Arch: Australia Disasters Hurt Results
Bermuda based Arch Capital Group Ltd. yesterday [Feb. 4] reported net income available to common shareholders for the 2010 fourth quarter was $227.7 million, or $4.54 per share, compared to $284.7 million, or $4.75 per share, for the 2009 fourth quarter. The Company also reported after-tax operating income available to common shareholders of $129.5 million, or $2.58 per share, for the 2010 fourth quarter, compared to $159.4 million, or $2.66 per share, for the 2009 fourth quarter. All earnings per share amounts discussed in this release are on a diluted basis.
Arch, with approximately $4.91 billion in capital at December 31, 2010, provides insurance and reinsurance on a worldwide basis through its wholly owned subsidiaries.
The Company’s book value per common share was $89.98 at December 31, 2010, a 0.8% increase from $89.24 per share at September 30, 2010 and a 23.2% increase from $73.01 per share at December 31, 2009. The Company’s after-tax operating income available to common shareholders represented a 12.1% annualized return on average common equity for the 2010 fourth quarter, compared to 15.7% for the 2009 fourth quarter.
In the 2010 fourth quarter, the Company recorded net losses for the Australian floods that occurred in December 2010 of approximately $22.5 million, or $0.45 per share, net of reinsurance and reinstatement premiums. The Company’s 2011 first quarter results will be impacted by subsequent Australian flooding and Cyclone Yasi that occurred in Australia in 2011. Although it is early in the estimation process, the Company’s preliminary estimate of losses for the 2011 first quarter events is in the range of $30 million to $60 million, net of reinsurance and reinstatement premiums. The Company’s estimates for the 2010 and 2011 Australian floods are based, in part, on preliminary estimates of industry insured losses ranging from $3.0 billion to $6.0 billion, and the Company’s estimates for Cyclone Yasi are based, in part, on preliminary estimates of industry insured losses ranging from $0.5 billion to $1.5 billion.
The Company’s preliminary estimates for the 2010 and 2011 Australian floods and Cyclone Yasi are based on currently available information derived from modeling techniques, industry assessments of exposure, preliminary claims information obtained from the Company’s clients and brokers to date and a review of in-force contracts. The Company’s actual losses from these events may vary materially from the estimates due to the inherent uncertainties in making such determinations resulting from several factors, including the preliminary nature of available information, the potential inaccuracies and inadequacies in the data provided by clients and brokers, the modeling techniques and the application of such techniques, the contingent nature of business interruption exposures, the effects of any resultant demand surge on claims activity and attendant coverage issues. In addition, actual losses may increase if the Company’s reinsurers fail to meet their obligations to the Company or the reinsurance protections purchased by the Company are exhausted or are otherwise unavailable.
The following table summarizes the Company’s underwriting results:
| Three Months Ended | Year Ended | |||||||||||
| December 31, | December 31, | |||||||||||
| (U.S. dollars in thousands) | 2010 | 2009 | 2010 | 2009 | ||||||||
| Gross premiums written | $ | 664,212 | $ | 718,712 | $ | 3,266,787 | $ | 3,592,931 | ||||
| Net premiums written | 482,911 | 519,087 | 2,511,040 | 2,763,112 | ||||||||
| Net premiums earned | 632,146 | 708,538 | 2,552,483 | 2,842,745 | ||||||||
| Underwriting income | 48,356 | 79,218 | 195,004 | 336,066 | ||||||||
| Combined ratio | 92.7% | 88.8% | 92.5% | 88.1% | ||||||||
The following table summarizes, on an after-tax basis, the Company’s consolidated financial data, including a reconciliation of after-tax operating income available to common shareholders to net income available to common shareholders and related diluted per share results:
| Three Months Ended | Year Ended | |||||||||||
| December 31, | December 31, | |||||||||||
| (U.S. dollars in thousands, except share data) | 2010 | 2009 | 2010 | 2009 | ||||||||
| After-tax operating income available to common shareholders | $ | 129,489 | $ | 159,431 | $ | 491,074 | $ | 651,805 | ||||
| Net realized gains, net of tax | 71,821 | 88,592 | 247,054 | 137,428 | ||||||||
| Net impairment losses recognized in earnings, net of tax | (3,230) | (4,493) | (11,321) | (66,056) | ||||||||
| Equity in net income of investment funds accounted for using the equity method, net of tax | 22,990 | 32,391 | 61,400 | 167,819 | ||||||||
| Net foreign exchange gains (losses), net of tax | 6,581 | 8,775 | 28,537 | (39,895) | ||||||||
| Net income available to common shareholders | $ | 227,651 | $ | 284,696 | $ | 816,744 | $ | 851,101 | ||||
| Diluted per common share results: | ||||||||||||
| After-tax operating income available to common shareholders | $ | 2.58 | $ | 2.66 | $ | 9.35 | $ | 10.53 | ||||
| Net realized gains, net of tax | 1.43 | 1.48 | 4.70 | 2.22 | ||||||||
| Net impairment losses recognized in earnings, net of tax | (0.06) | (0.08) | (0.21) | (1.07) | ||||||||
| Equity in net income of investment funds accounted for using the equity method, net of tax | 0.46 | 0.54 | 1.17 | 2.71 | ||||||||
| Net foreign exchange gains (losses), net of tax | 0.13 | 0.15 | 0.54 | (0.65) | ||||||||
| Net income available to common shareholders | $ | 4.54 | $ | 4.75 | $ | 15.55 | $ | 13.74 | ||||
| Weighted average common shares and common share equivalents outstanding – diluted | 50,102,143 | 59,910,667 | 52,521,719 | 61,927,132 | ||||||||
The combined ratio represents a measure of underwriting profitability, excluding investment income, and is the sum of the loss ratio and expense ratio. A combined ratio under 100% represents an underwriting profit and a combined ratio over 100% represents an underwriting loss. For the 2010 fourth quarter, the combined ratio of the Company’s insurance and reinsurance subsidiaries consisted of a loss ratio of 58.1% and an underwriting expense ratio of 34.6%, compared to a loss ratio of 57.9% and an underwriting expense ratio of 30.9% for the 2009 fourth quarter. For the year ended December 31, 2010, the combined ratio of the Company’s insurance and reinsurance subsidiaries consisted of a loss ratio of 59.5% and an underwriting expense ratio of 33.0%, compared to a loss ratio of 58.2% and an underwriting expense ratio of 29.9% for the year ended December 31, 2009.
In establishing the reserves for losses and loss adjustment expenses, the Company has made various assumptions relating to the pricing of its reinsurance contracts and insurance policies and also has considered available historical industry experience and current industry conditions. Any estimates and assumptions made as part of the reserving process could prove to be inaccurate due to several factors, including the fact that relatively limited historical information has been reported to the Company through December 31, 2010. As actual loss information is reported to the Company and it develops its own loss experience, the Company will give more emphasis to other actuarial techniques.
The Company’s investment portfolio continues to be comprised primarily of high quality fixed income securities with an average credit quality of “AA+.” The average effective duration of the investment portfolio was 2.83 years at December 31, 2010, compared to 3.11 years at September 30, 2010 and 2.87 years at December 31, 2009. During 2010, the Company has continued to diversify its investment portfolio by increasing its holdings in portfolios which include allocations to global natural resource markets and other sectors and investment funds which invest in fixed income securities, commodities, property and emerging markets as part of total return objectives. Such amounts, which are included in ‘Other investments’ on the Company’s balance sheet, were approximately 2.9% of total investable assets at December 31, 2010. In addition, the Company increased its allocation in equity securities and investment funds that invest in global equities during 2010. Equity securities were approximately 3.1% of total investable assets at December 31, 2010.
Including the effects of foreign exchange, total return on the Company’s investment portfolio was approximately (0.07)% for the 2010 fourth quarter, compared to 1.15% for the 2009 fourth quarter, and 7.00% for the year ended December 31, 2010, compared to 11.28% for the year ended December 31, 2009. Excluding the effects of foreign exchange, total return was (0.04)% for the 2010 fourth quarter, compared to 1.16% for the 2009 fourth quarter, and 7.26% for the year ended December 31, 2010, compared to 10.56% for the year ended December 31, 2009.
Net investment income for the 2010 fourth quarter was $90.6 million, or $1.81 per share, compared to $93.6 million, or $1.56 per share, for the 2009 fourth quarter. The comparability of net investment income between the 2010 and 2009 periods was influenced by the Company’s share repurchase program described below. The pre-tax investment income yield was 3.24% for the 2010 fourth quarter, compared to 3.44% for the 2009 fourth quarter, and 3.34% for the year ended December 31, 2010, compared to 3.74% for the year ended December 31, 2009. The lower yields in the 2010 periods primarily reflect lower prevailing interest rates available in the market. Consolidated cash flow provided by operating activities for the 2010 fourth quarter was $144.5 million, compared to $184.0 million for the 2009 fourth quarter, and $802.1 million for the year ended December 31, 2010, compared to $992.6 million for the year ended December 31, 2009. The decline in operating cash flows in the 2010 periods primarily reflect a lower level of premium volume and changes in the mix of business.
For the year ended December 31, 2010, the Company’s effective tax rates on income before income taxes and pre-tax operating income were 0.9% and 0.5%, respectively, compared to 2.3% and 2.0%, respectively, for the year ended December 31, 2009. The Company’s effective tax rates may fluctuate from period to period based on the relative mix of income reported by jurisdiction primarily due to the varying tax rates in each jurisdiction. The Company’s quarterly tax provision is adjusted to reflect changes in its expected annual effective tax rate, if any. The Company’s estimated effective tax rate on pre-tax operating income was 2.0% at September 30, 2010. The impact of applying the 0.5% annual effective tax rate on pre-tax operating income for the nine months ended September 30, 2010 increased the Company’s after-tax results for the 2010 fourth quarter by $5.2 million, or $0.10 per share. The Company currently expects that its annual effective tax rate on pre-tax operating income available to common shareholders for the year ended December 31, 2011 will be in the range of 1% to 3%. In addition, the Company’s Bermuda-based reinsurer incurs federal excise taxes for premiums assumed on US risks. The Company incurred $11.5 million of federal excise taxes for the year ended December 31, 2010, compared to $12.8 million for the year ended December 31, 2009. Such amounts are reflected as acquisition expenses in the Company’s consolidated statements of income.
Net foreign exchange gains for the 2010 fourth quarter were $6.0 million (net unrealized gains of $8.5 million and net realized losses of $2.5 million), compared to net foreign exchange gains for the 2009 fourth quarter of $9.1 million (net unrealized gains of $7.6 million and net realized gains of $1.5 million). Net foreign exchange gains for the year ended December 31, 2010 were $28.1 million (net unrealized gains of $29.5 million and net realized losses of $1.4 million), compared to net foreign exchange losses for the year ended December 31, 2009 of $39.2 million (net unrealized losses of $37.6 million and net realized losses of $1.6 million).
Net unrealized foreign exchange gains or losses result from the effects of revaluing the Company’s net insurance liabilities required to be settled in foreign currencies at each balance sheet date. Historically, the Company has held investments in foreign currencies which are intended to mitigate its exposure to foreign currency fluctuations in its net insurance liabilities. However, changes in the value of such investments due to foreign currency rate movements are reflected as a direct increase or decrease to shareholders’ equity and are not included in the consolidated statements of income. As a result of the current financial and economic environment as well as the potential for additional investment returns, the Company may not match a portion of its projected liabilities in foreign currencies with investments in the same currencies, which could increase the Company’s exposure to foreign currency fluctuations and increase the volatility of the Company’s shareholders’ equity.
During the 2010 fourth quarter, the Company repurchased 2.9 million common shares for an aggregate purchase price of $258.2 million under its share repurchase program. Since the inception of the share repurchase program through December 31, 2010, ACGL has repurchased 31.7 million common shares for an aggregate purchase price of $2.27 billion. From January 1 to February 11, 2011, the Company repurchased an additional 1.6 million common shares for an aggregate purchase price of $139.6 million. At February 11, 2011, $89.9 million of repurchases were available under the share repurchase program.
At December 31, 2010, the Company’s capital of $4.91 billion consisted of $300.0 million of senior notes, representing 6.1% of the total, $100.0 million of revolving credit agreement borrowings due in August 2011, representing 2.0% of the total, $325.0 million of preferred shares, representing 6.6% of the total, and common shareholders’ equity of $4.19 billion, representing the balance. At December 31, 2009, the Company’s capital of $4.72 billion consisted of $300.0 million of senior notes, representing 6.4% of the total, $100.0 million of revolving credit agreement borrowings due in August 2011, representing 2.1% of the total, $325.0 million of preferred shares, representing 6.9% of the total, and common shareholders’ equity of $4.0 billion, representing the balance.
