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 has been revised to Positive from Stable. A complete list of ratings is provided at the end of this release.
KEY RATING DRIVERS
The Outlook revision to Positive reflects ACGL's consistently strong and stable profitability, measured progression into a larger and more favorable market position in both insurance and reinsurance lines and steady growth in capital to a sizable level of shareholders' equity. The ratings also continue to reflect the company's reasonable financial leverage, strong interest and preferred dividend coverage, solid capitalization and well managed reserve risk. These favorable factors are partially offset by potential volatility from large catastrophe-related events, exposure to potential adverse reserve development due to the relatively large portion of casualty reserves, integration risk associated with the recent acquisition of CMG Mortgage Insurance Company (CMG) and the continuing challenging reinsurance market conditions.
ACGL has a broad product portfolio of both property/casualty primary insurance and reinsurance, with total company 2013 net premiums written ($3.35 billion) split 58% insurance and 42% reinsurance, providing diversified sources of revenues and earnings. Fitch views this favorably as it provides the company flexibility to emphasize various products when market conditions are favorable and reduces the company's dependency on any single product line. Fitch expects that ACGL will continue to successfully manage through various market conditions and cycles.
Fitch views ACGL's profitability as strong, characterized by low and stable combined ratios and high returns on average common equity, with the most recent five-year averages (2009-2013) at 92.0% and 15.9%, respectfully. These results are in line with or better than peer averages and align with Fitch's median 'AA' and 'AAA' (re)insurance sector credit factors, respectfully.
ACGL's earnings are exposed to potential volatility and can decline materially in response to large industry-insured, catastrophe-related events. However, Fitch notes that ACGL has posted an underwriting profit and overall net income in every year of its 12 year operating history, compared to most peers that experienced underwriting and net losses during years in which significant insured catastrophe events occurred.
Fitch believes that ACGL's financial leverage ratio is reasonable for the rating category at 13.8% as of Dec. 31, 2013, although up considerably from 7.4% at Dec. 31, 2012. The increase reflects $500 million of senior notes issued by Arch Capital Group (U.S.) Inc. in December 2013. The net proceeds from the offering were used to purchase CMG and for funding growth opportunities in mortgage and other select businesses.
ACGL's operating earnings-based interest and preferred dividend coverage has been strong, averaging a favorable 11.4x from 2009-2013. GAAP earnings coverage was 14.3x in 2013, improved from 8.1x in 2012, due to increased earnings with reduced catastrophes in 2013, lower interest expense and reduced preferred dividends. Following the $500 million senior note issuance in December 2013, pro forma coverage is approximately 10x.
ACGL's capital position improved in 2013, with GAAP shareholders' equity of $5.6 billion at Dec. 31, 2013, up 9% from year-end 2012 and 65% higher than $3.4 billion five years ago at year-end 2008. Operating leverage has remained conservative and steady with a ratio of net premiums written to equity of 0.6x in each of the past five years.
ACGL's entrance into the U.S. mortgage insurance market through the January 2014 acquisition of CMG (renamed to Arch Mortgage Insurance Company) and the operating platform of PMI Mortgage Insurance Co represents an opportunity for an additional diversified source of earnings under current, generally favorable, market conditions, adding to the company's European Union-based mortgage insurance business. However, it also represents a challenge in generating favorable profitability in a line of business that experienced severe difficulty during the financial crisis, although CMG posted less severe losses reflective of the higher quality credit union marketplace. 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, utilizing an experienced team to operate and manage the business.
Key rating triggers that could result in 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. Successfully integrating the U.S. mortgage insurance operations with exposure growth prudently managed would be viewed favorably by Fitch. Other upgrade triggers include maintaining a net written premiums-to-equity ratio of 0.8x or lower; a financial leverage ratio at or below 20%; and operating earnings-based interest and preferred dividend coverage of at least 10x.
Key rating triggers that could result in a downgrade include sizable adverse prior year reserve development that causes 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 a financial leverage ratio above 25% could generate negative rating pressure.
Fitch affirms the following ratings with a Positive 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 Capital Group (U.S.) Inc.
--$500 million 5.144% senior notes due 2043 at 'A-';
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 (Nov. 13, 2013).
Applicable Criteria and Related Research:
Insurance Rating Methodology