Loading...
Docoh

Arch Capital (ACGL)

Filed: 6 Aug 20, 1:56pm
0000947484 us-gaap:EstimateOfFairValueFairValueDisclosureMember us-gaap:FairValueMeasurementsRecurringMember acgl:FairValueOptionMember 2019-12-31


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549
 
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    
For the quarterly period ended June 30, 2020
   
Or
    
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number:  001-16209

 archlogorgbsolida36.jpg
ARCH CAPITAL GROUP LTD.
(Exact name of registrant as specified in its charter)
Bermuda98-0374481
(State or other jurisdiction of incorporation or organization)(I.R.S. Employer Identification No.)
  
Waterloo House, Ground Floor 
100 Pitts Bay Road,PembrokeHM 08,Bermuda(441)278-9250
(Address of principal executive offices)(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Exchange Act:
Title of each class Trading Symbol (s) Name of each exchange on which registered
Common shares, $0.0011 par value per share ACGL NASDAQ Stock Market
Depositary shares, each representing a 1/1000th interest in a 5.25% Series E preferred share
 ACGLP NASDAQ Stock Market
Depositary shares, each representing a 1/1000th interest in a 5.45% Series F preferred share
 ACGLO NASDAQ Stock Market
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes     No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes      No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer Accelerated Filer Non-accelerated Filer Smaller reporting company Emerging growth company
If an emerging growth company, indicate by check mark if the Registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes    No

As of July 31, 2020, there were 405,972,280 common shares, $0.0011 par value per share, of the registrant outstanding.




ARCH CAPITAL GROUP LTD.
 
INDEX TO FORM 10-Q
 

ARCH CAPITAL 12020 SECOND QUARTER FORM 10-Q


PART I.  FINANCIAL INFORMATION
Cautionary Note Regarding Forward-Looking Statements 
The Private Securities Litigation Reform Act of 1995 (“PSLRA”) provides a “safe harbor” for forward-looking statements. This report or any other written or oral statements made by or on behalf of us may include forward-looking statements, which reflect our current views with respect to future events and financial performance. All statements other than statements of historical fact included in or incorporated by reference in this report are forward-looking statements. Forward-looking statements, for purposes of the PSLRA or otherwise, can generally be identified by the use of forward-looking terminology such as “may,” “will,” “expect,” “intend,” “estimate,” “anticipate,” “believe” or “continue” and similar statements of a future or forward-looking nature or their negative or variations or similar terminology.
Forward-looking statements involve our current assessment of risks and uncertainties. Actual events and results may differ materially from those expressed or implied in these statements. Important factors that could cause actual events or results to differ materially from those indicated in such statements are discussed below and elsewhere in this report and in our periodic reports filed with the Securities and Exchange Commission (the “SEC”), and include:
our ability to successfully implement our business strategy during “soft” as well as “hard” markets;
acceptance of our business strategy, security and financial condition by rating agencies and regulators, as well as by brokers and our insureds and reinsureds;
the integration of any businesses we have acquired or may acquire into our existing operations;
our ability to maintain or improve our ratings, which may be affected by our ability to raise additional equity or debt financings, by ratings agencies’ existing or new policies and practices, as well as other factors described herein;
general economic and market conditions (including inflation, interest rates, unemployment, housing prices, foreign currency exchange rates, prevailing credit terms and the depth and duration of a recession, including those resulting from COVID-19) and conditions specific to the reinsurance and insurance markets in which we operate;
competition, including increased competition, on the basis of pricing, capacity (including alternative sources of capital), coverage terms, or other factors;
developments in the world’s financial and capital markets and our access to such markets;
our ability to successfully enhance, integrate and maintain operating procedures (including information technology) to effectively support our current and new business;
the loss of key personnel;
accuracy of those estimates and judgments utilized in the preparation of our financial statements, including those related to revenue recognition, insurance and other reserves, reinsurance recoverables, investment valuations, intangible assets, bad debts, income taxes, contingencies and litigation, and any determination to use the deposit method of accounting;
greater than expected loss ratios on business written by us and adverse development on claim and/or claim expense liabilities related to business written by our insurance and reinsurance subsidiaries;
severity and/or frequency of losses;
claims for natural or man-made catastrophic events or severe economic events in our insurance, reinsurance and mortgage businesses could cause large losses and substantial volatility in our results of operations;
the effect of climate change on our business;
acts of terrorism, political unrest and other hostilities or other unforecasted and unpredictable events;
the effect of contagious disease (including COVID-19) on our business;
availability to us of reinsurance to manage our gross and net exposures and the cost of such reinsurance;
the failure of reinsurers, managing general agents, third party administrators or others to meet their obligations to us;
the timing of loss payments being faster or the receipt of reinsurance recoverables being slower than anticipated by us;

ARCH CAPITAL 22020 SECOND QUARTER FORM 10-Q


our investment performance, including legislative or regulatory developments that may adversely affect the fair value of our investments;
changes in general economic conditions, including sovereign debt concerns or downgrades of U.S. securities by credit rating agencies, which could affect our business, financial condition and results of operations;
changes in the method for determining the London Inter-bank Offered Rate (“LIBOR”) and the potential replacement of LIBOR;
the volatility of our shareholders’ equity from foreign currency fluctuations, which could increase due to us not matching portions of our projected liabilities in foreign currencies with investments in the same currencies;
changes in accounting principles or policies or in our application of such accounting principles or policies;
changes in the political environment of certain countries in which we operate or underwrite business;
a disruption caused by cyber-attacks or other technology breaches or failures on us or our business partners and service providers, which could negatively impact our business and/or expose us to litigation;
statutory or regulatory developments, including as to tax matters and insurance and other regulatory matters such as the adoption of proposed legislation that would affect Bermuda-headquartered companies and/or Bermuda-based insurers or reinsurers and/or changes in regulations or tax laws applicable to us, our subsidiaries, brokers or customers, including the Tax Cuts and Jobs Act of 2017; and
the other matters set forth under Item 1A “Risk Factors”, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and other sections of our Annual Report on Form 10-K for the year ended December 31, 2019, “ITEM 1A—Risk Factors” of this Form 10-Q as well as the other factors set forth in our other documents on file with the SEC, and management’s response to any of the aforementioned factors.
 
All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. The foregoing review of important factors should not be construed as exhaustive and should be read in conjunction with other cautionary statements that are included herein or elsewhere. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise. 


ARCH CAPITAL 32020 SECOND QUARTER FORM 10-Q



ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS


ARCH CAPITAL 42020 SECOND QUARTER FORM 10-Q


Report of Independent Registered Public Accounting Firm


To the Board of Directors and Shareholders of Arch Capital Group Ltd.


Results of Review of Interim Financial Statements

We have reviewed the accompanying consolidated balance sheet of Arch Capital Group Ltd. and its subsidiaries (the “Company”) as of June 30, 2020, and the related consolidated statements of income, comprehensive income, and changes in shareholders’ equity for the three-month and six-month periods ended June 30, 2020 and 2019, and the consolidated statements of cash flows for the six-month periods ended June 30, 2020 and 2019, including the related notes (collectively referred to as the “interim financial statements”). Based on our reviews, we are not aware of any material modifications that should be made to the accompanying interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheet of the Company as of December 31, 2019, and the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for the year then ended (not presented herein), and in our report dated February 28, 2020, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet as of December 31, 2019, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

Basis for Review Results

These interim financial statements are the responsibility of the Company’s management. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our review in accordance with the standards of the PCAOB. A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the PCAOB, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.





/s/ PricewaterhouseCoopers LLP


New York, NY
August 6, 2020


ARCH CAPITAL 52020 SECOND QUARTER FORM 10-Q


ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(U.S. dollars in thousands, except share data)
 (Unaudited)
 June 30,
2020
 December 31,
2019
Assets 
  
Investments: 
  
Fixed maturities available for sale, at fair value (amortized cost: $16,733,493 and $16,598,808; net of allowance for credit losses: $5,869 at June 30, 2020)$17,207,731
 $16,894,526
Short-term investments available for sale, at fair value (amortized cost: $2,276,413 and $957,283; net of allowance for credit losses: $0 at June 30, 2020)2,277,866
 956,546
Collateral received under securities lending, at fair value (amortized cost: $473,783 and $388,366)473,790
 388,376
Equity securities, at fair value1,257,317
 838,925
Investments accounted for using the fair value option3,520,771
 3,663,477
Investments accounted for using the equity method1,727,302
 1,660,396
Total investments26,464,777
 24,402,246
    
Cash854,259
 726,230
Accrued investment income102,064
 117,937
Securities pledged under securities lending, at fair value (amortized cost: $460,760 and $378,738)464,503
 379,868
Premiums receivable (net of allowance for credit losses: $36,054 and $21,003)2,203,753
 1,778,717
Reinsurance recoverable on unpaid and paid losses and loss adjustment expenses (net of allowance for credit losses: $13,595 and $1,364)4,363,507
 4,346,816
Contractholder receivables (net of allowance for credit losses: $6,290 and $0)2,179,124
 2,119,460
Ceded unearned premiums1,364,603
 1,234,683
Deferred acquisition costs714,531
 633,400
Receivable for securities sold167,281
 24,133
Goodwill and intangible assets688,490
 738,083
Other assets1,632,756
 1,383,788
Total assets$41,199,648
 $37,885,361
    
Liabilities   
Reserve for losses and loss adjustment expenses$15,044,874
 $13,891,842
Unearned premiums4,827,445
 4,339,549
Reinsurance balances payable793,467
 667,072
Contractholder payables2,185,414
 2,119,460
Collateral held for insured obligations208,449
 206,698
Senior notes2,860,733
 1,871,626
Revolving credit agreement borrowings335,587
 484,287
Securities lending payable473,783
 388,366
Payable for securities purchased275,257
 87,579
Other liabilities1,467,739
 1,513,330
Total liabilities28,472,748
 25,569,809
    
Commitments and Contingencies


 


Redeemable noncontrolling interests55,986
 55,404
    
Shareholders' Equity   
Non-cumulative preferred shares780,000
 780,000
Common shares ($0.0011 par, shares issued: 577,956,232 and 574,617,195)642
 638
Additional paid-in capital1,935,514
 1,889,683
Retained earnings11,420,686
 11,021,006
Accumulated other comprehensive income (loss), net of deferred income tax349,488
 212,091
Common shares held in treasury, at cost (shares: 171,985,981 and 168,997,994)(2,494,505) (2,406,047)
Total shareholders' equity available to Arch11,991,825
 11,497,371
Non-redeemable noncontrolling interests679,089
 762,777
Total shareholders' equity12,670,914
 12,260,148
Total liabilities, noncontrolling interests and shareholders' equity$41,199,648
 $37,885,361


See Notes to Consolidated Financial Statements

ARCH CAPITAL62020 SECOND QUARTER FORM 10-Q


ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(U.S. dollars in thousands, except share data)
 (Unaudited) (Unaudited)
 Three Months Ended Six Months Ended
 June 30, June 30,
 2020 2019 2020 2019
Revenues 
  
  
  
Net premiums written$1,668,311
 $1,444,898
 $3,805,557
 $2,970,157
Change in unearned premiums(2,957) 18,829
 (395,759) (137,564)
Net premiums earned1,665,354
 1,463,727
 3,409,798
 2,832,593
Net investment income131,485
 155,038
 276,638
 311,987
Net realized gains (losses)556,588
 120,757
 189,628
 261,013
Other underwriting income6,667
 5,953
 13,519
 14,778
Equity in net income (loss) of investment funds accounted for using the equity method(65,119) 32,536
 (69,328) 79,403
Other income (loss)(3,140) 1,129
 5,408
 2,212
Total revenues2,291,835
 1,779,140
 3,825,663
 3,501,986
        
Expenses       
Losses and loss adjustment expenses1,230,522
 767,543
 2,345,941
 1,486,075
Acquisition expenses254,789
 210,089
 502,072
 407,937
Other operating expenses209,249
 198,914
 443,793
 400,077
Corporate expenses17,920
 18,251
 38,716
 36,213
Amortization of intangible assets16,489
 19,794
 33,120
 40,211
Interest expense31,139
 29,280
 63,694
 58,345
Net foreign exchange (gains) losses39,211
 4,952
 (33,460) 1,427
Total expenses1,799,319
 1,248,823
 3,393,876
 2,430,285
        
Income (loss) before income taxes492,516
 530,317
 431,787
 1,071,701
Income tax expense(26,127) (44,472) (54,072) (90,358)
Net income (loss)$466,389
 $485,845
 $377,715
 $981,343
Net (income) loss attributable to noncontrolling interests(167,568) (16,891) 65,223
 (63,861)
Net income (loss) available to Arch298,821
 468,954
 442,938
 917,482
Preferred dividends(10,403) (10,403) (20,806) (20,806)
Net income (loss) available to Arch common shareholders$288,418
 $458,551
 $422,132
 $896,676
        
Net income per common share and common share equivalent 
  
  
  
Basic$0.72
 $1.14
 $1.05
 $2.24
Diluted$0.71
 $1.12
 $1.03
 $2.19
        
Weighted average common shares and common share equivalents outstanding     
  
Basic402,503,687
 401,482,784
 403,197,924
 400,837,181
Diluted408,119,681
 410,899,483
 411,005,591
 409,755,250




See Notes to Consolidated Financial Statements

ARCH CAPITAL72020 SECOND QUARTER FORM 10-Q


ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(U.S. dollars in thousands)
 (Unaudited) (Unaudited)
 Three Months Ended Six Months Ended
 June 30, June 30,
 2020 2019 2020 2019
Comprehensive Income     
  
Net income (loss)$466,389
 $485,845
 $377,715
 $981,343
Other comprehensive income (loss), net of deferred income tax       
Unrealized appreciation (decline) in value of available-for-sale investments:       
Unrealized holding gains (losses) arising during period492,796
 222,473
 435,509
 448,360
Reclassification of net realized (gains) losses, included in net income (loss)(167,391) (55,345) (288,620) (65,566)
Foreign currency translation adjustments22,251
 4,267
 (22,438) 9,783
Comprehensive income (loss)814,045
 657,240
 502,166
 1,373,920
Net (income) loss attributable to noncontrolling interests(167,568) (16,891) 65,223
 (63,861)
Other comprehensive (income) loss attributable to noncontrolling interests(20,111) (2,891) 12,947
 (7,030)
Comprehensive income (loss) available to Arch$626,366
 $637,458
 $580,336
 $1,303,029




See Notes to Consolidated Financial Statements

ARCH CAPITAL82020 SECOND QUARTER FORM 10-Q


ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(U.S. dollars in thousands)
 (Unaudited) (Unaudited)
 Three Months Ended Six Months Ended
 June 30, June 30,
 2020 2019 2020 2019
Non-cumulative preferred shares     
  
Balance at beginning and end of period$780,000
 $780,000
 $780,000
 $780,000
        
        
Common shares       
Balance at beginning of period642
 636
 638
 634
Common shares issued, net
 2
 4
 4
Balance at end of period642
 638
 642
 638
        
Additional paid-in capital     
  
Balance at beginning of period1,921,487
 1,819,605
 1,889,683
 1,793,781
Amortization of share-based compensation13,160
 13,607
 41,210
 39,515
Other changes867

14,737

4,621

14,653
Balance at end of period1,935,514
 1,847,949
 1,935,514
 1,847,949
        
Retained earnings     
  
Balance at beginning of period11,132,268
 9,864,424
 11,021,006
 9,426,299
Cumulative effect of an accounting change (1)
 
 (22,452) 
Balance at beginning of period, as adjusted11,132,268
 9,864,424
 10,998,554
 9,426,299
Net income (loss)466,389
 485,845
 377,715
 981,343
Net (income) loss attributable to noncontrolling interests(167,568) (16,891) 65,223
 (63,861)
Preferred share dividends(10,403) (10,403) (20,806) (20,806)
Balance at end of period11,420,686
 10,322,975
 11,420,686
 10,322,975
        
Accumulated other comprehensive income (loss), net of deferred income tax       
Balance at beginning of period21,944
 38,323
 212,091
 (178,720)
Unrealized appreciation (decline) in value of available-for-sale investments, net of deferred income tax:       
Balance at beginning of period113,149
 97,202
 258,486
 (114,178)
Unrealized holding gains (losses) during period, net of reclassification adjustment325,405
 167,128
 146,889
 382,794
Unrealized holding gains (losses) during period attributable to noncontrolling interests(20,067) (2,703) 13,112
 (6,989)
Balance at end of period418,487
 261,627
 418,487
 261,627
Foreign currency translation adjustments, net of deferred income tax:       
Balance at beginning of period(91,205) (58,879) (46,395) (64,542)
Foreign currency translation adjustments22,251
 4,267
 (22,438) 9,783
Foreign currency translation adjustments attributable to noncontrolling interests(45) (188) (166) (41)
Balance at end of period(68,999) (54,800) (68,999) (54,800)
Balance at end of period349,488
 206,827
 349,488
 206,827
        
Common shares held in treasury, at cost       
Balance at beginning of period(2,489,097) (2,388,392) (2,406,047) (2,382,167)
Shares repurchased for treasury(5,408) (12,645) (88,458) (18,870)
Balance at end of period(2,494,505) (2,401,037) (2,494,505) (2,401,037)
        
Total shareholders’ equity available to Arch11,991,825
 10,757,352
 11,991,825
 10,757,352
Non-redeemable noncontrolling interests679,089
 855,347
 679,089
 855,347
Total shareholders’ equity$12,670,914
 $11,612,699
 $12,670,914
 $11,612,699

(1) Adoption of ASU 2016-13, “Financial Instruments - Credit Losses (Topic 326)” See note 1.


See Notes to Consolidated Financial Statements

ARCH CAPITAL92020 SECOND QUARTER FORM 10-Q


ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(U.S. dollars in thousands)
 (Unaudited)
 Six Months Ended
 June 30,
 2020 2019
Operating Activities 
  
Net income (loss)$377,715
 $981,343
Adjustments to reconcile net income (loss) to net cash provided by operating activities:   
Net realized (gains) losses(194,776) (262,935)
Equity in net income or loss of investment funds accounted for using the equity method and other income or loss125,384
 (45,720)
Amortization of intangible assets33,120
 40,211
Share-based compensation41,912
 41,537
Changes in:   
Reserve for losses and loss adjustment expenses, net of unpaid losses and loss adjustment expenses recoverable1,158,446
 154,396
Unearned premiums, net of ceded unearned premiums395,759
 137,564
Premiums receivable(463,638) (302,050)
Deferred acquisition costs(92,437) (24,790)
Reinsurance balances payable132,161
 139,415
Other items, net(192,066) (146,447)
Net cash provided by (used for) operating activities1,321,580
 712,524
Investing Activities 
  
Purchases of fixed maturity investments(25,410,849) (16,332,646)
Purchases of equity securities(1,025,149) (431,939)
Purchases of other investments(501,692) (677,063)
Proceeds from sales of fixed maturity investments24,833,030
 15,632,482
Proceeds from sales of equity securities580,346
 176,701
Proceeds from sales, redemptions and maturities of other investments472,188
 534,698
Proceeds from redemptions and maturities of fixed maturity investments369,240
 244,949
Net settlements of derivative instruments150,471
 87,701
Net (purchases) sales of short-term investments(1,323,363) 201,520
Change in cash collateral related to securities lending54,596
 7,590
Purchases of fixed assets(17,687) (16,359)
Other8,679
 (174,578)
Net cash provided by (used for) investing activities(1,810,190) (746,944)
Financing Activities 
  
Purchases of common shares under share repurchase program(75,486) (2,871)
Proceeds from common shares issued, net(9,661) (557)
Proceeds from borrowings1,004,918
 62,800
Repayments of borrowings(165,000) (27,538)
Change in cash collateral related to securities lending(54,596) (7,590)
Third party investment in non-redeemable noncontrolling interests(2,867) 
Dividends paid to redeemable noncontrolling interests(2,540) (8,994)
Other(2,625) (3,529)
Preferred dividends paid(20,806) (20,806)
Net cash provided by (used for) financing activities671,337
 (9,085)
    
Effects of exchange rate changes on foreign currency cash and restricted cash(21,742) 1,937
    
Increase (decrease) in cash and restricted cash160,985
 (41,568)
Cash and restricted cash, beginning of year903,698
 724,643
Cash and restricted cash, end of period$1,064,683
 $683,075



See Notes to Consolidated Financial Statements

ARCH CAPITAL102020 SECOND QUARTER FORM 10-Q

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)


1.    Basis of Presentation and Recent Accounting Pronouncements

General
Arch Capital Group Ltd. (“Arch Capital”) is a Bermuda public limited liability company which provides insurance, reinsurance and mortgage insurance on a worldwide basis through its wholly-owned subsidiaries. As used herein, the “Company” means Arch Capital and its subsidiaries. The Company’s consolidated financial statements include the results of Watford Holdings Ltd. and its wholly owned subsidiaries (“Watford”). Watford is a multi-line Bermuda reinsurance company. Watford’s own management and board of directors are responsible for its results and profitability. See note 12.
Basis of Presentation
The interim consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”). All significant intercompany transactions and balances have been eliminated in consolidation. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from those estimates and assumptions. In the opinion of management, the accompanying unaudited interim consolidated financial statements reflect all adjustments (consisting of normally recurring accruals) necessary for a fair statement of results on an interim basis. The results of any interim period are not necessarily indicative of the results for a full year or any future periods.
Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted; however, management believes that the disclosures are adequate to make the information presented not misleading. This report should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2019 (“2019 Form 10-K”), including the Company’s audited consolidated financial statements and related notes.
The Company has reclassified the presentation of certain prior year information to conform to the current presentation. Such reclassifications had no effect on the Company’s net income, comprehensive income, shareholders’ equity or cash flows. Tabular amounts are in U.S. Dollars in thousands, except share amounts, unless otherwise noted.
 
Recent Accounting Pronouncements
Recently Issued Accounting Standards Adopted
The Company adopted ASU 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement.” The ASU modifies the disclosure requirements on fair value measurement as part of the disclosure framework project with the objective to improve the effectiveness of disclosures in the notes to the financial statements. The amendments in this update allow for removal of (1) the amount and reasons for transfer between Level 1 and Level 2 of the fair value hierarchy; (2) the policy for transfers between levels; and (3) the valuation processes for Level 3 fair value measurements. The adoption of this guidance did not have a material effect on the Company’s consolidated financial statements.
The Company adopted ASU 2018-15, “Intangibles - Goodwill and Other - Internal Use Software (Subtopic 350-40).” This ASU aligns the requirements for capitalizing certain implementation costs incurred in a cloud computing arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The guidance provides flexibility in adoption, allowing for either retrospective adjustment or prospective adjustment for all implementation costs incurred after the date of adoption. The Company adopted this guidance prospectively. The adoption of this guidance did not have a material effect on the Company’s consolidated financial statements.
In March 2020, the SEC amended Rule 3-10 of Regulation S-X regarding financial disclosure requirements for registered debt offerings involving subsidiaries as either issuers or guarantors and affiliates whose securities are pledged as collateral. This new guidance narrows the circumstances that require separate financial statements of subsidiary issuers and guarantors and streamlines the alternative disclosures required in lieu of those statements. The amendment is effective on January 4, 2021 with early adoption permitted. The Company elected to apply the amended requirements for the quarter ended March 31, 2020, and is no longer providing condensed consolidating financial information that resulted from the registered debt obligations of its subsidiaries, Arch Capital Group (U.S.) Inc. and Arch Capital Finance LLC., that were disclosed in Note 26 of the financial statements in the Company’s 2019 Form 10-K.
The Company adopted ASU 2016-13, “Financial Instruments - Credit Losses (Topic 326).” The ASU applies a new credit loss model (current expected credit losses) for determining credit related impairments for financial instruments measured at amortized cost, including reinsurance recoverable, contractholder receivables, and premiums receivable, and requires an entity to estimate its lifetime “expected credit loss” and record an allowance that, when deducted from the

ARCH CAPITAL 112020 SECOND QUARTER FORM 10-Q

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

amortized cost basis of the financial asset, presents the net amount expected to be collected on the financial asset. The estimate of expected credit losses should consider historical information, current information, as well as reasonable and supportable forecasts, including estimates of prepayments.
The ASU also amends the previous other-than-temporary impairment model for available-for-sale debt securities by requiring the recognition of impairments relating to credit losses through an allowance account and limits the amount of credit loss to the difference between a security’s amortized cost basis and its fair value. In addition, the length of time a security has been in an unrealized loss position will no longer impact the determination of whether a credit loss exists.
The Company adopted the ASU for the quarter ending March 31, 2020 by recognizing an after-tax cumulative effect adjustment of $22.5 million to the opening balance of retained earnings as of January 1, 2020. The cumulative effect adjustment decreased retained earnings and increased the allowance for credit losses.
Significant Accounting Policies
The following accounting policies have been updated to reflect the Company's adoption of the new accounting guidance on credit losses.
Investments
The Company conducts a periodic review to identify and evaluate credit based impairments related to the Company’s available for sale investments. The Company derives estimated credit losses by comparing expected future cash flows to be collected to the amortized cost of the security. Estimates of expected future cash flows consider among other things, macroeconomic conditions as well as the financial condition, near-term and long-term prospects for the issuer, and the likelihood of the recoverability of principal and interest. Effective January 1, 2020, credit losses are recognized through an allowance account subject to reversal, rather than a reduction in amortized cost. Declines in value attributable to factors other than credit are reported in other comprehensive income while the allowance for credit loss is charged to net realized gains (losses).
For available for sale investments that the Company intends to sell or for which it is more likely than not that the Company would be required to sell before an anticipated recovery in value, the full amount of the impairment is included in net realized gains (losses). The new cost basis of the investment is the previous amortized cost basis reduced by the impairment recognized in net realized gains (losses). The new cost basis is not adjusted for any subsequent recoveries in fair value.
The Company reports accrued investment income separately from investment balances and has elected not to measure an
 
allowance for credit losses for accrued investment income. Any uncollectible accrued interest income is written off in the period it is deemed uncollectible.
Reinsurance Recoverables
In the normal course of business, the Company’s subsidiaries cede a portion of their premium and losses through pro rata and excess of loss reinsurance agreements on a treaty or facultative basis. Reinsurance recoverables are recorded as assets, predicated on the reinsurers’ ability to meet their obligations under the reinsurance agreements. In certain instances, the Company obtains collateral, including letters of credit and trust accounts to further reduce the credit exposure on its reinsurance recoverables. The Company reports its reinsurance recoverables net of an allowance for expected credit loss. The allowance is based upon the Company’s ongoing review of amounts outstanding, the financial condition of its 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. Any allowance for credit losses is charged to net realized gains (losses) in the period the recoverable is recorded and revised in subsequent periods to reflect changes in the Company’s estimate of expected credit losses.
Contractholder Receivables
Certain insurance policies written by the Company’s U.S. insurance operations feature large deductibles, primarily in its construction and national accounts line of business. Under such contracts, the Company is obligated to pay the claimant for the full amount of the claim. The Company is subsequently reimbursed by the policy holder for the deductible amount. These amounts are included on a gross basis in the consolidated balance sheet as contractholder payables and contractholder receivables. In the event that the Company is unable to collect from the policyholder, the Company would be liable for such defaulted amounts. Collateral, primarily in the form of letters of credit, cash and trusts, is obtained from the policyholder to mitigate the Company’s credit risk.
Contractholder receivables are reported net of an allowance for expected credit losses. The allowance is based upon the Company’s ongoing review of amounts outstanding, changes in policyholder credit standing, 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 losses. Any allowance for credit losses is charged to net realized gains (losses) in the period the receivable is recorded and revised in subsequent periods to reflect changes in the Company’s estimate of expected credit losses.

ARCH CAPITAL 122020 SECOND QUARTER FORM 10-Q

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Premiums Receivable
Premiums receivable include amounts receivable from agents, brokers and insured that are both currently due and amounts not yet due on insurance, reinsurance and mortgage insurance policies. Premiums receivable balances are reported net of an allowance for expected credit losses. The Company monitors credit risk associated with premiums receivable through its ongoing review of amounts outstanding, aging of the receivable, historical loss data, and counterparty financial strength measures. The allowance also includes estimated uncollectible amounts related to dispute risk. In certain instances, credit risk may be reduced by the Company’s right to offset loss obligations or unearned premiums against premiums receivable. Any allowance for credit losses is charged to net realized gains (losses) in the period the receivable is recorded and revised in subsequent periods to reflect changes in the Company’s estimate of expected credit losses.
Recently Issued Accounting Standards Not Yet Adopted
In December 2019, the FASB issued ASU 2019-12, “Simplifying the Accounting for Income Taxes.” This ASU eliminates certain exceptions for recognizing deferred taxes for investments, performing intraperiod tax allocation and calculating income taxes in interim periods. The ASU also clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill. The ASU is effective for fiscal years beginning after December 15, 2020 and interim periods within those fiscal years with early adoption permitted. The Company is currently evaluating the impact of the new guidance on its consolidated financial statements and does not expect this guidance to have a material effect on the Company’s consolidated financial statements.
In March 2020, the FASB issued ASU 2020-04, “Facilitation of the Effects of Reference Rate Reform on Financial Reporting.” This ASU provides optional expedients and exceptions for applying GAAP to investments, derivatives, or other transactions that reference the London Interbank Offered Rate (LIBOR) or another reference rate expected to be discontinued because of reference rate reform. Along with the optional expedients, the amendments include a general principle that permits an entity to consider contract modifications due to reference reform to be an event that does not require contract re-measurement at the modification date or reassessment of a previous accounting determination. This standard may be elected over time through December 31, 2022 as reference rate reform activities occur. The Company is currently evaluating the impact of the new guidance on its consolidated financial statements and does not expect this guidance to have a material effect on the Company’s consolidated financial statements.
For information regarding additional accounting standards that the Company has not yet adopted, see note 3(r), “Significant Accounting Policies—Recent Accounting Pronouncements,”
 
of the notes to consolidated financial statements in the Company’s 2019 Form 10-K.
2.    Share Transactions

Share Repurchases 
The board of directors of Arch Capital has authorized the investment in Arch Capital’s common shares through a share repurchase program. Since the inception of the share repurchase program, Arch Capital has repurchased 388.9 million common shares for an aggregate purchase price of $4.04 billion. For the six months ended June 30, 2020, Arch Capital repurchased 2.6 million shares under the share repurchase program with an aggregate purchase price of $75.5 million. Arch Capital repurchased 0.1 million shares under the share repurchase program with an aggregate purchase price of $2.9 million during the six months ended June 30, 2019. At June 30, 2020, $924.5 million of share repurchases were available under the program, which may be effected from time to time in open market or privately negotiated transactions through December 31, 2021. The timing and amount of the repurchase transactions under this program will depend on a variety of factors, including market conditions and corporate and regulatory considerations. Depending upon results of operations, market conditions and the development of the economy, as well as other factors, generally Arch Capital will consider share repurchases on an opportunistic basis from time to time. During the 2020 second quarter, Arch Capital has not repurchased any shares under our share repurchase program and we do not expect to repurchase any shares for the remainder of 2020.

ARCH CAPITAL 132020 SECOND QUARTER FORM 10-Q

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

3.    Earnings Per Common Share

The following table sets forth the computation of basic and diluted earnings per common share:
 Three Months Ended
Six Months Ended
 June 30, June 30,
 2020 2019 2020 2019
Numerator:       
Net income (loss)$466,389
 $485,845
 $377,715
 $981,343
Amounts attributable to noncontrolling interests(167,568) (16,891) 65,223
 (63,861)
Net income (loss) available to Arch298,821
 468,954
 442,938
 917,482
Preferred dividends(10,403) (10,403) (20,806) (20,806)
Net income (loss) available to Arch common shareholders$288,418
 $458,551
 $422,132
 $896,676
        
Denominator:       
Weighted average common shares and common share equivalents outstanding — basic402,503,687
 401,482,784
 403,197,924
 400,837,181
Effect of dilutive common share equivalents:       
Nonvested restricted shares1,597,701
 1,937,626
 1,829,239
 1,720,417
Stock options (1)4,018,293
 7,479,073
 5,978,428
 7,197,652
Weighted average common shares and common share equivalents outstanding — diluted408,119,681
 410,899,483
 411,005,591
 409,755,250
        
Earnings per common share:       
Basic$0.72
 $1.14
 $1.05
 $2.24
Diluted$0.71
 $1.12
 $1.03
 $2.19

(1)Certain stock options were not included in the computation of diluted earnings per share where the exercise price of the stock options exceeded the average market price and would have been anti-dilutive or where, when applying the treasury stock method to in-the-money options, the sum of the proceeds, including unrecognized compensation, exceeded the average market price and would have been anti-dilutive. For the 2020 second quarter and 2019 second quarter, the number of stock options excluded were 6,982,107 and 2,016,830, respectively. For the six months ended June 30, 2020 and 2019 period, the number of stock options excluded were 2,038,758 and 2,560,755, respectively.

ARCH CAPITAL 142020 SECOND QUARTER FORM 10-Q

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

4.    Segment Information

The Company classifies its businesses into 3 underwriting segments — insurance, reinsurance and mortgage — and 2 other operating segments — ‘other’ and corporate (non-underwriting). The Company determined its 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 the Company’s consolidated financial statements. Intersegment business is allocated to the segment accountable for the underwriting results.
The Company’s 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 the Company’s chief operating decision makers, the President and Chief Executive Officer of Arch Capital, and the Chief Financial Officer of Arch 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 its three underwriting segments based on underwriting income or loss. The Company does not manage its assets by underwriting segment, with the exception of goodwill and intangible assets, and, accordingly, investment income is not allocated to each underwriting segment.
The insurance segment consists of the Company’s insurance underwriting units which offer specialty product lines on a worldwide basis. Product lines include: construction and national accounts; excess and surplus casualty; lenders products; professional lines; programs; property, energy, marine and aviation; travel, accident and health; and other (consisting of alternative markets, excess workers' compensation and surety business).
The reinsurance segment consists of the Company’s reinsurance underwriting units which offer specialty product lines on a worldwide basis. Product lines include: casualty; marine and aviation; other specialty; property catastrophe; property excluding property catastrophe (losses on a single risk, both excess of loss and pro rata); and other (consisting of life reinsurance, casualty clash and other).
The mortgage segment includes the Company’s U.S. and international mortgage insurance and reinsurance operations as well as government sponsored enterprise (“GSE”) credit-risk sharing transactions. Arch Mortgage Insurance Company and United Guaranty Residential Insurance Company (combined “Arch MI U.S.”) are approved as eligible mortgage insurers by Federal National Mortgage Association (“Fannie Mae”) and Federal Home Loan Mortgage Corporation (“Freddie Mac”), each a GSE.
The corporate (non-underwriting) segment results include net investment income, other income (loss), corporate expenses, transaction costs and other, interest expense, items related to the Company’s non-cumulative preferred shares, net realized gains or losses (which includes changes in the allowance for credit losses on financial assets and net impairment losses recognized in earnings), equity in net income or loss of investment funds accounted for using the equity method, net foreign exchange gains or losses and income taxes. Such amounts exclude the results of the ‘other’ segment.
The ‘other’ segment includes the results of Watford (see note 12). For the ‘other’ segment, performance is measured based on net income or loss.

ARCH CAPITAL 152020 SECOND QUARTER FORM 10-Q

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following tables summarize the Company’s underwriting income or loss by segment, together with a reconciliation of underwriting income or loss to net income available to Arch common shareholders:
 Three Months Ended
 June 30, 2020
 Insurance Reinsurance Mortgage Sub-Total Other Total
            
Gross premiums written (1)$1,030,362
 $807,065
 $369,144
 $2,206,410
 $157,927
 $2,317,692
Premiums ceded(358,101) (241,971) (44,044) (643,955) (52,071) (649,381)
Net premiums written672,261
 565,094
 325,100
 1,562,455
 105,856
 1,668,311
Change in unearned premiums15,648
 (84,897) 40,613
 (28,636) 25,679
 (2,957)
Net premiums earned687,909
 480,197
 365,713
 1,533,819
 131,535
 1,665,354
Other underwriting income (loss)
 (651) 6,450
 5,799
 868
 6,667
Losses and loss adjustment expenses(518,203) (383,433) (224,100) (1,125,736) (104,786) (1,230,522)
Acquisition expenses(107,671) (90,522) (34,052) (232,245) (22,544) (254,789)
Other operating expenses(118,757) (38,716) (37,574) (195,047) (14,202) (209,249)
Underwriting income (loss)$(56,722) $(33,125) $76,437
 (13,410) (9,129) (22,539)
            
Net investment income      101,031
 30,454
 131,485
Net realized gains (losses)      385,089
 171,499
 556,588
Equity in net income (loss) of investment funds accounted for using the equity method      (65,119) 
 (65,119)
Other income (loss)      (3,140) 
 (3,140)
Corporate expenses (2)      (16,943) 
 (16,943)
Transaction costs and other (2)      (977) 
 (977)
Amortization of intangible assets      (16,489) 
 (16,489)
Interest expense      (25,130) (6,009) (31,139)
Net foreign exchange gains (losses)      (42,438) 3,227
 (39,211)
Income (loss) before income taxes      302,474
 190,042
 492,516
Income tax (expense) benefit      (26,529) 402
 (26,127)
Net income (loss)      275,945
 190,444
 466,389
Amounts attributable to redeemable noncontrolling interests      (934) (1,036) (1,970)
Amounts attributable to nonredeemable noncontrolling interests      
 (165,598) (165,598)
Net income (loss) available to Arch      275,011
 23,810
 298,821
Preferred dividends      (10,403) 
 (10,403)
Net income (loss) available to Arch common shareholders      $264,608
 $23,810
 $288,418
            
Underwriting Ratios           
Loss ratio75.3% 79.8% 61.3% 73.4% 79.7% 73.9%
Acquisition expense ratio15.7% 18.9% 9.3% 15.1% 17.1% 15.3%
Other operating expense ratio17.3% 8.1% 10.3% 12.7% 10.8% 12.6%
Combined ratio108.3% 106.8% 80.9% 101.2% 107.6% 101.8%
            
Goodwill and intangible assets$263,086
 $2,516
 $415,238
 $680,840
 $7,650
 $688,490
(1)Certain amounts included in the gross premiums written of each segment are related to intersegment transactions. Accordingly, the sum of gross premiums written for each segment does not agree to the total gross premiums written as shown in the table above due to the elimination of intersegment transactions in the total.
(2)Certain expenses have been excluded from ‘corporate expenses’ and reflected in ‘transaction costs and other.’


ARCH CAPITAL 162020 SECOND QUARTER FORM 10-Q

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 Three Months Ended
 June 30, 2019
 Insurance Reinsurance Mortgage Sub-Total Other Total
            
Gross premiums written (1)$919,925
 $545,547
 $364,465
 $1,829,829
 $161,978
 $1,937,809
Premiums ceded(292,095) (169,457) (42,857) (504,301) (42,608) (492,911)
Net premiums written627,830
 376,090
 321,608
 1,325,528
 119,370
 1,444,898
Change in unearned premiums(35,388) (8,906) 31,175
 (13,119) 31,948
 18,829
Net premiums earned592,442
 367,184
 352,783
 1,312,409
 151,318
 1,463,727
Other underwriting income (loss)
 1,224
 4,056
 5,280
 673
 5,953
Losses and loss adjustment expenses(389,172) (240,958) (25,997) (656,127) (111,416) (767,543)
Acquisition expenses(91,094) (56,785) (32,654) (180,533) (29,556) (210,089)
Other operating expenses(109,523) (33,960) (39,819) (183,302) (15,612) (198,914)
Underwriting income (loss)$2,653
 $36,705
 $258,369
 297,727
 (4,593) 293,134
            
Net investment income      123,038
 32,000
 155,038
Net realized gains (losses)      125,063
 (4,306) 120,757
Equity in net income (loss) of investment funds accounted for using the equity method      32,536
 
 32,536
Other income (loss)      1,129
 
 1,129
Corporate expenses (2)      (16,073) 
 (16,073)
Transaction costs and other (2)      (2,178) 
 (2,178)
Amortization of intangible assets      (19,794) 
 (19,794)
Interest expense      (23,375) (5,905) (29,280)
Net foreign exchange gains (losses)      (6,190) 1,238
 (4,952)
Income (loss) before income taxes      511,883
 18,434
 530,317
Income tax (expense) benefit      (44,452) (20) (44,472)
Net income (loss)      467,431
 18,414
 485,845
Amounts attributable to redeemable noncontrolling interests      
 (4,590) (4,590)
Amounts attributable to nonredeemable noncontrolling interests      
 (12,301) (12,301)
Net income (loss) available to Arch      467,431
 1,523
 468,954
Preferred dividends      (10,403) 
 (10,403)
Net income (loss) available to Arch common shareholders      $457,028
 $1,523
 $458,551
            
Underwriting Ratios 
  
  
    
  
Loss ratio65.7% 65.6% 7.4% 50.0% 73.6% 52.4%
Acquisition expense ratio15.4% 15.5% 9.3% 13.8% 19.5% 14.4%
Other operating expense ratio18.5% 9.2% 11.3% 14.0% 10.3% 13.6%
Combined ratio99.6% 90.3% 28.0% 77.8% 103.4% 80.4%
            
Goodwill and intangible assets$157,440
 $
 $475,920
 $633,360
 $7,650
 $641,010

(1)Certain amounts included in the gross premiums written of each segment are related to intersegment transactions. Accordingly, the sum of gross premiums written for each segment does not agree to the total gross premiums written as shown in the table above due to the elimination of intersegment transactions in the total.
(2)Certain expenses have been excluded from ‘corporate expenses’ and reflected in ‘transaction costs and other.’

ARCH CAPITAL 172020 SECOND QUARTER FORM 10-Q

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 Six Months Ended
 June 30, 2020
 Insurance Reinsurance Mortgage Sub-Total Other Total
            
Gross premiums written (1)$2,238,007
 $1,929,584
 $738,089
 $4,904,947
 $392,829
 $5,150,522
Premiums ceded(736,998) (567,310) (88,371) (1,391,946) (100,273) (1,344,965)
Net premiums written1,501,009
 1,362,274
 649,718
 3,513,001
 292,556
 3,805,557
Change in unearned premiums(97,181) (338,617) 61,021
 (374,777) (20,982) (395,759)
Net premiums earned1,403,828
 1,023,657
 710,739
 3,138,224
 271,574
 3,409,798
Other underwriting income (loss)
 1,469
 11,049
 12,518
 1,001
 13,519
Losses and loss adjustment expenses(1,025,311) (813,502) (291,666) (2,130,479) (215,462) (2,345,941)
Acquisition expenses(215,008) (170,128) (72,588) (457,724) (44,348) (502,072)
Other operating expenses(248,406) (84,013) (83,470) (415,889) (27,904) (443,793)
Underwriting income (loss)$(84,897) $(42,517) $274,064
 146,650
 (15,139) 131,511
            
Net investment income      214,059
 62,579
 276,638
Net realized gains (losses)      312,980
 (123,352) 189,628
Equity in net income (loss) of investment funds accounted for using the equity method      (69,328) 
 (69,328)
Other income (loss)      5,408
 
 5,408
Corporate expenses (2)      (35,144) 
 (35,144)
Transaction costs and other (2)      (3,572) 
 (3,572)
Amortization of intangible assets      (33,120) 
 (33,120)
Interest expense      (50,375) (13,319) (63,694)
Net foreign exchange gains (losses)      20,869
 12,591
 33,460
Income (loss) before income taxes      508,427
 (76,640) 431,787
Income tax (expense) benefit      (54,474) 402
 (54,072)
Net income (loss)      453,953
 (76,238) 377,715
Dividends attributable to redeemable noncontrolling interests      (991) (2,132) (3,123)
Amounts attributable to nonredeemable noncontrolling interests      
 68,346
 68,346
Net income (loss) available to Arch      452,962
 (10,024) 442,938
Preferred dividends      (20,806) 
 (20,806)
Net income (loss) available to Arch common shareholders      $432,156
 $(10,024) $422,132
            
Underwriting Ratios 
  
  
    
  
Loss ratio73.0% 79.5% 41.0% 67.9% 79.3% 68.8%
Acquisition expense ratio15.3% 16.6% 10.2% 14.6% 16.3% 14.7%
Other operating expense ratio17.7% 8.2% 11.7% 13.3% 10.3% 13.0%
Combined ratio106.0% 104.3% 62.9% 95.8% 105.9% 96.5%
(1)Certain amounts included in the gross premiums written of each segment are related to intersegment transactions. Accordingly, the sum of gross premiums written for each segment does not agree to the total gross premiums written as shown in the table above due to the elimination of intersegment transactions in the total.
(2)Certain expenses have been excluded from ‘corporate expenses’ and reflected in ‘transaction costs and other.’


ARCH CAPITAL 182020 SECOND QUARTER FORM 10-Q

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 Six Months Ended
 June 30, 2019
 Insurance Reinsurance Mortgage Sub-Total Other Total
            
Gross premiums written (1)$1,861,879
 $1,228,402
 $720,515
 $3,810,282
 $348,667
 $4,015,688
Premiums ceded(612,717) (401,024) (91,655) (1,104,882) (83,910) (1,045,531)
Net premiums written1,249,162
 827,378
 628,860
 2,705,400
 264,757
 2,970,157
Change in unearned premiums(103,215) (113,829) 46,825
 (170,219) 32,655
 (137,564)
Net premiums earned1,145,947
 713,549
 675,685
 2,535,181
 297,412
 2,832,593
Other underwriting income (loss)
 5,601
 7,912
 13,513
 1,265
 14,778
Losses and loss adjustment expenses(745,895) (480,768) (37,146) (1,263,809) (222,266) (1,486,075)
Acquisition expenses(173,918) (111,111) (64,326) (349,355) (58,582) (407,937)
Other operating expenses(222,919) (69,664) (79,694) (372,277) (27,800) (400,077)
Underwriting income (loss)$3,215
 $57,607
 $502,431
 563,253
 (9,971) 553,282
            
Net investment income      244,287
 67,700
 311,987
Net realized gains (losses)      236,187
 24,826
 261,013
Equity in net income (loss) of investment funds accounted for using the equity method      79,403
 
 79,403
Other income (loss)      2,212
 
 2,212
Corporate expenses (2)      (32,845) 
 (32,845)
Transaction costs and other (2)      (3,368) 
 (3,368)
Amortization of intangible assets      (40,211) 
 (40,211)
Interest expense      (46,857) (11,488) (58,345)
Net foreign exchange gains (losses)      (1,015) (412) (1,427)
Income (loss) before income taxes      1,001,046
 70,655
 1,071,701
Income tax (expense) benefit      (90,338) (20) (90,358)
Net income (loss)      910,708
 70,635
 981,343
Dividends attributable to redeemable noncontrolling interests      
 (9,178) (9,178)
Amounts attributable to nonredeemable noncontrolling interests      
 (54,683) (54,683)
Net income (loss) available to Arch      910,708
 6,774
 917,482
Preferred dividends      (20,806) 
 (20,806)
Net income (loss) available to Arch common shareholders      $889,902
 $6,774
 $896,676
            
Underwriting Ratios 
  
  
    
  
Loss ratio65.1% 67.4% 5.5% 49.9% 74.7% 52.5%
Acquisition expense ratio15.2% 15.6% 9.5% 13.8% 19.7% 14.4%
Other operating expense ratio19.5% 9.8% 11.8% 14.7% 9.3% 14.1%
Combined ratio99.8% 92.8% 26.8% 78.4% 103.7% 81.0%

(1)Certain amounts included in the gross premiums written of each segment are related to intersegment transactions. Accordingly, the sum of gross premiums written for each segment does not agree to the total gross premiums written as shown in the table above due to the elimination of intersegment transactions in the total.
(2)Certain expenses have been excluded from ‘corporate expenses’ and reflected in ‘transaction costs and other.’




ARCH CAPITAL 192020 SECOND QUARTER FORM 10-Q

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

5.    Reserve for Losses and Loss Adjustment Expenses

The following table represents an analysis of losses and loss adjustment expenses and a reconciliation of the beginning and ending reserve for losses and loss adjustment expenses:
 Three Months Ended Six Months Ended
 June 30, June 30,
 2020 2019 2020 2019
Reserve for losses and loss adjustment expenses at beginning of period$14,309,580
 $12,010,041
 $13,891,842
 $11,853,297
Unpaid losses and loss adjustment expenses recoverable4,070,114
 2,970,159
 4,082,650
 2,814,291
Net reserve for losses and loss adjustment expenses at beginning of period10,239,466
 9,039,882
 9,809,192
 9,039,006
        
Net incurred losses and loss adjustment expenses relating to losses occurring in:       
Current year1,274,589
 805,728
 2,409,031
 1,563,692
Prior years(44,067) (38,185) (63,090) (77,617)
Total net incurred losses and loss adjustment expenses1,230,522
 767,543
 2,345,941
 1,486,075
        
Retroactive reinsurance transactions (1)
 
 60,635
 (225,500)
        
Net foreign exchange (gains) losses51,157
 (1,277) (91,416) (1,781)
        
Net paid losses and loss adjustment expenses relating to losses occurring in:       
Current year(128,174) (61,148) (169,434) (125,488)
Prior years(504,254) (539,481) (1,066,201) (966,793)
Total net paid losses and loss adjustment expenses(632,428) (600,629) (1,235,635) (1,092,281)
        
Net reserve for losses and loss adjustment expenses at end of period10,888,717
 9,205,519
 10,888,717
 9,205,519
Unpaid losses and loss adjustment expenses recoverable4,156,157
 3,024,797
 4,156,157
 3,024,797
Reserve for losses and loss adjustment expenses at end of period$15,044,874
 $12,230,316
 $15,044,874
 $12,230,316

(1)During 2020 first quarter, a subsidiary of the Company entered into a reinsurance to close agreement of the 2017 and prior years of account previously covered by a third party arrangement, while in the 2019 first quarter, a subsidiary of the Company entered into a retroactive reinsurance transaction with third party reinsurer to reinsure run-off liabilities associated with certain U.S. insurance exposures.

Development on Prior Year Loss Reserves

2020 Second Quarter

During the 2020 second quarter, the Company recorded net favorable development on prior year loss reserves of $44.1 million, which consisted of $2.5 million from the insurance segment, $40.2 million from the reinsurance segment, $0.2 million from the mortgage segment and $1.1 million from the ‘other’ segment.
The insurance segment’s net favorable development of $2.5 million, or 0.4 loss ratio points, for the 2020 second quarter consisted of $19.7 million of net favorable development in short-tailed and long-tailed lines and $17.1 million of net adverse development in medium-tailed lines. Net favorable development of $11.5 million in short-tailed lines reflected $7.5 million of favorable development from property (excluding marine), primarily from the 2016 to 2019 accident years (i.e., the year in which a loss occurred) and $3.5 million of favorable development on travel and accident, primarily from the 2019 accident year. Net favorable development of $8.1 million in long-tailed lines reflected $2.4 million of favorable
 
development in executive assurance, primarily from the 2013 accident year, and $4.9 million of favorable development related to other business, including alternative markets and excess workers’ compensation, across most accident years. Net adverse development in medium-tailed lines included $6.3 million of adverse development in professional liability, primarily from the 2009, 2016 and 2019 accident years, $6.1 million of adverse development in contract binding, across all accident years, and $4.0 million of adverse development on program business, primarily from the 2014 and 2017 accident years.

The reinsurance segment’s net favorable development of $40.2 million, or 8.4 loss ratio points, for the 2020 second quarter consisted of $46.2 million of net favorable development from short-tailed lines and net adverse development of $6.0 million from and medium-tailed and long-tailed lines. Net favorable development in short-tailed lines reflected $27.5 million of favorable development from other specialty, across most underwriting years (i.e., all premiums and losses attributable to contracts having an inception or renewal date within the given twelve-month period), and $18.3 million of favorable development related to property catastrophe and property other

ARCH CAPITAL 202020 SECOND QUARTER FORM 10-Q

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

than property catastrophe business, primarily from the 2016 to 2019 underwriting years. Adverse development of $5.8 million in long-tailed lines reflected an increase in reserves from casualty, primarily from the 2012 to 2015 underwriting years.

The mortgage segment’s net favorable development was $0.2 million, or 0.1 loss ratio points, for the 2020 second quarter.
2019 Second Quarter
During the 2019 second quarter, the Company recorded net favorable development on prior year loss reserves of $38.2 million, which consisted of $2.6 million from the insurance segment, $12.7 million from the reinsurance segment, $22.8 million from the mortgage segment and $0.1 million from the ‘other’ segment.
The insurance segment’s net favorable development of $2.6 million, or 0.4 loss ratio points, for the 2019 second quarter consisted of $8.0 million of net favorable development in short-tailed lines, $10.4 million of net adverse development in medium-tailed lines and $4.9 million of net favorable development in long-tailed lines. Net favorable development in short-tailed lines primarily resulted from property (excluding marine) reserves across all accident years (i.e., the year in which a loss occurred). Net adverse development in medium-tailed lines primarily resulted from $15.5 million of adverse development on program business. Such amounts were partially offset by $5.1 million of net favorable development in other medium-tailed lines, including surety business and professional liability, across most accident years. Net favorable development in long-tailed lines primarily resulted from reductions in executive assurance reserves of $5.1 million, primarily from the 2008 to 2014 accident years.
The reinsurance segment’s net favorable development of $12.7 million, or 3.5 loss ratio points, for the 2019 second quarter consisted of $1.8 million of net favorable development from short-tailed lines and $10.9 million of net favorable development from long-tailed and medium-tailed lines. Net favorable development in short-tailed lines primarily resulted from other specialty lines across most underwriting years (i.e., all premiums and losses attributable to contracts having an inception or renewal date within the given twelve-month period) and in property other than property catastrophe reserves from earlier underwriting years, partially offset by a small amount of adverse development from property catastrophe and property other than property catastrophe reserves in the 2015 and 2018 underwriting years. Favorable development in long-tailed and medium-tailed lines reflected reductions in casualty and marine reserves from most underwriting years.
The mortgage segment’s net favorable development was $22.8 million, or 6.5 loss ratio points, for the 2019 second quarter. The 2019 second quarter development was primarily driven by continued favorable claim rates on first lien business and subrogation recoveries on second lien business.
 
Six Months Ended June 30, 2020
During the six months ended June 30, 2020, the Company recorded net favorable development on prior year loss reserves of $63.1 million, which consisted of $3.6 million from the insurance segment, $51.8 million from the reinsurance segment, $6.3 million from the mortgage segment and $1.3 million from the ‘other’ segment.
The insurance segment’s net favorable development of $3.6 million, or 0.3 loss ratio points, for the 2020 period consisted of $28.7 million of net favorable development in short-tailed and long-tailed lines, partially offset by $25.1 million of net adverse development in medium-tailed lines. Net favorable development of $15.4 million in short-tailed lines reflected $9.6 million of favorable development from property (excluding marine), primarily from the 2015 to 2018 accident years and $3.1 million of favorable development in lenders products, primarily from the 2017 to 2019 accident years. Net favorable development of $13.3 million in long-tailed lines included $7.6 million of favorable development related to other business, including alternative markets and excess workers’ compensation, primarily in the 2016 and 2017 accident years. Net adverse development in medium-tailed lines reflected $19.3 million of adverse development in contract binding business, primarily in the 2016 to 2019 accident years, and $6.3 million of adverse development in program business, primarily from the 2017 and 2018 accident years.
The reinsurance segment’s net favorable development of $51.8 million, or 5.1 loss ratio points, for the 2020 period consisted of $67.4 million of net favorable development from short-tailed and medium-tailed lines, offset by $15.6 million of net adverse development from long-tailed lines. Net favorable development of $65.7 million in short-tailed lines reflected $39.3 million from other specialty lines and $21.3 million from property catastrophe, primarily from the 2015 to 2019 underwriting years. Adverse development in long-tailed lines reflected an increase in reserves from casualty, primarily from the 2012 to 2015 underwriting years.
The mortgage segment’s net favorable development was $6.3 million, or 0.9 loss ratio points, for the 2020 period. The 2020 development was primarily driven by subrogation recoveries on second lien business and student loan business.
Six Months Ended June 30, 2019

During the six months ended June 30, 2019, the Company recorded net favorable development on prior year loss reserves of $77.6 million, which consisted of $7.0 million from the insurance segment, $11.0 million from the reinsurance segment, $59.4 million from the mortgage segment and $0.1 million from the ‘other’ segment.
The insurance segment’s net favorable development of $7.0 million, or 0.6 loss ratio points, for the 2019 period consisted

ARCH CAPITAL 212020 SECOND QUARTER FORM 10-Q

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

of $17.7 million of net favorable development in short-tailed lines and $6.6 million of net favorable development in long-tailed lines, partially offset by $17.3 million of net adverse development in medium-tailed lines. Net favorable development in short-tailed lines primarily resulted from property (excluding marine) reserves from the 2010 to 2018 accident years. Net favorable development in long-tailed lines reflected net reductions in executive assurance reserves of $5.7 million, primarily from the 2013 and 2015 accident years. Net adverse development in medium-tailed lines reflected $23.2 million of adverse development in program business, primarily from the 2018 accident year, and $9.7 million of adverse development on contract binding business, across most accident years. Such amounts were partially offset by $15.6 million of net favorable development in other medium-tailed lines, including professional liability, marine and surety business, across most accident years.
The reinsurance segment’s net favorable development of $11.0 million, or 1.5 loss ratio points, for the 2019 period consisted of $4.3 million of net adverse development from short-tailed lines, offset by $15.3 million of net favorable development from long-tailed and medium-tailed lines. Net adverse development in short-tailed lines reflected $17.9 million from property catastrophe and property other than property catastrophe reserves, reflecting an increase in reserves on Typhoon Jebi in the 2019 first quarter of $16.0 million following receipt of updated information from cedents and additional updated industry data. Such amounts were partially offset by $10.2 million of favorable development on other specialty lines, primarily from the 2016 to 2018 underwriting years. Favorable development in long-tailed and medium-tailed lines reflected reductions in casualty reserves of $9.1 million based on varying levels of reported and paid claims activity, primarily from the 2002 to 2007 underwriting years, and favorable development in marine reserves of $6.2 million, primarily from the 2015 to 2018 underwriting years.
The mortgage segment’s net favorable development was $59.4 million, or 8.8 loss ratio points, for the 2019 period. The 2019 development was primarily driven by continued lower than expected claim rates on first lien business and subrogation recoveries on second lien business.
6.    Allowance for Expected Credit Losses
Premiums Receivable
The following table provides a roll forward of the allowance for expected credit losses of the Company’s premium receivables:
 
  June 30, 2020

 Premium Receivables, Net of Allowance Allowance for Expected Credit Losses
Three Months Ended    
Balance at beginning of period $2,155,204
 $27,990
Cumulative effect of accounting change (1)   
Change for provision of expected credit losses (2)   8,064
Balance at end of period $2,203,753
 $36,054
     
Six Months Ended    
Balance at beginning of period $1,778,717
 $21,003
Cumulative effect of accounting change (1)   6,539
Change for provision of expected credit losses (2)   8,512
Balance at end of period $2,203,753
 $36,054
(1) Adoption of ASU 2016-13, “Financial Instruments - Credit Losses (Topic 326)” See note 1.
(2) Amounts deemed uncollectible are written-off in operating expenses. For the 2020 second quarter and six months ended June 30, 2020, amounts written off totaled $1.8 million and $2.3 million, respectively.
Reinsurance Recoverables
The following table provides a roll forward of the allowance for expected credit losses of the Company’s reinsurance recoverables:
  June 30, 2020
  Reinsurance Recoverables, Net of Allowance Allowance for Expected Credit Losses
Three Months Ended    
Balance at beginning of period $4,303,135
 $13,700
Cumulative effect of accounting change (1)   
Change for provision of expected credit losses   (105)
Balance at end of period $4,363,507
 $13,595
     
Six Months Ended    
Balance at beginning of period $4,346,816
 $1,364
Cumulative effect of accounting change (1)   12,010
Change for provision of expected credit losses   221
Balance at end of period $4,363,507
 $13,595

(1) Adoption of ASU 2016-13, “Financial Instruments - Credit Losses (Topic 326)” See note 1.

ARCH CAPITAL 222020 SECOND QUARTER FORM 10-Q

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

At June 30, 2020 and December 31, 2019, approximately 63.1% and 61.2% of reinsurance recoverables on paid and unpaid losses (not including ceded unearned premiums) of $4.38 billion and $4.35 billion, respectively, were due from carriers which had an A.M. Best rating of “A-” or better while 36.7% and 38.8%, respectively, were from companies not rated. For items not rated, over 90% of such amount was collateralized through reinsurance trusts or letters of credit at June 30, 2020 and December 31, 2019. The largest reinsurance recoverables from any one carrier were approximately 1.8% and 1.7%, of total shareholders’ equity available to Arch at June 30, 2020 and December 31, 2019, respectively.
Contractholder Receivables
The following table provides a roll forward of the allowance for expected credit losses of the Company’s contractholder receivables:
  June 30, 2020
  Contractholder Receivables, Net of Allowance Allowance for Expected Credit Losses
Three Months Ended    
Balance at beginning of period $2,140,724
 $9,038
Cumulative effect of accounting change (1)   
Change for provision of expected credit losses   (2,748)
Balance at end of period $2,179,124
 $6,290
     
Six Months Ended    
Balance at beginning of period $2,119,460
 $
Cumulative effect of accounting change (1)   6,663
Change for provision of expected credit losses   (373)
Balance at end of period $2,179,124
 $6,290
(1) Adoption of ASU 2016-13, “Financial Instruments - Credit Losses (Topic 326)” See note 1.


ARCH CAPITAL 232020 SECOND QUARTER FORM 10-Q

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

7.    Investment Information


At June 30, 2020, total investable assets of $27.17 billion included $24.53 billion held by the Company and $2.64 billion attributable to Watford.
Available For Sale Investments
The following table summarizes the fair value and cost or amortized cost of the Company’s securities classified as available for sale:
 
Estimated
Fair
Value
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 Allowance for Expected Credit Losses (2) 
Cost or
Amortized
Cost
June 30, 2020         
Fixed maturities (1):         
Corporate bonds$7,143,600
 $405,579
 $(34,700) $(4,116) $6,776,837
Mortgage backed securities610,839
 12,417
 (5,245) (222) 603,889
Municipal bonds517,089
 25,222
 (542) (28) 492,437
Commercial mortgage backed securities395,682
 7,603
 (8,005) (109) 396,193
U.S. government and government agencies5,192,991
 64,502
 (2,708) 
 5,131,197
Non-U.S. government securities2,171,955
 71,666
 (43,928) 
 2,144,217
Asset backed securities1,633,481
 31,410
 (39,421) (1,394) 1,642,886
Total17,665,637
 618,399
 (134,549) (5,869) 17,187,656
Short-term investments2,277,866
 2,087
 (634) 
 2,276,413
Total$19,943,503
 $620,486
 $(135,183) $(5,869) $19,464,069
          
December 31, 2019         
Fixed maturities (1):         
Corporate bonds$6,406,591
 $191,889
 $(12,793)   $6,227,495
Mortgage backed securities562,309
 9,669
 (931)   553,571
Municipal bonds881,926
 24,628
 (2,213)   859,511
Commercial mortgage backed securities733,108
 14,951
 (2,330)   720,487
U.S. government and government agencies4,916,592
 36,600
 (10,134)   4,890,126
Non-U.S. government securities2,078,757
 48,549
 (20,330)   2,050,538
Asset backed securities1,683,753
 24,017
 (4,724)   1,664,460
Total17,263,036
 350,303
 (53,455)   16,966,188
Short-term investments956,546
 811
 (1,548)   957,283
Total$18,219,582
 $351,114
 $(55,003)   $17,923,471
(1)In securities lending transactions, the Company receives collateral in excess of the fair value of the fixed maturities pledged. For purposes of this table, the Company has excluded the collateral received under securities lending, at fair value and included the securities pledged under securities lending, at fair value. See “—Securities Lending Agreements.”
(2)
Effective January 1, 2020, the Company adopted ASU 2016-13 and as a result any credit impairment losses on the Company’s available-for-sale investments are recorded as an allowance, subject to reversal. See note 1.

ARCH CAPITAL 242020 SECOND QUARTER FORM 10-Q

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following table summarizes, for all available for sale securities in an unrealized loss position, the fair value and gross unrealized loss by length of time the security has been in a continual unrealized loss position:
 Less than 12 Months 12 Months or More Total
 Estimated
Fair
Value
 
Gross
Unrealized
Losses
 Estimated
Fair
Value
 
Gross
Unrealized
Losses
 Estimated
Fair
Value
 
Gross
Unrealized
Losses
June 30, 2020           
Fixed maturities (1):           
Corporate bonds$737,840
 $(32,848) $8,726
 $(1,852) $746,566
 $(34,700)
Mortgage backed securities150,547
 (5,212) 108
 (33) 150,655
 (5,245)
Municipal bonds46,969
 (542) 
 
 46,969
 (542)
Commercial mortgage backed securities205,336
 (7,858) 2,523
 (147) 207,859
 (8,005)
U.S. government and government agencies412,319
 (2,708) 
 
 412,319
 (2,708)
Non-U.S. government securities1,371,109
 (43,928) 
 
 1,371,109
 (43,928)
Asset backed securities721,451
 (37,069) 32,198
 (2,352) 753,649
 (39,421)
Total3,645,571
 (130,165) 43,555
 (4,384) 3,689,126
 (134,549)
Short-term investments1,025,993
 (634) 
 
 1,025,993
 (634)
Total$4,671,564
 $(130,799) $43,555
 $(4,384) $4,715,119
 $(135,183)
            
December 31, 2019           
Fixed maturities (1):           
Corporate bonds$675,131
 $(12,350) $37,671
 $(443) $712,802
 $(12,793)
Mortgage backed securities102,887
 (927) 203
 (4) 103,090
 (931)
Municipal bonds220,296
 (2,213) 
 
 220,296
 (2,213)
Commercial mortgage backed securities147,290
 (2,302) 2,683
 (28) 149,973
 (2,330)
U.S. government and government agencies1,373,127
 (10,089) 32,058
 (45) 1,405,185
 (10,134)
Non-U.S. government securities1,224,243
 (20,163) 37,610
 (167) 1,261,853
 (20,330)
Asset backed securities441,522
 (3,334) 48,313
 (1,390) 489,835
 (4,724)
Total4,184,496
 (51,378) 158,538
 (2,077) 4,343,034
 (53,455)
Short-term investments95,777
 (1,548) 
 
 95,777
 (1,548)
Total$4,280,273
 $(52,926) $158,538
 $(2,077) $4,438,811
 $(55,003)
(1)In securities lending transactions, the Company receives collateral in excess of the fair value of the fixed maturities pledged. For purposes of this table, the Company has excluded the collateral received under securities lending, at fair value and included the securities pledged under securities lending, at fair value. See “—Securities Lending Agreements.”

At June 30, 2020, on a lot level basis, approximately 3,730 security lots out of a total of approximately 10,540 security lots were in an unrealized loss position and the largest single unrealized loss from a single lot in the Company’s fixed maturity portfolio was $1.2 million. At December 31, 2019, on a lot level basis, approximately 2,230 security lots out of a total of approximately 9,590 security lots were in an unrealized loss position and the largest single unrealized loss from a single lot in the Company’s fixed maturity portfolio was $0.9 million.

ARCH CAPITAL 252020 SECOND QUARTER FORM 10-Q

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The contractual maturities of the Company’s fixed maturities are shown in the following table. Expected maturities, which are management’s best estimates, will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
  June 30, 2020 December 31, 2019
Maturity 
Estimated
Fair
Value
 
Amortized
Cost
 Estimated
Fair
Value
 
Amortized
Cost
Due in one year or less $344,032
 $339,451
 $428,659
 $423,617
Due after one year through five years 9,873,345
 9,645,073
 10,126,403
 9,996,206
Due after five years through 10 years 4,379,828
 4,163,392
 3,317,535
 3,219,567
Due after 10 years 428,430
 396,772
 411,269
 388,280
  15,025,635
 14,544,688
 14,283,866
 14,027,670
Mortgage backed securities 610,839
 603,889
 562,309
 553,571
Commercial mortgage backed securities 395,682
 396,193
 733,108
 720,487
Asset backed securities 1,633,481
 1,642,886
 1,683,753
 1,664,460
Total (1) $17,665,637
 $17,187,656
 $17,263,036
 $16,966,188

(1)In securities lending transactions, the Company receives collateral in excess of the fair value of the fixed maturities pledged. For purposes of this table, the Company has excluded the collateral received under securities lending, at fair value and included the securities pledged under securities lending, at fair value.
See “—Securities Lending Agreements.”

Securities Lending Agreements
The Company enters into securities lending agreements with financial institutions to enhance investment income whereby it loans certain of its securities to third parties, primarily major brokerage firms, for short periods of time through a lending agent. The Company maintains legal control over the securities it lends (shown as ‘Securities pledged under securities lending, at fair value’ on the Company’s balance sheet), retains the earnings and cash flows associated with the loaned securities and receives a fee from the borrower for the temporary use of the securities. An indemnification agreement with the lending agent protects the Company in the event a borrower becomes insolvent or fails to return any of the securities on loan from the Company.
The Company receives collateral (shown as ‘Collateral received under securities lending, at fair value’ on the Company’s balance sheet) in the form of cash or U.S. government and government agency securities. At June 30, 2020, the fair value of the cash collateral received on securities lending was $26.6 million and the fair value of security collateral received was $447.2 million. At December 31, 2019, the fair value of the cash collateral received on securities lending was $81.2 million, and the fair value of security collateral received was $307.2 million.

ARCH CAPITAL 262020 SECOND QUARTER FORM 10-Q

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The carrying value of collateral held under the Company’s securities lending transactions by significant investment category and remaining contractual maturity of the underlying agreements is as follows:
  Remaining Contractual Maturity of the Agreements
  Overnight and Continuous Less than 30 Days 30-90 Days 90 Days or More Total
June 30, 2020          
U.S. government and government agencies $291,730
 $
 $153,552
 $
 $445,282
Corporate bonds 2,336
 
 
 
 2,336
Equity securities 26,165
 
 
 
 26,165
Total $320,231
 $
 $153,552
 $
 $473,783
Gross amount of recognized liabilities for securities lending in offsetting disclosure in note 9 $
Amounts related to securities lending not included in offsetting disclosure in note 9 $473,783
           
December 31, 2019          
U.S. government and government agencies $240,332
 $
 $115,973
 $
 $356,305
Corporate bonds 2,570
 
 
 
 2,570
Equity securities 29,491
 
 
 
 29,491
Total $272,393
 $
 $115,973
 $
 $388,366
Gross amount of recognized liabilities for securities lending in offsetting disclosure in note 9
 $
Amounts related to securities lending not included in offsetting disclosure in note 9
 $388,366

Equity Securities, at Fair Value
At June 30, 2020, the Company held $1.26 billion of equity securities, at fair value, compared to $838.9 million at December 31, 2019. Such holdings include publicly traded common stocks primarily in the consumer cyclical and non-cyclical, technology, communication and financial sectors and exchange-traded funds in fixed income, equity and other sectors.
Other Investments
The following table summarizes the Company’s other investments which are included in investments accounted for using the fair value option, by strategy:
 June 30,
2020
 December 31,
2019
Term loan investments$1,109,031
 $1,326,018
Lending579,320
 602,841
Credit related funds92,970
 123,020
Energy66,667
 97,402
Investment grade fixed income133,936
 151,594
Infrastructure48,427
 61,786
Private equity72,888
 49,376
Real estate19,251
 17,279
Total$2,122,490
 $2,429,316

 
Investments Accounted For Using the Equity Method
The following table summarizes the Company’s investments accounted for using the equity method, by strategy:
 June 30,
2020
 December 31,
2019
Credit related funds$624,382
 $428,437
Equities292,499
 293,686
Real estate249,822
 246,851
Lending137,270
 202,690
Private equity181,492
 144,983
Infrastructure141,972
 235,033
Energy99,865
 108,716
Total$1,727,302
 $1,660,396

Certain of the Company’s other investments are in investment funds for which the Company has the option to redeem at agreed upon values as described in each investment fund’s subscription agreement. Depending on the terms of the various subscription agreements, investments in investment funds may be redeemed daily, monthly, quarterly or on other terms. Two common redemption restrictions which may impact the Company’s ability to redeem these investment funds are gates and lockups. A gate is a suspension of redemptions which may be implemented by the general partner or investment manager of the fund in order to defer, in whole or in part, the redemption request in the event the aggregate amount of redemption requests exceeds a predetermined percentage of the investment fund’s net assets which may otherwise hinder the general partner or investment manager’s ability to liquidate holdings in an orderly fashion in order to generate the cash necessary to fund extraordinarily large redemption payouts. A lockup period

ARCH CAPITAL 272020 SECOND QUARTER FORM 10-Q

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

is the initial amount of time an investor is contractually required to hold the security before having the ability to redeem. If the investment funds are eligible to be redeemed, the time to redeem such fund can take weeks or months following the notification.
Fair Value Option 
The following table summarizes the Company’s assets which are accounted for using the fair value option:
 June 30,
2020
 December 31,
2019
Fixed maturities$923,804
 $754,452
Other investments2,122,490
 2,429,316
Short-term investments384,382
 377,014
Equity securities90,095
 102,695
Investments accounted for using the fair value option$3,520,771
 $3,663,477

Limited Partnership Interests
In the normal course of its activities, the Company invests in limited partnerships as part of its overall investment strategy. Such amounts are included in ‘investments accounted for using the equity method’ and ‘investments accounted for using the fair value option.’ The Company has determined that it is not required to consolidate these investments because it is not the primary beneficiary of the funds. The Company’s maximum exposure to loss with respect to these investments is limited to the investment carrying amounts reported in the Company’s consolidated balance sheet and any unfunded commitment.
The following table summarizes investments in limited partnership interests where the Company has a variable interest by balance sheet line item:
 June 30,
2020
 December 31,
2019
Investments accounted for using the equity method (1)1,727,302
 1,660,396
Investments accounted for using the fair value option (2)178,894
 188,283
Total$1,906,196
 $1,848,679
(1)Aggregate unfunded commitments were $1.44 billion at June 30, 2020, compared to $1.36 billion at December 31, 2019.
(2)Aggregate unfunded commitments were $32.3 million at June 30, 2020, compared to $41.7 million at December 31, 2019.
 
Net Investment Income
The components of net investment income were derived from the following sources:
 June 30,
 2020 2019
Three Months Ended   
Fixed maturities$105,391
 $125,018
Term loans20,512
 24,730
Equity securities6,219
 4,368
Short-term investments3,383
 3,859
Other (1)16,460
 18,523
Gross investment income151,965
 176,498
Investment expenses(20,480) (21,460)
Net investment income$131,485
 $155,038
    
Six Months Ended   
Fixed maturities$220,238
 $254,817
Term loans43,682
 49,346
Equity securities12,226
 7,356
Short-term investments8,279
 8,038
Other (1)35,866
 39,719
Gross investment income320,291
 359,276
Investment expenses(43,653) (47,289)
Net investment income$276,638
 $311,987
(1)Includes income distributions from investment funds and other items.

ARCH CAPITAL 282020 SECOND QUARTER FORM 10-Q

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Net Realized Gains (Losses)
Net realized gains (losses), which include changes in the allowance for credit losses on financial assets and net impairment losses recognized in earnings were as follows:
 June 30,
 2020 2019
Three Months Ended   
Available for sale securities: 
  
Gross gains on investment sales$232,153
 $75,090
Gross losses on investment sales(49,824) (15,281)
Change in fair value of assets and liabilities accounted for using the fair value option:   
Fixed maturities68,181
 11,429
Other investments178,570
 (33,780)
Equity securities6,664
 6,414
Short-term investments3,368
 (1,392)
Equity securities, at fair value:   
Net realized gains (losses) on sales during the period(18,250) (6,644)
Net unrealized gains (losses) on equity securities still held at reporting date145,686
 22,632
Allowance for credit losses:   
Investments related3,225
 
Underwriting related(5,834) 
Net impairment losses
 (49)
Derivative instruments (1)(836) 63,966
Other(6,515) (1,628)
Net realized gains (losses)$556,588
 $120,757
    
Six Months Ended   
Available for sale securities:   
Gross gains on investment sales$410,353
 $118,455
Gross losses on investment sales(81,792) (46,937)
Change in fair value of assets and liabilities accounted for using the fair value option:   
Fixed maturities(59,485) 42,577
Other investments(129,230) (15,585)
Equity securities1,755
 10,680
Short-term investments(5,313) (672)
Equity securities, at fair value:   
Net realized gains (losses) on sales during the period(18,789) 4,286
Net unrealized gains (losses) on equity securities still held at reporting date(29,880) 59,768
Allowance for credit losses:   
Investments related(6,095) 
Underwriting related(9,104) 
Net impairments losses(533) (1,358)
Derivative instruments (1)126,353
 99,837
Other(8,612) (10,038)
Net realized gains (losses)$189,628
 $261,013

(1)
See note 9 for information on the Company’s derivative instruments.

 
Equity in Net Income (Loss) of Investment Funds Accounted for Using the Equity Method
The Company recorded a loss of $65.1 million related to investment funds accounted for using the equity method in the 2020 second quarter, compared to income of $32.5 million for the 2019 second quarter, and a loss of $69.3 million for the six months ended June 30, 2020, compared to income of $79.4 million for the six months ended June 30, 2019. In applying the equity method, investments are initially recorded at cost and are subsequently adjusted based on the Company’s 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). Such investments are generally recorded on a one to three month lag based on the availability of reports from the investment funds.

ARCH CAPITAL 292020 SECOND QUARTER FORM 10-Q

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Allowance for Expected Credit Losses
The following table provides a roll forward of the allowance for expected credit losses of the Company’s securities classified as available for sale:
  June 30, 2020
  Structured Securities (1) 
Municipal
Bonds
 
Corporate
Bonds
 Short Term Investments Total
Three Months Ended        
Balance at beginning of period $2,654
 $23
 $7,232
 $29
 $9,938
Cumulative effect of accounting change 
 
 
 
 
Additions for current-period provision for expected credit losses 695
 44
 290
 (29) 1,000
Additions (reductions) for previously recognized expected credit losses (1,304) (25) (2,903) 
 (4,232)
Reductions due to disposals (319) (14) (504) 
 (837)
Write-offs charged against the allowance 
 
 
 
 
Balance at end of period $1,726
 $28
 $4,115
 $
 $5,869
           
Six Months Ended          
Balance at beginning of period $
 $
 $
 $
 $
Cumulative effect of accounting change 517
 
 117
 
 634
Additions for current-period provision for expected credit losses 2,841
 67
 7,441
 
 10,349
Additions (reductions) for previously recognized expected credit losses (1,306) (25) (2,924) 
 (4,255)
Reductions due to disposals (326) (14) (519) 
 (859)
Write-offs charged against the allowance 
 
 
 
 
Balance at end of period $1,726
 $28
 $4,115
 $
 $5,869
(1)Includes asset backed securities, mortgage backed securities and commercial mortgage backed securities.

Restricted Assets
The Company is required to maintain assets on deposit, which primarily consist of fixed maturities, with various regulatory authorities to support its underwriting operations. The Company’s subsidiaries maintain assets in trust accounts as collateral for transactions with affiliated companies and also have investments in segregated portfolios primarily to provide collateral or guarantees for letters of credit to third parties. See note 17, “Commitments and Contingencies,” of the notes to consolidated financial statements in the Company’s 2019 Form 10-K.
The following table details the value of the Company’s restricted assets:
 June 30,
2020
 December 31,
2019
Assets used for collateral or guarantees: 
  
Affiliated transactions$4,633,689
 $4,526,761
Third party agreements2,525,173
 2,278,248
Deposits with U.S. regulatory authorities862,859
 797,371
Deposits with non-U.S. regulatory authorities189,107
 119,238
Total restricted assets$8,210,828
 $7,721,618


 
In addition, Watford maintains secured credit facilities to provide borrowing capacity for investment purposes and a total return swap agreement and maintains assets pledged as collateral for such purposes. The Company does not guarantee or provide credit support for Watford, and the Company’s financial exposure to Watford is limited to its investment in Watford’s senior notes, common and preferred shares and counterparty credit risk (mitigated by collateral) arising from reinsurance transactions. As of June 30, 2020 and December 31, 2019, Watford held $1.14 billion and $1.0 billion, respectively, in pledged assets to collateralize the credit facility mentioned above.
Reconciliation of Cash and Restricted Cash
The following table details reconciliation of cash and restricted cash within the Consolidated Balance Sheets:
 June 30,
2020
 December 31,
2019
Cash$854,259
 $726,230
Restricted cash (included in ‘other assets’)$210,424
 $177,468
Cash and restricted cash$1,064,683
 $903,698



ARCH CAPITAL 302020 SECOND QUARTER FORM 10-Q

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

8.    Fair Value

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. It defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly fashion between market participants at the measurement date. In addition, it establishes a three-level valuation hierarchy for the disclosure of fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The level in the hierarchy within which a given fair value measurement falls is determined based on the lowest level input that is significant to the measurement (Level 1 being the highest priority and Level 3 being the lowest priority).
The levels in the hierarchy are defined as follows:
Level 1:
Inputs to the valuation methodology are observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets
Level 2:Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument
Level 3:Inputs to the valuation methodology are unobservable and significant to the fair value measurement
Following is a description of the valuation methodologies used for securities measured at fair value, as well as the general classification of such securities pursuant to the valuation hierarchy. The Company reviews its securities measured at fair value and discusses the proper classification of such investments with investment advisers and others.
The Company determines the existence of an active market based on its judgment as to whether transactions for the financial instrument occur in such market with sufficient frequency and volume to provide reliable pricing information. The independent pricing sources obtain market quotations and actual transaction prices for securities that have quoted prices in active markets. The Company uses quoted values and other data provided by nationally recognized independent pricing sources as inputs into its process for determining fair values of its fixed maturity investments. To validate the techniques or models used by pricing sources, the Company's review process includes, but is not limited to: (i) quantitative analysis (e.g.,
 
comparing the quarterly return for each managed portfolio to its target benchmark, with significant differences identified and investigated); (ii) a review of the average number of prices obtained in the pricing process and the range of resulting fair values; (iii) initial and ongoing evaluation of methodologies used by outside parties to calculate fair value; (iv) a comparison of the fair value estimates to the Company’s knowledge of the current market; (v) a comparison of the pricing services' fair values to other pricing services' fair values for the same investments; and (vi) periodic back-testing, which includes randomly selecting purchased or sold securities and comparing the executed prices to the fair value estimates from the pricing service. A price source hierarchy was maintained in order to determine which price source would be used (i.e., a price obtained from a pricing service with more seniority in the hierarchy will be used over a less senior one in all cases). The hierarchy prioritizes pricing services based on availability and reliability and assigns the highest priority to index providers. Based on the above review, the Company will challenge any prices for a security or portfolio which are considered not to be representative of fair value. The Company did not adjust any of the prices obtained from the independent pricing sources at June 30, 2020.
In certain circumstances, when fair values are unavailable from these independent pricing sources, quotes are obtained directly from broker-dealers who are active in the corresponding markets. Such quotes are subject to the validation procedures noted above. Where quotes are unavailable, fair value is determined by the Investment Manager using quantitative and qualitative assessments such as internally modeled values. Of the $24.92 billion of financial assets and liabilities measured at fair value at June 30, 2020, approximately $121.1 million, or 0.5%, were priced using non-binding broker-dealer quotes or modeled valuations. Of the $22.90 billion of financial assets and liabilities measured at fair value at December 31, 2019, approximately $179.6 million, or 0.8%, were priced using non-binding broker-dealer quotes or modeled valuations.
Fixed maturities
The Company uses the market approach valuation technique to estimate the fair value of its fixed maturity securities, when possible. The market approach includes obtaining prices from independent pricing services, such as index providers and pricing vendors, as well as to a lesser extent quotes from broker-dealers. The independent pricing sources obtain market quotations and actual transaction prices for securities that have quoted prices in active markets. Each source has its own proprietary method for determining the fair value of securities that are not actively traded. In general, these methods involve the use of “matrix pricing” in which the independent pricing source uses observable market inputs including, but not limited to, investment yields, credit risks and spreads, benchmarking of like securities, broker-dealer quotes, reported trades and sector groupings to determine a reasonable fair value.

ARCH CAPITAL 312020 SECOND QUARTER FORM 10-Q

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following describes the significant inputs generally used to determine the fair value of the Company’s fixed maturity securities by asset class:
U.S. government and government agencies — valuations provided by independent pricing services, with all prices provided through index providers and pricing vendors. The Company determined that all U.S. Treasuries would be classified as Level 1 securities due to observed levels of trading activity, the high number of strongly correlated pricing quotes received on U.S. Treasuries and other factors. The fair values of U.S. government agency securities are generally determined using the spread above the risk-free yield curve. As the yields for the risk-free yield curve and the spreads for these securities are observable market inputs, the fair values of U.S. government agency securities are classified within Level 2.
Corporate bonds — valuations provided by independent pricing services, substantially all through index providers and pricing vendors with a small amount through broker-dealers. The fair values of these securities are generally determined using the spread above the risk-free yield curve. These spreads are generally obtained from the new issue market, secondary trading and from broker-dealers who trade in the relevant security market. As the significant inputs used in the pricing process for corporate bonds are observable market inputs, the fair value of these securities are classified within Level 2. A small number of securities are included in Level 3 due to a low level of transparency on the inputs used in the pricing process.
Mortgage-backed securities — valuations provided by independent pricing services, substantially all through pricing vendors and index providers with a small amount through broker-dealers. The fair values of these securities are generally determined through the use of pricing models (including Option Adjusted Spread) which use spreads to determine the expected average life of the securities. These spreads are generally obtained from the new issue market, secondary trading and from broker-dealers who trade in the relevant security market. The pricing services also review prepayment speeds and other indicators, when applicable. As the significant inputs used in the pricing process for mortgage-backed securities are observable market inputs, the fair value of these securities are classified within Level 2. A small number of securities are included in Level 3 due to a low level of transparency on the inputs used in the pricing process.
Municipal bonds — valuations provided by independent pricing services, with all prices provided through index providers and pricing vendors. The fair values of these securities are generally determined using spreads obtained from broker-dealers who trade in the relevant security market, trade prices and the new issue market. As the significant inputs used in the pricing process for municipal bonds are observable market inputs, the fair value of these securities are classified within Level 2.
 
Commercial mortgage-backed securities — valuations provided by independent pricing services, substantially all through index providers and pricing vendors with a small amount through broker-dealers. The fair values of these securities are generally determined through the use of pricing models which use spreads to determine the appropriate average life of the securities. These spreads are generally obtained from the new issue market, secondary trading and from broker-dealers who trade in the relevant security market. The pricing services also review prepayment speeds and other indicators, when applicable. As the significant inputs used in the pricing process for commercial mortgage-backed securities are observable market inputs, the fair value of these securities are classified within Level 2.
Non-U.S. government securities — valuations provided by independent pricing services, with all prices provided through index providers and pricing vendors. The fair values of these securities are generally based on international indices or valuation models which include daily observed yield curves, cross-currency basis index spreads and country credit spreads. As the significant inputs used in the pricing process for non-U.S. government securities are observable market inputs, the fair value of these securities are classified within Level 2.
Asset-backed securities — valuations provided by independent pricing services, substantially all through index providers and pricing vendors with a small amount through broker-dealers. The fair values of these securities are generally determined through the use of pricing models (including Option Adjusted Spread) which use spreads to determine the appropriate average life of the securities. These spreads are generally obtained from the new issue market, secondary trading and from broker-dealers who trade in the relevant security market. The pricing services also review prepayment speeds and other indicators, when applicable. As the significant inputs used in the pricing process for asset-backed securities are observable market inputs, the fair value of these securities are classified within Level 2. A small number of securities are included in Level 3 due to a low level of transparency on the inputs used in the pricing process.
Equity securities
The Company determined that exchange-traded equity securities would be included in Level 1 as their fair values are based on quoted market prices in active markets. Certain equity securities are included in Level 2 of the valuation hierarchy as the significant inputs used in the pricing process for such securities are observable market inputs. Other equity securities are included in Level 3 due to the lack of an available independent price source for such securities. As the significant inputs used to price these securities are unobservable, the fair value of such securities are classified as Level 3.

ARCH CAPITAL 322020 SECOND QUARTER FORM 10-Q

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Other investments
The Company determined that exchange-traded investments in mutual funds would be included in Level 1 as their fair values are based on quoted market prices in active markets. Other investments also include term loan investments for which fair values are estimated by using quoted prices of term loan investments with similar characteristics, pricing models or matrix pricing. Such investments are generally classified within Level 2. The fair values for certain of the Company’s other investments are determined using net asset values as advised by external fund managers. The net asset value is based on the fund manager’s valuation of the underlying holdings in accordance with the fund’s governing documents. In accordance with applicable accounting guidance, certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been classified in the fair value hierarchy. A small number of securities are included in Level 3 due to the lack of an available independent price source for such securities.
 
Derivative instruments
The Company’s futures contracts, foreign currency forward contracts, interest rate swaps and other derivatives trade in the over-the-counter derivative market. The Company uses the market approach valuation technique to estimate the fair value for these derivatives based on significant observable market inputs from third party pricing vendors, non-binding broker-dealer quotes and/or recent trading activity. As the significant inputs used in the pricing process for these derivative instruments are observable market inputs, the fair value of these securities are classified within Level 2.
Short-term investments
The Company determined that certain of its short-term investments held in highly liquid money market-type funds, Treasury bills and commercial paper would be included in Level 1 as their fair values are based on quoted market prices in active markets. The fair values of other short-term investments are generally determined using the spread above the risk-free yield curve and are classified within Level 2.


ARCH CAPITAL 332020 SECOND QUARTER FORM 10-Q

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following table presents the Company’s financial assets and liabilities measured at fair value by level at June 30, 2020:
   Estimated Fair Value Measurements Using:
 
Estimated
Fair
Value
 
Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Assets measured at fair value (1): 
  
  
  
Available for sale securities: 
  
  
  
Fixed maturities: 
  
  
  
Corporate bonds$7,143,600
 $
 $7,142,743
 $857
Mortgage backed securities610,839
 
 610,621
 218
Municipal bonds517,089
 
 517,089
 
Commercial mortgage backed securities395,682
 
 395,682
 
U.S. government and government agencies5,192,991
 5,077,056
 115,935
 
Non-U.S. government securities2,171,955
 
 2,171,955
 
Asset backed securities1,633,481
 
 1,630,249
 3,232
Total17,665,637
 5,077,056
 12,584,274
 4,307
        
Short-term investments2,277,866
 2,250,377
 27,489
 
        
Equity securities, at fair value1,263,914
 1,205,352
 6,581
 51,981
        
Derivative instruments (4)96,909
 
 96,909
 
        
Fair value option:       
Corporate bonds673,457
 
 672,459
 998
Non-U.S. government bonds68,340
 
 68,340
 
Mortgage backed securities14,142
 
 14,142
 
Municipal bonds249
 
 249
 
Commercial mortgage backed securities1,131
 
 1,131
 
Asset backed securities165,890
 
 165,890
 
U.S. government and government agencies595
 483
 112
 
Short-term investments384,382
 370,286
 14,096
 
Equity securities90,096
 28,507
 142
 61,447
Other investments1,167,345
 39,493
 1,081,399
 46,453
Other investments measured at net asset value (2)955,145
      
Total3,520,772
 438,769
 2,017,960
 108,898
        
Total assets measured at fair value$24,825,098
 $8,971,554
 $14,733,213
 $165,186
        
Liabilities measured at fair value: 
  
  
  
Contingent consideration liabilities$(1,250) $
 $
 $(1,250)
Securities sold but not yet purchased (3)(29,289) 
 (29,289) 
Derivative instruments (4)(66,821) 
 (66,821) 
Total liabilities measured at fair value$(97,360) $
 $(96,110) $(1,250)

(1)
In securities lending transactions, the Company receives collateral in excess of the fair value of the securities pledged. For purposes of this table, the Company has excluded the collateral received under securities lending, at fair value and included the securities pledged under securities lending, at fair value. See note 7, “—Securities Lending Agreements.”
(2)In accordance with applicable accounting guidance, certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been classified in the fair value hierarchy. The fair value amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the amounts presented in the consolidated balance sheets.
(3)Represents the Company’s obligations to deliver securities that it did not own at the time of sale. Such amounts are included in “other liabilities” on the Company’s consolidated balance sheets.
(4)
See note 9.

ARCH CAPITAL 342020 SECOND QUARTER FORM 10-Q

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following table presents the Company’s financial assets and liabilities measured at fair value by level at December 31, 2019:
   Estimated Fair Value Measurements Using:
 Estimated
Fair
Value
 
Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Assets measured at fair value (1):       
Available for sale securities:       
Fixed maturities:       
Corporate bonds$6,406,591
 $
 $6,397,740
 $8,851
Mortgage backed securities562,309
 
 562,055
 254
Municipal bonds881,926
 
 881,926
 
Commercial mortgage backed securities733,108
 
 733,108
 
U.S. government and government agencies4,916,592
 4,805,581
 111,011
 
Non-U.S. government securities2,078,757
 
 2,078,757
 
Asset backed securities1,683,753
 
 1,678,791
 4,962
Total17,263,036
 4,805,581
 12,443,388
 14,067
        
Short-term investments956,546
 904,804
 51,742
 
        
Equity securities, at fair value850,283
 789,596
 4,798
 55,889
        
Derivative instruments (4)48,946
 
 48,946
 
        
Fair value option:       
Corporate bonds488,402
 
 487,470
 932
Non-U.S. government bonds50,465
 
 50,465
 
Mortgage backed securities11,947
 
 11,947
 
Municipal bonds377
 
 377
 
Commercial mortgage backed securities1,134
 
 1,134
 
Asset backed securities200,163
 
 200,163
 
U.S. government and government agencies1,962
 1,852
 110
 
Short-term investments377,014
 333,320
 43,694
 
Equity securities102,697
 43,962
 641
 58,094
Other investments1,418,273
 53,287
 1,296,169
 68,817
Other investments measured at net asset value (2)1,011,043
      
Total3,663,477
 432,421
 2,092,170
 127,843
        
Total assets measured at fair value$22,782,288
 $6,932,402
 $14,641,044
 $197,799
        
Liabilities measured at fair value:       
Contingent consideration liabilities$(7,998) $
 $
 $(7,998)
Securities sold but not yet purchased (3)(66,257) 
 (66,257) 
Derivative instruments (4)(39,750) 
 (39,750) 
Total liabilities measured at fair value$(114,005) $
 $(106,007) $(7,998)

(1)
In securities lending transactions, the Company receives collateral in excess of the fair value of the securities pledged. For purposes of this table, the Company has excluded the collateral received under securities lending, at fair value and included the securities pledged under securities lending, at fair value. See note 7, “—Securities Lending Agreements.”
(2)In accordance with applicable accounting guidance, certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been classified in the fair value hierarchy. The fair value amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the amounts presented in the consolidated balance sheets.
(3)Represents the Company’s obligations to deliver securities that it did not own at the time of sale. Such amounts are included in “other liabilities” on the Company’s consolidated balance sheets.
(4)
See note 9.


ARCH CAPITAL 352020 SECOND QUARTER FORM 10-Q

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following table presents a reconciliation of the beginning and ending balances for all financial assets and liabilities measured at fair value on a recurring basis using Level 3 inputs:
 AssetsLiabilities
sAvailable For Sale Fair Value Option Fair Value  
 Structured Securities (1) Corporate
Bonds
 Corporate
Bonds
 
Other
Investments
 
Equity
Securities
 
Equity
Securities
 Contingent Consideration Liabilities
Three Months Ended June 30, 2020   
        
  
Balance at beginning of period$3,846
 $1,980
 $965
 $54,620
 $60,015
 $55,632
 $(7,967)
Total gains or (losses) (realized/unrealized)          

  
Included in earnings (2)(64) 
 
 (987) 1,432
 11,799
 (18)
Included in other comprehensive income(287) (1,123) 
 
 
 
 
Purchases, issuances, sales and settlements          

  
Purchases
 
 33
 3
 
 
 
Issuances
 
 
 
 
 
 
Sales
 
 
 (7,183) 
 (15,450) 
Settlements(45) 
 
 
 
 
 6,735
Transfers in and/or out of Level 3
 
 
 
 
 
 
Balance at end of period$3,450
 $857
 $998
 $46,453
 $61,447
 $51,981
 $(1,250)
              
Three Months Ended June 30, 2019   
        
  
Balance at beginning of period$302
 $7,567
 $2,233
 $62,329
 $
 $
 $(68,121)
Total gains or (losses) (realized/unrealized)          

  
Included in earnings (2)
 
 (49) (11,614) 
 
 (423)
Included in other comprehensive income1
 102
 
 
 
 
 
Purchases, issuances, sales and settlements          

  
Purchases
 429
 
 
 
 
 
Issuances
 
 
 
 
 
 
Sales
 
 
 (74) 
 
 
Settlements(13) (456) 
 
 
 
 60,719
Transfers in and/or out of Level 3
 
 23,919
 44,632
 56,145
 51,212
 
Balance at end of period$290
 $7,642
 $26,103
 $95,273
 $56,145
 $51,212
 $(7,825)
              
Six Months Ended June 30, 2020   
        
  
Balance at beginning of year$5,216
 $8,851
 $932
 $68,817
 $58,094
 $55,889
 $(7,998)
Total gains or (losses) (realized/unrealized)          

  
Included in earnings (2)(55) 7
 
 (1,014) 3,353
 8,078
 (72)
Included in other comprehensive income(309) (6,539) 
 
 
 
 
Purchases, issuances, sales and settlements          

  
Purchases
 
 66
 24
 
 3,464
 
Issuances
 
 
 
 
 
 
Sales
 
 
 (24,358) 
 (15,450) 
Settlements(1,402) (1,462) 
 
 
 
 6,820
Transfers in and/or out of Level 3
 
 
 2,984
 
 
 
Balance at end of period$3,450
 $857
 $998
 $46,453
 $61,447
 $51,981
 $(1,250)
              
Six Months Ended June 30, 2019   
        
  
Balance at beginning of year$313
 $8,141
 $5,758
 $62,705
 $
 $
 $(66,665)
Total gains or (losses) (realized/unrealized)          

  
Included in earnings (2)1,757
 
 (339) (11,316) 
 
 (1,331)
Included in other comprehensive income5
 (16) 
 
 
 
 
Purchases, issuances, sales and settlements          

  
Purchases
 429
 
 
 
 
 
Issuances
 
 
 
 
 
 (548)
Sales(1,757) 
 (3,235) (148) 
 
 
Settlements(28) (912) 
 (600) 
 
 60,719
Transfers in and/or out of Level 3
 
 23,919
 44,632
 56,145
 51,212
 
Balance at end of period$290
 $7,642
 $26,103
 $95,273
 $56,145
 $51,212
 $(7,825)

(1)Includes asset backed securities, mortgage backed securities and commercial mortgage backed securities.
(2)Gains or losses were included in net realized gains (losses).

ARCH CAPITAL 362020 SECOND QUARTER FORM 10-Q

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Financial Instruments Disclosed, But Not Carried, At Fair Value
The Company uses various financial instruments in the normal course of its business. The carrying values of cash, accrued investment income, receivable for securities sold, certain other assets, payable for securities purchased and certain other liabilities approximated their fair values at June 30, 2020, due to their respective short maturities. As these financial instruments are not actively traded, their respective fair values are classified within Level 2.
At June 30, 2020, the Company’s senior notes were carried at their cost, net of debt issuance costs, of $2.86 billion and had a fair value of $3.49 billion. At December 31, 2019, the Company’s senior notes were carried at their cost, net of debt issuance costs, of $1.87 billion and had a fair value of $2.34 billion. The fair values of the senior notes were obtained from a third party pricing service and are based on observable market inputs. As such, the fair values of the senior notes are classified within Level 2.
9.    Derivative Instruments

The Company’s investment strategy allows for the use of derivative instruments. The Company’s derivative instruments are recorded on its consolidated balance sheets at fair value. The Company utilizes exchange traded U.S. Treasury note, Eurodollar and other futures contracts and commodity futures to manage portfolio duration or replicate investment positions in its portfolios and the Company routinely utilizes foreign currency forward contracts, currency options, index futures contracts and other derivatives as part of its total return objective. In addition, certain of the Company’s investments are managed in portfolios which incorporate the use of foreign currency forward contracts which are intended to provide an economic hedge against foreign currency movements. 
In addition, the Company purchases to-be-announced mortgage backed securities (“TBAs”) as part of its investment strategy. TBAs represent commitments to purchase a future issuance of agency mortgage backed securities. For the period between purchase of a TBA and issuance of the underlying security, the Company’s position is accounted for as a derivative. The Company purchases TBAs in both long and short positions to enhance investment performance and as part of its overall investment strategy.
 
The following table summarizes information on the fair values and notional values of the Company’s derivative instruments:
 Estimated Fair Value  
 Asset Derivatives Liability Derivatives 
Notional
Value (1)
June 30, 2020     
Futures contracts (2)$17,181
 $(5,894) $2,635,862
Foreign currency forward contracts (2)12,366
 (9,400) 1,073,432
TBAs (3)5,973
 
 5,740
Other (2)67,362
 (51,527) 3,398,053
Total$102,882
 $(66,821)  
      
December 31, 2019     
Futures contracts (2)$10,065
 $(13,722) $4,104,559
Foreign currency forward contracts (2)5,352
 (5,327) 686,878
TBAs (3)55,010
 
 53,229
Other (2)33,529
 (20,701) 4,356,300
Total$103,956
 $(39,750)  
(1)Represents the absolute notional value of all outstanding contracts, consisting of long and short positions.
(2)The fair value of asset derivatives are included in ‘other assets’ and the fair value of liability derivatives are included in ‘other liabilities.’
(3)The fair value of TBAs are included in ‘fixed maturities available for sale, at fair value.’
The Company did not hold any derivatives which were designated as hedging instruments at June 30, 2020 or December 31, 2019.
The Company’s derivative instruments can be traded under master netting agreements, which establish terms that apply to all derivative transactions with a counterparty. In the event of a bankruptcy or other stipulated event of default, such agreements provide that the non-defaulting party may elect to terminate all outstanding derivative transactions, in which case all individual derivative positions (loss or gain) with a counterparty are closed out and netted and replaced with a single amount, usually referred to as the termination amount, which is expressed in a single currency. The resulting single net amount, where positive, is payable to the party “in-the-money” regardless of whether or not it is the defaulting party, unless the parties have agreed that only the non-defaulting party is entitled to receive a termination payment where the net amount is positive and is in its favor. Contractual close-out netting reduces derivatives credit exposure from gross to net exposure.
At June 30, 2020, asset derivatives and liability derivatives of $87.0 million and $60.3 million, respectively, were subject to a master netting agreement, compared to $97.8 million and $37.8 million, respectively, at December 31, 2019. The remaining derivatives included in the preceding table were not subject to a master netting agreement.
Realized and unrealized contract gains and losses on the Company’s derivative instruments are reflected in ‘net realized

ARCH CAPITAL 372020 SECOND QUARTER FORM 10-Q

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

gains (losses)’ in the consolidated statements of income, as summarized in the following table:
Derivatives not designated as June 30,
hedging instruments: 2020 2019
     
Three Months Ended    
Net realized gains (losses):    
Futures contracts $(1,607) $66,973
Foreign currency forward contracts 3,523
 (5,365)
TBAs 264
 48
Other (3,016) 2,310
Total $(836) $63,966
     
Six Months Ended    
Net realized gains (losses):    
Futures contracts $94,337
 $94,309
Foreign currency forward contracts (7,347) (19,074)
TBAs 1,009
 238
Other 38,354
 24,364
Total $126,353
 $99,837

10.    Commitments and Contingencies

Senior Notes
On June 30, 2020, Arch Capital completed a public offering of $1.0 billion aggregate principal amount of its 3.635% senior notes with a scheduled maturity of June 30, 2050 (the “2050 notes”). The 2050 notes are Arch Capital’s senior unsecured obligations and rank equally with all of its existing and future senior unsecured indebtedness. Interest payments on the 2050 notes are due semi-annually in arrears on June 30 and December 30, beginning on December 30, 2020, to holders of record on the preceding June 15 or December 15, as the case may be. Interest will be calculated on the basis of a 360-day year of twelve 30-day months. Subject to conditions of redemption, Arch Capital may redeem the 2050 notes at any time and from time to time prior to December 30, 2049, in whole or in part, at a redemption price equal to the “make-whole” redemption price, plus accrued and unpaid interest thereon to, but excluding, the redemption date. Arch Capital is planning to use the net proceeds for general corporate purposes.
Investment Commitments
The Company’s investment commitments, which are primarily related to agreements entered into by the Company to invest in funds and separately managed accounts when called upon, were approximately $1.77 billion at June 30, 2020, compared to $1.69 billion at December 31, 2019.
Interest Paid
Interest paid on the Company’s senior notes and other borrowings were $57.4 million for the six months ended June 30, 2020, consistent with $60.9 million for the 2019 period.
 
11.    Leases

In the ordinary course of business, the Company renews and enters into new leases for office property and equipment. At the lease inception date, the Company determines whether a contract contains a lease and its classification as a finance or operating lease. Primarily all of the Company’s leases are classified as operating leases. The Company’s operating leases have remaining lease terms of up to 11 years, some of which include options to extend the lease term. The Company considers these options when determining the lease term and measuring its lease liability and right-of-use asset. In addition, the Company’s lease agreements do not contain any material residual value guarantees or material restrictive covenants.
Short-term operating leases with an initial term of twelve months or less were excluded on the Company's consolidated balance sheet and represent an inconsequential amount of operating lease expense.
As most leases do not provide an implicit rate, the Company uses its incremental borrowing rate based on the information available at the lease commencement date in determining the present value of lease payments.
Additional information regarding the Company’s operating leases is as follows:
 June 30,
 2020 2019
Three Months Ended

   
Operating lease costs$7,821
 $7,244
Cash payments included in the measurement of lease liabilities reported in operating cash flows5,844
 7,685
Right-of-use assets obtained in exchange for new lease liabilities435
 4,420
Right-of-use assets (1)119,494
 134,061
Operating lease liability (1)139,772
 150,341
Weighted average discount rate3.9% 3.9%
Weighted average remaining lease term6.1 years
 6.5 years
    
Six Months Ended   
Operating lease costs

$15,812
 $14,860
Cash payments included in the measurement of lease liabilities reported in operating cash flows14,305
 14,585
Right-of-use assets obtained in exchange for new lease liabilities3,885
 4,420
Right-of-use assets (1)119,494
 134,061
Operating lease liability (1)139,772
 150,341
Weighted average discount rate3.9% 3.9%
Weighted average remaining lease term6.1 years
 6.5 years
(1)The right-of-use assets are included in ‘other assets’ while the operating lease liability is included in ‘other liabilities.’


ARCH CAPITAL 382020 SECOND QUARTER FORM 10-Q

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following table presents the contractual maturities of the Company's operating lease liabilities at June 30, 2020:
Years Ending December 31,  
2020 (remainder) $15,835
2021 31,475
2022 28,341
2023 23,820
2024 17,601
2025 and thereafter 40,139
Total undiscounted lease liability $157,211
Less: present value adjustment (17,439)
Operating lease liability $139,772


12.Variable Interest Entities and Noncontrolling Interests

Watford
In March 2014, the Company invested $100.0 million and acquired 2,500,000 common shares, approximately 11% of Watford’s outstanding common equity. Watford’s common shares are listed on the Nasdaq Select Global Market under the ticker symbol “WTRE”. As of June 30, 2020, the Company owns approximately 13% of Watford’s outstanding common equity.
In July 2019, Watford completed an offering of $175.0 million in aggregate principal amount of its 6.5% senior notes, due July 2, 2029 (“Watford Senior Notes”). Interest on the Watford Senior Notes is payable semi-annually in arrears on each January 2 and July 2 commencing on January 2, 2020. The $172.4 million net proceeds from the offering were used to redeem a portion of Watford’s outstanding preference shares (“Watford Preference Shares”). The Company purchased $35.0 million in aggregate principal amount of the Watford Senior Notes.
Watford is considered a VIE and the Company concluded that it is the primary beneficiary of Watford. As such, the results of Watford are included in the Company’s consolidated financial statements.
The Company does not guarantee or provide credit support for Watford, and the Company’s financial exposure to Watford is limited to its investment in Watford’s senior notes, common and preferred shares and counterparty credit risk (mitigated by collateral) arising from reinsurance transactions.
 
The following table provides the carrying amount and balance sheet caption in which the assets and liabilities of Watford are reported:
 June 30, December 31,
 2020 2019
Assets   
Investments accounted for using the fair value option$1,886,676
 $1,898,091
Fixed maturities available for sale, at fair value690,225
 745,708
Equity securities, at fair value62,443
 65,338
Cash107,653
 102,437
Accrued investment income14,364
 14,025
Premiums receivable258,178
 273,657
Reinsurance recoverable on unpaid and paid losses and LAE229,746
 170,973
Ceded unearned premiums131,919
 132,577
Deferred acquisition costs64,149
 64,044
Receivable for securities sold31,314
 16,287
Goodwill and intangible assets7,650
 7,650
Other assets63,441
 60,070
Total assets of consolidated VIE$3,547,758
 $3,550,857
    
Liabilities   
Reserve for losses and loss adjustment expenses$1,353,049
 $1,263,628
Unearned premiums456,170
 438,907
Reinsurance balances payable72,776
 77,066
Revolving credit agreement borrowings335,587
 484,287
Senior notes172,554
 172,418
Payable for securities purchased67,272
 18,180
Other liabilities (1)261,267
 171,714
Total liabilities of consolidated VIE$2,718,675
 $2,626,200
    
Redeemable noncontrolling interests$52,351
 $52,305

(1)Includes certain borrowings related to investing activities.
For the six months ended June 30, 2020, Watford generated $87.3 million of cash provided by operating activities, $78.0 million of cash provided by investing activities and $153.8 million of cash used for financing activities, compared to $115.9 million of cash provided by operating activities, $135.7 million of cash used for investing activities and $25.6 million of cash provided by financing activities for the six months ended June 30, 2019.
Non-redeemable noncontrolling interests
The Company accounts for the portion of Watford’s common equity attributable to third party investors in the shareholders’ equity section of its consolidated balance sheets. The noncontrolling ownership in Watford’s common shares was approximately 87% at June 30, 2020. The portion of Watford’s income or loss attributable to third party investors is recorded in the consolidated statements of income in ‘net (income) loss attributable to noncontrolling interests.’

ARCH CAPITAL 392020 SECOND QUARTER FORM 10-Q

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following table sets forth activity in the non-redeemable noncontrolling interests:
 June 30,
 2020 2019
Three Months Ended   
Balance, beginning of period$492,785
 $838,081
Additional paid in capital attributable to noncontrolling interests595
 2,074
Amounts attributable to noncontrolling interests165,598
 12,301
Other comprehensive income (loss) attributable to noncontrolling interests20,111
 2,891
Balance, end of period$679,089
 $855,347
    
Six Months Ended   
Balance, beginning of year$762,777
 $791,560
Additional paid in capital attributable to noncontrolling interests472
 2,074
Repurchases attributable to non-redeemable noncontrolling interests (1)
(2,867) 
Amounts attributable to noncontrolling interests(68,346) 54,683
Other comprehensive income (loss) attributable to noncontrolling interests(12,947) 7,030
Balance, end of period$679,089
 $855,347

(1) During 2020, Watford’s board of directors authorized the investment in Watford’s common shares through a share repurchase program.

Redeemable noncontrolling interests
The Company accounts for redeemable noncontrolling interests in the mezzanine section of its consolidated balance sheets in accordance with applicable accounting guidance. Such redeemable noncontrolling interests primarily relate to the Watford Preference Shares issued in late March 2014 with a par value of $0.01 per share and a liquidation preference of $25.00 per share. The Watford Preference Shares were issued at a discounted amount of $24.50 per share. Preferred dividends, including the accretion of the discount and issuance costs, are included in ‘net (income) loss attributable to noncontrolling interests’ in the Company’s consolidated statements of income.
In August 2019, Watford redeemed 6,919,998 of its 9,065,200 issued and outstanding Watford Preference Shares. The Watford Preference Shares were redeemed at a total redemption price of $25.19748 per share, inclusive of all declared and unpaid dividends, with accumulation of any undeclared dividends on or after June 30, 2019. In addition, the Company received $11.5 million pursuant to the redemption of Watford Preference Shares.
 
The following table sets forth activity in the redeemable non-controlling interests:
 June 30,
 2020 2019
Three Months Ended   
Balance, beginning of period$55,376
 $206,383
Accretion of preference share issuance costs23
 92
Other587
 
Balance, end of period$55,986
 $206,475
    
Six Months Ended   
Balance, beginning of year$55,404
 $206,292
Accretion of preference share issuance costs46
 183
Other536
 
Balance, end of period$55,986
 $206,475

The portion of income or loss attributable to third party investors, recorded in the Company’s consolidated statements of income in ‘net (income) loss attributable to noncontrolling interests,’ are summarized in the table below:
 June 30,
 2020 2019
Three Months Ended   
Amounts attributable to non-redeemable noncontrolling interests$(165,598) $(12,301)
Amounts attributable to redeemable noncontrolling interests(1,970) (4,590)
Net (income) loss attributable to noncontrolling interests$(167,568) $(16,891)
    
Six Months Ended   
Amounts attributable to non-redeemable noncontrolling interests$68,346
 $(54,683)
Amounts attributable to redeemable noncontrolling interests(3,123) (9,178)
Net (income) loss attributable to noncontrolling interests$65,223
 $(63,861)


ARCH CAPITAL 402020 SECOND QUARTER FORM 10-Q

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Bellemeade Re
The Company has entered into various aggregate excess of loss mortgage reinsurance agreements with various special purpose reinsurance companies domiciled in Bermuda (the “Bellemeade Agreements”). At the time the Bellemeade Agreements were entered into, the applicability of the accounting guidance that addresses VIEs was evaluated. As a result of the evaluation of the Bellemeade Agreements, the Company concluded that these entities are VIEs. However, given that the ceding insurers do not have the unilateral power to direct those activities that are significant to their economic performance, the Company does not consolidate such entities in its consolidated financial statements.
The following table presents the total assets of the Bellemeade entities, as well as the Company’s maximum exposure to loss associated with these VIEs, calculated as the maximum historical observable spread between the one month LIBOR, the basis for the contractual payments to bond holders, and short term invested trust asset yields.
 
   Maximum Exposure to Loss
Bellemeade Entities (Issue Date)Total VIE Assets On-Balance Sheet (Asset) Liability Off-Balance Sheet Total
Jun 30, 2020       
Bellemeade 2017-1 Ltd. (Oct-17)$145,573
 $(295) $2,469
 $2,174
Bellemeade 2018-1 Ltd. (Apr-18)250,095
 (1,244) 5,597
 4,353
Bellemeade 2018-2 Ltd. (Aug-18)272,685
 (1,206) 4,210
 3,004
Bellemeade 2018-3 Ltd. (Oct-18)302,563
 (1,883) 8,387
 6,504
Bellemeade 2019-1 Ltd. (Mar-19)219,256
 (83) 10,251
 10,168
Bellemeade 2019-2 Ltd. (Apr-19)398,316
 54
 13,088
 13,142
Bellemeade 2019-3 Ltd. (Jul-19)
528,084
 (248) 10,649
 10,401
Bellemeade 2019-4 Ltd. (Oct-19)

468,737
 257
 14,687
 14,944
Bellemeade 2020-1 Ltd. (Jun-20) (1)450,040
 (60) 8,984
 8,924
Total$3,035,349
 $(4,708) $78,322
 $73,614
Dec 31, 2019       
Bellemeade 2017-1 Ltd. (Oct-17)$216,429
 $(442) $2,794
 $2,352
Bellemeade 2018-1 Ltd. (Apr-18)328,482
 (1,574) 5,757
 4,183
Bellemeade 2018-2 Ltd. (Aug-18)437,009
 (877) 2,524
 1,647
Bellemeade 2018-3 Ltd. (Oct-18)426,806
 (1,113) 3,937
 2,824
Bellemeade 2019-1 Ltd. (Mar-19)257,358
 (226) 3,027
 2,801
Bellemeade 2019-2 Ltd. (Apr-19)525,959
 (78) 2,579
 2,501
Bellemeade 2019-3 Ltd. (Jul-19)656,523
 (585) 9,273
 8,688
Bellemeade 2019-4 Ltd. (Oct-19)577,267
 (302) 12,193
 11,891
Total$3,425,833
 $(5,197) $42,084
 $36,887

(1)  An additional $78.5 million capacity was provided directly to Arch MI U.S. by a separate panel of reinsurers and is not reflected in this table.



ARCH CAPITAL 412020 SECOND QUARTER FORM 10-Q

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

13.    Other Comprehensive Income (Loss)


The following tables present details about amounts reclassified from accumulated other comprehensive income and the tax effects allocated to each component of other comprehensive income (loss):
    Amounts Reclassified from AOCI
  Consolidated Statement of Income Three Months Ended Six Months Ended
Details About Line Item That Includes June 30, June 30,
AOCI Components Reclassification 2020 2019 2020 2019
           
Unrealized appreciation on available-for-sale investments        
  Net realized gains (losses) $182,329
 $59,809
 $328,561
 $71,518
  Provision for credit losses 3,225
 


 (6,095) 

  Other-than-temporary impairment losses 
 (49) (533) (1,358)
  Total before tax 185,554
 59,760
 321,933
 70,160
  Income tax (expense) benefit (18,163) (4,415) (33,313) (4,594)
  Net of tax $167,391
 $55,345
 $288,620
 $65,566

 Before Tax Amount Tax Expense (Benefit) Net of Tax Amount
Three Months Ended June 30, 2020     
Unrealized appreciation (decline) in value of investments:     
Unrealized holding gains (losses) arising during period$555,576
 $62,780
 $492,796
Less reclassification of net realized gains (losses) included in net income185,554
 18,163
 167,391
Foreign currency translation adjustments22,595
 344
 22,251
Other comprehensive income (loss)$392,617
 $44,961
 $347,656
      
Three Months Ended June 30, 2019     
Unrealized appreciation (decline) in value of investments:     
Unrealized holding gains (losses) arising during period$248,074
 $25,601
 $222,473
Less reclassification of net realized gains (losses) included in net income59,760
 4,415
 55,345
Foreign currency translation adjustments4,409
 142
 4,267
Other comprehensive income (loss)$192,723
 $21,328
 $171,395
      
Six Months Ended June 30, 2020     
Unrealized appreciation (decline) in value of investments:     
Unrealized holding gains (losses) arising during period$492,125
 $56,616
 $435,509
Less reclassification of net realized gains (losses) included in net income321,933
 33,313
 288,620
Foreign currency translation adjustments(22,829) (391) (22,438)
Other comprehensive income (loss)$147,363
 $22,912
 $124,451
      
Six Months Ended June 30, 2019     
Unrealized appreciation (decline) in value of investments:     
Unrealized holding gains (losses) arising during period$503,064
 $54,704
 $448,360
Less reclassification of net realized gains (losses) included in net income70,160
 4,594
 65,566
Foreign currency translation adjustments10,053
 270
 9,783
Other comprehensive income (loss)$442,957
 $50,380
 $392,577


ARCH CAPITAL 422020 SECOND QUARTER FORM 10-Q

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

14.    Income Taxes

The Company’s income tax provision on income before income taxes resulted in an effective tax rate of 12.5% for the six months ended June 30, 2020, compared to 8.4% for the 2019 period.
The Company’s effective tax rate, which is based upon the expected annual effective tax rate, may fluctuate from period to period based on the relative mix of income or loss reported by jurisdiction and the varying tax rates in each jurisdiction. For interim reporting purposes, the Company has calculated its annual effective tax rate for the full year 2020 by treating excess tax benefits in the U.S. that arise from the accounting for stock based compensation as a discrete item. The impact of the discrete item resulted in a benefit of 0.5% for the six months ended June 30, 2020.
The Company had a net deferred tax asset of $9.3 million at June 30, 2020, compared to a net deferred tax liability of $53.5 million at December 31, 2019. The change is primarily a result of fluctuations in the contingency reserve. In addition, the Company paid $10.4 million and $43.5 million of income taxes for the six months ended June 30, 2020 and 2019, respectively.
15.    Legal Proceedings

The Company, in common with the insurance industry in general, is subject to litigation and arbitration in the normal course of its business. As of June 30, 2020, the Company was not a party to any litigation or arbitration which is expected by management to have a material adverse effect on the Company’s results of operations and financial condition and liquidity.

 
16.    Transactions with Related Parties

In 2017, the Company acquired approximately 25% of Premia Holdings Ltd. Premia Holdings Ltd. is the parent of Premia Reinsurance Ltd., a multi-line Bermuda reinsurance company (together with Premia Holdings Ltd., “Premia”). Premia’s strategy is to reinsure or acquire companies or reserve portfolios in the non-life property and casualty insurance and reinsurance run-off market. Arch Re Bermuda and certain Arch co-investors invested $100.0 million and acquired approximately 25% of Premia as well as warrants to purchase additional common equity. Arch has appointed 2 directors to serve on the 7 person board of directors of Premia. Arch Re Bermuda is providing a 25% quota share reinsurance treaty on certain business written by Premia.
In the 2019 fourth quarter, Barbican Group Holdings Limited (“Barbican”), a wholly owned subsidiary of the Company, entered into certain reinsurance and related transactions with Premia pursuant to which Premia assumed a transfer of liability for the 2018 and prior years of account of Barbican as of July 1, 2019. Barbican recorded reinsurance recoverable on unpaid and paid losses and funds held liability of $181.9 million and $169.0 million, respectively, at June 30, 2020, compared to $177.7 million and $180.0 million, respectively, at December 31, 2019.
Certain directors and executive officers of the Company own common and preference shares of Watford. See note 12, “Variable Interest Entity and Noncontrolling Interests,” for information about Watford.

ARCH CAPITAL 432020 SECOND QUARTER FORM 10-Q



ITEM 2.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following is a discussion and analysis of our financial condition and results of operations. This should be read in conjunction with our consolidated financial statements included in Item 1 of this report and also our Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended December 31, 2019 (“2019 Form 10-K”). In addition, readers should review “Risk Factors” set forth in Item 1A of Part I of our 2019 Form 10-K and “ITEM 1A—Risk Factors” of this Form 10-Q. Tabular amounts are in U.S. Dollars in thousands, except share amounts, unless otherwise noted.
Arch Capital Group Ltd. (“Arch Capital” and, together with its subsidiaries, “Arch”, “we” or “us”) is a Bermuda public limited liability company with approximately $14.7 billion in capital at June 30, 2020 and, through operations in Bermuda, the United States, Europe, Canada, Australia and Hong Kong, writes insurance, reinsurance and mortgage insurance on a worldwide basis.
CURRENT OUTLOOK

We continue to look for opportunities to find acceptable books of business to underwrite without sacrificing underwriting discipline and 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. From an operating perspective, the 2020 second quarter reflected the benefits of rate improvements as all three of our underwriting segments are seeing attractive opportunities to grow at acceptable rates of return.
Consequently, these rate improvements enabled us to expand writings in our property casualty segments as risk adjusted returns are increasingly achieved. We know from experience that this environment is an opportune time to significantly expand our participation into this hardening market. To support this growth, we raised an additional $1.0 billion of capital in the form of long-term senior notes at the end of the 2020 second quarter.
COVID-19 has continued to significantly impact social and economic activity in the U.S. and global markets. We are committed to the safety of our employees, including restricting travel and instituting an extensive work from home policy. These actions have helped prevent a major disruption to our clients and operations. The impact of the spread of COVID-19, a developing recession and related levels of unemployment has changed some of our outlook for 2020, but we are navigating this period with a strong capital base. The extent to which
 
COVID-19 impacts our business, results of operations and financial results depends on numerous evolving factors including, but not limited to: the magnitude and duration of COVID-19, the extent to which it will impact macroeconomic conditions, the speed of the anticipated recovery and governmental, business and individual reactions to the pandemic. Given the continuing evolution of the COVID-19 outbreak and the response to curb its spread, currently we are not able to estimate the future effects of the COVID-19 outbreak to our results of operations, financial condition, or liquidity.
For the 2020 second quarter and six months ended June 30, 2020, we recorded $173.1 million and $259.7 million, respectively, for COVID-19 losses across our property casualty segments. We continue to have limited information to accurately quantify our potential exposure to the pandemic in certain areas but have established IBNR reserves for occurrences based on policy terms and conditions including limits, sub-limits, and deductibles. These reserves were recorded across a number of lines of business, such as trade credit, travel, workers compensation and property where we have limited exposure to policies that do not contain a specific pandemic exclusion and/or explicitly afford business interruption coverage under a pandemic. Given the unusual circumstances and breadth of the pandemic, we have classified COVID-19 losses as a catastrophe.
For our U.S. primary mortgage operations, reported delinquencies were 5.14% at June 30, 2020, compared to 1.42% at March 31, 2020 and came in better than our expectations last quarter at the beginning of the COVID-19 pandemic. We believe that the mortgage insurance industry is benefiting from solid credit quality of loan originations in the years after the 2008 Great Financial Crisis, a favorable supply and demand imbalance in housing and strong and swift government intervention. As a result, we are seeing better than expected delinquency rates emerging this quarter even as delinquency rates are at elevated levels, reflecting the impact of the recession and forbearance programs under the CARES Act to borrowers experiencing a hardship during COVID-19. Forbearance allows for mortgage payments to be suspended for up to 360 days along with a suspension of foreclosures and evictions. Our current view equates to a claim rate slightly above 5% primarily as a result of forbearances on newly reported delinquencies. While this claim rate is significantly higher than rates we experienced under other catastrophic events such as forbearance programs related to hurricanes, it is also lower than what the industry experienced in the 2008 Great Financial Crisis. See “Results of Operations—Mortgage Segment” for further details on our mortgage operations.

ARCH CAPITAL 442020 SECOND QUARTER FORM 10-Q


Record mortgage originations fueled by low mortgage rates are creating surges in both refinancing and purchase activity. This favorable financing environment is supporting home prices which we currently estimate to be rising around 5% annually across the U.S. The early indicators for housing and mortgage insurance specifically bode well for a better outcome than we expected at the end of the 2020 first quarter. However, there remains significant uncertainty on the path of this recession and caution is warranted on predicting how this will ultimately affect our results of operations.
We expect that delinquency rates may increase progressively from the current level, as more borrowers request forbearance on their mortgage loans under the CARES Act. We expect to record loss reserves on these delinquencies, which will likely result in elevated levels of incurred losses over the coming quarters. Over time, we would expect many of these delinquencies to cure and revert back to performing loans as the economy returns to a less-stressed state. At this time, we do not have enough visibility to predictably forecast the rate at which forbearance delinquencies will be reported to us, cure or ultimately turn into claims on an annual, let alone a quarterly basis. That said, based on our current analysis which tells us that the pandemic will represent an earnings event for our mortgage segment and not a capital event, our current expectation continues to be that our pre-tax underwriting income for the entire mortgage segment will be significantly lower than in 2019. However, there is likely to be variability in underwriting income between quarters based on the timing of receipt of notice of defaults. For further discussion of the potential impacts of COVID-19, see “ITEM 1A—Risk Factors”.
Arch remains committed to providing solutions across many offerings as the marketplace evolves, including the mortgage credit risk transfer programs initiated by government sponsored enterprises, or “GSEs.” Such programs have continued to generate business. In addition, we completed Bellemeade risk transfer in June 2020, increasing our protection for mortgage tail risk. The Bellemeade structures provide approximately $3.1 billion of aggregate reinsurance coverage as of June 30, 2020.

FINANCIAL MEASURES

Management uses the following three key financial indicators in evaluating our performance and measuring the overall growth in value generated for Arch Capital’s common shareholders:
Book Value per Share
Book value per share represents total common shareholders’ equity available to Arch divided by the number of common shares 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 of Arch 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 $27.62 at June 30, 2020, compared to $26.10 at March 31, 2020 and $24.64 at June 30, 2019. The 5.8% increase for the 2020 second quarter reflected the impact of total return on investments, partially offset by the impact of COVID-19 on underwriting results, while the 12.1% increase over the trailing twelve months reflected strong underwriting results and investment returns.
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 the average of beginning and ending common shareholders’ equity available to Arch during the period. After-tax operating income available to Arch common shareholders, a non-GAAP financial measure as defined in Regulation G, represents net income available to Arch common shareholders, excluding net realized gains or losses (which includes changes in the allowance for credit losses on financial assets and net impairment losses recognized in earnings) equity in net income or loss of investment funds accounted for using the equity method, net foreign exchange gains or losses, transaction costs and other and income taxes. Management uses Operating ROAE as a key measure of the return generated to common shareholders. See “Comment on Non-GAAP Financial Measures.”
Our Operating ROAE was 0.6% for the 2020 second quarter, compared to 13.1% for the 2019 second quarter, and 3.8% for six months ended June 30, 2020, compared to 12.7% for the 2019 period. The lower 2020 returns reflected the impact of COVID-19 on underwriting results and lower investment income than in the 2019 periods.
Total Return on Investments
Total return on investments includes investment income, equity in net income or loss of investment funds accounted for using the equity method, net realized gains and losses (excluding changes in the allowance for credit losses on non-investment related financial assets) 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. The following table summarizes our total return compared to the benchmark return against which we measured our portfolio during the periods. See “Comment on Non-GAAP Financial Measures.”

ARCH CAPITAL 452020 SECOND QUARTER FORM 10-Q


 
Arch
Portfolio
 
Benchmark
Return
Pre-tax total return (before investment expenses):   
2020 Second Quarter3.72% 6.06%
2019 Second Quarter2.37% 2.17%
    
Six Months Ended June 30, 20202.82% 1.23%
Six Months Ended June 30, 20195.14% 5.05%
Total return for the 2020 second quarter reflected a strong recovery in the capital markets which produced healthy returns across our entire portfolio. The equities markets rallied during the quarter and credit spreads tightened significantly. The total return for the six months ended June 30, 2020 outperformed our benchmark return index.
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. At June 30, 2020, the benchmark return index had an average credit quality of “Aa3” by Moody’s Investors Service (“Moody’s”), and an estimated duration of 3.04 years.
 
The benchmark return index included weightings to the following indices:
 %
ICE BoAML 1-10 Year A - AAA U.S. Corporate Index21.00%
ICE BoAML 1-5 Year U.S. Treasury Index15.00
MSCI ACWI Net Total Return USD Index8.60
ICE BoAML 3-5 Year Fixed Rate Asset Backed Securities Index7.00
S&P Leveraged Loan Total Return Index5.20
Bloomberg Barclays CMBS Invest Grade Aaa Total Return Index5.00
ICE BoAML 1-10 Year BBB U.S. Corporate Index4.00
ICE BoAML U.S. Mortgage Backed Securities Index4.00
ICE BoAML 1-5 Year U.K. Gilt Index4.00
ICE BoAML German Government 1-10 Year Index3.50
ICE BoAML 0-3 Month U.S. Treasury Bill Index3.25
ICE BoAML 1-10 Year U.S. Municipal Securities Index3.00
ICE BoAML 5-10 Year U.S. Treasury Index3.00
ICE BoAML 1-5 Year Australia Government Index2.75
ICE BoAML U.S. High Yield Constrained Index2.50
ICE BoAML 1-5 Year Canada Government Index2.00
Bloomberg Barclays Global High Yield Total Return Index1.50
Hedge Fund Research HFRX ED Distressed Restructuring Index (Flagship Funds)1.50
Dow Jones Global ex-US Select Real Estate Securities Total Return Net Index0.90
FTSE Nareit All Mortgage Capped Index Total Return USD0.90
Bloomberg Barclays CMBS: Erisa Eligible Unhedged USD0.90
ICE BoAML 20+ Year Canada Government Index0.50
Total100.00%
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 (which includes changes in the allowance for credit losses on financial assets and net impairment losses recognized in earnings), equity in net income or loss of investment funds 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 return on average common equity (the most directly comparable GAAP financial

ARCH CAPITAL 462020 SECOND QUARTER FORM 10-Q


measures) in accordance with Regulation G is included under “Results of Operations” below.
We believe that net realized gains or losses, equity in net income or loss of investment funds 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 investment funds 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 investment funds 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 the 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 investment funds 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. Due to these reasons, we exclude net realized gains or losses, equity in net income or loss of investment funds accounted for using the equity method, net foreign exchange gains or losses and transaction costs and other 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 (non-underwriting) segment. While these measures are presented in note 4, “Segment Information,” of the notes accompanying our consolidated financial statements, 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.

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 intangibles and, accordingly, investment income and other non-underwriting related items are not allocated to each underwriting segment. For the ‘other’ segment, performance is measured based on net income or loss.

Along with consolidated underwriting income, we provide a subtotal of underwriting income or loss before the contribution from the ‘other’ segment. The ‘other’ segment includes the results of Watford Holdings Ltd. Watford Holdings Ltd. is the parent of Watford Re Ltd., a multi-line Bermuda reinsurance company (together with Watford Holdings Ltd., “Watford”). Pursuant to generally accepted accounting principles, Watford is considered a variable interest entity and we concluded that we are the primary beneficiary of Watford. As such, we consolidate the results of Watford in our consolidated financial statements, although we only own approximately 13% of Watford’s common equity. Watford’s own management and board of directors are responsible for its results and profitability. In addition, we do not guarantee or provide credit support for

ARCH CAPITAL 472020 SECOND QUARTER FORM 10-Q


Watford. Since Watford is an independent company, the assets of Watford can be used only to settle obligations of Watford and Watford is solely responsible for its own liabilities and commitments. Our financial exposure to Watford is limited to our investment in Watford’s senior notes, common and preferred shares and counterparty credit risk (mitigated by collateral) arising from the reinsurance transactions. We believe that presenting certain information excluding the ‘other’ segment enables investors and other users of our financial information to analyze our performance in a manner similar to how our management analyzes performance.

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 investment funds accounted for using the equity method, net realized gains and losses (excluding changes in the allowance for credit losses on non-investment related financial assets) 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, and compares the return generated by our investment portfolio against benchmark returns during the periods.
 
RESULTS OF OPERATIONS

The following table summarizes our consolidated financial data, including a reconciliation of net income or loss available to Arch common shareholders to after-tax operating income or loss available to Arch common shareholders. Each line item reflects the impact of our percentage ownership of Watford’s common equity during such period.
 Three Months Ended Six Months Ended
 June 30, June 30,
 2020 2019 2020 2019
Net income available to Arch common shareholders$288,418
 $458,551
 $422,132
 $896,676
Net realized (gains) losses(406,645) (124,588) (297,281) (238,923)
Equity in net (income) loss of investment funds accounted for using the equity method65,119
 (32,536) 69,328
 (79,403)
Net foreign exchange (gains) losses42,032
 6,054
 (22,459) 1,060
Transaction costs and other977
 2,178
 3,572
 3,368
Income tax expense (1)26,713
 7,774
 31,078
 10,552
After-tax operating income available to Arch common shareholders$16,614
 $317,433
 $206,370
 $593,330
        
Beginning common shareholders’ equity$10,587,244
 $9,334,596
 $10,717,371
 $8,659,827
Ending common shareholders’ equity11,211,825
 9,977,352
 11,211,825
 9,977,352
Average common shareholders’ equity$10,899,535
 $9,655,974
 $10,964,598
 $9,318,590
        
Annualized return on average common equity %10.6
 19.0
 7.7
 19.2
Annualized operating return on average
common equity %
0.6
 13.1
 3.8
 12.7
(1) Income tax expense on net realized gains or losses, equity in net income or loss of investment funds 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.

ARCH CAPITAL 482020 SECOND QUARTER FORM 10-Q


Segment Information
We classify our businesses into three underwriting segments — insurance, reinsurance and mortgage — and two other operating segments — corporate (non-underwriting) 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 President and Chief Executive Officer of Arch Capital and the Chief Financial Officer of Arch 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, 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:
 Three Months Ended June 30,
 2020 2019 % Change
Gross premiums written$1,030,362
 $919,925
 12.0
Premiums ceded(358,101) (292,095)  
Net premiums written672,261
 627,830
 7.1
Change in unearned premiums15,648
 (35,388)  
Net premiums earned687,909
 592,442
 16.1
Losses and loss adjustment expenses(518,203) (389,172)  
Acquisition expenses(107,671) (91,094)  
Other operating expenses(118,757) (109,523)  
Underwriting income (loss)$(56,722) $2,653
 (2,238.0)
      
Underwriting Ratios 
  
 % Point
Change
Loss ratio75.3% 65.7% 9.6
Acquisition expense ratio15.7% 15.4% 0.3
Other operating expense ratio17.3% 18.5% (1.2)
Combined ratio108.3% 99.6% 8.7
 
 Six Months Ended June 30,
 2020 2019 % Change
Gross premiums written$2,238,007
 $1,861,879
 20.2
Premiums ceded(736,998) (612,717)  
Net premiums written1,501,009
 1,249,162
 20.2
Change in unearned premiums(97,181) (103,215)  
Net premiums earned1,403,828
 1,145,947
 22.5
Losses and loss adjustment expenses(1,025,311) (745,895)  
Acquisition expenses(215,008) (173,918)  
Other operating expenses(248,406) (222,919)  
Underwriting income (loss)$(84,897) $3,215
 (2,740.7)
      
Underwriting Ratios 
  
 % Point
Change
Loss ratio73.0% 65.1% 7.9
Acquisition expense ratio15.3% 15.2% 0.1
Other operating expense ratio17.7% 19.5% (1.8)
Combined ratio106.0% 99.8% 6.2
The insurance segment consists of our insurance underwriting units which offer specialty product lines on a worldwide basis. Product lines include:
Construction and national accounts: primary and excess casualty coverages to middle and large accounts in the construction industry and a wide range of products for middle and large national accounts, specializing in loss sensitive primary casualty insurance programs (including large deductible, self-insured retention and retrospectively rated programs).
Excess and surplus casualty: primary and excess casualty insurance coverages, including middle market energy business, and contract binding, which primarily provides casualty coverage through a network of appointed agents to small and medium risks.
Lenders products: collateral protection, debt cancellation and service contract reimbursement products to banks, credit unions, automotive dealerships and original equipment manufacturers and other specialty programs that pertain to automotive lending and leasing.
Professional lines: directors’ and officers’ liability, errors and omissions liability, employment practices liability, fiduciary liability, crime, professional indemnity and other financial related coverages for corporate, private equity, venture capital, real estate investment trust, limited partnership, financial institution and not-for-profit clients of all sizes and medical professional and general liability insurance coverages for the healthcare industry. The business is predominately written on a claims-made basis.
Programs: primarily package policies, underwriting workers’ compensation and umbrella liability business in support of desirable package programs, targeting program managers with unique expertise and niche products offering

ARCH CAPITAL 492020 SECOND QUARTER FORM 10-Q


general liability, commercial automobile, inland marine and property business with minimal catastrophe exposure.
Property, energy, marine and aviation: primary and excess general property insurance coverages, including catastrophe-exposed property coverage, for commercial clients. Coverages for marine include hull, war, specie and liability. Aviation and stand alone terrorism are also offered.
Travel, accident and health: specialty travel and accident and related insurance products for individual, group travelers, travel agents and suppliers, as well as accident and health, which provides accident, disability and medical plan insurance coverages for employer groups, medical plan members, students and other participant groups.
Other: includes alternative market risks (including captive insurance programs), excess workers’ compensation and employer’s liability insurance coverages for qualified self-insured groups, associations and trusts, and contract and commercial surety coverages, including contract bonds (payment and performance bonds) primarily for medium and large contractors and commercial surety bonds for Fortune 1,000 companies and smaller transaction business programs.
Premiums Written.
The following tables set forth our insurance segment’s net premiums written by major line of business:
 Three Months Ended June 30,
 2020 2019
 Amount % Amount %
Property, energy, marine and aviation$159,801
 23.8
 $103,819
 16.5
Professional Lines157,899
 23.5
 121,679
 19.4
Programs104,930
 15.6
 108,671
 17.3
Construction and national accounts57,144
 8.5
 60,888
 9.7
Excess and surplus casualty64,703
 9.6
 58,466
 9.3
Travel, accident and health27,997
 4.2
 76,537
 12.2
Lenders products23,690
 3.5
 22,373
 3.6
Other76,097
 11.3
 75,397
 12.0
Total$672,261
 100.0
 $627,830
 100.0
2020 Second Quarter versus 2019 Period. Gross premiums written by the insurance segment in the 2020 second quarter were 12.0% higher than in the 2019 second quarter, while net premiums written were 7.1% higher. The higher level of net premiums written primarily reflected increases in property, energy, marine and aviation and professional lines, due in part to new business opportunities, rate increases and growth in existing accounts. Such amounts were partially offset by a decrease in travel business, primarily due to the ongoing impact of COVID-19.
 
 Six Months Ended June 30,
 2020 2019
 Amount % Amount %
Property, energy, marine and aviation$287,386
 19.1
 $174,305
 14.0
Professional Lines327,017
 21.8
 250,913
 20.1
Programs217,462
 14.5
 209,843
 16.8
Construction and national accounts173,143
 11.5
 156,243
 12.5
Excess and surplus casualty130,122
 8.7
 103,631
 8.3
Travel, accident and health154,043
 10.3
 164,641
 13.2
Lenders products56,982
 3.8
 44,788
 3.6
Other154,854
 10.3
 144,798
 11.6
Total$1,501,009
 100.0
 $1,249,162
 100.0
Six Months Ended June 30, 2020 versus 2019 Period. Gross and net premiums written by the insurance segment for the six months ended June 30, 2020 were 20.2% higher than in the 2019 period. The higher level of net premiums written reflected increases in most lines of business, primarily due to new business opportunities, rate increases and growth in existing accounts. Such amounts were partially offset by a decrease in travel business, primarily due to the ongoing impact of COVID-19.
Net Premiums Earned.
The following tables set forth our insurance segment’s net premiums earned by major line of business:
 Three Months Ended June 30,
 2020 2019
 Amount % Amount %
Property, energy, marine and aviation$120,781
 17.6
 $68,995
 11.6
Professional Lines154,812
 22.5
 115,667
 19.5
Programs108,464
 15.8
 102,687
 17.3
Construction and national accounts91,605
 13.3
 76,795
 13.0
Excess and surplus casualty60,966
 8.9
 47,858
 8.1
Travel, accident and health52,117
 7.6
 83,636
 14.1
Lenders products23,111
 3.4
 23,570
 4.0
Other76,053
 11.1
 73,234
 12.4
Total$687,909
 100.0
 $592,442
 100.0

ARCH CAPITAL 502020 SECOND QUARTER FORM 10-Q


 Six Months Ended June 30,
 2020 2019
 Amount % Amount %
Property, energy, marine and aviation$231,964
 16.5
 $128,633
 11.2
Professional Lines306,512
 21.8
 230,458
 20.1
Programs217,342
 15.5
 200,173
 17.5
Construction and national accounts191,305
 13.6
 152,726
 13.3
Excess and surplus casualty126,063
 9.0
 90,227
 7.9
Travel, accident and health129,492
 9.2
 155,211
 13.5
Lenders products48,454
 3.5
 46,802
 4.1
Other152,696
 10.9
 141,717
 12.4
Total$1,403,828
 100.0
 $1,145,947
 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 in the 2020 second quarter were 16.1% higher than in the 2019 second quarter. For the six months ended June 30, 2020, net premiums earned were 22.5% higher than in the 2019 period. Net premiums earned reflect changes in net premiums written over the previous five quarters.
Losses and Loss Adjustment Expenses.
The table below shows the components of the insurance segment’s loss ratio:
 Three Months Ended Six Months Ended
 June 30, June 30,
 2020 2019 2020 2019
Current year75.7 % 66.1 % 73.3 % 65.7 %
Prior period reserve development(0.4)% (0.4)% (0.3)% (0.6)%
Loss ratio75.3 % 65.7 % 73.0 % 65.1 %
Current Year Loss Ratio.
2020 Second Quarter versus 2019 Period. The insurance segment’s current year loss ratio in the 2020 second quarter was 9.6 points higher than in the 2019 second quarter. The 2020 second quarter loss ratio reflected 12.5 points of current year catastrophic activity, which included 11.3 points for exposure related to COVID-19, compared to 0.4 points of catastrophic activity for the 2019 second quarter.
Six Months Ended June 30, 2020 versus 2019 Period. The insurance segment’s current year loss ratio for the six months ended June 30, 2020 was 7.6 points higher than in the 2019 period. The loss ratio for the six months ended June 30, 2020 reflected 9.6 points of current year catastrophic activity, including 8.1 points for exposure related to COVID-19, compared to 0.2 points of catastrophic activity in the 2019 period. The balance of the change in the 2020 loss ratios
 
resulted, in part, from changes in mix of business and the level of attritional losses.
Prior Period Reserve Development.
The insurance segment’s net favorable development was $2.5 million, or 0.4 points, for the 2020 second quarter, compared to $2.6 million, or 0.4 points, for the 2019 second quarter, and $3.6 million, or 0.3 points, for the six months ended June 30, 2020, compared to $7.0 million, or 0.6 points, for the 2019 period. See note 5, “Reserve for Losses and Loss Adjustment Expenses,” to our consolidated financial statements for information about the insurance segment’s prior year reserve development.
Underwriting Expenses.
2020 Second Quarter versus 2019 Period. The insurance segment’s underwriting expense ratio was 33.0% in the 2020 second quarter, compared to 33.9% in the 2019 second quarter, with the decrease primarily due to growth in net premiums earned.
Six Months Ended June 30, 2020 versus 2019 Period. The insurance segment’s underwriting expense ratio was 33.0% for the six months ended June 30, 2020, compared to 34.7% for the 2019 period, with the decrease primarily due to growth in net premiums earned.
Reinsurance Segment 
The following tables set forth our reinsurance segment’s underwriting results:
 Three Months Ended June 30,
 2020 2019 % Change
Gross premiums written$807,065
 $545,547
 47.9
Premiums ceded(241,971) (169,457)  
Net premiums written565,094
 376,090
 50.3
Change in unearned premiums(84,897) (8,906)  
Net premiums earned480,197
 367,184
 30.8
Other underwriting income (loss)(651) 1,224
  
Losses and loss adjustment expenses(383,433) (240,958)  
Acquisition expenses(90,522) (56,785)  
Other operating expenses(38,716) (33,960)  
Underwriting income$(33,125) $36,705
 (190.2)
      
Underwriting Ratios    % Point
Change
Loss ratio79.8% 65.6% 14.2
Acquisition expense ratio18.9% 15.5% 3.4
Other operating expense ratio8.1% 9.2% (1.1)
Combined ratio106.8% 90.3% 16.5

ARCH CAPITAL 512020 SECOND QUARTER FORM 10-Q


 Six Months Ended June 30,
 2020 2019 % Change
Gross premiums written$1,929,584
 $1,228,402
 57.1
Premiums ceded(567,310) (401,024)  
Net premiums written1,362,274
 827,378
 64.6
Change in unearned premiums(338,617) (113,829)  
Net premiums earned1,023,657
 713,549
 43.5
Other underwriting income1,469
 5,601
  
Losses and loss adjustment expenses(813,502) (480,768)  
Acquisition expenses(170,128) (111,111)  
Other operating expenses(84,013) (69,664)  
Underwriting income (loss)$(42,517) $57,607
 (173.8)
      
Underwriting Ratios    % Point
Change
Loss ratio79.5% 67.4% 12.1
Acquisition expense ratio16.6% 15.6% 1.0
Other operating expense ratio8.2% 9.8% (1.6)
Combined ratio104.3% 92.8% 11.5
The reinsurance segment consists of our reinsurance underwriting units which offer specialty product lines on a worldwide basis. Product lines include:
Casualty: provides coverage to ceding company clients on third party liability and workers’ compensation exposures from ceding company clients, primarily on a treaty basis. Exposures include, among others, executive assurance, professional liability, workers’ compensation, excess and umbrella liability, excess motor and healthcare business.
Marine and aviation: provides coverage for energy, hull, cargo, specie, liability and transit, and aviation business, including airline and general aviation risks. Business written may also include space business, which includes coverages for satellite assembly, launch and operation for commercial space programs.
Other specialty: provides coverage to ceding company clients for proportional motor and other lines, including surety, accident and health, workers’ compensation catastrophe, agriculture, trade credit and political risk.
Property catastrophe: provides protection for most catastrophic losses that are covered in the underlying policies written by reinsureds, including hurricane, earthquake, flood, tornado, hail and fire, and coverage for other perils on a case-by-case basis. Property catastrophe reinsurance provides coverage on an excess of loss basis when aggregate losses and loss adjustment expense from a single occurrence or aggregation of losses from a covered peril exceed the retention specified in the contract.
Property excluding property catastrophe: provides coverage for both personal lines and commercial property exposures and principally covers buildings, structures, equipment and contents. The primary perils in this business include fire, explosion, collapse, riot, vandalism, wind, tornado,
 
flood and earthquake. Business is assumed on both a proportional and excess of loss treaty basis and on a facultative basis. In addition, facultative business is written which focuses on commercial property risks on an excess of loss basis.
Other: includes life reinsurance business on both a proportional and non-proportional basis, casualty clash business and, in limited instances, non-traditional business which is intended to provide insurers with risk management solutions that complement traditional reinsurance.
Premiums Written.
The following tables set forth our reinsurance segment’s net premiums written by major line of business:
 Three Months Ended June 30,
 2020 2019
 Amount % Amount %
Property excluding property catastrophe$163,639
 29.0
 $96,050
 25.5
Property catastrophe117,676
 20.8
 46,594
 12.4
Other specialty117,375
 20.8
 129,174
 34.3
Casualty105,049
 18.6
 78,025
 20.7
Marine and aviation32,372
 5.7
 15,619
 4.2
Other28,983
 5.1
 10,628
 2.8
Total$565,094
 100.0
 $376,090
 100.0
2020 Second Quarter versus 2019 Period. Gross premiums written by the reinsurance segment in the 2020 second quarter were 47.9% higher than in the 2019 second quarter, while net premiums written were 50.3% higher. The higher level of net premiums written primarily reflected increases in property lines, due in part to new business and rate increases.
 Six Months Ended June 30,
 2020 2019
 Amount % Amount %
Property excluding property catastrophe$322,563
 23.7
 $198,790
 24.0
Property catastrophe206,768
 15.2
 49,977
 6.0
Other specialty402,327
 29.5
 269,651
 32.6
Casualty295,929
 21.7
 246,509
 29.8
Marine and aviation82,157
 6.0
 31,577
 3.8
Other52,530
 3.9
 30,874
 3.7
Total$1,362,274
 100.0
 $827,378
 100.0
Six Months Ended June 30, 2020 versus 2019 Period. Gross premiums written by the reinsurance segment for the six months ended June 30, 2020 were 57.1% higher than in the 2019 period, while net premiums written were 64.6% higher than in the 2019 period. The increase in net premiums written reflected growth across all lines of business due to new business and rate increases. The 2020 period was affected by the presence of an $88 million loss portfolio transfer contract, written and fully earned in the period in the other specialty line of business. The growth in net premiums written also reflected increases in most lines of business, primarily due to growth in existing accounts,

ARCH CAPITAL 522020 SECOND QUARTER FORM 10-Q


new business, including premiums written through Barbican which was acquired in the 2019 fourth quarter, and rate increases.
Net Premiums Earned.
The following tables set forth our reinsurance segment’s net premiums earned by major line of business:
 Three Months Ended June 30,
 2020 2019
 Amount % Amount %
Property excluding property catastrophe$124,019
 25.8
 $85,479
 23.3
Property catastrophe55,226
 11.5
 18,537
 5.0
Other specialty123,006
 25.6
 136,573
 37.2
Casualty132,756
 27.6
 103,164
 28.1
Marine and aviation24,960
 5.2
 12,498
 3.4
Other20,230
 4.2
 10,933
 3.0
Total$480,197
 100.0
 $367,184
 100.0
 Six Months Ended June 30,
 2020 2019
 Amount % Amount %
Property excluding property catastrophe$236,671
 23.1
 $169,271
 23.7
Property catastrophe108,226
 10.6
 37,269
 5.2
Other specialty326,391
 31.9
 258,094
 36.2
Casualty267,827
 26.2
 194,788
 27.3
Marine and aviation49,818
 4.9
 23,557
 3.3
Other34,724
 3.4
 30,570
 4.3
Total$1,023,657
 100.0
 $713,549
 100.0
Net premiums written, irrespective of the class of business, are generally earned on a pro rata basis over the terms of the underlying policies or reinsurance contracts. Net premiums earned by the reinsurance segment in the 2020 second quarter were 30.8% higher than in the 2019 second quarter. For the six months ended June 30, 2020, net premiums earned were 43.5% higher than in the 2019 period.
Other Underwriting Income (Loss).
Other underwriting income for the 2020 second quarter was a loss of $0.7 million, compared to income of $1.2 million for the 2019 second quarter, and $1.5 million for the six months ended June 30, 2020, compared to $5.6 million for the 2019 period.
 
Losses and Loss Adjustment Expenses.
The table below shows the components of the reinsurance segment’s loss ratio:
 Three Months Ended Six Months Ended
 June 30, June 30,
 2020 2019 2020 2019
Current year88.2 % 69.1 % 84.6 % 68.9 %
Prior period reserve development(8.4)% (3.5)% (5.1)% (1.5)%
Loss ratio79.8 % 65.6 % 79.5 % 67.4 %
Current Year Loss Ratio.
2020 Second Quarter versus 2019 Period. The reinsurance segment’s current year loss ratio in the 2020 second quarter was 19.1 points higher than in the 2019 second quarter. The 2020 second quarter loss ratio reflected 26.3 points of current year catastrophic activity, including 19.8 points for exposure related to COVID-19, compared to 1.3 points of catastrophic activity in the 2019 second quarter.
Six Months Ended June 30, 2020 versus 2019 Period. The reinsurance segment’s current year loss ratio for the six months ended June 30, 2020 was 15.7 points higher than in the 2019 period. The loss ratio for the six months ended June 30, 2020 reflected 19.1 points of current year catastrophic activity, including 14.2 points for exposure related to COVID-19, compared to 1.7 points for the 2019 period. The balance of the change in the 2020 loss ratios resulted, in part, from changes in mix of business and the level of attritional losses.
Prior Period Reserve Development.
The reinsurance segment’s net favorable development was $40.2 million, or 8.4 points, for the 2020 second quarter, compared to $12.7 million, or 3.5 points, for the 2019 second quarter, and $51.8 million, or 5.1 points, for the six months ended June 30, 2020, compared to $11.0 million, or 1.5 points, for the 2019 period. See note 5, “Reserve for Losses and Loss Adjustment Expenses,” to our consolidated financial statements for information about the reinsurance segment’s prior year reserve development.
Underwriting Expenses.
2020 Second Quarter versus 2019 Period. The underwriting expense ratio for the reinsurance segment was 27.0% in the 2020 second quarter, compared to 24.7% in the 2019 second quarter, with the increase reflecting additional acquisition expenses resulting primarily from the favorable prior year loss reserve development in the 2020 second quarter and changes in mix of business.

ARCH CAPITAL 532020 SECOND QUARTER FORM 10-Q


Six Months Ended June 30, 2020 versus 2019 Period. The underwriting expense ratio for the reinsurance segment was 24.8% for the six months ended June 30, 2020, compared to 25.4% for the 2019 period, and reflected a higher level of net premiums earned for the 2020 period.
Mortgage Segment 
Our mortgage operations include U.S. and international mortgage insurance and reinsurance operations as well as participation in GSE credit risk-sharing transactions. Our mortgage group includes direct mortgage insurance in the U.S. primarily through Arch Mortgage Insurance Company and United Guaranty Residential Insurance Company (together, “Arch MI U.S.”), mortgage reinsurance by Arch Reinsurance Ltd. (“Arch Re Bermuda”) to mortgage insurers on both a proportional and non-proportional basis globally; direct mortgage insurance in Europe through Arch Insurance (EU) Designated Activity Company (“Arch MI Europe”) and in Hong Kong through Arch MI Asia Limited (“Arch MI Asia”); and participation in various GSE credit risk-sharing products primarily through Arch Re Bermuda.
The following tables set forth our mortgage segment’s underwriting results.
 Three Months Ended June 30,
 2020 2019 % Change
Gross premiums written$369,144
 $364,465
 1.3
Premiums ceded(44,044) (42,857)  
Net premiums written325,100
 321,608
 1.1
Change in unearned premiums40,613
 31,175
  
Net premiums earned365,713
 352,783
 3.7
Other underwriting income6,450
 4,056
  
Losses and loss adjustment expenses(224,100) (25,997)  
Acquisition expenses(34,052) (32,654)  
Other operating expenses(37,574) (39,819)  
Underwriting income$76,437
 $258,369
 (70.4)
      
Underwriting Ratios    % Point
Change
Loss ratio61.3% 7.4% 53.9
Acquisition expense ratio9.3% 9.3% 
Other operating expense ratio10.3% 11.3% (1.0)
Combined ratio80.9% 28.0% 52.9

 
 Six Months Ended June 30,
 2020 2019 % Change
Gross premiums written$738,089
 $720,515
 2.4
Premiums ceded(88,371) (91,655)  
Net premiums written649,718
 628,860
 3.3
Change in unearned premiums61,021
 46,825
  
Net premiums earned710,739
 675,685
 5.2
Other underwriting income11,049
 7,912
  
Losses and loss adjustment expenses(291,666) (37,146)  
Acquisition expenses(72,588) (64,326)  
Other operating expenses(83,470) (79,694)  
Underwriting income$274,064
 $502,431
 (45.5)
      
Underwriting Ratios 
  
 % Point
Change
Loss ratio41.0% 5.5% 35.5
Acquisition expense ratio10.2% 9.5% 0.7
Other operating expense ratio11.7% 11.8% (0.1)
Combined ratio62.9% 26.8% 36.1
Premiums Written.
The following tables set forth our mortgage segment’s net premiums written by underwriting location (i.e., where the business is underwritten):
 Three Months Ended June 30,
 2020 2019
 Amount % Amount %
Underwriting location:       
United States$261,124
 80.3
 $258,774
 80.5
Other63,976
 19.7
 62,834
 19.5
Total$325,100
 100.0
 $321,608
 100.0
2020 Second Quarter versus 2019 Period. Gross premiums written by the mortgage segment in the 2020 second quarter were 1.3% higher than in the 2019 second quarter, while net premiums written were 1.1% higher. The growth in net premiums written reflected an increase in GSE credit risk-sharing transactions along with a lower level of ceded premiums on U.S. primary mortgage business.
 Six Months Ended June 30,
 2020 2019
 Amount % Amount %
Underwriting location:       
United States$525,232
 80.8
 $514,154
 81.8
Other124,486
 19.2
 114,706
 18.2
Total$649,718
 100.0
 $628,860
 100.0
Six Months Ended June 30, 2020 versus 2019 Period. Gross premiums written by the mortgage segment for the six months ended June 30, 2020 were 2.4% higher than in the 2019 period, while net premiums written for the six months ended June 30, 2020 were 3.3% higher than in the 2019 period. The growth in net premiums written primarily reflected lower ceded premiums and an increase in monthly premium business due to growth in insurance in force. The 2019 period included $17.1

ARCH CAPITAL 542020 SECOND QUARTER FORM 10-Q


million due to the novation of a quota share reinsurance arrangement on international business.
The persistency rate, which 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, of which the Arch MI U.S. portfolio of mortgage loans was 66.6% at June 30, 2020, reflecting the higher level of mortgage refinancing, compared to 75.7% at December 31, 2019.
Arch MI U.S. generated $24.6 billion of new insurance written (“NIW”) in the 2020 second quarter, compared to $17.2 billion in the 2019 second quarter. NIW represents the original principal balance of all loans that received coverage during the period. Monthly premium policies contributed 95.3% of NIW in the 2020 second quarter, compared to 92.9% for the 2019 second quarter.
The following tables provide details on the NIW generated by Arch MI U.S.:
(U.S. Dollars in millions)Three Months Ended June 30,
2020 2019
 Amount % Amount %
Total new insurance written (NIW) (1)$24,551
   $17,161
  
        
Credit quality (FICO):       
>=740$15,851
 64.6
 $9,862
 57.5
680-7397,781
 31.7
 6,139
 35.8
620-679919
 3.7
 1,160
 6.8
Total$24,551
 100.0
 $17,161
 100.0
        
Loan-to-value (LTV):       
95.01% and above$1,948
 7.9
 $2,530
 14.7
90.01% to 95.00%9,403
 38.3
 7,497
 43.7
85.01% to 90.00%8,140
 33.2
 5,026
 29.3
85.00% and below5,060
 20.6
 2,108
 12.3
Total$24,551
 100.0
 $17,161
 100.0
        
Monthly vs. single:       
Monthly$23,391
 95.3
 $15,935
 92.9
Single1,160
 4.7
 1,226
 7.1
Total$24,551
 100.0
 $17,161
 100.0
        
Purchase vs. refinance:       
Purchase$14,956
 60.9
 $14,992
 87.4
Refinance9,595
 39.1
 2,169
 12.6
Total$24,551
 100.0
 $17,161
 100.0
(1)Represents the original principal balance of all loans that received coverage during the period.
Arch MI U.S. generated $41.3 billion of new insurance written (“NIW”) for the six months ended June 30, 2020, compared to $28.4 billion for the 2019 period. Monthly premium policies contributed 94.6% of NIW for the six months ended June 30, 2020, compared to 92.4% for the 2019 period.
 
(U.S. Dollars in millions)Six Months Ended June 30,
2020 2019
 Amount % Amount %
Total new insurance written (NIW) (1)$41,329
   $28,368
  
        
Credit quality (FICO):       
>=740$25,920
 62.7
 $16,212
 57.1
680-73913,568
 32.8
 10,180
 35.9
620-6791,841
 4.5
 1,976
 7.0
Total$41,329
 100.0
 $28,368
 100.0
        
Loan-to-value (LTV):       
95.01% and above$3,616
 8.7
 $4,338
 15.3
90.01% to 95.00%16,602
 40.2
 12,472
 44.0
85.01% to 90.00%13,469
 32.6
 8,175
 28.8
85.00% and below7,642
 18.5
 3,383
 11.9
Total$41,329
 100.0
 $28,368
 100.0
        
Monthly vs. single:       
Monthly$39,083
 94.6
 $26,198
 92.4
Single2,246
 5.4
 2,170
 7.6
Total$41,329
 100.0
 $28,368
 100.0
        
Purchase vs. refinance:       
Purchase$27,255
 65.9
 $25,281
 89.1
Refinance14,074
 34.1
 3,087
 10.9
Total$41,329
 100.0
 $28,368
 100.0
(1)Represents the original principal balance of all loans that received coverage during the period.
Net Premiums Earned.
The following tables set forth our mortgage segment’s net premiums earned by underwriting location:
 Three Months Ended June 30,
 2020 2019
 Amount % Amount %
Underwriting location:       
United States$304,652
 83.3
 $282,062
 80.0
Other61,061
 16.7
 70,721
 20.0
Total$365,713
 100.0
 $352,783
 100.0
2020 Second Quarter versus 2019 Period. Net premiums earned for the 2020 second quarter were 3.7% higher than in the 2019 second quarter, primarily reflecting a higher level of single premiums earned as a result of policy terminations due to mortgage refinance activity, and to a lesser extent, the growth in insurance in force in the U.S. over the second half of 2019.
 Six Months Ended June 30,
 2020 2019
 Amount % Amount %
Underwriting location:       
United States$593,814
 83.5
 $556,535
 82.4
Other116,925
 16.5
 119,150
 17.6
Total$710,739
 100.0
 $675,685
 100.0
Six Months Ended June 30, 2020 versus 2019 Period. Net premiums earned for the six months ended June 30, 2020 were

ARCH CAPITAL 552020 SECOND QUARTER FORM 10-Q


5.2% higher than in the 2019 period, primarily reflecting a higher level of single premiums earned as a result of policy terminations due to mortgage refinance activity, and to a lesser extent the growth in insurance in force in the U.S. over the second half of 2019.
Other Underwriting Income.
Other underwriting income, which is primarily related to older GSE credit risk-sharing transactions receiving derivative accounting treatment and to a lesser extent contract underwriting fees, was $6.5 million for the 2020 second quarter, compared to $4.1 million for the 2019 second quarter.
Losses and Loss Adjustment Expenses.
The table below shows the components of the mortgage segment’s loss ratio:
 Three Months Ended Six Months Ended
 June 30, June 30,
 2020 2019 2020 2019
Current year61.4 % 13.9 % 41.9 % 14.3 %
Prior period reserve development(0.1)% (6.5)% (0.9)% (8.8)%
Loss ratio61.3 % 7.4 % 41.0 % 5.5 %
Current Year Loss Ratio.
2020 Second Quarter versus 2019 Period. The mortgage segment’s current year loss ratio was 47.5 points higher in the 2020 second quarter than in the 2019 second quarter. Incurred losses for the 2020 second quarter reflected elevated delinquency rates due, in part, to financial stress from the COVID-19 pandemic. The percentage of loans in default on U.S. primary mortgage business was 5.14% at June 30, 2020, compared to 1.45% at June 30, 2019. For U.S. primary mortgage insurance, loss reserving under GAAP is based on reported delinquencies. 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.
Six Months Ended June 30, 2020 versus 2019 Period. The mortgage segment’s current year loss ratio was 27.6 points higher for the six months ended June 30, 2020 than for the 2019 period.
Prior Period Reserve Development.
The mortgage segment’s net favorable development was $0.2 million, or 0.1 points, for the 2020 second quarter, compared to $22.8 million, or 6.5 points, for the 2019 second quarter, and $6.3 million, or 0.9 points, for the six months ended June 30,
 
2020, compared to $59.4 million, or 8.8 points, for the 2019 period. See note 5, “Reserve for Losses and Loss Adjustment Expenses,” to our consolidated financial statements for information about the mortgage segment’s prior year reserve development.
Underwriting Expenses.
2020 Second Quarter versus 2019 Period. The underwriting expense ratio for the mortgage segment was 19.6% in the 2020 second quarter, compared to 20.6% in the 2019 second quarter with the decrease primarily reflecting the higher level of net premiums earned.
Six Months Ended June 30, 2020 versus 2019 Period. The underwriting expense ratio for the mortgage segment was 21.9% for the six months ended June 30, 2020, compared to 21.3% for the 2019 period.
Corporate (Non-Underwriting) Segment
The corporate (non-underwriting) segment results include net investment income, other income (loss), corporate expenses, transaction costs and other, amortization of intangible assets, interest expense, items related to our non-cumulative preferred shares, net realized gains or losses (which includes changes in the allowance for credit losses on financial assets and net impairment losses recognized in earnings), equity in net income or loss of investment funds accounted for using the equity method, net foreign exchange gains or losses and income taxes. Such amounts exclude the results of the ‘other’ segment.
Net Investment Income.
The components of net investment income were derived from the following sources:
 Three Months Ended Six Months Ended
 June 30, June 30,
 2020 2019 2020 2019
Fixed maturities$91,491
 $111,335
 $193,254
 $221,986
Equity securities6,023
 3,494
 11,653
 5,740
Short-term investments897
 3,448
 4,282
 7,746
Other (1)17,825
 20,115
 38,304
 43,059
Gross investment income116,236
 138,392
 247,493
 278,531
Investment expenses (2)(15,205) (15,354) (33,434) (34,244)
Net investment income$101,031
 $123,038
 $214,059
 244,287
(1)Amounts include dividends and other distributions on investment funds, term loan investments, funds held balances, cash balances and other items.
(2)Investment expenses were approximately 0.28% of average invested assets for the 2020 second quarter, compared to 0.32% for the 2019 second quarter, and 0.32% for the six months ended June 30, 2020, compared to 0.35% for the 2019 period.

ARCH CAPITAL 562020 SECOND QUARTER FORM 10-Q


The lower level of net investment income for the 2020 period primarily related to lower yields available in the financial market. The pre-tax investment income yield, calculated based on amortized cost and on an annualized basis, was 1.92% for the 2020 second quarter, compared to 2.62% for the 2019 second quarter, and 2.08% for the six months ended June 30, 2020, compared to 2.64% for the 2019 period.
Corporate Expenses.
Corporate expenses were $16.9 million for the 2020 second quarter, compared to $16.1 million for the 2019 second quarter, and $35.1 million for the six months ended June 30, 2020, compared to $32.8 million for the 2019 period. The increase in corporate expenses primarily reflected higher professional fees and other costs.
Transaction Costs and Other.
Transaction costs and other were $1.0 million for the 2020 second quarter, compared to $2.2 million for the 2019 second quarter, and $3.6 million for the six months ended June 30, 2020, compared to $3.4 million for the 2019 period. Amounts in the 2020 period are primarily related to recent acquisition activity.
Amortization of Intangible Assets.
Amortization of intangible assets for the 2020 second quarter was $16.5 million, compared to $19.8 million for the 2019 second quarter, and $33.1 million for the six months ended June 30, 2020, compared to $40.2 million for the 2019 period. Such expenses are primarily related to the UGC acquisition and other acquisitions in late 2018 to 2019. See the consolidated financial statements contained in our 2019 Form 10-K for disclosures on our amortization pattern.
Interest Expense.
Interest expense was $25.1 million for the 2020 second quarter, compared to the $23.4 million for the 2019 second quarter and $50.4 million for the six months ended June 30, 2020, compared to $46.9 million for the 2019 period. The increase in the 2020 period reflected an increase in funds held liabilities. The second half of 2020 will reflect interest expense of $18.3 million related to the $1.0 billion of new senior notes issued on June 30, 2020.
Net Realized Gains or Losses.
We recorded net realized gains of $385.1 million for the 2020 second quarter, compared to net realized gains of $125.1 million for the 2019 second quarter, and net realized gains of $313.0 million for the six months ended June 30, 2020, compared to net realized gains of $236.2 million for the 2019 period. 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 7, “Investment Information—Net Realized Gains (Losses),” to our consolidated financial statements for additional information. See note 7, “Investment Information—Allowance for Credit Losses,” to our consolidated financial statements for additional information.
Equity in Net Income (Loss) of Investment Funds Accounted for Using the Equity Method.
We recorded a loss of $65.1 million for equity in net income or loss related to investment funds accounted for using the equity method in the 2020 second quarter, compared to $32.5 million of income for the 2019 second quarter, and a loss of $69.3 million for the six months ended June 30, 2020, compared to $79.4 million of income for the 2019 period. Such investments are generally recorded on a one to three month lag based on the availability of reports from the investment funds. Investment funds accounted for using the equity method totaled $1.73 billion at June 30, 2020, compared to $1.66 billion at December 31, 2019. See note 7, “Investment Information—Investments Accounted For Using the Equity Method,” to our consolidated financial statements for additional information.
Net Foreign Exchange Gains or Losses.
Net foreign exchange losses for the 2020 second quarter were $42.4 million, compared to net foreign exchange losses for the 2019 second quarter of $6.2 million. Net foreign exchange gains for the six months ended June 30, 2020 were $20.9 million, compared to net foreign exchange losses for the 2019 period of $1.0 million. Amounts in both periods were primarily unrealized and resulted from the effects of revaluing our net insurance liabilities required to be settled in foreign currencies at each balance sheet date.
Income Tax Expense.
Our income tax provision on income (loss) before income taxes resulted in an expense of 8.8% for the 2020 second quarter, compared to 8.7% for the 2019 second quarter and 10.7% for the six months ended June 30, 2020, compared to 9.0% for the 2019 period. Such amounts exclude the results of the ‘other’ segment. The effective tax rates for the 2020 second quarter and six months ended June 30, 2020 included a discrete income tax expense of $0.3 million and a discrete income tax benefit of $2.1 million respectively, related to share based

ARCH CAPITAL 572020 SECOND QUARTER FORM 10-Q


compensation. Our effective tax rate, which is based upon the expected annual effective tax rate, may fluctuate from period to period based on the relative mix of income or loss reported by jurisdiction and the varying tax rates in each jurisdiction.
Other Segment 
The ‘other’ segment includes the results of Watford. Pursuant to generally accepted accounting principles, Watford is considered a variable interest entity and we concluded that we are the primary beneficiary of Watford. As such, we consolidate the results of Watford in our consolidated financial statements, although we only own approximately 13% of Watford’s common equity. See note 12, “Variable Interest Entities and Noncontrolling Interests,” and note 4, “Segment Information,” to our consolidated financial statements for additional information on Watford.
CRITICAL ACCOUNTING POLICIES,
ESTIMATES AND RECENT ACCOUNTING PRONOUNCEMENTS

Critical accounting policies, estimates and recent accounting pronouncements are discussed in Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our 2019 Form 10-K, updated where applicable in the notes accompanying our consolidated financial statements, including note 1, “Basis of Presentation and Recent Accounting Pronouncements.”
FINANCIAL CONDITION

Investable Assets 
At June 30, 2020, total investable assets held by Arch were $24.53 billion, excluding the $2.64 billion included in the ‘other’ segment (i.e., attributable to Watford).
 
Investable Assets Held by Arch 
The following table summarizes the fair value of the investable assets held by Arch:
Investable assets (1):
Estimated
Fair Value
 
% of
Total
June 30, 2020   
Fixed maturities (2)$17,391,665
 70.9
Short-term investments (2)2,292,183
 9.3
Cash746,606
 3.0
Equity securities (2)1,232,668
 5.0
Other investments (2)1,212,788
 4.9
Investments accounted for using the equity method1,727,302
 7.0
Securities transactions entered into but not settled at the balance sheet date(72,018) (0.3)
Total investable assets held by Arch$24,531,194
 100.0
    
Average effective duration (in years)3.18
  
Average S&P/Moody’s credit ratings (3)AA/Aa2
  
Embedded book yield (4)1.85%  
    
December 31, 2019   
Fixed maturities (2)$16,894,021
 75.8
Short-term investments (2)1,004,257
 4.5
Cash623,793
 2.8
Equity securities (2)827,842
 3.7
Other investments (2)1,336,920
 6.0
Investments accounted for using the equity method1,660,396
 7.5
Securities transactions entered into but not settled at the balance sheet date(61,553) (0.3)
Total investable assets held by Arch$22,285,676
 100.0
    
Average effective duration (in years)3.40
  
Average S&P/Moody’s credit ratings (3)AA/Aa2
  
Embedded book yield (4)2.55%  
(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 at fair value under the fair value option.
(3)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”).
(4)Before investment expenses.
At June 30, 2020, approximately $18.09 billion, or 73.8%, of total investable assets held by Arch were internally managed, compared to $15.80 billion, or 70.9%, at December 31, 2019.

ARCH CAPITAL 582020 SECOND QUARTER FORM 10-Q


The following table summarizes our fixed maturities and fixed maturities pledged under securities lending agreements (“Fixed Maturities”) by type:
 
Estimated
Fair Value
 
% of
Total
June 30, 2020 
  
Corporate bonds$7,309,416
 42.0
Mortgage backed securities593,799
 3.4
Municipal bonds515,222
 3.0
Commercial mortgage backed securities396,813
 2.3
U.S. government and government agencies4,976,127
 28.6
Non-U.S. government securities2,089,171
 12.0
Asset backed securities1,511,117
 8.7
Total$17,391,665
 100.0
    
December 31, 2019 
  
Corporate bonds$6,561,354
 38.8
Mortgage backed securities541,800
 3.2
Municipal bonds880,119
 5.2
Commercial mortgage backed securities734,244
 4.3
U.S. government and government agencies4,632,947
 27.4
Non-U.S. government securities1,995,813
 11.8
Asset backed securities1,547,744
 9.2
Total$16,894,021
 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.
 Estimated Fair Value 
% of
Total
June 30, 2020   
U.S. government and gov’t agencies (1)$5,566,339
 32.0
AAA3,035,513
 17.5
AA1,818,693
 10.5
A4,232,245
 24.3
BBB1,874,332
 10.8
BB406,342
 2.3
B211,638
 1.2
Lower than B51,273
 0.3
Not rated195,290
 1.1
Total$17,391,665
 100.0
    
December 31, 2019   
U.S. government and gov’t agencies (1)$5,215,489
 30.9
AAA3,392,341
 20.1
AA2,115,828
 12.5
A3,849,458
 22.8
BBB1,495,467
 8.9
BB355,803
 2.1
B216,663
 1.3
Lower than B56,865
 0.3
Not rated196,107
 1.2
Total$16,894,021
 100.0
(1)Includes U.S. government-sponsored agency residential mortgage-backed securities and agency commercial mortgage-backed securities.
 
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:
Severity of gross unrealized losses:Estimated Fair Value 
Gross
Unrealized
Losses
 
% of
Total Gross
Unrealized
Losses
June 30, 2020     
0-10%$3,267,915
 $(82,417) 74.9
10-20%124,722
 (18,954) 17.2
20-30%14,736
 (4,848) 4.4
Greater than 30%3,900
 (3,796) 3.5
Total$3,411,273
 $(110,015) 100.0
      
December 31, 2019     
0-10%$4,136,798
 $(49,072) 95.3
10-20%12,405
 (1,796) 3.5
20-30%830
 (273) 0.5
Greater than 30%315
 (363) 0.7
Total$4,150,348
 $(51,504) 100.0
The following table summarizes our top ten exposures to fixed income corporate issuers by fair value at June 30, 2020, excluding guaranteed amounts and covered bonds:
 Estimated Fair Value 
Credit
Rating (1)
Bank of America Corporation$295,236
 A-/A2
Wells Fargo & Company262,510
 A-/A2
JPMorgan Chase & Co.226,876
 A-/A2
Apple Inc.180,336
 AA+/Aa1
Citigroup Inc.150,811
 BBB+/A3
Morgan Stanley136,897
 BBB+/A3
Comcast Corporation115,873
 A-/A3
International Business Machines Corporation114,080
 A/A2
Oracle Corporation109,003
 A/A3
The Goldman Sachs Group, Inc.108,248
 BBB+/A3
Total$1,699,870
  
(1)Average credit ratings as assigned by S&P and Moody’s, respectively.

ARCH CAPITAL 592020 SECOND QUARTER FORM 10-Q


The following table provides information on our structured securities, which includes residential mortgage-backed securities (“RMBS”), commercial mortgage-backed securities (“CMBS”) and asset-backed securities (“ABS”):
 Agencies Investment Grade Below Investment Grade Total
Jun 30, 2020       
RMBS$560,870
 $4,515
 $28,414
 $593,799
CMBS29,342
 346,393
 21,078
 396,813
ABS
 1,451,117
 60,000
 1,511,117
Total$590,212
 $1,802,025
 $109,492
 $2,501,729
        
Dec 31, 2019       
RMBS$503,929
 $7,770
 $30,101
 $541,800
CMBS78,612
 629,424
 26,208
 734,244
ABS
 1,483,449
 64,295
 1,547,744
Total$582,541
 $2,120,643
 $120,604
 $2,823,788
At June 30, 2020, our structured securities included $31.7 million par value in sub-prime securities with a fair value of $26.1 million and average credit quality ratings from S&P/Moody’s of “CCC+/Caa2,” compared to $38.3 million par value with a fair value of $30.6 million and average credit quality ratings of “CCC-/Caa3” at December 31, 2019.
The following table summarizes our equity securities, which include investments in exchange traded funds:
 June 30,
2020
 December 31,
2019
Equities (1)$450,794
 $375,067
Exchange traded funds   
Fixed income (2)418,309
 7,237
Equity and other (3)363,565
 445,538
Total$1,232,668
 $827,842
(1)Primarily in consumer non-cyclical, consumer cyclical, technology, communications and financial stocks at June 30, 2020.
(2)Primarily in MBS, corporate and municipal strategies at June 30, 2020.
(3)Primarily in large cap stocks and foreign equities at June 30, 2020.

 
The following table summarizes our other investments which are included in investments accounted for using the fair value option, by strategy:
 June 30,
2020
 December 31,
2019
Lending$579,320
 $602,841
Term loan investments233,471
 264,083
Energy66,667
 97,402
Credit related funds92,970
 123,020
Investment grade fixed income133,936
 151,594
Infrastructure48,427
 61,786
Private equity38,746
 18,915
Real estate19,251
 17,279
Total$1,212,788
 $1,336,920
For details on our investments accounted for using the equity method, see note 7, “Investment Information—Investments Accounted For Using the Equity Method,” to our consolidated financial statements.
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 9, “Derivative Instruments,” to our consolidated financial statements for additional disclosures related to 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 8, “Fair Value,” to our consolidated financial statements for a summary of our financial assets and liabilities measured at fair value, segregated by level in the fair value hierarchy.
Investable Assets in the ‘Other’ Segment
Investable assets in the ‘other’ segment are managed by Watford. The board of directors of Watford establishes its investment policies and guidelines. A significant amount of Watford’s investments are accounted for using the fair value option with changes in the carrying value of such investments recorded in net realized gains or losses.

ARCH CAPITAL 602020 SECOND QUARTER FORM 10-Q


The following table summarizes investable assets in the ‘other’ segment:
 June 30,
2020
 December 31,
2019
Investments accounted for using the fair value option:   
Other investments$909,702
 $1,092,396
Fixed maturities548,011
 416,592
Short-term investments370,065
 329,303
Equity securities58,898
 59,799
Total1,886,676
 1,898,090
Fixed maturities available for sale, at fair value649,765
 706,875
Equity securities, at fair value62,443
 65,337
Cash107,653
 102,437
Securities sold but not yet purchased(29,289) (66,257)
Securities transactions entered into but not settled at the balance sheet date(35,958) (1,893)
Total investable assets included in ‘other’ segment$2,641,290
 $2,704,589
Reinsurance
The effects of reinsurance on written and earned premiums and losses and loss adjustment expenses (“LAE”) with unaffiliated reinsurers were as follows:
 Three Months Ended Six Months Ended
 June 30, June 30,
 2020 2019 2020 2019
Premiums written:       
Direct$1,485,627
 $1,373,825
 $3,174,425
 $2,737,331
Assumed832,065
 563,984
 1,976,097
 1,278,357
Ceded(649,381) (492,911) (1,344,965) (1,045,531)
Net$1,668,311
 $1,444,898
 $3,805,557
 $2,970,157
        
Premiums earned:       
Direct$1,559,222
 $1,335,558
 $3,105,047
 $2,601,621
Assumed746,188
 574,899
 1,507,262
 1,108,178
Ceded(640,056) (446,730) (1,202,511) (877,206)
Net$1,665,354
 $1,463,727
 $3,409,798
 $2,832,593
        
Losses and LAE:       
Direct$1,162,958
 $705,235
 $2,148,041
 $1,321,297
Assumed508,108
 388,237
 1,053,977
 726,637
Ceded(440,544) (325,929) (856,077) (561,859)
Net$1,230,522
 $767,543
 $2,345,941
 $1,486,075
See note 6, “Allowance for Expected Credit Losses,” to our consolidated financial statements for information about our reinsurance recoverables and related allowance for credit losses.
 
Bellemeade Re
We have entered into various aggregate excess of loss mortgage reinsurance agreements with various special purpose reinsurance companies domiciled in Bermuda (the “Bellemeade Agreements”). For the respective coverage periods, we will retain the first layer of the respective aggregate losses and the special purpose reinsurance companies will provide second layer coverage up to the outstanding coverage amount. We will then retain losses in excess of the outstanding coverage limit. The aggregate excess of loss reinsurance coverage generally decreases over a ten-year period as the underlying covered mortgages amortize, unless provisional call options embedded within certain of the Bellemeade Agreements are executed or if pre-defined delinquency triggering events occur.
The following table summarizes the respective coverages and retentions at June 30, 2020:
   June 30, 2020
 Initial Coverage at Issuance Current Coverage Remaining Retention, Net
Bellemeade 2017-1 Ltd. (1)$368,114
 $145,573
 $140,110
Bellemeade 2018-1 Ltd. (2)374,460
 250,095
 139,538
Bellemeade 2018-2 Ltd. (3)653,278
 272,685
 319,768
Bellemeade 2018-3 Ltd. (4)506,110
 302,563
 148,814
Bellemeade 2019-1 Ltd. (5)341,790
 219,256
 142,145
Bellemeade 2019-2 Ltd. (6)621,022
 398,316
 189,771
Bellemeade 2019-3 Ltd. (7)700,920
 528,084
 201,022
Bellemeade 2019-4 Ltd. (8)577,267
 468,737
 139,810
Bellemeade 2020-1 Ltd. (9)528,540
 528,540
 780,853
Total$4,671,501
 $3,113,849
 $2,201,831
(1)Issued in October 2017, covering in-force policies issued between January 1, 2017 and June 30, 2017.
(2)Issued in April 2018, covering in-force policies issued between July 1, 2017 and December 31, 2017.
(3)Issued in August 2018, covering in-force policies issued between April 1, 2013 and December 31, 2015.
(4)Issued in October 2018, covering in-force policies issued between January 1, 2018 and June 30, 2018.
(5)Issued in March 2019, covering in-force policies primarily issued between 2005-2008 under United Guaranty Residential Insurance Company (“UGRIC”); as well as policies issued through 2015 under both UGRIC and Arch Mortgage Insurance Company.
(6)Issued in April 2019, covering in-force policies issued between July 1, 2018 and December 31, 2018.
(7)Issued in July 2019, covering in-force policies issued in 2016.
(8)Issued in October 2019, covering in-force policies issued between January 1, 2019 and June 30, 2019.
(9)Issued in June 2020, covering in-force policies issued between July 1, 2019 and December 31, 2019. $450 million was directly funded by Bellemeade 2020-1 Ltd. with an additional $78.5 million of capacity provided directly to Arch MI U.S. by a separate panel of reinsurers.

Reserve for Losses and Loss Adjustment Expenses 
We establish reserve for losses and loss adjustment expenses (“Loss Reserves”) which represent estimates involving

ARCH CAPITAL 612020 SECOND QUARTER FORM 10-Q


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, which is exacerbated by the fact that we have relatively limited historical experience upon which to base such estimates. 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.
At June 30, 2020 and December 31, 2019, our Loss Reserves, net of unpaid losses and loss adjustment expenses recoverable, by type and by operating segment were as follows:
 June 30,
2020
 December 31,
2019
Insurance segment: 
  
Case reserves$1,690,175
 $1,601,627
IBNR reserves3,679,454
 3,403,051
Total net reserves5,369,629
 5,004,678
Reinsurance segment:   
Case reserves1,434,628
 1,273,523
Additional case reserves200,687
 166,251
IBNR reserves2,073,557
 1,835,993
Total net reserves3,708,872
 3,275,767
Mortgage segment:   
Case reserves424,003
 266,030
IBNR reserves245,745
 157,712
Total net reserves (1)669,748
 423,742
Other segment:   
Case reserves495,452
 478,036
Additional case reserves29,660
 29,059
IBNR reserves615,356
 597,910
Total net reserves1,140,468
 1,105,005
Total: 
  
Case reserves4,044,258
 3,619,216
Additional case reserves230,347
 195,310
IBNR reserves6,614,112
 5,994,666
Total net reserves$10,888,717
 $9,809,192
(1)At June 30, 2020, total net reserves include $466.3 million from U.S. primary mortgage insurance business, of which 25.5% represents policy years 2010 and prior and the remainder from later policy years. At December 31, 2019, total net reserves include $278.7 million from U.S. primary mortgage insurance business, of which 58.2% represents policy years 2010 and prior and the remainder from later policy years.
 
At June 30, 2020 and December 31, 2019, the insurance segment’s Loss Reserves by major line of business, net of unpaid losses and loss adjustment expenses recoverable, were as follows:
 June 30,
2020
 December 31,
2019
Insurance segment:   
Professional lines (1)$1,385,471
 $1,322,969
Construction and national accounts1,329,230
 1,248,750
Excess and surplus casualty (2)626,937
 564,254
Programs628,216
 571,926
Property, energy, marine and aviation415,024
 371,822
Travel, accident and health120,893
 109,613
Lenders products28,434
 28,233
Other (3)835,424
 787,111
Total net reserves$5,369,629
 $5,004,678
(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.
At June 30, 2020 and December 31, 2019, the reinsurance segment’s Loss Reserves by major line of business, net of unpaid losses and loss adjustment expenses recoverable, were as follows:
 June 30,
2020
 December 31,
2019
Reinsurance segment:   
Casualty (1)$1,900,900
 $1,796,073
Other specialty (2)806,201
 649,309
Property excluding property catastrophe522,914
 471,775
Marine and aviation188,749
 160,930
Property catastrophe188,560
 113,565
Other (3)101,548
 84,115
Total net reserves$3,708,872
 $3,275,767
(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 life, casualty clash and other.

ARCH CAPITAL 622020 SECOND QUARTER FORM 10-Q


Mortgage Operations Supplemental Information
The mortgage segment’s insurance in force (“IIF”) and risk in force (“RIF”) were as follows at June 30, 2020 and December 31, 2019:
(U.S. Dollars in millions)June 30, 2020 December 31, 2019
Amount % Amount %
Insurance In Force (IIF) (1):       
U.S. primary mortgage insurance$276,643
 65.9
 $287,150
 68.7
Mortgage reinsurance27,457
 6.5
 26,768
 6.4
Other (2)115,803
 27.6
 104,346
 24.9
Total$419,903
 100.0
 $418,264
 100.0
        
Risk In Force (RIF) (3):       
U.S. primary mortgage insurance$70,200
 91.0
 $73,388
 91.9
Mortgage reinsurance2,116
 2.7
 2,129
 2.7
Other (2)4,795
 6.2
 4,380
 5.5
Total$77,111
 100.0
 $79,897
 100.0
(1)Represents the aggregate dollar amount of each insured mortgage loan’s current principal balance.
(2)Includes GSE credit risk-sharing transactions and international insurance business.
(3)Represents 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 credit risk-sharing or reinsurance transactions.
The insurance in force and risk in force for our U.S. primary mortgage insurance business by policy year were as follows at June 30, 2020:
(U.S. Dollars in millions)IIF RIF Delinquency
Amount % Amount % Rate (1)
Policy year:         
2010 and prior$15,538
 5.6
 $3,555
 5.1
 11.62%
20111,350
 0.5
 369
 0.5
 3.85%
20125,131
 1.9
 1,418
 2.0
 3.23%
201310,009
 3.6
 2,803
 4.0
 3.47%
201411,133
 4.0
 3,068
 4.4
 3.98%
201520,749
 7.5
 5,578
 7.9
 3.79%
201634,024
 12.3
 8,950
 12.7
 5.03%
201735,019
 12.7
 9,031
 12.9
 5.62%
201839,385
 14.2
 9,969
 14.2
 6.33%
201963,647
 23.0
 15,683
 22.3
 4.63%
202040,658
 14.7
 9,776
 13.9
 1.58%
Total$276,643
 100.0
 $70,200
 100.0
 5.14%
(1)Represents the ending percentage of loans in default.
 
The insurance in force and risk in force for our U.S. primary mortgage insurance business by policy year were as follows at December 31, 2019:
(U.S. Dollars in millions)IIF RIF Delinquency
Amount % Amount % Rate (1)
Policy year:         
2010 and prior$17,251
 6.0
 $3,990
 5.4
 8.79%
20111,678
 0.6
 464
 0.6
 1.59%
20126,293
 2.2
 1,753
 2.4
 0.89%
201312,276
 4.3
 3,433
 4.7
 0.99%
201413,714
 4.8
 3,778
 5.1
 1.16%
201525,788
 9.0
 6,880
 9.4
 0.87%
201640,898
 14.2
 10,670
 14.5
 1.03%
201743,896
 15.3
 11,262
 15.3
 1.00%
201851,776
 18.0
 13,086
 17.8
 0.86%
201973,580
 25.6
 18,072
 24.6
 0.14%
Total$287,150
 100.0
 $73,388
 100.0
 1.54%
(1)Represents the ending percentage of loans in default.
The following tables provide supplemental disclosures on risk in force for our U.S. primary mortgage insurance business at June 30, 2020 and December 31, 2019:
(U.S. Dollars in millions)June 30, 2020 December 31, 2019
Amount % Amount %
Credit quality (FICO):       
>=740$40,297
 57.4
 $42,301
 57.6
680-73924,346
 34.7
 25,240
 34.4
620-6795,188
 7.4
 5,444
 7.4
<620369
 0.5
 403
 0.5
Total$70,200
 100.0
 $73,388
 100.0
Weighted average FICO score743
   743
  
        
Loan-to-value (LTV):       
95.01% and above$8,859
 12.6
 $9,064
 12.4
90.01% to 95.00%37,830
 53.9
 40,136
 54.7
85.01% to 90.00%20,071
 28.6
 20,890
 28.5
85.00% and below3,440
 4.9
 3,298
 4.5
Total$70,200
 100.0
 $73,388
 100.0
Weighted average LTV92.9%   93.0%  
        
Total RIF, net of external reinsurance$57,258
   $58,512
  

ARCH CAPITAL 632020 SECOND QUARTER FORM 10-Q


(U.S. Dollars in millions)June 30, 2020 December 31, 2019
Amount % Amount %
Total RIF by State:       
Texas$5,560
 7.9
 $5,678
 7.7
California4,948
 7.0
 5,187
 7.1
Florida3,737
 5.3
 3,887
 5.3
Georgia2,861
 4.1
 2,753
 3.8
Virginia2,656
 3.8
 2,881
 3.9
Illinois2,643
 3.8
 2,616
 3.6
Minnesota2,473
 3.5
 2,514
 3.4
North Carolina2,459
 3.5
 2,470
 3.4
Washington2,291
 3.3
 2,474
 3.4
Maryland2,248
 3.2
 2,437
 3.3
Others38,324
 54.6
 40,491
 55.2
Total$70,200
 100.0
 $73,388
 100.0
The following table provides supplemental disclosures for our U.S. primary mortgage insurance business related to insured loans and loss metrics:
(U.S. Dollars in thousands, except policy, loan and claim count)Six Months Ended
June 30,
2020 2019
Roll-forward of insured loans in default:   
Beginning delinquent number of loans20,163
 20,665
New notices67,793
 18,617
Cures(22,205) (18,907)
Paid claims(1,084) (1,614)
Ending delinquent number of loans (1)64,667
 18,761
    
Ending number of policies in force (1)1,259,328
 1,292,215
    
Delinquency rate (1)5.14% 1.45%
    
Losses:   
Number of claims paid1,084
 1,614
Total paid claims$46,139
 $65,519
Average per claim$42.6
 $40.6
Severity (2)94.3% 97.0%
Average case reserve per default (in thousands)$6.9
 $16.1
(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 MI U.S. was approximately 10.2 to 1 at June 30, 2020, compared to 12.0 to 1 at December 31, 2019.
Shareholders’ Equity and Book Value per Share
Total shareholders’ equity available to Arch was $11.99 billion at June 30, 2020, compared to $11.50 billion at December 31, 2019. The increase primarily reflected the impact of total return on investments, partially offset by the impact of COVID-19 on underwriting returns.
 
The following table presents the calculation of book value per share:
(U.S. dollars in thousands, except 
share data)
June 30,
2020
 December 31,
2019
Total shareholders’ equity available to Arch$11,991,825
 $11,497,371
Less preferred shareholders’ equity780,000
 780,000
Common shareholders’ equity available to Arch$11,211,825
 $10,717,371
Common shares and common share equivalents outstanding, net of treasury shares (1)405,970,251
 405,619,201
Book value per share$27.62
 $26.42
(1)Excludes the effects of 18,017,208 and 18,853,018 stock options and 1,094,288 and 1,586,779 restricted stock units outstanding at June 30, 2020 and December 31, 2019, respectively.
LIQUIDITY

Our liquidity and capital resources were not materially impacted by COVID-19 during the second quarter of 2020. For further discussion of the risks related to our potential future impacts of COVID-19 on our liquidity and capital resources, see “ITEM 1A—Risk Factors”.

This section does not include information specific to Watford. We do not guarantee or provide credit support for Watford, and our financial exposure to Watford is limited to our investment in Watford’s senior notes, common and preferred shares and counterparty credit risk (mitigated by collateral) arising from reinsurance transactions with Watford.
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.

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.
For the six months ended June 30, 2020, Arch Capital received dividends of $143.0 million from Arch Re Bermuda, our Bermuda-based reinsurer and insurer, which can pay approximately $2.96 billion to Arch Capital during the remainder of 2020 without providing an affidavit to the Bermuda Monetary Authority (“BMA”).
We expect that our liquidity needs, including our anticipated (re)insurance obligations and operating and capital expenditure needs, for the next twelve months, will be met by funds generated from underwriting activities and investment income,

ARCH CAPITAL 642020 SECOND QUARTER FORM 10-Q


as well as by our balance of cash, short-term investments, proceeds on the sale or maturity of our investments, and our credit facilities.
Cash Flows
The following table summarizes our cash flows from operating, investing and financing activities, excluding amounts related to the ‘other’ segment (i.e., Watford). See note 12, “Variable Interest Entities and Noncontrolling Interests,” for cash flows related to Watford.
 Six Months Ended
 June 30,
 2020 2019
Total cash provided by (used for): 
  
Operating activities$1,234,383
 $597,276
Investing activities(1,888,221) (611,199)
Financing activities824,990
 (35,352)
Effects of exchange rate changes on foreign currency cash(15,384) 2,259
Increase (decrease) in cash and restricted cash$155,768
 $(47,016)
Cash provided by operating activities for the six months ended June 30, 2020 reflected a higher level of premiums collected than in the 2019 period.
Cash used for investing activities for the six months ended June 30, 2020 was higher than in the 2019 period, reflecting a higher level of securities purchased, and the investing of proceeds from our issuance of senior notes.
Cash provided by financing activities for the six months ended June 30, 2020, primarily reflected the issuance of $1.0 billion of senior notes. Cash flows also reflected $75.5 million of repurchases under our share repurchase program.
CAPITAL RESOURCES

This section does not include information specific to Watford. We do not guarantee or provide credit support for Watford, and our financial exposure to Watford is limited to our investment in Watford’s senior notes, common and preferred shares and counterparty credit risk (mitigated by collateral) arising from reinsurance transactions with Watford.
 
The following table provides an analysis of our capital structure:
(U.S. dollars in thousands, except 
share data)
June 30,
2020
 Dec 31,
2019
Senior notes$2,723,180
 $1,734,209
    
Shareholders’ equity available to Arch:   
Series E non-cumulative preferred shares$450,000
 $450,000
Series F non-cumulative preferred shares330,000
 330,000
Common shareholders’ equity11,211,825
 10,717,371
Total$11,991,825
 $11,497,371
    
Total capital available to Arch$14,715,005
 $13,231,580
    
Debt to total capital (%)18.5
 13.1
Preferred to total capital (%)5.3
 5.9
Debt and preferred to total capital (%)23.8
 19.0
On June 30, 2020, Arch Capital issued $1.0 billion of 30 year senior notes. The net proceeds of the offering were contributed to Arch Re Bermuda to support our underwriting operations.
Arch MI U.S. is required to maintain compliance with the GSEs requirements, known as the Private Mortgage Insurer Eligibility Requirements or “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 MI U.S. satisfied the PMIERs’ financial requirements as of June 30, 2020 with an estimated PMIER sufficiency ratio of 161%, consistent with 161% at December 31, 2019.
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, our insurance, reinsurance and mortgage insurance subsidiaries have entered into separate reinsurance arrangements with Arch Re Bermuda covering individual lines of business. The reinsurance agreements between our U.S.-based property casualty insurance and reinsurance subsidiaries and Arch Re Bermuda were canceled on a cutoff basis as of January 1, 2018. In 2019, certain reinsurance agreements between our insurance subsidiaries and Arch Re Bermuda were reinstated.

ARCH CAPITAL 652020 SECOND QUARTER FORM 10-Q


GUARANTOR INFORMATION

The below table provides a description of our senior notes payable at June 30, 2020, excluding amounts attributable to the ‘other’ segment (i.e., Watford):
  Interest Principal Carrying
Issuer/Due (Fixed) Amount Amount
Arch Capital:      
May 1, 2034 7.350% $300,000
 $297,310
June 30, 2050 3.635% 1,000,000
 988,618
Arch-U.S.:      
Nov. 1, 2043 (1) 5.144% 500,000
 494,887
Arch Finance:      
Dec. 15, 2026 (1) 4.011% 500,000
 497,006
Dec. 15, 2046 (1) 5.031% 450,000
 445,359
Total   $2,750,000
 $2,723,180
(1)Fully and unconditionally guaranteed by Arch Capital.
Our senior notes were issued by Arch Capital, Arch Capital Group (U.S.) Inc. (“Arch-U.S.”) and Arch Capital Finance LLC
 
(“Arch Finance”). Arch-U.S. is a wholly-owned subsidiary of Arch Capital and Arch Finance is a wholly-owned finance subsidiary of Arch-U.S. Our 2034 senior notes and 2050 senior notes issued by Arch Capital are unsecured and unsubordinated obligations of Arch Capital and ranked equally with all of its existing and future unsecured and unsubordinated indebtedness. The 2043 senior notes issued by Arch-U.S. are unsecured and unsubordinated obligations of Arch-U.S. and Arch Capital and rank equally and ratably with the other unsecured and unsubordinated indebtedness of Arch-U.S. and Arch Capital.The 2026 senior notes and 2046 senior notes issued by Arch Finance are unsecured and unsubordinated obligations of Arch Finance and Arch Capital and rank equally and ratably with the other unsecured and unsubordinated indebtedness of Arch Finance and Arch Capital.
Arch-U.S. and Arch Finance depend on their available cash resources, liquid investments and dividends or other distributions from their subsidiaries or affiliates to make payments, including the payment of debt service obligations and operating expenses they may incur.

The following tables present condensed financial information for Arch Capital (parent guarantor) and Arch-U.S. (subsidiary issuer):
 June 30, 2020 December 31, 2019
 Arch Capital Arch-U.S. Arch Capital Arch-U.S.
Assets       
Total investments$2,857
 $669,134
 $42
 $692,606
Cash7,258
 51,179
 18,113
 54,518
Investments in subsidiaries13,268,434
 4,644,981
 11,786,861
 4,347,806
Due from subsidiaries and affiliates
 202,131
 17
 200,635
Other assets20,488
 32,940
 20,461
 32,187
Total assets$13,299,037
 $5,600,365
 $11,825,494
 $5,327,752
        
Liabilities       
Senior notes1,285,928
 494,887
 297,254
 494,831
Due to subsidiaries and affiliates136
 536,747
 
 536,805
Other liabilities21,148
 30,875
 30,869
 33,267
Total liabilities1,307,212
 1,062,509
 328,123
 1,064,903
        
        
Shareholders' Equity       
Total shareholders' equity available to Arch11,991,825
 4,537,856
 11,497,371
 4,262,849
Total shareholders' equity11,991,825
 4,537,856
 11,497,371
 4,262,849
        
Total liabilities and shareholders' equity$13,299,037
 $5,600,365
 $11,825,494
 $5,327,752

ARCH CAPITAL 662020 SECOND QUARTER FORM 10-Q


 Six Months Ended Year Ended
 June 30, 2020 December 31, 2019
 Arch Capital Arch-U.S. Arch Capital Arch-U.S.
        
Revenues       
Net investment income$53
 $8,621
 $212
 $14,270
Net realized gains (losses)
 (8,154) 
 25,313
Equity in net income (loss) of investments accounted for using the equity method
 (2,902) 
 779
Other income (loss)(207) 
 (762) 
Total revenues(154) (2,435) (550) 40,362
        
Expenses       
Corporate expenses32,369
 4,094
 62,701
 7,221
Interest expense11,080
 23,733
 22,154
 47,951
Net foreign exchange (gains) losses3
 
 1
 
Total expenses43,452
 27,827
 84,856
 55,172
        
Income (loss) before income taxes(43,606) (30,262) (85,406) (14,810)
Income tax (expense) benefit
 6,525
 
 3,696
Income (loss) before equity in net income of subsidiaries(43,606) (23,737) (85,406) (11,114)
Equity in net income of subsidiaries486,544
 201,426
 1,721,725
 564,657
Net income available to Arch442,938
 177,689
 1,636,319
 553,543
Preferred dividends(20,806) 
 (41,612) 
Net income available to Arch common shareholders$422,132
 $177,689
 $1,594,707
 $553,543

ARCH CAPITAL 672020 SECOND QUARTER FORM 10-Q


SHARE REPURCHASE PROGRAM

The board of directors of Arch Capital has authorized the investment in Arch Capital’s common shares through a share repurchase program. For the six months ended June 30, 2020, Arch Capital repurchased 2.6 million shares under the share repurchase program with an aggregate purchase price of $75.5 million. Since the inception of the share repurchase program through June 30, 2020, Arch Capital has repurchased 388.9 million common shares for an aggregate purchase price of $4.04 billion. At June 30, 2020, approximately $924.5 million of share repurchases were available under the program, which may be effected from time to time in open market or privately negotiated transactions through December 31, 2021. The timing and amount of the repurchase transactions under this program will depend on a variety of factors, including market conditions and corporate and regulatory considerations. Depending upon results of operations, market conditions and the development of the economy, as well as other factors, generally we will consider share repurchases on an opportunistic basis from time to time. During the 2020 second quarter, we have not repurchased any shares under our share repurchase program and we do not expect to repurchase any shares for the remainder of 2020.
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. Man-made catastrophic events may include acts of war, acts of terrorism and political instability. 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.
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 of July 1, 2020, our modeled peak zone catastrophe exposure was a windstorm affecting the Florida Tri-County, with a net probable maximum pre-tax loss of $832 million, followed by windstorms affecting Northeastern U.S. and the Gulf of Mexico regions with net probable maximum pre-tax losses of $658 and $621 million, respectively. Our exposures to other perils, such as U.S. earthquake and international events, were less than the exposures arising from U.S. windstorms and hurricanes. As of July 1, 2020, our modeled peak zone earthquake exposure (San Francisco earthquake) represented approximately 58% of our peak zone catastrophe exposure, and our modeled peak zone international exposure (Japan earthquake) was substantially less than both our peak zone windstorm and earthquake exposures.
Effective July 1, 2020, our insurance operations had in effect a reinsurance program which provided coverage for certain property-catastrophe related losses equal to $243 million in excess of various retentions per occurrence.
We also have significant exposure to losses due to mortgage defaults resulting from severe economic events in the future. For our U.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 tangible shareholders’ equity available to Arch. We reserve the right to change this threshold at any time. Based on in-force exposure estimated as of July 1, 2020, our modeled RDS loss was approximately 8% 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

ARCH CAPITAL 682020 SECOND QUARTER FORM 10-Q


shareholders’ equity from one or more catastrophic events or severe economic events due to several factors. These factors include 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” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Catastrophic Events and Severe Economic Events” in our 2019 Form 10-K, updated where applicable in “ITEM 1A—Risk Factors”
OFF-BALANCE SHEET ARRANGEMENTS

Off-balance sheet arrangements are discussed in Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our 2019 Form 10-K.
MARKET SENSITIVE INSTRUMENTS AND RISK MANAGEMENT

In accordance with the SEC’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 of June 30, 2020. Market risk represents the risk of changes in the fair value of a financial instrument and is comprised of several components, including liquidity, basis and price risks. We have not included Watford in the following analyses as we do not guarantee or provide credit support for Watford, and our financial exposure to Watford is limited to our investment in Watford’s senior notes, common and preferred shares and counterparty credit risk (mitigated by collateral) arising from reinsurance transactions.
An analysis of material changes in market risk exposures at June 30, 2020 that affect the quantitative and qualitative disclosures presented in our 2019 Form 10-K (see section captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Market Sensitive Instruments and Risk Management”) were as follows: 
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 our Fixed 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 in U.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 Fixed Income Securities:
(U.S. dollars in 
billions)
Interest Rate Shift in Basis Points
-100 -50  +50 +100
June 30, 2020 
  
  
  
  
Total fair value$23.71
 $23.34
 $22.97
 $22.60
 $22.24
Change from base3.2% 1.6%   (1.6)% (3.2)%
Change in unrealized value$0.74
 $0.37
   $(0.37) $(0.74)
          
Dec 31, 2019         
Total fair value$21.54
 $21.19
 $20.83
 $20.48
 $20.13
Change from base3.4% 1.7%   (1.7)% (3.4)%
Change in unrealized value$0.71
 $0.35
   $(0.35) $(0.71)
In addition, we consider the effect of credit spread movements on the market value of our Fixed Income Securities and the corresponding change in unrealized value. As credit spreads widen, the fair value of our Fixed Income Securities falls, and the converse is also true. In periods where the spreads on our Fixed 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 our Fixed Income Securities:
(U.S. dollars in 
billions)
Credit Spread Shift in Percentage Points
-100 -50  +50 +100
June 30, 2020         
Total fair value$23.73
 $23.34
 $22.97
 $22.60
 $22.21
Change from base3.3% 1.6%   (1.6)% (3.3)%
Change in unrealized value$0.76
 $0.37
   $(0.37) $(0.76)
          
Dec 31, 2019         
Total fair value$21.19
 $21.02
 $20.83
 $20.65
 $20.48
Change from base1.7% 0.9%   (0.9)% (1.7)%
Change in unrealized value$0.35
 $0.19
   $(0.19) $(0.35)

ARCH CAPITAL 692020 SECOND QUARTER FORM 10-Q


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 June 30, 2020, our portfolio’s VaR was estimated to be 10.1% compared to an estimated 3.19% at December 31, 2019. In periods where the volatility of the risk factors mapped to our portfolio’s exposures is higher due to market conditions, the resulting VaR is higher than in other periods.
Equity Securities. At June 30, 2020 and December 31, 2019, the fair value of our investments in equity securities (excluding securities included in Fixed Income Securities above) totaled $814.4 million and $827.8 million, 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 $81.4 million and $82.8 million at June 30, 2020 and December 31, 2019, respectively, and would have decreased book value per share by approximately $0.20 and $0.20, respectively. An immediate hypothetical 10% increase in the value of each position would increase the fair value of such investments by approximately $81.4 million and $82.8 million at June 30, 2020 and December 31, 2019, respectively, and would have increased book value per share by approximately $0.20 and $0.20, respectively.
Investment-Related Derivatives. At June 30, 2020, the notional value of all derivative instruments (excluding to-be-announced mortgage backed securities which are included in the fixed income securities analysis above and foreign currency forward contracts which are included in the foreign currency exchange risk analysis below) was $5.66 billion, compared to $8.04 billion at December 31, 2019. If the underlying exposure of each investment-related derivative held at June 30, 2020 depreciated by 100 basis points, it would have resulted in a reduction in net income of approximately $56.6 million, and a decrease in book value per share of approximately $0.14 per share, compared to $80.4 million and $0.20 per share, respectively, on investment-related derivatives held at December 31, 2019. If the underlying exposure of each investment-related derivative held at June 30, 2020 appreciated by 100 basis points, it would have resulted in an increase in net income of approximately $56.6 million, and an increase in book value per share of approximately $0.14 per share, compared to $80.4 million and $0.20 per share, respectively, on investment-
 
related derivatives held at December 31, 2019. See note 9, “Derivative Instruments,” to our consolidated financial statements for additional disclosures concerning derivatives.
For further discussion on investment activity, please refer to “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 the U.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 9, “Derivative Instruments,” to our consolidated financial statements 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 
per share data)
June 30,
2020
 December 31,
2019
Net assets (liabilities), denominated in foreign currencies, excluding shareholders’ equity and derivatives$(399,022) $265,501
Shareholders’ equity denominated in foreign currencies (1)752,257
 744,690
Net foreign currency forward contracts outstanding (2)125,858
 81,731
Net exposures denominated in foreign currencies$479,093
 $1,091,922
    
Pre-tax impact of a hypothetical 10% appreciation of the U.S. Dollar against foreign currencies: 
  
Shareholders’ equity$(47,909) $(109,192)
Book value per share$(0.12) $(0.27)
    
Pre-tax impact of a hypothetical 10% decline of the U.S. Dollar against foreign currencies: 
  
Shareholders’ equity$47,909
 $109,192
Book value per share$0.12
 $0.27
(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.
Although we generally attempt to match the currency of our projected liabilities with investments in the same currencies, from time to time we may elect to over or underweight one or more currencies, which could increase our exposure to foreign currency fluctuations and increase the volatility of our shareholders’ equity. Historical observations indicate a low

ARCH CAPITAL 702020 SECOND QUARTER FORM 10-Q


probability that all foreign currency exchange rates would shift against the U.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 reserve for losses and loss adjustment expenses and interest rates. The potential exists, after a catastrophe loss or pandemic events like COVID-19, 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.
OTHER FINANCIAL INFORMATION

The consolidated financial statements as of June 30, 2020 and for the three month and six month periods ended June 30, 2020 and 2019 have been reviewed by PricewaterhouseCoopers LLP, the registrant's independent public accountants, whose report is included as an exhibit to this filing. The report of PricewaterhouseCoopers LLP states that they did not audit and they do not express an opinion on that unaudited financial information. Accordingly, the degree of reliance on their report on such information should be restricted in light of the limited nature of the review procedures applied. PricewaterhouseCoopers LLP is not subject to the liability provisions of Section 11 of the Securities Act of 1933 for their report on the unaudited financial information because that report is not a "report" or a "part" of the registration statement prepared or certified by PricewaterhouseCoopers LLP within the meaning of Sections 7 and 11 of the Securities Act of 1933.

ITEM 3. 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 Operations,” which information is hereby incorporated by reference. 
 

ITEM 4. CONTROLS AND PROCEDURES
 
Evaluation of Disclosure Controls and Procedures
In connection with the filing of this Form 10-Q, our management, including the Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of disclosure controls and procedures pursuant to applicable Exchange Act Rules as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures were effective as of the end of and during the period covered by this report with respect to information being recorded, processed, summarized and reported within time periods specified in the SEC’s rules and forms and with respect to timely communication to them and other members of management responsible for preparing periodic reports of all material information required to be disclosed in this report as it relates to Arch Capital and its consolidated subsidiaries.
We continue to enhance our operating procedures and internal controls to effectively support our business and our regulatory and reporting requirements. Our management does not expect that our disclosure controls or our internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. As a result of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons or by collusion of two or more people. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. As a result of the inherent limitations in a cost-effective control system, misstatement due to error or fraud may occur and not be detected. Accordingly, our disclosure controls and procedures are designed to provide reasonable, not absolute, assurance that the disclosure controls and procedures are met.

ARCH CAPITAL 712020 SECOND QUARTER FORM 10-Q


Changes in Internal Controls Over Financial Reporting
There have been no changes in internal control over financial reporting that occurred during the quarter ended June 30, 2020 that have materially affected, or are reasonably likely to materially affect, internal control over financial reporting. We have not experienced any material impact to our internal controls over financial reporting despite the fact that most of our employees are working remotely due to the COVID-19. We are continually monitoring and assessing COVID-19 situation on our internal controls to minimize the impact on their design and operating effectiveness.
PART II.  OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS
We, in common with the insurance industry in general, are subject to litigation and arbitration in the normal course of our business. As of June 30, 2020, we were not a party to any litigation or arbitration which is expected by management to have a material adverse effect on our results of operations and financial condition and liquidity.

ITEM 1A. RISK FACTORS
Our business is subject to a number of risks, including those identified in Part I—Item 1A of our 2019 Form 10-K, that could have a material adverse effect on our business, results of operations, financial condition and/or liquidity and that could cause our operating results to vary significantly from period to period. The risks described in our 2019 Form 10-K are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also could have a material adverse effect on our business, results of operations, financial condition and/or liquidity. Other than as described below, there have been no material changes to the risk factors disclosed in Part I—Item 1A of our 2019 Form 10-K.

The impact of COVID-19 and related risks could materially affect our results of operations, financial position and/or liquidity.
The continuing global pandemic related to the novel coronavirus COVID-19 has impacted the global economy, financial markets and our results of operations. In addition, COVID-19 could materially disrupt the business operations of third parties with whom we interact. Because of the size and breadth of this pandemic, all of the direct and indirect consequences of COVID-19 are not yet known and may not emerge for some time.
 
The pandemic could have a significant effect on our Company’s business, results of operations, and current and future financial performance. We may experience higher levels of loss and claims activity in certain lines of business and our premiums written and earned could also be adversely affected by a suppression of global commercial activity that results in a reduction in insurable assets and other exposure. Conditions of the financial markets resulting from the virus may also have a negative effect on the value and quality of the assets we hold within our portfolio of invested assets, thereby adversely affecting our investment income and increasing our credit and related risk. Certain lines of our business may require additional forms of collateral in the event of a decline in the fair value of securities and benchmarks to which those repayment mechanisms are linked. The continued impacts of the pandemic to the financial markets may also adversely affect our ability to fund through public or private equity offerings, debt financings, and through other means at acceptable terms. For a further discussion, see “We could face unanticipated losses from war, terrorism, cyber-attacks, pandemics and political instability, and these or other unanticipated losses could have a material adverse effect on our financial condition and results of operations” and “Emerging claim and coverage issues may adversely affect our business” included in “Part I-Item 1A-Risk Factors” in our 2019 Form 10-K.

The disruption in the financial markets related to COVID-19 has contributed to net realized losses, primarily due to the impact of changes in fair value on our equity investments and, to a lesser extent, our fixed-income investment portfolio. Our corporate fixed income portfolio may be adversely impacted by ratings downgrades, increased bankruptcies and credit spread widening in distressed industries, such as energy, gaming, lodging and leisure, autos, airlines and retail. In addition, in recent years, many state and local governments have been operating under deficits or projected deficits. These deficits may be exacerbated by the costs of responding to COVID-19 and reduced tax revenues due to adverse economic conditions. The severity and duration of these deficits could have an adverse impact on the collectability and valuation of our municipal bond portfolio. Our investment portfolio also includes residential mortgage-backed securities, commercial mortgage-backed securities and commercial mortgage loans, all of which could be adversely impacted by declines in real estate valuations and/or financial market disruption, including a heightened collection risk on the underlying mortgages and on rent receivables. Further disruptions in global financial markets due to the continuing impact of COVID-19 could result in additional net realized investment losses, including potential impairments in our fixed income portfolio. In addition, declines in fixed income yields would result in decreases in net investment income from future investment activity, including re-investments. Furthermore, issuers of the investments we hold under the equity method of accounting report their financial information to us one month to three months following

ARCH CAPITAL 722020 SECOND QUARTER FORM 10-Q


the end of the reporting period. Accordingly, the adverse impact of any disruptions in global financial markets on equity method income from these investments would likely not be reflected in our current quarter results and would instead be reported in the subsequent quarter. Further disruptions in global financial markets could adversely impact our net investment income in future periods from its non-fixed income investment portfolio. For further discussion of the risks related to our investment portfolio see “We may be adversely affected by changes in economic conditions, including interest rate changes” and “The determination of the amount of allowances and impairments taken on our investments is highly subjective and could materially impact our results of operations or financial position” included in “Part I—Item 1A—Risk Factors” in our 2019 Form 10-K.
Governmental, regulatory and rating actions in response to the COVID-19 pandemic may adversely affect our financial performance and our ability to conduct our businesses as we have in the past.

Federal, state and local government actions in the U.S. and other countries where we do business to address and mitigate the impact of COVID-19 may adversely affect us. For example, we are potentially subject to legislative and/or regulatory action that seeks to retroactively mandate coverage for losses which our insurance policies were not designed or priced to cover. Currently, in some states there is proposed legislation to require insurers to cover business interruption claims irrespective of terms, exclusions or other conditions included in the policies that would otherwise preclude coverage. In addition, a number of states have instituted, and other states are considering instituting, changes designed to effectively expand workers' compensation coverage by creating presumptions of compensability of claims for certain types of workers. Regulatory restrictions or requirements could also impact pricing, risk selection and our rights and obligations with respect to our policies and insureds, including our ability to cancel policies or our right to collect premiums. Some state regulators have issued orders to review insurers’ rates to determine whether premium refunds are required, and regulators in other states could take similar actions. Many insurers, including us, have also voluntarily provided, and may further provide, premium refunds to their customers. It is also possible that changes in economic conditions and steps taken by federal, state and local governments in response to COVID-19 could require an increase in taxes at the federal, state and local levels, which would adversely impact our results of operations.
We expect the pandemic to result in a material increase in new defaults as borrowers fail to make timely payments on their mortgages, including as a result of entering mortgage forbearance programs that allow borrowers to defer mortgage payments, which may impact our eligible insurers’ ability to remain compliant with the Private Mortgage Insurers Eligibility
 
Requirements (“PMIERs”) financial requirements. On March 18, 2020, the Federal Housing Finance Agency (“FHFA”) directed Fannie Mae and Freddie Mac (the “GSEs”), the primary purchasers of mortgages insured by the Company, to suspend foreclosures and evictions for at least 60 days and to provide payment forbearance to borrowers impacted by COVID-19. On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") was enacted. The CARES Act suspends foreclosures and evictions for at least 60 days from March 18, 2020, on mortgages purchased or securitized by the GSEs. In addition, the CARES Act provides for payment forbearance for up to 360 days to borrowers experiencing a hardship during the COVID-19 emergency. On June 17, 2020, FHFA directed Fannie Mae and Freddie Mac to extend the suspension of eviction and foreclosure-related activities through at least August 31, 2020.
Consistent with the CARES Act, the GSEs will provide a forbearance plan to any borrower who requests a forbearance with an attestation of the financial hardship caused by the COVID-19 emergency; and no additional documentation other than the borrower’s attestation to a financial hardship caused by the COVID-19 emergency is required. It is unclear how many borrowers will obtain forbearance plans, the length of assistance borrowers will require, and whether borrowers will be able to resume their mortgage payments thereafter. Increases in unemployment as well as borrowers entering into forbearance plans will result in higher notices of delinquency (“NODs”) which may have an adverse impact on our results or operations. In addition, as a result of COVID-19-related relief programs, the defaults related to the pandemic, if not cured, could remain in our defaulted loan inventory for a protracted period of time, potentially resulting in higher frequency (claim rate) and severity (amount of the claim) for those loans that ultimately result in a claim. Accordingly, extended or extensive forbearance programs and other changes in regulations or laws may adversely impact our mortgage insurance segment.
When a borrower obtains a forbearance plan and does not make their mortgage payment for two consecutive months, the servicer will report the NOD with a special code that indicates the loan is subject to a COVID-19 related forbearance plan. Under PMIERs, eligible insurers are required to hold additional risk-based required assets for delinquent mortgages. However, this amount is reduced for mortgages backed by a property located in a FEMA Declared Major Disaster Area that are either 1) subject to a forbearance plan executed in response to a FEMA Declared Major Disaster Area eligible for Individual Assistance, or 2) has an initial default date occurring up to either (i) 30 days prior to or (ii) 90 days following the Major Disaster event. FEMA has issued Major Disaster Area declarations in all states related to COVID-19, noting the incident date as January 20, 2020. On June 30, 2020, the GSEs published guidance clarifying the applicability of the reduced delinquent loan charges on loans with their first missed payments occurring between March 1, 2020 and December 31, 2020 in response to

ARCH CAPITAL 732020 SECOND QUARTER FORM 10-Q


a hardship related to Covid-19. Additionally, through March 31, 2021, the GSEs have temporarily required eligible insurers to obtain prior approval of dividends or entering into any new arrangements or altering any existing arrangements under tax sharing and intercompany expense-sharing agreements. The Company is reliant on the accurate reporting of servicers to correctly identify which NODs are subject to COVID-19 related forbearance plans and, the reduced delinquent loan charge. In addition, the rating agencies continually review the financial strength ratings assigned to the Company and its subsidiaries, and the ratings are subject to change. The COVID-19 pandemic and its impact on financial results and condition, could cause one or more of the rating agencies to downgrade the ratings assigned to the Company and its subsidiaries.
The disruption and other effects caused by COVID-19 could adversely impact our business operations, which could adversely affect our financial performance and results.
To protect our employees and in response to the global and regional restrictions on interpersonal contact and travel because of the COVID-19 pandemic, our work force (other than a small percentage of workers performing services which require them to visit the office) is working remotely, placing increased demands on our IT systems. Remote working arrangements may increase the risk of cyber-security attacks or data security incidents. While we have continued to conduct our business effectively, there is no assurance that our ability to continue to function in this new environment will not be adversely affected by an extended period of limited access to our physical facilities or by other developments such as an extended disruption to our systems that support our remote work capability. We depend on third-party platforms and other infrastructure to provide certain of our products and services, and such third-party infrastructures face similar risks. In addition, the continuation of the COVID-19 pandemic may continue to adversely affect our business operations, including our ability to carry on business development activities and unavailability of employees due to illness or quarantines, among others. For a further discussion, see “Our information technology systems may be unable to meet the demands of customers” and “Technology breaches or failures, including, but not limited to, those resulting from a malicious cyber-attack on us or our business partners and service providers, could disrupt or otherwise negatively impact our business and/or expose us to litigation” included in “Part I—Item 1A-Risk Factors” in our 2019 Form 10-K.

ARCH CAPITAL 742020 SECOND QUARTER FORM 10-Q



ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The following table summarizes our purchases of common shares for the 2020 second quarter:
  Issuer Purchases of Equity Securities
Period 
Total Number of Shares
Purchased (1)
 Average Price Paid per Share 
Total Number of Shares Purchased as Part of
Publicly Announced
Plans or Programs
 
Approximate Dollar
Value of Shares that
 May Yet be Purchased
Under the Plan or
Programs (2)
4/1/2020 - 4/30/2020 11,043
 $26.51
 
 $924,514
5/1/2020 - 5/31/2020 190,321
 25.55
 
 $924,514
6/1/2020 - 6/30/2020 7,685
 32.82
 
 $924,514
Total 209,049
 $25.87
 
  
(1)Represents repurchases by Arch Capital of shares, from time to time, from employees in order to facilitate the payment of withholding taxes on restricted shares granted and the exercise of stock appreciation rights. We purchased these shares at their fair value, as determined by reference to the closing price of our common shares on the day the restricted shares vested or the stock appreciation rights were exercised.
(2)Remaining amount available at June 30, 2020 under Arch Capital’s share repurchase authorization, under which repurchases may be effected from time to time in open market or privately negotiated transactions through December 31, 2021.

ARCH CAPITAL 752020 SECOND QUARTER FORM 10-Q



ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.

ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.


ITEM 5. OTHER INFORMATION
In accordance with Section 10a(i)(2) of the Securities Exchange Act of 1934, as amended, we are responsible for disclosing non-audit services to be provided by our independent auditor, PricewaterhouseCoopers LLP, which are approved by the Audit Committee of our board of directors. During the 2020 second quarter, the Audit Committee approved engagements of PricewaterhouseCoopers LLP for permitted non-audit services, which consisted of tax consulting services, tax compliance services and other accounting consulting services.
Disclosure of Certain Activities Under Section 13(r) of the Securities Exchange Act of 1934

Section 13(r) of the Securities Exchange Act of 1934, as amended, requires an issuer to disclose in its annual or quarterly reports whether it or an affiliate knowingly engaged in certain activities described in that section, including certain activities related to Iran during the period covered by the report.
Certain of our non-U.S. subsidiaries underwrite insurance and facultative reinsurance on a global basis to non-U.S. insureds and insurers, including for liability, marine, aviation and energy risks. Coverage provided to non-Iranian business may indirectly cover an exposure in Iran. For example, certain of our operations underwrite global marine hull and cargo policies that provide coverage for vessels navigating into and out of ports worldwide, including Iran. For the quarter ended June 30, 2020, there has been no material amount of premium allocated or apportioned to activities relating to Iran, and we are unable to attribute gross revenues or net profits from any such policies because they insure multiple voyages and fleets containing multiple ships. Such non-U.S. subsidiaries will continue to provide such coverage only to the extent permitted by applicable law.

ARCH CAPITAL 762020 SECOND QUARTER FORM 10-Q



ITEM 6. EXHIBITS
 
    Incorporated by Reference  
Exhibit Number Exhibit Description Form Original Number Date Filed Filed Herewith
15        X
31.1        X
31.2        X
32.1        X
32.2        X
101.INS XBRL Instance Document        
101.SCH XBRL Taxonomy Extension Schema Document        
101.CAL XBRL Taxonomy Extension Calculation Linkbase Document        
101.DEF XBRL Taxonomy Extension Definition Linkbase Document        
101.LAB XBRL Taxonomy Extension Label Linkbase Document        
101.PRE XBRL Taxonomy Extension Presentation Linkbase Document        

ARCH CAPITAL 772020 SECOND QUARTER FORM 10-Q


SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
  ARCH CAPITAL GROUP LTD.
  (REGISTRANT)
   
  /s/ Marc Grandisson
Date: August 6, 2020 Marc Grandisson
  President and Chief Executive Officer (Principal Executive Officer)
   
  /s/ François Morin
Date: August 6, 2020 François Morin
  Executive Vice President, Chief Financial Officer and Treasurer (Principal Financial and Accounting Officer)

ARCH CAPITAL 782020 SECOND QUARTER FORM 10-Q