Fitch Ratings has affirmed the Insurer Financial Strength (IFS) ratings of Arch Capital Group Ltd.'s (ACGL) various primary insurance and reinsurance operating subsidiaries at 'A+' (Strong).
The IFS Rating Outlook has been revised to Positive from Stable.
Fitch has also affirmed ACGL's Issuer Default Rating (IDR) at 'A-' and the ratings on ACGL's senior unsecured notes and preferred shares at 'BBB+' and 'BBB', respectively. The IDR Outlook is Stable.
Key Rating Drivers
The IFS Outlook revision to Positive reflects business profile improvement to favorable from moderate and improving underwriting performance, combined with expectations of improved future underwriting performance. Fitch's rating affirmation also reflects ACGL's diversified product portfolio of property/casualty (P/C) insurance and reinsurance business, consistent profitability, reasonable financial leverage, strong fixed-charge coverage and strong reserve adequacy. These favorable factors are partially offset by potential risks associated with the U.S. mortgage insurance (USMI) operations ('A-' standalone IFS credit profile).
Fitch views ACGL's overall business profile to be favorable (low end of 'aa' category IFS credit factor score) compared with all other U.S./Bermuda non-life (re)insurance organizations and is considered to have a higher influence on ACGL's ratings. This business profile score is improved from moderate (high end of 'a' category IFS credit factor score) due to improvement in competitive positioning to favorable from moderate.
In particular, ACGL's operating scale improved to favorable, with net premiums written (NPW) of $5.6 billion in the company's insurance ($3.2 billion) and reinsurance ($2.5 billion) segments, up a considerable 32% from $4.2 billion in 2019. This growth reflects attractive opportunities in the hardening P/C (re)insurance market, consistent with the company's approach as an adept and active underwriting cycle manager.
ACGL's profitability is characterized by favorable combined ratios and high ROAE, with the most recent five-year averages (2016-2020) at 88.2% and 10.8%, respectively, which are better than peer averages. ACGL posted an underwriting and overall net income profit in every year of its 19-year history. Excluding the mortgage and other (Watford) segments, the five-year average combined ratio was higher at 99.4%, as the recently profitable mortgage insurance segment drives down the overall combined ratio.
ACGL's 6M21 combined ratio of 86.2% included 6.3 points for catastrophes, primarily from winter storms Uri and Viola, improved from 96.5% in 6M21. The insurance/reinsurance segments' 6M21 combined ratio was 95.3%, compared to 105.3% in 6M20, which included 10.7 points of pandemic losses. Excluding reserve development, catastrophes and coronavirus losses, the insurance/reinsurance segments 6M21 underlying accident year combined ratio was 89.5%, down considerably from 94.2% in 6M20, driven by a favorable market pricing environment and mix of business changes.
The mortgage segment's combined ratio declined to 34.5% in 6M21 from 62.9% in 6M20, reflecting a decrease in pandemic-related loss assumptions, with the USMI loans in default dropping to 3.11% at June 30, 2021. This level is approaching the pre-pandemic 1.42% rate at March 31, 2020.
ACGL's financial leverage ratio (FLR) is reasonable for the rating category at 16.5% as of June 30, 2021 (excluding $294 million of Watford borrowings). ACGL's shareholders' equity is a sizable $14.9 billion at June 30, 2021, up 7% from $13.9 billion at YE 2020 due to net income posted in 6M21 and $500 million of preferred shares issued in June 2021, partially offset by increased common share repurchases.
The company's GAAP fixed-charge coverage averaged a strong 7.8x from 2016 to 2020. This includes 5.1x in 2020, which is down from 11.3x in 2019 as operating earnings were reduced by coronavirus pandemic and catastrophe losses. Fixed-charge coverage improved to 10.2x for 6M21 as a result of higher earnings with de minimis pandemic losses.
ACGL is a leading provider of USMI business, with $1.3 billion of mortgage segment NPW in 2020. While Fitch does not formally rate ACGL's USMI operations, Fitch views the stand-alone IFS credit profile at 'A-' with a Positive Outlook. The Positive Outlook reflects improved capital strength, as measured by increased Private Mortgage Insurer Eligibility Requirements (PMIERs) coverage ratios and reduced risk-to-capital ratios, and improved earnings to pre-pandemic levels thus far in 2021, following reduced earnings in 2020.
Per its criteria for holding company notching, Fitch establishes an IFS anchor rating for ACGL, which is a combined assessment of ACGL's primary insurance, reinsurance and mortgage operations. This group credit profile of an 'A+' IFS/Stable Outlook serves as the anchor rating for notching to the holding company IDR.
The IDR Rating Outlook remains Stable, in line with the Stable Outlook on the anchor IFS rating. As such, Fitch does not expect the holdings company ratings to be upgraded if the insurance/reinsurance IFS ratings are upgraded, as the lower IFS credit profile of the USMI operations serves as an offset to the higher IFS ratings of the insurance/reinsurance operations.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Producing a very strong combined ratio within the insurance/reinsurance segments, successfully managing the USMI operations, maintaining an FLR at or below 20%, fixed-charge coverage of at least 10x, and a NPW-to-equity ratio of 0.8x or lower. A combined ratio of 97% or below would support an upgrade if all of the other factors above are met, and a combined ratio in the low-90s would be supportive if most, but not all of the other factors are met;
ACGL's holding company ratings could be upgraded if Fitch raised the company's combined primary insurance, reinsurance and mortgage operations 'A+' IFS group credit profile.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
An IFS Outlook revision to Stable could occur if the insurance/reinsurance segments combined ratio is above 97%, or if ACGL is not meeting the other upgrade rating sensitivities;
A NPW-to-equity ratio above 1.0x, an FLR above 25%, sizable adverse prior-year reserve development, difficulties experienced in the USMI operations, such as reporting sustained GAAP underwriting losses;
Fitch could downgrade the primary insurance and reinsurance 'A+' IFS ratings if the group credit profile IFS is lowered by more than one notch;
ACGL's holding company ratings could be downgraded if Fitch lowered the company's combined primary insurance, reinsurance and mortgage operations 'A+' IFS group credit profile;
ACGL's hybrid securities ratings could be lowered by one notch to reflect higher nonperformance risk should Fitch views Bermuda's regulatory environment as becoming more restrictive in its supervision of (re)insurers with respect to hybrid features.
Best/Worst Case Rating Scenario
International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579
Summary of Financial Adjustments
Fitch has adjusted ACGL's financial leverage and fixed-charge coverage ratios to exclude Watford Holdings Ltd.'s senior notes, revolving credit agreement borrowings, interest expense and non-controlling interest. As of June 30, 2021, ACGL owned approximately 10.2% of the common equity of Watford. However, Watford's financial results were required to be consolidated into ACGL through June 30, 2021, as ACGL was considered the primary beneficiary of Watford. The adjustment did not result in a different rating than had the adjustment not been made, but it is material in how Fitch views financial leverage and fixed-charge coverage.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.
RATING ACTIONSENTITY/DEBT RATING PRIOR
Arch Reinsurance Company Ins Fin Str A+ Affirmed A+
Arch Insurance (UK) Limited Ins Fin Str A+ Affirmed A+
Arch Capital Finance LLC
LT BBB+ Affirmed BBB+
Arch Insurance Company Ins Fin Str A+ Affirmed A+
Arch Reinsurance Ltd. Ins Fin Str A+ Affirmed A+
Arch Capital Group (U.S.) Inc.
LT BBB+ Affirmed BBB+
Arch Specialty Insurance Company Ins Fin Str A+ Affirmed A+
Arch Capital Group Ltd. LT IDR A- Affirmed A-
LT BBB Affirmed BBB
LT BBB+ Affirmed BBB+
Arch Reinsurance Europe Underwriting Designated Activity Company Ins Fin Str A+ Affirmed A+
Arch Property Casualty Insurance Company Ins Fin Str A+ Affirmed A+
VIEW ADDITIONAL RATING DETAILS
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