ACGL 10-Q Quarterly Report Sept. 30, 2013 | Alphaminr
ARCH CAPITAL GROUP LTD.
ALPHAMINR

ACGL 10-Q Quarter ended Sept. 30, 2013

Balance Sheet
Cash Flow
Income Statement
ARCH CAPITAL GROUP LTD.
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10-Q 1 acgl10q93013.htm 10-Q ACGL 10Q 9.30.13
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 period ended September 30, 2013
Or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file number:  001-26456
ARCH CAPITAL GROUP LTD.
(Exact name of registrant as specified in its charter)
Bermuda
(State or other jurisdiction of incorporation or organization)
Not Applicable
(I.R.S. Employer Identification No.)
Waterloo House, Ground Floor
100 Pitts Bay Road
Pembroke HM 08, Bermuda
(Address of principal executive offices)
(441) 278-9250
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer x
Accelerated filer o
Non-accelerated filer o
Smaller reporting company o
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No x
The number of the registrant’s common shares (par value, $0.0033 per share) outstanding as of October 31, 2013 was 133,543,538 .


ARCH CAPITAL GROUP LTD.
INDEX
Page No.
PART I. Financial Information
Item 1 — Consolidated Financial Statements
September 30, 2013 (unaudited) and December 31, 2012
For the three and nine month periods ended September 30, 2013 and 2012 (unaudited)
For the three and nine month periods ended September 30, 2013 and 2012 (unaudited)
For the nine month periods ended September 30, 2013 and 2012 (unaudited)
For the nine month periods ended September 30, 2013 and 2012 (unaudited)

1

Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of
Arch Capital Group Ltd.:
We have reviewed the accompanying consolidated balance sheet of Arch Capital Group Ltd. and its subsidiaries (the “Company”) as of September 30, 2013 , and the related consolidated statements of income and comprehensive income for the three-month and nine-month periods ended September 30, 2013 and September 30, 2012 , and the consolidated statements of changes in shareholders’ equity and cash flows for the nine-month periods ended September 30, 2013 and September 30, 2012 . These interim financial statements are the responsibility of the Company’s management.
We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States).  A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters.  It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole.  Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should be made to the accompanying consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.
We previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet as of December 31, 2012 , and the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for the year then ended (not presented herein), and in our report dated March 1, 2013, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet as of December 31, 2012 , 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, NY
November 8, 2013

2

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(U.S. dollars in thousands, except share data)
(Unaudited)
September 30,
2013
December 31,
2012
Assets


Investments:


Fixed maturities available for sale, at fair value (amortized cost: $9,671,665 and $9,567,290)
$
9,688,345

$
9,839,988

Short-term investments available for sale, at fair value (amortized cost: $992,644 and $719,848)
993,375

722,121

Investment of funds received under securities lending, at fair value (amortized cost: $39,793 and $42,302)
42,135

42,531

Equity securities available for sale, at fair value (cost: $418,319 and $298,414)
452,195

312,749

Other investments available for sale, at fair value (cost: $527,435 and $519,955)
528,938

549,280

Investments accounted for using the fair value option
1,139,725

917,466

Investments accounted for using the equity method
226,644

307,105

Total investments
13,071,357

12,691,240

Cash
436,141

371,041

Accrued investment income
64,428

71,748

Investment in joint venture (cost: $100,000)
106,982

107,284

Fixed maturities and short-term investments pledged under securities lending, at fair value
48,361

50,848

Premiums receivable
850,386

688,873

Reinsurance recoverable on unpaid and paid losses and loss adjustment expenses
1,795,888

1,870,037

Contractholder receivables
1,028,772

865,728

Prepaid reinsurance premiums
330,980

298,484

Deferred acquisition costs, net
338,671

262,822

Receivable for securities sold
288,080

19,248

Other assets
570,777

519,409

Total Assets
$
18,930,823

$
17,816,762

Liabilities


Reserve for losses and loss adjustment expenses
$
8,819,419

$
8,933,292

Unearned premiums
1,983,408

1,647,978

Reinsurance balances payable
190,721

188,546

Contractholder payables
1,028,772

865,728

Senior notes
300,000

300,000

Revolving credit agreement borrowings
100,000

100,000

Securities lending payable
49,849

52,356

Payable for securities purchased
519,244

37,788

Other liabilities
496,125

522,196

Total Liabilities
13,487,538

12,647,884

Commitments and Contingencies




Shareholders’ Equity


Non-cumulative preferred shares
325,000

325,000

Common shares ($0.0033 par, shares issued: 169,350,789 and 168,255,572)
565

561

Additional paid-in capital
283,449

227,778

Retained earnings
5,886,149

5,354,361

Accumulated other comprehensive income, net of deferred income tax
41,955

287,017

Common shares held in treasury, at cost (shares: 35,870,466 and 34,412,959)
(1,093,833
)
(1,025,839
)
Total Shareholders' Equity
5,443,285

5,168,878

Total Liabilities and Shareholders' Equity
$
18,930,823

$
17,816,762



See Notes to Consolidated Financial Statements

3

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(U.S. dollars in thousands, except share data)
(Unaudited)
(Unaudited)
Three Months Ended
Nine Months Ended
September 30,
September 30,
2013
2012
2013
2012
Revenues




Net premiums written
$
839,135

$
755,249

$
2,602,446

$
2,439,093

Change in unearned premiums
(44,135
)
(6,558
)
(295,860
)
(283,434
)
Net premiums earned
795,000

748,691

2,306,586

2,155,659

Net investment income
66,083

73,221

200,124

221,126

Net realized gains (losses)
(6,022
)
60,391

64,970

139,379

Other-than-temporary impairment losses
(901
)
(2,644
)
(3,873
)
(6,129
)
Less investment impairments recognized in other comprehensive income, before taxes
173

265

175

776

Net impairment losses recognized in earnings
(728
)
(2,379
)
(3,698
)
(5,353
)
Fee income
526

1,077

1,966

2,426

Equity in net income of investment funds accounted for using the equity method
5,665

24,330

30,429

56,943

Other income (loss)
624

(532
)
2,702

(7,905
)
Total revenues
861,148

904,799

2,603,079

2,562,275

Expenses




Losses and loss adjustment expenses
427,045

443,871

1,245,101

1,238,771

Acquisition expenses
147,313

128,065

406,582

375,316

Other operating expenses
118,070

113,429

365,661

337,602

Interest expense
5,937

7,378

17,687

22,338

Net foreign exchange losses
40,562

16,959

2,487

5,958

Total expenses
738,927

709,702

2,037,518

1,979,985

Income before income taxes
122,221

195,097

565,561

582,290

Income tax expense
7,396

5,441

17,320

8,110

Net income
114,825

189,656

548,241

574,180

Preferred dividends
5,484

5,484

16,453

19,594

Loss on repurchase of preferred shares
—

—

—

10,612

Net income available to common shareholders
$
109,341

$
184,172

$
531,788

$
543,974

Net income per common share




Basic
$
0.83

$
1.36

$
4.05

$
4.04

Diluted
$
0.80

$
1.33

$
3.92

$
3.93

Weighted average common shares and common share equivalents outstanding




Basic
131,495,296

135,067,360

131,262,309

134,519,046

Diluted
136,034,413

138,696,934

135,680,829

138,235,995



See Notes to Consolidated Financial Statements

4

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(U.S. dollars in thousands)
(Unaudited)
(Unaudited)
Three Months Ended
Nine Months Ended
September 30,
September 30,
2013
2012
2013
2012
Comprehensive Income (Loss)


Net income
$
114,825

$
189,656

$
548,241

$
574,180

Other comprehensive income, net of deferred income tax


Unrealized appreciation (decline) in value of investments:


Unrealized holding gains (losses) arising during period
41,226

164,733

(208,865
)
277,656

Portion of other-than-temporary impairment losses recognized in other comprehensive income, net of deferred income tax
(173
)
(265
)
(175
)
(776
)
Reclassification of net realized gains, net of income taxes, included in net income
20,701

(47,411
)
(31,916
)
(118,714
)
Foreign currency translation adjustments, net of deferred income tax
29,523

13,978

(4,106
)
12,043

Other comprehensive income (loss)
91,277

131,035

(245,062
)
170,209

Comprehensive Income
$
206,102

$
320,691

$
303,179

$
744,389


See Notes to Consolidated Financial Statements

5

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(U.S. dollars in thousands)
(Unaudited)
Nine Months Ended
September 30,
2013
2012
Non-Cumulative Preferred Shares


Balance at beginning of year
$
325,000

$
325,000

Shares issued - Series C
—

325,000

Shares repurchased - Series A and B
—

(325,000
)
Balance at end of period
325,000

325,000

Common Shares


Balance at beginning of year
561

549

Common shares issued, net
4

7

Balance at end of period
565

556

Additional Paid-in Capital


Balance at beginning of year
227,778

161,419

Common shares issued, net
5,583

4,561

Issue costs on Series C preferred shares
—

(9,398
)
Reversal of issue costs on repurchase of preferred shares
—

10,612

Exercise of stock options
7,438

7,619

Amortization of share-based compensation
40,305

34,659

Other
2,345

1,747

Balance at end of period
283,449

211,219

Retained Earnings


Balance at beginning of year
5,354,361

4,796,655

Net income
548,241

574,180

Dividends declared on preferred shares
(16,453
)
(19,594
)
Loss on repurchase of preferred shares
—

(10,612
)
Balance at end of period
5,886,149

5,340,629

Accumulated Other Comprehensive Income


Balance at beginning of year
287,017

153,923

Change in unrealized appreciation (decline) in value of investments, net of deferred income tax
(240,781
)
158,942

Portion of other-than-temporary impairment losses recognized in other comprehensive income, net of deferred income tax
(175
)
(776
)
Foreign currency translation adjustments, net of deferred income tax
(4,106
)
12,043

Balance at end of period
41,955

324,132

Common Shares Held in Treasury, at Cost


Balance at beginning of year
(1,025,839
)
(845,472
)
Shares repurchased for treasury
(67,994
)
(7,270
)
Balance at end of period
(1,093,833
)
(852,742
)
Total Shareholders’ Equity
$
5,443,285

$
5,348,794


See Notes to Consolidated Financial Statements

6

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(U.S. dollars in thousands)
(Unaudited)
Nine Months Ended
September 30,
2013
2012
Operating Activities


Net income
$
548,241

$
574,180

Adjustments to reconcile net income to net cash provided by operating activities:


Net realized losses
(66,957
)
(142,703
)
Net impairment losses recognized in earnings
3,698

5,353

Equity in net income or loss of investment funds accounted for using the equity method and other income or loss
35,634

(37,318
)
Share-based compensation
40,305

34,659

Changes in:


Reserve for losses and loss adjustment expenses, net of unpaid losses and loss adjustment expenses recoverable
(24,305
)
180,016

Unearned premiums, net of prepaid reinsurance premiums
295,860

283,433

Premiums receivable
(160,091
)
(204,854
)
Deferred acquisition costs, net
(73,793
)
(51,222
)
Reinsurance balances payable
2,573

19,171

Other liabilities
(15,893
)
21,664

Other items, net
41,776

49,572

Net Cash Provided By Operating Activities
627,048

731,951

Investing Activities


Purchases of:


Fixed maturity investments
(12,436,587
)
(12,670,073
)
Equity securities
(438,255
)
(215,921
)
Other investments
(992,935
)
(700,308
)
Proceeds from the sales of:


Fixed maturity investments
11,877,419

11,522,538

Equity securities
373,000

264,417

Other investments
813,596

329,093

Proceeds from redemptions and maturities of fixed maturity investments
595,503

867,080

Net purchases of short-term investments
(268,968
)
72,139

Change in investment of securities lending collateral
2,508

22,840

Purchase of business, net of cash acquired
—

28,948

Purchases of furniture, equipment and other assets
(10,953
)
(13,894
)
Net Cash Used For Investing Activities
(485,672
)
(493,141
)
Financing Activities


Proceeds from issuance of Series C preferred shares, net
—

315,763

Repurchase of Series A and B preferred shares
—

(325,000
)
Purchases of common shares under share repurchase program
(57,796
)
—

Proceeds from common shares issued, net
(425
)
1,604

Repayments of borrowings
—

(124,577
)
Change in securities lending collateral
(2,508
)
(22,840
)
Other
5,679

4,479

Preferred dividends paid
(16,453
)
(22,897
)
Net Cash Used For Financing Activities
(71,503
)
(173,468
)
Effects of exchange rate changes on foreign currency cash
(4,773
)
5,399

Increase in cash
65,100

70,741

Cash beginning of year
371,041

351,699

Cash end of period
$
436,141

$
422,440


See Notes to Consolidated Financial Statements

7
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)


1. General
Arch Capital Group Ltd. (“ACGL”) is a Bermuda public limited liability company which provides insurance and reinsurance on a worldwide basis through its wholly owned subsidiaries.
The interim consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”) and include the accounts of ACGL and its wholly owned subsidiaries (together with ACGL, the “Company”). All significant intercompany transactions and balances have been eliminated in consolidation. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates and assumptions. In the opinion of management, the accompanying unaudited interim consolidated financial statements reflect all adjustments (consisting of normally recurring accruals) necessary for a fair statement of results on an interim basis. The results of any interim period are not necessarily indicative of the results for a full year or any future periods.
Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted; however, management believes that the disclosures are adequate to make the information presented not misleading. This report should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2012 , including the Company’s audited consolidated financial statements and related notes.
The Company has reclassified the presentation of certain prior year information to conform to the current presentation. Such reclassifications had no effect on the Company’s net income, comprehensive income, shareholders’ equity or cash flows. Tabular amounts are in U.S. Dollars in thousands, except share amounts, unless otherwise noted.
2. Share Transactions
Share Repurchases
The board of directors of ACGL has authorized the investment in ACGL’s common shares through a share repurchase program. Repurchases under the program may be effected from time to time in open market or privately negotiated transactions through December 2014. Since the inception of the share repurchase program, ACGL has repurchased approximately 109.9 million common shares for an aggregate purchase price of $2.79 billion . During the 2013 third quarter and nine months ended September 30, 2013 , ACGL repurchased 26,300 and 1.3 million common shares, respectively, for an aggregate purchase price of $1.3 million and $57.8 million , respectively. No share repurchases were made in the comparable 2012 periods. At September 30, 2013 , $712.1 million of share repurchases were available under the program. The timing and amount of the repurchase transactions under this program will depend on a variety of factors, including market conditions and corporate and regulatory considerations.

Loss on Repurchase of Preferred Shares

The Company issued $325.0 million of 6.75% Series C preferred shares in April 2012 and subsequently redeemed all of its $200.0 million of 8.0% Series A preferred shares and $125.0 million of 7.875% Series B preferred shares at a redemption price equal to $25.00 per share in May 2012. In accordance with GAAP, upon issuance of the Series A and B preferred shares in 2006, costs of $10.6 million were recognized as a reduction of additional paid-in capital in shareholders' equity. Following the redemption of such shares, such issue costs were recorded as a “loss on repurchase of preferred shares” to remove the costs from additional paid-in capital in the second quarter of 2012, as revised and as disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012 (see Note 16 and Note 21).

3. Recent Accounting Pronouncements
Effective January 1, 2013, the Company adopted Financial Accounting Standards Board ("FASB") guidance requiring additional disclosures about reclassification adjustments from accumulated other comprehensive income. As this guidance is disclosure-related only, the adoption of this guidance did not impact the Company’s results of operations, financial condition or liquidity. The additional disclosures are provided in Note 11, "Other Comprehensive Income."

8


Effective January 1, 2013, the Company adopted FASB guidance requiring additional disclosures about financial instruments and derivative instruments that are either: (1) offset for balance sheet presentation purposes or (2) subject to an enforceable master netting arrangement or similar arrangement, regardless of whether they are offset for balance sheet presentation purposes. The disclosure requirements of this guidance are limited to derivatives, repurchase agreements and reverse repurchase agreements, and securities borrowing/lending transactions. As this guidance is disclosure-related only and did not amend existing balance sheet offsetting guidance, adoption did not impact the Company’s results of operations, financial condition or liquidity. The additional disclosures are provided in Note 7, "Investment Information," and Note 9, "Derivative Instruments."

4. Commitments and Contingencies
Letter of Credit and Revolving Credit Facilities
As of September 30, 2013 , the Company had a $300 million unsecured revolving loan and letter of credit facility and a $500 million secured letter of credit facility (the “Credit Agreement”). The Credit Agreement expires on August 18, 2014 . In addition, the Company had access to secured letter of credit facilities of approximately $113.8 million as of September 30, 2013 , which are available on a limited basis and for limited purposes (together with the secured portion of the Credit Agreement and these letter of credit facilities, the “LOC Facilities”). At September 30, 2013 , the Company had $408.4 million in outstanding letters of credit under the LOC Facilities, which were secured by investments with a fair value of $480.4 million , and had $100.0 million of borrowings outstanding under the Credit Agreement. The Company was in compliance with all covenants contained in the LOC Facilities at September 30, 2013 .
Investment Commitments
The Company’s investment commitments, which are primarily related to agreements entered into by the Company to invest in funds and separately managed accounts when called upon, were approximately $815.3 million at September 30, 2013 .

Acquisition of CMG Mortgage Insurance Company and Mortgage Insurance Operating Platform of PMI

In February 2013, certain of the Company's U.S.-based subsidiaries (collectively “Arch U.S. MI”) entered into a definitive agreement to acquire (1) CMG Mortgage Insurance Company (“CMG MI”) from its current owners, PMI Mortgage Insurance Co. in rehabilitation (“PMI”), which has been under the receivership of the Arizona Department of Insurance since 2011, and CMFG Life Insurance Company, and (2) PMI's mortgage insurance operating platform and certain related assets from PMI. In connection with the closing of the transactions, PMI and an affiliate of the Company's U.S.-based subsidiaries will enter into a quota share reinsurance agreement pursuant to which such affiliate, as the reinsurer, will agree to provide 100% quota share indemnity reinsurance to PMI for all certificates of insurance that were issued by PMI between and including January 1, 2009 and December 31, 2011 that are not in default as of an agreed upon effective date. At closing, it is currently estimated that the Company's U.S.-based subsidiaries will pay aggregate consideration of approximately $300 million under all transaction documents. Additional amounts may be paid based on the actual results of CMG MI's pre-closing portfolio over an agreed upon period. In addition, the Company will enter into a services agreement with PMI to provide for necessary services to administer the run-off of PMI's legacy business at the direction of PMI.

On June 20, 2013, the Arizona receivership court provided the required approval of the acquisition. The transaction is also subject to approvals of the applicable regulators and approvals by the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation of Arch U.S. MI as an eligible insurance carrier in the U.S. mortgage insurance marketplace, as well as the satisfaction of customary closing conditions. In connection with obtaining such consents of regulatory authorities and government-sponsored entities, it is anticipated that Arch U.S. MI or its affiliates will be required to make certain financial commitments to CMG MI, the form and amount of which will be determined based upon discussions with such authorities and entities. Arch U.S. MI's obligation to the sellers to accept financial requirements imposed by regulatory authorities and government-sponsored entities will be determined on the basis of, among other things, the appropriateness of such requirements in light of Arch U.S. MI's business plan and the consistency of such requirements with those imposed on other active participants in the U.S. mortgage insurance industry, as described in the purchase agreements. If these approvals are obtained, it is expected the transaction will close during the 2013 fourth quarter or early 2014.

9
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

5. Earnings Per Common Share
The following table sets forth the computation of basic and diluted earnings per common share:
Three Months Ended
Nine Months Ended
September 30,
September 30,
2013
2012
2013
2012
Numerator:




Net income
$
114,825

$
189,656

$
548,241

$
574,180

Preferred dividends
(5,484
)
(5,484
)
(16,453
)
(19,594
)
Loss on repurchase of preferred shares
—

—

—

(10,612
)
Net income available to common shareholders
$
109,341

$
184,172

$
531,788

$
543,974

Denominator:




Weighted average common shares outstanding — basic
131,495,296

135,067,360

131,262,309

134,519,046

Effect of dilutive common share equivalents:




Nonvested restricted shares
1,124,644

723,538

1,094,327

847,959

Stock options (1)
3,414,473

2,906,036

3,324,193

2,868,990

Weighted average common shares and common share equivalents outstanding — diluted
136,034,413

138,696,934

135,680,829

138,235,995

Earnings per common share:




Basic
$
0.83

$
1.36

$
4.05

$
4.04

Diluted
$
0.80

$
1.33

$
3.92

$
3.93

_________________________________________________
(1)
Certain stock options were not included in the computation of diluted earnings per share where the exercise price of the stock options exceeded the average market price and would have been anti-dilutive or where, when applying the treasury stock method to in-the-money options, the sum of the proceeds, including unrecognized compensation, exceeded the average market price and would have been anti-dilutive. For the 2013 third quarter and 2012 third quarter , the number of stock options excluded were 387,249 and 621,556 , respectively. For the nine months ended September 30, 2013 and 2012 , the number of stock options excluded were 1,735,995 and 860,088 , respectively.


10
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

6. Segment Information
The following tables summarize the Company’s underwriting income or loss by segment, together with a reconciliation of underwriting income or loss to net income available to common shareholders:
Three Months Ended
Three Months Ended
September 30, 2013
September 30, 2012
Insurance
Reinsurance
Total
Insurance
Reinsurance
Total
Gross premiums written (1)
$
682,839

$
355,091

$
1,036,987

$
658,599

$
279,751

$
936,764

Net premiums written
501,971

337,164

839,135

483,356

271,893

755,249

Net premiums earned
$
479,129

$
315,871

$
795,000

$
456,341

$
292,350

$
748,691

Fee income
545

(19
)
526

645

432

1,077

Losses and loss adjustment expenses
(305,921
)
(121,124
)
(427,045
)
(307,155
)
(136,716
)
(443,871
)
Acquisition expenses, net
(82,799
)
(64,514
)
(147,313
)
(73,663
)
(54,402
)
(128,065
)
Other operating expenses
(75,734
)
(34,442
)
(110,176
)
(75,379
)
(29,001
)
(104,380
)
Underwriting income
$
15,220

$
95,772

110,992

$
789

$
72,663

73,452

Net investment income


66,083



73,221

Net realized gains (losses)


(6,022
)


60,391

Net impairment losses recognized in earnings


(728
)


(2,379
)
Equity in net income of investment funds accounted for using the equity method


5,665



24,330

Other income (loss)


624



(532
)
Other expenses


(7,894
)


(9,049
)
Interest expense


(5,937
)


(7,378
)
Net foreign exchange losses


(40,562
)


(16,959
)
Income before income taxes


122,221



195,097

Income tax expense


(7,396
)


(5,441
)
Net income


114,825



189,656

Preferred dividends


(5,484
)


(5,484
)
Net income available to common shareholders


$
109,341



$
184,172

Underwriting Ratios






Loss ratio
63.8
%
38.3
%
53.7
%
67.3
%
46.8
%
59.3
%
Acquisition expense ratio (2)
17.2
%
20.4
%
18.5
%
16.0
%
18.6
%
17.0
%
Other operating expense ratio
15.8
%
10.9
%
13.8
%
16.5
%
9.9
%
13.9
%
Combined ratio
96.8
%
69.6
%
86.0
%
99.8
%
75.3
%
90.2
%
_________________________________________________
(1)     Certain amounts included in the gross premiums written of each segment are related to intersegment transactions. Accordingly, the sum of gross premiums written for each segment does not agree to the total gross premiums written as shown in the table above due to the elimination of intersegment transactions in the total.
(2)     The acquisition expense ratio is adjusted to include policy-related fee income.


11
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)


Nine Months Ended
Nine Months Ended
September 30, 2013
September 30, 2012
Insurance
Reinsurance
Total
Insurance
Reinsurance
Total
Gross premiums written (1)
$
2,075,560

$
1,168,938

$
3,241,424

$
2,022,802

$
1,036,708

$
3,055,233

Net premiums written
1,508,089

1,094,357

2,602,446

1,438,620

1,000,473

2,439,093

Net premiums earned
$
1,382,750

$
923,836

$
2,306,586

$
1,344,675

$
810,984

$
2,155,659

Fee income
1,599

367

1,966

1,803

623

2,426

Losses and loss adjustment expenses
(880,580
)
(364,521
)
(1,245,101
)
(900,735
)
(338,036
)
(1,238,771
)
Acquisition expenses, net
(227,806
)
(178,776
)
(406,582
)
(223,591
)
(151,725
)
(375,316
)
Other operating expenses
(232,216
)
(101,234
)
(333,450
)
(225,366
)
(84,264
)
(309,630
)
Underwriting income (loss)
$
43,747

$
279,672

323,419

$
(3,214
)
$
237,582

234,368

Net investment income


200,124



221,126

Net realized gains


64,970



139,379

Net impairment losses recognized in earnings


(3,698
)


(5,353
)
Equity in net income of investment funds accounted for using the equity method


30,429



56,943

Other income (loss)


2,702



(7,905
)
Other expenses


(32,211
)


(27,972
)
Interest expense


(17,687
)


(22,338
)
Net foreign exchange losses


(2,487
)


(5,958
)
Income before income taxes


565,561



582,290

Income tax expense


(17,320
)


(8,110
)
Net income


548,241



574,180

Preferred dividends


(16,453
)


(19,594
)
Loss on repurchase of preferred shares
—

(10,612
)
Net income available to common shareholders


$
531,788



$
543,974

Underwriting Ratios






Loss ratio
63.7
%
39.5
%
54.0
%
67.0
%
41.7
%
57.5
%
Acquisition expense ratio (2)
16.4
%
19.4
%
17.5
%
16.5
%
18.7
%
17.3
%
Other operating expense ratio
16.8
%
11.0
%
14.5
%
16.8
%
10.4
%
14.4
%
Combined ratio
96.9
%
69.9
%
86.0
%
100.3
%
70.8
%
89.2
%
_________________________________________________
(1)     Certain amounts included in the gross premiums written of each segment are related to intersegment transactions. Accordingly, the sum of gross premiums written for each segment does not agree to the total gross premiums written as shown in the table above due to the elimination of intersegment transactions in the total.
(2)     The acquisition expense ratio is adjusted to include policy-related fee income.


12
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

7. Investment Information
Available For Sale Investments
The following table summarizes the fair value and cost or amortized cost of the Company’s investments classified as available for sale:
Fair
Value
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Cost or
Amortized
Cost
OTTI
Unrealized
Losses (2)
September 30, 2013





Fixed maturities and fixed maturities pledged under securities lending agreements (1):





Corporate bonds
$
2,428,219

$
37,646

$
(46,263
)
$
2,436,836

$
(21
)
Mortgage backed securities
1,499,403

17,831

(36,567
)
1,518,139

(9,335
)
Municipal bonds
1,531,324

36,907

(9,079
)
1,503,496

(17
)
Commercial mortgage backed securities
783,718

13,690

(11,322
)
781,350

(199
)
U.S. government and government agencies
1,121,898

11,336

(4,299
)
1,114,861

(19
)
Non-U.S. government securities
1,172,057

16,401

(15,789
)
1,171,445

—

Asset backed securities
1,199,241

19,442

(12,221
)
1,192,020

(3,494
)
Total
9,735,860

153,253

(135,540
)
9,718,147

(13,085
)
Equity securities
452,195

41,295

(7,419
)
418,319

—

Other investments
528,938

26,860

(25,357
)
527,435

—

Short-term investments
994,221

1,172

(449
)
993,498

—

Total
$
11,711,214

$
222,580

$
(168,765
)
$
11,657,399

$
(13,085
)
December 31, 2012





Fixed maturities and fixed maturities pledged under securities lending agreements (1):





Corporate bonds
$
2,857,513

$
105,798

$
(6,710
)
$
2,758,425

$
(62
)
Mortgage backed securities
1,532,736

24,809

(7,484
)
1,515,411

(9,329
)
Municipal bonds
1,463,586

62,322

(1,421
)
1,402,685

(17
)
Commercial mortgage backed securities
824,165

37,514

(4,468
)
791,119

(270
)
U.S. government and government agencies
1,131,688

20,178

(1,095
)
1,112,605

(19
)
Non-U.S. government securities
998,901

33,701

(8,860
)
974,060

—

Asset backed securities
1,073,999

25,528

(5,838
)
1,054,309

(3,346
)
Total
9,882,588

309,850

(35,876
)
9,608,614

(13,043
)
Equity securities
312,749

26,625

(12,290
)
298,414

—

Other investments
549,280

32,582

(3,257
)
519,955

—

Short-term investments
730,369

3,521

(1,248
)
728,096

—

Total
$
11,474,986

$
372,578

$
(52,671
)
$
11,155,079

$
(13,043
)
_________________________________________________
(1)
In securities lending transactions, the Company receives collateral in excess of the fair value of the fixed maturities and short-term investments pledged. For purposes of this table, the Company has excluded the collateral received and reinvested and included the fixed maturities and short-term investments pledged. See “—Securities Lending Agreements.”
(2)
Represents the total other-than-temporary impairments (“OTTI”) recognized in accumulated other comprehensive income (“AOCI”). It does not include the change in fair value subsequent to the impairment measurement date. At September 30, 2013 , the net unrealized gain related to securities for which a non-credit OTTI was recognized in AOCI was $5.1 million , compared to a net unrealized gain of $2.0 million at December 31, 2012 .


13
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following table summarizes, for all available for sale securities in an unrealized loss position, the fair value and gross unrealized loss by length of time the security has been in a continual unrealized loss position:
Less than 12 Months
12 Months or More
Total
Fair
Value
Gross
Unrealized
Losses
Fair
Value
Gross
Unrealized
Losses
Fair
Value
Gross
Unrealized
Losses
September 30, 2013






Fixed maturities and fixed maturities pledged under securities lending agreements (1):






Corporate bonds
$
1,351,619

$
(44,843
)
$
18,507

$
(1,420
)
$
1,370,126

$
(46,263
)
Mortgage backed securities
750,898

(32,059
)
51,227

(4,508
)
802,125

(36,567
)
Municipal bonds
444,603

(8,886
)
3,817

(193
)
448,420

(9,079
)
Commercial mortgage backed securities
381,215

(11,157
)
1,660

(165
)
382,875

(11,322
)
U.S. government and government agencies
266,379

(4,299
)
—

—

266,379

(4,299
)
Non-U.S. government securities
615,731

(13,890
)
10,138

(1,899
)
625,869

(15,789
)
Asset backed securities
588,492

(9,962
)
38,279

(2,259
)
626,771

(12,221
)
Total
4,398,937

(125,096
)
123,628

(10,444
)
4,522,565

(135,540
)
Equity securities
151,580

(7,419
)
—

—

151,580

(7,419
)
Other investments
183,501

(20,934
)
46,988

(4,423
)
230,489

(25,357
)
Short-term investments
9,500

(449
)
—

—

9,500

(449
)
Total
$
4,743,518

$
(153,898
)
$
170,616

$
(14,867
)
$
4,914,134

$
(168,765
)
December 31, 2012






Fixed maturities and fixed maturities pledged under securities lending agreements (1):






Corporate bonds
$
490,784

$
(3,692
)
$
52,334

$
(3,018
)
$
543,118

$
(6,710
)
Mortgage backed securities
537,883

(4,290
)
60,574

(3,194
)
598,457

(7,484
)
Municipal bonds
147,766

(1,120
)
7,052

(301
)
154,818

(1,421
)
Commercial mortgage backed securities
36,649

(2,261
)
8,878

(2,207
)
45,527

(4,468
)
U.S. government and government agencies
146,526

(1,095
)
—

—

146,526

(1,095
)
Non-U.S. government securities
244,827

(1,070
)
135,564

(7,790
)
380,391

(8,860
)
Asset backed securities
234,584

(1,508
)
57,371

(4,330
)
291,955

(5,838
)
Total
1,839,019

(15,036
)
321,773

(20,840
)
2,160,792

(35,876
)
Equity securities
130,385

(10,200
)
16,469

(2,090
)
146,854

(12,290
)
Other investments
23,849

(2,474
)
35,083

(783
)
58,932

(3,257
)
Short-term investments
57,415

(1,248
)
—

—

57,415

(1,248
)
Total
$
2,050,668

$
(28,958
)
$
373,325

$
(23,713
)
$
2,423,993

$
(52,671
)
_________________________________________________
(1)
In securities lending transactions, the Company receives collateral in excess of the fair value of the fixed maturities and short-term investments pledged. For purposes of this table, the Company has excluded the collateral received and reinvested and included the fixed maturities and short-term investments pledged. See “—Securities Lending Agreements.”


14
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

At September 30, 2013 , on a lot level basis, approximately 1,840 security lots out of a total of approximately 4,560 security lots were in an unrealized loss position and the largest single unrealized loss from a single lot in the Company’s fixed maturity portfolio was $3.0 million . At December 31, 2012 , on a lot level basis, approximately 910 security lots out of a total of approximately 4,580 security lots were in an unrealized loss position and the largest single unrealized loss from a single lot in the Company’s fixed maturity portfolio was $2.5 million .
The contractual maturities of the Company’s fixed maturities and fixed maturities pledged under securities lending agreements are shown in the following table. Expected maturities, which are management’s best estimates, will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
September 30, 2013
December 31, 2012
Maturity
Fair Value
Amortized
Cost
Fair Value
Amortized
Cost
Due in one year or less
$
247,663

$
243,987

$
446,402

$
436,376

Due after one year through five years
3,743,302

3,703,446

3,876,062

3,769,426

Due after five years through 10 years
2,009,579

2,023,258

1,949,297

1,869,698

Due after 10 years
252,954

255,947

179,927

172,275

6,253,498

6,226,638

6,451,688

6,247,775

Mortgage backed securities
1,499,403

1,518,139

1,532,736

1,515,411

Commercial mortgage backed securities
783,718

781,350

824,165

791,119

Asset backed securities
1,199,241

1,192,020

1,073,999

1,054,309

Total
$
9,735,860

$
9,718,147

$
9,882,588

$
9,608,614

Securities Lending Agreements
The Company operates a securities lending program under which certain of its fixed income portfolio securities are loaned to third parties, primarily major brokerage firms, for short periods of time through a lending agent. The fair value and amortized cost of fixed maturities and short-term investments pledged under securities lending agreements were $48.4 million and $47.3 million , respectively, at September 30, 2013 , compared to $50.8 million and $49.6 million , respectively, at December 31, 2012 . The fair value of the portfolio of collateral backing the Company's securities lending program was $42.1 million at September 30, 2013 , compared to $42.5 million at December 31, 2012 . Such amounts included approximately $6.4 million of sub-prime securities at September 30, 2013 , compared to $5.4 million at December 31, 2012 . The Company maintains legal control over the securities it lends, retains the earnings and cash flows associated with the loaned securities and receives a fee from the borrower for the temporary use of the securities. An indemnification agreement with the lending agent protects the Company in the event a borrower becomes insolvent or fails to return any of the securities on loan to the Company .


15
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Other Investments

The following table summarizes the Company's other investments, including available for sale and fair value option components:

September 30,
2013
December 31,
2012
Available for sale:
Asian and emerging markets
$
357,069

$
316,860

Investment grade fixed income
164,768

220,410

Other
7,101

12,010

Total available for sale
528,938

549,280

Fair value option:
Term loan investments (par value: $487,083 and $307,016)
496,477

308,596

Asian and emerging markets
19,705

24,035

Investment grade fixed income
75,328

67,624

Non-investment grade fixed income
9,408

11,093

Other (1)
171,655

116,623

Total fair value option
772,573

527,971

Total
$
1,301,511

$
1,077,251

_________________________________________________
(1)
Includes fund investments with strategies in mortgage servicing rights, transportation and infrastructure assets and other.

Certain of the Company's other investments are in investment funds for which the Company has the option to redeem at agreed upon values as described in each investment fund's subscription agreement. Depending on the terms of the various subscription agreements, investments in investment funds may be redeemed daily, monthly, quarterly or on other terms. Two common redemption restrictions which may impact the Company's ability to redeem these investment funds are gates and lockups. A gate is a suspension of redemptions which may be implemented by the general partner or investment manager of the fund in order to defer, in whole or in part, the redemption request in the event the aggregate amount of redemption requests exceeds a predetermined percentage of the investment fund's net assets which may otherwise hinder the general partner or investment manager's ability to liquidate holdings in an orderly fashion in order to generate the cash necessary to fund extraordinarily large redemption payouts. A lockup period is the initial amount of time an investor is contractually required to hold the security before having the ability to redeem. If the investment funds are eligible to be redeemed, the time to redeem such fund can take weeks or months following the notification.


16
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Fair Value Option
The Company elected to carry certain fixed maturity securities, equity securities and other investments (primarily term loans) at fair value under the fair value option afforded by accounting guidance regarding the fair value option for financial assets and liabilities. Changes in fair value of investments accounted for using the fair value option are included in net realized gains or losses while interest income, dividends received and distributions from fund investments which are not a return of capital are reflected in net investment income, where practicable. The primary reasons for electing the fair value option were to reflect economic events in earnings on a timely basis and to address practicality and cost-benefit considerations.
The following table summarizes the Company’s assets and liabilities which are accounted for using the fair value option:
September 30,
2013
December 31,
2012
Fixed maturities
$
367,152

$
363,541

Other investments
772,573

527,971

Equity securities
—

25,954

Investments accounted for using the fair value option
1,139,725

917,466

Securities sold but not yet purchased (1)
—

(6,924
)
Net assets accounted for using the fair value option
$
1,139,725

$
910,542

_________________________________________________
(1)
Represents the Company’s obligation to deliver equity securities that it did not own at the time of sale. Such amounts are included in “other liabilities” on the Company’s consolidated balance sheets.

Net Investment Income
The components of net investment income were derived from the following sources:
Three Months Ended
Nine Months Ended
September 30,
September 30,
2013
2012
2013
2012
Fixed maturities
$
62,447

$
68,202

$
186,457

$
211,942

Term loan investments (1)
5,296

4,876

15,539

10,732

Equity securities
2,241

2,009

6,828

6,098

Short-term investments
417

485

1,173

1,617

Other (2)
3,753

3,795

14,786

9,968

Gross investment income
74,154

79,367

224,783

240,357

Investment expenses
(8,071
)
(6,146
)
(24,659
)
(19,231
)
Net investment income
$
66,083

$
73,221

$
200,124

$
221,126

_________________________________________________
(1)
Included in “investments accounted for using the fair value option” on the Company’s consolidated balance sheets.
(2)
Amounts include dividends on investment funds and other items.

17
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Net Realized Gains (Losses)
Net realized gains (losses) were as follows, excluding other-than-temporary impairment provisions:
Three Months Ended
Nine Months Ended
September 30,
September 30,
2013
2012
2013
2012
Available for sale securities:




Gross gains on investment sales
$
47,433

$
70,510

$
183,306

$
186,458

Gross losses on investment sales
(69,256
)
(20,672
)
(149,095
)
(59,365
)
Change in fair value of assets and liabilities accounted for using the fair value option:




Fixed maturities
5,599

5,322

3,955

8,729

Equity securities
—

1,466

704

1,264

Other investments
8,221

3,810

8,670

5,819

TALF investments
—

(21
)
—

(71
)
TALF borrowings
—

(209
)
—

686

Derivative instruments (1)
1,574

297

16,842

(4,095
)
Other
407

(112
)
588

(46
)
Net realized gains (losses)
$
(6,022
)
$
60,391

$
64,970

$
139,379

_________________________________________________
(1)
See Note 9 for information on the Company’s derivative instruments.
Other-Than-Temporary Impairments
The Company performs quarterly reviews of its available for sale investments in order to determine whether declines in fair value below the amortized cost basis were considered other-than-temporary in accordance with applicable guidance. The following table details the net impairment losses recognized in earnings by asset class:
Three Months Ended
Nine Months Ended
September 30,
September 30,
2013
2012
2013
2012
Fixed maturities:




Mortgage backed securities
$
(280
)
$
(1,511
)
$
(295
)
$
(2,403
)
Corporate bonds
(88
)
(150
)
(88
)
(1,512
)
Non-U.S. government securities
—

—

—

(261
)
Commercial mortgage backed securities
—

(211
)
—

(211
)
Asset backed securities
(20
)
—

(40
)
(106
)
U.S. government and government agencies
—

—

—

(10
)
Total
(388
)
(1,872
)
(423
)
(4,503
)
Investment of funds received under securities lending agreements
—

—

—

(87
)
Equity securities
(340
)
(507
)
(3,275
)
(763
)
Net impairment losses recognized in earnings
$
(728
)
$
(2,379
)
$
(3,698
)
$
(5,353
)
A description of the methodology and significant inputs used to measure the amount of net impairment losses recognized in earnings in the 2013 periods is as follows:

•
Equity securities — the Company utilized information received from asset managers on common stocks, including the business prospects, recent events, industry and market data and other factors. For certain equities which were in an unrealized loss position and where the Company determined that it did not have the intent or ability to hold such securities for a reasonable period of time by which the fair value of the securities would increase and the Company would recover its cost, the cost basis of such securities was adjusted down accordingly;

•
Mortgage backed and asset backed securities — the Company utilized underlying data provided by asset managers, cash flow projections and additional information from credit agencies in order to determine an

18
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

expected recovery value for each security. The analysis includes expected cash flow projections under base case and stress case scenarios which modify the expected default expectations, loss severities and prepayment assumptions. The significant inputs in the models include the expected default rates, delinquency rates and foreclosure costs. The expected recovery values were reduced on a small number of securities, primarily as a result of increases in expected default expectations and foreclosure costs. The amortized cost basis of the securities were adjusted down, if required, to the expected recovery value calculated in the OTTI review process;

•
Corporate bonds — the Company reviewed the business prospects, credit ratings, estimated loss given default factors, foreign currency impacts and information received from asset managers and rating agencies for certain corporate bonds. The amortized cost basis of the corporate bonds were adjusted down, if required, to the expected recovery value calculated in the OTTI review process.

The Company believes that the $13.1 million of OTTI included in accumulated other comprehensive income at September 30, 2013 on the securities which were considered by the Company to be impaired was due to market and sector-related factors ( i.e. , not credit losses). At September 30, 2013 , the Company did not intend to sell these securities, or any other securities which were in an unrealized loss position, and determined that it is more likely than not that the Company will not be required to sell such securities before recovery of their cost basis.
The following table provides a roll forward of the amount related to credit losses recognized in earnings for which a portion of an OTTI was recognized in accumulated other comprehensive income:
Three Months Ended
Nine Months Ended
September 30,
September 30,
2013
2012
2013
2012
Balance at start of period
$
61,449

$
62,526

$
62,001

$
66,545

Credit loss impairments recognized on securities not previously impaired
369

747

402

2,652

Credit loss impairments recognized on securities previously impaired
19

1,632

21

2,701

Reductions for increases in cash flows expected to be collected that are recognized over the remaining life of the security
—

—

—

—

Reductions for securities sold during the period
—

(1,709
)
(587
)
(8,702
)
Balance at end of period
$
61,837

$
63,196

$
61,837

$
63,196

Restricted Assets
The Company is required to maintain assets on deposit, which primarily consist of fixed maturities, with various regulatory authorities to support its insurance and reinsurance operations. The Company’s insurance and reinsurance subsidiaries maintain assets in trust accounts as collateral for insurance and reinsurance transactions with affiliated companies and also have investments in segregated portfolios primarily to provide collateral or guarantees for letters of credit to third parties. See Note 4, “Commitments and Contingencies—Letter of Credit and Revolving Credit Facilities,” for further details. The following table details the value of the Company’s restricted assets:
September 30,
2013
December 31,
2012
Assets used for collateral or guarantees:


Affiliated transactions
$
4,146,190

$
4,062,097

Third party agreements
784,567

771,631

Deposits with U.S. regulatory authorities
303,634

290,441

Deposits with non-U.S. regulatory authorities
6,765

247,321

Trust funds
75,531

96,342

Total restricted assets
$
5,316,687

$
5,467,832



19
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

8. Fair Value
Accounting guidance regarding fair value measurements addresses how companies should measure fair value when they are required to use a fair value measure for recognition or disclosure purposes under GAAP and provides a common definition of fair value to be used throughout GAAP. It defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly fashion between market participants at the measurement date. In addition, it establishes a three-level valuation hierarchy for the disclosure of fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The level in the hierarchy within which a given fair value measurement falls is determined based on the lowest level input that is significant to the measurement (Level 1 being the highest priority and Level 3 being the lowest priority).
The levels in the hierarchy are defined as follows:
Level 1:
Inputs to the valuation methodology are observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets
Level 2:
Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument
Level 3:
Inputs to the valuation methodology are unobservable and significant to the fair value measurement
Following is a description of the valuation methodologies used for securities measured at fair value, as well as the general classification of such securities pursuant to the valuation hierarchy.
The Company determines the existence of an active market based on its judgment as to whether transactions for the financial instrument occur in such market with sufficient frequency and volume to provide reliable pricing information. The independent pricing sources obtain market quotations and actual transaction prices for securities that have quoted prices in active markets. The Company uses quoted values and other data provided by nationally recognized independent pricing sources as inputs into its process for determining fair values of its fixed maturity investments. To validate the techniques or models used by pricing sources, the Company's review process includes, but is not limited to: (i) quantitative analysis ( e.g. , comparing the quarterly return for each managed portfolio to its target benchmark, with significant differences identified and investigated); (ii) a review of the average number of prices obtained in the pricing process and the range of resulting fair values; (iii) initial and ongoing evaluation of methodologies used by outside parties to calculate fair value including a review of deep dive reports on selected securities which indicate the use of observable inputs in the pricing process; (iv) comparing the fair value estimates to its knowledge of the current market; (v) a comparison of the pricing services' fair values to other pricing services' fair values for the same investments; and (vi) back-testing, which includes randomly selecting purchased or sold securities and comparing the executed prices to the fair value estimates from the pricing service. For a majority of investments, the Company obtained multiple quotes. A price source hierarchy was maintained in order to determine which price source would be used ( i.e. , a price obtained from a pricing service with more seniority in the hierarchy will be used over a less senior one in all cases). The hierarchy prioritizes pricing services based on availability and reliability and assigns the highest priority to index providers. Based on the above review, the Company will challenge any prices for a security or portfolio which are considered not to be representative of fair value. The Company did not adjust any of the prices obtained from the pricing services at September 30, 2013 .

The independent pricing sources obtain market quotations and actual transaction prices for securities that have quoted prices in active markets. Each source has its own proprietary method for determining the fair value of securities that are not actively traded. In general, these methods involve the use of “matrix pricing” in which the independent pricing source uses observable market inputs including, but not limited to, investment yields, credit risks and spreads, benchmarking of like securities, broker-dealer quotes, reported trades and sector groupings to determine a reasonable fair value. In addition, pricing vendors use model processes, such as an Option Adjusted Spread model, to develop prepayment and interest rate scenarios. The Option Adjusted Spread model is commonly used to estimate fair value for securities such as mortgage backed and asset backed securities. In certain circumstances, when fair values are unavailable from these independent pricing sources, quotes are obtained directly from broker-dealers who are active in the corresponding markets. Such quotes are subject to the validation procedures noted above. Of the $12.85 billion of financial assets and liabilities measured at fair value at September 30, 2013 , approximately $874.1 million , or 6.8% , were priced using non-binding broker-dealer quotes. Of the $12.40 billion of financial

20
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

assets and liabilities measured at fair value at December 31, 2012 , approximately $927.9 million , or 7.5% , were priced using non-binding broker-dealer quotes.

The Company reviews its securities measured at fair value and discusses the proper classification of such investments with investment advisors and others. A discussion of the general classification of the Company's financial instruments follows:

Fixed maturities . The Company determined that all U.S. Treasuries would be classified as Level 1 securities due to observed levels of trading activity, the high number of strongly correlated pricing quotes received on U.S. Treasuries and other factors. Where the Company believes that quoted market prices are not available or that the market is not active, fair values are estimated by using quoted prices of securities with similar characteristics, pricing models or matrix pricing and are generally classified as Level 2 securities. The Company determined that Level 2 securities included corporate bonds, mortgage backed securities, municipal bonds, asset backed securities and non-U.S. government securities.

Equity securities . The Company determined that exchange-traded equity securities would be included in Level 1 as their fair values are based on quoted market prices in active markets. Other equity securities are included in Level 2 of the valuation hierarchy.

Other investments . The fair values for certain of the Company's other investments are determined using net asset values (“NAV”) as advised by external fund managers. The NAV is based on the fund manager's valuation of the underlying holdings in accordance with the fund's governing documents. Periodically, the Company performs a number of monitoring procedures in order to assess the quality of the NAVs, including regular review and discussion of each fund's performance, regular evaluation of fund performance against applicable benchmarks and the backtesting of the NAVs against audited and interim financial statements. Other investments with liquidity terms allowing the Company to substantially redeem its holdings in a short time frame at the applicable NAV are reflected in Level 2. Other investments with redemption restrictions that prevent the Company from redeeming in the near term are classified in Level 3 of the valuation hierarchy.

Short-term investments . The Company determined that certain of its short-term investments held in highly liquid money market-type funds would be included in Level 1 as their fair values are based on quoted market prices in active markets. Other short-term investments are classified in Level 2 of the valuation hierarchy.

The Company reviews the classification of its investments each quarter. No transfers were made in the periods presented.

In securities lending transactions, the Company receives collateral in excess of the fair value of the fixed maturities and short-term investments pledged under securities lending agreements. For purposes of the following tables, the Company has excluded the collateral received and reinvested and included the fixed maturities and short-term investments pledged under securities lending agreements, at fair value.




21
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following table presents the Company’s financial assets and liabilities measured at fair value by level at September 30, 2013 :
Fair Value Measurement Using:
Fair
Value
Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
Significant
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Assets measured at fair value:




Available for sale securities:




Fixed maturities and fixed maturities pledged under securities lending agreements (1):




Corporate bonds
$
2,428,219

$
—

$
2,426,130

$
2,089

Mortgage backed securities
1,499,403

—

1,499,403

—

Municipal bonds
1,531,324

—

1,531,324

—

Commercial mortgage backed securities
783,718

—

783,718

—

U.S. government and government agencies
1,121,898

1,121,898

—

—

Non-U.S. government securities
1,172,057

—

1,172,057

—

Asset backed securities
1,199,241

—

1,199,241

—

Total
9,735,860

1,121,898

8,611,873

2,089

Equity securities
452,195

452,020

175

—

Other investments
528,938

—

324,284

204,654

Short-term investments
994,221

978,604

15,617

—

Fair value option:




Investments accounted for using the fair value option:




Corporate bonds
314,109

—

314,109

—

Non-U.S. government bonds
53,043

—

53,043

—

Other investments
772,573

—

413,729

358,844

Equity securities
—

—

—

—

Total
1,139,725

—

780,881

358,844

Total assets measured at fair value
$
12,850,939

$
2,552,522

$
9,732,830

$
565,587

Liabilities measured at fair value:




Fair value option:




Securities sold but not yet purchased (2)
$
—

$
—

$
—

$
—

Total liabilities measured at fair value
$
—

$
—

$
—

$
—

_________________________________________________
(1)
In securities lending transactions, the Company receives collateral in excess of the fair value of the fixed maturities and short-term investments pledged. For purposes of this table, the Company has excluded the collateral received and reinvested and included the fixed maturities and short-term investments pledged.
(2)
Represents the Company’s obligation to deliver securities that it did not own at the time of sale. Such amounts are included in “other liabilities” on the Company’s consolidated balance sheets.


22
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following table presents the Company’s financial assets and liabilities measured at fair value by level at December 31, 2012 :
Fair Value Measurement Using:
Fair
Value
Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
Significant
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Assets measured at fair value:




Available for sale securities:




Fixed maturities and fixed maturities pledged under securities lending agreements (1):




Corporate bonds
$
2,857,513

$
—

$
2,759,109

$
98,404

Mortgage backed securities
1,532,736

—

1,532,736

—

Municipal bonds
1,463,586

—

1,463,586

—

Commercial mortgage backed securities
824,165

—

824,165

—

U.S. government and government agencies
1,131,688

1,131,688

—

—

Non-U.S. government securities
998,901

—

998,901

—

Asset backed securities
1,073,999

—

1,073,999

—

Total
9,882,588

1,131,688

8,652,496

98,404

Equity securities
312,749

312,666

83

—

Other investments
549,280

—

365,078

184,202

Short-term investments
730,369

678,441

51,928

—

Fair value option:




Investments accounted for using the fair value option:




Corporate bonds
275,132

—

275,132

—

Non-U.S. government bonds
88,409

—

88,409

—

Other investments
527,971

—

332,621

195,350

Equity securities
25,954

25,954

—

—

Total
917,466

25,954

696,162

195,350

Total assets measured at fair value
$
12,392,452

$
2,148,749

$
9,765,747

$
477,956

Liabilities measured at fair value:




Fair value option:




Securities sold but not yet purchased (2)
$
6,924

$
6,924

$
—

$
—

Total liabilities measured at fair value
$
6,924

$
6,924

$
—

$
—

_________________________________________________
(1)
In securities lending transactions, the Company receives collateral in excess of the fair value of the fixed maturities and short-term investments pledged. For purposes of this table, the Company has excluded the collateral received and reinvested and included the fixed maturities and short-term investments pledged.
(2)
Represents the Company’s obligation to deliver securities that it did not own at the time of sale. Such amounts are included in “other liabilities” on the Company’s consolidated balance sheets.

23
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following tables present a reconciliation of the beginning and ending balances for all investments measured at fair value on a recurring basis using Level 3 inputs:
Fair Value Measurements Using:
Significant Unobservable Inputs (Level 3)
s
Available-For-Sale
Fair Value Option
Corporate
Bonds
Other
Investments
Other
Investments
Total
Three Months Ended September 30, 2013



Balance at beginning of period
$
2,360

$
189,893

$
290,189

$
482,442

Total gains or (losses) (realized/unrealized)



Included in earnings (1)
—

—

8,731

8,731

Included in other comprehensive income
—

(5,239
)
—

(5,239
)
Purchases, issuances, sales and settlements



Purchases
—

20,000

63,348

83,348

Issuances
—

—

—

—

Sales
—

—

—

—

Settlements
(271
)
—

(3,424
)
(3,695
)
Transfers in and/or out of Level 3
—

—

—

—

Balance at end of period
$
2,089

$
204,654

$
358,844

$
565,587

Three Months Ended September 30, 2012



Balance at beginning of period
$
92,036

$
6,386

$
—

$
98,422

Total gains or (losses) (realized/unrealized)



Included in earnings (1)
1,402

1,627

—

3,029

Included in other comprehensive income
1,229

(1,590
)
—

(361
)
Purchases, issuances, sales and settlements



Purchases
—

—

—

—

Issuances
—

—

—

—

Sales
—

—

—

—

Settlements
(38
)
(1,627
)
—

(1,665
)
Transfers in and/or out of Level 3
—

—

—

—

Balance at end of period
$
94,629

$
4,796

$
—

$
99,425

_________________________________________________
(1)
Gains or losses on corporate bonds were included in net realized gains (losses) while gains or losses on other investments were recorded in net realized gains (losses) or net investment income.


24
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)


Fair Value Measurements Using:
Significant Unobservable Inputs (Level 3)
s
Available-For-Sale
Fair Value Option
Corporate
Bonds
Other
Investments
Other
Investments
Total
Nine Months Ended September 30, 2013



Balance at beginning of period
$
98,404

$
184,202

$
195,350

$
477,956

Total gains or (losses) (realized/unrealized)
Included in earnings (1)
4,679

4,762

7,029

16,470

Included in other comprehensive income
(3,051
)
632

—

(2,419
)
Purchases, issuances, sales and settlements
Purchases
—

25,000

223,918

248,918

Issuances
—

—

—

—

Sales
(96,655
)
—

—

(96,655
)
Settlements
(1,288
)
(9,942
)
(67,453
)
(78,683
)
Transfers in and/or out of Level 3
—

—

—

—

Balance at end of period
$
2,089

$
204,654

$
358,844

$
565,587

Nine Months Ended September 30, 2012



Balance at beginning of period
$
92,091

$
5,124

$
—

$
97,215

Total gains or (losses) (realized/unrealized)
Included in earnings (1)
3,185

1,708

—

4,893

Included in other comprehensive income
(530
)
(328
)
—

(858
)
Purchases, issuances, sales and settlements
Purchases
—

—

—

—

Issuances
—

—

—

—

Sales
—

—

—

—

Settlements
(117
)
(1,708
)
—

(1,825
)
Transfers in and/or out of Level 3
—

—

—

—

Balance at end of period
$
94,629

$
4,796

$
—

$
99,425

_________________________________________________
(1)
Gains or losses on corporate bonds were included in net realized gains (losses) while gains or losses on other investments were recorded in net realized gains (losses) or net investment income.
The amount of total gains for the 2013 third quarter included in earnings attributable to the change in unrealized gains or losses relating to assets still held at September 30, 2013 was $8.7 million , while the amount of total gains for the nine months ended September 30, 2013 included in earnings attributable to the change in unrealized gains or losses relating to assets still held at September 30, 2013 was $13.2 million . The amount of total gains for the 2012 third quarter included in earnings attributable to the change in unrealized gains or losses relating to assets still held at September 30, 2012 was $3.0 million , while the amount of total gains for the nine months ended September 30, 2012 was $4.9 million .
Financial Instruments Disclosed, But Not Carried, At Fair Value
The Company uses various financial instruments in the normal course of its business. The carrying values of cash, accrued investment income, receivable for securities sold, certain other assets, payable for securities purchased and certain other liabilities approximated their fair values at September 30, 2013 , due to their respective short maturities. As these financial instruments are not actively traded, their respective fair values are classified within Level 2.
At September 30, 2013 , the Company’s senior notes were carried at their cost of $300.0 million and had a fair value of $379.4 million . The fair value of the Company's senior notes was obtained from a third party pricing service and are based on observable market inputs. As such, the fair value of the senior notes is classified within Level 2.

25
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

9. Derivative Instruments
The Company’s investment strategy allows for the use of derivative securities. The Company’s derivative instruments are recorded on its consolidated balance sheets at fair value. The fair values of those derivatives are based on quoted market prices. All realized and unrealized contract gains and losses are reflected in the Company’s results of operations. The Company utilizes exchange traded U.S. Treasury note, Eurodollar and other futures contracts and commodity futures to manage portfolio duration or replicate investment positions in its portfolios. Certain of the Company’s corporate bonds are managed in a global bond portfolio which incorporates the use of foreign currency forward contracts which are intended to provide an economic hedge against foreign currency movements on the portfolio’s non-U.S. Dollar denominated holdings. The Company routinely utilizes other foreign currency forward contracts, currency options, index futures contracts and other derivatives as part of its total return objective.
In addition, the Company purchases to-be-announced mortgage backed securities (“TBAs”) as part of its investment strategy. TBAs represent commitments to purchase a future issuance of agency mortgage backed securities. For the period between purchase of a TBA and issuance of the underlying security, the Company’s position is accounted for as a derivative. The Company purchases TBAs in both long and short positions to enhance investment performance and as part of its overall investment strategy. The Company did not hold any derivatives which were designated as hedging instruments at September 30, 2013 or December 31, 2012 .
The following table summarizes information on the fair values and notional values of the Company’s derivative instruments. The fair value of TBAs is included in “fixed maturities available for sale, at fair value” while the fair value of all other derivatives is included in “other investments available for sale, at fair value” in the consolidated balance sheets.
Asset
Derivatives
Liability Derivatives
Net
Derivatives
Fair Value
Fair Value
Fair Value
Notional Value
September 30, 2013




Futures contracts
$
82

$
(207
)
$
(125
)
$
412,884

Foreign currency forward contracts
6,183

(4,912
)
1,271

566,070

TBAs
381,739

(192,563
)
189,176

551,990

Other
1,384

(1,203
)
181

409,996

Total
$
389,388

$
(198,885
)
$
190,503


December 31, 2012




Futures contracts
$
52

$
(52
)
$
—

$
340,400

Foreign currency forward contracts
2,809

(2,678
)
131

396,468

TBAs
23,599

(4,346
)
19,253

26,000

Other
448

(676
)
(228
)
50,341

Total
$
26,908

$
(7,752
)
$
19,156



The Company's derivative instruments are generally traded under master netting agreements, which establish terms that apply to all derivative transactions with a counterparty. In the event of a bankruptcy or other stipulated event of default, such agreements provide that the non-defaulting party may elect to terminate all outstanding derivative transactions, in which case all individual derivative positions (loss or gain) with a counterparty are closed out and netted and replaced with a single amount, usually referred to as the termination amount, which is expressed in a single currency. The resulting single net amount, where positive, is payable to the party "in-the-money" regardless of whether or not it is the defaulting party, unless the parties have agreed that only the non-defaulting party is entitled to receive a termination payment where the net amount is positive and is in its favor. Effectively, contractual close-out netting reduces derivatives credit exposure from gross to net exposure. At September 30, 2013 , asset derivatives and liability derivatives of $251.2 million and $81.4 million , respectively, were subject to a master netting agreement, compared to $26.9 million and $7.8 million , respectively, at December 31, 2012 . The remaining derivatives included in the table above were not subject to a master netting agreement.

26
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)


The following table summarizes net realized gains (losses) recorded on the Company’s derivative instruments in the consolidated statements of income:
Three Months Ended
Nine Months Ended
Derivatives not designated as
September 30,
September 30,
hedging instruments
2013
2012
2013
2012
Futures contracts
$
(2,804
)
$
(245
)
$
6,990

$
(4,588
)
Foreign currency forward contracts
1,344

737

8,224

(206
)
TBAs
2,511

1,140

(699
)
2,882

Other
523

(1,335
)
2,327

(2,183
)
Total
$
1,574

$
297

$
16,842

$
(4,095
)
10. Income Taxes
ACGL is incorporated under the laws of Bermuda and, under current Bermuda law, is not obligated to pay any taxes in Bermuda based upon income or capital gains. The Company has received a written undertaking from the Minister of Finance in Bermuda under the Exempted Undertakings Tax Protection Act 1966 that, in the event that any legislation is enacted in Bermuda imposing any tax computed on profits, income, gain or appreciation on any capital asset, or any tax in the nature of estate duty or inheritance tax, such tax will not be applicable to ACGL or any of its operations until March 31, 2035. This undertaking does not, however, prevent the imposition of taxes on any person ordinarily resident in Bermuda or any company in respect of its ownership of real property or leasehold interests in Bermuda.
ACGL and its non-U.S. subsidiaries will be subject to U.S. federal income tax only to the extent that they derive U.S. source income that is subject to U.S. withholding tax or income that is effectively connected with the conduct of a trade or business within the U.S. and is not exempt from U.S. tax under an applicable income tax treaty with the U.S. ACGL and its non-U.S. subsidiaries will be subject to a withholding tax on dividends from U.S. investments and interest from certain U.S. payors (subject to reduction by any applicable income tax treaty). ACGL and its non-U.S. subsidiaries intend to conduct their operations in a manner that will not cause them to be treated as engaged in a trade or business in the United States and, therefore, will not be required to pay U.S. federal income taxes (other than U.S. excise taxes on insurance and reinsurance premium and withholding taxes on dividends and certain other U.S. source investment income). However, because there is uncertainty as to the activities which constitute being engaged in a trade or business within the United States, there can be no assurances that the U.S. Internal Revenue Service will not contend successfully that ACGL or its non-U.S. subsidiaries are engaged in a trade or business in the United States. If ACGL or any of its non-U.S. subsidiaries were subject to U.S. income tax, ACGL’s shareholders’ equity and earnings could be materially adversely affected. ACGL has subsidiaries and branches that operate in various jurisdictions around the world that are subject to tax in the jurisdictions in which they operate. The significant jurisdictions in which ACGL’s subsidiaries and branches are subject to tax are the United States, United Kingdom, Ireland, Canada, Switzerland and Denmark.
The Company’s income tax provision on income before income taxes resulted in an expense of 3.1% for the nine months ended September 30, 2013 , compared to an expense of 1.4% for the 2012 period. The Company’s effective tax rate, which is based upon the expected annual effective tax rate, may fluctuate from period to period based on the relative mix of income or loss reported by jurisdiction and the varying tax rates in each jurisdiction. The Company had a net deferred tax asset of $143.8 million at September 30, 2013 , compared to $98.6 million at December 31, 2012 . In addition, the Company paid $7.6 million in income taxes for the nine months ended September 30, 2013 , while the Company paid $4.1 million for the 2012 period.
The United States also imposes an excise tax on insurance and reinsurance premiums paid to non-U.S. insurers or reinsurers with respect to risks located in the United States. The Company incurs federal excise taxes on certain of its reinsurance transactions, including amounts ceded through intercompany transactions. The Company incurred $6.8 million of federal excise taxes for the nine months ended September 30, 2013 , compared to $6.2 million for the 2012 period. Such amounts are reflected as acquisition expenses in the Company’s consolidated statements of income.

27
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

11. Other Comprehensive Income (Loss)
The following table presents the changes in each component of accumulated other comprehensive income ("AOCI"), net of tax:

Unrealized Gains on Available-For-Sale Securities
Foreign Currency Translation Adjustments
Total
Three Months Ended September 30, 2013
Beginning balance
$
(12,753
)
$
(36,569
)
$
(49,322
)
Other comprehensive income before reclassifications
41,053

29,523

70,576

Amounts reclassified from accumulated other comprehensive income
20,701

—

20,701

Net current period other comprehensive income
61,754

29,523

91,277

Ending balance
$
49,001

$
(7,046
)
$
41,955

Nine Months Ended September 30, 2013
Beginning balance
$
289,957

$
(2,940
)
$
287,017

Other comprehensive income before reclassifications
(209,040
)
(4,106
)
(213,146
)
Amounts reclassified from accumulated other comprehensive income
(31,916
)
—

(31,916
)
Net current period other comprehensive income (loss)
(240,956
)
(4,106
)
$
(245,062
)
Ending balance
$
49,001

$
(7,046
)
$
41,955


The following table presents details about amounts reclassified from accumulated other comprehensive income:



Amounts Reclassed from AOCI
Details About AOCI Components
Consolidated Statement of Income Line Item That Includes Reclassification
Three Months Ended
Nine Months Ended
September 30, 2013
September 30, 2013
Unrealized Gains on Available-For-Sale Securities
Net realized gains (losses)
$
(21,825
)
$
37,176

Net impairment losses included in earnings
(901
)
(3,873
)
Total before tax
(22,726
)
33,303

Income tax benefit (expense)
2,025

(1,387
)
Net of tax
$
(20,701
)
$
31,916



28
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following table presents the tax effects allocated to each component of other comprehensive income (loss):

Before Tax Amount
Tax Expense (Benefit)
Net of Tax Amount
Three Months Ended September 30, 2013
Unrealized appreciation (decline) in value of investments:
Unrealized holding gains (losses) arising during period
$
41,122

$
(104
)
$
41,226

Portion of other-than-temporary impairment losses recognized in other comprehensive income (loss)
(173
)
—

(173
)
Less reclassification of net realized gains included in net income
(22,726
)
(2,025
)
(20,701
)
Foreign currency translation adjustments
29,523

—

29,523

Other comprehensive income (loss)
$
93,198

$
1,921

$
91,277

Three Months Ended September 30, 2012
Unrealized appreciation (decline) in value of investments:
Unrealized holding gains (losses) arising during period
$
170,287

$
5,554

$
164,733

Portion of other-than-temporary impairment losses recognized in other comprehensive income (loss)
(265
)
—

(265
)
Less reclassification of net realized gains included in net income
48,898

1,487

47,411

Foreign currency translation adjustments
16,420

2,442

13,978

Other comprehensive income (loss)
$
137,544

$
6,509

$
131,035

Nine Months Ended September 30, 2013
Unrealized appreciation (decline) in value of investments:
Unrealized holding gains (losses) arising during period
$
(229,921
)
$
(21,056
)
$
(208,865
)
Portion of other-than-temporary impairment losses recognized in other comprehensive income (loss)
(175
)
—

(175
)
Less reclassification of net realized gains included in net income
33,303

1,387

31,916

Foreign currency translation adjustments
(4,104
)
2

(4,106
)
Other comprehensive income (loss)
$
(267,503
)
$
(22,441
)
$
(245,062
)
Nine Months Ended September 30, 2012
Unrealized appreciation (decline) in value of investments:
Unrealized holding gains (losses) arising during period
$
272,487

$
(5,169
)
$
277,656

Portion of other-than-temporary impairment losses recognized in other comprehensive income (loss)
(776
)
—

(776
)
Less reclassification of net realized gains included in net income
125,041

6,327

118,714

Foreign currency translation adjustments
13,590

1,547

12,043

Other comprehensive income (loss)
$
160,260

$
(9,949
)
$
170,209



12. Legal Proceedings
The Company, in common with the insurance industry in general, is subject to litigation and arbitration in the normal course of its business. As of September 30, 2013 , the Company was not a party to any litigation or arbitration which is expected by management to have a material adverse effect on the Company’s results of operations and financial condition and liquidity.

29

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following is a discussion and analysis of our financial condition and results of operations. This should be read in conjunction with our consolidated financial statements included in Item 1 of this report and also our Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended December 31, 2012 (“2012 Form 10-K”). In addition, readers should review “Risk Factors” set forth in Item 1A of Part I of our 2012 Form 10-K. Tabular amounts are in U.S. Dollars in thousands, except share amounts, unless otherwise noted.
Arch Capital Group Ltd. (“ACGL” and, together with its subsidiaries, “we” or “us”) is a Bermuda public limited liability company with approximately $5.84 billion in capital at September 30, 2013 and, through operations in Bermuda, the United States, Europe and Canada, writes insurance and reinsurance on a worldwide basis. While we are positioned to provide a full range of property and casualty insurance and reinsurance lines, we focus on writing specialty lines of insurance and reinsurance. It is our belief that our underwriting platform, our experienced management team and our strong capital base that is unencumbered by significant pre-2002 risks have enabled us to establish a strong presence in the insurance and reinsurance markets.
Current Outlook
The broad market environment continued to show improvement in the 2013 third quarter , although rate increases moderated somewhat relative to earlier in 2013. In our U.S. insurance business, weighted rate increases provided 1.7% of expected margin improvement (i.e., rates in excess of loss cost trends) in the 2013 third quarter . We expanded our insurance underwriting platform in the excess and surplus lines market in March 2013 by starting a binding authority insurance facility that caters to smaller accounts through the wholesale distribution channel. This group immediately began contributing to our premiums and continues to gain traction across Arch's distribution platform. On an absolute basis, we believe that most longer-tail casualty business still requires rate improvement to meet our return objectives but some segments are approaching rate adequacy. In our reinsurance business, we see pressure on terms and conditions in property catastrophe business, where alternative capacity is putting pressure on rates. In addition, cedents have pressed for additional ceding commissions (generally one to two points) and are moving to excess of loss instead of pro rata coverage. Our underwriting teams continue to execute a disciplined strategy by emphasizing small and medium-sized accounts over large accounts and focusing more on short-tail business.
Our objective is to achieve an average operating return on average equity of 15% or greater over the insurance cycle, which we believe to be an attractive return to our common shareholders given the risks we assume. We continue to look for opportunities to find acceptable books of business to underwrite without sacrificing underwriting discipline and continue to write a significant portion of our overall book in catastrophe-exposed business which has the potential to increase the volatility of our operating results.
The current economic conditions could continue to have a material impact on the frequency and severity of claims and, therefore, could negatively impact our underwriting returns. In addition, volatility in the financial markets could continue to significantly affect our investment returns, reported results and shareholders’ equity. We consider the potential impact of economic trends in the estimation process for establishing unpaid losses and loss adjustment expenses and in determining our investment strategies.
In addition, the impact of the continuing weakness of the U.S., European countries and other key economies, projected budget deficits for the U.S., European countries and other governments and the consequences associated with possible additional downgrades of securities of the U.S., European countries and other governments by credit rating agencies is inherently unpredictable and could have a material adverse effect on financial markets and economic conditions in the U.S. and throughout the world. In turn, this could have a material adverse effect on our business, financial condition and results of operations and, in particular, this could have a material adverse effect on the value of securities in our investment portfolio.
Natural Catastrophe Risk
We monitor our natural catastrophe risk globally for all perils and regions, in each case, where we believe there is significant exposure. Our models employ both proprietary and vendor-based systems and include cross-line correlations for property, marine, offshore energy, aviation, workers compensation and personal accident. Currently, we seek to limit our 1-in-250 year return period net probable maximum pre-tax loss from a severe catastrophic event in any geographic zone to approximately 25% of total shareholders’ equity. We reserve the right to change this threshold at any time. Based on in-force exposure estimated as of October 1, 2013 , our modeled peak zone catastrophe exposure was a windstorm affecting the

30

Northeastern U.S., with a net probable maximum pre-tax loss of $868 million , followed by windstorms affecting the Gulf of Mexico and Florida Tri-County with net probable maximum pre-tax losses of $736 million and $615 million , respectively. Based on in-force exposure estimated as of July 1, 2013 , our modeled peak zone exposure was a windstorm affecting the Northeastern U.S., with a net probable maximum pre-tax loss of $858 million , followed by windstorms affecting the Gulf of Mexico and Florida Tri-County with net probable maximum pre-tax losses of $746 million and $606 million , respectively. Our exposures to other perils, such as U.S. earthquake and international events, was less than the exposures arising from U.S. windstorms and hurricanes in both periods. As of October 1, 2013 , our modeled peak zone earthquake exposure ( New Madrid earthquake ) represented less than 45% of our peak zone catastrophe exposure, and our modeled peak zone international exposure ( Japan earthquake ) was substantially less than both our peak zone windstorm and earthquake exposures. Net probable maximum pre-tax loss estimates are net of expected reinsurance recoveries, before income tax and before excess reinsurance reinstatement premiums. Loss estimates are reflective of the zone indicated and not the entire portfolio. Since hurricanes and windstorms can affect more than one zone and make multiple landfalls, our loss estimates include clash estimates from other zones.
The loss estimates shown above do not represent our maximum exposures and it is highly likely that our actual incurred losses would vary materially from the modeled estimates. There can be no assurances that we will not suffer a net loss greater than 25% of our total shareholders’ equity from one or more catastrophic events due to several factors, including the inherent uncertainties in estimating the frequency and severity of such events and the margin of error in making such determinations resulting from potential inaccuracies and inadequacies in the data provided by clients and brokers, the modeling techniques and the application of such techniques or as a result of a decision to change the percentage of shareholders’ equity exposed to a single catastrophic event. Actual losses may also increase if our reinsurers fail to meet their obligations to us or the reinsurance protections purchased by us are exhausted or are otherwise unavailable. See “Risk Factors—Risk Relating to Our Industry” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Natural and Man-Made Catastrophic Events” in our 2012 Form 10-K.
Financial Measures
Management uses the following three key financial indicators in evaluating our performance and measuring the overall growth in value generated for ACGL’s common shareholders:
Book Value per Common Share
Book value per common share represents total common shareholders’ equity divided by the number of common shares outstanding. Management uses growth in book value per common share as a key measure of the value generated for our common shareholders each period and believes that book value per common share is the key driver of ACGL’s share price over time. Book value per common share is impacted by, among other factors, our underwriting results, investment returns and share repurchase activity, which has an accretive or dilutive impact on book value per common share depending on the purchase price. Book value per common share was $38.34 at September 30, 2013 , compared to $36.80 at June 30, 2013 and $36.79 at September 30, 2012 . The 4.2% increase in the 2013 third quarter and trailing twelve months was primarily driven by strong underwriting results.
Operating Return on Average Common Equity
Operating return on average common equity (“Operating ROAE”) represents annualized after-tax operating income available to common shareholders divided by the average of beginning and ending common shareholders’ equity during the period. After-tax operating income available to common shareholders, a “non-GAAP measure” as defined in the SEC rules, represents net income available to common shareholders, excluding net realized gains or losses, net impairment losses recognized in earnings, equity in net income or loss of investment funds accounted for using the equity method, net foreign exchange gains or losses and loss on repurchase of preferred shares, net of income taxes. Management uses Operating ROAE as a key measure of the return generated to common shareholders and has set an objective to achieve an average Operating ROAE of 15% or greater over the insurance cycle, which it believes to be an attractive return to common shareholders given the risks we assume. See “Comment on Non-GAAP Financial Measures.” Our Operating ROAE was 11.9% for the 2013 third quarter , compared to 9.9% for the 2012 third quarter , and 11.9% for the nine months ended September 30, 2013 , compared to 10.8% for the 2012 period. The higher level of Operating ROAE for the 2013 periods primarily resulted from better underwriting results in our reinsurance and insurance segments.

31

Total Return on Investments
Total return on investments includes investment income, equity in net income or loss of investment funds accounted for using the equity method, net realized gains and losses and the change in unrealized gains and losses generated by our investment portfolio. Total return is calculated on a pre-tax basis and before investment expenses and includes the effect of financial market conditions along with foreign currency fluctuations. Management uses total return on investments as a key measure of the return generated to common shareholders on the capital held in the business, and compares the return generated by our investment portfolio against benchmark returns which we measured our portfolio against during the periods. The benchmark return is a weighted average of the benchmarks assigned to each of our investment managers and vary based on the nature of the portfolios under management.
The benchmark return index is a customized combination of indices intended to approximate a target portfolio by asset mix and average credit quality while also matching the approximate estimated duration and currency mix of our insurance and reinsurance liabilities. Although the estimated duration and average credit quality of this index will move as the duration and rating of its constituent securities change, generally we do not adjust the composition of the benchmark return index. The benchmark return index should not be interpreted as expressing a preference for or aversion to any particular sector or sector weight. The index is intended solely to provide, unlike many master indices that change based on the size of their constituent indices, a relatively stable basket of investable indices.

At September 30, 2013 , the benchmark return index had an average credit quality of “ Aa2 ” by Moody’s Investors Service (“Moody’s”), an estimated duration of 3.56 years and included weightings to the following indices:
Weighting
The Bank of America Merrill Lynch 1-10 Year U.S. Treasury & Agency Index
30.875
%
The Bank of America Merrill Lynch 1-10 Year AA U.S. Corporate & Yankees Index
20.875
%
The Bank of America Merrill Lynch U.S. Mortgage Backed Securities Index
11.875
%
Barclays Capital CMBS, AAA Index
10.000
%
The Bank of America Merrill Lynch 1-10 Year U.S. Municipal Securities Index
7.125
%
MSCI World Free Index
5.000
%
The Bank of America Merrill Lynch 0-3 Month U.S. Treasury Bill Index
4.750
%
The Bank of America Merrill Lynch U.S. High Yield Constrained Index
2.375
%
Barclays Capital U.S. High-Yield Corporate Loan Index
2.375
%
The Bank of America Merrill Lynch 1-10 Year U.K. Gilt Index
2.375
%
The Bank of America Merrill Lynch 1-10 Year Euro Government Index
2.375
%
Total
100.000
%
The following table summarizes the pre-tax total return (before investment expenses) of our investment portfolio compared to the benchmark return against which we measured our portfolio during the periods:
Arch
Portfolio
Benchmark
Return
Pre-tax total return (before investment expenses):


2013 third quarter
1.43
%
1.36
%
2012 third quarter
2.45
%
1.86
%
Nine Months Ended September 30, 2013
0.31
%
0.38
%
Nine Months Ended September 30, 2012
5.04
%
4.34
%
Total return for the 2013 periods reflected positive returns of our equity and alternatives portfolios, partially offset by the impact of both higher interest rates and wider credit spreads compared to the 2012 periods. Excluding foreign exchange, total return was 0.84% for the 2013 third quarter , compared to 2.17% for the 2012 third quarter , and 0.27% for the nine months ended September 30, 2013 , compared to 4.89% for the 2012 period.

32

Comment on Non-GAAP Financial Measures
Throughout this filing, we present our operations in the way we believe will be the most meaningful and useful to investors, analysts, rating agencies and others who use our financial information in evaluating the performance of our company. This presentation includes the use of after-tax operating income available to common shareholders, which is defined as net income available to common shareholders, excluding net realized gains or losses, net impairment losses recognized in earnings, equity in net income or loss of investment funds accounted for using the equity method, net foreign exchange gains or losses and loss on repurchase of preferred shares, net of income taxes. The presentation of after-tax operating income available to common shareholders is a “non-GAAP financial measure” as defined in Regulation G. The reconciliation of such measure to net income available to common shareholders (the most directly comparable GAAP financial measure) in accordance with Regulation G is included under “Results of Operations” below.
We believe that net realized gains or losses, net impairment losses recognized in earnings, equity in net income or loss of investment funds accounted for using the equity method, net foreign exchange gains or losses and loss on repurchase of preferred shares in any particular period are not indicative of the performance of, or trends in, our business. Although net realized gains or losses, net impairment losses recognized in earnings, equity in net income or loss of investment funds accounted for using the equity method and net foreign exchange gains or losses are an integral part of our operations, the decision to realize investment gains or losses, the recognition of the change in the carrying value of investments accounted for using the fair value option in net realized gains or losses, the recognition of net impairment losses, the recognition of equity in net income or loss of investment funds accounted for using the equity method and the recognition of foreign exchange gains or losses are independent of the insurance underwriting process and result, in large part, from general economic and financial market conditions. Furthermore, certain users of our financial information believe that, for many companies, the timing of the realization of investment gains or losses is largely opportunistic. In addition, net impairment losses recognized in earnings on our investments represent other-than-temporary declines in expected recovery values on securities without actual realization. The use of the equity method on certain of our investments in certain funds that invest in fixed maturity securities is driven by the ownership structure of such funds (either limited partnerships or limited liability companies). In applying the equity method, these investments are initially recorded at cost and are subsequently adjusted based on our proportionate share of the net income or loss of the funds (which include changes in the market value of the underlying securities in the funds). This method of accounting is different from the way we account for our other fixed maturity securities and the timing of the recognition of equity in net income or loss of investment funds accounted for using the equity method may differ from gains or losses in the future upon sale or maturity of such investments. The loss on repurchase of preferred shares related to the redemption of the Series A and B preferred shares in April 2012 and had no impact on total shareholders' equity or cash flows. Due to these reasons, we exclude net realized gains or losses, net impairment losses recognized in earnings, equity in net income or loss of investment funds accounted for using the equity method, net foreign exchange gains or losses and loss on repurchase of preferred shares from the calculation of after-tax operating income available to common shareholders.
We believe that showing net income available to common shareholders exclusive of the items referred to above reflects the underlying fundamentals of our business since we evaluate the performance of and manage our business to produce an underwriting profit. In addition to presenting net income available to common shareholders, we believe that this presentation enables investors and other users of our financial information to analyze our performance in a manner similar to how management analyzes performance. We also believe that this measure follows industry practice and, therefore, allows the users of financial information to compare our performance with our industry peer group. We believe that the equity analysts and certain rating agencies which follow us and the insurance industry as a whole generally exclude these items from their analyses for the same reasons.

33

RESULTS OF OPERATIONS
The following table summarizes, on an after-tax basis, our consolidated financial data, including a reconciliation of after-tax operating income available to common shareholders to net income available to common shareholders:
Three Months Ended
Nine Months Ended
September 30,
September 30,
2013
2012
2013
2012
After-tax operating income available to common shareholders
$
149,205

$
120,247

$
442,974

$
375,307

Net realized gains (losses), net of tax
(3,442
)
58,904

65,260

133,052

Net impairment losses recognized in earnings, net of tax
(728
)
(2,379
)
(3,698
)
(5,353
)
Equity in net income of investment funds accounted for using the equity method, net of tax
5,665

24,330

30,429

56,943

Net foreign exchange losses, net of tax
(41,359
)
(16,930
)
(3,177
)
(5,363
)
Loss on repurchase of preferred shares, net of tax
—

—

—

(10,612
)
Net income available to common shareholders
$
109,341

$
184,172

$
531,788

$
543,974


Segment Information
We classify our businesses into two underwriting segments — insurance and reinsurance — and corporate and other (non-underwriting). Management measures segment performance based on underwriting income or loss. We do not manage our assets by segment and, accordingly, investment income is not allocated to each underwriting segment. In addition, other revenue and expense items are not evaluated by segment.
Insurance Segment
The following table sets forth our insurance segment’s underwriting results:
Three Months Ended September 30,
Nine Months Ended September 30,
2013
2012
% Change
2013
2012
% Change
Gross premiums written
$
682,839

$
658,599

3.7

$
2,075,560

$
2,022,802

2.6

Net premiums written
501,971

483,356

3.9

1,508,089

1,438,620

4.8

Net premiums earned
$
479,129

$
456,341

5.0

$
1,382,750

$
1,344,675

2.8

Fee income
545

645


1,599

1,803


Losses and loss adjustment expenses
(305,921
)
(307,155
)

(880,580
)
(900,735
)

Acquisition expenses, net
(82,799
)
(73,663
)

(227,806
)
(223,591
)

Other operating expenses
(75,734
)
(75,379
)

(232,216
)
(225,366
)

Underwriting income (loss)
$
15,220

$
789

n/m

$
43,747

$
(3,214
)
n/m

Underwriting Ratios


% Point
Change


% Point
Change
Loss ratio
63.8
%
67.3
%
(3.5
)
63.7
%
67.0
%
(3.3
)
Acquisition expense ratio (1)
17.2
%
16.0
%
1.2

16.4
%
16.5
%
(0.1
)
Other operating expense ratio
15.8
%
16.5
%
(0.7
)
16.8
%
16.8
%
—

Combined ratio
96.8
%
99.8
%
(3.0
)
96.9
%
100.3
%
(3.4
)
_________________________________________________
(1)     The acquisition expense ratio is adjusted to include certain fee income.


34

Premiums Written .
The following table sets forth our insurance segment’s net premiums written by major line of business:
Three Months Ended September 30,
Nine Months Ended September 30,
2013
2012
2013
2012
Amount
%
Amount
%
Amount
%
Amount
%
Programs
$
116,399

23

$
98,052

20

$
339,895

23

$
272,666

19

Property, energy, marine and aviation
77,201

15

92,266

19

242,487

16

258,475

18

Professional liability
57,367

11

68,923

14

179,289

12

204,682

14

Executive assurance
56,410

11

63,059

13

160,483

11

191,642

13

Construction
29,927

6

23,481

5

127,557

8

106,918

7

Casualty
29,311

6

23,662

5

79,343

5

81,273

6

National accounts
18,618

4

22,483

5

77,376

5

62,882

4

Lenders products
16,848

3

20,257

4

61,361

4

63,149

4

Surety
17,324

3

14,958

3

50,081

3

39,815

3

Travel and accident
14,068

3

22,017

5

47,283

3

65,147

5

Healthcare
10,227

2

8,722

2

30,247

2

27,316

2

Other (1)
58,271

13

25,476

5

112,687

8

64,655

5

Total
$
501,971

100

$
483,356

100

$
1,508,089

100

$
1,438,620

100

_________________________________________________
(1)
Includes alternative markets, contract binding, accident and health and excess workers’ compensation business.
2013 third quarter versus 2012 . Net premiums written were 3.9% higher than in the 2012 third quarter with increases in programs, contract binding (launched in March 2013), excess workers' compensation, construction and accident and health lines, partially offset by a reduction in property lines, professional liability, executive assurance and travel premiums. The increase in program business resulted from a mix of new business, underlying exposure growth within existing programs and rate increases. Growth in excess workers' compensation and accident and health primarily resulted from new business while the higher level of construction business resulted from expanded product lines, new business and rate increases. The decrease in property lines reflected reductions in offshore and onshore energy, property and marine business in response to current market conditions while the lower level of professional liability and executive assurance business resulted from a continued strategic reduction in exposure to international business. The decline in travel premiums was due in part to a change in distribution strategy at the end of 2012.

Nine Months Ended September 30, 2013 versus 2012 . Net premiums written were 4.8% higher than in the 2012 period with increases in programs, contract binding, construction and accident and health lines, partially offset by reduction in executive assurance, professional liability, travel and property premiums. The increase in program business resulted from a mix of new business, underlying exposure growth within existing programs and rate increases. The increase in construction business resulted from expanded product lines, new business and rate increases while growth in accident and health primarily resulted from new business. The lower level of executive assurance and professional liability business resulted from a continued strategic reduction in exposure to international business, while the decline in travel premiums was due in part to a change in distribution strategy at the end of 2012. The decrease in property lines reflected reductions in offshore and onshore energy, property and marine business in response to current market conditions.


35

Net Premiums Earned .
The following table sets forth our insurance segment’s net premiums earned by major line of business:
Three Months Ended September 30,
Nine Months Ended September 30,
2013
2012
2013
2012
Amount
%
Amount
%
Amount
%
Amount
%
Programs
$
103,603

22

$
83,978

18

$
293,247

21

$
238,565

18

Property, energy, marine and aviation
77,437

16

77,862

17

227,420

16

233,946

17

Professional liability
58,948

12

66,299

15

177,002

13

197,572

15

Executive assurance
54,628

11

61,599

13

168,322

12

181,221

13

Construction
37,378

8

32,409

7

109,868

8

95,909

7

Casualty
26,146

5

27,175

6

76,430

6

84,342

6

National accounts
27,957

6

21,919

5

73,542

5

59,470

4

Lenders products
20,220

4

20,271

4

62,032

4

73,835

5

Surety
15,023

3

12,643

3

42,512

3

34,001

3

Travel and accident
12,953

3

21,826

5

43,751

3

59,200

4

Healthcare
10,445

2

9,565

2

28,894

2

27,540

2

Other (1)
34,391

8

20,795

5

79,730

7

59,074

6

Total
$
479,129

100

$
456,341

100

$
1,382,750

100

$
1,344,675

100

_________________________________________________
(1)
Includes alternative markets, contract binding, accident and health and excess workers’ compensation business.
Net premiums written are primarily earned on a pro rata basis over the terms of the policies for all products, usually 12 months. Net premiums earned reflect changes in net premiums written over the previous five quarters.
Losses and Loss Adjustment Expenses .
The table below shows the components of the insurance segment’s loss ratio:
Three Months Ended
Nine Months Ended
September 30,
September 30,
2013
2012
2013
2012
Current year
67.5
%
69.6
%
66.5
%
69.1
%
Prior period reserve development
(3.7
)%
(2.3
)%
(2.8
)%
(2.1
)%
Loss ratio
63.8
%
67.3
%
63.7
%
67.0
%
Current Year Loss Ratio .
The insurance segment’s current year loss ratio was 2.1 points lower in the 2013 third quarter compared to the 2012 third quarter and 2.6 points lower for the nine months ended September 30, 2013 than in the 2012 period. The 2013 third quarter loss ratio reflected 2.6 points of current year catastrophic activity, compared to 3.1 points for the 2012 third quarter . The loss ratio for the nine months ended September 30, 2013 reflected 1.4 points of catastrophic activity, compared to 1.4 points for the 2012 period. The loss ratios for the 2013 periods reflected continued margin expansion and changes in the mix of business earned.

Prior Period Reserve Development .
2013 third quarter : The insurance segment’s net favorable development of $17.5 million , or 3.7 points, consisted of $24.9 million of net favorable development in short-tailed lines and $7.4 million of net adverse development in medium-tailed and long-tailed lines. Favorable development in short-tailed lines primarily consisted of reductions in property (including special risk other than marine) reserves from the 2007 to 2012 accident years ( i.e. , the year in which a loss occurred), primarily due to varying levels of reported claims activity. Development on the 2005 to 2012 named catastrophic events was favorable by $6.9 million in the quarter. Net adverse development in medium-tailed and long-tailed lines reflected increases of $16.3 million in program reserves, primarily due to a small number of programs, $4.5 million in casualty reserves, primarily from the 2006 and 2008 accident years, and $5.2 million in construction reserves, spread between the 2007 to 2010 accident years. Such amounts were partially offset by reductions of $7.4 million in healthcare reserves, $4.7 million in executive assurance reserves and $4.6 million in excess workers' compensation reserves, all spread across various accident years.


36

2012 third quarter : The insurance segment’s net favorable development of $10.3 million , or 2.3 points, consisted of net favorable development of $9.9 million in short-tailed lines and $0.4 million in medium-tailed and long-tailed lines. Favorable development in short-tailed lines primarily consisted of reductions in property (including special risk other than marine) reserves from the 2007 to 2010 accident years, primarily due to varying levels of reported claims activity. Favorable development in medium-tailed and long-tailed lines reflected a reduction of $15.6 million in professional liability reserves, primarily from the 2006 to 2010 accident years, partially offset by increases of $6.3 million in casualty reserves, primarily from the 2003 to 2005 accident years, $5.3 million in executive assurance reserves in the 2007 to 2011 accident years, and $2.7 million in programs, spread across a number of years.

Nine Months Ended September 30, 2013 : The insurance segment’s net favorable development of $38.5 million , or 2.8 points, consisted of $52.7 million of net favorable development in short-tailed lines, partially offset by $14.2 million of net adverse development in medium-tailed and long-tailed lines. Favorable development in short-tailed lines primarily consisted of reductions in property (including special risk other than marine) reserves from the 2008 to 2011 accident years, primarily due to varying levels of reported claims activity. Development on the 2005 to 2012 named catastrophic events was favorable by $15.5 million in the period. Net adverse development in medium-tailed and long-tailed lines included increases of $19.1 million in program reserves, primarily due to a small number of programs, $14.9 million in casualty reserves, primarily related to claims from the two most recent accident years on certain Canadian accounts which have been non-renewed, and $10.5 million in construction reserves, spread between the 2007 to 2010 accident years, partially offset by reductions of $14.9 million in healthcare reserves, $4.6 million in national accounts, $4.5 million in marine, and $4.2 million in excess workers' compensation, all spread across various accident years.

Nine Months Ended September 30, 2012 : The insurance segment’s net favorable development of $28.0 million , or 2.1 points, consisted of net favorable development of $47.3 million in short-tailed lines, partially offset by $19.3 million of net adverse development in medium-tailed and long-tailed lines. Favorable development in short-tailed lines primarily consisted of reductions in property (including special risk other than marine) reserves from the 2007 to 2011 accident years, primarily due to varying levels of reported claims activity. Adverse development in medium-tailed and long-tailed lines included increases of $21.1 million in executive assurance reserves, primarily from the 2007 to 2011 accident years, $17.5 million in casualty reserves, primarily from the 2004 to 2008 accident years, and $8.5 million in construction reserves, primarily from the 2007 to 2009 accident years. Such amounts were partially offset by favorable development of $19.3 million in professional liability reserves, primarily from the 2009 accident year, and $9.9 million in healthcare reserves across most accident years.
Underwriting Expenses .
2013 third quarter versus 2012 : The insurance segment’s underwriting expense ratio was 33.0% in the 2013 third quarter , compared to 32.5% in the 2012 third quarter . The acquisition expense ratio was 17.2% in the 2013 third quarter , compared to 16.0% in the 2012 third quarter . The comparison of the 2013 third quarter and 2012 third quarter acquisition expense ratios is influenced by, among other things, the mix and type of business written and earned and the level of ceding commissions. In addition, the acquisition expense ratio was impacted by changes in development of prior year ceded loss reserves which increased the 2013 third quarter commission expense ratio by 0.9 points, compared to a 0.6 point reduction in the 2012 third quarter . The other operating expense ratio was 15.8% for the 2013 third quarter , compared to 16.5% for the 2012 third quarter . The 2013 third quarter operating expense ratio benefited from the higher level of net premiums earned as aggregate expenses were in line with the 2012 third quarter .
Nine Months Ended September 30, 2013 versus 2012 : The insurance segment’s underwriting expense ratio was 33.2% for the 2013 period, compared to 33.3% for the 2012 period. The acquisition expense ratio was 16.4% for the 2013 period, compared to 16.5% for the 2012 period. The acquisition expense ratio for the 2013 period included 0.4 points of commission expense related to development in prior year loss reserves, compared to 0.1 point in the 2012 period. The other operating expense ratio was 16.8% for the 2013 period, compared to 16.8% for the 2012 period.


37

Reinsurance Segment
The following table sets forth our reinsurance segment’s underwriting results:
Three Months Ended September 30,
Nine Months Ended September 30,
2013
2012
% Change
2013
2012
% Change
Gross premiums written
$
355,091

$
279,751

26.9

$
1,168,938

$
1,036,708

12.8

Net premiums written
337,164

271,893

24.0

1,094,357

1,000,473

9.4

Net premiums earned
$
315,871

$
292,350

8.0

$
923,836

$
810,984

13.9

Fee income
(19
)
432


367

623


Losses and loss adjustment expenses
(121,124
)
(136,716
)

(364,521
)
(338,036
)

Acquisition expenses, net
(64,514
)
(54,402
)

(178,776
)
(151,725
)

Other operating expenses
(34,442
)
(29,001
)

(101,234
)
(84,264
)

Underwriting income
$
95,772

$
72,663

31.8

$
279,672

$
237,582

17.7

Underwriting Ratios


% Point
Change


% Point
Change
Loss ratio
38.3
%
46.8
%
(8.5
)
39.5
%
41.7
%
(2.2
)
Acquisition expense ratio
20.4
%
18.6
%
1.8

19.4
%
18.7
%
0.7

Other operating expense ratio
10.9
%
9.9
%
1.0

11.0
%
10.4
%
0.6

Combined ratio
69.6
%
75.3
%
(5.7
)
69.9
%
70.8
%
(0.9
)

Premiums Written .
The following table sets forth our reinsurance segment’s net premiums written by major line of business:
Three Months Ended September 30,
Nine Months Ended September 30,
2013
2012
2013
2012
Amount
%
Amount
%
Amount
%
Amount
%
Other specialty (1)
$
125,666

37

$
71,854

26

$
318,483

29

$
240,727

24

Property excluding property catastrophe (2)
78,085

23

68,627

25

230,083

21

209,854

21

Property catastrophe
33,810

10

50,196

18

210,826

19

265,994

27

Casualty (3)
58,893

17

36,831

14

207,640

19

163,343

16

Marine and aviation
13,283

4

19,152

7

50,744

5

63,611

6

Other (4)
27,427

9

25,233

10

76,581

7

56,944

6

Total
$
337,164

100

$
271,893

100

$
1,094,357

100

$
1,000,473

100

Pro rata
$
233,334

69

$
170,556

63

$
536,290

49

$
439,435

44

Excess of loss
103,830

31

101,337

37

558,067

51

561,038

56

Total
$
337,164

100

$
271,893

100

$
1,094,357

100

$
1,000,473

100

_________________________________________________
(1)
Includes U.K. motor, trade credit, surety, workers’ compensation catastrophe, accident and health and other.
(2)
Includes facultative business.
(3)
Includes professional liability, executive assurance and healthcare business.
(4)
Includes mortgage, life, casualty clash and other.

2013 third quarter versus 2012 . Net premiums written were 24.0% higher than in the 2012 third quarter , reflecting increases in other specialty, and new business written in casualty multi-line and property facultative lines, partially offset by reductions in property catastrophe. Growth in other specialty premiums primarily resulted from the impact of a multi-line quota share reinsurance agreement entered into during the 2013 third quarter , covering certain brokerage commercial automobile liability, commercial multi-peril property, commercial multi-peril liability and other liability business. Such agreement resulted in $55.2 million of premiums written, including a $39.7 million unearned premium transfer from policies in-force at June 30, 2013, and is not expected to recur in 2014. In addition, other specialty premiums reflected growth in trade credit and crop hail business, partially offset by a continued reduction in U.K. motor business. The reduction in property catastrophe business reflected market conditions, selected non-renewals and a higher usage of retrocessional coverage.

Nine Months Ended September 30, 2013 versus 2012 . Net premiums written were 9.4% higher than in the 2012 period, reflecting increases in other specialty, casualty and mortgage business, partially offset by reductions in property catastrophe business. The growth in other specialty business primarily resulted from the other specialty reinsurance transaction noted above

38

along with renewals of the credit and surety business acquired from Ariel Reinsurance Company Ltd. ("Ariel") in April 2012, partially offset by a lower level of U.K. motor business. The increase in casualty business primarily resulted from new multi-line and professional liability contracts written in the period. The reduction in property catastrophe business was due to rate reductions as well as to a targeted reduction in the utilization of limits in reaction to changing market conditions and an increase in the usage of retrocessional protection.
Net Premiums Earned .
The following table sets forth our reinsurance segment’s net premiums earned by major line of business:
Three Months Ended September 30,
Nine Months Ended September 30,
2013
2012
2013
2012
Amount
%
Amount
%
Amount
%
Amount
%
Other specialty (1)
$
103,565

33

$
88,570

30

$
272,666

30

$
214,622

26

Property excluding property catastrophe (2)
69,975

22

63,572

22

201,857

22

183,924

23

Property catastrophe
48,595

15

69,059

24

176,160

19

199,914

25

Casualty (3)
59,324

19

47,429

16

169,251

18

140,240

17

Marine and aviation
18,566

6

16,853

6

59,062

6

57,502

7

Other (4)
15,846

5

6,867

2

44,840

5

14,782

2

Total
$
315,871

100

$
292,350

100

$
923,836

100

$
810,984

100

Pro rata
$
172,703

55

$
140,111

48

$
468,509

51

$
364,977

45

Excess of loss
143,168

45

152,239

52

455,327

49

446,007

55

Total
$
315,871

100

$
292,350

100

$
923,836

100

$
810,984

100

_________________________________________________
(1)
Includes U.K. motor, trade credit, surety, workers’ compensation catastrophe, accident and health and other.
(2)
Includes facultative business.
(3)
Includes professional liability, executive assurance and healthcare business.
(4)
Includes mortgage, life, casualty clash and other.
Net premiums written, irrespective of the class of business, are generally earned on a pro rata basis over the terms of the underlying policies or reinsurance contracts. Net premiums earned reflect changes in net premiums written over the previous five quarters, including the mix and type of business written. Net premiums earned in the 2013 periods included $15.2 million related to the other specialty reinsurance transaction noted above.

Losses and Loss Adjustment Expenses .
The table below shows the components of the reinsurance segment’s loss ratio:
Three Months Ended
Nine Months Ended
September 30,
September 30,
2013
2012
2013
2012
Current year
54.6
%
60.6
%
56.2
%
58.9
%
Prior period reserve development
(16.3
)%
(13.8
)%
(16.7
)%
(17.2
)%
Loss ratio
38.3
%
46.8
%
39.5
%
41.7
%
Current Year Loss Ratio .
The reinsurance segment’s current year loss ratio was 6.0 points lower in the 2013 third quarter compared to the 2012 third quarter and 2.7 points lower for the nine months ended September 30, 2013 than in the 2012 period. The 2013 third quarter loss ratio reflected 2.2 points related to current year catastrophic activity, compared to 4.6 points of catastrophic activity in the 2012 third quarter . The loss ratio for the nine months ended September 30, 2013 reflected 5.2 points of catastrophic activity, compared to 4.8 points for the 2012 period. The current year loss ratio for the 2013 periods also reflect changes in the mix of business earned including a higher contribution from mortgage business when compared to the 2012 periods.

39

Prior Period Reserve Development .
2013 third quarter : The reinsurance segment’s net favorable development of $51.4 million , or 16.3 points, consisted of $29.0 million from short-tailed lines, $21.5 million from long-tailed lines and $0.9 million from medium-tailed lines. Favorable development in short-tailed lines included $23.5 million from property catastrophe and property other than property catastrophe reserves, primarily from the 2010 to 2012 underwriting years ( i.e. , all premiums and losses attributable to contracts having an inception or renewal date within the given twelve-month period). Contained within this amount was favorable development from the 2005 to 2012 named catastrophic events of $8.4 million. The net reduction of loss estimates for the reinsurance segment's short-tailed lines primarily resulted from varying levels of reported and paid claims activity than previously anticipated which led to decreases in certain loss ratio selections during the period. Favorable development in long-tailed lines reflected reductions in casualty reserves, primarily from the 2002 to 2008 underwriting years based on varying levels of reported and paid claims activity.
2012 third quarter : The reinsurance segment’s net favorable development of $40.2 million , or 13.8 points, consisted of $23.8 million from short-tailed lines and $16.4 million of net favorable development from medium-tailed and long-tailed lines. Favorable development in short-tailed lines included $16.5 million from property catastrophe and property other than property catastrophe reserves, primarily from the 2008 to 2011 underwriting years. The net reduction of loss estimates for the reinsurance segment's short-tailed lines primarily resulted from varying levels of reported and paid claims activity than previously anticipated which led to decreases in certain loss ratio selections during the period. Net favorable development of $16.4 million in medium-tailed and long-tailed lines included reductions in casualty reserves of $11.5 million, primarily from the 2003 to 2006 underwriting years, and $4.5 million in marine and aviation reserves, spread across various underwriting years.

Nine Months Ended September 30, 2013 : The reinsurance segment’s net favorable development of $154.3 million , or 16.7 points, consisted of $87.0 million of net favorable development in short-tailed lines, $57.8 million from long-tailed lines and $9.5 million from medium-tailed lines. Favorable development in short-tailed lines included $92.5 million from property catastrophe and property other than property catastrophe reserves, primarily from the 2008 to 2012 underwriting years. Contained within this amount was favorable development from the 2005 to 2012 named catastrophic events of $27.6 million. The net reduction of loss estimates for the reinsurance segment's short-tailed lines primarily resulted from varying levels of reported and paid claims activity than previously anticipated which led to decreases in certain loss ratio selections during the period. Such amounts were partially offset by an increase in estimates for U.S. crop hail losses of $8.6 million. Favorable development in long-tailed lines reflected reductions in casualty reserves, primarily from the 2002 to 2008 underwriting years based on varying levels of reported and paid claims activity, while favorable development in medium-tailed lines was across most underwriting years.

Nine Months Ended September 30, 2012 : The reinsurance segment’s net favorable development of $139.6 million , or 17.2 points, consisted of $83.9 million from short-tailed lines and $55.7 million of net favorable development from medium-tailed and long-tailed lines. Favorable development in short-tailed lines included $63.7 million from property catastrophe and property other than property catastrophe reserves, primarily from the 2008 to 2011 underwriting years. The net reduction of loss estimates for the reinsurance segment's short-tailed lines primarily resulted from varying levels of reported and paid claims activity than previously anticipated which led to decreases in certain loss ratio selections during the period. Net favorable development of $55.7 million in medium-tailed and long-tailed lines included reductions in casualty reserves of $42.1 million, primarily from the 2003 to 2006 underwriting years, and $13.0 million in marine and aviation reserves, spread across various underwriting years.
Underwriting Expenses .
2013 third quarter versus 2012 : The underwriting expense ratio for the reinsurance segment was 31.3% in the 2013 third quarter , compared to 28.5% in the 2012 third quarter . The acquisition expense ratio for the 2013 third quarter was 20.4% , compared to 18.6% for the 2012 third quarter . The comparison of the 2013 third quarter and 2012 third quarter acquisition expense ratios is influenced by, among other things, the mix and type of business written and earned and the level of ceding commissions. The operating expense ratio for the 2013 third quarter was 10.9% , compared to 9.9% in the 2012 third quarter . The 2013 third quarter operating expense ratio reflected an increase in aggregate expenses due, in part, to selected expansion of the reinsurance segment’s operating platform, partially offset by the benefit of a higher level of net premiums earned.


40

Nine Months Ended September 30, 2013 versus 2012 : The reinsurance segment’s underwriting expense ratio was 30.4% for the 2013 period, compared to 29.1% for the 2012 period. The acquisition expense ratio was 19.4% for the 2013 period, compared to 18.7% for the 2012 period. The other operating expense ratio was 11.0% for the 2013 period, compared to 10.4% for the 2012 period. The operating expense ratio for the 2013 period reflected a higher level of aggregate expenses than in the 2012 period due, in part, to selected expansion of the reinsurance segment's operating platform and increased share based compensation costs, partially offset by the benefit of a higher level of net premiums earned.
Other Income or Expense Items
Net Investment Income . The components of net investment income were derived from the following sources:
Three Months Ended
Nine Months Ended
September 30,
September 30,
2013
2012
2013
2012
Fixed maturities
$
62,447

$
68,202

$
186,457

$
211,942

Term loan investments (1)
5,296

4,876

15,539

10,732

Equity securities
2,241

2,009

6,828

6,098

Short-term investments
417

485

1,173

1,617

Other (2)
3,753

3,795

14,786

9,968

Gross investment income
74,154

79,367

224,783

240,357

Investment expenses (3)
(8,071
)
(6,146
)
(24,659
)
(19,231
)
Net investment income
$
66,083

73,221

$
200,124

221,126

_________________________________________________
(1)
Included in “investments accounted for using the fair value option” on the consolidated balance sheets.
(2)
Amounts include dividends on investment funds and other items.
(3)
Investment expenses were approximately 0.25% of average invested assets for the 2013 third quarter , compared to 0.21% for the 2012 third quarter , and 0.27% for the nine months ended September 30, 2013 , compared to 0.22% for the 2012 period.

The pre-tax investment income yield, calculated based on amortized cost and on an annualized basis, was 2.08% for the 2013 third quarter , compared to 2.20% for the 2013 first quarter and 2.45% for the 2012 third quarter . The pre-tax investment income yield was 2.16% for the nine months ended September 30, 2013 , compared to 2.51% for the 2012 period. The lower yields in the 2013 periods compared to the 2012 periods reflect the effects of lower reinvestment yields, higher investment expenses and the impact of inflation adjustments on U.S. Treasury Inflation-Protected Securities. In addition, the decline in the 2013 periods also reflects our investment strategy which puts a priority on total return. Yields on future investment income may vary based on financial market conditions, investment allocation decisions and other factors.
Other Income (Loss). We record income or loss from our investments in Aeolus LP and Gulf Reinsurance Limited (joint venture) using the equity method on a three month lag basis based on the availability of their financial statements. We recorded income of $0.6 million on such investments in the 2013 third quarter , compared to a loss of $0.5 million in the 2012 third quarter , and income of $2.7 million for the nine months ended September 30, 2013 , compared to a loss of $7.9 million for the 2012 period. The amounts recorded for the 2013 periods primarily related to Gulf Reinsurance Limited. while the amount recorded in the nine months ended September 30, 2012 was primarily related to Aeolus LP, which is in runoff. The carrying value of our investment in Aeolus LP at September 30, 2013 was $2.3 million.
Equity in Net Income of Investment Funds Accounted for Using the Equity Method. We recorded $5.7 million of equity in net income related to investment funds accounted for using the equity method in the 2013 third quarter , compared to $24.3 million for the 2012 third quarter , and $30.4 million for the nine months ended September 30, 2013 , compared to $56.9 million for the 2012 period. We use the equity method on certain investments (which primarily invest in fixed maturity securities) due to the ownership structure of these investment funds, where we do not have a controlling interest and are not the primary beneficiary. In applying the equity method, these investments are initially recorded at cost and are subsequently adjusted based on our proportionate share of the net income or loss of the funds (which include changes in the market value of the underlying securities in the funds). Such investments, which are typically structured as limited partnerships, are generally recorded on a one month lag with some investments reported on a three month lag based on the availability of reports from the investment funds. Certain of these funds employ leverage to achieve a higher rate of return on their assets under management. While leverage presents opportunities for increasing the total return of such investments, it may increase losses as well. Fluctuations in the carrying value of the investment funds accounted for using the equity method may increase the volatility of our reported results of operations. Investment funds accounted for using the equity method totaled $226.6 million at September 30, 2013 , compared to $307.1 million at December 31, 2012 . The lower level of investment funds accounted for using the equity method

41

at September 30, 2013 and related income for the 2013 periods primarily resulted from the redemption of one investment during the period.

Net Realized Gains or Losses. We recorded net realized losses of $6.0 million for the 2013 third quarter , compared to net realized gains of $60.4 million for the 2012 third quarter , and net realized gains of $65.0 million for the nine months ended September 30, 2013 , compared to net realized gains of $139.4 million for the 2012 period. Currently, our portfolio is actively managed to maximize total return within certain guidelines. In assessing returns under this approach, we include net investment income, net realized gains and losses and the change in unrealized gains and losses generated by our investment portfolio. The effect of financial market movements on the investment portfolio will directly impact net realized gains and losses as the portfolio is adjusted and rebalanced. Net realized gains or losses from the sale of fixed maturities primarily resulted from our decisions to reduce credit exposure, to change duration targets, to rebalance our portfolios or due to relative value determinations. In addition, net realized gains or losses include changes in the fair value of assets and liabilities accounted for using the fair value option. See note 7, “Investment Information—Net Realized Gains (Losses),” of the notes accompanying our consolidated financial statements for additional information.
Net Impairment Losses Recognized in Earnings. On a quarterly basis, we perform reviews of our available for sale investments to determine whether declines in fair value below the cost basis are considered other-than-temporary in accordance with applicable accounting guidance regarding the recognition and presentation of other-than-temporary impairments. The process of determining whether a security is other-than-temporarily impaired requires judgment and involves analyzing many factors. These factors include (i) an analysis of the liquidity, business prospects and overall financial condition of the issuer, (ii) the time period in which there was a significant decline in value, (iii) the significance of the decline, and (iv) the analysis of specific credit events. We evaluate the unrealized losses of our equity securities by issuer and determine if we can forecast a reasonable period of time by which the fair value of the securities would increase and we would recover our cost. If we are unable to forecast a reasonable period of time in which to recover the cost of our equity securities, we record a net impairment loss in earnings equivalent to the entire unrealized loss. We recorded $0.7 million of credit related impairments in earnings for the 2013 third quarter , compared to $2.4 million for the 2012 third quarter , and $3.7 million for the nine months ended September 30, 2013 , compared to $5.4 million for the 2012 period. The OTTI recorded for the nine months ended September 30, 2013 were primarily on equity securities following a review of available positive and negative evidence. See note 7, “Investment Information—Other-Than-Temporary Impairments,” of the notes accompanying our consolidated financial statements for additional information.

Other Expenses. Other expenses, which are included in our other operating expenses and part of corporate and other (non-underwriting), were $7.9 million for the 2013 third quarter , compared to $9.0 million for the 2012 third quarter , and $32.2 million for the nine months ended September 30, 2013 , compared to $28.0 million for the 2012 period. Such amounts primarily represent certain holding company costs necessary to support our worldwide insurance and reinsurance operations, share based compensation expense and costs associated with operating as a publicly traded company. Other expenses for the nine months ended September 30, 2013 reflected a higher level of compensation and acquisition-related costs than in the 2012 period.
Net Foreign Exchange Gains or Losses. Net foreign exchange losses for the 2013 third quarter were $40.6 million (net unrealized losses of $39.4 million and net realized losses of $1.1 million ), compared to net foreign exchange losses for the 2012 third quarter of $17.0 million (net unrealized losses of $17.1 million and net realized gains of $0.2 million ). Net foreign exchange losses for the nine months ended September 30, 2013 were $2.5 million (net unrealized gains of $8.1 million and net realized losses of $10.6 million ), compared to net foreign exchange losses for the 2012 period of $6.0 million (net unrealized losses of $4.9 million and net realized losses of $1.0 million ). Net unrealized foreign exchange gains or losses result from the effects of revaluing the Company's net insurance liabilities required to be settled in foreign currencies at each balance sheet date. Changes in the value of investments held in foreign currencies due to foreign currency rate movements are reflected as a direct increase or decrease to shareholders' equity and are not included in the consolidated statements of income. The Company has not matched a portion of its projected liabilities in foreign currencies with investments in the same currencies and may not match such amounts in future periods, which could increase the Company's exposure to foreign currency fluctuations and increase the volatility of the Company's shareholders' equity.

Loss on Repurchase of Preferred Shares . Following the issuance of $325.0 million of 6.75% Series C preferred shares in April 2012, we redeemed all of our $200.0 million of 8.0% Series A preferred shares and $125.0 million of 7.875% Series B preferred shares at a redemption price equal to $25.00 per share in May 2012. In accordance with GAAP, upon issuance of the Series A and B preferred shares in 2006, costs of $10.6 million were recognized as a reduction of additional paid-in capital in shareholders' equity. Following the repurchase of such shares, the $10.6 million of costs were recorded as a "loss on repurchase of preferred shares" to remove the costs from additional paid-in capital. Such adjustment had no impact on total shareholders' equity or cash flows.


42



CRITICAL ACCOUNTING POLICIES, ESTIMATES AND RECENT ACCOUNTING PRONOUNCEMENTS
Critical accounting policies, estimates and recent accounting pronouncements are discussed in Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our 2012 Form 10-K, updated where applicable in the notes accompanying our consolidated financial statements.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
Financial Condition
Investable Assets
The finance and investment committee of our board of directors establishes our investment policies and sets the parameters for creating guidelines for our investment managers. The finance and investment committee reviews the implementation of the investment strategy on a regular basis. Our current approach stresses preservation of capital, market liquidity and diversification of risk. While maintaining our emphasis on preservation of capital and liquidity, we expect our portfolio to become more diversified and, as a result, we may expand into areas which are not currently part of our investment strategy. Our Chief Investment Officer administers the investment portfolio, oversees our investment managers, formulates investment strategy in conjunction with our finance and investment committee and directly manages certain portions of our fixed income and equity portfolios.

The following table summarizes our invested assets:
September 30, 2013
December 31, 2012
Amount
% of
Total
Amount
% of
Total
Fixed maturities available for sale, at fair value
$
9,688,345

72.9

$
9,839,988

75.4

Fixed maturities, at fair value (1)
367,152

2.8

363,541

2.8

Fixed maturities pledged under securities lending agreements, at fair value (2)
47,515

0.4

42,600

0.3

Total fixed maturities
10,103,012

76.1

10,246,129

78.5

Short-term investments available for sale, at fair value
993,375

7.5

722,121

5.5

Short-term investments pledged under securities lending agreements, at fair value (2)
846

—

8,248

0.1

Cash
436,141

3.3

371,041

2.8

Equity securities available for sale, at fair value
452,195

3.4

312,749

2.4

Equity securities, at fair value (1)
—

—

25,954

0.2

Other investments available for sale, at fair value
528,938

4.0

549,280

4.2

Other investments, at fair value (1)
772,573

5.8

527,971

4.0

Investments accounted for using the equity method (3)
226,644

1.7

307,105

2.4

Total cash and investments
13,513,724

101.7

13,070,598

100.2

Securities sold but not yet purchased (4)
—

—

(6,924
)
(0.1
)
Securities transactions entered into but not settled at the balance sheet date
(231,164
)
(1.7
)
(18,540
)
(0.1
)
Total investable assets
$
13,282,560

100.0

$
13,045,134

100.0

_________________________________________________
(1)
Represents securities which are carried at fair value under the fair value option and reflected as “investments accounted for using the fair value option” on our balance sheet. Changes in the carrying value of such securities are recorded in net realized gains or losses.
(2)
This table excludes the collateral received and reinvested and includes the fixed maturities and short-term investments pledged under securities lending agreements, at fair value.
(3)
Changes in the carrying value of investment funds accounted for using the equity method are recorded as “equity in net income (loss) of investments funds accounted for using the equity method” rather than as an unrealized gain or loss component of accumulated other comprehensive income.
(4)
Represents our obligation to deliver equity securities that we did not own at the time of sale. Such amounts are included in “other liabilities” on our balance sheet.
At September 30, 2013 , our fixed income portfolio, which includes fixed maturity securities and short-term investments, had average credit quality ratings from Standard & Poor’s Rating Services (“S&P”)/Moody’s of “ AA-/Aa2 ” and an average yield to maturity (embedded book yield), before investment expenses, of 2.41% . At December 31, 2012 , our fixed income portfolio had average credit quality ratings from S&P/Moody’s of “ AA-/Aa2 ” and an average yield to maturity of 2.60% . Our investment portfolio had an average effective duration of 2.83 years at September 30, 2013 , compared to 3.06 years at

43

December 31, 2012 . At September 30, 2013 , approximately $8.43 billion , or 63.4% , of our total investments and cash was internally managed, compared to $8.35 billion , or 64.0% , at December 31, 2012 .

The following table summarizes our fixed maturities and fixed maturities pledged under securities lending agreements ("Fixed Maturities") by type:
Fair
Value
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Cost or
Amortized
Cost
September 30, 2013




Corporate bonds
$
2,742,328

$
37,646

$
(46,263
)
$
2,750,945

Mortgage backed securities
1,499,403

17,831

(36,567
)
1,518,139

Municipal bonds
1,531,324

36,907

(9,079
)
1,503,496

Commercial mortgage backed securities
783,718

13,690

(11,322
)
781,350

U.S. government and government agencies
1,121,898

11,336

(4,299
)
1,114,861

Non-U.S. government securities
1,225,100

16,401

(15,789
)
1,224,488

Asset backed securities
1,199,241

19,442

(12,221
)
1,192,020

Total
$
10,103,012

$
153,253

$
(135,540
)
$
10,085,299

December 31, 2012




Corporate bonds
$
3,132,645

$
105,798

$
(6,710
)
$
3,033,557

Mortgage backed securities
1,532,736

24,809

(7,484
)
1,515,411

Municipal bonds
1,463,586

62,322

(1,421
)
1,402,685

Commercial mortgage backed securities
824,165

37,514

(4,468
)
791,119

U.S. government and government agencies
1,131,688

20,178

(1,095
)
1,112,605

Non-U.S. government securities
1,087,310

33,701

(8,860
)
1,062,469

Asset backed securities
1,073,999

25,528

(5,838
)
1,054,309

Total
$
10,246,129

$
309,850

$
(35,876
)
$
9,972,155


The following table provides the credit quality distribution of our Fixed Maturities:
September 30, 2013
December 31, 2012
Rating (1)
Fair Value
% of
Total
Fair Value
% of
Total
U.S. government and government agencies (2)
$
2,418,555

23.9

$
2,523,212

24.6

AAA
3,137,464

31.1

3,413,431

33.3

AA
2,071,761

20.5

1,563,846

15.3

A
1,341,236

13.3

1,501,156

14.7

BBB
387,243

3.8

538,140

5.3

BB
162,520

1.6

174,527

1.7

B
189,379

1.9

220,772

2.2

Lower than B
245,777

2.4

175,866

1.7

Not rated
149,077

1.5

135,179

1.2

Total
$
10,103,012

100.0

$
10,246,129

100.0

_________________________________________________
(1)
For individual fixed maturities, S&P ratings are used. In the absence of an S&P rating, ratings from Moody’s are used, followed by ratings from Fitch Ratings.
(2)
Includes U.S. government-sponsored agency mortgage backed securities and agency commercial mortgage backed securities.

44

At September 30, 2013 , below-investment grade securities comprised approximately 7.4% of our Fixed Maturities, compared to 6.9% at December 31, 2012 . In accordance with our investment strategy, we invest in high yield fixed income securities which are included in “Corporate bonds.” Upon issuance, these securities are typically rated below investment grade (i.e., rating assigned by the major rating agencies of “BB+” or less). At September 30, 2013 , corporate bonds represented 61% of the total below investment grade securities at fair value, mortgage backed securities represented 33% of the total and 6% were in other classes. At December 31, 2012 , corporate bonds represented 32% of the total below investment grade securities at fair value, mortgage backed securities represented 49% of the total and 19% were in other classes. Unrealized losses include the impact of foreign exchange movements on certain securities denominated in foreign currencies and, as such, the amount of securities in an unrealized loss position fluctuates due to foreign currency movements.
The following table provides information on the severity of the unrealized loss position as a percentage of amortized cost for all Fixed Maturities which were in an unrealized loss position:
September 30, 2013
December 31, 2012
Severity of
Unrealized Loss
Fair Value
Gross
Unrealized
Losses
% of
Total Gross
Unrealized
Losses
Fair Value
Gross
Unrealized
Losses
% of
Total Gross
Unrealized
Losses
0-10%
$
4,399,920

$
(112,355
)
82.9

$
2,113,835

$
(28,439
)
79.3

10-20%
106,514

(17,635
)
13.0

43,871

(6,363
)
17.7

20-30%
10,823

(3,128
)
2.3

3,086

(1,074
)
3.0

30-40%
5,308

(2,422
)
1.8

—

—

—

Total
$
4,522,565

$
(135,540
)
100.0

$
2,160,792

$
(35,876
)
100.0


The following table provides information on the severity of the unrealized loss position as a percentage of amortized cost for non-investment grade Fixed Maturities which were in an unrealized loss position:
September 30, 2013
December 31, 2012
Severity of
Unrealized Loss
Fair Value
Gross
Unrealized
Losses
% of
Total Gross
Unrealized
Losses
Fair Value
Gross
Unrealized
Losses
% of
Total Gross
Unrealized
Losses
0-10%
$
190,067

$
(6,877
)
5.1

$
87,223

$
(2,513
)
7.0

10-20%
7,944

(1,152
)
0.8

9,107

(1,529
)
4.3

20-30%
3,245

(1,011
)
0.7

—

—

—

30-80%
674

(372
)
0.3

—

—

—

Total
$
201,930

$
(9,412
)
6.9

$
96,330

$
(4,042
)
11.3

We determine estimated recovery values for our Fixed Maturities following a review of the business prospects, credit ratings, estimated loss given default factors and information received from asset managers and rating agencies for each security. For structured securities, we utilize underlying data, where available, for each security provided by asset managers and additional information from credit agencies in order to determine an expected recovery value for each security. The analysis provided by the asset managers includes expected cash flow projections under base case and stress case scenarios which modify expected default expectations and loss severities and slow down prepayment assumptions.


45

The following table summarizes our top ten exposures to fixed income corporate issuers by fair value at September 30, 2013 , excluding guaranteed amounts and covered bonds:
Fair Value
Credit
Rating (1)
General Electric Co.
$
62,884

AA+/Aa1
Apple Inc.
57,023

AA+/A1
Royal Dutch Shell PLC
53,768

AA/Aa1
Crown Castle Int'l Corp.
35,092

NR/A2
Caterpillar Inc.
35,040

A/A2
Merck & Co Inc.
33,668

AA/A2
Wal-Mart Stores Inc.
31,363

AA/Aa2
United Parcel Service Inc.
31,267

A+/Aa3
Bank of New York Mellon Corp.
31,133

A+/Aa3
Anheuser-Busch Inbev NV
30,186

A/A3
Total
$
401,424

_________________________________________________
(1)
Ratings as assigned by S&P/Moody’s.
At September 30, 2013 , we held insurance enhanced municipal bonds, net of prerefunded bonds that are escrowed in U.S. government obligations, the fair value of which was $185.0 million , or 1.4% of our total investable assets. These securities had average credit quality ratings from S&P/Moody’s of “ AA+/Aa2 ” with and without the insurance enhancement. This is due to the fact that, in cases where the claims paying ratings of the guarantors are below investment grade, those ratings have been withdrawn from the bonds by the relevant rating agencies, and the insured ratings have been equated to the underlying ratings. The ratings were obtained from the individual rating agencies and were assigned a numerical amount with 1 being the highest rating. The average ratings were calculated using the weighted average fair values of the individual bonds. The average ratings with and without the insurance enhancement are substantially the same at September 30, 2013 . Guarantors of our insurance enhanced municipal bonds, net of prerefunded bonds that are escrowed in U.S. government obligations, included National Public Finance Guarantee ( $98.3 million ), Assured Guaranty Ltd. ( $65.6 million ) and the Texas Permanent School Fund ( $21.2 million ). We do not have a significant exposure to insurance enhanced asset-backed or mortgage-backed securities. We do not have any significant investments in companies which guarantee securities at September 30, 2013 .

Our portfolio includes investments, such as mortgage-backed securities, which are subject to prepayment risk. At September 30, 2013 , our investments in residential mortgage-backed securities (“MBS”) amounted to approximately $1.50 billion , or 11.3% of total investable assets, compared to $1.53 billion , or 11.7% , at December 31, 2012 .  As with other fixed income investments, the fair value of these securities fluctuates depending on market and other general economic conditions and the interest rate environment. Changes in interest rates can expose us to changes in the prepayment rate on these investments. In periods of declining interest rates, mortgage prepayments generally increase and MBS are prepaid more quickly, requiring us to reinvest the proceeds at the then current market rates. Conversely, in periods of rising rates, mortgage prepayments generally fall, preventing us from taking full advantage of the higher level of rates. However, economic conditions may curtail prepayment activity if refinancing becomes more difficult, thus limiting prepayments on MBS. Our portfolio also includes commercial mortgage backed securities (“CMBS”). At September 30, 2013 , CMBS constituted approximately $783.7 million , or 5.9% of total investable assets, compared to $824.2 million , or 6.3% , at December 31, 2012 . The commercial real estate market has experienced price deterioration, which could lead to increased delinquencies and defaults on commercial real estate mortgages.

Delinquencies and losses with respect to residential mortgage loans from certain vintage years have increased since 2007 and may continue to increase, particularly in the sub-prime sector. In addition, during this period, residential property values in many states have declined or remained stable, after extended periods during which those values appreciated. A continued decline or an extended flattening in those values may result in additional increases in delinquencies and losses on residential mortgage loans generally, especially with respect to second homes and investment properties, and with respect to any residential mortgage loans where the aggregate loan amounts (including any subordinate loans) are close to or greater than the related property values. These developments may have a significant adverse effect on the prices of loans and securities, including those in our investment portfolio. The situation continues to have wide ranging consequences, including downward pressure on economic growth and the potential for increased insurance and reinsurance exposures, which could have an adverse impact on our results of operations, financial condition, business and operations.



46

The following table provides information on our MBS and CMBS at September 30, 2013 , excluding amounts guaranteed by the U.S. government:
Fair Value
Issuance
Year
Amortized
Cost
Average
Credit
Quality
Total
% of
Amortized
Cost
% of
Investable
Assets
Non-agency MBS:
2003
$
1,738

AA-
$
1,842

106.0
%
0.0
%
2004
6,029

BB
5,739

95.2
%
0.0
%
2005
47,397

CCC+
49,306

104.0
%
0.4
%
2006
70,772

CCC+
73,255

103.5
%
0.6
%
2007
72,458

C+
76,823

106.0
%
0.6
%
2008
5,368

CC+
5,621

104.7
%
0.0
%
2009
1,608

AA-
1,646

102.4
%
0.0
%
2010
12,986

AA-
12,996

100.1
%
0.1
%
2012
45,748

AA+
45,549

99.6
%
0.3
%
2013
111,904

AAA
106,279

95.0
%
0.8
%
Total non-agency MBS
$
376,008

BB+
$
379,056

100.8
%
2.9
%
Non-agency CMBS:
2004
677

AAA
627

92.6
%
0.0
%
2005
29,844

AAA
29,636

99.3
%
0.2
%
2006
18,148

AA+
18,116

99.8
%
0.1
%
2007
26,310

A-
27,689

105.2
%
0.2
%
2008
279

AA+
274

98.2
%
0.0
%
2009
237

AAA
221

93.2
%
0.0
%
2010
112,592

AAA
116,885

103.8
%
0.9
%
2011
128,417

AAA
134,245

104.5
%
1.0
%
2012
130,033

AA+
128,399

98.7
%
1.0
%
2013
154,595

AAA
151,316

97.9
%
1.1
%
Total non-agency CMBS
$
601,132

AA+
$
607,408

101.0
%
4.6
%
Non-Agency MBS
Non-Agency
Additional Statistics:
Re-REMICs
All Other
CMBS (1)
Weighted average loan age (months)
89

65

32

Weighted average life (months) (2)
19

53

48

Weighted average loan-to-value % (3)
69.6
%
67.1
%
59.9
%
Total delinquencies (4)
21.0
%
15.3
%
1.2
%
Current credit support % (5)
54.9
%
7.6
%
31.4
%
_________________________________________________
(1)
Loans defeased with government/agency obligations were not material to the collateral underlying our CMBS holdings.
(2)
The weighted average life for MBS is based on the interest rates in effect at September 30, 2013 . The weighted average life for CMBS reflects the average life of the collateral underlying our CMBS holdings.
(3)
The range of loan-to-values is 25% to 117% on MBS and 7% to 103% on CMBS.
(4)
Total delinquencies includes 60 days and over.
(5)
Current credit support % represents the % for a collateralized mortgage obligation (“CMO”) or CMBS class/tranche from other subordinate classes in the same CMO or CMBS deal.




47

The following table provides information on our asset backed securities (“ABS”) at September 30, 2013 :
Fair Value
Amortized
Cost
Average
Credit
Quality
Weighted Average Credit Support
Total
% of
Amortized
Cost
% of
Investable
Assets
Sector:




Equipment
$
308,909

AA-
7
%
$
303,771

98.3
%
2.3
%
Credit cards
325,870

AAA
18
%
328,941

100.9
%
2.5
%
Loans
209,007

AA+
48
%
209,550

100.3
%
1.6
%
Autos
145,854

AAA
29
%
144,986

99.4
%
1.1
%
Rate reduction bonds
71,525

AAA
5
%
73,209

102.4
%
0.6
%
Home equity
43,797

BBB
22
%
50,853

116.1
%
0.4
%
Commodities
23,000

AA+
6
%
23,310

101.3
%
0.2
%
U.K. securitized
16,743

AAA
19
%
17,192

102.7
%
0.1
%
Other
47,315

AA
47,429

100.2
%
0.4
%
Total ABS (1)
$
1,192,020

AA+
$
1,199,241

100.6
%
9.0
%
_________________________________________________
(1)
The effective duration of the total ABS was 1.9 years at September 30, 2013 .
At September 30, 2013 , our fixed income portfolio included $49.3 million par value in sub-prime securities with a fair value of $27.2 million and average credit quality ratings from S&P/Moody’s of “ B/Caa1 .” At December 31, 2012 , our fixed income portfolio included $66.9 million par value in sub-prime securities with a fair value of $42.1 million and average credit quality ratings from S&P/Moody’s of “ A-/B2 .” Such amounts were primarily in the home equity sector of our asset backed securities, with the balance in other ABS, MBS and CMBS sectors. We define sub-prime mortgage-backed securities as investments in which the underlying loans primarily exhibit one or more of the following characteristics: low FICO scores, above-prime interest rates, high loan-to-value ratios or high debt-to-income ratios. In addition, the portfolio of collateral backing our securities lending program contained $6.4 million fair value of sub-prime securities with average credit quality ratings from S&P/Moody’s of “ CC/Caa3 ” at September 30, 2013 , compared to $5.4 million and “ CCC-/Caa3 ” at December 31, 2012 .
The following table provides information on the fair value of our Eurozone investments at September 30, 2013 :
Sovereign (2)
Financial
Corporates
Other
Corporates
Covered
Bonds (3)
Bank
Loans (4)
Equities and
Other
Total
Country (1)







Germany
$
83,090

$
—

$
4,295

$
10,075

$
4,864

$
7,973

$
110,297

Finland
101,733

—

—

—

—

—

101,733

Netherlands
1,884

463

81,026

—

5,533

6,750

95,656

Belgium
34,291

—

203

—

—

—

34,494

Supranational (5)
27,023

—

—

—

—

—

27,023

Luxembourg
—

—

17,702

—

6,240

372

24,314

France
—

4,973

7,261

—

4,494

4,538

21,266

Austria
10,464

3,450

440

—

—

—

14,354

Ireland
1,625

657

5,601

—

—

1,290

9,173

Spain
—

—

—

559

1,934

—

2,493

Italy
—

—

—

—

1,850

—

1,850

Cyprus
$
—

$
—

$
339

$
—

$
—

$
—

$
339

Total
$
260,110

$
9,543

$
116,867

$
10,634

$
24,915

$
20,923

$
442,992

_________________________________________________
(1)
The country allocations set forth in the table are based on various assumptions made by us in assessing the country in which the underlying credit risk resides, including a review of the jurisdiction of organization, business operations and other factors. Based on such analysis, we do not believe that we have any Eurozone investments from Estonia, Greece, Malta, Portugal, Slovakia or Slovenia at September 30, 2013 .
(2)
Sovereign includes securities issued and/or guaranteed by Eurozone governments.
(3)
Securities issued by Eurozone banks where the security is backed by a separate group of loans.
(4)
Included in "investments accounted for using the fair value option".
(5)
Includes World Bank, European Investment Bank, International Finance Corp. and European Bank for Reconstruction and Development.
At September 30, 2013 , our equity portfolio included $452.2 million of equity securities, compared to $331.8 million at December 31, 2012 , net of securities sold but not purchased. Our equity portfolio primarily consists of publicly traded common

48

stocks in the consumer staples, real estate and natural resources sectors. The following table provides information on the severity of the unrealized loss position as a percentage of cost for all equity securities classified as available for sale which were in an unrealized loss position:
September 30, 2013
December 31, 2012
Severity of
Unrealized Loss
Fair Value
Gross
Unrealized
Losses
% of
Total Gross
Unrealized
Losses
Fair Value
Gross
Unrealized
Losses
% of
Total Gross
Unrealized
Losses
0-10%
$
137,640

$
(4,808
)
64.8

$
114,670

$
(4,704
)
38.3

10-20%
12,828

(2,131
)
28.7

22,851

(3,612
)
29.4

20-30%
622

(206
)
2.8

6,205

(1,973
)
16.1

30-40%
490

(274
)
3.7

1,953

(981
)
8.0

40-50%
—

—

—

1,027

(829
)
6.7

50-80%
—

—

—

148

(191
)
1.5

Total
$
151,580

$
(7,419
)
100.0

$
146,854

$
(12,290
)
100.0

On a quarterly basis, we evaluate the unrealized losses of our equity securities by issuer and forecast a reasonable period of time by which the fair value of the securities would increase and we would recover the cost basis. Substantially all of the unrealized losses on equity securities were on holdings which have been in a continual unrealized loss position for less than 12 months at September 30, 2013 . We believe that a reasonable period of time exists to allow for recovery of the cost basis of our equity securities that are in an unrealized loss position at September 30, 2013 .
The following table summarizes our other investments:

September 30,
2013
December 31,
2012
Available for sale:
Asian and emerging markets
$
357,069

$
316,860

Investment grade fixed income
164,768

220,410

Other
7,101

12,010

Total available for sale
528,938

549,280

Fair value option:
Term loan investments (par value: $487,083 and $307,016)
496,477

308,596

Asian and emerging markets
19,705

24,035

Investment grade fixed income
75,328

67,624

Non-investment grade fixed income
9,408

11,093

Other (1)
171,655

116,623

Total fair value option
$
772,573

$
527,971

Total
$
1,301,511

$
1,077,251

________________________________________________
(1)
Includes fund investments with strategies in mortgage servicing rights, transportation and infrastructure assets and other.

Certain of our other investments are in investment funds for which we have the option to redeem at agreed upon values as described in each investment fund's subscription agreement. Depending on the terms of the various subscription agreements, investments in investment funds may be redeemed daily, monthly, quarterly or on other terms. Two common redemption restrictions which may impact our ability to redeem these investment funds are gates and lockups. A gate is a suspension of redemptions which may be implemented by the general partner or investment manager of the fund in order to defer, in whole or in part, the redemption request in the event the aggregate amount of redemption requests exceeds a predetermined percentage of the investment fund's net assets which may otherwise hinder the general partner or investment manager's ability to liquidate holdings in an orderly fashion in order to generate the cash necessary to fund extraordinarily large redemption payouts. A lockup period is the initial amount of time an investor is contractually required to hold the security before having the ability to redeem. If our investment is eligible to be redeemed, the time to redeem such investment can take weeks or months following the notification.

Certain of our investment managers may use leverage to achieve a higher rate of return on their assets under management, primarily those included in “other investments available for sale, at fair value,” “investments accounted for using the fair value option” and “investments accounted for using the equity method” on our balance sheet. While leverage presents opportunities for increasing the total return of such investments, it may increase losses as well. Accordingly, any event that adversely affects the value of the underlying holdings would be magnified to the extent leverage is used and our potential losses would be

49

magnified. In addition, the structures used to generate leverage may lead to such investments being required to meet covenants based on market valuations and asset coverage. Market valuation declines could force the sale of investments into a depressed market, which may result in significant additional losses. Alternatively, the levered investments may attempt to deleverage by raising additional equity or potentially changing the terms of the established financing arrangements. We may choose to participate in the additional funding of such investments.
Our investment strategy allows for the use of derivative instruments. We utilize various derivative instruments such as futures contracts to enhance investment performance, replicate investment positions or manage market exposures and duration risk that would be allowed under our investment guidelines if implemented in other ways. See note 9, “Derivative Instruments,” of the notes accompanying our consolidated financial statements for additional disclosures concerning derivatives.
Accounting guidance regarding fair value measurements addresses how companies should measure fair value when they are required to use a fair value measure for recognition or disclosure purposes under GAAP and provides a common definition of fair value to be used throughout GAAP. See note 8, “Fair Value,” of the notes accompanying our consolidated financial statements for a summary of our financial assets and liabilities measured at fair value at September 30, 2013 and December 31, 2012 segregated by level in the fair value hierarchy.

Premiums Receivable and Reinsurance Recoverables
At September 30, 2013 , 81.0% of premiums receivable of $850.4 million represented amounts not yet due, while amounts in excess of 90 days overdue were 4.0% of the total. At December 31, 2012 , 69.6% of premiums receivable of $688.9 million represented amounts not yet due, while amounts in excess of 90 days overdue were 5.7% of the total. Approximately 28.1% of the $49.3 million of paid losses and loss adjustment expenses recoverable at September 30, 2013 were more than 90 days overdue, while 18.9% of the $41.0 million of paid losses and loss adjustment expenses recoverable at December 31, 2012 were more than 90 days overdue. Our reserves for doubtful accounts were approximately $11.9 million at September 30, 2013 , compared to $12.0 million at December 31, 2012 .
At September 30, 2013 , approximately 86.6% of reinsurance recoverables on paid and unpaid losses (not including prepaid reinsurance premiums) of $1.80 billion were due from carriers which had an A.M. Best rating of “A-” or better and the largest reinsurance recoverables from any one carrier was approximately 4.3% of our total shareholders’ equity. At December 31, 2012 , approximately 87.5% of reinsurance recoverables on paid and unpaid losses (not including prepaid reinsurance premiums) of $1.87 billion were due from carriers which had an A.M. Best rating of “A-” or better and the largest reinsurance recoverables from any one carrier was approximately 4.7% of our total shareholders’ equity.
The effects of reinsurance on written and earned premiums and losses and loss adjustment expenses with unaffiliated reinsurers were as follows:
Three Months Ended
Nine Months Ended
September 30,
September 30,
2013
2012
2013
2012
Premiums Written




Direct
$
681,772

$
677,516

$
2,113,548

$
2,082,991

Assumed
355,214

259,248

1,127,875

972,242

Ceded
(197,851
)
(181,515
)
(638,977
)
(616,140
)
Net
$
839,135

$
755,249

$
2,602,446

$
2,439,093

Premiums Earned




Direct
$
673,199

$
658,256

$
1,977,421

$
1,905,608

Assumed
328,720

294,089

935,059

844,625

Ceded
(206,919
)
(203,654
)
(605,894
)
(594,574
)
Net
$
795,000

$
748,691

$
2,306,586

$
2,155,659

Losses and Loss Adjustment Expenses




Direct
$
409,623

$
383,436

$
1,177,156

$
1,123,268

Assumed
106,620

126,558

330,151

339,342

Ceded
(89,198
)
(66,123
)
(262,206
)
(223,839
)
Net
$
427,045

$
443,871

$
1,245,101

$
1,238,771


50

Reserves for Losses and Loss Adjustment Expenses
We establish reserves for losses and loss adjustment expenses (“Loss Reserves”) which represent estimates involving actuarial and statistical projections, at a given point in time, of our expectations of the ultimate settlement and administration costs of losses incurred. Estimating Loss Reserves is inherently difficult, which is exacerbated by the fact that we are a relatively new company with relatively limited historical experience upon which to base such estimates. We utilize actuarial models as well as available historical insurance industry loss ratio experience and loss development patterns to assist in the establishment of Loss Reserves. Actual losses and loss adjustment expenses paid will deviate, perhaps substantially, from the reserve estimates reflected in our financial statements.

At September 30, 2013 and December 31, 2012 , our Loss Reserves, net of unpaid losses and loss adjustment expenses recoverable, by type and by operating segment were as follows:
September 30,
2013
December 31,
2012
Insurance:


Case reserves
$
1,447,816

$
1,438,575

IBNR reserves
3,007,721

2,979,344

Total net reserves
$
4,455,537

$
4,417,919

Reinsurance:


Case reserves
$
732,952

$
781,894

Additional case reserves
131,049

195,033

IBNR reserves
1,753,264

1,709,376

Total net reserves
$
2,617,265

$
2,686,303

Total:


Case reserves
$
2,180,768

$
2,220,469

Additional case reserves
131,049

195,033

IBNR reserves
4,760,985

4,688,720

Total net reserves
$
7,072,802

$
7,104,222

At September 30, 2013 and December 31, 2012 , the insurance segment’s Loss Reserves by major line of business, net of unpaid losses and loss adjustment expenses recoverable, were as follows:
September 30,
2013
December 31,
2012
Executive assurance
$
790,847

$
772,768

Casualty
673,702

663,703

Programs
630,826

592,235

Professional liability
591,906

598,638

Property, energy, marine and aviation
529,511

613,176

Construction
445,540

430,170

National accounts
231,747

207,551

Healthcare
128,587

135,227

Surety
91,042

95,139

Travel and accident
34,542

36,568

Lenders products
32,685

28,606

Other (1)
274,602

244,138

Total net reserves
$
4,455,537

$
4,417,919

_________________________________________________
(1)
Includes alternative markets, contract binding, accident and health and excess workers' compensation business.


51

At September 30, 2013 and December 31, 2012 , the reinsurance segment’s Loss Reserves by major line of business, net of unpaid losses and loss adjustment expenses recoverable, were as follows:
September 30,
2013
December 31,
2012
Casualty
$
1,543,500

$
1,570,165

Other specialty
377,496

288,797

Property excluding property catastrophe
262,937

323,727

Property catastrophe
201,011

277,817

Marine and aviation
168,056

169,190

Other
64,265

56,607

Total net reserves
$
2,617,265

$
2,686,303

Shareholders’ Equity
Our shareholders’ equity was $5.44 billion at September 30, 2013 , compared to $5.17 billion at December 31, 2012 . The increase in 2013 was primarily attributable to underwriting returns, partially offset by the impact of unrealized losses on our investment portfolio during 2013 .
Book Value per Common Share
The following table presents the calculation of book value per common share:
(U.S. dollars in thousands, except share data)
September 30,
2013
December 31,
2012
Calculation of book value per common share:


Total shareholders’ equity
$
5,443,285

$
5,168,878

Less preferred shareholders’ equity
325,000

325,000

Common shareholders’ equity
$
5,118,285

$
4,843,878

Common shares outstanding (1)
133,480,323

133,842,613

Book value per common share
$
38.34

$
36.19

_________________________________________________
(1)
Excludes the effects of 8,493,395 and 8,221,444 stock options and 459,009 and 480,406 restricted stock units outstanding at September 30, 2013 and December 31, 2012 , respectively.
Liquidity and Capital Resources
ACGL is a holding company whose assets primarily consist of the shares in its subsidiaries. Generally, ACGL depends on its available cash resources, liquid investments and dividends or other distributions from its subsidiaries to make payments, including the payment of debt service obligations and operating expenses it may incur and any dividends or liquidation amounts with respect to the non-cumulative preferred shares and common shares. ACGL’s readily available cash, short-term investments and marketable securities, excluding amounts held by our regulated insurance and reinsurance subsidiaries, totaled $1.9 million at September 30, 2013 , compared to $14.7 million at December 31, 2012 . For the nine months ended September 30, 2013 , ACGL received dividends of $94.0 million from Arch Reinsurance Ltd. (“Arch Re Bermuda”), our Bermuda-based reinsurer and insurer.
The ability of our regulated insurance and reinsurance subsidiaries to pay dividends or make distributions or other payments to us is dependent on their ability to meet applicable regulatory standards. Under Bermuda law, Arch Re Bermuda is required to maintain an enhanced capital requirement which must equal or exceed its minimum solvency margin (i.e., the amount by which the value of its general business assets must exceed its general business liabilities) equal to the greatest of (1) $100.0 million, (2) 50% of net premiums written (being gross premiums written less any premiums ceded by Arch Re Bermuda, but Arch Re Bermuda may not deduct more than 25% of gross premiums when computing net premiums written) and (3) 15% of net aggregated losses and loss expense provisions and other insurance reserves. Arch Re Bermuda is prohibited from declaring or paying any dividends during any financial year if it is not in compliance with its enhanced capital requirement, minimum solvency margin or minimum liquidity ratio. In addition, Arch Re Bermuda is prohibited from declaring or paying in any financial year dividends of more than 25% of its total statutory capital and surplus (as shown on its previous financial year's statutory balance sheet) unless it files, at least seven days before payment of such dividends, with the Bermuda Monetary Authority (“BMA”) an affidavit stating that it will continue to meet the required margins. In addition, Arch Re Bermuda is prohibited, without prior approval of the BMA, from reducing by 15% or more its total statutory capital, as set out in its prev

52

ious year's statutory financial statements. As a Class 4 insurer, Arch Re Bermuda is required to maintain available statutory capital and surplus pertaining to its general business at a level equal to or in excess of its enhanced capital requirement ("ECR") which is established by reference to either the BSCR model (“BSCR”) or an approved internal capital model. At December 31, 2012 , as determined under Bermuda law, Arch Re Bermuda had statutory capital of $2.32 billion and statutory capital and surplus of $5.01 billion , which amounts were in compliance with Arch Re Bermuda's ECR at such date. Such amounts include ownership interests in U.S. insurance and reinsurance subsidiaries. Accordingly, Arch Re Bermuda can pay approximately $1.16 billion to ACGL during the remainder of 2013 without providing an affidavit to the BMA, as discussed above. In addition, under BMA guidelines that became effective on January 1, 2013, the value of the assets of our insurance group (i.e., the group of companies that conducts exclusively, or mainly, insurance business) must exceed the amount of the group's liabilities by the aggregate minimum margin of solvency of each qualifying member of the group (the “Group MSM”). A member is a qualifying member of the insurance group if it is subject to solvency requirements in the jurisdiction in which it is registered. We were in compliance with the Group MSM at December 31, 2012 .

In addition to meeting applicable regulatory standards, the ability of our insurance and reinsurance subsidiaries to pay dividends to intermediate parent companies owned by Arch Re Bermuda is also constrained by our dependence on the financial strength ratings of our insurance and reinsurance subsidiaries from independent rating agencies. The ratings from these agencies depend to a large extent on the capitalization levels of our insurance and reinsurance subsidiaries. We believe that ACGL has sufficient cash resources and available dividend capacity to service its indebtedness and other current outstanding obligations.

Our insurance and reinsurance subsidiaries are required to maintain assets on deposit, which primarily consist of fixed maturities, with various regulatory authorities to support their operations. The assets on deposit are available to settle insurance and reinsurance liabilities to third parties. Our insurance and reinsurance subsidiaries maintain assets in trust accounts as collateral for insurance and reinsurance transactions with affiliated companies and also have investments in segregated portfolios primarily to provide collateral or guarantees for letters of credit to third parties. At September 30, 2013 and December 31, 2012 , such amounts approximated $5.32 billion and $5.47 billion , respectively.
Our non-U.S. operations account for a significant percentage of our net premiums written. In general, the business written by our non-U.S. operations, which is heavily weighted towards reinsurance business, has been more profitable than the business written in our U.S. operations, which is weighted more towards insurance business. In general, our reinsurance segment has operated at a higher margin than our insurance segment, which is due to prevailing market conditions and the mix and type of business written. The most profitable line of business in the current environment continues to be catastrophe-exposed property reinsurance, which is written primarily in our non-U.S. operations. Additionally, a significant component of our pre-tax income is generated through our investment performance. We hold a substantial amount of our investable assets in our non-U.S. operations and, accordingly, a large portion of our investment income is produced in our non-U.S. operations. In addition, ACGL, through its subsidiaries, provides financial support to certain of its insurance subsidiaries and affiliates, through certain reinsurance arrangements beneficial to the ratings of such subsidiaries. Our U.S.-based insurance and reinsurance groups enter into separate reinsurance arrangements with Arch Re Bermuda covering individual lines of business. For the 2012 calendar year, the U.S. groups ceded business to Arch Re Bermuda at an aggregate net cession rate (i.e., net of third party reinsurance) of approximately 46% (compared to 51% for 2011). All of the above factors have resulted in the non-U.S. group providing a higher contribution to our overall pre-tax income in the current period than the percentage of net premiums written would indicate.
Except as described in the above paragraph, or where express reinsurance, guarantee or other financial support contractual arrangements are in place, each of ACGL’s subsidiaries or affiliates is solely responsible for its own liabilities and commitments (and no other ACGL subsidiary or affiliate is so responsible). Any reinsurance arrangements, guarantees or other financial support contractual arrangements that are in place are solely for the benefit of the ACGL subsidiary or affiliate involved and third parties (creditors or insureds of such entity) are not express beneficiaries of such arrangements.

53

The following table summarizes our consolidated cash flows from operating, investing and financing activities:
Nine Months Ended
September 30,
2013
2012
Total cash provided by (used for):


Operating activities
$
627,048

$
731,951

Investing activities
(485,672
)
(493,141
)
Financing activities
(71,503
)
(173,468
)
Effects of exchange rate changes on foreign currency cash
(4,773
)
5,399

Increase in cash
$
65,100

$
70,741

•
Cash provided by operating activities for the nine months ended September 30, 2013 was lower than in the 2012 period. The decrease in operating cash flows primarily resulted from higher paid losses for the nine months ended September 30, 2013 , including outflows on named catastrophic events and the maturation of our reserves, partially offset by an increase in premium receipts. Cash flows for the nine months ended September 30, 2013 also included an income distribution from an investment fund accounted for using the equity method upon the redemption of such investment.

•
Cash used for investing activities for the nine months ended September 30, 2013 was lower than in the 2012 period. Activity for the nine months ended September 30, 2013 reflected a lower level of net purchases of fixed maturity investments, partially offset by a higher level of net purchases of equity securities and other investments than in the 2012 period.

•
Cash used for financing activities for the nine months ended September 30, 2013 was lower than in the 2012 period. The 2012 period reflected the repayment of $124.6 million of TALF borrowings. Activity for the nine months ended September 30, 2013 reflected $57.8 million of share repurchases under our share repurchase program while the 2012 period did not include any repurchase activity. In addition, the 2012 period reflected the issuance and repurchase of preferred shares.
Our insurance and reinsurance operations provide liquidity in that premiums are received in advance, sometimes substantially in advance, of the time losses are paid. The period of time from the occurrence of a claim through the settlement of the liability may extend many years into the future. Sources of liquidity include cash flows from operations, financing arrangements or routine sales of investments.
As part of our investment strategy, we seek to establish a level of cash and highly liquid short-term and intermediate-term securities which, combined with expected cash flow, is believed by us to be adequate to meet our foreseeable payment obligations. However, due to the nature of our operations, cash flows are affected by claim payments that may comprise large payments on a limited number of claims and which can fluctuate from year to year. We believe that our liquid investments and cash flow will provide us with sufficient liquidity in order to meet our claim payment obligations. However, the timing and amounts of actual claim payments related to recorded Loss Reserves vary based on many factors, including large individual losses, changes in the legal environment, as well as general market conditions. The ultimate amount of the claim payments could differ materially from our estimated amounts. Certain lines of business written by us, such as excess casualty, have loss experience characterized as low frequency and high severity. The foregoing may result in significant variability in loss payment patterns. The impact of this variability can be exacerbated by the fact that the timing of the receipt of reinsurance recoverables owed to us may be slower than anticipated by us. Therefore, the irregular timing of claim payments can create significant variations in cash flows from operations between periods and may require us to utilize other sources of liquidity to make these payments, which may include the sale of investments or utilization of existing or new credit facilities or capital market transactions. If the source of liquidity is the sale of investments, we may be forced to sell such investments at a loss, which may be material.
Our investments in certain securities, including certain fixed income and structured securities, investments in funds accounted for using the equity method, other investments and our investment in Gulf Reinsurance Limited (joint venture) may be illiquid due to contractual provisions or investment market conditions. If we require significant amounts of cash on short notice in excess of anticipated cash requirements, then we may have difficulty selling these investments in a timely manner or may be forced to sell or terminate them at unfavorable values.

54

On a consolidated basis, our aggregate investable assets totaled $13.28 billion at September 30, 2013 , compared to $13.05 billion at December 31, 2012 . The primary goals of our asset liability management process are to satisfy the insurance liabilities, manage the interest rate risk embedded in those insurance liabilities and maintain sufficient liquidity to cover fluctuations in projected liability cash flows, including debt service obligations. Generally, the expected principal and interest payments produced by our fixed income portfolio adequately fund the estimated runoff of our insurance reserves. Although this is not an exact cash flow match in each period, the substantial degree by which the fair value of the fixed income portfolio exceeds the expected present value of the net insurance liabilities, as well as the positive cash flow from newly sold policies and the large amount of high quality liquid bonds, provide assurance of our ability to fund the payment of claims and to service our outstanding debt without having to sell securities at distressed prices or access credit facilities. Our unfunded investment commitments totaled approximately $815.3 million at September 30, 2013 .
Various rating agencies have announced the possibility of future downgrades of the United States’ credit rating, depending on spending levels, interest rates, fiscal pressures that result in a higher general government debt trajectory and other factors. In addition, the impact of the continuing weakness of the U.S., European countries and other key economies, projected budget deficits for the U.S., European countries and other governments and the consequences associated with possible additional downgrades of securities of the U.S., European countries and other governments by credit rating agencies is inherently unpredictable and could have a material adverse effect on financial markets and economic conditions in the U.S. and throughout the world. In turn, this could have a material adverse effect on our business, financial condition and results of operations and, in particular, this could have a material adverse effect on the value and liquidity of securities in our investment portfolio. Our investment portfolio as of September 30, 2013 included $1.12 billion of obligations of the U.S. government and government agencies at fair value and $1.53 billion of municipal bonds at fair value. Please refer to Item 1A “Risk Factors” of our 2012 Form 10-K for a discussion of other risks relating to our business and investment portfolio.
We expect that our liquidity needs, including our anticipated insurance obligations and operating and capital expenditure needs, for the next twelve months, at a minimum, will be met by funds generated from underwriting activities and investment income, as well as by our balance of cash, short-term investments, proceeds on the sale or maturity of our investments, and our credit facilities.

We monitor our capital adequacy on a regular basis and will seek to adjust our capital base (up or down) according to the needs of our business. The future capital requirements of our business will depend on many factors, including our ability to write new business successfully and to establish premium rates and reserves at levels sufficient to cover losses. Our ability to underwrite is largely dependent upon the quality of our claims paying and financial strength ratings as evaluated by independent rating agencies. In particular, we require (1) sufficient capital to maintain our financial strength ratings, as issued by several ratings agencies, at a level considered necessary by management to enable our key operating subsidiaries to compete; (2) sufficient capital to enable our underwriting subsidiaries to meet the capital adequacy tests performed by statutory agencies in the U.S. and other key markets; and (3) letters of credit and other forms of collateral that are necessary for our non-U.S. operating companies because they are “non-admitted” under U.S. state insurance regulations.
In February 2013, certain of our U.S.-based subsidiaries (collectively “Arch U.S. MI”) entered into a definitive agreement to acquire (1) CMG Mortgage Insurance Company (“CMG MI”) from its current owners, PMI Mortgage Insurance Co. in rehabilitation (“PMI”), which has been under the receivership of the Arizona Department of Insurance since 2011, and CMFG Life Insurance Company, and (2) PMI's mortgage insurance operating platform and certain related assets from PMI. In connection with the closing of the transactions, PMI and an affiliate of our U.S.-based subsidiaries will enter into a quota share reinsurance agreement pursuant to which such affiliate, as the reinsurer, will agree to provide 100% quota share indemnity reinsurance to PMI for all certificates of insurance that were issued by PMI between and including January 1, 2009 and December 31, 2011 that are not in default as of an agreed upon effective date. At closing, it is currently estimated that our U.S.-based subsidiaries will pay aggregate consideration of approximately $300 million under all transaction documents. Additional amounts may be paid based on the actual results of CMG MI's pre-closing portfolio over an agreed upon period. In addition, we will enter into a services agreement with PMI to provide for necessary services to administer the run-off of PMI's legacy business at the direction of PMI.

On June 20, 2013, the Arizona receivership court provided the required approval of the acquisition. The transaction is also subject to approvals of the applicable regulators and approvals by the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation of Arch U.S. MI as an eligible insurance carrier in the U.S. mortgage insurance marketplace, as well as the satisfaction of customary closing conditions. In connection with obtaining such consents of regulatory authorities and government-sponsored entities, it is anticipated that Arch U.S. MI or its affiliates will be required to make certain financial commitments to CMG MI, the form and amount of which will be determined based upon discussions with such authorities and entities. Arch U.S. MI's obligation to the sellers to accept financial requirements imposed by regulatory authorities and government-sponsored entities will be determined on the basis of, among other things, the appropriateness of such requirements

55

in light of Arch U.S. MI's business plan and the consistency of such requirements with those imposed on other active participants in the U.S. mortgage insurance industry, as described in the purchase agreements. If these approvals are obtained, it is expected the transaction will close during the 2013 fourth quarter or early 2014.

As part of our capital management program, we may seek to raise additional capital or may seek to return capital to our shareholders through share repurchases, cash dividends or other methods (or a combination of such methods). Any such determination will be at the discretion of our board of directors and will be dependent upon our profits, financial requirements and other factors, including legal restrictions, rating agency requirements and such other factors as our board of directors deems relevant.
The board of directors of ACGL has authorized the investment in ACGL’s common shares through a share repurchase program. Authorizations have consisted of a $1.0 billion authorization in February 2007, a $500.0 million authorization in May 2008, a $1.0 billion authorization in November 2009 and a $1.0 billion authorization in February 2011. Since the inception of the share repurchase program through September 30, 2013 , ACGL has repurchased 109.9 million common shares for an aggregate purchase price of $2.79 billion . At September 30, 2013 , $712.1 million of share repurchases were available under the program. Repurchases under the program may be effected from time to time in open market or privately negotiated transactions through December 2014. The timing and amount of the repurchase transactions under this program will depend on a variety of factors, including market conditions and corporate and regulatory considerations. We will continue to monitor our share price and, depending upon results of operations, market conditions and the development of the economy, as well as other factors, we will consider share repurchases on an opportunistic basis.
To the extent that our existing capital is insufficient to fund our future operating requirements or maintain such ratings, we may need to raise additional funds through financings or limit our growth. We can provide no assurance that, if needed, we would be able to obtain additional funds through financing on satisfactory terms or at all. Adverse developments in the financial markets, such as disruptions, uncertainty or volatility in the capital and credit markets, may result in realized and unrealized capital losses that could have a material adverse effect on our results of operations, financial position and our businesses, and may also limit our access to capital required to operate our business.
If we are not able to obtain adequate capital, our business, results of operations and financial condition could be adversely affected, which could include, among other things, the following possible outcomes: (1) potential downgrades in the financial strength ratings assigned by ratings agencies to our operating subsidiaries, which could place those operating subsidiaries at a competitive disadvantage compared to higher-rated competitors; (2) reductions in the amount of business that our operating subsidiaries are able to write in order to meet capital adequacy-based tests enforced by statutory agencies; and (3) any resultant ratings downgrades could, among other things, affect our ability to write business and increase the cost of bank credit and letters of credit. In addition, under certain of the reinsurance agreements assumed by our reinsurance operations, upon the occurrence of a ratings downgrade or other specified triggering event with respect to our reinsurance operations, such as a reduction in surplus by specified amounts during specified periods, our ceding company clients may be provided with certain rights, including, among other things, the right to terminate the subject reinsurance agreement and/or to require that our reinsurance operations post additional collateral.
In addition to common share capital, we depend on external sources of finance to support our underwriting activities, which can be in the form (or any combination) of debt securities, preference shares, common equity and bank credit facilities providing loans and/or letters of credit. As noted above, equity or debt financing, if available at all, may be on terms that are unfavorable to us. In the case of equity financings, dilution to our shareholders could result, and, in any case, such securities may have rights, preferences and privileges that are senior to those of our outstanding securities.
In August 2011, we entered into a three-year agreement for a $300 million unsecured revolving loan and letter of credit facility and a $500 million secured letter of credit facility. Under the terms of the agreement, Arch Reinsurance Company, our U.S.-based reinsurer, and Arch Re Bermuda are limited to issuing $100 million of unsecured letters of credit as part of the unsecured revolving loan. In addition, we have access to secured letter of credit facilities of approximately $113.8 million , which are available on a limited basis and for limited purposes. Refer to note 4, “Commitments and Contingencies—Letter of Credit and Revolving Credit Facilities,” of the notes accompanying our consolidated financial statements for a discussion of our available facilities, applicable covenants on such facilities and available capacity.
In March 2012, ACGL and Arch Capital Group (U.S.) Inc. filed a universal shelf registration statement with the SEC. This registration statement allows for the possible future offer and sale by us of various types of securities, including unsecured debt securities, preference shares, common shares, warrants, share purchase contracts and units and depositary shares. The shelf registration statement enables us to efficiently access the public debt and/or equity capital markets in order to meet our future capital needs. The shelf registration statement also allows selling shareholders to resell common shares that they own in one or

56

more offerings from time to time. We will not receive any proceeds from any shares offered by the selling shareholders. This report is not an offer to sell or the solicitation of an offer to buy nor shall there be any sale of these securities in any state in which such offer, solicitation or sale would be unlawful prior to registration or qualification under the securities laws of any such state.
In April 2012, ACGL completed the underwritten public offering of $325 million of its 6.75% Series C non-cumulative preferred shares. Except in specified circumstances relating to certain tax or corporate events, the Series C non-cumulative preferred shares are not redeemable prior to April 2, 2017. Dividends on the Series C preferred shares are non-cumulative. Consequently, in the event dividends are not declared on the Series C preferred shares for any dividend period, holders of preferred shares will not be entitled to receive a dividend for such period, and such undeclared dividend will not accrue and will not be payable. Holders of Series C preferred shares will be entitled to receive dividend payments only when, as and if declared by ACGL’s board of directors or a duly authorized committee of ACGL’s board of directors. Any such dividends will be payable from the date of original issue on a non-cumulative basis, quarterly in arrears on the last day of each period. To the extent declared, these dividends will accumulate, with respect to each dividend period, in an amount per share equal to 6.75% of the $25.00 liquidation preference per annum.
At September 30, 2013 , ACGL’s capital of $5.84 billion consisted of $300.0 million of senior notes, representing 5.1% of the total, $100.0 million of revolving credit agreement borrowings due in August 2014, representing 1.7% of the total, $325.0 million of preferred shares, representing 5.6% of the total, and common shareholders’ equity of $5.12 billion , representing the balance. At December 31, 2012 , ACGL’s capital of $5.57 billion consisted of $300.0 million of senior notes, representing 5.4% of the total, $100.0 million of revolving credit agreement borrowings due in August 2014, representing 1.8% of the total, $325.0 million of preferred shares, representing 5.8% of the total, and common shareholders’ equity of $4.84 billion , representing the balance. The increase in capital during 2013 was primarily attributable to positive underwriting and investment returns.
Off-Balance Sheet Arrangements
Off-balance sheet arrangements are discussed in Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our 2012 Form 10-K.
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 September 30, 2013 . 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. An analysis of material changes in market risk exposures at September 30, 2013 that affect the quantitative and qualitative disclosures presented in our 2012 Form 10-K (see section captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Market Sensitive Instruments and Risk Management”) were as follows:
Investment Market Risk
Fixed Income Securities . We invest in interest rate sensitive securities, primarily debt securities. We consider the effect of interest rate movements on the fair value of our fixed maturities, fixed maturities pledged under securities lending agreements, short-term investments and certain of our other investments which invest in fixed income securities and the corresponding change in unrealized appreciation. As interest rates rise, the fair value of our interest rate sensitive securities falls, and the converse is also true. Based on historical observations, there is a low probability that all interest rate yield curves would shift in the same direction at the same time. Accordingly, the actual effect of interest rate movements may differ materially from the amounts set forth in the following tables.

57

The following table summarizes the effect that an immediate, parallel shift in the interest rate yield curve would have had on our fixed income securities:
Interest Rate Shift in Basis Points
(U.S. dollars in millions)
-100
-50
—
+50
+100
September 30, 2013





Total fair value
$
12,563.7

$
12,400.9

$
12,229.5

$
12,057.8

$
11,887.5

Change from base
2.73
%
1.40
%
—

(1.40
)%
(2.80
)%
Change in unrealized value
$
334.2

$
171.4

$
—

$
(171.7
)
$
(342.0
)
December 31, 2012





Total fair value
$
12,463.4

$
12,303.5

$
12,121.9

$
11,937.4

$
11,751.6

Change from base
2.82
%
1.50
%
—

(1.52
)%
(3.05
)%
Change in unrealized value
$
341.5

$
181.6

$
—

$
(184.5
)
$
(370.3
)
In addition, we consider the effect of credit spread movements on the fair value of our fixed maturities, fixed maturities pledged under securities lending agreements, short-term investments and certain of our other investments and investment funds accounted for using the equity method which invest in fixed income securities and the corresponding change in unrealized appreciation. As credit spreads widen, the fair value of our fixed income securities falls, and the converse is also true.
The following table summarizes the effect that an immediate, parallel shift in credit spreads in a static interest rate environment would have had on our fixed income securities:
Credit Spread Shift in Basis Points
(U.S. dollars in millions)
-100
-50
—
+50
+100
September 30, 2013





Total fair value
$
12,441.0

$
12,349.0

$
12,229.5

$
12,119.5

$
12,009.5

Change from base
1.73
%
0.98
%
—

(0.90
)%
(1.80
)%
Change in unrealized value
$
211.5

$
119.5

$
—

$
(110.0
)
$
(220.0
)
December 31, 2012


Total fair value
$
12,337.5

$
12,242.7

$
12,121.9

$
12,008.8

$
11,894.8

Change from base
1.78
%
1.00
%
—

(0.93
)%
(1.87
)%
Change in unrealized value
$
215.6

$
120.8

$
—

$
(113.1
)
$
(227.1
)
Another method that attempts to measure portfolio risk is Value-at-Risk (“VaR”). VaR attempts to take into account a broad cross-section of risks facing a portfolio by utilizing relevant securities volatility data skewed towards the most recent months and quarters. VaR measures the amount of a portfolio at risk for outcomes 1.65 standard deviations from the mean based on normal market conditions over a one year time horizon and is expressed as a percentage of the portfolio’s initial value. In other words, 95% of the time, should the risks taken into account in the VaR model perform per their historical tendencies, the portfolio’s loss in any one year period is expected to be less than or equal to the calculated VaR, stated as a percentage of the measured portfolio’s initial value. As of September 30, 2013 , our portfolio’s VaR was estimated to be 3.90% , compared to an estimated 2.75% at December 31, 2012 .
Certain Other Investments and Equity Securities. Our investment portfolio includes certain other investments which do not invest in fixed income securities along with equity holdings. At September 30, 2013 and December 31, 2012 , the fair value of such investments totaled $617.4 million and $563.7 million , respectively. These investments are exposed to price risk, which is the potential loss arising from decreases in fair value. An immediate hypothetical 10% decline in the value of each position would reduce the fair value of such investments by approximately $61.7 million and $56.4 million at September 30, 2013 and December 31, 2012 , respectively, and would have decreased book value per common share by approximately $0.46 and $0.42 , respectively. An immediate hypothetical 10% increase in the value of each position would increase the fair value of such investments by approximately $61.7 million and $56.4 million at September 30, 2013 and December 31, 2012 , respectively, and would have increased book value per common share by approximately $0.46 and $0.42 , respectively.
Investment-Related Derivatives. Derivative instruments may be used to enhance investment performance, replicate investment positions or manage market exposures and duration risk that would be allowed under our investment guidelines if implemented in other ways. The fair values of those derivatives are based on quoted market prices. See note 9, “Derivative Instruments,” of the notes accompanying our consolidated financial statements for additional disclosures concerning

58

derivatives. At September 30, 2013 , the notional value of the net long position of derivative instruments (excluding to-be-announced mortgage backed securities which are included in the fixed income securities analysis above and foreign currency forward contracts which are included in the foreign currency exchange risk analysis below) was $822.9 million , compared to $390.7 million at December 31, 2012 . A 100 basis point depreciation of the underlying exposure to these derivative instruments at September 30, 2013 and December 31, 2012 would have resulted in a reduction in net income of approximately $8.2 million and $3.9 million , respectively, and would have decreased book value per common share by $0.06 and $0.03 , respectively. A 100 basis point appreciation of the underlying exposure to these derivative instruments at September 30, 2013 and December 31, 2012 would have resulted in an increase in net income of approximately $8.2 million and $3.9 million , respectively, and would have increased book value per common share by $0.06 and $0.03 , respectively.
For further discussion on investment activity, please refer to “—Financial Condition, Liquidity and Capital Resources—Financial Condition—Investable Assets.”
Foreign Currency Exchange Risk
Foreign currency rate risk is the potential change in value, income and cash flow arising from adverse changes in foreign currency exchange rates. Through our subsidiaries and branches located in various foreign countries, we conduct our insurance and reinsurance operations in a variety of local currencies other than the U.S. Dollar. We generally hold investments in foreign currencies which are intended to mitigate our exposure to foreign currency fluctuations in our net insurance liabilities. We may also utilize foreign currency forward contracts and currency options as part of our investment strategy. See Note 9, “Derivative Instruments,” of the notes accompanying our consolidated financial statements for additional information.
The following table provides a summary of our net foreign currency exchange exposures, as well as foreign currency derivatives in place to manage these exposures:
(U.S. dollars in thousands, except per share data)
September 30,
2013
December 31,
2012
Assets, net of insurance liabilities, denominated in foreign currencies, excluding shareholders’ equity and derivatives
$
74,133

$
146,227

Shareholders’ equity denominated in foreign currencies (1)
375,166

290,310

Net foreign currency forward contracts outstanding (2)
(65,962
)
(76,517
)
Net exposures denominated in foreign currencies
$
383,337

$
360,020

Pre-tax impact of a hypothetical 10% appreciation of the U.S. Dollar against foreign currencies:


Shareholders’ equity
$
(38,334
)
$
(36,002
)
Book value per common share
$
(0.29
)
$
(0.27
)
Pre-tax impact of a hypothetical 10% decline of the U.S. Dollar against foreign currencies:


Shareholders’ equity
$
38,334

$
36,002

Book value per common share
$
0.29

$
0.27

_________________________________________________
(1)
Represents capital contributions held in the foreign currencies of our operating units.
(2)
Notional value of the outstanding foreign currency forward contracts in U.S. Dollars.
As a result of the current financial and economic environment as well as the potential for additional investment returns, we may not match a portion of our projected liabilities in foreign currencies with investments in the same currencies, which would increase our exposure to foreign currency fluctuations and increase the volatility in our results of operations. Historical observations indicate a low probability that all foreign currency exchange rates would shift against the U.S. Dollar in the same direction and at the same time and, accordingly, the actual effect of foreign currency rate movements may differ materially from the amounts set forth above. For further discussion on foreign exchange activity, please refer to “—Results of Operations.”

59

Cautionary Note Regarding Forward-Looking Statements
The Private Securities Litigation Reform Act of 1995 (“PSLRA”) provides a “safe harbor” for forward-looking statements. This release or any other written or oral statements made by or on behalf of us 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 or incorporated by reference in this release are forward-looking statements. Forward-looking statements, for purposes of the PSLRA or otherwise, can generally be identified by the use of forward-looking terminology such as “may,” “will,” “expect,” “intend,” “estimate,” “anticipate,” “believe” or “continue” and similar statements of a future or forward-looking nature 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 release and in our periodic reports filed with the Securities and Exchange Commission (the “SEC”), and include:
•
our ability to successfully implement its business strategy during “soft” as well as “hard” markets;

•
acceptance of our business strategy, security and financial condition by rating agencies and regulators, as well as by brokers and our insureds and reinsureds;
•
our ability to maintain or improve our ratings, which may be affected by our ability to raise additional equity or debt financings, by ratings agencies’ existing or new policies and practices, as well as other factors described herein;

•
general economic and market conditions (including inflation, interest rates, foreign currency exchange rates, prevailing credit terms and the depth and duration of a recession) and conditions specific to the reinsurance and insurance markets (including the length and magnitude of the current “soft” market) in which we operate;

•
competition, including increased competition, on the basis of pricing, capacity, coverage terms or other factors;

•
developments in the world’s financial and capital markets and our access to such markets;

•
our ability to successfully enhance, integrate and maintain operating procedures (including information technology) to effectively support our current and new business;

•
the loss of key personnel;

•
the integration of businesses we have acquired or may acquire into our existing operations;

•
accuracy of those estimates and judgments utilized in the preparation of our financial statements, including those related to revenue recognition, insurance and other reserves, reinsurance recoverables, investment valuations, intangible assets, bad debts, income taxes, contingencies and litigation, and any determination to use the deposit method of accounting, which for a relatively new insurance and reinsurance company, like our company, are even more difficult to make than those made in a mature company since relatively limited historical information has been reported to us through September 30, 2013 ;

•
greater than expected loss ratios on business written by us and adverse development on claim and/or claim expense liabilities related to business written by our insurance and reinsurance subsidiaries;

•
severity and/or frequency of losses;

•
claims for natural or man-made catastrophic events in our insurance or reinsurance business could cause large losses and substantial volatility in our results of operations;

•
acts of terrorism, political unrest and other hostilities or other unforecasted and unpredictable events;

•
availability to us of reinsurance to manage our gross and net exposures and the cost of such reinsurance;

•
the failure of reinsurers, managing general agents, third party administrators or others to meet their obligations to us;


60

•
the timing of loss payments being faster or the receipt of reinsurance recoverables being slower than anticipated by us;

•
our investment performance, including legislative or regulatory developments that may adversely affect the fair value of our investments;

•
the impact of the continued weakness of the U.S., European countries or other key economies, projected budget deficits for the U.S., European countries and other governments and the consequences associated with possible additional downgrades of securities of the U.S., European countries and other governments by credit rating agencies, and the resulting effect on the value of securities in our investment portfolio as well as the uncertainty in the market generally;

•
losses relating to aviation business and business produced by a certain managing underwriting agency for which we may be liable to the purchaser of its prior reinsurance business or to others in connection with the May 5, 2000 asset sale described in our periodic reports filed with the SEC;

•
changes in accounting principles or policies or in our application of such accounting principles or policies;

•
changes in the political environment of certain countries in which we operates, underwrites business or invests;

•
statutory or regulatory developments, including as to tax policy matters and insurance and other regulatory matters such as the adoption of proposed legislation that would affect Bermuda-headquartered companies and/or Bermuda-based insurers or reinsurers and/or changes in regulations or tax laws applicable to us, our subsidiaries, brokers or customers; and

•
the other matters set forth under Item 1A “Risk Factors”, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and other sections of our Annual Report on Form 10-K, as well as the other factors set forth in our other documents on file with the SEC, and management’s response to any of the aforementioned factors.
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.
Other Financial Information
The consolidated financial statements as of September 30, 2013 and for the three month and nine month periods ended September 30, 2013 and 2012 have been reviewed by PricewaterhouseCoopers LLP, an independent registered public accounting firm. Their report (dated November 8, 2013 ) is included on page 2. The report of PricewaterhouseCoopers LLP states that they did not audit and they do not express an opinion on that unaudited financial information. Accordingly, the degree of reliance on their report on such information should be restricted in light of the limited nature of the review procedures applied. PricewaterhouseCoopers LLP is not subject to the liability provisions of Section 11 of the Securities Act of 1933 for their report on the unaudited financial information because that report is not a “report” or a “part” of the registration statement prepared or certified by PricewaterhouseCoopers LLP within the meaning of Sections 7 and 11 of the Securities Act of 1933.

ITEM 3.  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.
ITEM 4.  CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
In connection with the filing of this Form 10-Q, our management, including the Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of disclosure controls and procedures pursuant to applicable Exchange Act Rules as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer

61

and Chief Financial Officer concluded that the disclosure controls and procedures were effective as of the end of and during the period covered by this report with respect to information being recorded, processed, summarized and reported within time periods specified in the SEC’s rules and forms and with respect to timely communication to them and other members of management responsible for preparing periodic reports of all material information required to be disclosed in this report as it relates to ACGL and its consolidated subsidiaries.
We continue to enhance our operating procedures and internal controls to effectively support our business and our regulatory and reporting requirements. Our management does not expect that our disclosure controls or our internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. As a result of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons or by collusion of two or more people. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. As a result of the inherent limitations in a cost-effective control system, misstatement due to error or fraud may occur and not be detected. Accordingly, our disclosure controls and procedures are designed to provide reasonable, not absolute, assurance that the disclosure controls and procedures are met.

Changes in Internal Controls Over Financial Reporting
There have been no changes in internal control over financial reporting that occurred during the fiscal quarter ended September 30, 2013 that have materially affected, or are reasonably likely to materially affect, internal control over financial reporting.

PART II.  OTHER INFORMATION
Item 1.  Legal Proceedings
We, in common with the insurance industry in general, are subject to litigation and arbitration in the normal course of our business. As of September 30, 2013 , we were not a party to any litigation or arbitration which is expected by management to have a material adverse effect on our results of operations and financial condition and liquidity.

62

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds
The following table summarizes our purchases of our common shares for the 2013 third quarter :
(U.S. dollars in thousands, except share data)
Issuer Purchases of Equity Securities
Period
Total Number of
Shares
Purchased (1)
Average Price
Paid per Share
Total Number of
Shares Purchased
as Part of
Publicly
Announced Plans
or Programs (2)
Approximate
Dollar Value
of Shares that
May Yet be
Purchased Under the Plan
or Programs
7/1/2013 - 7/31/2013
34,428

$
51.24

26,300

$
712,115

8/1/2013 - 8/31/2013
5,098

53.82

—

$
712,115

9/1/2013 - 9/30/2013
1,988

53.84

—

$
712,115

Total
41,514

$
51.68

26,300

$
712,115

_________________________________________________
(1)
Includes repurchases by ACGL of shares, from time to time, from employees in order to facilitate the payment of withholding taxes on restricted shares granted and the exercise of stock appreciation rights. We purchased these shares at their fair value, as determined by reference to the closing price of our common shares on the day the restricted shares vested or the stock appreciation rights were exercised.
(2)
The board of directors of ACGL has authorized the investment in ACGL’s common shares through a share repurchase program. Repurchases under the program may be effected from time to time in open market or privately negotiated transactions through December 2014. Since the inception of the share repurchase program, ACGL has repurchased 109.9 million common shares for an aggregate purchase price of $2.79 billion . The timing and amount of the repurchase transactions under this program will depend on a variety of factors, including market conditions and corporate and regulatory considerations.
Item 5.  Other Information
In accordance with Section 10a(i)(2) of the Securities Exchange Act of 1934, as amended, we are responsible for disclosing non-audit services to be provided by our independent auditor, PricewaterhouseCoopers LLP, which are approved by the Audit Committee of our board of directors. During the 2013 third quarter , the Audit Committee approved engagements of PricewaterhouseCoopers LLP for permitted non-audit services, which consisted of tax consulting services, tax compliance services and other accounting consulting services.

Item 6.  Exhibits
Exhibit No.
Description
10.1
Restricted Share Agreement with Arch Capital Group Ltd. substantially in the form signed by each of Constantine Iordanou, Marc Grandisson, W. Preston Hutchings, Mark D. Lyons and Louis T. Petrillo for May 9, 2013 grants

10.2
Share Appreciation Right Agreement with Arch Capital Group Ltd. substantially in the form signed by each of Constantine Iordanou, Mark D. Lyons, Marc Grandisson, W. Preston Hutchings, Mark D. Lyons, David McElroy and Louis T. Petrillo for May 9, 2013 grants
10.3
Restricted Share Unit Agreement, dated as of May 9, 2013, between Arch Capital Group Ltd. and David McElroy

15
Accountants’ Awareness Letter (regarding unaudited interim financial information)
31.1
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1
Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2
Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101
The following financial information from Arch Capital Group Ltd.’s Quarterly Report for the quarter ended September 30, 2013 formatted in XBRL: (i) Consolidated Balance Sheets at September 30, 2013 and December 31, 2012; (ii) Consolidated Statements of Income for the three and nine month periods ended September 30, 2013 and 2012; (iii) Consolidated Statements of Comprehensive Income for the three and nine month periods ended September 30, 2013 and 2012; (iv) Consolidated Statements of Changes in Shareholders’ Equity for the nine month periods ended September 30, 2013 and 2012; (v) Consolidated Statements of Cash Flows for the nine month periods ended September 30, 2013 and 2012; and (vi) Notes to Consolidated Financial Statements.**
_________________________________________________
* Filed as an exhibit to our Report on Form 8-K, as filed with the SEC on June 5, 2013, and incorporated by reference.
** This exhibit will not be deemed “filed” for the purposes of Section 18 of the Securities Exchange Act of 1934 (15 U.S.C. 78r) , or otherwise subject to the liability of that section. Such exhibit will not be deemed to be incorporated by reference into any filing under the Securities Act or Securities Exchange Act, except to the extent that Arch Capital Group Ltd. specifically incorporates it by reference.

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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/ Constantine Iordanou
Date: November 8, 2013
Constantine Iordanou
President and Chief Executive Officer
(Principal Executive Officer) and Chairman of the Board of Directors
/s/ Mark D. Lyons
Date: November 8, 2013
Mark D. Lyons
Executive Vice President, Chief Financial Officer and Treasurer (Principal Financial and Accounting Officer)

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EXHIBIT INDEX

Exhibit No.
Description
10.1
Restricted Share Agreement with Arch Capital Group Ltd. substantially in the form signed by each of Constantine Iordanou, Marc Grandisson, W. Preston Hutchings, Mark D. Lyons and Louis T. Petrillo for May 9, 2013 grants
10.2
Share Appreciation Right Agreement with Arch Capital Group Ltd. substantially in the form signed by each of Constantine Iordanou, Mark D. Lyons, Marc Grandisson, W. Preston Hutchings, Mark D. Lyons, David McElroy and Louis T. Petrillo for May 9, 2013 grants
10.3
Restricted Share Unit Agreement, dated as of May 9, 2013, between Arch Capital Group Ltd. and David McElroy
15
Accountants’ Awareness Letter (regarding unaudited interim financial information)
31.1
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1
Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2
Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101
The following financial information from Arch Capital Group Ltd.’s Quarterly Report for the quarter ended September 30, 2013 formatted in XBRL: (i) Consolidated Balance Sheets at September 30, 2013 and December 31, 2012; (ii) Consolidated Statements of Income for the three and nine month periods ended September 30, 2013 and 2012; (iii) Consolidated Statements of Comprehensive Income for the three and nine month periods ended September 30, 2013 and 2012; (iv) Consolidated Statements of Changes in Shareholders’ Equity for the nine month periods ended September 30, 2013 and 2012; (v) Consolidated Statements of Cash Flows for the nine month periods ended September 30, 2013 and 2012; and (vi) Notes to Consolidated Financial Statements.**
_________________________________________________
* Filed as an exhibit to our Report on Form 8-K, as filed with the SEC on June 5, 2013, and incorporated by reference.
** This exhibit will not be deemed “filed” for the purposes of Section 18 of the Securities Exchange Act of 1934 (15 U.S.C. 78r) , or otherwise subject to the liability of that section. Such exhibit will not be deemed to be incorporated by reference into any filing under the Securities Act or Securities Exchange Act, except to the extent that Arch Capital Group Ltd. specifically incorporates it by reference.


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