CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed Arch Capital Group Ltd.'s (ACGL) Issuer Default Rating (IDR) at 'A' and the ratings on ACGL's senior unsecured notes and preferred shares at 'A-' and 'BBB', respectively. Additionally, Fitch has affirmed the Insurer Financial Strength (IFS) ratings of ACGL's various subsidiaries at 'A+'. The Rating Outlook is Stable. A complete list of ratings is provided at the end of this release.
KEY RATING DRIVERS
Fitch's affirmation of ACGL's ratings reflects the company's consistently strong run rate profitability, low financial leverage, strong interest and preferred dividend coverage and well managed reserve risk. The ratings also reflect potential volatility from large catastrophe-related events, potential adverse development due to the relatively large proportion of its reserves derived from longer duration casualty lines of business, and anticipated challenges in the overall competitive but generally improving property/casualty market rate environment.
ACGL posted net income of $422 million for the first six months of 2013, improved from net income of $360 million for the first six months of 2012 due to more modest catastrophe losses thus far in 2013. ACGL's GAAP combined ratio was 86% in the first six months of 2013 compared to 95.4% for full year 2012, which included 8.8 points for catastrophe losses, primarily from Hurricane Sandy. Excluding the impact of catastrophes (3.1 points) and favorable reserve development (8.2 points), ACGL's combined ratio for the first six months of 2013 was 91.1%, improved from 94.1% for full year 2012.
Fitch believes that ACGL's financial leverage ratio continues to be modest at 7.1% as of June 30, 2013, down slightly from 7.4% at year-end 2012. ACGL's operating earnings-based interest and preferred dividend coverage improved to a very strong 17.0 times (x) through the first six months of 2013, following 8.1x in 2012. This improvement is due to increased earnings with reduced catastrophes thus far in 2013, lower interest expense on the company's revolving credit agreement borrowings and reduced preferred dividends following the preferred share refinancing in April 2012. ACGL's coverage averaged a favorable 10.6x from 2008-2012.
Fitch believes that ACGL's loss reserves are adequate and well-managed, although the company is exposed to potential adverse development due to the relatively large proportion of its reserves derived from longer duration casualty lines of business. Prior year reserve development has made meaningful contributions to ACGL's profitability. However, Fitch notes that underwriting profitability will be pressured going forward to the extent that future reserve development trends are not as favorable as they have been in recent years.
ACGL expected entrance into the U.S. mortgage insurance market through the acquisition of CMG Mortgage Insurance Company and the operating platform of PMI Mortgage Insurance Co. (expected to close by year-end 2013, subject to regulatory approval) represents an opportunity for an additional diversified source of earnings. However, it also represents a challenge in generating favorable profitability in a line of business that experienced severe difficulty during the financial crisis. Nevertheless, Fitch expects that ACGL's approach to developing this business will be controlled and prudently managed to the company's conservative underwriting and risk-management standards.
Key rating triggers that could lead to an upgrade include continued growth in equity into a larger market position and size/scale, while maintaining favorable run-rate earnings and low volatility, with a combined ratio in the low 90s. In addition, continued reasonable operating leverage, with a net written premiums-to-equity ratio of 0.8x of lower, a financial leverage ratio at or below 20% and operating-earnings-based interest and preferred dividend coverage of at least 10x could generate positive rating pressure.
Key rating triggers that could result in a downgrade include sizable adverse prior year reserve development that caused Fitch to question ACGL's better than peer underwriting results and lower than peer underwriting volatility. In addition, increases in underwriting leverage above 1.0x net written premiums-to-equity ratio or equity-credit adjusted financial leverage above 25% could generate negative rating pressure.
Fitch affirms the following ratings with a Stable Outlook:
Arch Capital Group, Ltd.
--IDR at 'A';
--$300 million 7.35% senior unsecured notes due 2034 at 'A-';
--$325 million 6.75% series C non-cumulative preferred shares at 'BBB'.
Arch Reinsurance Ltd.
Arch Reinsurance Company
Arch Reinsurance Europe Underwriting Limited
Arch Insurance Company
Arch Excess and Surplus Insurance Company
Arch Specialty Insurance Company
Arch Indemnity Insurance Company
Arch Insurance Company (Europe) Limited
--IFS at 'A+'.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--Insurance Rating Methodology (Aug. 19, 2013).
Applicable Criteria and Related Research:
Insurance Rating Methodology