<PAGE>
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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, 2000
Or
/ / 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)
<TABLE>
<S> <C>
Delaware 06-1424716
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
20 Horseneck Lane
Greenwich, Connecticut 06830
(Address of principal executive offices) (Zip Code)
</TABLE>
Registrant's telephone number, including area code: (203) 862-4300
--------------------------------------------------------------------------------
(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
----- -----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock.
<TABLE>
<CAPTION>
CLASS OUTSTANDING AT JUNE 30, 2000
----- ----------------------------
<S> <C>
Common Stock, $.01 par value 12,400,117
</TABLE>
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<PAGE>
ARCH CAPITAL GROUP LTD.
INDEX
<TABLE>
<CAPTION>
PAGE NO.
--------
<S> <C>
PART I. FINANCIAL INFORMATION
ITEM 1 - CONSOLIDATED FINANCIAL STATEMENTS
Review Report of Independent Accountants 1
Consolidated Balance Sheet 2
June 30, 2000 and December 31, 1999
Consolidated Statement of Income and Comprehensive Income 3
For the three and six month periods ended June 30, 2000 and 1999
Consolidated Statement of Changes in Stockholders' Equity 4
For the six month periods ended June 30, 2000 and 1999
Consolidated Statement of Cash Flows 5
For the six month periods ended June 30, 2000 and 1999
Notes to Consolidated Financial Statements 6
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 18
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 26
PART II. OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS 26
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 26
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K 26
</TABLE>
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
Arch Capital Group Ltd.:
We have reviewed the accompanying consolidated balance sheet of Arch Capital
Group Ltd. (formerly known as Risk Capital Holdings, Inc.) and its subsidiaries
as of June 30, 2000, and the related consolidated statement of income and
comprehensive income for each of the three-month and six month periods ended
June 30, 2000 and 1999 and the consolidated statements of changes in
stockholders' equity and of cash flows for the six-month periods ended June 30,
2000 and 1999. These financial statements are the responsibility of the
Company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with auditing standards generally accepted in the United States of America, 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 information for it to
be in conformity with accounting principles generally accepted in the United
States of America
We previously audited in accordance with auditing standards generally accepted
in the United States of America, the consolidated balance sheet as of December
31, 1999, and the related consolidated statements of income and comprehensive
income, changes in stockholders' equity, and of cash flows for the year then
ended (not presented herein), and in our report dated February 1, 2000, except
as to Note 14, which is as of March 2, 2000, 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, 1999, 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 9, 2000
1
<PAGE>
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
(UNAUDITED)
JUNE 30, DECEMBER 31,
2000 1999
---- ----
<S> <C> <C>
ASSETS
Investments:
Fixed maturities (amortized cost: 2000, $82,557 1999, $270,345) ....... $ 77,481 $261,067
Publicly traded equity securities (cost: 2000, $46,671; 1999, $105,747) 44,231 158,631
Privately held securities (cost: 2000, $62,437; 1999, $85,748) ........ 61,043 83,969
Securities held in escrow (amortized cost: 2000, $20,265) .............. 20,317
Short-term investments ................................................. 38,806 72,785
------- -------
Total investments ...................................................... 241,878 576,452
------- -------
Cash ................................................................... 17,374 9,457
Accrued investment income .............................................. 1,870 4,527
Premiums receivable .................................................... 119,320
Reinsurance recoverable ................................................ 73,122
Deferred policy acquisition costs ...................................... 23,585
Investment accounts receivable ......................................... 491
Federal income tax recoverable ......................................... 8,758
Deferred income tax asset .............................................. 4,779 7,834
Other insurance assets ................................................. 36,975
Other assets ........................................................... 2,191 4,329
------- -------
TOTAL ASSETS ........................................................... $268,583 $864,359
======== ========
LIABILITIES
Claims and claims expenses ............................................. $364,554
Unearned premiums ...................................................... 108,743
Reinsurance balances payable ........................................... 14,666
Investment accounts payable ............................................ $ 749
Other insurance liabilities ............................................ 24,541
Other liabilities ...................................................... 12,929 5,341
======== ========
TOTAL LIABILITIES ...................................................... 13,678 517,845
-------- --------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value:
20,000,000 shares authorized (none issued)
Common stock, $.01 par value:
80,000,000 shares authorized
(issued: 2000, 17,190,532; 1999, 17,109,736) .......................... 172 171
Additional paid-in capital ............................................. 343,255 342,034
Deferred compensation under stock award plan ........................... (943) (317)
Retained earnings (deficit) ............................................ (18,919) (22,175)
Less treasury stock, at cost (2000, 4,790,415; 1999, 21,766 shares) .... (59,802) (387)
Accumulated other comprehensive income (loss) consisting of unrealized
(depreciation) appreciation of investments, net of income tax .......... (8,858) 27,188
-------- --------
TOTAL STOCKHOLDERS' EQUITY ............................................. 254,905 346,514
-------- --------
Total Liabilities & Stockholders' Equity ............................... $268,583 $864,359
======== ========
</TABLE>
See Notes to Consolidated Financial Statements
2
<PAGE>
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INCOME AND COMPREHENSIVE INCOME
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
PREMIUMS AND OTHER REVENUES
Net premiums written ...................................... ($63,493) $91,517 ($10,604) $155,954
(Increase) decrease in unearned premiums .................. 92,861 (4,529) 98,134 (6,044)
------ ------ ------ ------
Net premiums earned ....................................... 29,368 86,988 87,530 149,910
Net investment income ..................................... 4,257 4,817 9,547 9,300
Gain on sale of reinsurance operations .................... 2,191 2,191
Net investment gains (losses) ............................. (367) 23,386 28,933 22,234
------ ------ ------ ------
TOTAL REVENUES ............................................ 35,449 115,191 128,201 181,444
EXPENSES
Claims and claims expenses ................................ 22,388 65,438 76,263 146,170
Commissions and brokerage ................................. 10,003 22,869 26,756 42,407
Other operating expenses .................................. 1,678 3,772 4,246 7,433
Foreign exchange (gain) loss .............................. (450) 1,159 (62)
------ ------ ------ ------
TOTAL EXPENSES ............................................ 34,069 91,629 108,424 195,948
INCOME (LOSS) BEFORE INCOME TAXES, EQUITY IN NET INCOME OF
INVESTEES AND CUMULATIVE EFFECT OF ACCOUNTING CHANGE....... 1,380 23,562 19,777 (14,504)
Federal income taxes:
Current ................................................... 4,748 (1,252)
Deferred .................................................. 4,541 3,127 17,160 (4,494)
------ ------ ------ ------
Income tax expense (benefit) .............................. 4,541 7,875 17,160 (5,746)
------ ------ ------ ------
INCOME (LOSS) BEFORE EQUITY IN NET INCOME OF
INVESTEES AND CUMULATIVE EFFECT
OF ACCOUNTING CHANGE ...................................... (3,161) 15,687 2,617 (8,758)
Equity in net income of investees ......................... 609 196 639 33
------ ------ ------ ------
INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE (2,552) 15,883 3,256 (8,725)
Cumulative effect of accounting change .................... (383)
------ ------ ------ ------
NET INCOME (LOSS) ......................................... (2,552) 15,883 3,256 (9,108)
------ ------ ------ ------
OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX
Change in net unrealized appreciation (depreciation)
of investments, net of tax ................................ 7,884 (7,163) (36,046) (17,663)
------ ------ ------ ------
COMPREHENSIVE INCOME (LOSS) ............................... $5,332 $8,720 ($32,790) ($26,771)
------ ------ ------ ------
------ ------ ------ ------
AVERAGE SHARES OUTSTANDING
Basic ..................................................... 12,379,371 17,085,826 13,948,267 17,086,212
Diluted ................................................... 12,381,576 17,085,826 13,949,503 17,086,212
PER SHARE DATA
Net Income (Loss) - Basic and diluted .................... ($0.21) $0.93 $0.23 ($0.53)
Comprehensive Income (Loss) - Basic and diluted ........... $0.43 $0.51 ($2.35) ($1.57)
</TABLE>
See Notes to Consolidated Financial Statements
3
<PAGE>
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
(UNAUDITED)
SIX MONTHS ENDED,
JUNE 30,
2000 1999
---- ----
<S> <C> <C>
COMMON STOCK
Balance at beginning of year ........................................... $171 $171
Common stock issued .................................................... 1
-------- --------
Balance at end of period ............................................... 172 171
-------- --------
ADDITIONAL PAID-IN CAPITAL
Balance at beginning of year ........................................... 342,034 341,878
Common stock issued..................................................... 1,221
-------- --------
Balance at end of period ............................................... 343,255 341,878
-------- --------
DEFERRED COMPENSATION UNDER STOCK AWARD PLAN
Balance at beginning of year ........................................... (317) (1,062)
Restricted common stock issued ......................................... (1,122)
Compensation expense recognized ........................................ 496 394
-------- --------
Balance at end of period ............................................... (943) (668)
-------- --------
RETAINED EARNINGS (DEFICIT)
Balance at beginning of year ........................................... (22,175) 10,261
Net income (loss) ...................................................... 3,256 (9,108)
-------- --------
Balance at end of period ............................................... (18,919) 1,153
-------- --------
TREASURY STOCK, AT COST
Balance at beginning of year ........................................... (387) (284)
Purchase of treasury stock ............................................. (59,415) (45)
-------- --------
Balance at end of period ............................................... (59,802) (329)
-------- --------
ACCUMULATED OTHER COMPREHENSIVE INCOME CONSISTING OF
UNREALIZED (DEPRECIATION) APPRECIATION OF INVESTMENTS, NET OF INCOME TAX
Balance at beginning of year ........................................... 27,188 47,038
Change in unrealized appreciation (depreciation) ....................... (36,046) (17,663)
-------- --------
Balance at end of period ............................................... (8,858) 29,375
-------- --------
TOTAL STOCKHOLDERS' EQUITY
Balance at beginning of year ........................................... 346,514 398,002
Issuance of common stock................................................ 1,222
Change in deferred compensation ........................................ (626) 394
Net income (loss) ...................................................... 3,256 (9,108)
Purchase of treasury stock ............................................. (59,415) (45)
Change in unrealized appreciation (depreciation)
of investments, net of income tax .................................... (36,046) (17,663)
-------- --------
Balance at end of period ............................................... $254,905 $371,580
======== ========
</TABLE>
See Notes to Consolidated Financial Statements
4
<PAGE>
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
(UNAUDITED)
SIX MONTHS ENDED,
JUNE 30,
2000 1999
---- ----
<S> <C> <C>
OPERATING ACTIVITIES
Net income (loss) .................................. $3,256 ($9,108)
Adjustments to reconcile net income
to net cash provided by operating activities:
Liability for claims and claims expenses ......... 7,069 110,259
Unearned premiums ................................ (5,226) 16,672
Premiums receivable .............................. 10,733 (26,516)
Accrued investment income ........................ 996 (1,297)
Reinsurance recoverable .......................... (11,093) (28,398)
Reinsurance balances payable ..................... (5,121) 5,613
Deferred policy acquisition costs ................ 344 (3,816)
Net investment (gains)/losses .................... (23,603) (22,234)
Deferred income tax asset ........................ 4,222 (4,682)
Other liabilities ................................ 9,031 (4,452)
Other items, net ................................. 8,960 (6,656)
------- -------
NET CASH PROVIDED BY (USED FOR) OPERATING ACTIVITIES (432) 25,385
------- -------
INVESTING ACTIVITIES
Purchases of fixed maturity investments ............ (89,166) (220,839)
Sales of fixed maturity investments ................ 85,445 128,133
Purchases of equity securities ..................... (18,233) (20,712)
Sales of equity securities ......................... 133,477 63,997
Net (purchases)/sales of short-term investments .... (111,978) 23,605
Proceeds from sale of reinsurance operations ....... 4,842
Sale or disposal of furniture and equipment ........ 6 (282)
------- -------
NET CASH PROVIDED BY (USED FOR) INVESTING ACTIVITIES 4,393 (26,098)
------- -------
FINANCING ACTIVITIES
Common stock issued ................................ 1,222
Purchase of treasury stock ......................... 3,432 (45)
Deferred compensation on restricted stock........... (698)
------- -------
NET CASH PROVIDED BY (USED FOR) FINANCING ACTIVITIES 3,956 (45)
------- -------
Increase (decrease) in cash ........................ 7,917 (758)
Cash beginning of year ............................. 9,457 12,037
------- -------
Cash end of period ................................. $17,374 $11,279
------- -------
------- -------
</TABLE>
See Notes to Consolidated Financial Statements
5
<PAGE>
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION
Arch Capital Group Ltd. (the "Company"), formerly known as Risk Capital
Holdings, Inc., is a holding company that was incorporated in March 1995 under
the laws of the State of Delaware and commenced operations in September 1995
upon completion of an initial public offering. In September 1995, through its
initial public offering, related exercise of the underwriters' over-allotment
option and direct sales of 16,750,625 shares of the Company's common stock, par
value $.01 per share (the "Common Stock"), at $20 per share, and the issuance of
warrants, the Company was capitalized with net proceeds of approximately $335.0
million, of which $328.0 million was contributed to the statutory capital of
Arch Reinsurance Company ("Arch Re"), formerly known as Risk Capital Reinsurance
Company. At June 30, 2000, Arch Re had statutory capital of $222 million. In
July 1998, Arch Re capitalized its wholly owned subsidiary, Cross River
Insurance Company ("Cross River"), with $20 million. Cross River received its
Nebraska license in October 1998, and is currently authorized to write insurance
on an excess and surplus lines basis in 22 other states. On May 5, 2000, the
Company sold the reinsurance operations of Arch Re to Folksamerica Reinsurance
Company in the asset sale described below in Note 9.
Class A warrants to purchase an aggregate of 2,531,079 shares of Common
Stock and Class B warrants to purchase an aggregate of 1,920,601 shares of
Common Stock were issued in connection with the direct sales of Common Stock in
the Company's initial public offering. Class A warrants are immediately
exercisable at $20 per share and expire September 19, 2002. Class B warrants are
exercisable at $20 per share during the seven year period commencing September
19, 1998, provided that the Common Stock has traded at or above $30 per share
for 20 out of 30 consecutive trading days. To date, the Class B warrants have
not become exercisable.
2. GENERAL
The accompanying interim consolidated financial statements have been
prepared in conformity with accounting principles generally accepted in the
United States of America ("GAAP") and, in the opinion of management, reflect all
adjustments necessary (consisting of normal recurring accruals) for a fair
presentation of results for such periods. These consolidated financial
statements should be read in conjunction with the 1999 consolidated financial
statements and related notes contained in the Company's Annual Report on Form
10-K for the fiscal year ended December 31, 1999.
3. COMPREHENSIVE INCOME
In presenting its financial statements, the Company has adopted the
reporting of comprehensive income in a one financial statement approach,
consistent with Statement of Financial Accounting Standards No. 130 of the
Financial Accounting Standards Board ("FASB"). Comprehensive income is comprised
of net income and other comprehensive income, which for the Company consists of
the change in net unrealized appreciation or depreciation of investments, net of
income tax, as follows:
6
<PAGE>
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. COMPREHENSIVE INCOME (CONT'D.)
<TABLE>
<CAPTION>
(IN THOUSANDS)
SIX MONTHS ENDED
JUNE 30,
2000 1999
---- ----
<S> <C> <C>
Net income (loss) ............................................ $3,256 ($9,108)
Other comprehensive income, net of tax:
Unrealized appreciation (depreciation) of investments:
Unrealized holdings gains (losses) arising ............... (17,240) (3,211)
during period (1)
Less, reclassification adjustment for net realized (gains)
losses included in net income ............................ (18,806) (14,452)
-------- --------
Other comprehensive income (loss) ............................ (36,046) (17,663)
-------- --------
Comprehensive income (loss) .................................. ($32,790) ($26,771)
======== ========
</TABLE>
(1) Includes a deferred income tax asset valuation allowance of $3.1
million at June 30, 2000. See Note 6.
4. EARNINGS PER SHARE DATA
Earnings per share are computed in accordance with FASB Statement No.
128 "Earnings Per Share."
Basic earnings per share excludes dilution and is computed by dividing
income available to common stockholders by the weighted average number of shares
of Common Stock outstanding for the periods. Diluted earnings per share reflect
the potential dilution that could occur if Class A and B warrants and employee
stock options were exercised or converted into Common Stock. Diluted per share
amounts are computed using basic average shares outstanding when a loss occurs
since the inclusion of dilutive securities in dilutive earnings per share would
be anti-dilutive.
The following table sets forth the computation of basic and diluted
earnings per share:
<TABLE>
<CAPTION>
(IN THOUSANDS, EXCEPT SHARE DATA)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
NET INCOME
BASIC EARNINGS PER SHARE:
Net income (loss) ......................... ($2,552) $15,883 $3,256 ($9,108)
Divided by:
Weighted average shares outstanding for the 12,379,371 17,085,826 13,948,267 17,086,212
period
Basic earnings (loss) per share ........... ($0.21) $0.93 $0.23 ($0.53)
DILUTED EARNINGS PER SHARE:
Net income (loss) ......................... ($2,552) 15,883 $3,256 ($9,108)
Divided by:
Weighted average shares outstanding for the 12,379,371 17,085,826 13,948,267 17,086,212
period
Effect of dilutive securities:
Warrants
Employee stock options ............... 1,236
---------- ---------- ---------- ----------
Total shares .............................. 12,379,371 17,085,826 13,949,503 17,086,212
========== ========== ========== ==========
Diluted earnings (loss) per share ......... ($0.21) $0.93 $0.23 ($0.53)
</TABLE>
7
<PAGE>
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. EARNINGS PER SHARE DATA (CONT'D.)
<TABLE>
<CAPTION>
(IN THOUSANDS, EXCEPT SHARE DATA)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
COMPREHENSIVE INCOME
BASIC EARNINGS PER SHARE:
Comprehensive income (loss) $5,332 $8,720 ($32,790) ($26,771)
Divided by:
Weighted average shares outstanding for the 12,379,371 17,085,826 13,948,267 17,086,212
period
Basic earnings (loss) per share $0.43 $0.51 ($2.35) ($1.57)
DILUTED EARNINGS PER SHARE:
Comprehensive income (loss) $5,332 $8,720 ($32,790) ($26,771)
Divided by:
Weighted average shares outstanding for the 12,379,371 17,085,826 13,948,267 17,086,212
period
Effect of dilutive securities:
Warrants
Employee stock options 2,205
---------- ---------- ---------- ----------
Total shares 12,381,586 17,085,826 13,948,267 17,086,212
========== ========== ========== ==========
Diluted earnings (loss) per share $0.43 $0.51 ($2.35) ($1.57)
</TABLE>
5. INVESTMENT INFORMATION
Realized investment gains (losses) for the three and six month periods
ended June 30, 2000 consisted of the following:
<TABLE>
<CAPTION>
(IN THOUSANDS)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 2000 JUNE 30, 2000
----------------------------- -----------------------------
NET NET
GROSS GROSS REALIZED GROSS GROSS REALIZED
REALIZED REALIZED GAINS REALIZED REALIZED GAINS
GAINS LOSSES (LOSSES) GAINS LOSSES (LOSSES)
-------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Fixed maturity securities $45 ($587) ($542) $342 ($3,283) ($2,941)
Publicly traded equity
securities .............. 387 (212) 175 37,500 (1,966) 35,534
Privately held securities (3,660) (3,660)
---- ----- ----- ------- ------- -------
Total ................... $432 ($799) ($367) $37,842 ($8,909) $28,933
==== ===== ===== ======= ======= =======
</TABLE>
8
<PAGE>
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. INVESTMENT INFORMATION (CONT'D.)
The following table reconciles estimated fair value and carrying value to
the amortized cost of fixed maturity and equity securities:
<TABLE>
<CAPTION>
(IN THOUSANDS)
JUNE 30, 2000
-------------------------------------------------------------------------------
ESTIMATED
FAIR VALUE
AND GROSS GROSS
CARRYING UNREALIZED UNREALIZED AMORTIZED
VALUE GAINS (LOSSES) COST
----- ----- -------- ----
<S> <C> <C> <C> <C>
Fixed maturities $77,481 $ 401 ($5,477) $82,557
Publicly traded equity securities 44,231 7,891 (10,331) 46,671
Privately held securities 61,043 (1,394) 62,437
Securities held in escrow 20,317 63 (11) 20,265
-------- ----- ------- --------
Total $203,072 $8,355 ($17,213) $211,930
-------- ----- ------- --------
-------- ----- ------- --------
</TABLE>
The Company classifies all of its publicly traded fixed maturity and
equity securities as "available for sale" and, accordingly, they are carried at
estimated fair value. The fair value of publicly traded fixed maturity
securities and publicly traded equity securities is estimated using quoted
market prices or dealer quotes. Short-term investments, which have a maturity of
one year or less at the date of acquisition, are carried at cost, which
approximates fair value.
All of the Company's publicly traded equity securities and privately held
securities were issued by insurance and reinsurance companies or companies
providing services to the insurance industry. At June 30, 2000, the publicly
traded equity portfolio consisted of the following:
<TABLE>
<CAPTION>
JUNE 30, 2000
------------------------------------------------
ESTIMATED
FAIR VALUE
AND GROSS GROSS
CARRYING UNREALIZED UNREALIZED
VALUE GAINS (LOSSES) COST
--------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
COMMON STOCK:
ACE Limited ....................... $9,055 $ 913 $8,142
XL Capital Ltd ................... 14,072 5,197 8,875
E.W. Blanch Holdings, Inc. ........ 2,915 36 2,879
Farm Family Holdings, Inc. ........ 947 35 912
IPC Holdings, Ltd. ................ 7,448 (7,420) 14,868
Limit PLC ......................... 2,045 (766) 2,811
Meadowbrook Insurance Group ....... 937 (2,145) 3,082
Renaissance Re .................... 2,178 468 1,710
Metropolitan Life Insurance Company 4,634 1,242 3,392
OTHER:
Markel Corp (62,239 Contingent
Value Rights)
------- ------ -------- -------
Total .................... $44,231 $7,891 ($10,331) $46,671
------- ------ -------- -------
------- ------ -------- -------
</TABLE>
9
<PAGE>
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. INVESTMENT INFORMATION (CONT'D.)
Investments in privately held securities may include both equity
securities and securities convertible into, or exercisable for, equity
securities (some of which may have fixed maturities). Privately held securities
are subject to trading restrictions or are otherwise illiquid and do not have
readily ascertainable market values. The risk of investing in such securities is
generally greater than the risk of investing in securities of widely held,
publicly traded companies. Lack of a secondary market and resale restrictions
may result in the Company's inability to sell a security at a price that would
otherwise be obtainable if such restrictions did not exist and may substantially
delay the sale of a security which the Company seeks to sell. Such investments
are classified as "available for sale" and carried at estimated fair value,
except for investments in which the Company believes it has the ability to
exercise significant influence (generally defined as investments in which the
Company owns 20% or more of the outstanding voting common stock of the issuer),
which are carried under the equity method of accounting. Under this method, the
Company records its proportionate share of income or loss for such investments
in results of operations.
Goodwill for privately held equity securities carried under the equity
method of accounting was $8.2 million at June 30, 2000, compared to $8.9 million
at December 31, 1999.
The estimated fair value of investments in privately held securities,
other than those carried under the equity method or those with quoted market
values, is initially equal to the cost of such investments until the investments
are revalued based principally on substantive events or other factors which
could indicate a diminution or appreciation in value, such as an arm's-length
third party transaction justifying an increased valuation or adverse development
of a significant nature requiring a write-down. The Company periodically reviews
the valuation of investments in privately held securities with Marsh & McLennan
Capital, Inc., its equity investment advisor with respect to certain of the
Company's privately held securities.
Privately held securities consisted of the following:
<TABLE>
<CAPTION>
(IN THOUSANDS)
JUNE 30, DECEMBER 31,
2000 1999
---- ----
<S> <C> <C>
CARRIED UNDER THE EQUITY METHOD:
The ARC Group, LLC ........................... $ 8,442 $ 8,687
Arx Holding Corp. ............................ 2,839 2,654
Island Heritage Insurance Company, Ltd. ...... 4,312 4,356
LARC Holdings, Ltd. .......................... 24,039
New Europe Insurance Ventures ................ 723 819
Sunshine State Holding Corporation ........... 1,654 1,885
------ ------
Sub-total ............................... 17,970 42,440
------ ------
CARRIED AT FAIR VALUE:
Altus Holdings, Ltd. ......................... 16,000 19,173
American Independent Insurance Holding Company 7,350 4,250
GuideStar Health Systems, Inc. ............... 500 500
Sorrento Holdings, Inc. ...................... 311 1,517
Stockton Holdings Limited .................... 10,000 10,000
Trident II, L.P. ............................. 8,912 6,089
------ ------
Sub-total ............................... 43,073 41,529
------ ------
Total ................................... $61,043 $83,969
------ ------
------ ------
</TABLE>
10
<PAGE>
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. INVESTMENT INFORMATION (CONT'D.)
During the six month period ended June 30, 2000, the Company received a
distribution from The ARC Group, LLC totaling $1,080,000.
The Company also received $1,234,356 from Sorrento Holdings, Inc.
("Sorrento") for the redemption of 1,206 shares of preferred stock of Sorrento,
which redemption amount included a payment of $1,000 per share and interest
income at 6%.
At June 30, 2000, the Company had investment commitments relating to its
privately held securities totaling approximately $20.3 million. The outstanding
commitments at June 30, 2000 included $16.1 million committed to Trident II,
L.P., an investment fund formed in 1999 dedicated to making private equity and
equity related investments in the global insurance, reinsurance and related
industries.
Set forth below is certain information relating to the Company's private
investment activity for the six month period ended June 30, 2000:
ALTUS HOLDINGS, LTD.
In the 2000 first quarter, the Company reduced the carrying value of
Altus Holdings, Ltd. ("Altus") by $3.2 million, realizing an after-tax loss of
$2.1 million. In reducing the carrying value of Altus, the Company, in
consultation with its investment advisor, took into account the 1999 financial
results of Altus and certain other factors, and based such write-down on a
conservative valuation of Altus' economic book value at December 31, 1999.
AMERICAN INDEPENDENT INSURANCE HOLDING COMPANY
On March 6, 2000, the Company provided an additional loan in an aggregate
principal amount of $3.5 million to American Independent Insurance Holding
Company ("AIHC"). The loan is secured by a second priority pledge of the capital
stock of AIHC and assets of AIHC, and matures on September 6, 2001 (which date
may be extended to March 6, 2002 upon the occurrence of certain events). The net
proceeds of the loan were contributed to the surplus of AIHC's subsidiary,
American Independent Insurance Company. In connection with the loan, the Company
was issued warrants (in addition to the warrants issued to the Company in
connection with a prior loan to AIHC) granting the Company the right to acquire
equity in AIHC.
As of June 30, 2000, based on a comparison of the AIHC notes to bonds
with similar characteristics, the Company recorded a $1.1 million pre-tax
unrealized loss to adjust the aggregate carrying value of the aggregate of $8.5
million in loans made to AIHC ($5 million in February 1999 and $3.5 million in
March 2000).
LARC HOLDINGS, LTD.
As of March 2, 2000, the Company transferred to XL Capital Ltd ("XL
Capital") the Company's interest in privately held LARC Holdings, Ltd. (parent
of Latin American Reinsurance Company), valued at $25 million, in connection
with the Company's repurchase from XL Capital of the Common Stock it previously
held. See Note 8.
TRIDENT II, L.P.
During the six months ended June 30, 2000, the Company funded
approximately $2.8 million of its commitment to Trident II, L.P. At June 30,
2000, the Company's remaining commitment to Trident II was $16.1 million.
11
<PAGE>
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. INCOME TAXES
The Company, Arch Re and Cross River file a consolidated federal income
tax return and have a tax sharing agreement (the "Tax Sharing Agreement"),
allocating the consolidated income tax liability on a separate return basis.
Pursuant to the Tax Sharing Agreement, Arch Re and Cross River make tax sharing
payments to the Company based on such allocation.
The provision for federal income taxes has been determined on the basis
of a consolidated tax return consisting of the Company, Arch Re and Cross River.
An analysis of the Company's effective tax rate for the six months ended
June 30, 2000 and 1999 follows:
<TABLE>
<CAPTION>
(IN THOUSANDS)
SIX MONTHS ENDED
JUNE 30,
2000 1999
---- ----
<S> <C> <C>
Income taxes (benefit) computed on pre-tax income (loss) $6,922 ($5,076)
Addition (reduction) in income taxes resulting from:
Valuation allowance ............................... 10,205
Tax-exempt investment income ...................... (230) (337)
Dividend received deduction ....................... (196) (563)
Limitation on executive compensation .............. 322
Other ............................................. 137 230
------- -------
Income tax expense (benefit) on pre-tax income (loss) .. $17,160 ($5,746)
------- -------
------- -------
</TABLE>
The Company had no current federal tax expense or benefit for the six
months ended June 30, 2000 due to its net operating losses and the full
utilization of the two-year carry-back provision at December 31, 1999. The
Company's current federal tax benefit for the six months ended June 30, 1999 was
based on regular taxable income.
As a result of the Company's net operating losses in 1999 and 2000, the
Company has net operating loss carryforwards totaling $34.7 million at June 30,
2000. Such net operating losses are currently available to offset future taxable
income of the Company with the following expiration dates: $18.3 million
expiring in 2019, and $16.4 million expiring in 2020. The Company also has an
alternative minimum tax ("AMT") credit carryforward in the amount of $651,000,
which can be carried forward without expiration.
The repurchase of Common Stock held by XL Capital resulted in a 27.8%
change in ownership by 5% stockholders. If, in the ensuing three years, there is
more than a 22.2% additional change in ownership by 5% stockholders, an
"ownership change" will have taken place for federal income tax purposes. If
such ownership change occurs, the amount of loss carryforwards that can be used
in any subsequent year may be severely limited and could be eliminated in
certain circumstances.
The net deferred income tax asset reflects temporary differences between
the carrying amounts of assets and liabilities for financial reporting and
income tax purposes, net of a valuation allowance for any portion of the
deferred tax asset that management believes may not be realized. Significant
components of the Company's deferred income tax assets and liabilities as of
June 30, 2000 and December 31, 1999 were as follows:
12
<PAGE>
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. INCOME TAXES (CONT'D.)
<TABLE>
<CAPTION>
(IN THOUSANDS)
JUNE 30, DECEMBER 31,
2000 1999
---- ----
<S> <C> <C>
Deferred income tax assets:
Net operating loss ........................ $12,135 $ 7,334
AMT credit carryforward ................... 651
Net claim reserve discount ................ 15,639
Net unearned premium reserve .............. 6,573
Net unrealized depreciation of investments 3,100
Loss on investees, net .................... 1,907 7
Compensation liabilities .................. 70 372
Other, net ................................ 221 165
------ ------
Total deferred tax assets ...................... 18,084 30,090
------ ------
Deferred income tax liabilities:
Deferred policy acquisition cost .......... (8,255)
Net unrealized appreciation of investments (14,001)
------ ------
Total deferred tax liabilities ................. (22,256)
------ ------
Valuation allowance ............................ (13,305)
------ ------
Net deferred income tax asset .................. $4,779 $7,834
====== ======
</TABLE>
As of June 30, 2000, the Company has a deferred income tax valuation
allowance of $13.3 million that adjusts the deferred income tax asset to its
estimated net realizable value of $4.8 million. Deferred income tax expense for
the six months ended June 30, 2000 included a charge for such allowance of $10.2
million, and the deferred income tax benefit on the change in net unrealized
depreciation of investments for the six months ended June 30, 2000 was decreased
by $3.1 million for such valuation allowance.
At December 31, 1999, the Company did not have a deferred income tax
valuation allowance because it believed at that time that its entire deferred
tax asset was realizable due to the Company's ability to generate future taxable
income from its invested asset base of $576.5 million. At that time, the closing
of the Folksamerica transaction was uncertain and, consequently, the tax
implications of the transaction were not considered in evaluating the
realizability of the deferred tax asset. During the 2000 first quarter, the
Company entered into the agreement with Folksamerica to sell the Company's
reinsurance operations. The asset sale generated a tax loss of $30 million, and
the related transfer of assets to Folksamerica resulted in a significant
reduction in the Company's invested assets and its ability to generate future
taxable income. In addition, the market values of the Company's invested assets
depreciated significantly resulting in the 2000 first quarter change in net
unrealized depreciation of $58.6 million. Based on these factors, the Company
recorded a $12.1 million valuation allowance in the 2000 first quarter. For the
2000 first quarter, deferred income tax expense included a charge for such
allowance of $6.3 million and the deferred income tax benefit of the change in
net unrealized depreciation of investments was decreased by $5.8 million for
such valuation allowance.
7. ACCOUNTING PRONOUNCEMENTS
START-UP COSTS
Effective January 1, 1999, the Company changed its method of accounting
for start-up costs in accordance with the Accounting Standards Executive
Committee's Statement of Position ("SOP") 98-5 "Reporting on the Costs of
Start-Up Activities." The change in accounting principle resulted in the
write-off of the start-up costs capitalized as of January 1, 1999 for the
Company and its investee companies carried under the equity method of
accounting. The cumulative effect of the write-off, which totaled $383,000,
after-tax, or $0.02 per share, was included in the 1999 first quarter net loss.
13
<PAGE>
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. ACCOUNTING PRONOUNCEMENTS (CONT'D.)
MARKET RISK SENSITIVE INSTRUMENTS
The Securities and Exchange Commission ("SEC") issued Financial Reporting
Release ("FRR") No. 48 which included amended rules requiring domestic and
foreign issuers to clarify and expand existing disclosure for derivative
financial instruments, other financial instruments and derivative commodity
instruments (collectively, "market risk sensitive instruments"). The amendments
require enhanced disclosure of accounting policies for derivative financial
instruments and derivative commodity instruments (collectively, "derivatives").
In addition, the amendments expand existing disclosure requirements to include
quantitative and qualitative information about market risk inherent in market
risk sensitive instruments, which disclosure will be subject to safe harbor
protection under SEC rules (see "Management's Discussion and Analysis of
Financial Condition and Results of Operations" included elsewhere in this Form
10-Q). These amendments are designed to provide additional information about
market risk sensitive instruments which investors can use to better understand
and evaluate market risk exposures of registrants, including the Company. There
have been no material changes in market risk exposures that affect the
quantitative and qualitative disclosures presented as of the year ended December
31, 1999, except that the Company no longer has any foreign currency exchange
rate risk.
8. XL TRANSACTION
On March 2, 2000, the Company repurchased from XL Capital, then the
Company's single largest stockholder, all of the 4,755,000 shares of Common
Stock held by it for a purchase price of $12.45 per share of Common Stock, or a
total of $59.2 million. The per share repurchase price was determined as the
lesser of (1) 85% of the average closing market price of Common Stock during the
20 trading days beginning on the third business day following public
announcement of the stock repurchase and asset sale (January 21, 2000), which
was $14.65, and (2) $15. The Company paid XL Capital the consideration for the
repurchase with: (i) the Company's interest in privately held LARC Holdings,
Ltd. (parent of Latin American Reinsurance Company Ltd.), valued at $25 million,
and (ii) all of the Company's interest in Annuity and Life Re (Holdings), Ltd.,
valued at $25.38 per share and $18.50 per warrant, or $37.8 million in the
aggregate. XL Capital paid the Company in cash the difference (equal to $3.6
million) between the repurchase price and the value of the Company's interests
in LARC Holdings and Annuity and Life Re. The value per share of Annuity and
Life Re was determined by taking the average of the closing price of Annuity and
Life Re shares for the same period used in determining the repurchase price of
the Company's shares. The value of the warrants was determined using a Black
Scholes methodology.
The cost of the stock repurchase of $59.2 million was recorded as a
reduction to stockholders' equity reflected as treasury stock.
Arch Re's statutory surplus was reduced by $62.8 million due to the
distribution to the Company of the stock and warrants in both LARC Holdings,
Ltd. and Annuity and Life Re Holdings, Ltd. based on statutory carrying values.
9. FOLKSAMERICA TRANSACTION
On May 5, 2000, the Company sold the reinsurance operations of Arch Re
pursuant to an agreement entered into as of January 10, 2000 with Folksamerica
Reinsurance Company and Folksamerica Holding Company (collectively,
"Folksamerica"). Folksamerica Reinsurance Company assumed Arch Re's liabilities
under the reinsurance agreements transferred in the asset sale and Arch Re
transferred to Folksamerica Reinsurance Company assets estimated in an aggregate
amount equal in book value to the book value of the liabilities assumed. In
consideration for the transfer of Arch Re's book of business, Folksamerica paid
$20.084 million (net of a credit equal to $251,000 granted to Folksamerica for
certain tax costs) in cash at the closing, subject to post-closing adjustments
based on an independent actuarial report of the claim liabilities transferred
14
<PAGE>
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. FOLKSAMERICA TRANSACTION (CONT'D.)
and an independent audit of the net assets sold. Following the completion of
such report and audit, the parties agreed upon net post-closing adjustments in
the amount of approximately $3.2 million payable by the Company, which consisted
of a $4.2 million reduction in the purchase price less $1 million in net book
value of the assets and liabilities actually transferred at closing.
Under the terms of the agreement, $20 million has been placed in escrow
for a period of five years. These funds will be primarily used to reimburse
Folksamerica to the extent that the loss reserves (which were $35.1 million at
March 31, 2000) relating to business produced on behalf of Arch Re by a certain
managing underwriting agency are deficient as measured at the end of such five
year period. To the extent that such loss reserves are redundant, all of the
escrowed funds will be returned to the Company and Folksamerica will pay the
Company an amount equal to such redundancy. In connection with the escrow
arrangement, the Company will record a loss in an amount equal to any probable
deficiency in the related reserve that may become known during or at the end of
the five year period. The agreement also provided that an additional amount of
up to $5 million would be placed in escrow for a period of five years to the
extent that Arch Re's reserves at closing on all business other than that
covered by the $20 million escrow were less by at least a specified amount than
those estimated by its independent actuaries. No such supplemental escrow was
required.
Under the terms of the agreement, the Company has also purchased
reinsurance protection covering the Company's aviation business to reduce the
net financial loss to Folksamerica on any large commercial airline catastrophe
to $5.4 million, net of reinstatement premiums. Although the Company believes
that any such net financial loss will not exceed $5.4 million, the Company has
agreed to reimburse Folksamerica for a net financial loss it may incur that is
in excess of $5.4 million for aviation losses under certain circumstances prior
to May 5, 2003.
The Company also made representations and warranties to Folksamerica
about the Company and the business transferred to Folksamerica for which the
Company retains exposure for certain periods.
15
<PAGE>
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. FOLKSAMERICA TRANSACTION (CONT'D.)
The net book value gain resulting from the sale of the Company's
reinsurance operations to Folksamerica is calculated as follows (in thousands):
<TABLE>
<S> <C>
Consideration received, consisting of the following:
Total liabilities transferred $514,330
Cash premium received 16,920
------
531,250
------
Assets transferred 478,687
Amortization of deferred policy acquisition costs 23,242
Transaction costs 21,800
------
523,729
------
Pre-tax gain 7,521
Income tax expense (1) 4,137
------
Net gain 3,384
Realized (loss), net of income tax, for securities transferred at market value (2) (5,330)
------
Net (loss) (1,946)
Change in net unrealized depreciation of investments, net of tax (2) 5,330
------
Comprehensive income and net book value gain $3,384
======
</TABLE>
(1) The income tax benefit of $1.5 million relating to post-closing adjustments
of $4.2 million was offset by an equivalent deferred tax asset valuation
allowance.
(2) The related income tax benefit of $1.9 million was offset by an equivalent
deferred tax asset valuation allowance.
Transaction costs consist of the following (in millions):
<TABLE>
<S> <C>
Severance and other related costs $11.0
Reinsurance costs 4.8
Investment banking, legal and accounting fees 2.3
Write-off of furniture, equipment and leasehold improvements 1.7
Write-off of lease obligation 1.3
Other 0.7
----------
Total $21.8
==========
</TABLE>
As of June 30, 2000, accrued and unpaid transaction costs amounted to
approximately $7.8 million. Of such amount, $1.9 million relates to severance
and other related costs expected to be paid to employees terminated as of June
30, 2000 during the next 18 months under the Company's severance arrangements;
$1.3 million relates to the write-off of the Company's lease obligation expected
to be paid over the remainder of the lease term expiring in October 2002; and
the balance of $4.6 million is expected to be paid by December 31, 2000.
16
<PAGE>
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. FOLKSAMERICA TRANSACTION (CONT'D.)
The GAAP book value of the assets and liabilities transferred to
Folksamerica recorded in the accompanying financial statements at closing are as
follows (in millions):
<TABLE>
<S> <C>
Fixed maturities, short-term investments and accrued interest income $249.9
Premiums receivable 108.6
Reinsurance recoverable 73.2
Deferred policy acquisition costs 23.2
Deferred income tax asset 13.5
Other insurance assets 47.0
------
Total Assets $515.4
------
Reserve for claims and claims expenses $371.6
Net unearned premium reserve 103.4
Reinsurance premiums payable 9.5
Other insurance liabilities 29.8
------
Total Liabilities $514.3
------
Net book value of assets and liabilities transferred $1.1
------
------
</TABLE>
At the closing of the asset sale, Arch Re and Folksamerica entered into a
transfer and assumption agreement, under which Folksamerica assumed Arch Re's
rights and obligations under the reinsurance agreements transferred in the asset
sale. The reinsureds under such agreements that were in-force were notified that
Folksamerica had assumed Arch Re's obligations and that, unless the reinsureds
object to the assumption, Arch Re will be released from its obligations to those
reinsureds. None of such reinsureds objected to the assumption and, accordingly,
the gross liabilities for such business have been removed from the accounts of
Arch Re for statutory and GAAP accounting purposes. However, Arch Re will
continue to be liable under those reinsurance agreements if the notice is found
not to be an effective release by the reinsureds. Folksamerica has agreed to
indemnify the Company for any losses arising out of the reinsurance agreements
transferred to Folksamerica Reinsurance Company in the asset sale. However, in
the event that Folksamerica refuses or is unable to perform its obligations to
the Company, Arch Re may incur losses relating to the reinsurance agreements
transferred in the asset sale.
10. ARCH RE DISTRIBUTION
Upon payment of a contemplated distribution from Arch Re to the Company
that is currently anticipated to occur in the third quarter of 2000, the
Company's assets would consist of fixed maturity and short term investments
(including amounts placed in escrow for five years as described above), publicly
traded equity securities and privately held securities. The Company will also
continue to own all of the outstanding capital stock of Arch Re and Cross River,
each with statutory surplus of a minimum of approximately $20 million in order
to maintain the insurance licenses and other authorizations they currently hold.
The Company's remaining $16.1 million investment commitment to Trident II, L.P.
would also remain in place.
17
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
GENERAL
THE COMPANY
Arch Capital Group Ltd. (formerly known as Risk Capital Holdings, Inc.)
is a holding company that was incorporated in March 1995 and commenced
operations in September 1995 upon completion of our initial public offering. We
received aggregate net proceeds from the offering of approximately $335 million,
of which $328 million was contributed to the capital of our wholly owned
subsidiary Arch Reinsurance Company ("Arch Re"), formerly known as Risk Capital
Reinsurance Company. On November 6, 1995, Arch Re was licensed under the
insurance laws of the State of Nebraska and is currently licensed or accredited
as a reinsurer in 44 states. As of June 30, 2000, the statutory surplus of Arch
Re was approximately $222 million. In July 1998, Arch Re capitalized its wholly
owned subsidiary, Cross River Insurance Company ("Cross River"), with $20
million. Cross River received its Nebraska insurance license in October 1998,
and is currently authorized to write insurance on an excess and surplus lines
basis in 22 other states.
FOLKSAMERICA TRANSACTION
On May 5, 2000, we sold the reinsurance operations of Arch Re pursuant to
an agreement entered into as of January 10, 2000 with Folksamerica Reinsurance
Company and Folksamerica Holding Company (collectively, "Folksamerica").
Folksamerica Reinsurance Company assumed Arch Re's liabilities under the
reinsurance agreements transferred in the asset sale and Arch Re transferred to
Folksamerica Reinsurance Company assets estimated in an aggregate amount equal
in book value to the book value of the liabilities assumed. In consideration for
the transfer of Arch Re's book of business, Folksamerica paid $20.084 million
(net of a credit equal to $251,000 granted to Folksamerica for certain tax
costs) in cash at the closing, subject to post-closing adjustments based on an
independent actuarial report of the claim liabilities transferred and an
independent audit of the net assets sold. Following the completion of such
report and audit, the parties agreed upon net post-closing adjustments in the
amount of approximately $3.2 million payable by us, which consisted of a $4.2
million reduction in the purchase price less $1 million in net book value of the
assets and liabilities actually transferred at closing.
Under the terms of the agreement, $20 million has been placed in escrow
for a period of five years. These funds will be primarily used to reimburse
Folksamerica to the extent that the loss reserves (which were $35.1 million at
March 31, 2000) relating to business produced on behalf of Arch Re by a certain
managing underwriting agency are deficient as measured at the end of such five
year period. To the extent that such loss reserves are redundant, all of the
escrowed funds will be returned to us and Folksamerica will pay us an amount
equal to such redundancy. In connection with the escrow arrangement, we will
record a loss in an amount equal to any probable deficiency in the related
reserve that may become known during or at the end of the five year period. The
agreement also provided that an additional amount of up to $5 million would be
placed in escrow for a period of five years to the extent that Arch Re's
reserves at closing on all business other than that covered by the $20 million
escrow were less by at least a specified amount than those estimated by its
independent actuaries. No such supplemental escrow was required.
Under the terms of the agreement, we have also purchased reinsurance
protection covering our aviation business to reduce the net financial loss to
Folksamerica on any large commercial airline catastrophe to $5.4 million, net of
reinstatement premiums. Although we believe that any such net financial loss
will not exceed $5.4 million, we have agreed to reimburse Folksamerica for a net
financial loss it may incur that is in excess of $5.4 million for aviation
losses under certain circumstances prior to May 5, 2003.
We also made representations and warranties about us and the business
transferred to Folksamerica for which we retain exposure for certain periods.
18
<PAGE>
The GAAP book value of the assets and liabilities transferred to
Folksamerica recorded in the accompanying financial statements at closing are as
follows (in millions):
<TABLE>
<S> <C>
Fixed maturities and short-term investments $249.9
Premiums receivable 108.6
Reinsurance recoverable 73.2
Deferred policy acquisition costs 23.2
Deferred income tax asset 13.5
Other insurance assets 47.0
------
Total Assets $515.4
------
Reserve for claims and claims expenses $371.6
Net unearned premium reserve 103.4
Reinsurance premiums payable 9.5
Other insurance liabilities 29.8
------
Total Liabilities $514.3
------
Net book value of assets and liabilities transferred $1.1
------
------
</TABLE>
At the closing of the asset sale, Arch Re and Folksamerica entered into a
transfer and assumption agreement, under which Folksamerica assumed Arch Re's
rights and obligations under the reinsurance agreements transferred in the asset
sale. The reinsureds under such agreements that were in-force were notified that
Folksamerica had assumed Arch Re's obligations and that, unless the reinsureds
object to the assumption, Arch Re will be released from its obligations to those
reinsureds. None of such reinsureds objected to the assumption and, accordingly,
gross liabilities for such business have been removed from the accounts of Arch
Re for statutory and GAAP accounting purposes. However, Arch Re will continue to
be liable under those reinsurance agreements if the notice is found not to be an
effective release by the reinsureds. Folksamerica has agreed to indemnify us for
any losses arising out of the reinsurance agreements transferred to Folksamerica
Reinsurance Company in the asset sale. However, in the event that Folksamerica
refuses or is unable to perform its obligations to us, Arch Re may incur losses
relating to the reinsurance agreements transferred in the asset sale.
See Note 9 to the accompanying consolidated financial statements.
ARCH RE DISTRIBUTION
Upon payment of a contemplated distribution from Arch Re to us that is
currently anticipated to occur in the third quarter, our assets would consist of
fixed maturity and short term investments, publicly traded equity securities and
privately held securities. We will also continue to own all of the outstanding
capital stock of Arch Re and Cross River, each with statutory surplus of a
minimum of approximately $20 million in order to maintain the insurance licenses
and other authorizations they currently hold. Our remaining $16.1 million
investment commitment to Trident II, L.P. would also remain in place. See
"Liquidity and Capital Resources" below for a discussion of the regulatory
issues relating to distributions by Arch Re.
FUTURE OPERATIONS
Our strategy is to pursue business combinations and ventures with
operating businesses. Our success will depend to a large extent on the
operations, financial condition and management of the companies with which we
may merge or which we may acquire in whole or in part. We are currently
evaluating certain business opportunities that we may pursue. Accordingly, the
financial and operational risks that we may encounter in the future cannot be
specified.
19
<PAGE>
RESULTS OF OPERATIONS
We had consolidated comprehensive income of $5.3 million, which was
composed of a net loss of $2.6 million and other comprehensive income of $7.9
million, consisting of the change in after-tax unrealized depreciation of
investments. Comprehensive income included an after-tax gain of $3.4 million
related to the sale of the Company's reinsurance operations to Folksamerica; net
loss included $1.9 million related to the sale. The 2000 second quarter net loss
also included after-tax realized investment losses of $239,000 and equity in net
income of investees of $609,000. These amounts compare with comprehensive income
for the 1999 second quarter of $8.7 million, which was composed of net income of
$15.9 million and the change in after-tax unrealized appreciation of investments
of $7.2 million. The 1999 second quarter net income included after-tax realized
investment gains of $15.2 million and equity in net income of investees of
$196,000.
We had consolidated comprehensive loss for the six months ended June 30,
2000 of $32.8 million, which was composed of net income of $3.3 million and
other comprehensive loss of $36.1 million, consisting of the change in after-tax
unrealized depreciation of investments. Net income for the six months ended June
30, 2000 included after-tax realized investment gains of $18.8 million and
equity in net income of investees of $639,000. These amounts compare with
comprehensive loss for the six months ended June 30, 1999 of $26.8 million,
which was composed of net loss of $9.1 million and the change in after-tax
unrealized appreciation of investments of $17.7 million. Net loss for the six
months ended June 30, 1999 included after-tax realized investment gains of
approximately $14.5 million, equity in net income of investees of $33,000 and a
loss of $383,000 from the cumulative effect of an accounting change.
Following is a table of per share data for the three and six months
periods ended June 30, 2000 and 1999 on an after-tax basis:
<TABLE>
<CAPTION>
THEE MONTH ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
BASIC AND DILUTED EARNINGS PER SHARE:
Underwriting loss ...................... ($0.31) ($0.18) ($1.50) ($1.75)
Net investment income .................. 0.23 0.21 0.47 0.39
Net realized investment gains .......... (0.02) 0.89 1.35 0.85
(Loss) on sale of reinsurance operations (0.16) (0.14)
Equity in net income of investees ...... 0.05 0.01 0.05
Cumulative effect of accounting change . (0.02)
------ ------ ------ ------
Net income (loss) ...................... (0.21) 0.93 0.23 (0.53)
Change in net unrealized appreciation
(depreciation) of investments ......... 0.64 (0.42) (2.58) (1.04)
------ ------ ------ ------
Comprehensive income (loss) ............ $0.43 $0.51 ($2.35) ($1.57)
------ ------ ------ ------
Average shares outstanding (000's)
Basic ............... 12,379 17,086 13,948 17,086
Diluted ............. 12,382 17,086 13,949 17,086
</TABLE>
20
<PAGE>
The sale of our reinsurance operations to Folksamerica resulted in a net
book value gain of approximately $3.4 million, or $0.27 per share, based on
12,400,117 shares outstanding, which amount includes the post-closing
adjustments described above (See "--General--Folksamerica Transaction"). The net
book value gain on the sale of our reinsurance operations is calculated as
follows (in millions):
<TABLE>
<S> <C>
Gain on sale....................................................... $7.5
Tax expense (1).................................................... 4.1
---
Net gain........................................................... 3.4
Realized (loss) on securities transferred at market value (2)...... (5.3)
----
Net (loss)......................................................... (1.9)
Change in after-tax unrealized depreciation of investments (2)..... 5.3
----
Comprehensive income and net book value gain....................... $3.4
====
</TABLE>
(1) The related income tax expense includes a charge of $1.5 million resulting
from our deferred tax asset valuation allowance.
(2) The related income tax benefit of $1.9 million was offset by an equivalent
deferred tax asset valuation allowance.
See Note 9 to the accompanying consolidated financial statements.
At June 30, 2000, consolidated stockholders' equity totaled $254.9
million, compared with $346.5 million at December 31, 1999. On a basic and
diluted basis, book value per share was $20.56 based on 12,400,117 shares
outstanding at June 30, 2000, compared with $20.28 based on 17,087,970 shares
outstanding at December 31, 1999. At June 30, 2000, book value and per share
amounts reflect the repurchase from XL Capital Ltd of all of the 4,755,000
shares of our common stock held by it for a total of $59.2 million, or $12.45
per share. (See Note 8 to the accompanying consolidated financial statements).
NET PREMIUMS WRITTEN
With respect to our divested reinsurance operations, net premiums written
for the three and six month periods ended June 30, 2000 and 1999 were as follows
(in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
CORE BUSINESS 2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Property ..................... $13,129 $27,100 $15,809 $39,345
Casualty ..................... 7,614 18,172 19,743 38,022
Multi-line ................... 843 20,346 12,808 37,801
Other ........................ (83) 5,361 4,224 769
-------- ------- -------- --------
Sub-total Core Business ...... 21,503 70,979 52,584 115,937
-------- ------- -------- --------
SPECIALTY BUSINESS
Accident & Health ............ 7,440 12,684 26,862 20,752
Aviation & Space ............. (1,601) 2,723 (1,895) 8,365
Marine ....................... 1,542 2,707 3,739 6,672
Surety & Fidelity ............ 530 2,424 1,013 4,228
Sub-total Specialty Business.. 7,911 20,538 29,719 40,017
-------- ------- -------- --------
Unearned premium portfolio
transfer and assumption... (92,907) (92,907)
-------- ------- -------- --------
Total ........................ ($63,493) $91,517 ($10,604) $155,954
======== ======= ======== ========
</TABLE>
Premiums written for the three and six month periods ended June 30, 2000
include business recorded through May 5, 2000, the closing date of the sale of
our reinsurance operations to Folksamerica and, consequently, comparisons with
prior periods are not meaningful. The decline in net premiums written for the
21
<PAGE>
business recorded through May 5, 2000 was due to several factors which included
(i) the previously announced asset sale; (ii) discontinuing aviation and space
business in 1999; and (iii) non-renewals in other classes of business, due to
(a) our adherence to underwriting standards in competitive market conditions and
(b) the effect on cedents of our poor underwriting performance, coupled with a
decline in Arch Re's A.M. Best rating from A to A- during 1999. Such decline was
partially offset by increased in-force premiums in Accident & Health business
where significant underwriting capacity has exited the market since 1998.
Set forth below are our statutory combined ratios for the three and six
month periods ended June 30, 2000 (prior to recording the transfer and
assumption of reinsurance liabilities to Folksamerica on May 5, 2000) and 1999:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2000 1999 2000 1999
----------- -------------- ----------- --------------
<S> <C> <C> <C> <C>
Claims and claims expenses....... 76.2% 75.2% 87.1% 97.5%
Commissions and brokerage........ 37.3 27.1 32.1 29.6
Other operating expenses......... 4.8 4.0 4.6 4.6
----------- -------------- ----------- --------------
Statutory combined ratio......... 118.3% 106.3% 123.8% 131.7%
=========== ============== =========== ==============
</TABLE>
The statutory combined ratio for the first half of 2000 (which included
results through May 5, 2000, the closing date of the sale of our reinsurance
operations) was adversely affected by poor underwriting results in our aviation
and property lines of business.
FOREIGN EXCHANGE
Pre-tax foreign exchange gains and losses are recorded separately from
statutory underwriting results and are therefore excluded from the statutory
combined ratio. Unhedged monetary assets and liabilities are translated at the
exchange rate in effect at the balance sheet date, with the resulting foreign
exchange gains or losses recognized in income. We do not have any remaining
assets or liabilities denominated in foreign currency as a result of the asset
sale to Folksamerica.
NET INVESTMENT INCOME
Invested assets, including accrued investment income, net of investment
accounts receivable and payable, consisted of the following at June 30, 2000
compared to December 31, 1999 (in millions):
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
2000 1999
---- ----
<S> <C> <C>
Fixed maturities
Taxable - Investment grade ................... $42.1 $171.2
- Non-investment grade ............... 35.4 37.6
Tax Exempt - Investment grade ................ 52.3
Tax Exempt - Escrowed funds .................. 20.3
97.8 261.1
Publicly traded equity securities ............... 44.2 158.8
Privately held securities ....................... 61.0 83.9
Cash, short-term investments and accrued interest 58.1 86.7
Total ........................................... $261.1 $590.5
</TABLE>
Approximately 63% of the fixed maturity and short-term investments were
rated investment grade by Moody's and Standard & Poor's and had an average
quality rating of AA and average duration of 3.1 years.
During the 2000 first quarter, we liquidated a substantial portion of the
public equity portfolio and reduced our investment in tax-exempt securities for
tax planning purposes. All funds were reinvested in short-term securities in
anticipation of the delivery of a substantial portion of the investment
portfolio to Folksamerica. On
22
<PAGE>
May 5, 2000, we transferred $248.2 million of fixed maturities and short-term
investments in connection with the sale of our reinsurance operations. All fixed
maturity and short-term investments transferred on May 5, 2000 to Folksamerica
and the securities placed in the escrow account are rated investment grade.
At June 30, 2000, our private equity portfolio consisted of 11
investments, having an aggregate carrying value of $61 million, with additional
investment portfolio commitments in the aggregate amount of approximately $20.3
million.
See Note 5 under the caption "Investment Information" of the accompanying
notes to our unaudited consolidated financial statements for the six months
ended June 30, 2000 for certain information regarding our publicly traded and
privately held securities and their carrying values.
After-tax net investment income for the 2000 second quarter was $2.9
million, compared with $3.5 million for the 1999 second quarter. For the first
half of 2000, after-tax net investment income was $6.6 million, compared with
$6.7 million for the comparable prior year period. Our results reflect higher
pre-tax and net of tax yields of approximately 3.8% and 2.7%, respectively, for
the first half of 2000, compared to 3.5% and 2.6%, respectively, for the same
prior year period. Our yields have moderately increased as proceeds from the
sales of public equity securities have been allocated into fixed maturity and
short-term investments over the last several quarterly periods.
Our sources of net realized investment gain (losses) for the three and
six month periods ended June 30, 2000 were as follows (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, 2000
-------------
<S> <C> <C>
Fixed maturities ............................. ($541) ($2,940)
Publicly traded equity securities ............ 174 35,533
------- -------
Privately held securities .................... (3,660)
------- -------
Sub-total .................................... (367) 28,933
Fixed maturities transferred to Folksamerica.. (5,330) (5,330)
------- -------
Total......................................... ($5,697) $23,603
======= =======
</TABLE>
During the six months ended June 30, 2000, we disposed of, or reduced our
position in, several publicly traded equity security investments, including our
investment in Annuity and Life Re (Holdings), Ltd. for a net gain of $17.3
million. The realized loss on privately held securities includes a net loss of
$487,000 resulting from the disposition of our investment in LARC Holdings, Ltd.
and a write-down of $3.2 million in the carrying value of our investment in
Altus Holdings, Ltd. (See Note 5 to the accompanying consolidated financial
statements.)
The change in after-tax net unrealized depreciation of investments of
$36.1 million for the first six months ended June 30, 2000 reflects the
following (in millions):
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
2000 1999 CHANGE
---- ---- ------
<S> <C> <C> <C>
Pre-tax unrealized appreciation (depreciation) ... ($8.9) $41.8 ($50.7)
Deferred income tax (benefit) expense ............ (3.1) 14.6 (17.7)
Valuation allowance .............................. 3.1 3.1
----- ----- ------
After-tax unrealized appreciation (depreciation).. ($8.9) $27.2 ($36.1)
===== ===== ======
</TABLE>
INCOME TAXES
As of June 30, 2000, we have established a deferred income tax asset
valuation allowance of $13.3 million that adjusts our deferred income tax asset
to its estimated net realizable value of approximately $4.8 million. Deferred
income tax expense for the six months ended June 30, 2000 included a charge for
such allowance of
23
<PAGE>
$10.2 million and the deferred income tax benefit, on the change in net
unrealized depreciation of investments for the six months ended June 30,
2000, was decreased by $3.1 million for such valuation allowance. (See Note 6
to the accompanying consolidated financial statements.)
LIQUIDITY AND CAPITAL RESOURCES
We are a holding company and currently have no significant assets other
than our ownership of the capital stock of Arch Re. We rely on cash dividends
and distributions from Arch Re to make payments, including for any operating
expenses that we may incur and for any dividends or stock repurchases as our
board of directors may determine. Our board currently does not intend to declare
dividends or make any other distributions. Arch Re's ability to pay dividends or
make distributions to us is dependent upon its ability to meet regulatory
standards of the State of Nebraska, as described below. There are presently no
contractual restrictions on Arch Re's payment of dividends or the making of
distributions to us. We intend to cause Arch Re to make an extraordinary
distribution to us, as described below.
Nebraska insurance laws provide that, without prior approval of the
Nebraska Director of Insurance (the "Nebraska Director"), Arch Re cannot pay a
dividend or make a distribution that (together with other dividends or
distributions paid during the preceding 12 months) exceeds the greater of (i)
10% of statutory surplus as of the preceding December 31 or (ii) statutory net
income from operations from the preceding calendar year not including realized
capital gains. Net income (exclusive of realized capital gains) not previously
distributed or paid as dividends from the preceding two calendar years may be
carried forward for dividends and distribution purposes. Any proposed dividend
or distribution in excess of such amount is called an "extraordinary" dividend
or distribution and may not be paid until either it has been approved, or a
30-day waiting period has passed during which it has not been disapproved, by
the Nebraska Director. Notwithstanding the foregoing, Nebraska insurance laws
provide that any distribution that is a dividend may be paid by Arch Re only out
of earned surplus arising from its business, which is defined as unassigned
funds (surplus) as reported in the statutory financial statement filed by Arch
Re with the Nebraska Insurance Department for the most recent year, including
any surplus arising from unrealized capital gains or revaluations of assets. Any
distribution that is a dividend and that is in excess of Arch Re's unassigned
funds, exclusive of any surplus arising from unrealized capital gains or
revaluation of assets, will be deemed an "extraordinary" dividend subject to the
foregoing requirements. Due to the distribution that was required to be made in
connection with the XL Capital stock repurchase, we may not declare any other
distribution for twelve months from the closing date of the stock repurchase
unless such subsequent distribution is approved by the Nebraska Director.
Arch Re is in the process of applying to the Nebraska Director for permission
to distribute to us all of its assets other than statutory surplus of a
minimum of approximately $20 million required to maintain the insurance
licenses and other authorizations it currently holds. We anticipate that this
extraordinary distribution could occur during the 2000 third quarter. See
"--General--Arch Re Distribution."
Net cash flow provided by (used for) operating activities for the six
months ended June 30, 2000 and the comparable prior year period was
approximately ($432,000) and $25.4 million, respectively, consisting principally
of premiums received, investment income (excluding net realized investment
gains), offset by operating costs and expenses.
The primary sources of liquidity are from short-term and fixed maturity
investments presently owned directly by us ($24.5 million at June 30, 2000) and
the invested assets to be distributed to the Company by Arch Re as an
extraordinary distribution, as described above. Such invested assets may
include $37.7 million of privately held securities at June 30, 2000, which
are generally restricted as to resale, do not have readily ascertainable
market values or are otherwise illiquid.
Investments that are restricted or unavailable for liquidity purposes
also include $20.3 million of fixed maturity investments currently held in
escrow for a period of five years under the terms of the asset purchase
agreement with Folksamerica and our investments in Arch Re and Cross River, each
contemplated to have a minimum of approximately $20 million in statutory surplus
in order to maintain the insurance licenses and other authorizations they
currently hold. In addition, we have investment commitments relating to our
privately held securities totaling approximately $20.3 million. See Note 5 to
the accompanying consolidated financial statements.
We do not currently have any material commitments for capital
expenditures over the next 12 months. We expect that our financing and
operational needs for the foreseeable future will be met by our balance of cash
and short-term investments, as well as by funds generated from investment
income. Our objective is to pursue business combinations and ventures with
operating businesses and, accordingly, we may need to secure
24
<PAGE>
additional financing to carry out our business plan. We cannot assure you that
we will be successful in obtaining any such financing or in the implementation
of our future business strategy.
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 December 31, 1999. (See "Management's Discussion and
Analysis of Financial Condition and Results of Operations" included in our 1999
Annual Report on Form 10-K.) 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. At June 30, 2000, there have been no
material changes in market risk exposures that affect the quantitative and
qualitative disclosures presented as of December 31, 1999.
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
The Private Securities Litigation Reform Act of 1995 provides a "safe
harbor" for forward-looking statements. This report or any other written or oral
statements made by or on behalf of the Company 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 this report are forward-looking statements. Forward-looking
statements can generally be identified by the use of forward-looking terminology
such as "may," "will," "expect," "intend," "estimate," "anticipate," "believe"
or "continue" 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 include:
o the availability of investments on attractive terms;
o competition, including increased competition;
o changes in the performance of the insurance sector of the public
equity markets or market professionals' views as to such sector;
o general economic conditions;
o regulatory changes and conditions;
o claims development and losses, including as to the frequency or
severity of claims and losses and the timing of claim reports, on
aviation business and certain business produced by a certain managing
underwriting agency for which the Company has retained exposure under
certain indemnity obligations to Folksamerica in connection with the
asset sale;
o our future business operations and strategy; and
o loss of key personnel.
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.
25
<PAGE>
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.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is subject to litigation and arbitration in the ordinary
course of business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) A special meeting of stockholders (the "Special Meeting") of the Company was
held on April 17, 2000.
(b) The Special Meeting did not involve the election of directors.
(c) At the Special Meeting, the stockholders approved the sale of the Company's
reinsurance business through the transfer of the reinsurance assets and
liabilities of its operating subsidiary, Arch Reinsurance Company (formerly Risk
Capital Reinsurance Company), to Folksamerica Reinsurance Company, pursuant to
the Asset Purchase Agreement dated as of January 10, 2000 among the Company,
Arch Reinsurance Company, Folksamerica Holding Company, Inc. and Folksamerica
Reinsurance Company and, effective upon the consummation of the asset sale, the
amendment of the Company's certificate of incorporation to change the name of
the company from "Risk Capital Holdings, Inc." to "Arch Capital Group Ltd."
Following are the voting results:
<TABLE>
FOR AGAINST ABSTAIN
--------- --------- -------
<S> <C> <C>
8,232,946 2,033,626 2,500
</TABLE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS.
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
----------- -----------
<S> <C>
15 Accountants' Awareness Letter and Limitation of Liability (regarding
unaudited interim financial information)
27 Financial Data Schedule
</TABLE>
(b) REPORTS ON FORM 8-K.
The Company filed reports on Form 8-K during the three month period
ended June 30, 2000 on May 8, 2000 and May 19, 2000 reporting the
disposition of the Company's reinsurance operations to Folksamerica
Reinsurance Company.
Omitted from this Part II are items which are inapplicable or to
which the answer is negative for the period covered.
26
<PAGE>
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/ Peter A. Appel
--------------------------------
Date: August 14, 2000 Peter A. Appel
President And Chief Executive
Officer
/s/ Debra M. O'Connor
--------------------------------
Date: August 14, 2000 Debra M. O'Connor
Senior Vice President,
Controller & Treasurer
27
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
----------- -----------
<S> <C>
15 Accountants' Awareness Letter and Limitation of Liability (regarding unaudited
interim financial information)
27 Financial Data Schedule
</TABLE>
