LongLow convictionOpen
Arch Capital Group Ltd
Long. Elite specialty underwriting compounder.
- Thesis
- Arch Capital Group is an elite, disciplined specialty underwriter that compounds intrinsic book value at double-digit rates, backed by unmatched underwriting margins, negative loss ratios in mortgage insurance, and high free cash flow conversion. However, post-2024 share price stagnation and persistent post-earnings sell-offs reflect valid market apprehension: softening property catastrophe reinsurance pricing, peak reserve release benefits in mortgage lines, and the structural headwind of Bermuda's 15% corporate income tax kicking in for FY2025. At an implied reverse DCF hurdle of just 2.94%, the stock offers substantial margin of safety, provided its underwriting culture and investment float returns remain resilient through the cycle.
- Key assumption
- I assume that mortgage insurance reserve releases reflect permanent underwriting quality: I assume negative loss ratios and substantial prior-year reserve releases in mortgage insurance are driven by structural borrower credit quality and proprietary risk-scoring models, rather than an unsustainable peak in the housing cycle that will sharply revert. I assume specialty underwriting discipline will protect margins against soft-market cycles: I assume Arch’s opportunistic cycle management will protect ROE and keep consolidated combined ratios well below peer averages, even as property and casualty reinsurance pricing softens from 2023–2024 peaks.
- What would prove me wrong
- A sharp spike in mortgage defaults and exhaustion of reserve releases: a macroeconomic downturn or home price decline triggering a wave of mortgage insurance claims, turning negative loss ratios positive and eliminating a massive source of historical underwriting profit. Secondly, severe softening in reinsurance treaty renewals: accelerating competition and excess capital across the global reinsurance space driving premium rates down by double digits across consecutive renewals, eroding Arch's primary underwriting margin buffer.
Entry$92.34
Price now$96.11marked 10 Sep 2026
Return+4.1%
Benchmark+10.7%S&P 500
vs benchmark−6.6 pp
Held9 monthsopen
- Bermuda registered S&P500 member which writes insurance, reinsurance and mortgage insurance worldwide. Specializes in specialty lines. Founded in 2000. Added to S&P500 in 2022.
- Recent expansions have been largely centered in mortgage insurance, which helps protect a lender against loss in the event that a borrower cannot repay their loan.
- Well ran (in my opinion) in terms of matrix structures and talent-intensive underwriting.
- Highly cyclical industry and many external risks
- Share price has increased significantly over time but peaked in 2024 and then subsequently declined. Insurance ETFs show prices increasing over time and no dip after 2024.
- Arch collects premiums and invests these before claims are paid out.
- Gross premiums are increasing every year, with peaks in Q1 and Q2. Net premiums follow a similar trend (net premiums = gross - reinsurance). Net premiums earned (meaning expired) naturally follows this same trend.
- Very strong loss ratios, particularly in mortgage insurance, which records a negative loss ratio (due to releasing funds held in reserve). A low loss ratio is better.
- Financial strength (6): very poor cash-to-debt vs industry. High debt is typical in the insurance industry as premiums collected (but not earned yet) count as liabilities, which are invested in longer-term assets. Debt to equity is at 0.12, which is excellent vs history and good vs industry. ROIC > WACC.
- Growth (9): 3Y revenue growth rate, EBITDA, and EPS excellent vs industry. FCF growth rate also exceptional vs industry. Best is book growth rate vs industry. Growth rates are average vs history except for EBITDA growth rate which is excellent currently. However, future estimates are more conservative, and poor vs industry.
- Momentum (1): poor return last year, RSI suggest oversold.
- Dividend and buy back: average buyback ratio vs industry and history. Average shareholder yield vs industry.
- Profitability (8): strong margins vs industry and good vs history. ROIC is 5.78%. 10 years of profitability within last 10 years, which is excellent for insurance industry, 5 moat score, and 9 tariff resilience (best in industry).
- Value (8): good PE ratio vs industry and history. Forward PE ratio and Shiller PE ratio are average. PEG is good. PB ratio average. Price to FCF good. Historical EV ratios are good. EV to EBIT at all time lows. Price to FCF, DCF, median PS value are all very strong vs industry and history. Earnings yield, FCF yield and forward rate of return are all excellent vs industry and history.
- Revenue has increased significantly, but net income fell from 2023 to 2024 caused by some catastrophes and also more competition driving down premiums. Debt is consistently higher than cash, but premiums count as liabilities so this should correlate with revenue.
- Free cash flow has consistently risen, in addition to operating cash flow, while stock based compensation remains a small portion. ROE has consistently outpaced WACC.
- Shares have been bought back in recent years at a large amount, while in the last 2 years, share count has been diluted (roughly 0.8% each year).
- Total assets is increasing significantly while total stockholders equity rises with it.
- Gurus are buying recently.
- Directors have long experience working as director of ACGL.
- Very strong correlations between price and revenue, price and book, and 97% correlation between price vs operating cash flow, as operating cash flow dipped in 2024 when the share price dipped (quarterly) (annually there was no dip).
- Reversed DCF growth rate is 2.94%. 20% EPS growth rate 67.5% margin of safety and $285.94 price (without tangible book value). 20% FCF growth rate 82% margin of safety and $517.8 share price (without tangible book value). Also undervalued using adjusted dividend model.
- Every single quarter since Q1 2024, share price has dropped following earnings call.
- Must remain cautious with external risks and lack of knowledge about insurance, otherwise would be 5 star.
- Bermuda corporate tax rate change for FY starting Jan 1, 2025. 0% —> 15%.
Updates
The note above is unedited. Anything that changed goes below it, dated.