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 Positive. A complete list of ratings is provided at the end of this release.
KEY RATING DRIVERS
Fitch's affirmation of ACGL's ratings 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.
The Positive Outlook 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.
ACGL has a broad product portfolio of both property/casualty primary insurance and reinsurance, including the recently added U.S. mortgage insurance business. Total company's first half 2014 net premiums written ($2.04 billion) segment split was 55% insurance, 36% reinsurance, 5% mortgage and 4% other (Watford), providing diversified sources of revenues and earnings. Fitch views this favorably as it provides the company flexibility to deemphasize various products when market conditions are poor 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 (ROAE), with the most recent five-year averages (2009-2013) at 92% 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. Through the first six months of 2014, ACGL reported a combined ratio of 85.7% and annualized ROAE of 13.5%. ACGL has posted an underwriting profit and overall net income in every year of its 12-year operating history.
ACGL's financial leverage ratio is modest at 12.8% as of June 30, 2014, down from 13.8% at year-end 2013. This decline reflects 10% growth in first half 2014 shareholders' equity available to ACGL to $6.2 billion at June 30, 2014 from net earnings and unrealized investment gains.
Operating earnings-based interest and preferred dividend coverage was a strong 9.4x through the first half of 2014, down from 14.3x in 2013. This drop reflects additional interest expense on $500 million of senior notes issued by Arch Capital Group (U.S.) Inc. in December 2013 for the purchase of CMG Mortgage Insurance Company (CMG) and for funding growth opportunities in mortgage and other select businesses.
ACGL cosponsored a new Bermuda-domiciled reinsurer, Watford Re Ltd, which was launched in March 2014 with $1.1 billion of initial capital. Although ACGL only owns approximately 11% of Watford Holdings Ltd.'s (parent of Watford Re) common equity, the company is consolidated into ACGL's financial results as ACGL is considered to be the primary beneficiary of Watford Re.
Watford Re provides ACGL an alternative capital, more permanent sidecar vehicle that generates an additional diversified source of revenue through fee income for performing the underwriting services for the reinsurer or through premiums by participating on Watford Re's business, which is primarily multi-line casualty risk. Fitch does not believe that Watford Re's operations present meaningful additional risk or volatility to ACGL's overall profile.
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 in mortgage insurance. However, it also represents a challenge in generating favorable profitability in a line of business that experienced severe difficulty during the financial crisis. 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 both the U.S. mortgage insurance operations and the Watford Re platform, 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.
Fitch's evolving view of negative fundamental trends in the reinsurance sector could result in an affirmation and return to a Stable Outlook.
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