UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)
x		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2007
Or
o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period                              to
Commission file number: 0-26456

 

ARCH CAPITAL GROUP LTD.
(Exact name of registrant as specified in its charter)

 

(441) 278-9250

Registrant’s telephone number, including area code:

 

(Former name, former address and former fiscal year, if changed since last report)

 

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   x     No   o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer    x                 Accelerated Filer     o                Non-Accelerated Filer    o

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes   o    No   x

 

Indicate the number of shares outstanding of each of the issuer’s classes of common shares as of the latest practicable date.

 

 

ARCH CAPITAL GROUP LTD.

INDEX

		Page No.
PART I.  Financial Information
Item 1 — Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm		2
Consolidated Balance Sheets		3
June 30, 2007 (unaudited) and December 31, 2006
Consolidated Statements of Income		4
For the three and six month periods ended June 30, 2007 and 2006 (unaudited)
Consolidated Statements of Changes in Shareholders’ Equity		5
For the six month periods ended June 30, 2007 and 2006 (unaudited)
Consolidated Statements of Comprehensive Income		6
For the six month periods ended June 30, 2007 and 2006 (unaudited)
Consolidated Statements of Cash Flows		7
For the six month periods ended June 30, 2007 and 2006 (unaudited)
Notes to Consolidated Financial Statements (unaudited)		8
Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations		31
Item 3 — Quantitative and Qualitative Disclosures About Market Risk		53
Item 4 — Controls and Procedures		53
PART II.  Other Information
Item 1 — Legal Proceedings		53
Item 2 — Unregistered Sales of Equity Securities and Use of Proceeds		54
Item 4 — Submission of Matters to a Vote of Security Holders		54
Item 5 — Other Information		56
Item 6 — Exhibits		56

 

1

Report of Independent Registered Public Accounting Firm

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

We have reviewed the accompanying consolidated balance sheet of Arch Capital Group Ltd. and its subsidiaries (the “Company”) as of June 30, 2007, and the related consolidated statements of income for each of the three-month and six-month periods ended June 30, 2007 and 2006, and the consolidated statements of changes in shareholders’ equity, comprehensive income and cash flows for each of the six-month periods ended June 30, 2007 and 2006. These interim financial statements are the responsibility of the Company’s management.

We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). 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 Public Company Accounting Oversight Board (United States), 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.

Based on our review, we are not aware of any material modifications that should be made to the accompanying consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

We previously audited in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet as of December 31, 2006, and the related consolidated statements of income, changes in shareholders’ equity, comprehensive income, and cash flows for the year then ended (not presented herein), and in our report dated February 28, 2007 we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet information as of December 31, 2006, is fairly stated in all material respects in relation to the consolidated balance sheet from which it has been derived.

/s/ PricewaterhouseCoopers LLP
New York, New York
August 8, 2007

2

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(U.S. dollars in thousands, except share data)

		(Unaudited)
		June 30, 2007			December 31, 2006
Assets
Investments:
Fixed maturities available for sale, at fair value (amortized cost: 2007, $6,972,705; 2006, $6,858,970)		$	6,923,478		$	6,876,548
Short-term investments available for sale, at fair value (amortized cost: 2007, $1,110,053; 2006, $956,926)		1,114,485			957,698
Short-term investment of funds received under securities lending agreements, at fair value		1,114,959			891,376
Other investments (cost: 2007, $429,486; 2006, $282,923)		461,835			307,082
Total investments		9,614,757			9,032,704
Cash		245,143			317,017
Accrued investment income		71,064			68,440
Fixed maturities and short-term investments pledged under securities lending agreements, at fair value		1,085,757			860,803
Premiums receivable		1,041,921			749,961
Funds held by reinsureds		79,335			82,385
Unpaid losses and loss adjustment expenses recoverable		1,545,820			1,552,157
Paid losses and loss adjustment expenses recoverable		131,441			122,149
Prepaid reinsurance premiums		544,137			470,138
Deferred income tax assets, net		70,688			63,606
Deferred acquisition costs, net		309,651			290,999
Receivable for securities sold		54,954			190,168
Other assets		499,100			511,940
Total Assets		$	15,293,768		$	14,312,467
Liabilities
Reserve for losses and loss adjustment expenses		$	6,782,433		$	6,463,041
Unearned premiums		2,001,736			1,791,922
Reinsurance balances payable		382,488			301,679
Senior notes		300,000			300,000
Deposit accounting liabilities		43,559			45,107
Securities lending collateral		1,114,959			891,376
Payable for securities purchased		434,624			418,109
Other liabilities		529,902			510,614
Total Liabilities		11,589,701			10,721,848
Commitments and Contingencies
Shareholders’ Equity
Non-cumulative preferred shares ($0.01 par value, 50,000,000 shares authorized)
- Series A (issued: 2007 and 2006, 8,000,000)		80			80
- Series B (issued: 2007 and 2006, 5,000,000)		50			50
Common shares ($0.01 par value, 200,000,000 shares authorized, issued: 2007, 71,273,285; 2006, 74,270,466)		713			743
Additional paid-in capital		1,716,295			1,944,304
Retained earnings		1,993,963			1,596,018
Accumulated other comprehensive income (loss), net of deferred income tax		(7,034		)	49,424
Total Shareholders’ Equity		3,704,067			3,590,619
Total Liabilities and Shareholders’ Equity		$	15,293,768		$	14,312,467

 

See Notes to Consolidated Financial Statements

3

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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(U.S. dollars in thousands, except share data)

		(Unaudited)						(Unaudited)
		Three Months Ended June 30,						Six Months Ended June 30,
		2007			2006			2007			2006
Revenues
Net premiums written		$	757,895		$	794,558		$	1,629,640		$	1,668,277
(Increase) decrease in unearned premiums		(6,483		)	2,892			(132,735		)	(109,226		)
Net premiums earned		751,412			797,450			1,496,905			1,559,051
Net investment income		117,299			90,503			229,988			170,829
Net realized losses		(3,757		)	(32,202		)	(4,738		)	(35,585		)
Fee income		2,091			3,468			4,060			5,273
Other income		265			—			869			—
Total revenues		867,310			859,219			1,727,084			1,699,568
Expenses
Losses and loss adjustment expenses		425,663			462,255			845,724			930,433
Acquisition expenses		117,277			148,581			237,405			278,253
Other operating expenses		100,505			84,367			191,318			167,344
Interest expense		5,523			5,651			11,046			11,206
Net foreign exchange losses		6,450			1,146			16,192			11,399
Total expenses		655,418			702,000			1,301,685			1,398,635
Income before income taxes		211,892			157,219			425,399			300,933
Income tax expense		6,037			14,332			14,532			25,756
Net income		205,855			142,887			410,867			275,177
Preferred dividends		6,461			5,039			12,922			7,706
Net income available to common shareholders		$	199,394		$	137,848		$	397,945		$	267,471
Net income per common share
Basic		$	2.75		$	1.88		$	5.44		$	3.66
Diluted		$	2.65		$	1.81		$	5.24		$	3.52
Weighted average common shares and common share equivalents outstanding
Basic		72,494,823			73,188,101			73,209,439			73,044,473
Diluted		75,254,846			76,155,438			75,947,858			76,014,819

 

See Notes to Consolidated Financial Statements

4

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(U.S. dollars in thousands)

 

		(Unaudited) Six Months Ended June 30,
		2007			2006
Non-Cumulative Preferred Shares
Balance at beginning of period		$	130		$	—
Preferred shares issued		—			130
Balance at end of period		130			130
Common Shares
Balance at beginning of year		743			733
Common shares issued, net		6			6
Purchases of common shares under share repurchase program		(36		)	—
Balance at end of period		713			739
Additional Paid-in Capital
Balance at beginning of year		1,944,304			1,595,440
Cumulative effect of change in accounting for unearned stock grant compensation		—			(9,646		)
Series A non-cumulative preferred shares issued		—			193,388
Series B non-cumulative preferred shares issued		—			120,866
Common shares issued		405			410
Exercise of stock options		13,373			15,572
Common shares retired		(257,162		)	(658		)
Amortization of share-based compensation		14,457			7,510
Other		918			274
Balance at end of period		1,716,295			1,923,156
Deferred Compensation Under Share Award Plan
Balance at beginning of year		—			(9,646		)
Cumulative effect of change in accounting for unearned stock grant compensation		—			9,646
Balance at end of period		—			—
Retained Earnings
Balance at beginning of year		1,593,907			901,348
Adjustment to adopt SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments—an amendment of FASB Statements No. 133 and 140”		2,111			—
Balance at beginning of year, as adjusted		1,596,018			901,348
Dividends declared on preferred shares		(12,922		)	(7,706		)
Net income		410,867			275,177
Balance at end of period		1,993,963			1,168,819
Accumulated Other Comprehensive Income (Loss)
Balance at beginning of year		51,535			(7,348		)
Adjustment to adopt SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments—an amendment of FASB Statements No. 133 and 140”		(2,111		)	—
Balance at beginning of year, as adjusted		49,424			(7,348		)
Change in unrealized appreciation (decline) in value of investments, net of deferred income tax		(67,513		)	(64,272		)
Foreign currency translation adjustments, net of deferred income tax		11,055			(5,444		)
Balance at end of period		(7,034		)	(77,064		)
Total Shareholders’ Equity		$	3,704,067		$	3,015,780

 

See Notes to Consolidated Financial Statements

5

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 (U.S. dollars in thousands)

 

		(Unaudited)
		Six Months Ended
		June 30,
		2007			2006
Comprehensive Income
Net income		$	410,867		$	275,177
Other comprehensive loss, net of deferred income tax
Unrealized decline in value of investments:
Unrealized holding losses arising during period		(72,486		)	(97,560		)
Reclassification of net realized losses, net of income taxes, included in net income		4,973			33,288
Foreign currency translation adjustments		11,055			(5,444		)
Other comprehensive loss		(56,458		)	(69,716		)
Comprehensive Income		$	354,409		$	205,461

 

See Notes to Consolidated Financial Statements

6

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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(U.S. dollars in thousands)

 

		(Unaudited) Six Months Ended June 30,
		2007			2006
Operating Activities
Net income		$	410,867		$	275,177
Adjustments to reconcile net income to net cash provided by
operating activities:
Net realized losses		4,854			35,673
Other income		(869		)	—
Share-based compensation		14,457			7,510
Changes in:
Reserve for losses and loss adjustment expenses, net of unpaid losses and loss adjustment expenses recoverable		324,793			473,996
Unearned premiums, net of prepaid reinsurance premiums		135,525			117,298
Premiums receivable		(290,437		)	(224,498		)
Deferred acquisition costs, net		(18,702		)	(5,971		)
Funds held by reinsureds		3,050			82,879
Reinsurance balances payable		79,254			105,193
Deferred income tax assets, net		(3,757		)	(5,555		)
Other liabilities		1,737			18,331
Other items, net		16,231			(56,879		)
Net Cash Provided By Operating Activities		677,003			823,154
Investing Activities
Purchases of fixed maturity investments		(8,933,304		)	(8,196,081		)
Proceeds from sales of fixed maturity investments		8,407,340			7,440,922
Proceeds from redemptions and maturities of fixed maturity investments		305,847			96,360
Purchases of other investments		(185,357		)	(63,813		)
Proceeds from sales of other investments		62,309			6,062
Net purchases of short-term investments		(141,217		)	(279,297		)
Change in securities lending collateral		(223,583		)	131,153
Purchases of furniture, equipment and other		(8,998		)	(8,679		)
Net Cash Used For Investing Activities		(716,963		)	(873,373		)
Financing Activities
Purchases of common shares under share repurchase program		(254,973		)	—
Proceeds from common shares issued, net		7,427			11,212
Proceeds from preferred shares issued, net of issuance costs		—			314,538
Change in securities lending collateral		223,583			(131,153		)
Excess tax benefits from share-based compensation		3,965			3,143
Preferred dividends paid		(12,922		)	(4,622		)
Net Cash Provided By Financing Activities		(32,920		)	193,118
Effects of exchange rate changes on foreign currency cash		1,006			997
(Decrease) increase in cash		(71,874		)	143,896
Cash beginning of year		317,017			222,477
Cash end of period		$	245,143		$	366,373
Income taxes paid, net		$	1,881		$	32,407
Interest paid		$	11,025		$	11,067

 

See Notes to Consolidated Financial Statements

7

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

1.      General

Arch Capital Group Ltd. (“ACGL”) is a Bermuda public limited liability company which provides insurance and reinsurance on a worldwide basis through its wholly owned subsidiaries.

The interim consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”) and include the accounts of ACGL and its wholly owned subsidiaries (together with ACGL, the “Company”). 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 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, 2006, including the Company’s audited consolidated financial statements and related notes and the section entitled “Risk Factors.”

To facilitate period-to-period comparisons, certain amounts in the 2006 consolidated financial statements have been reclassified to conform to the 2007 presentation. Such reclassifications had no effect on the Company’s consolidated net income.

2.      Share Transactions

Share Repurchase Program

On February 28, 2007, ACGL’s board of directors authorized the investment of up to $1 billion in ACGL’s common shares through a share repurchase program. Repurchases under the program may be effected from time to time in open market or privately negotiated transactions through February 2009. During the 2007 second quarter and six months ended June 30, 2007, ACGL repurchased approximately 3.0 million and 3.6 million common shares, respectively, for an aggregate purchase price of $210.5 million and $255.0 million, respectively. As a result of share repurchase transactions through June 30, 2007, book value per common share was reduced by $1.10 per share at June 30, 2007 and weighted average shares outstanding for the 2007 second quarter and six months ended June 30, 2007 were reduced by 1.8 million and 1.0 million shares, respectively. 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. In connection with the repurchase program, the Warburg Pincus funds waived their rights relating to share repurchases under its shareholders agreement with ACGL for all repurchases of common shares by ACGL under the repurchase program in open market transactions and certain privately negotiated transactions.

8

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Non-Cumulative Preferred Shares

During 2006, ACGL completed two public offerings of non-cumulative preferred shares (“Preferred Shares”). On February 1, 2006, $200.0 million principal amount of 8.0% series A non-cumulative preferred shares (“Series A Preferred Shares”) were issued with net proceeds of $193.5 million and, on May 24, 2006, $125.0 million principal amount of 7.875% series B non-cumulative preferred shares (“Series B Preferred Shares”) were issued with net proceeds of $120.9 million. The net proceeds of the offerings were used to support the underwriting activities of ACGL’s insurance and reinsurance subsidiaries. ACGL has the right to redeem all or a portion of each series of Preferred Shares at a redemption price of $25.00 per share on or after (1) February 1, 2011 for the Series A Preferred Shares and (2) May 15, 2011 for the Series B Preferred Shares. Dividends on the Preferred Shares are non-cumulative. Consequently, in the event dividends are not declared on the Preferred Shares for any dividend period, holders of Preferred Shares will not be entitled to receive a dividend for such period, and such undeclared dividend will not accrue and will not be payable. Holders of Preferred Shares will be entitled to receive dividend payments only when, as and if declared by ACGL’s board of directors or a duly authorized committee of the board of directors. Any such dividends will be payable from the date of original issue on a non-cumulative basis, quarterly in arrears. To the extent declared, these dividends will accumulate, with respect to each dividend period, in an amount per share equal to 8.0% of the $25.00 liquidation preference per annum for the Series A Preferred Shares and 7.875% of the $25.00 liquidation preference per annum for the Series B Preferred Shares. At June 30, 2007, the Company had declared an aggregate of $3.3 million of dividends to be paid (subject to certain conditions) to holders of the Preferred Shares.

Share-Based Compensation

As required by the provisions of Financial Accounting Standards Board (“FASB”) Statement No. 123 (revised 2004), “Share-Based Payment” (“SFAS No. 123(R)”), the Company recorded after-tax share-based compensation expense related to stock options in the 2007 second quarter of $2.8 million, or $0.04 per diluted share, compared to $1.7 million, or $0.02 per diluted share, in the 2006 second quarter, and $4.4 million, or $0.06 per diluted share, for the six months ended June 30, 2007, compared to $2.8 million, or $0.04 per diluted share, for the six months ended June 30, 2006.

During the 2007 second quarter, the Company made a stock grant of 323,630 stock appreciation rights and stock options and 323,480 restricted shares and units to certain employees. The stock appreciation rights and stock options were valued at the grant date using the Black-Scholes option pricing model. The weighted average grant-date fair value of the stock appreciation rights and options and restricted shares and units granted were approximately $22.50 and $69.97 per share, respectively. Such value will be amortized over the respective substantive vesting period.

9

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3.      Debt and Financing Arrangements

Senior Notes

On May 4, 2004, ACGL completed a public offering of $300 million principal amount of 7.35% senior notes (“Senior Notes”) due May 1, 2034 and received net proceeds of $296.4 million. ACGL used $200 million of the net proceeds to repay all amounts outstanding under a revolving credit agreement. The Senior Notes are ACGL’s senior unsecured obligations and rank equally with all of its existing and future senior unsecured indebtedness. Interest payments on the Senior Notes are due on May 1st and November 1st of each year. ACGL may redeem the Senior Notes at any time and from time to time, in whole or in part, at a “make-whole” redemption price. For the six months ended June 30, 2007 and 2006, interest expense on the Senior Notes was approximately $11.0 million. The market value of the Senior Notes at June 30, 2007 and December 31, 2006 was $318.0 million and $332.0 million, respectively.

Letter of Credit and Revolving Credit Facilities

As of June 30, 2007, the Company had a $300 million unsecured revolving loan and letter of credit facility and a $1.0 billion secured letter of credit facility. The $300 million unsecured revolving loan is also available for the issuance of unsecured letters of credit up to $100 million for Arch Reinsurance Company (“Arch Re U.S.”). Borrowings of revolving loans may be made by ACGL and Arch Re U.S. at a variable rate based on LIBOR or an alternative base rate at the option of the Company. Secured letters of credit are available for issuance on behalf of the Company’s insurance and reinsurance subsidiaries. Issuance of letters of credit and borrowings under the Credit Agreement are subject to the Company’s compliance with certain covenants and conditions, including absence of a material adverse change. These covenants require, among other things, that the Company maintain a debt to shareholders’ equity ratio of not greater than 0.35 to 1 and shareholders’ equity in excess of $1.95 billion plus 25% of future aggregate net income for each quarterly period (not including any future net losses) beginning after June 30, 2006 and 25% of future aggregate proceeds from the issuance of common or preferred equity and that the Company’s principal insurance and reinsurance subsidiaries maintain at least a “B++” rating from A.M. Best. In addition, certain of the Company’s subsidiaries which are party to the Credit Agreement are required to maintain minimum shareholders’ equity levels. The Company was in compliance with all covenants contained in the Credit Agreement at June 30, 2007. The Credit Agreement expires on August 30, 2011.

Including the secured letter of credit portion of the Credit Agreement and another letter of credit facility (together, the “LOC Facilities”), the Company has access to letter of credit facilities for up to a total of $1.45 billion. The principal purpose of the LOC Facilities is to issue, as required, evergreen standby letters of credit in favor of primary insurance or reinsurance counterparties with which the Company has entered into reinsurance arrangements to ensure that such counterparties are permitted to take credit for reinsurance obtained from the Company’s reinsurance subsidiaries in United States jurisdictions where such subsidiaries are not licensed or otherwise admitted as an insurer, as required under insurance regulations in the United States, and to comply with requirements of Lloyd’s of London in connection with qualifying quota share and other arrangements. The amount of letters of credit issued is driven by, among other things, the timing and payment of catastrophe losses, loss development of existing reserves, the payment pattern of such reserves, the further expansion of the Company’s business and the loss experience of such business. When issued, certain letters of credit are secured by a portion of the Company’s investment portfolio. In addition, the LOC Facilities also require the maintenance of certain covenants, which the Company was in compliance with at June 30, 2007. At such date, the Company had approximately $617.0 million in outstanding letters of credit under the LOC Facilities, which were secured by investments totaling $653.7 million. The other letter of credit facility was amended and restated in December 2006. It is anticipated that the LOC Facilities will be renewed (or replaced) on expiry, but such renewal (or replacement) will be subject to the availability of credit from banks which the Company utilizes. In addition to letters of credit, the Company has and may establish insurance trust accounts in the U.S. and Canada to secure its reinsurance amounts payable as required.

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4.      Segment Information

The Company classifies its businesses into two underwriting segments—insurance and reinsurance—and a corporate and other segment (non-underwriting). The Company’s insurance and reinsurance operating segments each have segment 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 ACGL and the Chief Financial Officer of ACGL. The chief operating decision makers do not assess performance, measure return on equity or make resource allocation decisions on a line of business basis. The Company determined its reportable operating segments using the management approach described in SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information.”

Management measures segment performance based on underwriting income or loss. The Company does not manage its assets by segment and, accordingly, investment income is not allocated to each underwriting segment. In addition, other revenue and expense items are not evaluated by segment. 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 insurance segment consists of the Company’s insurance underwriting subsidiaries which primarily write on both an admitted and non-admitted basis. The insurance segment consists of eight product lines: casualty; construction, surety and national accounts; executive assurance; healthcare; professional liability; programs; property, marine and aviation; and other (consisting of collateral protection, excess workers’ compensation and employers’ liability business).

The reinsurance segment consists of the Company’s reinsurance underwriting subsidiaries. The reinsurance segment generally seeks to write significant lines on specialty property and casualty reinsurance treaties. Classes of business 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 non-traditional and casualty clash business).

The corporate and other segment (non-underwriting) includes net investment income, other income (loss), other expenses incurred by the Company, interest expense, net realized gains or losses, net foreign exchange gains or losses and income taxes. In addition, results for the corporate and other segment include dividends on the Company’s non-cumulative preferred shares.

11

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The following tables set forth an analysis of the Company’s underwriting income by segment, together with a reconciliation of underwriting income to net income available to common shareholders:

		(Unaudited)
		Three Months Ended
		June 30, 2007
(U.S. dollars in thousands)		Insurance			Reinsurance			Total
Gross premiums written(1)		$	684,725		$	427,348		$	1,102,210
Net premiums written(1)		451,828			306,067			757,895
Net premiums earned(1)		$	432,560		$	318,852		$	751,412
Fee income		1,276			815			2,091
Losses and loss adjustment expenses		(272,658		)	(153,005		)	(425,663		)
Acquisition expenses, net		(47,532		)	(69,745		)	(117,277		)
Other operating expenses		(70,269		)	(19,999		)	(90,268		)
Underwriting income		$	43,377		$	76,918		120,295
Net investment income								117,299
Net realized losses								(3,757		)
Other income								265
Other expenses								(10,237		)
Interest expense								(5,523		)
Net foreign exchange losses								(6,450		)
Income before income taxes								211,892
Income tax expense								(6,037		)
Net income								205,855
Preferred dividends								(6,461		)
Net income available to common shareholders								$	199,394
Underwriting Ratios
Loss ratio		63.0		%	48.0		%	56.6		%
Acquisition expense ratio(2)		10.8		%	21.9		%	15.5		%
Other operating expense ratio		16.2		%	6.3		%	12.0		%
Combined ratio		90.0		%	76.2		%	84.1		%

(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. The insurance segment and reinsurance segment results include $0.3 million and $9.6 million, respectively, of gross and net premiums written and $0.3 million and $10.8 million, respectively, of net premiums earned assumed through intersegment transactions.

(2)             The acquisition expense ratio is adjusted to include policy-related fee income.

12

 

		(Unaudited)
		Three Months Ended
		June 30, 2006
(U.S. dollars in thousands)		Insurance			Reinsurance			Total
Gross premiums written (1)		$	647,817		$	499,241		$	1,136,274
Net premiums written (1)		409,302			385,256			794,558
Net premiums earned (1)		$	385,877		$	411,573		$	797,450
Fee income		1,253			2,215			3,468
Losses and loss adjustment expenses		(251,172		)	(211,083		)	(462,255		)
Acquisition expenses, net		(41,275		)	(107,306		)	(148,581		)
Other operating expenses		(63,689		)	(14,179		)	(77,868		)
Underwriting income		$	30,994		$	81,220		112,214
Net investment income								90,503
Net realized losses								(32,202		)
Other income								—
Other expenses								(6,499		)
Interest expense								(5,651		)
Net foreign exchange losses								(1,146		)
Income before income taxes								157,219
Income tax expense								(14,332		)
Net income								142,887
Preferred dividends								(5,039		)
Net income available to common shareholders								$	137,848
Underwriting Ratios
Loss ratio		65.1		%	51.3		%	58.0		%
Acquisition expense ratio (2)		10.5		%	26.1		%	18.5		%
Other operating expense ratio		16.5		%	3.4		%	9.8		%
Combined ratio		92.1		%	80.8		%	86.3		%

(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. The insurance segment and reinsurance segment results include nil and $10.9 million, respectively, of gross and net premiums written and $0.5 million and $12.3 million, respectively, of net premiums earned assumed through intersegment transactions.

(2)          The acquisition expense ratio is adjusted to include certain fee income.

13

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		(Unaudited)
		Six Months Ended
		June 30, 2007
(U.S. dollars in thousands)		Insurance			Reinsurance			Total
Gross premiums written (1)		$	1,345,935		$	986,002		$	2,312,824
Net premiums written (1)		880,172			749,468			1,629,640
Net premiums earned (1)		$	846,407		$	650,498		$	1,496,905
Fee income		2,701			1,359			4,060
Losses and loss adjustment expenses		(531,980		)	(313,744		)	(845,724		)
Acquisition expenses, net		(94,227		)	(143,178		)	(237,405		)
Other operating expenses		(139,163		)	(33,780		)	(172,943		)
Underwriting income		$	83,738		$	161,155		244,893
Net investment income								229,988
Net realized losses								(4,738		)
Other income								869
Other expenses								(18,375		)
Interest expense								(11,046		)
Net foreign exchange losses								(16,192		)
Income before income taxes								425,399
Income tax expense								(14,532		)
Net income								410,867
Preferred dividends								(12,922		)
Net income available to common shareholders								$	397,945
Underwriting Ratios
Loss ratio		62.9		%	48.2		%	56.5		%
Acquisition expense ratio (2)		10.9		%	22.0		%	15.8		%
Other operating expense ratio		16.4		%	5.2		%	11.6		%
Combined ratio		90.2		%	75.4		%	83.9		%

(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. The insurance segment and reinsurance segment results include $0.8 million and $18.3 million, respectively, of gross and net premiums written and $0.8 million and $21.4 million, respectively, of net premiums earned assumed through intersegment transactions.

(2)          The acquisition expense ratio is adjusted to include policy-related fee income.

14

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		(Unaudited)
		Six Months Ended
		June 30, 2006
(U.S. dollars in thousands)		Insurance			Reinsurance			Total
Gross premiums written (1)		$	1,263,301		$	1,063,909		$	2,304,088
Net premiums written (1)		806,556			861,721			1,668,277
Net premiums earned (1)		$	766,131		$	792,920		$	1,559,051
Fee income		2,657			2,616			5,273
Losses and loss adjustment expenses		(499,174		)	(431,259		)	(930,433		)
Acquisition expenses, net		(79,160		)	(199,093		)	(278,253		)
Other operating expenses		(125,765		)	(27,431		)	(153,196		)
Underwriting income		$	64,689		$	137,753		202,442
Net investment income								170,829
Net realized losses								(35,585		)
Other income								—
Other expenses								(14,148		)
Interest expense								(11,206		)
Net foreign exchange losses								(11,399		)
Income before income taxes								300,933
Income tax expense								(25,756		)
Net income								275,177
Preferred dividends								(7,706		)
Net income available to common shareholders								$	267,471
Underwriting Ratios
Loss ratio		65.2		%	54.4		%	59.7		%
Acquisition expense ratio (2)		10.1		%	25.1		%	17.7		%
Other operating expense ratio		16.4		%	3.5		%	9.8		%
Combined ratio		91.7		%	83.0		%	87.2		%

(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. The insurance segment and reinsurance segment results include $0.8 million and $22.4 million, respectively, of gross and net premiums written and $1.4 million and $25.1 million, respectively, of net premiums earned assumed through intersegment transactions.

(2)          The acquisition expense ratio is adjusted to include policy-related fee income.

15