Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis contains forward-looking statements which involve inherent risks and uncertainties. All statements other than statements of historical fact are forward-looking statements. These statements are based on our current assessment of risks and uncertainties. Actual results may differ materially from those expressed or implied in these statements and, therefore, undue reliance should not be placed on them. Important factors that could cause actual events or results to differ materially from those indicated in such statements are discussed in this report, including the sections entitled “Cautionary Note Regarding Forward-Looking Statements,” and “Risk Factors.”

This discussion and analysis should be read in conjunction with our audited consolidated financial statements and notes thereto presented under Item 8. Tabular amounts are in U.S. Dollars in thousands, except share amounts, unless otherwise noted.

GENERAL

Overview

Arch Capital Group Ltd. (“ACGL” and, together with its subsidiaries, “we” or “us”) is a Bermuda public limited liability company with approximately $7.03 billion in capital at December 31, 2014 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.

The worldwide insurance and reinsurance industry is highly competitive and has traditionally been subject to an underwriting cycle in which a hard market (high premium rates, restrictive underwriting standards, as well as terms and conditions, and underwriting gains) is eventually followed by a soft market (low premium rates, relaxed underwriting standards, as well as broader terms and conditions, and underwriting losses). Insurance market conditions may affect, among other things, the demand for our products, our ability to increase premium rates, the terms and conditions of the insurance policies we write, changes in the products offered by us or changes in our business strategy.

The financial results of the insurance and reinsurance industry are influenced by factors such as the frequency and/or severity of claims and losses, including natural disasters or other catastrophic events, variations in interest rates and financial markets, changes in the legal, regulatory and judicial environments, inflationary pressures and general economic conditions. These factors influence, among other things, the demand for insurance or reinsurance, the supply of which is generally related to the total capital of competitors in the market.

Current Outlook

The broad market environment continues to be competitive in our reinsurance business reflecting a continuation of softening in pricing and broadening pressures on terms and conditions. In the primary markets in which our insurance business participates our insurance business continued to obtain rate increases in most lines of business, albeit at lower levels during the second half of 2014 than in the first half. With the continued low interest rate environment, additional increases are needed in many lines in order for us to achieve our return requirements. Our underwriting teams continue to execute a disciplined strategy by emphasizing small and medium-sized accounts over large accounts.

The mortgage segment was formed in the 2014 first quarter and consists of our mortgage insurance and reinsurance business. On January 30, 2014, we completed the acquisition of CMG Mortgage Insurance Company (subsequently renamed Arch Mortgage Insurance Company, “Arch MI U.S.”), which prior to the acquisition had been approved as an eligible mortgage insurer by Federal National Mortgage Association and Federal Home Loan Mortgage Corporation (each a government sponsored enterprise, or “GSE”) only for credit union customers. As part of the transaction, Arch MI U.S. was approved as an eligible mortgage insurer by the GSEs. The completion of the transaction enabled us to enter the U.S. mortgage insurance marketplace and to serve banks and other lenders nationwide, including existing credit union customers. The mortgage segment also provides reinsurance on both a proportional and non-proportional basis on a global basis, direct mortgage insurance in Europe and various risk-sharing products to government agencies and mortgage lenders. As of December 31, 2014, Arch MI U.S. reviewed and approved 481 master policy applications from banks and more than

150 of these banks have submitted loans for approval, and approved master policy applications from 19 of the top 25 mortgage originators for conforming mortgages sold to the GSEs with mortgage insurance.

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. We expect that catastrophe-exposed business will continue to represent a significant proportion of our overall book, which could increase the volatility of our operating results.

Changing economic conditions could 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, 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 potential 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.

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 January 1, 2015, our modeled peak zone catastrophe exposure is a windstorm affecting the Northeastern U.S., with a net probable maximum pre-tax loss of $544 million, followed by windstorms affecting the Gulf of Mexico and Florida Tri-County with net probable maximum pre-tax losses of $527 million and $419 million, respectively. Our exposures to other perils, such as U.S. earthquake and international events, are less than the exposures arising from U.S. windstorms and hurricanes. As of January 1, 2015, our modeled peak zone earthquake exposure (Los Angeles area earthquake) represented approximately 58% of our peak zone catastrophe exposure, and our modeled peak zone international exposure (Japan earthquake) is 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. In addition, actual losses may 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.”

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 common 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 $45.58 at December 31, 2014, a 14.5% increase from $39.82 at December 31, 2013. The growth in 2014 was primarily generated through underwriting and investment returns.

After-Tax Operating Return on Average Common Equity

After-tax operating return on average common equity (“Operating ROAE”) represents after-tax operating income available to Arch common shareholders divided by the average of beginning and ending common shareholders’ equity available to Arch during the period. After-tax operating income available to Arch common shareholders, a “non-GAAP measure” as defined in the SEC rules, represents net income available to Arch 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 Arch 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 11.1% for 2014, compared to 11.7% for 2013 and 7.7% for 2012. The Operating ROAE for 2014 reflects a similar level of after-tax operating income, with a higher average common shareholders’ equity in the 2014 period resulting in a lower Operating ROAE. Such amounts reflected the impact of low interest yields on the investment portfolio while the 2012 Operating ROAE reflected a higher level of losses from catastrophic events, including Superstorm Sandy.

Total Return on Investments

Total return on investments includes net 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 the investment portfolio managed by Arch. 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 Arch common shareholders on the capital held in the business, and compares the return generated by the investment portfolio managed by Arch against a benchmark return index.

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 December 31, 2014, the benchmark return index had an average Moody’s credit quality of “Aa2”, an estimated duration of 3.44 years and included weightings to the following indices:

	Weighting
The Bank of America Merrill Lynch 1-10 Year AA U.S. Corporate & Yankees Index	21.250	%
The Bank of America Merrill Lynch 1-5 Year U.S. Treasury Index	13.000
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
The Bank of America Merrill Lynch 1-10 Year EMU Governments Index	5.500
The Bank of America Merrill Lynch U.S. High Yield Constrained Index	5.500
The Bank of America Merrill Lynch U.S. Bullet Agency Securities 1-10 Years Index	5.000
MSCI All Country World Gross Total Return Index	5.000
The Bank of America Merrill Lynch 0-3 Month U.S. Treasury Bill Index	5.000
The Bank of America Merrill Lynch 5-10 Year U.S. Treasury Index	3.250
The Bank of America Merrill Lynch 1-5 Year U.K. Gilt Index	3.000
The Bank of America Merrill Lynch 1-10 Year Australian Governments Index	2.500
The Bank of America Merrill Lynch 1-5 Year CAD Governments Index	2.000
Total	100.000	%

The following table summarizes the pre-tax total return (before investment expenses) of the investment portfolio managed by Arch compared to the benchmark return against which we measured our portfolio during the periods:

	Arch Portfolio (1)			Benchmark Return
Pre-tax total return (before investment expenses):
Year Ended December 31, 2014	3.21	%		2.58	%
Year Ended December 31, 2013	1.28	%		0.85	%
Year Ended December 31, 2012	5.88	%		4.90	%

(1) Our investment expenses were approximately 0.28%, 0.26% and 0.22%, respectively, of average invested assets in 2014, 2013 and 2012.

Total return for our investment portfolio outperformed that of the benchmark return index in 2014 and primarily reflected returns on our investment grade fixed income portfolio, augmented by strong returns on alternative investments and equities. Total return was impacted by strengthening of the U.S. Dollar against the Euro, British Pound Sterling and other major currencies on non-U.S. Dollar denominated investments during 2014. Excluding foreign exchange, total return was 4.26% for 2014, compared to 1.13% for 2013 and 5.59% for 2012.

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 Arch common shareholders, which is defined as net income available to Arch 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 Arch common shareholders is a “non-GAAP financial measure” as defined in Regulation G. The reconciliation of such measure to net income available to Arch 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 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 fair 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, which related to the redemption of the Series A and B preferred shares in April 2012, 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 Arch common shareholders.

We believe that showing net income available to Arch 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 underwriting to produce a profit. In addition to presenting net income available to Arch 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.

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 Arch common shareholders to net income available to Arch common shareholders:

	Year Ended December 31,
	2014				2013				2012
After-tax operating income available to Arch common shareholders	$	617,312			$	595,715			$	350,640
Net realized gains, net of tax	122,863				73,844				184,083
Net impairment losses recognized in earnings, net of tax	(30,150		)		(3,786		)		(11,388		)
Equity in net income of investment funds accounted for using the equity method, net of tax	19,235				35,738				73,510
Net foreign exchange gains (losses), net of tax	83,157				(13,718		)		(28,527		)
Loss on repurchase of preferred shares, net of tax	—				—				(10,612		)
Net income available to Arch common shareholders	$	812,417			$	687,793			$	557,706

After-tax operating income in both 2014 and 2013 reflected a lower level of losses from catastrophic events compared to 2012. Results in all periods presented reflected the impact of current insurance and reinsurance market conditions and the impact of low interest yields on the investment portfolio.

Segment Information

During the 2014 first quarter, to reflect activity during the period as described below, we changed our segment structure and added two new segments (mortgage and ‘other’). We now classify our businesses into three underwriting segments — insurance, reinsurance and mortgage — and two other operating segments — ‘other’ and corporate (non-underwriting). Our insurance, reinsurance and mortgage segments each have managers who are responsible for the overall profitability of their respective segments and who are directly accountable to our chief operating decision makers, the Chairman, President and Chief Executive Officer of ACGL and the Chief Financial Officer of ACGL. The chief operating decision makers do not assess performance, measure return on equity or make resource allocation decisions on a line of business basis. Management measures segment performance for our three underwriting segments based on underwriting

income or loss. We do not manage our assets by underwriting segment, with the exception of goodwill and intangible assets, and, accordingly, investment income is not allocated to each underwriting segment.

We determined our reportable segments using the management approach described in accounting guidance regarding disclosures about segments of an enterprise and related information. The accounting policies of the segments are the same as those used for the preparation of our consolidated financial statements. Intersegment business is allocated to the segment accountable for the underwriting results. The corporate (non-underwriting) segment results include net investment income, other income (loss), other expenses incurred by us, interest expense, net realized gains or losses, net impairment losses included in earnings, equity in net income (loss) of investment funds accounted for using the equity method, net foreign exchange gains or losses, income taxes and items related to our non-cumulative preferred shares. Such amounts exclude the results of the ‘other’ segment.

The mortgage segment was formed in the 2014 first quarter and consists of our mortgage insurance and reinsurance business, including Arch MI U.S. The mortgage segment also provides reinsurance on both a proportional and non-proportional basis globally, direct mortgage insurance in Europe and various risk-sharing products to government sponsored entities and mortgage lenders.

The ‘other’ segment includes the results of Watford Re, a multi-line Bermuda reinsurance company launched in late March 2014. Watford Re has its own management and board of directors that is responsible for the overall profitability of its results. We are required to consolidate the results of Watford Re in our financial statements. The portion of Watford Re’s earnings attributable to third party investors is recorded in the consolidated statements of income as ‘amounts attributable to noncontrolling interests.’ For the ‘other’ segment, performance is measured based on net income or loss.

Insurance Segment

The following table sets forth our insurance segment’s underwriting results:

	Year Ended December 31,											Year Ended December 31,
	2014				2013				% Change			2013				2012				% Change
Gross premiums written	$	3,008,669			$	2,712,509			10.9			$	2,712,509			$	2,593,959			4.6
Premiums ceded	(862,015		)		(763,713		)					(763,713		)		(768,625		)
Net premiums written	2,146,654				1,948,796				10.2			1,948,796				1,825,334				6.8
Change in unearned premiums	(129,284		)		(72,782		)					(72,782		)		(24,991		)
Net premiums earned	2,017,370				1,876,014				7.5			1,876,014				1,800,343				4.2
Other underwriting income	2,135				2,122							2,122				2,335
Losses and loss adjustment expenses	(1,260,953		)		(1,188,445		)					(1,188,445		)		(1,283,841		)
Acquisition expenses, net	(316,308		)		(311,904		)					(311,904		)		(298,983		)
Other operating expenses	(335,157		)		(315,387		)					(315,387		)		(307,489		)
Underwriting income (loss)	$	107,087			$	62,400			71.6			$	62,400			$	(87,635	)		n/m
Underwriting Ratios									% Point Change											% Point Change
Loss ratio	62.5		%		63.3		%		(0.8	)		63.3		%		71.3		%		(8.0	)
Acquisition expense ratio	15.7		%		16.6		%		(0.9	)		16.6		%		16.6		%		—
Other operating expense ratio	16.6		%		16.8		%		(0.2	)		16.8		%		17.1		%		(0.3	)
Combined ratio	94.8		%		96.7		%		(1.9	)		96.7		%		105.0		%		(8.3	)

The insurance segment consists of our insurance underwriting units which offer specialty product lines on a worldwide basis. Product lines include:

•	Construction and national accounts: primary and excess casualty coverages to middle and large accounts in the construction industry and a wide range of products for middle and large national accounts, specializing in loss sensitive primary casualty insurance programs (including large deductible, self-insured retention and retrospectively rated programs).

•	Excess and surplus casualty: primary and excess casualty insurance coverages, including middle market energy business, and contract binding, which primarily provides casualty coverage through a network of appointed agents to small and medium risks.

•	Lenders products: collateral protection, debt cancellation and service contract reimbursement products to banks, credit unions, automotive dealerships and original equipment manufacturers and other specialty programs that pertain to automotive lending and leasing.

•

Professional lines: directors’ and officers’ liability, errors and omissions liability, employment practices liability, fiduciary liability, crime, professional indemnity and other financial related coverages for corporate, private equity, venture capital, real estate investment trust, limited partnership, financial institution and not-for-profit clients of all sizes and medical professional and general liability insurance coverages for the healthcare industry. The business is predominately written on a claims-made basis.

•	Programs: primarily package policies, underwriting workers’ compensation and umbrella liability business in support of desirable package programs, targeting program managers with unique expertise and niche products offering general liability, commercial automobile, inland marine and property business with minimal catastrophe exposure.

•	Property, energy, marine and aviation: primary and excess general property insurance coverages, including catastrophe-exposed property coverage, for commercial clients. Coverages for marine include hull, war, specie and liability. Aviation and stand alone terrorism are also offered.

•	Travel, accident and health: specialty travel and accident and related insurance products for individual, group travelers, travel agents and suppliers, as well as accident and health, which provides accident, disability and medical plan insurance coverages for employer groups, medical plan members, students and other participant groups.

•

Other: includes alternative market risks (including captive insurance programs), excess workers’ compensation and employer’s liability insurance coverages for qualified self-insured groups, associations and trusts, and contract and commercial surety coverages, including contract bonds (payment and performance bonds) primarily for medium and large contractors and commercial surety bonds for Fortune 1,000 companies and smaller transaction business programs.

Premiums Written.

The following table sets forth our insurance segment’s net premiums written by major line of business:

	Year Ended December 31,
	2014						2013						2012
	Amount				%		Amount				%		Amount				%
Programs	$	480,580			22		$	419,673			22		$	340,130			19
Professional lines	476,604				22		476,193				25		548,423				30
Construction and national accounts	286,994				13		271,110				14		211,130				12
Property, energy, marine and aviation	244,640				11		280,551				14		294,690				16
Excess and surplus casualty	212,519				10		149,286				8		112,307				6
Travel, accident and health	145,732				7		104,903				5		106,871				6
Lenders products	100,407				6		101,576				5		99,724				5
Other	199,178				9		145,504				7		112,059				6
Total	$	2,146,654			100		$	1,948,796			100		$	1,825,334			100

2014 versus 2013: Net premiums written by the insurance segment were 10.2% higher in 2014 than in 2013. Increases in excess and surplus casualty, programs, travel, accident and health and other were partially offset by reductions in property, energy, marine and aviation. The increase in excess and surplus casualty primarily resulted from contract binding, launched in early 2013, while growth in program business was due to a combination of new business, underlying exposure growth and the impact of rate increases. Growth in travel, accident and health reflects primarily resulted from expansion in existing and new distribution channels while the increase in other lines primarily resulted from alternative markets business, which reflected new accounts written subsequent to a renewal rights agreement entered into in the 2014 second quarter. The decrease in property, energy, marine and aviation reflected reductions in property and marine business in response to current market conditions.

2013 versus 2012: Net premiums written by the insurance segment were 6.8% higher in 2013 than in 2012. Increases in programs, construction and national accounts, excess and surplus casualty and other were partially offset by reductions in professional lines. The increase in program business was due to a combination of new business, underlying exposure growth and the impact of rate increases while the growth in construction and national accounts primarily resulted from new business and strong renewal retention. The increase in excess and surplus casualty primarily resulted from growth in

contract binding while the increase in other lines primarily resulted from alternative markets business. The reductions in professional lines resulted from a continued strategic reduction in exposure to international business.

Net Premiums Earned.

The following table sets forth our insurance segment’s net premiums earned by major line of business:

	Year Ended December 31,
	2014						2013						2012
	Amount				%		Amount				%		Amount				%
Programs	$	460,392			23		$	386,840			21		$	318,740			18
Property, energy, marine and aviation	456,508				23		491,791				26		536,971				30
Professional lines	277,811				14		250,729				14		209,217				12
Construction and national accounts	244,974				12		304,294				16		313,081				17
Excess and surplus casualty	182,024				9		118,395				6		113,597				6
Travel, accident and health	127,691				6		97,135				5		98,686				5
Lenders products	94,438				5		99,847				5		103,478				6
Other	173,532				8		126,983				7		106,573				6
Total	$	2,017,370			100		$	1,876,014			100		$	1,800,343			100

Net premiums earned by the insurance segment were 7.5% higher in 2014 than in 2013, reflecting changes in net premiums written over the previous five quarters. Net premiums earned by the insurance segment were 4.2% higher in 2013 than in 2012.

Losses and Loss Adjustment Expenses.

The table below shows the components of the insurance segment’s loss ratio:

	Year Ended December 31,
	2014			2013			2012
Current year	65.4	%		65.7	%		73.0	%
Prior period reserve development	(2.9	)%		(2.4	)%		(1.7	)%
Loss ratio	62.5	%		63.3	%		71.3	%

Current Year Loss Ratio.

2014 versus 2013: The insurance segment’s current year loss ratio was 0.3 points lower in 2014 than in 2013. The 2014 loss ratio included 0.7 points of current year catastrophic event activity, compared to 1.2 points in 2013. The 2014 loss ratio reflected estimated margin expansion along with changes in the mix of business.

2013 versus 2012: The insurance segment’s current year loss ratio was 7.3 points lower in 2013 than in 2012. The 2013 loss ratio included 1.2 points of current year catastrophic event activity, compared to 5.9 points in 2012. The 2013 loss ratio reflected estimated margin expansion along with a lower level of non-catastrophic large loss activity than in 2012

Prior Period Reserve Development.

2014 prior period reserve development: The insurance segment’s net favorable development of $58.7 million, or 2.9 points of net earned premium, consisted of $73.5 million of net favorable development from short-tailed lines, partially offset by $14.8 million of net adverse development from medium-tailed and long-tailed lines. Favorable development in short-tailed lines predominantly consisted of $60.5 million of net favorable development in property lines, primarily from the 2008 to 2013 accident years (i.e., the year in which a loss occurred), with the balance emanating from lenders products, primarily from the 2012 accident year, and travel and accident, primarily from the 2012 and 2013 accident years. Contained within this short tail release was favorable development of $7.9 million from 2005 to 2013 named catastrophic events. Net adverse development in medium-tailed and long-tailed lines of $14.8 million included a net increase of $41.3 million in construction reserves, primarily from the 2009 to 2013 accident years. The adverse development in construction was largely driven by general liability claims involving New York labor law matters. In addition, the insurance segment experienced $26.2 million of net adverse development in program business, primarily from the 2011 and 2012 accident years. Such amounts were partially offset by $39.0 million of net favorable development on professional lines, primarily

from the 2003 to 2011 accident years, and $7.8 million of net favorable development on surety business, primarily from the 2011 to 2013 accident years.

2013 prior period reserve development: The insurance segment’s net favorable development of $45.1 million, or 2.4 points of net earned premium, consisted of $67.0 million of net favorable development from short-tailed lines, partially offset by $21.9 million of net adverse development from medium-tailed and long-tailed lines. Favorable development in short-tailed lines predominantly consisted of $62.4 million of net favorable development in property lines from the 2008 to 2011 accident years, with the balance emanating from lenders products, primarily from the 2011 and 2012 accident years, and travel and accident, primarily from the 2009 and 2010 accident years. Contained within this short tail release was favorable development of $15.9 million from 2005 to 2012 named catastrophic events. Net adverse development in medium-tailed and long-tailed lines of $21.9 million included a net increase of $28.0 million in specialty casualty reserves. Such development primarily stemmed from losses in two captive programs written by the insurance segment's Canadian operation, which was partially offset by favorable development in non-captive business, and from three large excess casualty claims in the insurance segment's U.S. operation, all of the above in the more recent accident years. In addition, the insurance segment experienced $26.2 million of net adverse development in program business, with nearly 90% of this development emanating from a single canceled program whose last inception year was 2011. Such amounts were partially offset by net favorable development spread across various lines and accident years.

2012 prior period reserve development: The insurance segment’s net favorable development of $31.2 million, or 1.7 points of net earned premium, consisted of $79.3 million of net favorable development from short-tailed lines, partially offset by $48.1 million of net adverse development from medium-tailed and long-tailed lines. Favorable development in short-tailed lines predominantly consisted of $69.0 million of net favorable development in property lines from the 2007 to 2011 accident years, with the balance emanating from travel and accident and lender’s products, both primarily from the 2009 to 2011 accident years. Contained within this short tail release was favorable development of $19.1 million from 2005 to 2011 named catastrophic events. Net adverse development in medium-tailed and long-tailed lines of $48.1 million included a net increase of $38.9 million from the insurance segment’s U.K. underwriting operations for the 2007 to 2010 accident years, primarily due to an increase in Australian executive assurance reserves. In addition, U.S. primary specialty casualty reserves reflected a net increase of $23.0 million, primarily from the 2003 to 2005 accident years, and $19.8 million from U.S. professional liability in the two most recent accident years. Such amounts were partially offset by net favorable development spread across various lines and accident years.

Underwriting Expenses.

2014 versus 2013: The insurance segment’s underwriting expense ratio was 32.3% in 2014, compared to 33.4% in 2013. The acquisition expense ratio was 15.7% for 2014, compared to 16.6% for 2013. The acquisition expense ratio is influenced by, among other things, (1) the amount of ceding commissions received from reinsurers, (2) the amount of business written on a surplus lines (non-admitted) basis and (3) mix of business. The 2014 acquisition expense ratio reflected changes in the form of reinsurance ceded and mix of business. The insurance segment’s other operating expense ratio was 16.6% for 2014, compared to 16.8% for 2013, reflecting the benefits of continued expense management and a higher level of net premiums earned.

2013 versus 2012: The insurance segment’s underwriting expense ratio was 33.4% in 2013, compared to 33.7% in 2012. The acquisition expense ratio was 16.6% for 2013, compared to 16.6% for 2012. The acquisition expense ratio is influenced by, among other things, (1) the amount of ceding commissions received from reinsurers, (2) the amount of business written on a surplus lines (non-admitted) basis and (3) mix of business. The 2013 acquisition expense ratio reflected changes in the form of reinsurance ceded and mix of business. The insurance segment’s other operating expense ratio was 16.8% for 2013, compared to 17.1% for 2012, reflecting the benefits of continued expense management and a higher level of net premiums earned.

Reinsurance Segment

The following table sets forth our reinsurance segment’s underwriting results:

	Year Ended December 31,											Year Ended December 31,
	2014				2013				% Change			2013				2012				% Change
Gross premiums written	$	1,527,245			$	1,399,621			9.1			$	1,399,621			$	1,213,889			15.3
Premiums ceded	(261,254		)		(86,620		)					(86,620		)		(55,099		)
Net premiums written	1,265,991				1,313,001				(3.6	)		1,313,001				1,158,790				13.3
Change in unearned premiums	13,337				(94,329		)					(94,329		)		(40,663		)
Net premiums earned	1,279,328				1,218,672				5.0			1,218,672				1,118,127				9.0
Other underwriting income	3,167				5,258							5,258				5,755
Losses and loss adjustment expenses	(532,450		)		(486,236		)					(486,236		)		(574,821		)
Acquisition expenses, net	(261,438		)		(234,373		)					(234,373		)		(204,903		)
Other operating expense	(147,964		)		(134,563		)					(134,563		)		(118,245		)
Underwriting income	$	340,643			$	368,758			(7.6	)		$	368,758			$	225,913			63.2
Underwriting Ratios									% Point Change											% Point Change
Loss ratio	41.6		%		39.9		%		1.7			39.9		%		51.4		%		(11.5	)
Acquisition expense ratio	20.4		%		19.2		%		1.2			19.2		%		18.3		%		0.9
Other operating expense ratio	11.6		%		11.0		%		0.6			11.0		%		10.6		%		0.4
Combined ratio	73.6		%		70.1		%		3.5			70.1		%		80.3		%		(10.2	)

The reinsurance segment consists of our reinsurance underwriting units which offer specialty product lines on a worldwide basis. Product lines include:

•	Casualty: provides coverage to ceding company clients on third party liability and workers’ compensation exposures from ceding company clients, primarily on a treaty basis. Exposures include, among others, executive assurance, professional liability, workers’ compensation, excess and umbrella liability, excess motor and healthcare business.

•	Marine and aviation: provides coverage for energy, hull, cargo, specie, liability and transit, and aviation business, including airline and general aviation risks. Business written may also include space business, which includes coverages for satellite assembly, launch and operation for commercial space programs.

•	Other specialty: provides coverage to ceding company clients for non-excess motor, including U.K. business primarily emanating from one client, and other lines including surety, accident and health, workers’ compensation catastrophe, agriculture, trade credit and political risk.

•

Property catastrophe: provides protection for most catastrophic losses that are covered in the underlying policies written by reinsureds, including hurricane, earthquake, flood, tornado, hail and fire, and coverage for other perils on a case-by-case basis. Property catastrophe reinsurance provides coverage on an excess of loss basis when aggregate losses and loss adjustment expense from a single occurrence of a covered peril exceed the retention specified in the contract.

•

Property excluding property catastrophe: provides coverage for both personal lines and commercial property exposures and principally covers buildings, structures, equipment and contents. The primary perils in this business include fire, explosion, collapse, riot, vandalism, wind, tornado, flood and earthquake. Business is assumed on both a proportional and excess of loss basis. In addition, facultative business is written which focuses on commercial property risks on an excess of loss basis.

•	Other. includes life reinsurance business on both a proportional and non-proportional basis, casualty clash business and, in limited instances, non-traditional business which is intended to provide insurers with risk management solutions that complement traditional reinsurance.

Premiums Written.

The following table sets forth our reinsurance segment’s net premiums written by major line of business:

	Year Ended December 31,
	2014						2013						2012
	Amount				%		Amount				%		Amount				%
Other specialty	$	405,126			32		$	417,865			32		$	308,104			27
Property excluding property catastrophe	343,043				27		292,536				22		265,783				23
Casualty	317,996				25		306,304				23		205,925				18
Property catastrophe	137,471				11		220,749				17		283,677				24
Marine and aviation	50,444				4		64,380				5		84,649				7
Other	11,911				1		11,167				1		10,652				1
Total	$	1,265,991			100		$	1,313,001			100		$	1,158,790			100
Pro rata	$	663,135			52		$	692,024			53		$	530,763			46
Excess of loss	602,856				48		620,977				47		628,027				54
Total	$	1,265,991			100		$	1,313,001			100		$	1,158,790			100

2014 versus 2013: Gross premiums written by the reinsurance segment in 2014 were 9.1% higher than in 2013, while net premiums written were 3.6% lower than in 2013. The differential in gross versus net premiums written reflects the cession of premiums to the ‘other’ segment (Watford Re) in 2014. The decline in net premiums written reflected reductions in property catastrophe and marine and aviation business, partially offset by an increase in property excluding property catastrophe and casualty business. The reduction in property catastrophe and marine and aviation business reflected non-renewals and share decreases in response to current market conditions and a higher usage of retrocessional coverage. The growth in property excluding property catastrophe business in the 2014 fourth quarter primarily resulted from an unearned premium portfolio transfer from Gulf Reinsurance Limited (“Gulf Re”) of $50.2 million. Effective as of October 1, 2014, we entered into a 90% whole account quota share retrocession arrangement of Gulf Re’s net liabilities and a portfolio transfer of all of Gulf Re’s existing business (both unearned premium and loss reserves). Growth in casualty premiums reflected new international excess motor business and quota shares of U.S. professional liability business.

2013 versus 2012: Net premiums written in 2013 were 13.3% higher than in 2012. The growth in net premiums written primarily reflected increases in other specialty and casualty lines, partially offset by reductions in property catastrophe and marine business. The increase in other specialty business was primarily due to a multi-line quota share reinsurance agreement entered into in the 2013 third quarter which resulted in approximately $66 million of premiums written in 2013, including a $40 million unearned premium transfer. In addition, other specialty premiums reflected growth in trade credit and crop hail business, partially offset by a continued reduction in non-excess motor business. Growth in casualty business was due, in part, to a professional liability quota share contract entered into in the 2013 fourth quarter which contributed $59 million of premiums written in 2013, including a $44 million unearned premium transfer, along with new casualty multi-line treaties written during 2013. The reduction in property catastrophe and marine business reflected market conditions, selected non-renewals and a higher usage of retrocessional coverage.

Net Premiums Earned.

The following table sets forth our reinsurance segment’s net premiums earned by major line of business:

	Year Ended December 31,
	2014						2013						2012
	Amount				%		Amount				%		Amount				%
Other specialty	$	424,725			33		$	387,630			32		$	309,101			27
Property excluding property catastrophe	303,496				24		274,719				23		254,338				23
Casualty	327,518				26		241,774				20		188,963				17
Property catastrophe	150,761				11		232,423				19		280,185				25
Marine and aviation	61,118				5		70,105				5		76,145				7
Other	11,710				1		12,021				1		9,395				1
Total	$	1,279,328			100		$	1,218,672			100		$	1,118,127			100
Pro rata	$	686,201			54		$	608,586			50		$	499,094			45
Excess of loss	593,127				46		610,086				50		619,033				55
Total	$	1,279,328			100		$	1,218,672			100		$	1,118,127			100

Net premiums earned in 2014 were 5.0% higher than in 2013, reflecting changes in net premiums written over the previous five quarters, including the mix and type of business written. Net premiums earned in 2013 were 9.0% higher than in 2012.

Losses and Loss Adjustment Expenses.

The table below shows the components of the reinsurance segment’s loss ratio:

	Year Ended December 31,
	2014			2013			2012
Current year	62.5	%		57.8	%		68.4	%
Prior period reserve development	(20.9	)%		(17.9	)%		(17.0	)%
Loss ratio	41.6	%		39.9	%		51.4	%

Current Year Loss Ratio.

2014 versus 2013: The reinsurance segment’s current year loss ratio was 4.7 points higher in 2014 than in 2013. The 2014 loss ratio included 3.5 points for current year catastrophic event activity, compared to 5.4 points in 2013. The 2014 current year loss ratio reflected a significantly lower contribution from property catastrophe business than in 2013.

2013 versus 2012: The reinsurance segment’s current year loss ratio was 10.6 points lower in 2013 than in 2012. The 2013 loss ratio included 5.4 points for current year catastrophic event activity, compared to 15.0 points in 2012. The 2013 loss ratio also reflected changes in the mix of business.

Prior Period Reserve Development.

2014 prior period reserve development: The reinsurance segment’s net favorable development of $267.3 million, or 20.9 points of net earned premium, consisted of $146.7 million from short-tailed lines and $120.6 million of net favorable development from medium-tailed and long-tailed lines. Favorable development in short-tailed lines included $107.6 million from property catastrophe and property other than property catastrophe reserves, primarily from the 2011 to 2013 underwriting years (i.e., losses attributable to contracts having an inception or renewal date within the given twelve-month period). Contained within this release was favorable development of $23.3 million from the 2005 to 2013 named catastrophic events. 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 2014. Net favorable development of $120.6 million in medium-tailed and long-tailed lines included reductions in casualty reserves of $101.6 million, primarily from the 2003 to 2006 underwriting years and the 2009 and 2010 underwriting years, and marine and aviation reserves of $14.7 million, primarily from the 2008 to 2012 underwriting years. The balance of net favorable development was spread across various lines and underwriting years.

2013 prior period reserve development: The reinsurance segment’s net favorable development of $217.9 million, or 17.9 points of net earned premium, consisted of $111.1 million from short-tailed lines and $106.8 million of net favorable development from medium-tailed and long-tailed lines. Favorable development in short-tailed lines included $110.1 million from property catastrophe and property other than property catastrophe reserves, primarily from the 2009 to 2012 underwriting years. Contained within this release was favorable development of $28.6 million from the 2005 to 2012 named catastrophic events. 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 2013. Net favorable development of $106.8 million in medium-tailed and long-tailed lines included reductions in casualty reserves of $98.8 million, primarily from the 2003 to 2009 underwriting years, and marine and aviation reserves of $8.1 million, primarily from the 2007 and 2009 underwriting years. The balance of net favorable development was spread across various lines and underwriting years.

2012 prior period reserve development: The reinsurance segment’s net favorable development of $190.3 million, or 17.0 points of net earned premium, consisted of $117.6 million from short-tailed lines and $72.7 million of net favorable development from medium-tailed and long-tailed lines. Favorable development in short-tailed lines included $92.1 million from property catastrophe and property other than property catastrophe reserves, primarily from the 2008 to 2011 underwriting years. Contained within this release was favorable development of $16.8 million from the 2005 to 2011 named catastrophic events. 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 2012. Net favorable development of $72.7 million in medium-tailed and long-tailed lines included reductions in casualty reserves of $55.9 million, primarily from the 2003 to 2009 underwriting years, and marine and aviation reserves of $16.8 million, primarily from the 2008 to 2010 underwriting years. The balance of net favorable development was spread across various lines and underwriting years.

Underwriting Expenses.

2014 versus 2013: The underwriting expense ratio for the reinsurance segment was 32.0% in 2014, compared to 30.2% in 2013. The acquisition expense ratio for 2014 was 20.4%, compared to 19.2% for 2013. The comparison of the 2014 and 2013 acquisition expense ratios is influenced by, among other things, the mix and type of business written and earned and the level of ceding commission income. The operating expense ratio for 2014 of 11.6% was higher than the 2013 ratio of 11.0% primarily due to selected expansion of the reinsurance segment’s operating platform, partially offset by the benefits of a higher level of net premiums earned.

2013 versus 2012: The underwriting expense ratio for the reinsurance segment was 30.2% in 2013, compared to 28.9% in 2012. The acquisition expense ratio for 2013 was 19.2%, compared to 18.3% for 2012. The comparison of the 2013 and 2012 acquisition expense ratios is influenced by, among other things, the mix and type of business written and earned and the level of ceding commission income. The operating expense ratio for 2013 of 11.0% was higher than the 2012 ratio of 10.6% primarily due to selected expansion of the reinsurance segment’s operating platform, partially offset by the benefits of a higher level of net premiums earned.

Mortgage Segment

The following table sets forth our mortgage segment’s underwriting results:

	Year Ended December 31,											Year Ended December 31,
	2014				2013				% Change			2013				2012				% Change
Gross premiums written	$	227,356			$	89,570			153.8			$	89,570			$	68,111			31.5
Premiums ceded	(22,519		)		—							—				—
Net premiums written	204,837				89,570				128.7			89,570				68,111				31.5
Change in unearned premiums	(11,264		)		(38,304		)					(38,304		)		(51,441		)
Net premiums earned	193,573				51,266				277.6			51,266				16,670				207.5
Other underwriting income	4,840				259							259				—
Losses and loss adjustment expenses	(55,674		)		(4,743		)					(4,743		)		(2,615		)
Acquisition expenses, net	(49,400		)		(17,826		)					(17,826		)		(4,998		)
Other operating expense	(66,891		)		(8,377		)					(8,377		)		(4,301		)
Underwriting income	$	26,448			$	20,579			28.5			$	20,579			$	4,756			332.7
Underwriting Ratios									% Point Change											% Point Change
Loss ratio	28.8		%		9.3		%		19.5			9.3		%		15.7		%		(6.4	)
Acquisition expense ratio	25.5		%		34.8		%		(9.3	)		34.8		%		30.0		%		4.8
Other operating expense ratio	34.6		%		16.3		%		18.3			16.3		%		25.8		%		(9.5	)
Combined ratio	88.9		%		60.4		%		28.5			60.4		%		71.5		%		(11.1	)

The mortgage segment includes the results of Arch MI U.S., a leading provider of mortgage insurance products and services to credit unions in the U.S. marketplace, which was acquired in January 2014, along with other global mortgage insurance, reinsurance and risk-sharing products. Since the acquisition, Arch MI U.S. has substantially completed building out its sales force to serve banks and other mortgage originators.

Premiums Written.

The following table sets forth our mortgage segment’s net premiums written by client location and underwriting location (i.e., where the business is underwritten):

	Year Ended December 31,
	2014				2013				2012
Net premiums written by client location
United States	$	184,333			$	63,692			$	61,571
Other	20,504				25,878				6,540
Total	$	204,837			$	89,570			$	68,111
Net premiums written by underwriting location
United States	$	98,809			$	—			$	—
Other	106,028				89,570				68,111
Total	$	204,837			$	89,570			$	68,111

2014 versus 2013: Net premiums written in 2014 included $98.8 million of business underwritten by Arch MI U.S., including $90.0 million from credit union clients and $8.8 million from banks and other mortgage lenders. In addition, net premiums written included $32.5 million from the 100% quota share indemnity reinsurance agreement with PMI Mortgage Insurance Co., in Rehabilitation (“PMI”) for performing certificates of insurance that were issued by PMI from 2009 to 2011, along with growth in U.S. mortgage reinsurance business. The persistency rate of the Arch MI U.S. portfolio of mortgage loans was 80.9% at December 31, 2014. The persistency rate represents the percentage of mortgage insurance in force at the beginning of a 12-month period that remains in force at the end of such period.

2013 versus 2012: Net premiums written for 2013 and 2012 related to reinsurance treaties covering U.S. and international mortgages. The 31.5% increase in net premiums written primarily resulted from new international mortgage reinsurance business written in 2013.

Arch MI U.S. generated $4.92 billion of new insurance written (“NIW”) during 2014. NIW represents the original principal balance of all loans that received coverage during the period. The following table provides details on the NIW generated by Arch MI U.S., including information on credit quality and loan-to-value (“LTV”), for the 2014 periods:

(U.S. Dollars in millions)	Three Months Ended																												Year Ended
December 31, 2014							September 30, 2014							June 30, 2014							March 31, 2014 (1)							December 31, 2014 (1)
	Amount				%			Amount				%			Amount				%			Amount				%			Amount				%
Total new insurance written (NIW)	$	1,359						$	1,982						$	941						$	639						$	4,921
Total NIW by credit quality (FICO score):
>=740	$	730			54			$	1,279			64			$	534			57			$	375			59			$	2,918			59
680-739	480				35			629				32			339				36			225				35			1,673				34
620-679	149				11			74				4			68				7			39				6			330				7
Total	$	1,359			100			$	1,982			100			$	941			100			$	639			100			$	4,921			100
Total NIW by LTV:
95.01% and above	$	79			6			$	81			4			$	70			8			$	45			7			$	275			6
90.01% to 95.00%	620				45			904				46			500				53			330				52			2,354				48
85.01% to 90.00%	389				29			646				32			265				28			186				29			1,486				30
85.01% and below	271				20			351				18			106				11			78				12			806				16
Total	$	1,359			100			$	1,982			100			$	941			100			$	639			100			$	4,921			100
Total NIW purchase vs. refinance:
Purchase	$	950			70			$	1,234			62			$	786			84			$	487			76			$	3,457			70
Refinance	409				30			748				38			155				16			152				24			1,464				30
Total	$	1,359			100			$	1,982			100			$	941			100			$	639			100			$	4,921			100

(1)	Includes activity for January 2014 for comparability purposes (pre-acquisition date).

Net Premiums Earned.

Net premiums earned for 2014 was substantially higher than in 2013, primarily due to the acquisition of Arch MI U.S. along with a higher earned contribution from the mortgage segment’s quota share reinsurance business. Growth from 2012 to 2013 reflects the expansion of the mortgage segment in the periods.

Other Underwriting Income.

Other underwriting income for 2014 was $4.8 million, compared to $0.3 million for 2013. Such amounts primarily relate to risk-sharing products to government sponsored entities and mortgage lenders.

Losses and Loss Adjustment Expenses.

The table below shows the components of the mortgage segment’s loss ratio:

	Year Ended December 31,
	2014			2013			2012
Current year	29.3	%		11.2	%		15.7	%
Prior period reserve development	(0.5	)%		(1.9	)%		—
Loss ratio	28.8	%		9.3	%		15.7	%

Unlike property and casualty business for which we estimate ultimate losses on premiums earned, losses on mortgage insurance business are only recorded at the time a borrower is delinquent on their mortgage, in accordance with mortgage insurance industry practice. Because our mortgage insurance reserving process does not take into account the impact of future losses from loans that are not in default, mortgage insurance loss reserves are not an estimate of ultimate losses. In addition to establishing loss reserves for loans in default, under GAAP, we are required to establish a premium deficiency reserve for our mortgage insurance products if the amount of expected future losses for a particular product and maintenance costs for such product exceeds expected future premiums, existing reserves and the anticipated investment

income for such product. We evaluate whether a premium deficiency exists quarterly. No such reserve was established during 2014.

The mortgage segment’s current year loss ratio was 18.1 points higher in 2014 compared to 2013 and 4.5 points lower in 2013 compared to 2012. The current year loss ratio for 2014 reflects changes in the mix of business earned, resulting primarily from our acquisition of Arch MI U.S. The lower current year loss ratio for 2013 compared to 2012 resulted from changes in the mix of business earned and favorable experience on U.S. mortgage reinsurance business. The mortgage segment’s net favorable development on prior period reserves for 2014 and 2013 was spread across a number of underwriting years.

Underwriting Expenses.

2014 versus 2013: The underwriting expense ratio for the mortgage segment was 60.1% for 2014, compared to 51.1% for 2013. The acquisition expense ratio was 25.5% for 2014, compared to 34.8% for 2013. The operating expense ratio was 34.6% for 2014, compared to 16.3% for 2013. The increase in the underwriting expense ratio reflects the addition of Arch MI U.S. As the mortgage segment’s mix is expected to shift more towards U.S. mortgage insurance business over time, the underwriting expense ratio is expected to stay at an elevated rate until Arch MI U.S. reaches scale.

2013 versus 2012: The underwriting expense ratio for the mortgage segment was 51.1% for 2013, compared to 55.8% for 2012. The acquisition expense ratio was 34.8% for 2013, compared to 30.0% for 2012. The operating expense ratio was 16.3% for 2013, compared to 25.8% for 2012. Such amounts relate to the mortgage segment’s reinsurance business for both periods. The reduction in the operating expense ratio reflects the impact of higher net premiums earned in 2013.

Other Segment

As noted earlier, the ‘other’ segment includes the results of Watford Re. Watford Re has its own management and board of directors and is responsible for the overall profitability of its results. We act as Watford Re’s reinsurance underwriting manager and Highbridge Principal Strategies, a subsidiary of JPMorgan Chase & Co., manages Watford Re’s investment assets, each under a long term services agreement. We invested $100.0 million to acquire approximately 11% of Watford Re’s common equity and a warrant to purchase additional common equity. We performed an analysis of Watford Re and concluded that Watford Re is a variable interest entity (“VIE”) and concluded that we are the primary beneficiary of Watford Re. As such, 100% of the results of Watford Re are included in our consolidated financial statements. Management measures segment performance for the ‘other’ segment based on net income or loss. See note 4, “Variable Interest Entity and Noncontrolling Interests” and note 5, “Segment Information,” of the notes accompanying our consolidated financial statements for additional information.

The following table sets forth our ‘other’ segment’s results:

	Year Ended December 31, 2014
Gross premiums written	$	288,627
Premiums ceded	(14,171		)
Net premiums written	274,456
Change in unearned premiums	(170,979		)
Net premiums earned	103,477
Losses and loss adjustment expenses	(70,173		)
Acquisition expenses, net	(30,116		)
Other operating expenses	(6,268		)
Underwriting income (loss)	(3,080		)
Net investment income	18,249
Other expenses	(2,329		)
Net realized gains	(30,467		)
Net foreign exchange gains	1,086
Net income (loss)	(16,541		)
Dividends attributable to redeemable noncontrolling interests (1)	(14,728		)
Net income (loss) attributable to common interests	(31,269		)
Amounts attributable to nonredeemable noncontrolling interests (1)	27,823
Net income (loss) available to Arch	$	(3,446	)
Underwriting Ratios
Loss ratio	67.8		%
Acquisition expense ratio	29.1		%
Other operating expense ratio	6.1		%
Combined ratio	103.0		%
Total investable assets	$	1,163,240
Total assets	1,482,516
Total liabilities	398,660

(1) Recorded as ‘amounts attributable to noncontrolling interests’ in the consolidated statements of income.

Other Income or Expense Items (excluding amounts related to the ‘other’ segment)

Net Investment Income. The components of net investment income were derived from the following sources:

	Year Ended December 31,
	2014				2013				2012
Fixed maturities	$	265,219			$	249,833			$	281,140
Term loan investments	39,940				20,608				15,283
Equity securities	13,005				8,919				7,963
Short-term investments	1,888				1,259				1,980
Other (1)	28,869				19,710				14,196
Gross investment income	348,921				300,329				320,562
Investment expenses	(46,336		)		(33,110		)		(25,667		)
Net investment income	$	302,585			$	267,219			$	294,895

(1) Includes dividends on investment funds and other items.

The pre-tax investment income yield was 2.08% for 2014, compared to 2.12% for 2013 and 2.51% for 2012. The comparability of net investment income between the periods was influenced by our share repurchase program, as well as the decrease in the pre-tax investment income yield, due in part to the prevailing interest rate environment. The pre-tax investment income yields were calculated based on amortized cost. Yields on future investment income may vary based on financial market conditions, investment allocation decisions and other factors.

Other Income (Loss). Other income or loss primarily reflects the results from our investment in Gulf Reinsurance Limited (“Gulf Re”) and certain other investments which are accounted for using the equity method on a three month lag basis based on the availability of their financial statements. In addition, other income (loss) from time to time includes certain non-recurring items. For such items, we recorded a loss of $10.3 million for 2014, compared to a loss of $0.6 million for 2013, and a loss of $12.1 million for 2012. Results for 2014 reflected $14.1 million of losses from Gulf Re, which experienced a number of large technical risk losses. Results for 2012 reflected results from our investment in Aeolus L.P., which experienced a high level of losses from catastrophic activity. See note 10, “Investment in Joint Venture,” of the notes accompanying our consolidated financial statements for additional information on Gulf Re.

Equity in Net Income (Loss) of Investment Funds Accounted for Using the Equity Method. We recorded $19.9 million of equity in net income for 2014, compared to $35.7 million for 2013 and $73.5 million for 2012. 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 to 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 $349.0 million at December 31, 2014, compared to $244.3 million at December 31, 2013.

Net Realized Gains (Losses). We recorded net realized gains of $133.4 million, $74.0 million and $194.2 million, respectively, for 2014, 2013 and 2012. 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. Net realized gains or losses also included changes in the fair value of assets and liabilities accounted for using the fair value option along with remeasurement of the contingent consideration liability related to our purchase of the CMG Entities. See note 2, “Business Acquired,” and note 8, “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. For 2014, we recorded $30.2 million of credit related impairments in earnings, compared to $3.8 million in 2013 and $11.4 million in 2012. The other-than-temporary impairments (“OTTI”) recorded in 2014 primarily resulted from impairments taken on one investment fund where we determined that we did not intend to hold such investment for a reasonable period of time by which the fair value of the fund would increase and we would recover our cost, while impairments in 2013 and 2012 primarily resulted from reductions in estimated recovery values on certain mortgage-backed and asset-backed securities following the review of such securities and on equity securities following a review of available positive and negative evidence. See note 8, “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, were $47.6 million for 2014, compared to $42.4 million for 2013 and $35.3 million for 2012. Such amounts are included in the corporate (non-underwriting) segment and 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.

Interest Expense. Interest expense was $45.6 million for 2014, compared to $27.1 million for 2013 and $28.5 million for 2012. Interest expense for 2014 included $49.5 million related to our senior notes and other borrowings, partially offset by a $3.9 million reduction in interest expense on a deposit accounting liability (i.e., a contract that does not pass risk transfer) in accordance with GAAP. The reduction resulted from a reassessment of the estimated ultimate liability in the 2014 third quarter due to a determination that paid losses are expected to be lower than initially anticipated. Because the contract does not pass risk transfer under GAAP, it is accounted for similar to a borrowing with accretion and changes in expectations surrounding the estimated ultimate liability impacting interest expense. The reduction of the estimated ultimate liability reduced the rate of accretion recorded in interest expense in the second half of 2014 and is expected to reduce the rate of accretion for future periods. The higher level of interest expense for 2014 compared to 2013 and 2012 primarily resulted from interest related to the $500.0 million of 5.144% senior notes issued by Arch Capital Group (U.S.) Inc. (“Arch-U.S.”) in December 2013.

Net Foreign Exchange Gains or Losses. Net foreign exchange gains for 2014 of $82.7 million consisted of net unrealized gains of $84.8 million and net realized losses of $2.1 million, compared to net foreign exchange losses for 2013 of $12.3 million which consisted of net unrealized gains of $0.7 million and net realized losses of $13.0 million and net foreign exchange losses for 2012 of $29.0 million which consisted of net unrealized losses of $27.3 million and net realized losses of $1.6 million. Net unrealized foreign exchange gains or losses result from the effects of revaluing our net insurance liabilities required to be settled in foreign currencies at each balance sheet date. Historically, we have held investments in foreign currencies which are intended to mitigate our exposure to foreign currency fluctuations in our net insurance liabilities. However, changes in the value of such investments 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. At times, we have chosen not to match portions of our projected liabilities in foreign currencies with investments in the same currencies and may not match such amounts in future periods, which could increase our exposure to foreign currency fluctuations and increase the volatility of our 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 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. Such adjustment had no impact on total shareholders’ equity or cash flows.

Income Tax Expense. Our income tax provision on income before income taxes resulted in an expense of 2.7% for 2014, compared to an expense of 4.4% for 2013 and a benefit of 0.7% for 2012. Our effective tax rate fluctuates from year to year consistent with the relative mix of income or loss reported by jurisdiction and the varying tax rates in each jurisdiction. See note 14, “Income Taxes,” of the notes accompanying our consolidated financial statements for a reconciliation of the difference between the provision for income taxes and the expected tax provision at the weighted average statutory tax rate for 2014, 2013 and 2012.

CRITICAL ACCOUNTING POLICIES, ESTIMATES AND RECENT ACCOUNTING PRONOUNCEMENTS

The preparation of consolidated financial statements in accordance with GAAP requires us to make many estimates and judgments that affect the reported amounts of assets, liabilities (including reserves), revenues and expenses, and related disclosures of contingent liabilities. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, insurance and other reserves, reinsurance recoverables, allowance for doubtful accounts, investment valuations, intangible assets, bad debts, income taxes, contingencies and litigation. We base our estimates on historical experience, where possible, and on various other assumptions that we believe to be reasonable under the circumstances, which form the basis for our judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Estimates and judgments 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 December 31, 2014. Actual results will differ from these estimates and such differences may be material. We believe that the following critical accounting policies affect significant estimates used in the preparation of our consolidated financial statements.

Reserves for Losses and Loss Adjustment Expenses

We are required by applicable insurance laws and regulations and GAAP to establish reserves for losses and loss adjustment expenses (“Loss Reserves”) that arise from the business we underwrite. Loss Reserves for our insurance and reinsurance operations are balance sheet liabilities representing estimates of future amounts required to pay losses and loss adjustment expenses for insured or reinsured events which have occurred at or before the balance sheet date. Loss Reserves do not reflect contingency reserve allowances to account for future loss occurrences. Losses arising from future events will be estimated and recognized at the time the losses are incurred and could be substantial.

At December 31, 2014 and 2013, our Loss Reserves, net of unpaid losses and loss adjustment expenses recoverable, by type and by operating segment were as follows:

	December 31,
	2014				2013
Insurance:
Case reserves	$	1,459,040			$	1,446,029
IBNR reserves	3,066,962				3,037,755
Total net reserves	4,526,002				4,483,784
Reinsurance:
Case reserves	794,838				749,830
Additional case reserves	97,413				113,331
IBNR reserves	1,658,468				1,722,214
Total net reserves	2,550,719				2,585,375
Mortgage:
Case reserves	96,092				1,419
IBNR reserves	21,709				5,868
Total net reserves	117,801				7,287
Other:
Case reserves	12,010				—
IBNR reserves	51,613				—
Total net reserves	63,623				—
Total:
Case reserves	2,361,980				2,197,278
Additional case reserves	97,413				113,331
IBNR reserves	4,798,752				4,765,837
Total net reserves	$	7,258,145			$	7,076,446

Insurance Operations

Loss Reserves for our insurance operations are comprised of (1) estimated amounts for claims reported (“case reserves”) and (2) incurred but not reported (“IBNR”) losses. For our insurance operations, generally, claims personnel determine whether to establish a case reserve for the estimated amount of the ultimate settlement of individual claims. The estimate reflects the judgment of claims personnel based on general corporate reserving practices, the experience and knowledge of such personnel regarding the nature and value of the specific type of claim and, where appropriate, advice of counsel. Our insurance operations also contract with a number of outside third party administrators in the claims process who, in certain cases, have limited authority to establish case reserves. The work of such administrators is reviewed and monitored by our claims personnel. Loss Reserves are also established to provide for loss adjustment expenses and represent the estimated expense of settling claims, including legal and other fees and the general expenses of administering the claims adjustment process. Periodically, adjustments to the reported or case reserves may be made as additional information regarding the claims is reported or payments are made. IBNR reserves are established to provide for incurred claims which have not yet been reported at the balance sheet date as well as to adjust for any projected variance in case reserving. Actuaries estimate ultimate losses and loss adjustment expenses using various generally accepted actuarial methods applied to known losses and other relevant information. Like case reserves, IBNR reserves are adjusted as additional information becomes known or payments are made. The process of estimating reserves involves a considerable degree of judgment by management and, as of any given date, is inherently uncertain.

Ultimate losses and loss adjustment expenses are generally determined by extrapolation of claim emergence and settlement patterns observed in the past that can reasonably be expected to persist into the future. In forecasting ultimate

losses and loss adjustment expenses with respect to any line of business, past experience with respect to that line of business is the primary resource, developed through both industry and company experience, but cannot be relied upon in isolation. Uncertainties in estimating ultimate losses and loss adjustment expenses are magnified by the time lag between when a claim actually occurs and when it is reported and settled. This time lag is sometimes referred to as the “claim-tail.” The claim-tail for most property coverages is typically short (usually several months up to a few years). The claim-tail for certain professional liability, executive assurance and healthcare coverages, which are generally written on a claims-made basis, is typically longer than property coverages but shorter than casualty lines. The claim-tail for liability/casualty coverages, such as general liability, products liability, multiple peril coverage, and workers’ compensation, may be especially long as claims are often reported and ultimately paid or settled years, or even decades, after the related loss events occur. During the long claims reporting and settlement period, additional facts regarding coverages written in prior accident years, as well as about actual claims and trends, may become known and, as a result, our insurance operations may adjust their reserves. If management determines that an adjustment is appropriate, the adjustment is recorded in the accounting period in which such determination is made in accordance with GAAP. Accordingly, should Loss Reserves need to be increased or decreased in the future from amounts currently established, future results of operations would be negatively or positively impacted, respectively.

In determining ultimate losses and loss adjustment expenses, the cost to indemnify claimants, provide needed legal defense and other services for insureds and administer the investigation and adjustment of claims are considered. These claim costs are influenced by many factors that change over time, such as expanded coverage definitions as a result of new court decisions, inflation in costs to repair or replace damaged property, inflation in the cost of medical services and legislated changes in statutory benefits, as well as by the particular, unique facts that pertain to each claim. As a result, the rate at which claims arose in the past and the costs to settle them may not always be representative of what will occur in the future. The factors influencing changes in claim costs are often difficult to isolate or quantify and developments in paid and incurred losses from historical trends are frequently subject to multiple and conflicting interpretations. Changes in coverage terms or claims handling practices may also cause future experience and/or development patterns to vary from the past. A key objective of actuaries in developing estimates of ultimate losses and loss adjustment expenses, and resulting IBNR reserves, is to identify aberrations and systemic changes occurring within historical experience and accurately adjust for them so that the future can be projected reliably. Because of the factors previously discussed, this process requires the substantial use of informed judgment and is inherently uncertain.

At December 31, 2014 and 2013, the insurance segment’s Loss Reserves by major line of business, net of unpaid losses and loss adjustment expenses recoverable, were as follows:

	December 31,
	2014				2013
Professional lines (1)	$	1,453,770			$	1,525,360
Construction and national accounts	806,007				694,721
Excess and surplus casualty (2)	683,305				678,893
Programs	669,601				644,689
Property, energy, marine and aviation	407,730				503,208
Travel, accident and health	60,888				49,934
Lenders products	40,579				31,076
Other (3)	404,122				355,903
Total net reserves	$	4,526,002			$	4,483,784

(1)	Includes professional liability, executive assurance and healthcare business.

(2)	Includes casualty and contract binding business.

(3)	Includes alternative markets, excess workers’ compensation and surety business.

The initial reserving method for our insurance operations to date has been, to a large extent, the expected loss method, which is commonly applied when limited loss experience exists. Our insurance operations employ a number of different reserving methods depending on the line of business, the availability of historical loss experience and the stability of that loss experience. Over time, such techniques have been given more weight in the reserving process due to the continuing maturation of their Loss Reserves and the increased availability and credibility of the historical experience. Any estimates and assumptions made as part of the reserving process could prove to be inaccurate due to several factors, including the fact

that relatively limited historical information has been reported to our insurance operations through December 31, 2014 in some lines of business. See below for a discussion of the key assumptions in our insurance operations’ reserving process.

Although Loss Reserves are initially determined based on underwriting and pricing analyses, our insurance operations apply several generally accepted actuarial methods, as discussed below, on a quarterly basis to evaluate their Loss Reserves, in addition to the expected loss method, in particular for Loss Reserves from more mature accident years (the year in which a loss occurred). As noted below, our insurance operations give some weight to their own experience following reviews of open claims on lines of business written on a claims-made basis for which they developed a reasonable level of credible data. Each quarter, as part of the reserving process, actuaries at our insurance operations reaffirm that the assumptions used in the reserving process continue to form a sound basis for the projection of liabilities. If actual loss activity differs substantially from expectations based on historical information, an adjustment to loss reserves may be supported. Loss Reserves for more mature accident years are now based more on historical loss activity and patterns than on the initial assumptions based on pricing indications. More recent accident years rely more heavily on internal pricing assumptions. Our insurance operations place more or less reliance on a particular actuarial method based on the facts and circumstances at the time the estimates of Loss Reserves are made. These methods generally fall into one of the following categories or are hybrids of one or more of the following categories:

•

Expected loss methods – these methods are based on the assumption that ultimate losses vary proportionately with premiums. Expected loss and loss adjustment expense ratios are typically developed based upon the information derived by underwriters and actuaries during the initial pricing of the business, supplemented by industry data available from organizations, such as statistical bureaus and consulting firms, where appropriate. These ratios consider, among other things, rate increases and changes in terms and conditions that have been observed in the market. Expected loss methods are useful for estimating ultimate losses and loss adjustment expenses in the early years of long-tailed lines of business, when little or no paid or incurred loss information is available, and is commonly applied when limited loss experience exists for a company.

•

Historical incurred loss development methods – these methods assume that the ratio of losses in one period to losses in an earlier period will remain constant in the future. These methods use incurred losses (i.e., the sum of cumulative historical loss payments plus outstanding case reserves) over discrete periods of time to estimate future losses. Historical incurred loss development methods may be preferable to historical paid loss development methods because they explicitly take into account open cases and the claims adjusters’ evaluations of the cost to settle all known claims. However, historical incurred loss development methods necessarily assume that case reserving practices are consistently applied over time. Therefore, when there have been significant changes in how case reserves are established, using incurred loss data to project ultimate losses may be less reliable than other methods.

•

Historical paid loss development methods – these methods, like historical incurred loss development methods, assume that the ratio of losses in one period to losses in an earlier period will remain constant. These methods use historical loss payments over discrete periods of time to estimate future losses and necessarily assume that factors that have affected paid losses in the past, such as inflation or the effects of litigation, will remain constant in the future. Because historical paid loss development methods do not use incurred losses to estimate ultimate losses, they may be more reliable than the other methods that use incurred losses in situations where there are significant changes in how incurred losses are established by a company’s claims adjusters. However, historical paid loss development methods are more leveraged (meaning that small changes in payments have a larger impact on estimates of ultimate losses) than actuarial methods that use incurred losses because cumulative loss payments take much longer to equal the expected ultimate losses than cumulative incurred amounts. In addition, and for similar reasons, historical paid loss development methods are often slow to react to situations when new or different factors arise than those that have affected paid losses in the past.

•

Adjusted historical paid and incurred loss development methods – these methods take traditional historical paid and incurred loss development methods and adjust them for the estimated impact of changes from the past in factors such as inflation, the speed of claim payments or the adequacy of case reserves. Adjusted historical paid and incurred loss development methods are often more reliable methods of predicting ultimate losses in periods of significant change, provided the actuaries can develop methods to reasonably quantify the impact of changes. As such, these methods utilize more judgment than historical paid and incurred loss development methods.

•

Bornhuetter-Ferguson (“B-F”) paid and incurred loss methods – these methods utilize actual paid and incurred losses and expected patterns of paid and incurred losses, taking the initial expected ultimate losses into account to determine an estimate of expected ultimate losses. The B-F paid and incurred loss methods are useful when there are few reported claims and a relatively less stable pattern of reported losses.

•

Additional analyses – other methodologies are often used in the reserving process for specific types of claims or events, such as catastrophic or other specific major events. These include vendor catastrophe models, which are typically used in the estimation of Loss Reserves at the early stage of known catastrophic events before information has been reported to an insurer or reinsurer, and analyses of specific industry events, such as large lawsuits or claims.

In the initial reserving process for casualty business, primarily consisting of primary and excess exposures written on an occurrence basis, our insurance operations primarily rely on the expected loss method. The development of our insurance operations’ casualty business may be unstable due to its long-tail nature and the occurrence of high severity events, as a portion of our insurance operations’ casualty business is in high excess layers. As time passes, for a given accident year, additional weight is given to the paid and incurred B-F loss development methods and historical paid and incurred loss development methods in the reserving process. Our insurance operations make a number of key assumptions in reserving for casualty business, including that the pricing loss ratio is the best estimate of the ultimate loss ratio at the time the policy is entered into, that our insurance operations’ loss development patterns, which are based on a combination of company and industry loss development patterns and adjusted to reflect differences in our insurance operations’ mix of business, are reasonable and that our insurance operations’ claims personnel and underwriters analyses of our exposure to major events are assumed to be our best estimate of our exposure to the known claims on those events. As noted earlier, due to the long claims reporting and settlement period for casualty business, additional facts regarding coverages written in prior accident years, as well as about actual claims and trends may become known and, as a result, our insurance operations may be required to adjust their casualty reserves. The expected loss ratios used in the initial reserving process for our insurance operations’ casualty business for recent accident years have varied, in some cases significantly, from earlier accident years. As the credibility of historical experience for earlier accident years increases, the experience from these accident years will be given a greater weighting in the actuarial analysis to determine future accident year expected loss ratios, adjusted for changes in pricing, loss trends, terms and conditions and reinsurance structure.

In the initial reserving process for property, energy, marine and aviation business, which are primarily short-tail exposures, our insurance operations rely on a combination of the reserving methods discussed above. For catastrophe-exposed business, our insurance operations’ reserving process also includes the usage of catastrophe models for known events and a heavy reliance on analysis of individual catastrophic events and management judgment. The development of property losses can be unstable, especially for policies characterized by high severity, low frequency losses. As time passes, for a given accident year, additional weight is given to the paid and incurred B-F loss development methods and historical paid and incurred loss development methods in the reserving process. Our insurance operations make a number of key assumptions in their reserving process, including that historical paid and reported development patterns are stable, catastrophe models provide useful information about our exposure to catastrophic events that have occurred and our underwriters’ judgment as to potential loss exposures can be relied on. The expected loss ratios used in the initial reserving process for our insurance operations’ property business have varied over time due to changes in pricing, reinsurance structure, estimates of catastrophe losses, policy changes (such as attachment points, class and limits) and geographical distribution. As losses in property lines are reported relatively quickly, expected loss ratios are selected for the current accident year based upon actual attritional loss ratios for earlier accident years, adjusted for rate changes, inflation, changes in reinsurance programs and expected attritional losses based on modeling. Due to the short-tail nature of property business, reported loss experience emerges quickly and ultimate losses are known in a reasonably short period of time.

In addition to the assumptions and development characteristics noted above for casualty and property business, our insurance operations authorize managing general agents, general agents and other producers to write program business on their behalf within prescribed underwriting authorities. This adds additional complexity to the reserving process. To monitor adherence to the underwriting guidelines given to such parties, our insurance operations periodically perform claims due diligence reviews. In the initial reserving process for program business, consisting of property and liability exposures which are primarily written on an occurrence basis, our insurance operations primarily rely on the expected loss method. As time passes, for a given accident year, additional weight is given to the paid and incurred B-F loss development methods and historical paid and incurred loss development methods in the reserving process. The expected loss ratios used in the initial reserving process for our insurance operations’ program business have varied over time depending on the type

of exposures written (casualty or property) and changes in pricing, loss trends, reinsurance structure and changes in the underlying business.

In the initial reserving process for executive assurance, professional liability and healthcare business, primarily consisting of medium-tail exposures written on a claims-made basis, our insurance operations primarily rely on the expected loss method. As time passes, for a given accident year, additional weight is given to the paid and incurred B-F loss development methods and historical paid and incurred loss development methods in the reserving process. Beginning in 2005, our insurance operations began to give a relatively small amount of weight to their own experience following reviews of open claims, in particular for lines of business written on a claims-made basis for which they developed a reasonable level of credible data. Over the last few years, our insurance operations have increased their reliance on reviews of open claims. In general, the expected loss ratios established for executive assurance, professional liability and healthcare business for recent accident years vary, in some cases materially, from earlier accident years based on analysis of pricing, loss cost trends and changes in policy coverage. Since this business is primarily written on a claims-made basis and is subject to high severity, low frequency losses, a great deal of uncertainty exists in setting these initial reserves. In addition, only a limited number of years of historical experience is available for use in projecting loss experience using standard actuarial methods. As the credibility of historical experience for earlier accident years increases, the experience from these accident years will be given a greater weighting in the actuarial analysis to determine future accident year expected loss ratios, adjusted for the occurrence or lack of large losses, changes in pricing, loss trends, terms and conditions and reinsurance structure.

In the initial reserving process for construction and surety business, consisting of primary and excess casualty and contract surety coverages written on an occurrence and claims-made basis, our insurance operations primarily rely on a combination of the reserving methods discussed above. Such business is subject to the assumptions and development characteristics noted above for casualty business. As time passes, for a given accident year, additional weight has been given to the paid and incurred B-F loss development methods and historical paid and incurred loss development methods in the reserving process. In general, the expected loss ratios used in the initial reserving process for our insurance operations’ construction and surety business for recent accident years vary, in some cases materially, from earlier accident years. As the credibility of historical experience for earlier accident years has increased, the experience from these accident years has been given a greater weighting in the actuarial analysis to determine future accident year expected loss ratios, adjusted for anticipated changes in the regulatory environment, pricing, loss trends, terms and conditions and reinsurance structure.

Reinsurance Operations

Loss Reserves for our reinsurance operations are comprised of (1) case reserves for claims reported, (2) additional case reserves (“ACRs”) and (3) IBNR reserves. Our reinsurance operations receive reports of claims notices from ceding companies and record case reserves based upon the amount of reserves recommended by the ceding company. Case reserves on known events may be supplemented by ACRs, which are often estimated by our reinsurance operations’ claims personnel ahead of official notification from the ceding company, or when our reinsurance operations’ judgment regarding the size or severity of the known event differs from the ceding company. In certain instances, our reinsurance operations establish ACRs even when the ceding company does not report any liability on a known event. In addition, specific claim information reported by ceding companies or obtained through claim audits can alert our reinsurance operations to emerging trends such as changing legal interpretations of coverage and liability, claims from unexpected sources or classes of business, and significant changes in the frequency or severity of individual claims. Such information is often used in the process of estimating IBNR reserves.

The estimation of Loss Reserves for our reinsurance operations is subject to the same risk factors as the estimation of Loss Reserves for our insurance operations. In addition, the inherent uncertainties of estimating such reserves are even greater for reinsurers, due primarily to the following factors: (1) the claim-tail for reinsurers is generally longer because claims are first reported to the ceding company and then to the reinsurer through one or more intermediaries, (2) the reliance on premium estimates, where reports have not been received from the ceding company, in the reserving process, (3) the potential for writing a number of reinsurance contracts with different ceding companies with the same exposure to a single loss event, (4) the diversity of loss development patterns among different types of reinsurance contracts, (5) the necessary reliance on the ceding companies for information regarding reported claims and (6) the differing reserving practices among ceding companies.

As with our insurance operations, the process of estimating Loss Reserves for our reinsurance operations involves a considerable degree of judgment by management and, as of any given date, is inherently uncertain. As discussed above,

such uncertainty is greater for reinsurers compared to insurers. As a result, our reinsurance operations obtain information from numerous sources to assist in the process. Pricing actuaries from our reinsurance operations devote considerable effort to understanding and analyzing a ceding company’s operations and loss history during the underwriting of the business, using a combination of ceding company and industry statistics. Such statistics normally include historical premium and loss data by class of business, individual claim information for larger claims, distributions of insurance limits provided, loss reporting and payment patterns, and rate change history. This analysis is used to project expected loss ratios for each treaty during the upcoming contract period.

As mentioned above, there can be a considerable time lag from the time a claim is reported to a ceding company to the time it is reported to the reinsurer. The lag can be several years in some cases and may be attributed to a number of reasons, including the time it takes to investigate a claim, delays associated with the litigation process, the deterioration in a claimant’s physical condition many years after an accident occurs, the case reserving approach of the ceding company, etc. In the reserving process, our reinsurance operations assume that such lags are predictable, on average, over time and therefore the lags are contemplated in the loss reporting patterns used in their actuarial methods. This means that our reinsurance operations must rely on estimates for a longer period of time than does an insurance company. Backlogs in the recording of assumed reinsurance can also complicate the accuracy of loss reserve estimation. As of December 31, 2014 there were no significant backlogs related to the processing of assumed reinsurance information at our reinsurance operations.

Our reinsurance operations rely heavily on information reported by ceding companies, as discussed above. In order to determine the accuracy and completeness of such information, underwriters, actuaries, and claims personnel at our reinsurance operations often perform audits of ceding companies and regularly review information received from ceding companies for unusual or unexpected results. Material findings are usually discussed with the ceding companies. Our reinsurance operations sometimes encounter situations where they determine that a claim presentation from a ceding company is not in accordance with contract terms. In these situations, our reinsurance operations attempt to resolve the dispute with the ceding company. Most situations are resolved amicably and without the need for litigation or arbitration. However, in the infrequent situations where a resolution is not possible, our reinsurance operations will vigorously defend their position in such disputes.

At December 31, 2014 and 2013, the reinsurance segment’s Loss Reserves by major line of business, net of unpaid losses and loss adjustment expenses recoverable, were as follows:

	December 31,
	2014				2013
Casualty	$	1,432,203			$	1,513,205
Other specialty	448,418				397,776
Property excluding property catastrophe	346,610				260,968
Marine and aviation	139,318				163,293
Property catastrophe	128,436				190,027
Other	55,734				60,106
Total net reserves	$	2,550,719			$	2,585,375

Any estimates and assumptions made as part of the reserving process could prove to be inaccurate due to several factors, including the fact that relatively limited historical information has been reported to our reinsurance operations through December 31, 2014 in some lines of business. See below for a discussion of the key assumptions in our reinsurance operations’ reserving process.

Although Loss Reserves are initially determined based on underwriting and pricing analysis, our reinsurance operations apply several generally accepted actuarial methods, as discussed above, on a quarterly basis to evaluate their Loss Reserves in addition to the expected loss method, in particular for Loss Reserves from more mature underwriting years (the year in which business is underwritten). Each quarter, as part of the reserving process, actuaries at our reinsurance operations reaffirm that the assumptions used in the reserving process continue to form a sound basis for projection of liabilities. If actual loss activity differs substantially from expectations based on historical information, an adjustment to loss reserves may be supported. Estimated Loss Reserves for more mature underwriting years are now based more on actual loss activity and historical patterns than on the initial assumptions based on pricing indications. More recent underwriting years rely more heavily on internal pricing assumptions. Our reinsurance operations place more or less

reliance on a particular actuarial method based on the facts and circumstances at the time the estimates of Loss Reserves are made.

In the initial reserving process for medium-tail and long-tail lines, consisting of casualty, other specialty, marine and aviation and other exposures, our reinsurance operations primarily rely on the expected loss method. The development of medium-tail and long-tail business may be unstable, especially if there are high severity major events, with business written on an excess of loss basis typically having a longer tail than business written on a pro rata basis. As time passes, for a given underwriting year, additional weight is given to the paid and incurred B-F loss development methods and historical paid and incurred loss development methods in the reserving process. Our reinsurance operations make a number of key assumptions in reserving for medium-tail and long-tail lines, including that the pricing loss ratio is the best estimate of the ultimate loss ratio at the time the contract is entered into, historical paid and reported development patterns are stable and our reinsurance operations’ claims personnel and underwriters analyses of our exposure to major events are assumed to be our best estimate of our exposure to the known claims on those events. The expected loss ratios used in our reinsurance operations’ initial reserving process for medium-tail and long-tail contracts have varied over time due to changes in pricing, terms and conditions and reinsurance structure. As the credibility of historical experience for earlier underwriting years increases, the experience from these underwriting years will be used in the actuarial analysis to determine future underwriting year expected loss ratios, adjusted for changes in pricing, loss trends, terms and conditions and reinsurance structure.

In the initial reserving process for short-tail lines, consisting of property excluding property catastrophe and property catastrophe exposures, our reinsurance operations rely on a combination of the reserving methods discussed above. For known catastrophic events, our reinsurance operations’ reserving process also includes the usage of catastrophe models and a heavy reliance on analysis which includes ceding company inquiries and management judgment. The development of property losses may be unstable, especially where there is high catastrophic exposure, may be characterized by high severity, low frequency losses for excess and catastrophe-exposed business and may be highly correlated across contracts. As time passes, for a given underwriting year, additional weight is given to the paid and incurred B-F loss development methods and historical paid and incurred loss development methods in the reserving process. Our reinsurance operations make a number of key assumptions in reserving for short-tail lines, including that historical paid and reported development patterns are stable, catastrophe models provide useful information about our exposure to catastrophic events that have occurred and our underwriters’ judgment and guidance received from ceding companies as to potential loss exposures may be relied on. The expected loss ratios used in the initial reserving process for our reinsurance operations’ property exposures have varied over time due to changes in pricing, reinsurance structure, estimates of catastrophe losses, terms and conditions and geographical distribution. As losses in property lines are reported relatively quickly, expected loss ratios are selected for the current underwriting year incorporating the experience for earlier underwriting years, adjusted for rate changes, inflation, changes in reinsurance programs, expectations about present and future market conditions and expected attritional losses based on modeling. Due to the short-tail nature of property business, reported loss experience emerges quickly and ultimate losses are known in a reasonably short period of time.

Mortgage Operations

Our U.S. mortgage insurance operations establish case reserves for loans that have been reported as delinquent by loan servicers as well as those that are delinquent but not reported (IBNR). Our U.S. mortgage insurance operations also reserve for the expenses of adjusting claims related to these delinquencies. The trigger that creates a reserve estimate is that an insured loan is two payments in arrears, and the date of the second missed payment is considered to be the accident date. The actuarial reviews and documentation created in the reserving process are completed in accordance with generally accepted actuarial standards. The selected assumptions reflect the actuary’s judgment based on historical data and experience combined with information concerning current underwriting, economic, judicial, regulatory and other influences on ultimate claim settlements.

Because the reserving process requires our U.S. mortgage insurance operations to forecast future conditions, it is inherently uncertain and requires significant judgment and estimation. The use of different estimates would have resulted in the establishment of different reserve levels. Additionally, changes in accounting estimates are likely to occur from period to period as economic conditions change and the ultimate liability may vary significantly from the estimates used. Major risk factors include (but are not limited to) changes in home prices and borrower equity, which can limit the borrower’s ability to sell the property and satisfy the outstanding loan balance, and changes in unemployment, which can affect the borrower’s income and ability to make mortgage payments.

The lead methodology used by our U.S. mortgage insurance operations is a frequency-severity method based on the inventory of pending delinquencies. Each month the loan servicers report the delinquency status of each insured loan. Using the frequency-severity method allows our U.S. mortgage insurance operations to take advantage of its knowledge of the number of delinquent loans and the coverage provided (“risk size”) on those loans by directly relating the reserves to these amounts. The delinquencies are grouped by the year in which they were reported (“report year”). A claim rate is then developed for each report year which represents the frequency with which the delinquencies become claims. The claim rates are based on an analysis of the patterns of emerging cure counts and claim counts of the report year, the foreclosure status of the pending delinquencies, the product and geographical mix of the delinquencies and our view of future economic and claim conditions, which include trends in home prices and unemployment. Claim rates can vary materially by report year depending on the mix of delinquencies and economic conditions.

Claim size estimates are determined by examining the risk sizes on the delinquent loans and estimating the portion of risk that will be paid, as well as any expenses. This is done based on a review of historical data, an assessment of economic conditions and the level of equity the borrowers may have in their homes, as well as considering loss mitigation opportunities. Mortgage insurance is generally not subject to large claim sizes, as with some other lines of insurance. A claim size over $250,000 is rare, and this helps reduce the volatility of claim size estimates. The claim rate and claim size assumptions generate case reserves for each report year. The reserve for unreported delinquencies (included in IBNR) is estimated by looking at historical rates of late reporting of delinquencies. Claim rates and claim sizes can then be assigned to estimated future late reported delinquencies using assumptions made in the establishment of case reserves.

Mortgage insurance reserves are short-tail, in the sense that the vast majority of delinquencies are resolved within two years of being reported. While reserves are initially analyzed by report year, they are also rolled up by underwriting year to ensure that reserve assumptions are consistent with the performance of the underwriting year. The accuracy of prior reserve assumptions is also checked in hindsight to determine if adjustments are needed.

The following table provides supplemental disclosures for our U.S. mortgage insurance operations related to insured loans and loss metrics:

(U.S. Dollars in thousands, except loan count)					Three Months Ended												Year Ended
	December 31, 2014				September 30, 2014				June 30, 2014				March 31, 2014 (1)				December 31, 2014 (1)
Rollforward of insured loans in default:
Beginning delinquent number of loans	3,625				3,641				3,858				4,469				4,469
Plus: new notices	1,402				1,553				1,377				1,458				5,790
Less: cures	(1,202		)		(1,168		)		(1,202		)		(1,635		)		(5,207		)
Less: paid claims	(351		)		(397		)		(383		)		(429		)		(1,560		)
Less: delinquent rescissions and denials	—				(4		)		(9		)		(5		)		(18		)
Ending delinquent number of loans	3,474				3,625				3,641				3,858				3,474
Ending percentage of loans in default	2.6		%		2.8		%		2.9		%		3.0		%
Losses:
Number of claims paid	351				397				383				429				1,560
Total paid claims	$	15,358			$	17,093			$	16,190			$	18,117			$	66,758
Average per claim	$	43.8			$	43.1			$	42.3			$	42.2			$	42.8
Severity (2)	99.2		%		93.7		%		93.0		%		97.4		%		96.3		%
Average reserve per default	$	27.5			$	27.1			$	28.1			$	27.5

(1) Includes activity for January 2014 for comparability purposes (pre-acquisition date).

(2) Represents total paid claims divided by RIF of loans for which claims were paid.

Loss Reserves for our mortgage operations’ reinsurance business are comprised of (1) case reserves for claims reported and (2) IBNR reserves. Our mortgage reinsurance operations receive reports of delinquent loans and claims notices from ceding companies and record case reserves based upon the amount of reserves recommended by the ceding company. In addition, specific claim and delinquency information reported by ceding companies is used in the process of estimating IBNR reserves.

Other Operations

Loss Reserves for Watford Re are comprised of case reserves and IBNR losses. For all business assumed by Watford Re, we act as reinsurance underwriting manager, provide actuarial and risk management services and recommend a level of Loss Reserves to Watford Re. The estimation of Loss Reserves for Watford Re is subject to the same risk factors as the estimation of Loss Reserves for our underwriting operations as described earlier. Watford Re performs its own reserve reviews and sets its Loss Reserves independently.

Potential Variability in Loss Reserves

The tables below summarize the effect of reasonably likely scenarios on the key actuarial assumptions used to estimate our Loss Reserves, net of unpaid losses and loss adjustment expenses recoverable, at December 31, 2014 by underwriting segment (excluding the ‘other’ segment). The scenarios shown in the tables summarize the effect of (i) changes to the expected loss ratio selections used at December 31, 2014, which represent loss ratio point increases or decreases to the expected loss ratios used, and (ii) changes to the loss development patterns used in our reserving process at December 31, 2014, which represent claims reporting that is either slower or faster than the reporting patterns used. We believe that the illustrated sensitivities are indicative of the potential variability inherent in the estimation process of those parameters. The results show the impact of varying each key actuarial assumption using the chosen sensitivity on our IBNR reserves, on a net basis and across all accident years.

INSURANCE SEGMENT	Higher Expected Loss Ratios				Slower Loss Development Patterns				Lower Expected Loss Ratios				Faster Loss Development Patterns
Reserving lines selected assumptions:
Property, energy, marine and aviation	5 points				3 months				(5) points				(3) months
Third party occurrence business (1)	10				6				(10)				(6)
Third party claims-made business (2)	10				6				(10)				(6)
All other (3)	10				6				(10)				(6)
Increase (decrease) in Loss Reserves, net:
Property, energy, marine and aviation	$	21,491			$	27,237			$	(21,491	)		$	(19,277	)
Third party occurrence business (1)	185,228				98,986				(185,228		)		(95,160		)
Third party claims-made business (2)	120,501				144,579				(120,501		)		(113,507		)
All other (3)	110,901				115,238				(110,901		)		(91,532		)

(1)	Third party occurrence business includes casualty, construction, national accounts and excess workers’ compensation business.

(2)	Third party claims-made business includes executive assurance, healthcare and professional liability business.

(3)	All other includes programs, surety, lenders products, travel and accident and other business.

REINSURANCE SEGMENT	Higher Expected Loss Ratios				Slower Loss Development Patterns				Lower Expected Loss Ratios				Faster Loss Development Patterns
Reserving lines selected assumptions:
Casualty	10 points				6 months				(10) points				(6) months
Other specialty	5				3				(5)				(3)
Property excluding property catastrophe	5				3				(5)				(3)
Property catastrophe	5				3				(5)				(3)
Marine and aviation	5				3				(5)				(3)
Other	5				3				(5)				(3)
Increase (decrease) in Loss Reserves, net:
Casualty	$	121,748			$	127,281			$	(121,748	)		$	(101,919	)
Other specialty	45,619				27,684				(45,619		)		(41,441		)
Property excluding property catastrophe	12,932				29,601				(12,932		)		(28,304		)
Marine and aviation	7,298				10,829				(7,298		)		(11,032		)
Property catastrophe	11,610				18,644				(11,610		)		(13,029		)
Other	3,343				1,596				(3,343		)		(1,511		)

It is not necessarily appropriate to sum the total impact for a specific factor or the total impact for a specific business category as the business categories are not perfectly correlated. In addition, the potential variability shown in the tables

above are reasonably likely scenarios of changes in our key assumptions at December 31, 2014 and are not meant to be a “best case” or “worst case” series of outcomes and, therefore, it is possible that future variations may be more or less than the amounts set forth above.

For our mortgage segment, we considered the sensitivity of loss reserve estimates at December 31, 2014 by assessing the potential changes resulting from a parallel shift in severity and default to claim rate. For example, assuming all other factors remain constant, for every one percentage point change in primary claim severity (which we estimate to be 27% of unpaid principal balance at December 31, 2014), we estimated that our loss reserves would change by approximately $4 million at December 31, 2014. For every one percentage point change in our overall net default to claim rate (which we estimate to be approximately 53% at December 31, 2014), we estimated a $2 million change in our loss reserves at December 31, 2014.

Simulation Results

In order to illustrate the potential volatility in our Loss Reserves, we used a Monte Carlo simulation approach to simulate a range of results based on various probabilities. Both the probabilities and related modeling are subject to inherent uncertainties. The simulation relies on a significant number of assumptions, such as the potential for multiple entities to react similarly to external events, and includes other statistical assumptions. At December 31, 2014, our recorded Loss Reserves by underwriting segment, net of unpaid losses and loss adjustment expenses recoverable, and the results of the simulation were as follows:

	December 31, 2014
	Insurance				Reinsurance				Mortgage				Total
Total net reserves (1)		$4,526,002				$2,550,719				$117,801				$7,194,522
Simulation results:
90th percentile (2)		$5,441,906				$3,210,732				$141,019				$8,469,190
10th percentile (3)		$3,681,503				$1,972,965				$96,193				$6,018,955

(1)	Excludes amounts reflected in the ‘other’ segment.

(2)	Simulation results indicate that a 90% probability exists that the net reserves for losses and loss adjustment expenses will not exceed the indicated amount.

(3)	Simulation results indicate that a 10% probability exists that the net reserves for losses and loss adjustment expenses will be at or below the indicated amount.

The simulation results shown for each segment do not add to the total simulation results, as the individual segment simulation results do not reflect the diversification effects across our segments. For informational purposes, based on the total simulation results, a change in our Loss Reserves to the amount indicated at the 90th percentile would result in a decrease in income before income taxes of approximately $1.27 billion, or $9.45 per diluted share, while a change in our Loss Reserves to the amount indicated at the 10th percentile would result in an increase in income before income taxes of approximately $1.18 billion, or $8.71 per diluted share. The simulation results noted above are informational only, and no assurance can be given that our ultimate losses will not be significantly different than the simulation results shown above, and such differences could directly and significantly impact earnings favorably or unfavorably in the period they are determined. We do not have significant exposure to pre-2002 liabilities, such as asbestos-related illnesses and other long-tail liabilities. It is difficult to provide meaningful trend information for certain liability/casualty coverages for which the claim-tail may be especially long, as claims are often reported and ultimately paid or settled years, or even decades, after the related loss events occur. Any estimates and assumptions made as part of the reserving process could prove to be inaccurate due to several factors, including the fact that relatively limited historical information has been reported to us through December 31, 2014.

Mortgage Operations Supplemental Information

For each quarter end in 2014, the mortgage segment’s insurance in force (“IIF”), which represents the aggregate dollar amount of each insured mortgage loan’s original principal balance, and risk in force (“RIF”), which represents the aggregate dollar amount of each insured mortgage loan’s current principal balance multiplied by the insurance coverage percentage specified in the policy for insurance policies issued, are shown on the following table.

(U.S. Dollars in millions)	December 31, 2014							September 30, 2014							June 30, 2014							March 31, 2014
	Amount				%			Amount				%			Amount				%			Amount				%
Insurance In Force (IIF):
U.S. mortgage insurance	$	22,402			47			$	22,055			46			$	21,168			45			$	21,240			47
Mortgage reinsurance	20,772				44			21,097				44			21,405				45			21,161				47
Other (1)	4,400				9			4,464				10			4,586				10			2,869				6
Total	$	47,574			100			$	47,616			100			$	47,159			100			$	45,270			100
Risk In Force (RIF) (2):
U.S. mortgage insurance	$	5,600			56			$	5,506			55			$	5,273			53			$	5,275			53
Mortgage reinsurance	4,393				43			4,483				44			4,601				46			4,664				46
Other (1)	136				1			136				1			139				1			80				1
Total	$	10,129			100			$	10,125			100			$	10,013			100			$	10,019			100
Ending number of policies in force	131,111							129,665							126,347							127,019

(1)	Includes risk-sharing products offered to government sponsored enterprises and mortgage lenders and international insurance business.

(2)	For international business and risk-sharing products, the calculation is based on the maximum claim amount which we are exposed to on each insured mortgage loan. For certain of our mortgage reinsurance treaties, such amount incorporates loss ratio caps.

For each quarter end in 2014, the following table provides supplemental disclosures for our U.S. mortgage insurance operations’ risk in force:

(U.S. Dollars in millions)	December 31, 2014							September 30, 2014							June 30, 2014							March 31, 2014
	Amount				%			Amount				%			Amount				%			Amount				%
Total RIF by credit quality (FICO):
>=740	$	2,917			52			$	2,864			52			$	2,687			51			$	2,671			51
680-739	1,846				33			1,803				33			1,724				33			1,713				32
620-679	700				13			694				12			709				13			731				14
<620	137				2			145				3			153				3			160				3
Total	$	5,600			100			$	5,506			100			$	5,273			100			$	5,275			100
Weighted average FICO score	733							733							731							730
Total RIF by LTV:
95.01% and above	$	1,123			20			$	1,139			21			$	1,161			22			$	1,183			23
90.01% to 95.00%	2,652				47			2,558				46			2,389				45			2,337				44
85.01% to 90.00%	1,552				28			1,544				28			1,474				28			1,494				28
85.00% and below	273				5			265				5			249				5			261				5
Total	$	5,600			100			$	5,506			100			$	5,273			100			$	5,275			100
Weighted average LTV	93.4		%					93.4		%					93.4		%					93.4		%
Total RIF by State:
Wisconsin	$	538			10			$	532			10			$	517			10			$	510			10
California	480				9			474				9			454				9			460				9
Texas	302				5			293				5			283				5			285				5
Minnesota	274				5			271				5			258				5			255				5
Florida	273				5			271				5			264				5			268				5
Washington	232				4			231				4			228				4			230				4
Massachusetts	210				4			209				4			204				4			203				4
Alaska	209				4			207				4			202				4			201				4
Virginia	200				3			196				3			186				4			185				3
New York	188				3			188				3			184				3			186				4
Others	2,694				48			2,634				48			2,493				47			2,492				47
Total	$	5,600			100			$	5,506			100			$	5,273			100			$	5,275			100
Weighted average coverage (1)	25.0		%					25.0		%					24.9		%					24.8		%
Analysts’ persistency (2)	80.9		%					81.2		%					80.5		%					79.1		%
Risk-to-capital ratio (3)	9.5:1							9.3:1							8.9:1							9.0:1

(1)	Represents the end of period RIF divided by end of period IIF.

(2)	Represents the percentage of IIF at the beginning of a 12-month period that remained in force at the end of the period.

(3)	Represents total current (non-delinquent) RIF, net of reinsurance, divided by total statutory capital. Ratio calculated for Arch Mortgage Insurance Company only (estimate for December 31, 2014).

Ceded Reinsurance

In the normal course of business, our insurance operations cede a portion of their premium on a quota share or excess of loss basis through treaty or facultative reinsurance agreements. Our reinsurance operations also obtain reinsurance whereby another reinsurer contractually agrees to indemnify it for all or a portion of the reinsurance risks underwritten by our reinsurance operations. Such arrangements, where one reinsurer provides reinsurance to another reinsurer, are usually referred to as “retrocessional reinsurance” arrangements. In addition, our reinsurance subsidiaries participate in “common account” retrocessional arrangements for certain pro rata treaties. Such arrangements reduce the effect of individual or aggregate losses to all companies participating on such treaties, including the reinsurers, such as our reinsurance operations, and the ceding company. Reinsurance recoverables are recorded as assets, predicated on the reinsurers’ ability to meet their obligations under the reinsurance agreements. If the reinsurers are unable to satisfy their obligations under the agreements, our insurance or reinsurance operations would be liable for such defaulted amounts.

The availability and cost of reinsurance and retrocessional protection is subject to market conditions, which are beyond our control. Although we believe that our insurance and reinsurance operations have been successful in obtaining reinsurance and retrocessional protection, it is not certain that they will be able to continue to obtain adequate protection at cost effective levels. As a result of such market conditions and other factors, our insurance and reinsurance operations may not be able to successfully mitigate risk through reinsurance and retrocessional arrangements and may lead to increased volatility in our results of operations in future periods. See “Risk Factors—Risks Relating to Our Industry—The failure of any of the loss limitation methods we employ could have a material adverse effect on our financial condition or results of operations.”

Our insurance operations had in effect during 2014 a reinsurance program which provided coverage for certain property-catastrophe related losses equal to $200 million in excess of a $150 million retention per occurrence, consistent with the program in place for 2013. In the 2015 first quarter, our insurance operations renewed its reinsurance program with the same limits.

For purposes of managing risk, we reinsure a portion of our exposures, paying to reinsurers a part of the premiums received on the policies we write, and we may also use retrocessional protection. On a consolidated basis, ceded premiums written represented approximately 20% of gross premiums written for 2014, compared to 20% for 2013 and 21% for 2012. We monitor the financial condition of our reinsurers and attempt to place coverages only with substantial, financially sound carriers. If the financial condition of our reinsurers or retrocessionaires deteriorates, resulting in an impairment of their ability to make payments, we will provide for probable losses resulting from our inability to collect amounts due from such parties, as appropriate. We evaluate the credit worthiness of all the reinsurers to which we cede business. If our analysis indicates that there is significant uncertainty regarding our ability to collect amounts due from reinsurers, managing general agents, brokers and other clients, we will record a provision for doubtful accounts. See “Risk Factors—Risks Relating to Our Company—We are exposed to credit risk in certain of our business operations” and “Financial Condition, Liquidity and Capital Resources—Financial Condition—Premiums Receivable and Reinsurance Recoverables” for further details.

Premium Revenues and Related Expenses

Insurance premiums written are generally recorded at the policy inception and are primarily earned on a pro rata basis over the terms of the policies for all products, usually 12 months. Premiums written include estimates in our insurance operations’ programs, specialty lines, collateral protection business and for participation in involuntary pools. The amount of such insurance premium estimates, included in premiums receivable and other assets, was $88.0 million at December 31, 2014, compared to $53.5 million at December 31, 2013. Such premium estimates are derived from multiple sources which include the historical experience of the underlying business, similar business and available industry information. Unearned premium reserves represent the portion of premiums written that relates to the unexpired terms of in-force insurance policies.

Reinsurance premiums written include amounts reported by brokers and ceding companies, supplemented by our own estimates of premiums where reports have not been received. The determination of premium estimates requires a review of our experience with the ceding companies, familiarity with each market, the timing of the reported information, an analysis and understanding of the characteristics of each line of business, and management’s judgment of the impact of various factors, including premium or loss trends, on the volume of business written and ceded to us. On an ongoing basis, our underwriters review the amounts reported by these third parties for reasonableness based on their experience and

knowledge of the subject class of business, taking into account our historical experience with the brokers or ceding companies. In addition, reinsurance contracts under which we assume business generally contain specific provisions which allow us to perform audits of the ceding company to ensure compliance with the terms and conditions of the contract, including accurate and timely reporting of information. Based on a review of all available information, management establishes premium estimates where reports have not been received. Premium estimates are updated when new information is received and differences between such estimates and actual amounts are recorded in the period in which estimates are changed or the actual amounts are determined. Premiums written are recorded based on the type of contracts we write. Premiums on our excess of loss and pro rata reinsurance contracts are estimated when the business is underwritten. For excess of loss contracts, premiums are recorded as written based on the terms of the contract. Estimates of premiums written under pro rata contracts are recorded in the period in which the underlying risks incept and are based on information provided by the brokers and the ceding companies. For multi-year reinsurance treaties which are payable in annual installments, generally, only the initial annual installment is included as premiums written at policy inception due to the ability of the reinsured to commute or cancel coverage during the term of the policy. The remaining annual installments are included as premiums written at each successive anniversary date within the multi-year term.

Reinstatement premiums for our insurance and reinsurance operations are recognized at the time a loss event occurs, where coverage limits for the remaining life of the contract are reinstated under pre-defined contract terms. Reinstatement premiums, if obligatory, are fully earned when recognized. The accrual of reinstatement premiums is based on an estimate of losses and loss adjustment expenses, which reflects management’s judgment, as described above in “—Reserves for Losses and Loss Adjustment Expenses.”

The amount of reinsurance premium estimates included in premiums receivable and the amount of related acquisition expenses by type of business were as follows at December 31, 2014 and 2013:

	December 31, 2014												December 31, 2013
	Gross Amount				Acquisition Expenses				Net Amount				Gross Amount				Acquisition Expenses				Net Amount
Casualty	$	142,071			$	(45,193	)		$	96,878			$	72,130			$	(16,660	)		$	55,470
Other specialty	116,719				(28,881		)		87,838				112,235				(31,196		)		81,039
Property excluding property catastrophe	39,874				(10,533		)		29,341				41,573				(11,296		)		30,277
Marine and aviation	36,940				(9,762		)		27,178				48,603				(13,262		)		35,341
Property catastrophe	1,257				(71		)		1,186				1,349				(71		)		1,278
Other	21,425				(6,346		)		15,079				16,382				(5,010		)		11,372
Total	$	358,286			$	(100,786	)		$	257,500			$	292,272			$	(77,495	)		$	214,777

Premium estimates are reviewed by management at least quarterly. Such review includes a comparison of actual reported premiums to expected ultimate premiums along with a review of the aging and collection of premium estimates. Based on management’s review, the appropriateness of the premium estimates is evaluated, and any adjustment to these estimates is recorded in the period in which it becomes known. Adjustments to premium estimates could be material and such adjustments could directly and significantly impact earnings favorably or unfavorably in the period they are determined because the estimated premium may be fully or substantially earned.

A significant portion of amounts included as premiums receivable, which represent estimated premiums written, net of commissions, are not currently due based on the terms of the underlying contracts. Based on currently available information, management believes that the premium estimates included in premiums receivable will be collectible and, therefore, no provision for doubtful accounts has been recorded on the premium estimates at December 31, 2014.

Reinsurance premiums assumed, irrespective of the class of business, are generally earned on a pro rata basis over the terms of the underlying policies or reinsurance contracts. Contracts and policies written on a “losses occurring” basis cover claims that may occur during the term of the contract or policy, which is typically 12 months. Accordingly, the premium is earned evenly over the term. Contracts which are written on a “risks attaching” basis cover claims which attach to the underlying insurance policies written during the terms of such contracts. Premiums earned on such contracts usually extend beyond the original term of the reinsurance contract, typically resulting in recognition of premiums earned over a 24-month period.

Certain of our reinsurance contracts include provisions that adjust premiums or acquisition expenses based upon the experience under the contracts. Premiums written and earned, as well as related acquisition expenses, are recorded based upon the projected experience under such contracts.

Retroactive reinsurance reimburses a ceding company for liabilities incurred as a result of past insurable events covered by the underlying policies reinsured. In certain instances, reinsurance contracts cover losses both on a prospective basis and on a retroactive basis and, accordingly, we bifurcate the prospective and retrospective elements of these reinsurance contracts and account for each element separately. Underwriting income generated in connection with retroactive reinsurance contracts is deferred and amortized into income over the settlement period while losses are charged to income immediately. Subsequent changes in estimated or actual cash flows under such retroactive reinsurance contracts are accounted for by adjusting the previously deferred amount to the balance that would have existed had the revised estimate been available at the inception of the reinsurance transaction, with a corresponding charge or credit to income.

Mortgage guaranty insurance policies are contracts that are generally non-cancelable by the insurer, are renewable at a fixed price, and provide for payment of premiums on a monthly, annual or single basis. Upon renewal, we are not able to re-underwrite or re-price our policies. Consistent with industry accounting practices, premiums written on a monthly basis are earned as coverage is provided. Premiums written on an annual basis are amortized on a monthly pro rata basis over the year of coverage. Primary mortgage insurance premiums written on policies covering more than one year are referred to as single premiums. A portion of the revenue from single premiums is recognized in premiums earned in the current period, and the remaining portion is deferred as unearned premiums and earned over the estimated expiration of risk of the policy. If single premium policies related to insured loans are canceled due to repayment by the borrower and the policy is a non-refundable product, the remaining unearned premium related to each canceled policy is recognized as earned premium upon notification of the cancellation.

Unearned premiums represent the portion of premiums written that is applicable to the estimated unexpired risk of insured loans. A portion of premium payments may be refundable if the insured cancels coverage, which generally occurs when the loan is repaid, the loan amortizes to a sufficiently low amount to trigger a lender permitted or legally required cancellation, or the value of the property has increased sufficiently in accordance with the terms of the contract. Premium refunds reduce premiums earned in the consolidated statements of income. Generally, only unearned premiums are refundable. However, when we pay a claim on a delinquent loan, all servicer paid premiums received on the delinquent loan covering any period after the default date will be refunded, in accordance with the terms of the contract.

Acquisition expenses and other expenses related to our underwriting operations that vary with, and are directly related to, the successful acquisition or renewal of business are deferred and amortized based on the type of contract. For property and casualty insurance and reinsurance contracts, deferred acquisition costs are amortized over the period in which the related premiums are earned. Consistent with mortgage insurance industry accounting practice, amortization of acquisition costs related to the mortgage insurance contracts for each underwriting year’s book of business is recorded in proportion to estimated gross profits. Estimated gross profits are comprised of earned premiums and losses and loss adjustment expenses. For each underwriting year, we estimate the rate of amortization to reflect actual experience and any changes to persistency or loss development.

Acquisition expenses, net of ceding commissions received from reinsurers, consist principally of commissions and premium taxes paid to obtain our business. Other operating expenses also include expenses that vary with, and are directly related to, the successful acquisition of business. Deferred acquisition costs are carried at their estimated realizable value and take into account anticipated losses and loss adjustment expenses, based on historical and current experience, and anticipated investment income.

A premium deficiency occurs if the sum of anticipated losses and loss adjustment expenses, unamortized acquisition costs and maintenance costs and anticipated investment income exceed unearned premiums. A premium deficiency reserve (“PDR”) is recorded by charging any unamortized acquisition costs to expense to the extent required in order to eliminate the deficiency. If the premium deficiency exceeds unamortized acquisition costs then a liability is accrued for the excess deficiency.

To assess the need for a PDR on our mortgage exposures, we develop loss projections based on modeled loan defaults related to our current policies in force. This projection is based on recent trends in default experience, severity and rates of defaulted loans moving to claim, as well as recent trends in the rate at which loans are prepaid. Evaluating the expected profitability of our existing mortgage insurance business and the need for a PDR for our mortgage business involves

significant reliance upon assumptions and estimates with regard to the likelihood, magnitude and timing of potential losses and premium revenues. The models, assumptions and estimates we use to evaluate the need for a PDR may prove to be inaccurate, especially during an extended economic downturn or a period of extreme market volatility and uncertainty.

No premium deficiency charges were recorded by us during 2014, 2013 and 2012.

Fair Value Measurements

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).

We determine the existence of an active market based on our 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. We use quoted values and other data provided by nationally recognized independent pricing sources as inputs into our process for determining fair values of our fixed maturity investments. To validate the techniques or models used by pricing sources, our review process includes, but is not limited to: (i) quantitative analysis (e.g., comparing the quarterly return for each managed portfolio to their 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; (iv) comparing the fair value estimates to our 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. Where multiple quotes or prices were obtained, 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 from 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, we will challenge any prices for a security or portfolio which are considered not to be representative of fair value.

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 $15.1 billion of financial assets and liabilities measured at fair value at December 31, 2014, approximately $260.8 million, or 1.7%, were priced using non-binding broker-dealer quotes. Of the $13.4 billion of financial assets and liabilities measured at fair value at December 31, 2013, approximately $601.9 million, or 4.5%, were priced using non-binding broker-dealer quotes.

We review our securities measured at fair value and discuss the proper classification of such investments with investment advisors and others. See note 9, “Fair Value,” of the notes accompanying our consolidated financial statements for a summary of our financial assets and liabilities measured at fair value at December 31, 2014 by valuation hierarchy.

Other-Than-Temporary Impairments

On a quarterly basis, we perform reviews of our 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 OTTI. 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 an OTTI equivalent to the entire unrealized loss. For debt securities, we separate an OTTI into two components when there are credit related losses associated with the impaired debt security for which we assert that we do not have the intent to sell the security, and it is more likely than not that we will not be required to sell the security before recovery of its cost basis. The amount of the OTTI related to a credit loss is recognized in earnings, and the amount of the OTTI related to other factors (e.g., interest rates, market conditions, etc.) is recorded as a component of other comprehensive income or loss. The amount of the credit loss of an impaired debt security is the difference between the amortized cost and the greater of (i) the present value of expected future cash flows and (ii) the fair value of the security. In instances where no credit loss exists but it is more likely than not that we will have to sell the debt security prior to the anticipated recovery, the decline in fair value below amortized cost is recognized as an OTTI in earnings. In periods after the recognition of an OTTI on debt securities, we account for such securities as if they had been purchased on the measurement date of the OTTI at an amortized cost basis equal to the previous amortized cost basis less the OTTI recognized in earnings. For debt securities for which OTTI were recognized in earnings, the difference between the new amortized cost basis and the cash flows expected to be collected will be accreted or amortized into net investment income.

For 2014, we recorded $30.2 million of credit related impairments in earnings, compared to $3.8 million in 2013 and $11.4 million in 2012. See note 8, “Investment Information—Other-Than-Temporary Impairments,” of the notes accompanying our consolidated financial statements for additional information.

Reclassifications

We have reclassified the presentation of certain prior year information to conform to the current presentation. Such reclassifications had no effect on our net income, shareholders’ equity or cash flows.

Recent Accounting Pronouncements

See note 3(q), “Significant Accounting Policies—Recent Accounting Pronouncements,” of the notes accompanying our consolidated financial statements.

FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES

Financial Condition

Investable Assets Managed by Arch

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.

At December 31, 2014, total investable assets of $15.77 billion included $14.61 billion managed by Arch and $1.16 billion included in the ‘other’ segment (i.e., attributable to Watford Re), summarized as follows:

	December 31, 2014							December 31, 2013
	Amount				% of Total			Amount				% of Total
Investable assets (1) (2):
Fixed maturities available for sale, at fair value	$	10,750,770			73.6			$	9,571,776			68.1
Fixed maturities, at fair value (3)	377,053				2.6			448,254				3.2
Fixed maturities pledged under securities lending agreements, at fair value	50,802				0.3			105,081				0.8
Total fixed maturities	11,178,625				76.5			10,125,111				72.1
Short-term investments available for sale, at fair value	797,226				5.5			1,478,367				10.5
Cash	474,247				3.2			434,057				3.1
Equity securities available for sale, at fair value	658,182				4.5			496,824				3.5
Other investments available for sale, at fair value	296,224				2.0			498,310				3.6
Other investments, at fair value (3)	889,253				6.1			773,280				5.5
Investments accounted for using the equity method (4)	349,014				2.4			244,339				1.7
Securities transactions entered into but not settled at the balance sheet date	(32,802		)		(0.2	)		(763		)		—
Total investable assets managed by Arch	$	14,609,969			100.0			$	14,049,525			100.0

(1)	The table above excludes investable assets attributable to the ‘other’ segment. Such amounts are summarized as follows:

(U.S. dollars in thousands)	December 31, 2014
Investable assets in ‘other’ segment:
Cash	$	11,455
Investments accounted for using the fair value option (3)	1,169,226
Securities transactions entered into but not settled at the balance sheet date	(17,441		)
Total investable assets included in ‘other’ segment	$	1,163,240

(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)	Represents investments 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 investments are recorded in net realized gains or losses.

(4)	Changes in the carrying value of investment funds accounted for using the equity method are recorded as “equity in net income (loss) of investment funds accounted for using the equity method” rather than as an unrealized gain or loss component of accumulated other comprehensive income.

At December 31, 2014, our fixed income portfolio, which includes fixed maturity securities and short-term investments, had average credit quality ratings from S&P/Moody’s of “AA/Aa2” and an average yield to maturity (embedded book yield), before investment expenses, of 2.18%. At December 31, 2013, our fixed income portfolio had average credit quality ratings from S&P/Moody’s of “AA-/Aa2” and an average yield to maturity (embedded book yield), before investment expenses, of 2.38%. Our investment portfolio had an average effective duration of 3.34 years at December 31, 2014, compared to 2.62 years at December 31, 2013. At December 31, 2014, approximately $9.87 billion, or 68%, of our total investments and cash was internally managed, compared to $9.07 billion, or 65%, at December 31, 2013.

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
December 31, 2014
Corporate bonds	$	3,379,139			$	37,928			$	(38,974	)		$	3,380,185
Mortgage backed securities	965,533				18,843				(3,842		)		950,532
Municipal bonds	1,494,122				31,227				(1,044		)		1,463,939
Commercial mortgage backed securities	1,114,528				14,594				(3,822		)		1,103,756
U.S. government and government agencies	1,447,972				8,345				(1,760		)		1,441,387
Non-U.S. government securities	1,099,390				21,311				(37,203		)		1,115,282
Asset backed securities	1,677,941				8,425				(6,089		)		1,675,605
Total	$	11,178,625			$	140,673			$	(92,734	)		$	11,130,686
December 31, 2013
Corporate bonds	$	2,601,328			$	35,289			$	(35,537	)		$	2,601,576
Mortgage backed securities	1,174,128				16,270				(22,209		)		1,180,067
Municipal bonds	1,481,738				29,378				(9,730		)		1,462,090
Commercial mortgage backed securities	1,074,497				13,972				(15,224		)		1,075,749
U.S. government and government agencies	1,301,809				3,779				(11,242		)		1,309,272
Non-U.S. government securities	1,159,017				14,729				(19,363		)		1,163,651
Asset backed securities	1,332,594				20,033				(13,795		)		1,326,356
Total	$	10,125,111			$	133,450			$	(127,100	)		$	10,118,761

The following table provides the credit quality distribution of our Fixed Maturities:

		December 31, 2014							December 31, 2013
Rating (1)		Fair Value				% of Total			Fair Value				% of Total
U.S. government and government agencies (2)		$	2,245,489			20.1			$	2,284,053			22.6
AAA		4,299,060				38.5			3,709,872				36.6
AA		1,917,392				17.2			1,720,605				17.0
A		1,739,922				15.6			1,359,193				13.4
BBB		339,395				3.0			304,543				3.0
BB		157,232				1.4			180,125				1.8
B		184,869				1.7			188,119				1.9
Lower than B		154,823				1.4			241,463				2.4
Not rated		140,443				1.1			137,138				1.3
Total		$	11,178,625			100.0			$	10,125,111			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.

At December 31, 2014, below-investment grade securities comprised approximately 5.7% of our Fixed Maturities, compared to 7.4% at December 31, 2013. 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 December 31, 2014, corporate bonds represented 69% of the total below investment grade securities at fair value, mortgage backed securities represented 22% of the total and 9% were in other classes. At December 31, 2013, corporate bonds represented 46% of the total below investment grade securities at fair value, mortgage backed securities represented 46% of the total and 8% 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:

		December 31, 2014											December 31, 2013
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%		$	4,181,313			$	(55,498	)		59.8			$	6,006,316			$	(110,954	)		87.3
10-20%		239,158				(33,111		)		35.7			78,250				(11,465		)		9.0
20-30%		5,618				(1,990		)		2.1			13,955				(4,621		)		3.6
30-60%		3,437				(2,135		)		2.4			74				(60		)		0.1
Total		$	4,429,526			$	(92,734	)		100.0			$	6,098,595			$	(127,100	)		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:

		December 31, 2014											December 31, 2013
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%		$	141,986			$	(3,728	)		4.0			$	133,354			$	(3,882	)		3.1
10-20%		20,127				(3,530		)		3.8			444				(64		)		0.1
20-30%		5,618				(1,990		)		2.1			1,292				(350		)		0.3
30-80%		3,434				(2,133		)		2.3			28				(35		)		—
Total		$	171,165			$	(11,381	)		12.2			$	135,118			$	(4,331	)		3.5

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.

The following table summarizes our top ten exposures to fixed income corporate issuers by fair value at December 31, 2014, excluding guaranteed amounts and covered bonds:

	Fair Value				Credit Rating (1)
Apple Inc.	$	75,226			AA+/Aa1
General Electric Co.	74,471				AA+/A1
Toyota Motor Corporation	64,030				AA-/Aa3
Porsche Automobil Holding SE	58,583				A/A3
Wells Fargo & Company	56,958				A+/A1
Exxon Mobil Corp.	56,332				AAA/Aaa
Daimler AG	55,951				A-/A3
Caterpillar Inc	49,641				A/A2
Royal Dutch Shell PLC	44,317				AA/Aa1
New York Life Insurance Company	42,801				AA+/Aaa
Total	$	578,310

(1)	Ratings as assigned by S&P/Moody’s.

Our portfolio includes investments, such as mortgage-backed securities, which are subject to prepayment risk. At December 31, 2014, our investments in residential mortgage-backed securities (“MBS”) amounted to approximately $965.5 million, or 6.6% of total investable assets, compared to $1.17 billion, or 8.4%, at December 31, 2013. 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 December 31, 2014, CMBS constituted approximately $1.11 billion, or 7.6% of total investable assets, compared to $1.07 billion, or 7.6%, at December 31, 2013.

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. In addition, the commercial real estate market has experienced price deterioration, which could lead to increased delinquencies and defaults on commercial real estate mortgages.

The following table provides information on our mortgage backed securities (“MBS”) and CMBS at December 31, 2014, 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:	2003-2008		$	126,523			CCC-		$	135,797			107.3	%		0.9	%
	2009		28,906				AAA		28,718				99.3	%		0.2	%
	2010		24,336				AA+		23,915				98.3	%		0.2	%
	2013		90,285				AAA		91,304				101.1	%		0.6	%
	2014		21,679				A+		21,648				99.9	%		0.1	%
Total non-agency MBS			$	291,729			BBB-		$	301,382			103.3	%		2.1	%
Non-agency CMBS:	2002-2008		$	69,512			AA-		$	70,297			101.1	%		0.5	%
	2009		368				BBB-		368				100.0	%		0.0	%
	2010		43,394				AAA		44,905				103.5	%		0.3	%
	2011		62,963				AAA		63,820				101.4	%		0.4	%
	2012		88,584				AAA		89,851				101.4	%		0.6	%
	2013		239,980				AAA		244,559				101.9	%		1.7	%
	2014		462,801				AAA		467,362				101.0	%		3.2	%
Total non-agency CMBS			$	967,602			AAA		$	981,162			101.4	%		6.7	%

		Non-Agency			Non-Agency
Additional Statistics:		RMBS			CMBS (1)
Weighted average loan age (months)		82			27
Weighted average life (months) (2)		48			55
Weighted average loan-to-value % (3)		64.2	%		57.7	%
Total delinquencies (4)		10.4	%		0.5	%
Current credit support % (5)		11.5	%		35.5	%

(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 December 31, 2014. 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 21% to 99% on MBS and 11% to 100% 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.

The following table provides information on our asset backed securities (“ABS”) at December 31, 2014:

										Fair Value
	Amortized Cost				Average Credit Quality		Weighted Average Credit Support			Total				% of Amortized Cost			% of Investable Assets
Sector:
Credit cards	$	665,529			AAA		18	%		$	667,806			100.3	%		4.6	%
Loans	301,681				AA		52	%		301,121				99.8	%		2.1	%
Autos	297,384				AAA		27	%		297,954				100.2	%		2.0	%
Equipment	195,860				AA-		8	%		194,629				99.4	%		1.3	%
Other	215,151				AA		13	%		216,431				100.6	%		1.5	%
Total ABS (1)	$	1,675,605			AA+					$	1,677,941			100.1	%		11.5	%

(1)	The effective duration of the total ABS was 2.1 years at December 31, 2014.

At December 31, 2014, our fixed income portfolio included $16.9 million par value in sub-prime securities with an estimated fair value of $8.5 million and an average credit quality of “CCC/Caa3” from S&P/ Moody’s. At December 31, 2013, our fixed income portfolio included $48.5 million par value in sub-prime securities with an estimated fair value of $27.9 million and an average credit quality of “B/Caa1” from S&P/Moody’s. Such amounts were primarily in the home equity sector of our ABS, 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 contains approximately $5.8 million estimated fair value of sub-prime securities with an average credit quality of “CCC/Ca” from S&P/Moody’s at December 31, 2014, compared to approximately $6.3 million estimated fair value with an average credit quality of “CCC/Caa3” from S&P/Moody’s at December 31, 2013.

The following table provides information on the fair value of our Eurozone investments at December 31, 2014:

	Sovereign (2)				Financial Corporates				Other Corporates				Bank Loans (3)				Equities and Other				Total
Country (1)
Germany	$	174,554			$	—			$	11,427			$	23,183			$	—			$	209,164
Netherlands	107,114				1,057				59,092				16,914				—				184,177
Supranational (4)	59,095				—				—				—				—				59,095
Luxembourg	—				3,289				31,974				9,426				1,871				46,560
Belgium	43,960				—				—				—				—				43,960
France	2,082				2,372				8,146				3,957				2,966				19,523
Ireland	—				—				2,807				1,542				—				4,349
Finland	—				—				—				—				3,386				3,386
Italy	—				—				1,786				416				—				2,202
Spain	—				—				—				1,074				—				1,074
Slovenia	823				—				—				—				—				823
Greece	82				—				—				—				—				82
Total	$	387,710			$	6,718			$	115,232			$	56,512			$	8,223			$	574,395

(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 other Eurozone fixed maturities at December 31, 2014.

(2)	Sovereign includes securities issued and/or guaranteed by Eurozone governments.

(3)	Included in “investments accounted for using the fair value option.”

(4)	Includes World Bank, European Investment Bank, International Finance Corp. and European Bank for Reconstruction and Development.

At December 31, 2014, our equity portfolio consisted of $658.2 million of equity securities, compared to $496.8 million at December 31, 2013. Such amounts are shown net of securities sold but not purchased. Our equity portfolio primarily consists of publicly traded common stocks in the natural resources, energy and consumer staples 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:

		December 31, 2014										December 31, 2013
Severity of Unrealized Loss		Estimated Fair Value				Gross Unrealized Losses				% of Total Gross Unrealized Losses		Estimated Fair Value				Gross Unrealized Losses				% of Total Gross Unrealized Losses
0-10%		$	127,467			$	(4,973	)		37.2		52,964				(1,924		)		32.4
10-20%		47,880				(6,546		)		49.0		20,312				(2,792		)		47.0
20-30%		5,328				(1,695		)		12.7		3,103				(1,140		)		19.2
30-40%		327				(150		)		1.1		184				(82		)		1.4
Total		$	181,002			$	(13,364	)		100.0		$	76,563			$	(5,938	)		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 its cost basis. 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 December 31, 2014. 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 December 31, 2014.

The following table summarizes our other investments:

	December 31, 2014				December 31, 2013
Available for sale:
Asian and emerging markets	$	236,586			$	331,984
Investment grade fixed income	59,638				159,115
Other	—				7,211
Total available for sale	296,224				498,310
Fair value option:
Term loan investments (par value: $397,136 and $360,204)	410,995				399,591
Mezzanine debt funds	121,341				102,172
Credit related funds	114,436				63,271
Investment grade fixed income	69,108				75,062
Asian and emerging markets	25,800				14,054
Other (1)	147,573				119,130
Total fair value option	889,253				773,280
Total	$	1,185,477			$	1,271,590

(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 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 11, “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 9, “Fair Value” of the notes accompanying our consolidated financial statements for a summary of our financial assets and liabilities measured at fair value at December 31, 2014 and 2013 by level.

Investable Assets in the ‘Other’ Segment

Investable assets in the ‘other’ segment are managed by Watford Re. The board of directors of Watford Re establishes their investment policies and guidelines. Watford Re’s investments are accounted for using the fair value option with changes in the carrying value of such investments recorded in net realized gains or losses. At December 31, 2014, Watford Re’s investable assets consisted of the following:

	December 31, 2014
Cash	$	11,455
Investments accounted for using the fair value option:
Term loan investments (par value: $678,875)	662,654
Fixed maturities	254,971
Short-term investments	251,601
Total investments accounted for using the fair value option	1,169,226
Securities transactions entered into but not settled at the balance sheet date	(17,441		)
Total investable assets included in ‘other’ segment	$	1,163,240

Premiums Receivable and Reinsurance Recoverables

At December 31, 2014, 80.9% of premiums receivable of $948.7 million represented amounts not yet due, while amounts in excess of 90 days overdue were 5.4% of the total. At December 31, 2013, 80.0% of premiums receivable of $753.9 million represented amounts not yet due, while amounts in excess of 90 days overdue were 3.3% of the total. Approximately 1.0% of the $34.5 million of paid losses and loss adjustment expenses recoverable were in excess of 90 days overdue at December 31, 2014, compared to 27.6% of the $56.1 million of paid losses and loss adjustment expenses recoverable at December 31, 2013. No collection issues were indicated on the amount in excess of 90 days overdue at December 31, 2014. At December 31, 2014 and 2013, our reserves for doubtful accounts were approximately $13.4 million and $12.3 million, respectively.

The following table details our reinsurance recoverables at December 31, 2014:

	% of Total			A.M. Best Rating (1)
Everest Reinsurance Company	12.4	%		A+
Munich Reinsurance America, Inc.	8.8	%		A+
Lloyd’s syndicates (2)	6.0	%		A
Partner Reinsurance Company of the U.S.	5.4	%		A+
Transatlantic Reinsurance Company	5.1	%		A
Hannover Rückversicherung AG	4.7	%		A+
Odyssey America Reinsurance Corporation (3)	4.7	%		A
Allied World Assurance Company, Ltd.	3.8	%		A
Berkley Insurance Company	3.8	%		A+
Swiss Reinsurance America Corporation	3.8	%		A+
All other (4)	41.5	%
Total	100.0	%

(1)

The financial strength ratings are as of February 11, 2015 and were assigned by A.M. Best based on its opinion of the insurer’s financial strength as of such date. An explanation of the ratings listed in the table follows: the rating of “A+” is designated “Superior”; and the “A” rating is designated “Excellent.” Additionally, A.M. Best has five classifications within the “Not Rated” or “NR” category. Reasons for an “NR” rating being assigned by A.M. Best include insufficient data, size or operating experience, companies which are in run-off with no active business writings or are dormant, companies which disagree with their rating and request that a rating not be published or insurers that request not to be formally evaluated for the purposes of assigning a rating opinion.

(2)	The A.M. Best group rating of “A” (Excellent) has been applied to all Lloyd’s syndicates.

(3)	A significant portion of amounts due from Odyssey America Reinsurance Corporation is collateralized through reinsurance trusts.

(4)	Such amount included 24.5% due from companies rated “A-” or better and 17.0% from companies not rated. For items not rated, a substantial portion of such amount is collateralized through reinsurance trusts or letters of credit.

At December 31, 2014, approximately 83.0% of reinsurance recoverables on paid and unpaid losses (not including prepaid reinsurance premiums) of $1.81 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 3.7% of total shareholders’ equity available to Arch. At December 31, 2013, approximately 86.5% 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 4.2% of total shareholders’ equity available to Arch.

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. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies, Estimates and Recent Accounting Pronouncements—Reserves for Losses and Loss Adjustment Expenses” and “Business—Reserves” for further details.

Shareholders’ Equity

Shareholders’ equity available to Arch was $6.13 billion at December 31, 2014, compared to $5.65 billion at December 31, 2013. The increase in 2014 was primarily attributable to underwriting and investment returns, partially offset by share repurchase activity during the period.

Book Value per Common Share

The following table presents the calculation of book value per common share at December 31, 2014 and 2013:

(U.S. dollars in thousands, except share data)	December 31,
2014				2013
Calculation of book value per common share:
Total shareholders’ equity	$	6,130,053			$	5,647,496
Less preferred shareholders’ equity	325,000				325,000
Common shareholders’ equity	$	5,805,053			$	5,322,496
Common shares outstanding (1)	127,367,934				133,674,884
Book value per common share	$	45.58			$	39.82

(1)	Excludes the effects of 7,804,033 and 8,338,480 stock options and 447,073 and 443,710 restricted stock units outstanding at December 31, 2014 and 2013, 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 Series C 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 $3.3 million at December 31, 2014, compared to $5.8 million at December 31, 2013. During 2014, ACGL received dividends of $515.7 million from Arch Re Bermuda which were primarily used to fund the share repurchase program described below.

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 discounted 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 previous 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, 2014, as determined under Bermuda law, Arch Re Bermuda had statutory capital of $2.40 billion ($2.36 billion at December 31, 2013) and statutory capital and surplus of $5.42 billion ($5.42 billion at December 31, 2013), 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 $1.36 billion to ACGL during 2015 without providing an affidavit to the BMA, as discussed above. Under BMA guidelines, 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, 2014.

Our U.S. insurance and reinsurance subsidiaries are subject to insurance laws and regulations in the jurisdictions in which they operate. The ability of our regulated insurance subsidiaries to pay dividends or make distributions is dependent on their ability to meet applicable regulatory standards. These regulations include restrictions that limit the amount of dividends or other distributions, such as loans or cash advances, available to shareholders without prior approval of the insurance regulatory authorities. Dividends or distributions, if any, made by Arch Re U.S. would result in an increase in available capital at Arch Capital Group (U.S.) Inc. (“Arch-U.S.”), a wholly-owned subsidiary of ACGL. Arch Re U.S. can declare a maximum of approximately $110 million of dividends during 2015 subject to the approval of the Commissioner of the Delaware Department of Insurance (“Commissioner”). In addition, with respect to dividends in excess of the $110 million (extraordinary dividend), no payment can be made until (1) 30 days after the Commissioner has received notice of the declaration thereof and has not within such period disapproved such payments; or (2) the Commissioner shall have approved the payment within the 30-day period. Delaware insurance laws also require that the statutory surplus of Arch Re U.S. following any dividend or distribution be reasonable in relation to its outstanding liabilities and adequate to its financial needs.

Arch MI U.S. is currently approved by the GSEs as an eligible mortgage insurer. In addition to existing eligibility requirements applicable to all eligible mortgage insurers, the GSEs imposed conditions in connection with their approvals of Arch MI U.S. as a qualified mortgage insurer. These conditions require, among other things, that Arch MI U.S.: (i) maintain, through December 31, 2016, minimum capital funding of $400 million which may consist of statutory capital (policyholders’ surplus plus contingency reserves), dedicated reinsurance trust assets for any primary business reinsured and a value for purchased technology assets; (ii) maintain minimum statutory capital (defined as policyholders’ surplus plus contingency reserves) of no less than $260 million; (ii) maintain a risk-to-capital ratio of no greater than 18 to 1; and (iv) refrain from paying dividends to affiliates for three years commencing February 2014.

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 December 31, 2014 and 2013, such amounts approximated $5.52 billion and $5.30 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, largely due to the mix and type of business written. 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 2014 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 53% (compared to 55% for 2013). 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.

The following table summarizes our consolidated cash flows from operating, investing and financing activities:

	Year Ended
	December 31,
	2014				2013				2012
Total cash provided by (used for):
Operating activities	$	1,037,130			$	850,868			$	921,603
Investing activities	(1,505,421		)		(1,307,513		)		(395,968		)
Financing activities	539,943				524,018				(513,035		)
Effects of exchange rate changes on foreign currency cash	(20,007		)		(4,357		)		6,742
Increase (decrease) in cash	$	51,645			$	63,016			$	19,342

•	Cash provided by operating activities for 2014 was higher than in 2013, primarily due to a higher level of premiums collected in our underwriting operations, partially offset by a higher level of operating expenses reflecting the addition of Arch MI U.S. in 2014.

•	Cash used for investing activities for 2014 was higher than in 2013. Investing activities in 2014 reflected increases in both purchases and sales of fixed maturity investments compared to 2013 and continued funding of other investments (both existing and new investments).

•	Cash provided by financing activities for 2014 was higher than in 2013, primarily due to Watford Re capital activity of $1.01 billion, partially offset by increased share repurchases under our share repurchase program compared to 2013. The 2013 amount reflects our issuance of $500 million of senior notes.

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 Re (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.

At December 31, 2014, total investable assets of $15.77 billion included $14.61 billion managed by Arch and $1.16 billion included in the ‘other’ segment (i.e., attributable to Watford Re), compared to $14.05 billion managed by Arch at December 31, 2013. 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 $968.9 million at December 31, 2014.

Changes in general economic conditions, including new or continued sovereign debt concerns in Eurozone countries or downgrades of U.S. securities by credit rating agencies, 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 December 31, 2014 included $387.7 million of securities issued and/or guaranteed by Eurozone governments at fair value, $1.45 billion of obligations of the U.S. government and government agencies at fair value and $1.49 billion of municipal bonds at fair value. Please refer to Item 1A “Risk Factors” 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.

New financial requirements for private mortgage insurers were released for public comment by the Federal Housing Finance Agency (“FHFA”) in July 2014, and Arch MI U.S. will be subject to these requirements once enacted. The draft Private Mortgage Insurer Eligibility Requirements (“PMIERs”) establish new standards that mortgage insurers must meet in order to insure loans sold to or guaranteed by Federal National Mortgage Association and Federal Home Loan Mortgage

Corporation (the GSEs). The PMIERs were subject to a sixty-day public comment period which ended on September 8, 2014. The PMIERs’ financial requirements are based in part on a risk-based, required assets model and employ a grid approach based upon a number of factors, including vintage (origination year), original loan-to-value and original credit score of performing loans and the delinquency status of non-performing loans. The draft PMIERs propose up to a two year phase-in, beginning after publication of final PMIERs, for approved mortgage insurers to fully comply with the PMIER financial requirements. The available assets required to satisfy such final requirements at any point in time will be affected by many factors, including the content and timing of any final PMIERs, macro-economic conditions, and the size and composition of Arch MI U.S.’s mortgage insurance portfolio at the applicable point in time. Based upon its mortgage insurance portfolio as of December 31, 2014 (including credit for reinsurance ceded to affiliates), we believe that Arch MI U.S. currently satisfies the proposed financial requirements, although no assurance can be given as to what changes, if any, will be made to the final PMIERs.

In December 2013, Arch-U.S., a wholly-owned subsidiary of ACGL, completed a public offering of $500.0 million principal amount of 5.144% senior notes issued at par and due November 1, 2043 (“Arch-U.S. Senior Notes”), fully and unconditionally guaranteed by ACGL (the “Guarantee”). The Arch-U.S. Senior Notes are unsecured and unsubordinated obligations of Arch-U.S. and ACGL, respectively, and rank equally and ratably with the other unsecured and unsubordinated indebtedness of Arch-U.S. and ACGL, respectively. A portion of the proceeds from the offering were used to fund the acquisition of the mortgage operations noted below. In addition, the proceeds are available for other corporate purposes.

On January 30, 2014, we completed our acquisition of the CMG Entities. The Stock Purchase Agreement contains provisions for contingent consideration payments, subject to an overall maximum payment of 150% of closing book value of the pre-closing portfolio of the CMG Entities as re-calculated over an earn-out period and payable at the third, fifth and sixth anniversaries after closing (subject to a one time extension period of one to three years at the sellers’ discretion). The maximum amount of contingent consideration payments is $136.9 million over the earn-out period. To the extent that the adjusted book value of the CMG Entities drops below the cumulative amount paid by us, no additional payments would be due.

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, a $1.0 billion authorization in February 2011 and a $629.2 million authorization in November 2014. Since the inception of the share repurchase program through December 31, 2014, ACGL has repurchased approximately 118.1 million common shares for an aggregate purchase price of $3.24 billion. At December 31, 2014, approximately $887.1 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 31, 2016. 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. Given the recent severe disruptions in the public debt and equity markets, including among other things, widening of credit spreads, lack of liquidity and bankruptcies, we can provide no assurance that, if needed, we would be able to obtain additional funds through financing on satisfactory terms or at all. Continued 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 June 2014, we entered into a five-year agreement for a $300.0 million unsecured revolving loan and letter of credit facility and a $500.0 million secured letter of credit facility. Under the terms of the agreement, Arch Re U.S. and Arch Re Bermuda are limited to issuing an aggregate of $100.0 million of unsecured letters of credit as part of the unsecured revolving loan. In addition, we have access to letter of credit facilities for up to a total of $190.9 million, which are available on a limited basis and for limited purposes. Refer to note 16, “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-U.S. 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 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.

At December 31, 2014, ACGL’s capital of $7.03 billion consisted of $800.0 million of senior notes, representing 11.4% of the total, $100.0 million of revolving credit agreement borrowings due in June 2019, representing 1.4% of the total, $325.0 million of preferred shares, representing 4.6% of the total, and common shareholders’ equity of $5.81 billion, representing 82.6% of the total. At December 31, 2013, ACGL’s capital of $6.55 billion consisted of $800.0 million of senior notes, representing 12.2% of the total, $100.0 million of revolving credit agreement borrowings, representing 1.5% of the total, $325.0 million of preferred shares, representing 5.0% of the total, and common shareholders’ equity of $5.32 billion, representing 81.3% of the total. The increase in 2014 was primarily attributable to underwriting and investing returns, partially offset by share repurchases during the period.

NATURAL AND MAN-MADE CATASTROPHIC EVENTS

We have large aggregate exposures to natural and man-made catastrophic events. Catastrophes can be caused by various events, including hurricanes, floods, windstorms, earthquakes, hailstorms, tornados, explosions, severe winter weather, fires, droughts and other natural disasters. Catastrophes can also cause losses in non-property business such as workers’ compensation or general liability. In addition to the nature of property business, we believe that economic and geographic trends affecting insured property, including inflation, property value appreciation and geographic concentration, tend to generally increase the size of losses from catastrophic events over time.

We have substantial exposure to unexpected, large losses resulting from future man-made catastrophic events, such as acts of war, acts of terrorism and political instability. These risks are inherently unpredictable. It is difficult to predict the timing of such events with statistical certainty or estimate the amount of loss any given occurrence will generate. It is not possible to completely eliminate our exposure to unforecasted or unpredictable events and, to the extent that losses from such risks occur, our financial condition and results of operations could be materially adversely affected. Therefore, claims

for natural and man-made catastrophic events could expose us to large losses and cause substantial volatility in our results of operations, which could cause the value of our common shares to fluctuate widely. In certain instances, we specifically insure and reinsure risks resulting from terrorism. Even in cases where we attempt to exclude losses from terrorism and certain other similar risks from some coverages written by us, we may not be successful in doing so. Moreover, irrespective of the clarity and inclusiveness of policy language, there can be no assurance that a court or arbitration panel will limit enforceability of policy language or otherwise issue a ruling adverse to us.

We seek to limit our loss exposure by writing a number of our reinsurance contracts on an excess of loss basis, adhering to maximum limitations on reinsurance written in defined geographical zones, limiting program size for each client and prudent underwriting of each program written. In the case of proportional treaties, we may seek per occurrence limitations or loss ratio caps to limit the impact of losses from any one or series of events. In our insurance operations, we seek to limit our exposure through the purchase of reinsurance. We cannot be certain that any of these loss limitation methods will be effective. We also seek to limit our loss exposure by geographic diversification. Geographic zone limitations involve significant underwriting judgments, including the determination of the area of the zones and the inclusion of a particular policy within a particular zone's limits. There can be no assurance that various provisions of our policies, such as limitations or exclusions from coverage or choice of forum, will be enforceable in the manner we intend. Disputes relating to coverage and choice of legal forum may also arise. Underwriting is inherently a matter of judgment, involving important assumptions about matters that are inherently unpredictable and beyond our control, and for which historical experience and probability analysis may not provide sufficient guidance. One or more catastrophic or other events could result in claims that substantially exceed our expectations, which could have a material adverse effect on our financial condition or our results of operations, possibly to the extent of eliminating our shareholders' equity.

For our natural catastrophe exposed business, we seek to limit the amount of exposure we will assume from any one insured or reinsured and the amount of the exposure to catastrophe losses from a single event in any geographic zone. We monitor our exposure to catastrophic events, including earthquake and wind and periodically reevaluate the estimated probable maximum pre-tax loss for such exposures. Our estimated probable maximum pre-tax loss is determined through the use of modeling techniques, but such estimate does not represent our total potential loss for such exposures. 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. We seek to limit the probable maximum pre-tax loss to a specific level for severe catastrophic events. Currently, we seek to limit our 1-in-250 year return period net probable maximum 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. Net probable maximum 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. Our loss estimates 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 pre-tax losses 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. In addition, actual losses may 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.” Depending on business opportunities and the mix of business that may comprise our insurance and reinsurance portfolio, we may seek to adjust our self-imposed limitations on probable maximum pre-tax loss for catastrophe exposed business. See “—Critical Accounting Policies, Estimates and Recent Accounting Pronouncements—Ceded Reinsurance” for a discussion of our catastrophe reinsurance programs.

CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS

Letter of Credit and Revolving Credit Facilities

As of December 31, 2014, we had a $300.0 million unsecured revolving loan and letter of credit facility and a $500.0 million secured letter of credit facility (the “Credit Agreement”). Under the terms of the agreement, Arch Re U.S. and Arch Re Bermuda are limited to issuing an aggregate of $100.0 million of unsecured letters of credit as part of the $300.0 million unsecured revolving loan. Borrowings of revolving loans may be made by ACGL at a variable rate based on LIBOR or an alternative base rate at our option. Secured letters of credit are available for issuance on behalf of our insurance and reinsurance subsidiaries. The Credit Agreement and related documents are structured such that each party that requests a letter of credit or borrowing does so only for itself and for only its own obligations. Issuance of letters of credit and borrowings under the Credit Agreement are subject to our compliance with certain covenants and conditions, including absence of a material adverse change. These covenants require, among other things, that we maintain a debt to total capital ratio of not greater than 0.35 to 1 and consolidated tangible net worth in excess of $3.95 billion plus 25% of future aggregate net income for each quarterly period (not including any future net losses) beginning after March 31, 2014 and 25% of future aggregate proceeds from the issuance of common or preferred equity and that our principal insurance and reinsurance subsidiaries maintain at least a “B++” rating from A.M. Best. In addition, certain of our subsidiaries which are party to the Credit Agreement are required to maintain minimum shareholders’ equity levels. We were in compliance with all covenants contained in the Credit Agreement at December 31, 2014. The Credit Agreement expires on June 30, 2019.

We have access to other letter of credit facilities for up to a total of $190.9 million, 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”). The principal purpose of the LOC Facilities is to issue, as required, evergreen standby letters of credit in favor of primary insurance or reinsurance counterparties with which we have entered into reinsurance arrangements to ensure that such counterparties are permitted to take credit for reinsurance obtained from our reinsurance subsidiaries in United States jurisdictions where such subsidiaries are not licensed or otherwise admitted as an insurer, as required under insurance regulations in the United States, and to comply with requirements of Lloyd’s of London in connection with qualifying quota share and other arrangements. The amount of letters of credit issued is driven by, among other things, the timing and payment of catastrophe losses, loss development of existing reserves, the payment pattern of such reserves, the further expansion of our business and the loss experience of such business. When issued, certain letters of credit are secured by a portion of our investment portfolio. In addition, the LOC Facilities also require the maintenance of certain covenants, which we were in compliance with at December 31, 2014. At such date, we had approximately $423.2 million in outstanding letters of credit under the LOC Facilities, which were secured by investments with a fair value of $483.5 million, and had $100.0 million of borrowings outstanding under the Credit Agreement.

As of December 31, 2014, Watford Re had a $200 million line of credit facility that expires on May 19, 2015. At December 31, 2014, Watford Re had $26.0 million in outstanding letters of credit under that credit facility. Watford Re was in compliance with all covenants contained in its credit facility at December 31, 2014.

Senior Notes

On May 4, 2004, ACGL completed a public offering of $300.0 million principal amount of 7.35% senior notes due May 1, 2034 (“ACGL Senior Notes”). The ACGL Senior Notes are ACGL’s senior unsecured obligations and rank equally with all of its existing and future senior unsecured indebtedness. Interest payments on the ACGL Senior Notes are due on May 1st and November 1st of each year. ACGL may redeem the ACGL Senior Notes at any time and from time to time, in whole or in part, at a “make-whole” redemption price. The fair value of the ACGL Senior Notes at December 31, 2014 and 2013 was $462.4 million and $381.0 million, respectively.

On December 13, 2013, Arch-U.S., a wholly-owned subsidiary of ACGL, completed a public offering of $500.0 million principal amount of 5.144% senior notes due November 1, 2043 (“Arch-U.S. Senior Notes”), fully and unconditionally guaranteed by ACGL (the “Guarantee”). The Arch-U.S. Senior Notes are unsecured and unsubordinated obligations of Arch-U.S. and ACGL, respectively, and rank equally and ratably with the other unsecured and unsubordinated indebtedness of Arch-U.S. and ACGL, respectively. Interest payments on the Arch-U.S. Senior Notes are due on May 1st and November 1st of each year. Arch-U.S. may redeem the Arch-U.S. Senior Notes at any time and from time to time, in whole or in part, at a “make-whole” redemption price. The fair value of the Arch-U.S. Senior Notes at December 31, 2014 and 2013 was $609.9 million and $514.1 million, respectively.

ACGL and Arch-U.S. are each holding companies and, accordingly, they conduct substantially all of their operations through their operating subsidiaries. As a result, ACGL and Arch-U.S.'s cash flows and their ability to service their debt depends upon the earnings of their operating subsidiaries and on their ability to distribute the earnings, loans or other payments from such subsidiaries to ACGL and Arch-U.S., respectively.

During 2014, 2013 and 2012, we made interest payments of $46.4 million, $23.7 million and $29.1 million, respectively, related to its senior notes and other financing arrangements.

Investment in Joint Venture

In 2008, we provided $100.0 million of funding to Gulf Reinsurance Limited (“Gulf Re”), a specialty reinsurer based in the Dubai International Financial Centre which was founded jointly by Arch and Gulf Investment Corporation (“GIC”). Gulf Re targets the six member states of the Gulf Cooperation Council (“GCC”), which include Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates. Gulf Re provides property and casualty reinsurance primarily in the member states of the GCC. We account for our investment in Gulf Re, shown as ‘investment in joint venture,’ using the equity method and record our equity in the operating results of Gulf Re in ‘other income (loss).’ We entered into a number of strategic initiatives in the 2014 fourth quarter, including an agreement to acquire complete ownership of Gulf Re, which is currently pending approval by the Dubai Financial Services Authority. To further support Gulf Re’s business in advance of the January 1 renewal season, we entered into a 90% whole account quota share retrocession arrangement of Gulf Re’s net liabilities and a portfolio transfer of all of Gulf Re’s existing business (both unearned premium and loss reserves), effective as of October 1, 2014.

Contractual Obligations

The following table provides an analysis of our contractual commitments at December 31, 2014:

	Payment due by period
	Total				Less than 1 year				1-3 years				4-5 years				More than 5 years
Debt obligations	$	900,000			$	100,000			$	—			$	—			$	800,000
Interest expense on long-term debt obligations	1,175,855				47,770				95,540				95,540				937,005
Operating lease obligations	154,732				23,343				46,209				38,508				46,672
Purchase obligations	23,464				11,721				11,105				638				—
Reserve for losses and loss adjustment expenses, gross (1)	9,036,448				2,402,591				2,717,538				1,409,451				2,506,868
Deposit accounting liabilities (2)	327,384				52,878				73,554				47,465				153,487
Contractholder payables (3)	1,309,192				463,090				453,620				169,885				222,597
Securities lending collateral (4)	50,529				50,529				—				—				—
Unfunded investment commitments (5)	968,923				968,923				—				—				—
Total	$	13,946,527			$	4,120,845			$	3,397,566			$	1,761,487			$	4,666,629

(1)

The estimated expected contractual commitments related to the reserves for losses and loss adjustment expenses are presented on a gross basis. It should be noted that until a claim has been presented to us, determined to be valid, quantified and settled, there is no known obligation on an individual transaction basis, and while estimable in the aggregate, the timing and amount contain significant uncertainty. Approximately 66% of our reserves for losses and loss adjustment expenses were incurred but not reported at December 31, 2014.

(2)	The estimated expected contractual commitments related to deposit accounting liabilities have been estimated using projected cash flows from the underlying contracts. It should be noted that, due to the nature of such liabilities, the timing and amount contain significant uncertainty.

(3)

Certain insurance policies written by our insurance operations feature large deductibles, primarily in construction and national accounts lines. Under such contracts, we are obligated to pay the claimant for the full amount of the claim and are subsequently reimbursed by the policyholder for the deductible amount. In the event we are unable to collect from the policyholder, we would record an increase to losses and loss adjustment expenses related to such policy.

(4)

As part of our securities lending program, we loan certain fixed income securities to third parties and receive collateral, primarily in the form of cash. The collateral received is reinvested and is reflected as “Investment of funds received under securities lending agreements, at fair value” or “Securities purchased under agreements to resell using funds received under securities lending agreements.” Such collateral is due back to the third parties at the close of the securities lending transaction.

(5)	Unfunded investment commitments are callable by our investment managers. We have assumed that such investments will be funded in the next year but the funding may occur over a longer period of time, due to market conditions and other factors.

OFF-BALANCE SHEET ARRANGEMENTS

We are not party to any transaction, agreement or other contractual arrangement to which an entity unconsolidated with us is a party that management believes is reasonably likely to have a current or future effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.

MARKET SENSITIVE INSTRUMENTS AND RISK MANAGEMENT

Our investment results are subject to a variety of risks, including risks related to changes in the business, financial condition or results of operations of the entities in which we invest, as well as changes in general economic conditions and overall market conditions. We are also exposed to potential loss from various market risks, including changes in equity prices, interest rates and foreign currency exchange rates.

In accordance with the SEC’s Financial Reporting Release No. 48, we performed a sensitivity analysis to determine the effects that market risk exposures could have on the future earnings, fair values or cash flows of our financial instruments as of December 31, 2014. Market risk represents the risk of changes in the fair value of a financial instrument and consists of several components, including liquidity, basis and price risks.

The sensitivity analysis performed as of December 31, 2014 presents hypothetical losses in cash flows, earnings and fair values of market sensitive instruments which were held by us on December 31, 2014 and are sensitive to changes in interest rates and equity security prices. This risk management discussion and the estimated amounts generated from the following sensitivity analysis represent forward-looking statements of market risk assuming certain adverse market conditions occur. Actual results in the future may differ materially from these projected results due to actual developments in the global financial markets. The analysis methods used by us to assess and mitigate risk should not be considered projections of future events of losses.

The focus of the SEC’s market risk rules is on price risk. For purposes of specific risk analysis, we employ 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. The financial instruments included in the following sensitivity analysis consist of all of our investments and cash.

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 market 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 market 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. Furthermore, in recent months interest rate movements in many credit sectors have exhibited a much lower correlation to changes in U.S. Treasury yields. Accordingly, the actual effect of interest rate movements may differ materially from the amounts set forth in the following tables.

The following table summarizes the effect that an immediate, parallel shift in the interest rate yield curve would have had on the portfolio at December 31, 2014 and 2013:

	Interest Rate Shift in Basis Points
(U.S. dollars in millions)	-100				-50				-				+50				+100
December 31, 2014
Total fair value	$	14,753.8			$	14,523.4			$	14,292.1			$	14,067.5			$	13,850.4
Change from base	3.23		%		1.62		%						(1.57		)%		(3.09		)%
Change in unrealized value	$	461.7			$	231.3							$	(224.6	)		$	(441.7	)
December 31, 2013
Total fair value	$	13,338.9			$	13,178.2			$	13,009.5			$	12,839.6			$	12,671.3
Change from base	2.53		%		1.30		%						(1.31		)%		(2.60		)%
Change in unrealized value	$	329.4			$	168.7							$	(169.9	)		$	(338.2	)

In addition, we consider the effect of credit spread movements on the market 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 the portfolio at December 31, 2014 and 2013:

	Credit Spread Shift in Basis Points
(U.S. dollars in millions)	-100				-50				-				+50				+100
December 31, 2014
Total fair value	$	14,572.5			$	14,446.9			$	14,292.1			$	14,151.2			$	14,012.8
Change from base	1.96		%		1.08		%						(0.99		)%		(1.95		)%
Change in unrealized value	$	280.4			$	154.8							$	(140.9	)		$	(279.3	)
December 31, 2013
Total fair value	$	13,228.3			$	13,137.9			$	13,009.5			$	12,896.3			$	12,783.0
Change from base	1.68		%		0.99		%						(0.87		)%		(1.74		)%
Change in unrealized value	$	218.8			$	128.4							$	(113.2	)		$	(226.5	)

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 December 31, 2014, our portfolio’s VaR was estimated to be 2.86%, compared to an estimated 3.43% at December 31, 2013.

Equity Securities, Privately Held Securities and Other Investments. Our investment portfolio includes an allocation to equity securities, privately held securities and certain other investments. At December 31, 2014 and 2013, the fair value of our investments in equity securities, privately held securities and certain other investments totaled $658.2 million and $606.4 million, respectively. These securities are exposed to price risk, which is the potential loss arising from decreases in fair value. An immediate hypothetical 10% depreciation in the value of each position would reduce the fair value of such investments by approximately $65.8 million and $60.6 million at December 31, 2014 and 2013, respectively, and would have decreased book value per common share by approximately $0.52 and $0.45, 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 11, “Derivative Instruments,” of the notes accompanying our consolidated financial Statements for additional disclosures concerning derivatives. At December 31, 2014, 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 $3.28 billion, compared to $812.1 million at December 31, 2013. A 100 basis point depreciation of the underlying exposure to these derivative instruments at December 31, 2014 and 2013 would have resulted in a reduction in net income of approximately $32.8 million and $8.1 million, respectively, and would have decreased book value per common share by $0.26 and $0.06, respectively. A 100 basis point appreciation of the underlying exposure to these derivative instruments at December 31, 2014 and 2013 would have resulted in an increase in net income of approximately $32.8 million and $8.1 million, respectively, and would have increased book value per common share by $0.26 and $0.06, 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 11, “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, at December 31, 2014 and 2013:

(U.S. dollars in thousands, except per share data)	December 31,
2014				2013
Assets, net of insurance liabilities, denominated in foreign currencies, excluding shareholders’ equity and derivatives	$	35,372			$	168,352
Shareholders’ equity denominated in foreign currencies (1)	336,565				396,106
Net foreign currency forward contracts outstanding (2)	(308,149		)		(87,399		)
Net assets denominated in foreign currencies	$	63,788			$	477,059
Pre-tax impact of a hypothetical 10% appreciation of the U.S. Dollar against foreign currencies:
Shareholders’ equity	$	(6,379	)		$	(47,706	)
Book value per common share	$	(0.05	)		$	(0.36	)
Pre-tax impact of a hypothetical 10% decline of the U.S. Dollar against foreign currencies:
Shareholders’ equity	$	6,379			$	47,706
Book value per common share	$	0.05			$	0.36

(1) Represents net assets held in the foreign currencies of our operating units.

(2) Represents the notional value of 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.”

Effects of Inflation

We do not believe that inflation has had a material effect on our consolidated results of operations, except insofar as inflation may affect our reserves for losses and loss adjustment expenses and interest rates. The potential exists, after a catastrophe loss, for the development of inflationary pressures in a local economy. The anticipated effects of inflation on us are considered in our catastrophe loss models. The actual effects of inflation on our results cannot be accurately known until claims are ultimately settled.