Arch Capital Group Ltd. Reports 2007 Fourth Quarter Results

Arch Capital Group Ltd. (NASDAQ: ACGL) reports that net income available to common shareholders for the 2007 fourth quarter was $234.4 million, or $3.31 per share, compared to $239.3 million, or $3.12 per share, for the 2006 fourth quarter, and $832.1 million, or $11.28 per share, for the year ended December 31, 2007, compared to $692.6 million, or $9.08 per share, for the 2006 period. The Company also reported after-tax operating income available to common shareholders of $220.6 million, or $3.11 per share, for the 2007 fourth quarter, compared to $220.7 million, or $2.88 per share, for the 2006 fourth quarter, and $846.3 million, or $11.47 per share, for the year ended December 31, 2007, compared to $734.9 million, or $9.63 per share, for the 2006 period. All earnings per share amounts discussed in this release are on a diluted basis.

The Company’s after-tax operating income available to common shareholders represented a 24.3% annualized return on average common equity for the 2007 fourth quarter, compared to 28.1% for the 2006 fourth quarter, and 24.3% for the year ended December 31, 2007, compared to 25.6% for the 2006 period. After-tax operating income available to common shareholders, a non-GAAP measure, is defined as net income available to common shareholders, excluding net realized gains or losses and net foreign exchange gains or losses, net of income taxes. See page 6 for a further discussion of after-tax operating income available to common shareholders and Regulation G.

The Company’s book value per common share, including the net effect of share repurchases, increased to $55.12 at December 31, 2007 from $43.97 per share at December 31, 2006. Gross and net premiums written for the 2007 fourth quarter were $828.2 million and $577.7 million, respectively, compared to $873.2 million and $601.9 million, respectively, for the 2006 fourth quarter, and $4.14 billion and $2.9 billion, respectively, for the year ended December 31, 2007, compared to $4.28 billion and $3.02 billion, respectively, for the 2006 period. The Company’s combined ratio was 84.4% for the 2007 fourth quarter, compared to 83.0% for the 2006 fourth quarter, and 84.1% for the year ended December 31, 2007, compared to 85.4% for the 2006 period.

The following table summarizes the Company’s underwriting results:

The following table summarizes, on an after-tax basis, the Company’s consolidated financial data, including a reconciliation of after-tax operating income available to common shareholders to net income available to common shareholders and related diluted per share results:

The combined ratio represents a measure of underwriting profitability, excluding investment income, and is the sum of the loss ratio and expense ratio. A combined ratio under 100% represents an underwriting profit and a combined ratio over 100% represents an underwriting loss. The combined ratio of the Company’s insurance and reinsurance subsidiaries consisted of a loss ratio of 55.6% and an underwriting expense ratio of 28.8% for the 2007 fourth quarter, compared to a loss ratio of 54.2% and an underwriting expense ratio of 28.8% for the 2006 fourth quarter. The combined ratio of the Company’s insurance and reinsurance subsidiaries consisted of a loss ratio of 55.8% and an underwriting expense ratio of 28.3% for the year ended December 31, 2007, compared to a loss ratio of 58.1% and an underwriting expense ratio of 27.3% for the 2006 period. The loss ratio of 55.6% for the 2007 fourth quarter was comprised of 39.9 points of paid losses, 8.8 points related to reserves for reported losses and 6.9 points related to incurred but not reported reserves.

In establishing the reserves for losses and loss adjustment expenses, the Company has made various assumptions relating to the pricing of its reinsurance contracts and insurance policies and also has considered available historical industry experience and current industry conditions. The Company’s reserving method to date has been, to a large extent, the expected loss method, which is commonly applied when limited loss experience exists. Any estimates and assumptions made as part of the reserving process could prove to be inaccurate due to several factors, including the fact that limited historical information has been reported to the Company through December 31, 2007. For a discussion of underwriting activities and a review of the Company’s results by operating segment, see “Segment Information” in the Supplemental Financial Information section of this release.

Consolidated cash flow provided by operating activities for the 2007 fourth quarter was $332.9 million, compared to $359.0 million for the 2006 fourth quarter, and $1.44 billion for the year ended December 31, 2007, compared to $1.61 billion for the 2006 period. The lower level of operating cash flows for the year ended December 31, 2007 primarily resulted from an increase in paid losses, as the Company’s insurance and reinsurance loss reserves have continued to mature, along with a lower level of premiums written and collected.

Net investment income was $119.9 million for the 2007 fourth quarter (which included a $1.6 million reduction in the carrying value of certain fixed income investments accounted for using the equity method as discussed below), compared to $107.8 million for the 2006 fourth quarter, and $463.1 million for the year ended December 31, 2007 (which included a $1.7 million increase in the carrying value of such investments), compared to $380.2 million for the 2006 period. The increase in net investment income in the 2007 periods primarily resulted from a higher level of average invested assets. The Company’s investment portfolio, which mainly consists of high quality fixed income securities, had an average Standard & Poor’s quality rating of “AA+” at December 31, 2007, compared to “AAA” at December 31, 2006. The average effective duration of the Company’s investment portfolio was 3.29 years at December 31, 2007, compared to 3.23 years at December 31, 2006. For additional information on the Company’s investment portfolio, refer to the supplemental financial information portion of this release.

The Company’s investment portfolio includes certain funds that invest in fixed income securities which, due to their ownership structure, are accounted for by the Company using the equity method. In applying the equity method, these investments are initially recorded at cost and are subsequently adjusted based on the Company’s proportionate share of the net income or loss of the funds (which include changes in the market value of the underlying fixed income securities in the funds). Changes in the carrying value of such investments, which are primarily included in ‘other investments’ on the Company’s balance sheet, are recorded in net investment income rather than as an unrealized gain or loss component of accumulated other comprehensive income in shareholders’ equity as are changes in the carrying value of the Company’s other fixed income investments.

The Company recorded a pre-tax investment income yield on the portfolio of 4.88% for the 2007 fourth quarter, compared to 4.89% for the 2006 fourth quarter, and 4.88% for the year ended December 31, 2007, compared to 4.71% for the 2006 period. The adjustments to the carrying value of the investments accounted for using the equity method described above reduced the reported pre-tax investment income yield by 0.07% for the 2007 fourth quarter and increased the reported pre-tax investment yield by 0.02% for the year ended December 31, 2007.

For the year ended December 31, 2007, the effective tax rates on income before income taxes and pre-tax operating income were 1.8% and 1.9%, respectively, compared to 3.6% and 3.5%, respectively, for the 2006 period. The Company’s effective tax rates may fluctuate from period to period based on the relative mix of income reported by jurisdiction primarily due to the varying tax rates in each jurisdiction. The Company’s quarterly tax provision is adjusted to reflect changes in its expected and actual annual effective tax rates, if any. As discussed below, the Company recorded a tax benefit in the 2007 and 2006 fourth quarters.

A significant portion of the Company’s catastrophe-exposed property business is written by a Bermuda-based subsidiary. As a result, on a relative basis, the Company’s effective tax rate is likely to be favorably affected in periods that have a low level of catastrophic losses incurred and adversely impacted in periods with significant catastrophic claims activity. The Company’s actual annual effective tax rate on pre-tax operating income was reduced during the 2007 and 2006 fourth quarters, primarily due to the low level of catastrophic losses incurred in the periods. The impact of applying the lower effective tax rate on pre-tax operating income for the nine month periods increased the Company’s after-tax results by $6.2 million, or $0.09 per share, for the 2007 fourth quarter, while the impact on the 2006 fourth quarter was $9.8 million, or $0.13 per share. The Company currently expects that its annual effective tax rate on pre-tax operating income available to common shareholders for the year ended December 31, 2008 will be in the range of 2.0% to 4.0%. In addition, the Company’s Bermuda-based reinsurance subsidiary incurs federal excise taxes for premiums assumed on U.S. risks. Such expenses are included in the Company’s acquisition expenses.

Net foreign exchange losses for the 2007 fourth quarter of $4.1 million consisted of net unrealized losses of $3.1 million and net realized losses of $1.0 million, compared to net foreign exchange losses for the 2006 fourth quarter of $8.3 million, which consisted of net unrealized losses of $8.4 million and net realized gains of $0.1 million. Net foreign exchange losses for the year ended December 31, 2007 of $44.0 million consisted of net unrealized losses of $48.8 million and net realized gains of $4.8 million, compared to net foreign exchange losses for the 2006 period of $23.9 million, which consisted of net unrealized losses of $27.3 million and net realized gains of $3.4 million. Net unrealized foreign exchange gains or losses result from the effects of revaluing the Company’s net insurance liabilities required to be settled in foreign currencies at each balance sheet date. The net foreign exchange losses for the 2007 periods resulted from a weakening of the U.S. Dollar. The Company holds investments in foreign currencies which are intended to mitigate its exposure to foreign currency fluctuations in its 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 statement of income. For the 2007 and 2006 periods, the net unrealized foreign exchange gains or losses recorded by the Company were largely offset by changes in the value of the Company’s investments held in foreign currencies.

Diluted weighted average common shares and common share equivalents outstanding, used in the calculation of after-tax operating income and net income per common share, were 70.9 million in the 2007 fourth quarter, compared to 76.6 million in the 2006 fourth quarter, and 73.8 million for the year ended December 31, 2007, compared to 76.2 million in the 2006 period. The lower level of weighted average shares outstanding in the 2007 periods was primarily due to the weighted average impact of share repurchases as discussed below, partially offset by increases in the dilutive effects of stock options and nonvested restricted stock calculated using the treasury stock method and the exercise of stock options. Under the treasury stock method, the dilutive impact of options and nonvested stock on diluted weighted average shares outstanding increases as the market price of the Company’s common shares increases.

On February 28, 2007, ACGL’s Board of Directors authorized the investment of up to $1 billion in ACGL’s common shares through a share repurchase program. Repurchases under the program may be effected from time to time in open market or privately negotiated transactions through February 2009. During the 2007 fourth quarter and year ended December 31, 2007, ACGL repurchased approximately 2.0 million and 7.8 million common shares, respectively, under the share repurchase program for an aggregate purchase price of $136.4 million and $537.1 million, respectively. As a result of the share repurchase transactions, book value per common share was reduced by $1.45 per share at December 31, 2007 and weighted average shares outstanding for the 2007 fourth quarter and year ended December 31, 2007 were reduced by 6.5 million and 3.3 million shares, respectively. 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. For additional information on the Company’s share repurchase program, refer to the supplemental financial information portion of this release.

At December 31, 2007, the Company’s capital of $4.34 billion consisted of $300.0 million of senior notes, representing 6.9% of the total, $325.0 million of preferred shares, representing 7.5% of the total, and common shareholders’ equity of $3.71 billion, representing the balance. The increase in the Company’s capital during 2007 of $445.2 million was primarily attributable to operating income for 2007 and an after-tax increase in the fair value of the Company’s investment portfolio, partially offset by $537.1 million of share repurchases during the period. The increase in the fair value of the Company’s investment portfolio primarily resulted from changes in the level of interest rates and foreign exchange rates in the second half of 2007.

The Company will hold a conference call for investors and analysts at 11:00 a.m. Eastern Time on Tuesday, February 12, 2008. A live webcast of this call will be available via the Media-Earnings Webcasts section of the Company's website at http://www.archcapgroup.bm and will be archived on the website from 1:00 p.m. Eastern Time on February 12 through midnight Eastern Time on March 12, 2008. A telephone replay of the conference call also will be available beginning on February 12 at 1:00 p.m. Eastern Time until February 19 at midnight Eastern Time. To access the replay, domestic callers should dial 888-286-8010 (passcode 57998007), and international callers should dial 617-801-6888 (passcode 57998007).

Arch Capital Group Ltd., a Bermuda-based company with approximately $4.34 billion in capital at December 31, 2007, provides insurance and reinsurance on a worldwide basis through its wholly owned subsidiaries.

Cautionary Note Regarding Forward-Looking Statements

The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements. This release or any other written or oral statements made by or on behalf of the Company may include forward-looking statements, which reflect the Company’s current views with respect to future events and financial performance. All statements other than statements of historical fact included in this release are forward-looking statements. Forward-looking statements can generally be identified by the use of forward-looking terminology such as “may,”“will,” “expect,”“intend,” “estimate,”“anticipate,” “believe” or “continue” or their negative or variations or similar terminology.

Forward-looking statements involve the Company’s current assessment of risks and uncertainties. Actual events and results may differ materially from those expressed or implied in these statements. Important factors that could cause actual events or results to differ materially from those indicated in such statements are discussed below and elsewhere in this release and in the Company’s periodic reports filed with the Securities and Exchange Commission (the “SEC”), and include:

• the Company’s ability to successfully implement its business strategy during “soft” as well as “hard” markets;
• acceptance of the Company’s business strategy, security and financial condition by rating agencies and regulators, as well as by brokers and its insureds and reinsureds;
• the Company’s ability to maintain or improve its ratings, which may be affected by its ability to raise additional equity or debt financings, by ratings agencies’ existing or new policies and practices, as well as other factors described herein;
• general economic and market conditions (including inflation, interest rates and foreign currency exchange rates) and conditions specific to the reinsurance and insurance markets in which the Company operates;
• competition, including increased competition, on the basis of pricing, capacity, coverage terms or other factors;
• the Company’s ability to successfully integrate, establish and maintain operating procedures (including the implementation of improved computerized systems and programs to replace and support manual systems) to effectively support its underwriting initiatives and to develop accurate actuarial data, especially in light of the rapid growth of its business;
• the loss of key personnel;
• the integration of businesses the Company has acquired or may acquire into its existing operations;
• accuracy of those estimates and judgments utilized in the preparation of the Company’s financial statements, including those related to revenue recognition, insurance and other reserves, reinsurance recoverables, investment valuations, intangible assets, bad debts, income taxes, contingencies and litigation, and any determination to use the deposit method of accounting, which for a relatively new insurance and reinsurance company, like the Company, are even more difficult to make than those made in a mature company since limited historical information has been reported to the Company through December 31, 2007;
• greater than expected loss ratios on business written by the Company and adverse development on claim and/or claim expense liabilities related to business written by its insurance and reinsurance subsidiaries;
• severity and/or frequency of losses;
• claims for natural or man-made catastrophic events in the Company’s insurance or reinsurance business could cause large losses and substantial volatility in its results of operations;
• acts of terrorism, political unrest and other hostilities or other unforecasted and unpredictable events;
• losses relating to aviation business and business produced by a certain managing underwriting agency for which the Company may be liable to the purchaser of its prior reinsurance business or to others in connection with the May 5, 2000 asset sale described in the Company’s periodic reports filed with the SEC;
• availability to the Company of reinsurance to manage its gross and net exposures and the cost of such reinsurance;
• the failure of reinsurers, managing general agents, third party administrators or others to meet their obligations to the Company;
• the timing of loss payments being faster or the receipt of reinsurance recoverables being slower than anticipated by the Company;
• material differences between actual and expected assessments for guaranty funds and mandatory pooling arrangements;
• changes in accounting principles or policies or in the Company’s application of such accounting principles or policies; and
• statutory or regulatory developments, including as to tax policy and matters and insurance and other regulatory matters such as the adoption of proposed legislation that would affect Bermuda-headquartered companies and/or Bermuda-based insurers or reinsurers and/or changes in regulations or tax laws applicable to the Company, its subsidiaries, brokers or customers.

In addition, other general factors could affect the Company’s results, including developments in the world’s financial and capital markets and its access to such markets. All subsequent written and oral forward-looking statements attributable to the Company or persons acting on its behalf are expressly qualified in their entirety by these cautionary statements. The foregoing review of important factors should not be construed as exhaustive and should be read in conjunction with other cautionary statements that are included herein or elsewhere. The Company undertakes no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise.

Comment on Regulation G

Throughout this release, the Company presents its operations in the way it believes will be the most meaningful and useful to investors, analysts, rating agencies and others who use the Company’s financial information in evaluating the performance of the Company. This presentation includes the use of after-tax operating income available to common shareholders, which is defined as net income available to common shareholders, excluding net realized gains or losses and net foreign exchange gains or losses, net of income taxes. The presentation of after-tax operating income available to common shareholders is a “non-GAAP financial measure” as defined in Regulation G. The reconciliation of such measure to net income available to common shareholders (the most directly comparable GAAP financial measure) in accordance with Regulation G is included on page 2 of this release.

The Company believes that net realized gains or losses and net foreign exchange gains or losses in any particular period are not indicative of the performance of, or trends in, the Company’s business performance. Although net realized gains or losses and net foreign exchange gains or losses are an integral part of the Company’s operations, the decision to realize investment gains or losses 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 the Company’s financial information believe that, for many companies, the timing of the realization of investment gains or losses is largely opportunistic, and, under applicable GAAP accounting, losses on the Company’s investments can be realized as the result of other-than-temporary declines in value without actual realization. Due to these reasons, the Company excludes net realized gains or losses and net foreign exchange gains or losses from the calculation of after-tax operating income available to common shareholders.

The Company believes that showing net income available to common shareholders exclusive of the items referred to above reflects the underlying fundamentals of the Company’s business since the Company evaluates the performance of and manages its business to produce an underwriting profit. In addition to presenting net income available to common shareholders, the Company believes that this presentation enables investors and other users of the Company’s financial information to analyze the Company’s performance in a manner similar to how the Company’s management analyzes performance. The Company also believes that this measure follows industry practice and, therefore, allows the users of the Company’s financial information to compare the Company’s performance with its industry peer group. The Company believes that the equity analysts and certain rating agencies which follow the Company and the insurance industry as a whole generally exclude these items from their analyses for the same reasons.

(1) Excludes the effects of 5,486,033 and 5,669,994 stock options and 116,453 and 91,514 restricted stock units outstanding at December 31, 2007 and 2006, respectively.

(2) As the average price per share repurchased during the period exceeded the book value per common share at December 31, 2007, the repurchase of shares during the period reduced book value per common share.

(3) The estimated impact on diluted earnings per share was calculated comparing reported results versus (i) net income per share plus an estimate of lost net investment income on the share repurchases during 2007 divided by (ii) weighted average diluted shares outstanding plus an estimate of the weighted average shares repurchased during 2007. The repurchase of shares was accretive to diluted earnings per share in the 2007 periods.

(1) Equals estimated losses from catastrophic events occurring in the current accident year, net of reinsurance and reinstatement premiums. Amounts shown for the insurance segment are for named catastrophic events only. Amounts shown for the reinsurance segment include (i) named events with over $5 million of losses incurred by its Bermuda operations and (ii) all catastrophe losses incurred by its U.S. operations.

Investment Information (continued)

The following table provides information on the Company’s mortgage-related securities at December 31, 2007, which consist of investments classified as mortgage backed securities (“MBS”), commercial mortgage backed securities (“CMBS”) and certain subprime mortgage holdings, home equity, Alt-A and other investments included in asset backed securities:

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

SEGMENT INFORMATION

The Company classifies its businesses into two underwriting segments – insurance and reinsurance – and a corporate and other segment (non-underwriting). The Company’s insurance and reinsurance operating segments each have segment managers who are responsible for the overall profitability of their respective segments and who are directly accountable to the Company’s chief operating decision makers, the 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. The Company determined its reportable operating segments using the management approach described in SFAS No. 131, “Disclosures About Segments of an Enterprise and Related Information.”

Management measures segment performance based on underwriting income or loss. The Company does not manage its assets by segment and, accordingly, investment income is not allocated to each underwriting segment. In addition, other revenue and expense items are not evaluated by segment. The accounting policies of the segments are the same as those used for the preparation of the Company’s consolidated financial statements. Inter-segment insurance business is allocated to the segment accountable for the underwriting results.

The insurance segment consists of the Company’s insurance underwriting subsidiaries which primarily write on both an admitted and non-admitted basis. The insurance segment consists of eight specialty product lines, including: casualty; construction, surety and national accounts; executive assurance; healthcare; professional liability; programs; property, marine and aviation; and other (consisting of collateral protection, excess workers’ compensation and employers’ liability business).

The reinsurance segment consists of the Company’s reinsurance underwriting subsidiaries. The reinsurance segment generally seeks to write significant lines on specialty property and casualty reinsurance treaties. Classes of business include: casualty; marine and aviation; other specialty; property catastrophe; property excluding property catastrophe (losses on a single risk, both excess of loss and pro rata); and other (consisting of non-traditional and casualty clash business).

The corporate and other segment (non-underwriting) includes net investment income, other income (loss), other expenses incurred by the Company, interest expense, net realized gains or losses, net foreign exchange gains or losses and income taxes. In addition, results for the corporate and other segment include dividends on the Company’s non-cumulative preferred shares.

The following tables set forth underwriting income or loss by segment, together with a reconciliation of underwriting income to net income available to common shareholders:

(1) Certain amounts included in the gross premiums written of each segment are related to intersegment transactions and are included in the gross premiums written of each segment. Accordingly, the sum of gross premiums written for each segment does not agree to the total gross premiums written as shown in the table above due to the elimination of intersegment transactions in the total.

(2) The acquisition expense ratio is adjusted to include certain fee income.

(1) Certain amounts included in the gross premiums written of each segment are related to intersegment transactions and are included in the gross premiums written of each segment. Accordingly, the sum of gross premiums written for each segment does not agree to the total gross premiums written as shown in the table above due to the elimination of intersegment transactions in the total.

(2) The acquisition expense ratio is adjusted to include certain fee income.

(1) Certain amounts included in the gross premiums written of each segment are related to intersegment transactions and are included in the gross premiums written of each segment. Accordingly, the sum of gross premiums written for each segment does not agree to the total gross premiums written as shown in the table above due to the elimination of intersegment transactions in the total.

(2) The acquisition expense ratio is adjusted to include certain fee income.

(1) Certain amounts included in the gross premiums written of each segment are related to intersegment transactions and are included in the gross premiums written of each segment. Accordingly, the sum of gross premiums written for each segment does not agree to the total gross premiums written as shown in the table above due to the elimination of intersegment transactions in the total.

(2) The acquisition expense ratio is adjusted to include certain fee income.

The following table sets forth the insurance segment’s net premiums written and earned by major line of business, together with net premiums written by client and underwriting location:

(1) Includes travel and accident business.

(2) Includes excess workers’ compensation and employers’ liability business.

(1) Includes travel and accident business.

(2) Includes excess workers’ compensation and employers’ liability business.

The following table sets forth the reinsurance segment’s net premiums written and earned by major line of business and type of business, together with net premiums written by client and underwriting location:

(1) Includes professional liability and executive assurance business.

(2) Includes facultative business.

(1) Includes professional liability and executive assurance business.

(2) Includes facultative business.

Gross premiums written by the insurance segment in the 2007 fourth quarter were 3.1% lower than in the 2006 fourth quarter, while net premiums written were 0.7% higher. The growth in net premiums written primarily reflects changes in the mix of business, including a higher percentage in the 2007 fourth quarter of business written in lines in which the insurance segment buys a lower level of reinsurance. The growth in net premiums written resulted from increases in national accounts casualty business, excess workers’ compensation and employers’ liability business (included in ‘Other’) and European professional lines business, partially offset by decreases in U.S. specialty casualty and property lines of business in response to competition and the current rate environment. Net premiums earned by the insurance segment in the 2007 fourth quarter were 4.0% higher than in the 2006 fourth quarter, and reflect changes in net premiums written over the previous five quarters, including the mix and type of business written.

The loss ratio for the insurance segment was 63.8% in the 2007 fourth quarter, compared to 62.6% for the 2006 fourth quarter. The 2007 fourth quarter loss ratio was unchanged from the 2007 third quarter and reflected a 1.6 point reduction related to estimated net favorable development in prior year loss reserves, compared to a 1.5 point reduction in prior year loss reserves in the 2006 fourth quarter. The insurance segment’s loss ratio in the 2007 fourth quarter also reflects an increase in expected loss ratios across a number of lines of business and changes in the mix of business.

The insurance segment’s underwriting expense ratio was 28.7% in the 2007 fourth quarter, compared to 27.6% in the 2006 fourth quarter. The acquisition expense ratio was 12.6% for the 2007 fourth quarter, compared to 12.8% for the 2006 fourth quarter. The acquisition expense ratio is influenced by, among other things, (1) the amount of ceding commissions received from unaffiliated reinsurers, (2) the amount of business written on a surplus lines (non-admitted) basis and (3) mix of business. The acquisition expense ratio in the 2007 fourth quarter reflects changes in the form of reinsurance ceded and the mix of business and also included 1.0 point related to favorable prior year loss development. The insurance segment’s other operating expense ratio was 16.1% for the 2007 fourth quarter, compared to 16.0% in the 2007 third quarter and 14.8% for the 2006 fourth quarter. The higher operating expense ratio in the 2007 fourth quarter compared to the 2006 fourth quarter was primarily due to growth in compensation-related expenses without an attendant growth in net premiums earned.

Gross premiums written by the reinsurance segment in the 2007 fourth quarter were 10.1% lower than in the 2006 fourth quarter, with reductions in casualty, non-catastrophe exposed property and other specialty lines. The reductions were a result of continued competition which resulted in either non-renewals or lower shares written by the reinsurance segment.

Ceded premiums written by the reinsurance segment were 18.4% of gross premiums written for the 2007 fourth quarter, compared to 16.9% for the 2006 fourth quarter. In the 2007 fourth quarter, Arch Re Bermuda ceded $35.2 million, or 14.3% of gross premiums written, of certain lines of property and marine premiums written under the quota share reinsurance treaty (the “Treaty”) to Flatiron Re Ltd., compared to $35.3 million, or 12.9%, in the 2006 fourth quarter. On an earned basis, Arch Re Bermuda ceded $75.6 million to Flatiron Re Ltd. in the 2007 fourth quarter, compared to $61.8 million in the 2006 fourth quarter.

Under the Treaty, Flatiron Re Ltd. assumed a 45% quota share of certain lines of property and marine business underwritten by Arch Re Bermuda for the 2006 and 2007 underwriting years (the percentage ceded was increased from 45% to 70% of covered business bound from June 28, 2006 until August 15, 2006 provided such business did not incept beyond September 30, 2006). On December 31, 2007, the Treaty expired by its terms. At December 31, 2007, $144.9 million of premiums ceded to Flatiron Re Ltd. were unearned. The attendant premiums earned, losses incurred and acquisition expenses will be reflected in the reinsurance segment’s results of operations in 2008.

Net premiums earned by the reinsurance segment in the 2007 fourth quarter were 19.5% lower than in the 2006 fourth quarter. The decrease in net premiums earned in the 2007 fourth quarter primarily resulted from changes in net premiums written over the previous five quarters, including the mix and type of business written.

The reinsurance segment’s loss ratio was 43.3% in the 2007 fourth quarter, compared to 44.5% for the 2006 fourth quarter. The loss ratio for the 2007 fourth quarter reflected an 11.4 point reduction related to estimated net favorable development in prior year loss reserves, compared to an 11.5 point reduction in the 2006 fourth quarter. The 2007 fourth quarter loss ratio also reflected approximately 1.8 points of catastrophic activity, while the 2006 fourth quarter loss ratio reflected approximately 2.6 points of catastrophic activity. The reinsurance segment’s loss ratio in the 2007 fourth quarter also reflects an increase in expected loss ratios across a number of lines of business and changes in the mix of business.

The underwriting expense ratio for the reinsurance segment was 28.8% in the 2007 fourth quarter, compared to 30.4% in the 2006 fourth quarter. The acquisition expense ratio for the 2007 fourth quarter was 20.0%, compared to 26.7% for the 2006 fourth quarter. The acquisition expense ratio is influenced by, among other things, the mix and type of business written and earned and the level of ceding commission income. The acquisition expense ratio for the 2007 fourth quarter included 1.0 point related to favorable prior year loss development, compared to 4.0 points in the 2006 fourth quarter. In addition, the acquisition expense ratio included commission income (in excess of the reimbursement of direct acquisition expenses) on the quota-share reinsurance treaty with Flatiron Re Ltd. which reduced the 2007 fourth quarter acquisition expense ratio by 4.1 points, compared to 2.5 points in the 2006 fourth quarter. The reinsurance segment’s other operating expense ratio was 8.8% for the 2007 fourth quarter, compared to 3.7% for the 2006 fourth quarter. The higher ratio in the 2007 fourth quarter primarily resulted from expenses related to the reinsurance segment’s property facultative reinsurance operation, which commenced operations during the 2007 second quarter, and a lower level of net premiums earned.