Fitch Upgrades Arch Capital’s IFS Rankings; Debt Rankings Affirmed; Outlook Steady

Fitch Ratings has upgraded the Insurer Financial Strength (IFS) ratings of Arch Capital Group Ltd.’s (ACGL) various primary insurance and reinsurance operating subsidiaries to ‘AA-‘ (Very Strong) from ‘A+’ (Strong).

The IFS Rating Outlook is Stable.

Fitch has also affirmed ACGL’s Issuer Default Rating (IDR) at ‘A-‘ and the ratings on ACGL’s senior unsecured notes and preferred shares at ‘BBB+’ and ‘BBB’, respectively. The IDR Outlook is Stable.

Key Rating Drivers

The one-notch upgrade of ACGL’s insurance/reinsurance IFS ratings reflects improved underwriting performance in the company’s diversified product portfolio of property/casualty (P/C) insurance and reinsurance business. ACGL’s ratings also reflect its consistent profitability, favorable company profile, very strong capitalization with reasonable financial leverage, strong fixed-charge coverage and strong reserve adequacy. These factors are partially offset by potential risks associated with the US mortgage insurance (USMI) operations.

Per its criteria for holding company notching, Fitch establishes a group IFS assessment for ACGL, which is a combined evaluation of ACGL’s primary insurance, reinsurance and mortgage operations. This group assessment of ‘A+’ IFS/Stable Outlook remains unchanged and reflects a ‘A’ standalone IFS assessment of the USMI operations that partially offsets the ‘AA-‘ IFS ratings of the insurance/reinsurance operations. This group IFS assessment serves as the anchor rating for notching to the ACGL company IDR of ‘A-‘, which was affirmed in line with the unchanged group IFS assessment.

Fitch views ACGL’s overall business profile to be favorable (aa- IFS credit factor score) compared with all other US/Bermuda non-life (re)insurance organizations and is considered to have a higher influence on ACGL’s ratings. ACGL has a broad product portfolio of P/C insurance and reinsurance business and is a leading provider of USMI business. Gross premiums written for 2021 were 47% insurance, 41% reinsurance and 12% mortgage. Fitch favorably views this diversified source of revenues and earnings.

ACGL’s profitability is characterized by combined combined ratios and high ROAE, with the most recent five-year averages (2017-2021) at 87.3% and 12.1%, respectively, which are better than peer averages. ACGL posted an underwriting and net income profit in every year of its 20-year history.

ACGL’s 6M22 combined ratio of 77.9% included 3.8 points for catastrophes, primarily from Russia’s attack of Ukraine and a series of natural catastrophe events, improved from 86.2% in 6M21, which had 6.3 catastrophe points primarily from winter storms Uri and Viola. The insurance/reinsurance segments’ 6M22 combined ratio was 89.5%, down from 95.3% in 6M21, with the underlying accident-year combined ratio, excluding catastrophes of 87.6% in 6M22, down from 89.5% in 6M21, driven by favorable market pricing and mix of business changes.

The mortgage segment’s combined ratio plummeted to 0.8% in 6M22 from 34.5% in 6M21, reflecting fewer new delinquencies and 38.6 points of favorable reserve development in 6M22 compared with 8.3 points in 6M21 due primarily to favorable cure activity related to the US first lien portfolio from the 2020 accident year. ACGL’s USMI loans in default dropped to 1.77% at June 30, 2022 from 3.11% at June 30, 2021and are currently very near the pre-pandemic 1.42% rate at March 31, 2020.

ACGL scored ‘Extremely Strong’ on Fitch’s Prism factor-based capital model at YE 2021, which is consistent with prior years. The company’s financial leverage ratio (FLR) is reasonable for the rating category at 16.9% as of June 30, 2022. ACGL’s shareholders’ equity of $12.4 billion at June 30, 2022 is down 8% from $13.5 billion At YE 2021, as net income posted in 6M22 was more than offset by net unrealized losses on fixed-income securities due to a rise in interest rates and continued common share repurchases.

ACGL’s GAAP fixed-charge coverage averaged a strong 8.4x from 2017 to 2021. This includes 11.8x in 2021, which is improved from 5.1x in 2020 as a result of higher earnings with de minimis pandemic losses. Fixed-charge coverage was a very strong 14.3x in 6M22.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to negative rating action/downgrade

Net premiums written-to-equity ratio above 0.8x, an FLR above 20%, sizable adverse prior-year reserve development or fixed-charge coverage of below 10x; experienced difficulties in the USMI operations, such as reporting sustained GAAP underwriting losses;

The primary insurance and reinsurance ‘AA-‘ IFS ratings could be downgraded if the group assessment IFS is lowered by one or more notches;

ACGL’s holding company ratings could be downgraded if Fitch lowered the company’s combined primary insurance, reinsurance and mortgage operations ‘A+’ IFS group assessment;

ACGL’s hybrid securities ratings could be lowered by one notch to reflect higher nonperformance risk should Fitch view Bermuda’s regulatory environment as becoming more restrictive in its supervision of (re)insurers with respect to hybrid features.

Factors that could, individually or collectively, lead to positive rating action/upgrade

Improvement to a more favorable company profile, while producing very strong run-rate earnings with an insurance/reinsurance segments combined ratio in the high 80% range; successfully managing the USMI operations; maintaining an FLR at or below 15%, fixed-charge coverage of at least 12x, and a Fitch Prism factor-based capital model score of ‘Extremely Strong’;

ACGL’s holding company ratings could be upgraded if Fitch raised the company’s combined primary insurance, reinsurance and mortgage operations ‘A+’ IFS group assessment.

Best/Worst Case Rating Scenario

International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from ‘AAA‘ to ‘D’. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

Unless disclosed in this section, the highest level of ESG credit relevance is a score of ‘3’. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch’s ESG Relevance Scores, visit www.fitchratings.com/esg.

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