SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K
Current Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
May 5, 2000
--------------------------------------------------------------------------------
Date of Report (Date of earliest event reported)
Arch Capital Group Ltd.
--------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 0-26456 06-1424716
--------------------------------------------------------------------------------
(State or other jurisdiction of (Commission File Number) (I.R.S. Employer
incorporation or organization) Identification No.)
20 Horseneck Lane, Greenwich, Connecticut 06830
--------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code:
(203) 862-4300
Not Applicable
--------------------------------------------------------------------------------
(Former name or former address, if changed since last report)
<PAGE>
ITEM 5. OTHER EVENTS
On May 5, 2000, Arch Capital Group Ltd. (the "Company") sold the
reinsurance operations of Arch Reinsurance Company ("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 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 $32.3 million at
May 5, 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.
2
<PAGE>
The net book value gain resulting from the sale of the Company's
reinsurance operations to Folksamerica is calculated as follows (in thousands):
<TABLE>
<CAPTION>
<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):
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
===========
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.
3
<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):
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
=========
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.
ITEM 7. FINANCIAL STATEMENTS AND EXHIBITS
(b) Pro Forma Financial Information
The following unaudited pro forma statement of income and comprehensive
income for the six months ended June 30, 2000 and for the year ended December
31, 1999 reflects our historical accounts for that period, adjusted to give pro
forma effect to the asset sale as if it had occurred on January 1, 1999.
The pro forma financial data and accompanying notes should be read in
conjunction with the description of the asset sale contained in this report and
the unaudited consolidated financial statements and related notes for the six
months ended June 30, 2000 included in our June 30, 2000 Quarterly Report on
Form 10-Q as well as our audited consolidated financial statements and related
notes and the description of the asset sale included in our 1999 Annual Report
on Form 10-K and the proxy statement relating to our special meeting held on
April 17, 2000. We believe that the assumptions used in the following
statements, which are set forth in the
4
<PAGE>
accompanying notes, provide a reasonable basis on which to present the pro forma
financial data. The pro forma financial data is provided for informational
purposes only and should not be construed to be indicative of our financial
condition or results of operations had the asset sale been consummated on the
dates assumed and are not intended to project our financial condition on any
future date or results of operations for any future period.
5
<PAGE>
<TABLE>
<CAPTION>
Arch Capital Group Ltd.
Pro Forma Condensed Consolidated Statement of Income
and Comprehensive Income
For The Six Months Ended June 30, 2000
(Dollars in thousands, except per share data)
Folksamerica
Historical Transaction(1) Pro Forma
---------------- -------------------- -----------------
Revenues
<S> <C> <C>
Net premiums written ($10,604) $10,604 -
(Increase) decrease in unearned premiums 98,134 (98,134) -
---------------- -------------------- -----------------
Net premiums earned 87,530 (87,530) -
Net investment income 9,547 (4,099) $5,448
Gain on sale of reinsurance operations 2,191 (2,191) -
Net realized investment gains (losses) 28,933 28,933
---------------- -------------------- -----------------
Total revenues 128,201 (93,820) 34,381
Operating Costs and Expenses
Claims and claims expenses 76,263 (76,263)
Commissions and brokerage 26,756 (26,756)
Other operating expenses 4,246 (846) 3,400
Foreign exchange (gain) loss 1,159 (1,159)
---------------- -------------------- -----------------
Total operating costs and expenses 108,424 (105,024) 3,400
Income (Loss)
Income before income taxes and equity in net income of
investees 19,777 11,204 30,981
Federal income taxes expense (benefit) 17,160 (6,856) 10,304
---------------- -------------------- -----------------
Income before equity in net income of investees 2,617 18,060 20,677
Equity in net income of investees 639 639
---------------- -------------------- -----------------
Net income 3,256 18,060 21,316
Other Comprehensive Income (Loss), Net of Tax
Change in net unrealized depreciation of investments, net of
tax (36,046) (5,330) (41,376)
---------------- -------------------- -----------------
---------------- -------------------- -----------------
Comprehensive Income (Loss) ($32,790) $12,730 ($20,060)
================ ==================== =================
Average shares outstanding
Basic 13,948,267 13,948,267
Diluted 13,949,503 13,949,503
Per Share Data
Net Income (Loss) - Basic and diluted $0.23 $1.53
Comprehensive Income (Loss) - Basic and diluted ($2.35) ($1.44)
</TABLE>
6
<PAGE>
<TABLE>
<CAPTION>
Arch Capital Group Ltd.
Pro Forma Condensed Consolidated Statement of Income and
Comprehensive Income
For The Year Ended December 31, 1999
(Dollars in thousands, except per share data)
Folksamerica
Historical Transaction(1) Pro Forma
---------------- -------------------- -----------------
Revenues
<S> <C> <C>
Net premiums written $306,726 ($306,726) -
(Increase) decrease in unearned premiums 4,642 (4,642) -
---------------- -------------------- -----------------
Net premiums earned 311,368 (311,368) -
Net investment income 20,173 (10,253) $9,920
Net realized investment gains (losses) 17,227 1,192 18,419
---------------- -------------------- -----------------
Total revenues 348,768 (320,429) 28,339
Operating Costs and Expenses
Claims and claims expenses 305,841 (305,841)
Commissions and brokerage 80,540 (80,540)
Other operating expenses 14,816 (10,666) 4,150
Foreign exchange (gain) loss (198) 198
---------------- -------------------- -----------------
Total operating costs and expenses 400,999 (396,849) 4,150
Income (Loss)
Income (loss) before income taxes, equity in net income of investees and
cumulative effect of accounting change
(52,231) 76,420 24,189
Federal income taxes expense (benefit) (19,557) 27,171 7,614
---------------- -------------------- -----------------
Income (loss) before equity in net income of investees and
cumulative effect of accounting change (32,674) 49,249 16,575
Equity in net income of investees 621 621
---------------- -------------------- -----------------
Income (loss) before cumulative effect of accounting change
(32,053) 49,249 17,196
Cumulative effect of accounting change (383) (383)
---------------- -------------------- -----------------
Net income (loss) (32,436) 49,249 16,813
Other Comprehensive Income (Loss), Net of Tax
Change in net unrealized depreciation of investments, net of
tax (19,850) 4,553 (15,297)
---------------- -------------------- -----------------
Comprehensive Income (Loss) ($52,286) $53,802 $1,516
================ ==================== =================
Average shares outstanding
Basic 17,086,732 17,086,732
Diluted 17,086,808 17,086,808
Per Share Data
Net Income (Loss) - Basic and diluted ($1.90) $0.98
Comprehensive Income (Loss) - Basic and diluted ($3.06) $0.09
</TABLE>
7
<PAGE>
Notes to Pro Forma Statement of Income and Comprehensive Income
1. Represents all revenue and expense and other comprehensive income items
recorded during the six months ended June 30, 2000 and the year ended
December 31, 1999 related to our reinsurance business sold to Folksamerica
Reinsurance Company on May 5, 2000. Net investment income, net realized
investment gains (losses) and unrealized appreciation (depreciation) of
investments have been allocated based on the proportion of the average
amount of fixed maturities and short term investments related to the
business transferred to the average total fixed maturities and short term
investments in the six months ended June 30, 2000 and the year ended
December 31, 1999.
All other revenue and expense items were allocated based on specific
identification.
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 Arch Capital Group Ltd. 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 of
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.
8
<PAGE>
(c) Exhibits
See Exhibit Index.
9
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the registrant has duly caused this report to be signed on its behalf
by the undersigned.
ARCH CAPITAL GROUP LTD.
Date: September 8, 2000 By: /s/ Peter A. Appel
-------------------------------------
Name: Peter A. Appel
Title: President & Chief
Executive Officer
10
<PAGE>
EXHIBIT INDEX
Exhibit
Number Description
10.1 Asset Purchase Agreement, dated as of January 10, 2000, among Arch Capital
Group Ltd. ("ACGL"), Arch Reinsurance Company ("Arch Re"), Folksamerica
Holding Company, Inc. ("FHC") and Folksamerica Reinsurance Company ("FRC")
(filed as an exhibit to ACGL's Report on Form 8-K as filed with the SEC on
January 18, 2000, and incorporated by reference)
10.2 Transfer and Assumption Agreement, dated May 5, 2000, between Arch Re and
FRC (filed as an exhibit to ACGL's Report on Form 8-K as filed with the SEC
on May 19, 2000, and incorporated by reference)
10.3 Escrow Agreement, dated May 5, 2000, among Arch Re, FHC, FRC and the Escrow
Agent (filed as an exhibit to ACGL's Report on Form 8-K as filed with the
SEC on May 19, 2000, and incorporated by reference)
10.4 Agreement, dated May 5, 2000, among ACGL, Arch Re, FHC and FRC regarding
Aviation Business (filed as an exhibit to ACGL's Report on Form 8-K as
filed with the SEC on May 19, 2000, and incorporated by reference)
10.5 Change in Control Agreement dated as of May 5, 2000 between Arch Capital
Group Ltd. and Peter A. Appel.
10.6 Retention and Change in Control Agreement dated as of May 5, 2000 between
Arch Capital Group Ltd. and Robert Clements.
10.7 Employment and Change in Control Agreement dated as of May 5, 2000 between
Arch Capital Group Ltd. and Louis Petrillo.
10.8 Employment Agreement dated as of June 9, 2000 between Arch Capital Group
Ltd. and Debra M. O'Connor.
E-1
