Fitch Affirms Arch Capital Ratings, Outlook Stable

March 10, 2016

Fitch Ratings has affirmed Arch Capital Group Ltd.’s [ACGL] Issuer Default Rating [IDR] at ‘A’ and the ratings on ACGL’s senior unsecured notes and preferred shares at ‘A-’ and ‘BBB+’, respectively. Additionally, Fitch has affirmed the Insurer Financial Strength [IFS] ratings of ACGL’s various subsidiaries at ‘A+’. The Rating Outlook is Stable.

A statement from the ratings agency said, “Fitch’s affirmation of ACGL’s ratings reflects the company’s reasonable financial leverage, very strong fixed charge coverage, diversified market position in both insurance and reinsurance lines, solid capitalization and well-managed reserve risk.

“These favorable factors are partially offset by exposure to possible adverse reserve development due to the relatively large portion of casualty reserves and potential risks associated with its expanding mortgage operations. The ratings also reflect Fitch’s negative sector outlook on global reinsurance.

“ACGL has a broad product portfolio of property/casualty primary insurance, reinsurance and mortgage [re]insurance business. Total company 2015 net premiums written [$3.8 billion] segment split was 54% insurance, 27% reinsurance, 7% mortgage and 12% other [Watford Re].

“Fitch expects ACGL to continue to maintain a diversified specialty underwriting portfolio, although the composition may change over time. Fitch notes that ACGL has been increasing its premiums in mortgage and accident and health business, where profitability is currently more favorable, and decreasing its property catastrophe, energy and marine [re]insurance exposure, due to the continuing competitive market environment, particularly for property catastrophe excess of loss business.

“ACGL’s profitability is strong, characterized by low and stable combined ratios and high returns on average common equity, with the most recent five-year averages [2011-2015] at 91.3% and 11.8%, respectfully. These results are in line with or better than peer averages and align with Fitch’s median ‘AA’ IFS [re]insurance sector credit factors. Favorably, ACGL posted an underwriting and overall net income profit in every year of its 14-year operating history, compared with many peers that experienced underwriting and net losses during years in which significant catastrophe events occurred.

“Fitch believes that ACGL’s financial leverage ratio is conservative for the rating category at 12.5% as of Dec. 31, 2015 [excluding $430 million of revolving credit agreement borrowings by Watford Re]. ACGL’s capital position improved in 2015, with shareholders’ equity available to ACGL of $6.2 billion at Dec. 31, 2015, up 1% from $6.1 billion at Dec. 31, 2014, as net income was partially offset by unrealized investment losses, share repurchases and preferred share dividends. Fixed charge coverage [excluding Watford Re] was a very strong 10.5x in 2015 and 11.3x in 2014.

ACGL continues to expand and diversify into the U.S. mortgage insurance business as overall mortgage market conditions remain favorable. Thus far, ACGL’s approach to developing this business has been controlled and prudently managed to the company’s conservative underwriting and risk management standards, utilizing an experienced team to operate and manage the business. ACGL’s mortgage segment produced net premiums written of $267 million in 2015 and $205 million in 2014, with a combined ratio of 78.4% in 2015, improved from 88.9% in 2014.

“ACGL’s risk exposure to Watford Re is limited to its direct investment in Watford Re’s common and preferred shares and counterparty credit risk [mitigated by collateral] from business ceded to Watford Re. ACGL owns approximately 11% of the common equity of Watford Re. However, Watford Re is consolidated into ACGL’s financial results, as ACGL is considered to be the primary beneficiary of Watford Re. Watford Re generated $466 million of net premiums written in 2015, up from $274 million in 2014, with combined ratios of 102% and 103% in 2015 and 2014, respectively.”

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