equity $ 28,549$ 149,355 Book value per share $ 0.08 $ 0.37 (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. ARCH CAPITAL 88 2021 FORM 10-K
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Table of Contents 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
We do not believe that inflation has had a material effect on our consolidated results of operations, except insofar as inflation may affect our reserves for losses and loss adjustment expenses and interest rates. The potential exists, after a catastrophe loss, for the development of inflationary pressures in a local economy. The anticipated effects of inflation on us are considered in our catastrophe loss models. The actual effects of inflation on our results cannot be accurately known until claims are ultimately settled.
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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