Fitch Upgrades Arch Debt, IFS Ratings

Fitch Ratings has upgraded its issuer default rating (IDR) on Arch Capital Group, Ltd. to “A-” from “BBB+” and its rating on Arch’s $300 million of senior unsecured notes due 2034 to “BBB+” from “BBB”. Fitch also upgraded its ratings on Arch’s $200 million of series A and $125 million of series B preferred shares to “BBB” from “BBB-” and its insurer financial strength (IFS) rating on Arch Reinsurance Ltd. (Arch Re) to “A” from “A-.” The outlook on all the ratings is stable.

Fitch said its “decision to upgrade Arch’s ratings reflects the company’s consistently strong underwriting profitability and financial performance relative to peers. The upgrade also reflects Fitch’s heightened comfort with Arch’s casualty lines reserve adequacy and its effectiveness in maintaining underwriting discipline under various market conditions.

“The ratings continue to reflect benefits derived from Arch’s diverse premium base and the strong support Arch’s high-quality and liquid investment portfolio provides for the company’s loss reserves.”

The rating agency noted that it “views combined ratios over extended periods of time as a key reflection of underwriting performance.” Fitch indicated that “Arch’s average combined ratio from 2002 through the first nine months of 2006 was roughly six points lower than the average combined ratio of a peer group of companies that Fitch tracks. Additionally, Arch’s average ROAE was roughly two points higher than this peer group’s average ROAE over the same period.

“During the 2002-September 2006 period, Arch also generated less volatile underwriting results than many of its peers as evidenced by combined ratios that ranged from a high of 95.8 percent in 2005 to a low of 86.3 percent through the first nine months of 2006. In contrast, the range of combined ratios reported by many of Arch’s peers was much wider with several reporting combined ratios well in excess of 100 percent in hurricane plagued 2005.”

Fitch said it “believes that Arch’s strong long-term relative financial performance is partially due to the diversity of the company’s diverse premium base, which consists of specialty property and casualty lines equally divided between primary and reinsurance premiums. This diverse premium base enables Arch to benefit from a wide variety of market conditions and reduces the company’s exposure to any one segment of the market.”

In addition the Company’s “strong long-term financial performance reflects the company’s effectiveness in establishing controls and incentives that focus on underwriting profitability and returns on capital that help the company manage through the various phases of the underwriting cycle.”

Fitch noted that “more than 60 percent of Arch’s loss reserves are for longer-duration casualty business lines that remain somewhat unseasoned. However, the company’s ratio of paid losses-to-incurred losses and ratio of reserves for incurred but not reported losses to total reserves are conservative relative to industry-wide averages. Additionally, Fitch views the company’s accident year loss ratios as comparable to industry averages.

“Arch uses a modest amount of financial leverage and on a run-rate basis generates strong interest coverage. At September 30, 2006 the company’s equity-credit adjusted ratio of debt and preferred shares-to-capital was 8 percent. Fitch has assigned Arch’s preferred shares class E designations, which allocates 100 percent of the preferred shares’ principal to adjusted equity.

“Key features supporting the shares’ equity credit designation include their junior subordinated ranking, non-cumulative feature, and perpetual nature. Arch has the option to redeem the shares beginning in 2011. The shares’ dividend is not subject to a step-up provision if the company elects not to exercise this option. Thus, Fitch does not view the call option as having a limiting effect on the shares’ equity-credit designation.”

In conclusion Fitch pointed out that “Arch’s annualized operating earnings-based interest and preferred dividend coverage has historically been strong reflecting the company’s relatively modest interest and preferred dividend requirements and strong operating earnings. The company’s interest and preferred dividend coverage averaged 17 times (x) in 2004 and 2005 and was 18x through Sept. 30, 2006.”