AM Best Affirms Credit Ratings Of Arch Capital

September 1, 2017

A.M. Best has removed from under review with developing implications and affirmed the Financial Strength Rating [FSR] of A+ [Superior] and the Long-Term Issuer Credit Ratings [Long-Term ICRs] of “aa-” of Arch Reinsurance Ltd. [Arch] [Bermuda] and its strategic affiliates.

A.M. Best also has removed from under review with developing implications and affirmed the Long-Term ICR of “a-” and all Long-Term Issue Credit Ratings [Long-Term IRs] of the ultimate holding company, Arch Capital Group Ltd. [Arch Capital] [Bermuda] [ACGL], and Arch Capital Group [US] Inc [Delaware]. Additionally, A.M. Best has assigned a Long-Term ICR of “a-” to Arch Capital Finance LLC [Delaware]. The outlook assigned to these Credit Ratings [ratings] is negative

The ratings agency said, “The assigned negative outlooks primarily reflect a significant increase in financial leverage, as Arch issued $950 million of senior unsecured notes and $450 million of preferred shares at the end of 2016, the proceeds of which helped fund the purchase of United Guaranty Corporation.

“Interest and preferred dividend coverage remains strong. While financial leverage and coverage remain supportive of the ratings, the outlooks reflect the additional risk assumed by the organization, which may manifest itself in lost opportunity costs as Arch has made a significant commitment to the mortgage insurance industry.

“Additionally, the assigned negative outlooks reflect the significant mortgage insurance risk assumed by Arch upon the purchase of United Guaranty and the integration risk of this large acquisition. Arch’s ratings may be downgraded if mortgage insurance model results vary materially compared with underlying actual results, or if there is a degradation in underwriting standards in the mortgage insurance market or any other early warning sign of increasing unexpected risk.

“Additionally, loss or expense issues caused by an unsuccessful integration of United Guaranty and the mortgage risk written may result in additional rating pressure. The outlooks may be revised to stable if financial leverage measures decrease, and mortgage insurance risk continues to be relatively benign. Additionally, successful integration of United Guaranty and assumption of mortgage risk written may stabilize the ratings. The mortgage insurance business relies heavily on financial models that can have significant model result volatility based on model inputs and assumptions.

“A.M. Best contemplated what it believes to be a conservative stress scenario for Arch’s mortgage insurance book of business when calculating stress tested risk-adjusted capitalization. Mortgage insurance and reinsurance products have a relatively long tail as does most of Arch’s current property/casualty insurance and reinsurance products.

“These facts result in the ability to pay claims over time at the potential cost of losses manifesting themselves throughout the remaining tail of each respective product. A.M. Best considered long-term sources of liquidity in the evaluation of these potential tail risk events.

“The ratings are based on Arch’s historically strong operating performance compared with its peers, strong balance sheet strength, as measured by Best’s Capital Adequacy Ratio [BCAR], and strong management team. Arch continues to outperform many of its peers on most operating metrics, while maintaining a strong risk-adjusted capital position despite the soft pricing environment and anemic investment returns presented by the market. In years where there have been large market losses such as KRW in 2005, the financial crisis in 2008, and the string of global catastrophes in 2011, Arch has performed well compared with most of its peers. This robust performance is in part attributable to the result of Arch’s strong risk management framework. In addition, Arch has demonstrated that it will actively manage the re/insurance cycle, and over the past several years, Arch has strived to seek opportunities for return wherever they present themselves. Arch’s foray into the mortgage insurance business is a recent example of this flexibility. Arch has demonstrated that it prudently executes its business plan but remains nimble enough to take advantage of opportunities.

“Partially offsetting these positive rating attributes, in addition to the aforementioned increase in financial leverage and mortgage insurance risk, is the soft market conditions in insurance and reinsurance that Arch must contend with on a daily basis, and the integration risk of assuming a large acquisition.

“These market conditions will continue to challenge Arch to retain and find profitable business, as well as retain talented professionals. Despite the adversarial market conditions, Arch’s operating performance has held steady, and return-on-revenue and return-on-equity [compared with peer companies] measures indicate successful soft market navigation thus far.

“Factors that could lead to the rating outlooks being revised to stable or rating upgrades include decreased financial leverage, mortgage insurance actual results that confirm modeled results, continued long-term favorable operating profitability relative to its peers and maintenance of strong risk-adjusted capital levels, and the successful integration of United Guaranty.

“Factors that could cause rating downgrades include mortgage model results that differ materially from actual experience, unfavorable operating profitability trends compared with peers, outsized mortgage, catastrophe or investment losses relative to peers, significant adverse loss reserve development or a material decline in risk-adjusted capitalization, and loss and expense issues resulting from unsuccessful integration of United Guaranty.”

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