ARCH CAPITAL GROUP LTD - 10-Q Quarterly Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2002

Or

/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the transition period ___________________ to _____________________

Commission file number: 0-26456

ARCH CAPITAL GROUP LTD.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

Bermuda Not Applicable
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)

Wessex House, 3rd Floor
45 Reid Street
Hamilton, Bermuda HM 12
(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code: (441) 278-9250

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(Former name, former address and former fiscal year, if changed
since last report)

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.

Yes /X/ No / /

Indicate the number of shares outstanding of each of the issuer's classes of
common shares.

Class Outstanding at September 30, 2002
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Common Shares, $0.01 par value 27,586,184

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ARCH CAPITAL GROUP LTD.

INDEX

1

REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Shareholders of
Arch Capital Group Ltd.:

We have reviewed the accompanying consolidated balance sheet of Arch Capital
Group Ltd. and its subsidiaries as of September 30, 2002, and the related
consolidated statements of income for each of the three and nine month periods
ended September 30, 2002 and 2001, and the consolidated statements of
comprehensive income, changes in shareholders' equity, and cash flows for each
of the nine month periods ended September 30, 2002 and 2001. These financial
statements are the responsibility of the Company's management.

We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with generally accepted auditing standards, the objective of which is the
expression of an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.

Based on our review, we are not aware of any material modifications that should
be made to the accompanying consolidated interim financial information for it to
be in conformity with accounting principles generally accepted in the United
States of America.

We previously audited in accordance with auditing standards generally accepted
in the United States of America, the consolidated balance sheet as of December
31, 2001, and the related consolidated statements of income, comprehensive
income, changes in shareholders' equity, and of cash flows for the year then
ended (not presented herein), and in our report dated February 28, 2002, except
as to the matters described in Note 18 to the consolidated financial statements
which are as of March 7, 2002, we expressed an unqualified opinion on those
consolidated financial statements. In our opinion, the information set forth in
the accompanying consolidated balance sheet information as of December 31, 2001,
is fairly stated in all material respects in relation to the consolidated
balance sheet from which it has been derived.

/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
New York, New York
November 13, 2002

2

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)

See Notes to Consolidated Financial Statements

3

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT SHARE DATA)

See Notes to Consolidated Financial Statements

4

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(IN THOUSANDS)

See Notes to Consolidated Financial Statements

5

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(IN THOUSANDS)

See Notes to Consolidated Financial Statements

6

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)

See Notes to Consolidated Financial Statements

7

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. GENERAL

The interim consolidated financial statements have been prepared in
conformity with accounting principles generally accepted in the United States
("GAAP") and include the accounts of Arch Capital Group Ltd. ("ACGL") and its
subsidiaries (together with ACGL, the "Company"), including Arch Reinsurance
Ltd. ("Arch Re Bermuda"), Arch Capital Group (U.S.) Inc. ("Arch-U.S."), Arch
Reinsurance Company ("Arch Re U.S."), Arch Insurance Company ("Arch Insurance"),
formerly known as First American Insurance Company, Arch Excess & Surplus
Insurance Company ("Arch E&S"), formerly known as Cross River Insurance Company,
Arch Specialty Insurance Company ("Arch Specialty"), formerly known as Rock
River Insurance Company, Arch Risk Transfer Services Ltd. ("ART Services"),
American Independent Insurance Holding Company ("AIHC"), and Hales & Company
Inc. ("Hales"). All significant intercompany transactions and balances have been
eliminated in consolidation.

The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates. In the opinion of management, the accompanying unaudited interim
consolidated financial statements reflect all adjustments necessary (consisting
mainly of normal recurring accruals) for a fair statement of results on an
interim basis. The results of any interim period are not necessarily indicative
of the results for a full year or any future periods. Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with GAAP have been condensed or omitted pursuant to such rules and
regulations; however, management believes that the disclosures are adequate to
make the information presented not misleading. This report should be read in
conjunction with the Company's annual report on Form 10-K for the year ended
December 31, 2001, including the Company's audited consolidated financial
statements and related notes and the section entitled "Business--Risk Factors."
Many events, such as natural catastrophes such as earthquakes, hurricanes,
tornados and hailstorms, can have a significant impact on the results of any one
or more reporting periods.

In October 2001, the Company launched an underwriting initiative to meet
current and future demand in the global insurance and reinsurance markets that
included the recruitment of new management teams and an equity capital infusion
of $763.2 million. In April 2002, the Company completed an offering of 7,475,000
of its common shares and received net proceeds of $179.2 million. Due to the
significant changes in the Company's business and operations resulting from the
new underwriting initiative and related capital infusions, comparisons of 2002
to 2001 results are not meaningful.

2. ACCOUNTING PRONOUNCEMENTS

In August 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 144, "Accounting for
the Impairment or Disposal of Long-Lived Assets," which was adopted by the
Company on January 1, 2002. SFAS No. 144 addresses the accounting and reporting
for impairment of long-lived assets to be held and used, as well as long-lived
assets to be disposed of. The standard requires that long-lived assets to be
held and used will be written down to fair value when they are considered
impaired. Long-lived assets to be disposed of are required to be carried at the
lower of carrying amount or fair value less estimated cost to sell. SFAS No. 144
also broadens the presentation of discontinued operations on the income
statement to include a component of an entity (rather than a segment of a
business). The adoption of this standard did not have a material effect on the
Company's results of operations for the 2002 third quarter and nine months ended
September 30, 2002 or its financial position.

In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." SFAS No. 146 will be applied prospectively to
exit or disposal activities initiated after December 31, 2002 and requires
companies to recognize costs associated with exit activities when they are
incurred, rather than at the date of a commitment to an exit or disposal plan.
The Company is currently evaluating this standard.

8

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

3. RECLASSIFICATIONS

To facilitate period to period comparisons, certain amounts in the 2001
consolidated financial statements have been reclassified to conform to the 2002
presentation. Such reclassifications had no effect on the Company's net income,
shareholders' equity or cash flows.

4. GOODWILL

In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets," which became effective for the Company on January 1, 2002. In adopting
SFAS No. 142, the Company discontinued amortizing goodwill and will test
goodwill at least annually for impairment. SFAS No. 142 also requires that, upon
adoption, the Company complete a transitional goodwill impairment test six
months from the date of adoption. The Company tested its goodwill for impairment
at each reporting unit as of January 1, 2002 in accordance with SFAS No. 142
and, based on such evaluation, it was determined that goodwill was not impaired.
Goodwill will be tested for impairment on an annual basis and between annual
tests in certain circumstances.

The carrying amount of goodwill at September 30, 2002 was $28.6 million,
consisting of $22.9 million relating to the Company's insurance subsidiaries
($13.6 million, $6.5 million and $2.8 million relating to the acquisitions of
AIHC, ART Services and Arch Specialty, respectively) and $5.7 million relating
to the acquisition of Hales.

The following table provides the pro forma effect on net income (loss)
and basic and diluted earnings (loss) per share for the three and nine month
periods ended September 30, 2002 and 2001, as if the amortization of goodwill
had ceased at the beginning of 2001 (net of taxes):

5. CONTINGENCIES RELATING TO THE SALE OF PRIOR REINSURANCE OPERATION

On May 5, 2000, the Company sold the prior reinsurance operations of Arch Re
U.S. pursuant to an agreement entered into as of January 10, 2000 with
Folksamerica Reinsurance Company and Folksamerica Holding Company (collectively,
"Folksamerica"). The Folksamerica transaction was structured as a transfer and
assumption agreement (and not reinsurance), and, accordingly, the loss reserves
(and any related reinsurance recoverables) relating to the transferred business
are not included as assets or liabilities on the Company's

9

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

5. CONTINGENCIES RELATING TO THE SALE OF PRIOR REINSURANCE OPERATION
(CONTINUED)

balance sheet. Folksamerica assumed Arch Re U.S.'s rights and obligations under
the reinsurance agreements transferred in the asset sale. The reinsureds under
such agreements were notified that Folksamerica had assumed Arch Re U.S.'s
obligations and that, unless the reinsureds object to the assumption, Arch Re
U.S. will be released from its obligations to those reinsured. None of such
reinsureds objected to the assumption. However, Arch Re U.S. will continue to be
liable under those reinsurance agreements if the notice is found not to be an
effective release by the reinsureds. Folksamerica has agreed to indemnify the
Company for any losses arising out of the reinsurance agreements transferred to
Folksamerica Reinsurance Company in the asset sale. However, in the event that
Folksamerica refuses or is unable to perform its obligations to the Company,
Arch Re U.S. may incur losses relating to the reinsurance agreements transferred
in the asset sale. Folksamerica has an A.M. Best rating of "A-" (Excellent).

Under the terms of the agreement, $20 million of the purchase price had been
placed in escrow for a period of five years. Such amounts represented restricted
funds that appeared under a separate caption entitled "Securities held in
escrow" on the Company's consolidated balance sheet at December 31, 2001. These
funds were to be used to reimburse Folksamerica if the loss reserves (which were
$32.3 million at the closing of the asset sale) transferred to it in the asset
sale relating to business produced on behalf of Arch Re U.S. by a certain
managing underwriting agency were deficient as measured at the end of such
five-year period or to satisfy certain indemnity claims Folksamerica may have
had during such period. On February 25, 2002, the Company reached a definitive
settlement agreement with Folksamerica pursuant to which the Company satisfied
its obligations under the escrow agreement for consideration of $17.0 million,
plus accrued interest income of $1.8 million. Accordingly, during the 2001
fourth quarter, the Company recorded an after-tax benefit of $0.4 million, which
consisted of a charge of $2.5 million, offset by a reversal of a related reserve
in the amount of $2.9 million. The related reserve had been provided for the
purchase of reinsurance, which was no longer required due to the fact that the
escrow arrangements have been terminated under the above settlement agreement.

Under the terms of the agreement, the Company had also purchased in 2000
reinsurance protection covering the Company's transferred aviation business to
reduce the net financial loss to Folksamerica on any large commercial airline
catastrophe to $5.4 million, net of reinstatement premiums. Although the Company
believes that any such net financial loss will not exceed $5.4 million, the
Company has agreed to reimburse Folksamerica if a loss is incurred that exceeds
$5.4 million for aviation losses under certain circumstances prior to May 5,
2003. The Company also made representations and warranties to Folksamerica about
the Company and the business transferred to Folksamerica for which the Company
retains exposure for certain periods, and made certain other agreements,
including that the Company would not compete with Folksamerica to acquire or
reinsure any treaties included in the assumed business until May 5, 2004. In
consideration of a $2.5 million payment by the Company in October 2002,
Folksamerica agreed to terminate this non-competition provision and all related
obligations under such provision have been extinguished. The amount was recorded
by the Company in the 2002 third quarter and is reflected in acquisition
expenses.

In addition, the Company retained its tax and employee benefit liabilities
and other liabilities not assumed by Folksamerica, including all liabilities not
arising under reinsurance agreements transferred to Folksamerica in the asset
sale and all liabilities (other than liabilities arising under reinsurance
agreements) arising out of or relating to the managing underwriting agency
referred to above. Although Folksamerica has not asserted that any amount is
currently due under any of the indemnities provided by the Company under the
asset purchase agreement, Folksamerica has indicated a potential indemnity claim
under the agreement in the event of the occurrence of certain future events.
Based on all available information, the Company has denied the validity of any
such potential claim.

10

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

6. SEGMENT INFORMATION

The Company classifies its businesses into two underwriting segments -
reinsurance and insurance - and a corporate and other segment (non-
underwriting). Segment performance is evaluated based on underwriting income or
loss. Other revenue and expense items are not evaluated by segment. In addition,
the Company does not manage its assets by segment and, accordingly, investment
income is not allocated to each underwriting segment. The accounting policies of
the segments are the same as those used for the consolidated financial
statements. Inter-segment insurance business is allocated to the segment
accountable for the underwriting results in accordance with SFAS No. 131.

The reinsurance segment consists of the Company's reinsurance underwriting
subsidiaries, Arch Re Bermuda, based in Bermuda, and Arch Re U.S., based in the
United States. The reinsurance segment's strategy is to write significant
portions of business on a select number of specialty property and casualty
treaties. Classes of business focused on include property catastrophe
reinsurance, other property business (losses on a single risk, both excess of
loss and pro rata), casualty, other specialty business, marine, aviation and
space, casualty clash and non-traditional business.

The insurance segment includes the Company's primary underwriting
subsidiaries, which include Arch Insurance, Arch Specialty, Arch E&S and
American Independent. The insurance segment is comprised of six profit centers,
including property, casualty, executive assurance, healthcare, professional
liability insurance and program business, and other (currently identified as the
non-standard auto business of American Independent and the lenders business of
Arch Insurance).

The corporate and other segment (non-underwriting) includes net investment
income, other fee income and other expenses incurred by the Company, net
realized gains or losses, net foreign exchange gains or losses and non-cash
compensation. The corporate and other segment also includes the results of
Hales, the Company's merchant banking subsidiary. Due to the significant changes
in the Company's business and operations resulting from the new underwriting
initiative and related capital infusions, comparisons of 2002 and 2001 results
are not meaningful. Accordingly, segment information provided below relates
solely to 2002 periods. The following tables set forth an analysis of the
Company's underwriting income or loss by segment, together with a reconciliation
of underwriting income or loss to net income for the 2002 third quarter and nine
months ended September 30, 2002.

11

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

6. SEGMENT INFORMATION (CONTINUED)

(1) Reinsurance segment results include $16.9 million of net premiums written
assumed from the insurance segment.
(2) Underwriting ratios are calculated based on net premiums earned.
(3) The acquisition expense ratio is adjusted to include certain policy-related
fee income.

12

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

6. SEGMENT INFORMATION (CONTINUED)

(1) Reinsurance segment results include $53.9 million of net premiums written
assumed from the insurance segment.
(2) Underwriting ratios are calculated based on net premiums earned.
(3) The acquisition expense ratio is adjusted to include certain policy-related
fee income.

13

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

6. SEGMENT INFORMATION (CONTINUED)

Set forth below is summary information regarding net premiums written by
client location and by major line of business for the reinsurance and insurance
segments for the three and nine month periods ended September 30, 2002:

(1) Reinsurance segment results include $16.9 million and $53.9 million of net
premiums written, respectively, for the 2002 third quarter and nine month
periods ended September 30, 2002 assumed from the insurance segment.

14

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

7. REINSURANCE

In the normal course of business, the Company's insurance subsidiaries may
cede a portion of their premium through quota share, surplus, excess of loss and
facultative reinsurance agreements. The Company's reinsurance subsidiaries are
currently retaining substantially all of their assumed reinsurance premiums
written. The Company's reinsurance subsidiaries participate in "common account"
retrocessional arrangements for certain treaties. Such arrangements reduce the
effect of individual or aggregate losses to all companies participating on such
treaties, including the reinsurers, such as the Company's reinsurance
subsidiaries, 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, the Company's insurance subsidiaries would be
liable for such defaulted amounts.

With respect to 2002 and 2001 results reflected below, the following table
sets forth the effects of reinsurance on the Company's reinsurance and insurance
subsidiaries to unaffiliated reinsurers. With respect to 2001 results, the table
sets forth the effects of reinsurance on American Independent, which was
acquired by the Company in February 2001, and ART Services, which was acquired
in June 2001.

15

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

8. INVESTMENT INFORMATION

The following tables reconcile estimated fair value and carrying value to
the amortized cost of the Company's investment portfolio at September 30, 2002
and December 31, 2001:

Privately held securities consisted of the following at September 30, 2002
and December 31, 2001:

16

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

8. INVESTMENT INFORMATION (CONTINUED)

During the nine months ended September 30, 2002, the Company received
distributions from The ARC Group, LLC ("ARC") totaling $1.4 million. On April
12, 2002, the Company sold its investment in ARC to Trident II, L.P. and two
limited partnerships associated with Marsh & McLennan Companies, Inc. for
consideration of $14.5 million. The realized gain of $5.8 million on the sale of
the Company's investment in ARC is net of certain transaction expenses and was
recorded in the 2002 second quarter. During the nine months ended September 30,
2002, the Company also received aggregate distributions of $2.7 million from
Trident II, L.P. including (1) a return of capital of $2.3 million which reduced
the Company's carrying value in Trident II, L.P. and (2) net realized gains of
$434,000.

In August 2002, the Company received a return of capital of approximately
$392,000 from New Europe Insurance Ventures ("NEIV"), a limited partnership
which is running-off its business and operations. The August 2002 distribution
reduced the Company's carrying value in NEIV to $28,000 at such date and, during
the 2002 third quarter, the Company recorded a realized loss of $28,000 to write
off the remaining investment value to zero. The administrators of NEIV are
analyzing various alternatives in order to complete the run-off of the business
and operations of NEIV. At September 30, 2002, the Company had investment
commitments relating to its privately held securities totaling approximately
$0.4 million, which related to the Company's investment in Distribution
Investors, LLC.

9. EARNINGS (LOSS) PER SHARE

Due to the net loss for the 2002 third quarter, diluted average shares
outstanding for the 2002 third quarter do not include 39,304,796 shares of
dilutive securities since the inclusion of such securities would be
anti-dilutive. Since the Company reported net income for the nine months ended
September 30, 2002, the computation of diluted average shares outstanding
includes dilutive securities for such year-to-date period. The following table
sets forth the computation of basic and diluted earnings (loss) per share:

17

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

9. EARNINGS PER SHARE (CONTINUED)

On April 8, 2002, ACGL issued 7,475,000 of its common shares and received
net proceeds of approximately $179.2 million. In April 2002, 446,608 common
shares of ACGL were issued upon the exercise of 1,559,257 Class A warrants on a
cashless basis. On June 28, 2002, ACGL issued 875,753 additional Series A
convertible preference shares pursuant to a post-closing purchase price
adjustment mechanism under the subscription agreement entered into in connection
with the capital infusion completed in November 2001. From August to
September 2002, an aggregate of 3,748,946 common shares were issued upon the
exercise of all 3,842,450 outstanding Class A warrants, which were exercisable
for $20.00 per share and were scheduled to expire on September 19, 2002. Of such
amounts, 35,839 common shares of ACGL were issued upon the exercise of 129,343
Class A warrants on a cashless basis. The proceeds from the exercise of Class A
warrants on a cash basis increased shareholders' equity by approximately
$74.3 million.

10. INCOME TAXES

ACGL is incorporated under the laws of Bermuda and, under current Bermuda
law, is not obligated to pay any taxes in Bermuda based upon income or capital
gains. The Company has received a written undertaking from the Minister of
Finance in Bermuda under the Exempted Undertakings Tax Protection Act 1966 that,
in the event that any legislation is enacted in Bermuda imposing any tax
computed on profits, income, gain or appreciation on any capital asset, or any
tax in the nature of estate duty or inheritance tax, such tax will not be
applicable to ACGL or any of its operations until March 28, 2016. This
undertaking does not, however, prevent the imposition of taxes on any person
ordinarily resident in Bermuda or any company in respect of its ownership of
real property or leasehold interests in Bermuda.

ACGL will be subject to U.S. federal income tax only to the extent that it
derives U.S. source income that is subject to U.S. withholding tax or income
that is effectively connected with the conduct of a trade or business within the
U.S. and is not exempt from U.S. tax under an applicable income tax treaty with
the U.S. ACGL will be subject to a withholding tax on dividends from U.S.
investments and interest from certain U.S. taxpayers. ACGL does not consider
itself to be engaged in a trade or business within the U.S. and, consequently,
does not expect to be subject to direct U.S. income taxation. However, because
there is uncertainty as to the activities which constitute being engaged in a
trade or business within the United States, there can be no assurances that the
U.S. Internal Revenue Service will not contend successfully that ACGL or its
non-U.S. subsidiaries are engaged in a trade or business in the United States.
If ACGL or any of its non-U.S. subsidiaries were subject to U.S. income tax,
ACGL's shareholders' equity and earnings could be materially adversely affected.
ACGL's U.S. subsidiaries are subject to U.S. income taxes on their worldwide
income.

ACGL changed its legal domicile from the United States to Bermuda in
November 2000. Legislation has been introduced which (if enacted) could
eliminate the tax benefits available to companies that have changed their legal
domiciles to Bermuda, and such legislation may apply to ACGL. In addition, some
U.S. insurance companies have been lobbying Congress to pass legislation
intended to eliminate certain perceived tax advantages of U.S. insurance
companies with Bermuda affiliates resulting principally from reinsurance between
or among U.S. insurance companies and their Bermuda affiliates. This
legislation, if passed, and other changes in U.S. tax laws, regulations and
interpretations thereof to address these issues could materially adversely
affect the Company.

For the nine months ended September 30, 2002, the Company's income tax
provision resulted in an effective tax rate of 27.6%, excluding the reversal of
a $7.4 million valuation allowance on certain of the Company's deferred tax
assets during the 2002 second quarter. The Company's remaining valuation
allowance is $2.1 million at September 30, 2002. The effective tax rate will
fluctuate based on the relative amounts of the Company's U.S.-sourced income and
its worldwide income. The valuation allowance reversal was based on the
Company's recently completed restructuring of its U.S.-based insurance
underwriting operations and its business plan.

18

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

11. RELATED PARTY TRANSACTIONS

During the 2002 third quarter, the Company's board of directors accelerated
the vesting terms of certain restricted common shares granted to Robert
Clements, Chairman of the board, in connection with the November 2001 capital
infusion, and Mr. Clements agreed to repay the outstanding $13.5 million loan
previously made to him by the Company on or before November 12, 2002. Mr.
Clements was granted 1,689,629 restricted common shares which were initially
scheduled to vest in five equal annual amounts commencing on October 23, 2002.
The vesting period and the amounts have been changed as follows: 60% of the
shares vested on October 23, 2002 and the balance of the shares will vest in two
equal annual amounts on October 23, 2003 and October 23, 2004.

As previously announced, the $13.5 million loan made by the Company to Mr.
Clements was used by him to pay income and self employment taxes. Under his
retention agreement, Mr. Clements receives additional compensation in cash in an
amount sufficient to defray the loan's interest costs. In order to facilitate
the repayment of the loan, the Company agreed to repurchase, at Mr. Clements'
option, an amount of his shares equal to the principal balance of the loan less
any cash payment made by Mr. Clements, for a price per share based on the market
price for the common shares as reported on the NASDAQ National Market on the
date of sale. In addition, the Company agreed to make gross-up payments to Mr.
Clements in the event of certain tax liabilities in connection with the
repurchase. Pursuant to such arrangements, Mr. Clements sold 411,744 common
shares of ACGL for an aggregate purchase price of $11.5 million. Mr. Clements
used all of such sale proceeds and $2.0 million in cash to repay the entire loan
balance on November 12, 2002. The Company's book value per diluted share
decreased by approximately $0.04 following such share repurchase. During the
loan period, Mr. Clements received payments of $638,000 from the Company under
his retention agreement, of which $364,000 was used by him to pay interest on
the loan.

In connection with the Company's information technology initiative in 2002,
the Company has entered into arrangements with two software companies, which
provide document management systems and information and research tools to
insurance underwriters, in which Mr. Clements and John Pasquesi, the Vice
Chairman of ACGL's board of directors, each own minority ownership interests.
The Company will pay fees under such arrangements based on usage. Under one of
these agreements, fees payable are subject to a minimum of approximately
$575,000 for the two-year period ending July 2004. The Company has made payments
of approximately $167,000 under such arrangements through September 30, 2002.

From January 2002 to November 2002, the Company leased temporary office
space from Tri-City Brokerage Inc. (together with its affiliates, "Tri-City"), a
company in which Peter Appel, President and Chief Executive Officer of ACGL, Mr.
Clements and Distribution Investors, LLC hold ownership interests, for aggregate
rental expense of approximately $168,000 through September 30, 2002. In
addition, Tri-City, as broker, has placed business with the Company's insurance
operations and the Company has incurred commission expenses of approximately
$1.0 million under such arrangements through September 30, 2002.

12. SUBSEQUENT EVENTS

Please refer to Note 11 for information regarding the Company's repurchase
of common shares from Robert Clements, Chairman of the Company's board of
directors, and the repayment by Mr. Clements of his outstanding loan from the
Company in November 2002.

19

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

GENERAL

THE COMPANY

We are a Bermuda public limited liability company with over $1.3 billion in
equity capital and, through operations in Bermuda and the United States, are
positioned to write 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 are focusing on writing specialty lines of insurance and
reinsurance.

NEW UNDERWRITING INITIATIVE

In October 2001, we launched an underwriting initiative to meet current and
future demand in the global insurance and reinsurance markets that included the
recruitment of new insurance and reinsurance management teams and an equity
capital infusion of $763.2 million. It is our belief that our existing Bermuda
and U.S.-based underwriting platform, our strong management team and our $1.3
billion in capital that is unencumbered by significant exposure to pre-2002
risks have enabled us to establish an immediate presence in an attractive
insurance and reinsurance marketplace. In April 2002, we completed an offering
of 7,475,000 of our common shares and received net proceeds of $179.2 million
and, from August to September 2002, we received proceeds of $74.3 million
from the exercise of Class A Warrants by our principal shareholders and
certain other investors. The proceeds from the common share offering and
warrant exercises were contributed to the surplus of Arch Re Bermuda, our
Bermuda-based reinsurance and insurance subsidiary.

This 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. 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
section entitled "--Cautionary Note Regarding Forward Looking Statements," and
the section entitled "Business--Risk Factors" included in our Annual Report on
Form 10-K for the year ended December 31, 2001.

CRITICAL ACCOUNTING POLICIES, ESTIMATES AND RECENT ACCOUNTING PRONOUNCEMENTS

The preparation of consolidated financial statements requires us to make
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, 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, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions and such differences may be
material. As a relatively new insurance and reinsurance company, very limited
historical information has been reported to us as of September 30, 2002. We
believe that the following critical accounting policies require our more
significant judgments and estimates used in the preparation of our consolidated
financial statements.

PREMIUM REVENUES AND RELATED EXPENSES

Insurance premiums written are recorded in accordance with the terms of the
underlying policies. Reinsurance premiums assumed are recognized as income on a
straight line basis over the terms of the related reinsurance contracts. For
business written on a pro rata basis, premiums written are recorded as the
underlying policies are written, generally over a twelve-month period. For
excess of loss treaties, the minimum annual premium is recorded as written as of
the date of the treaty. These amounts are based on reports received from ceding
companies, supplemented by our own estimates of premiums for which ceding
company reports have not been received. Subsequent differences arising on such
estimates are recorded in the period they are determined. A significant portion
of amounts included as premiums receivable, which represent estimated premiums,
net of

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commissions, are not yet due based on the terms of the underlying contracts.
Unearned premium reserves represent the portion of premiums written that relates
to the unexpired terms of contracts in force. Certain of our contracts included
provisions that adjust premiums or acquisition expenses based upon the
experience under the contracts. Premiums written and earned as well as related
acquisition expenses under those contracts are recorded based upon the projected
ultimate experience under these contracts.

We also write non-traditional reinsurance business that is intended to
provide insurers with risk management solutions that complement traditional
reinsurance. Under these contracts, we assume a measured amount of insurance
risk in exchange for a specified margin. Coverages may include a combination of
sublimits and caps. Examples of such non-traditional business include aggregate
stop-loss coverages and financial quota share coverages.

Certain contracts included in our non-traditional reinsurance business,
which pursuant to Statement of Financial Accounting Standards ("SFAS") No. 113,
"Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration
Contracts," issued by the Financial Accounting Standards Board ("FASB"), are
deemed, for financial reporting purposes, not to transfer insurance risk, are
accounted for using the deposit method of accounting as prescribed in Statement
of Position 98-7, "Deposit Accounting: Accounting for Insurance and Reinsurance
Contracts That Do Not Transfer Insurance Risk." For those contracts that contain
an element of underwriting risk, non-refundable fees are deferred and amortized
over the contract period. Such fees are included in our underwriting results.
For those contracts that do not transfer an element of underwriting risk, the
expected profit is reflected in earnings over the estimated settlement period
using the interest method. Such profit is included in investment income.

Under generally accepted accounting principles ("GAAP"), acquisition
expenses and other expenses that vary with and are directly related to the
acquisition of business related to our underwriting operations are deferred and
amortized over the period in which the related premiums are earned. Under
statutory accounting principles, underwriting expenses are recognized
immediately as premiums are written.

Acquisition expenses consist principally of commissions and brokerage
expenses. Other operating expenses also include expenses that vary with and are
directly related to the acquisition of business. Acquisition expenses for the
insurance segment are reflected net of ceding commissions from third party
reinsurers. Deferred acquisition costs are carried at their estimated realizable
value based on the related unearned premiums and take into account anticipated
losses and loss adjustment expenses, based on historical and current experience,
and anticipated investment income.

RESERVES FOR LOSSES AND LOSS ADJUSTMENT EXPENSES

Insurance reserves are inherently subject to uncertainty. The reserves for
losses and loss adjustment expenses 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 and it is likely
that the ultimate liability may exceed or be less than such estimates. We
utilize actuarial models as well as available historical insurance and
reinsurance industry loss development patterns to assist in the establishment of
appropriate loss reserves. Even actuarially sound methods can lead to subsequent
adjustments to reserves that are both significant and irregular due to the
nature of the risks written, potentially by a material amount. If our reserves
for losses and loss adjustment expenses are determined to be inadequate, we will
be required to increase the reserves with a corresponding reduction in net
income in the period in which the deficiency is determined.

For reinsurance assumed, the reserves are based on reports received from
ceding companies, supplemented by our estimates of reserves for which ceding
company reports have not been received, and our own historical experience. For
our insurance operations, claims personnel determine whether to establish a case
reserve for the estimated amount of the ultimate settlement, if any. The
estimate reflects the judgment of claims personnel based on general corporate
reserving practices, and on 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 and managing general agents in the
claims process, and the work of such parties is reviewed by our claims
personnel. Reserves are also established to provide for 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
case reserves may be

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made as additional information regarding the claims is reported or payments are
made. In accordance with industry practice, we maintain incurred but not
reported ("IBNR") reserves. Such reserves are established to provide for future
case reserves and loss payments on incurred claims which have not yet been
reported to an insurer or reinsurer.

Even though most insurance contracts have policy limits, the nature of
property and casualty insurance and reinsurance is that losses can exceed policy
limits for a variety of reasons and could very significantly exceed the premiums
received on the underlying policies. We will attempt to limit our risk of loss
through reinsurance and may also use retrocessional arrangements. The
availability and cost of reinsurance and retrocessional protection is subject to
market conditions, which are beyond our control.

In establishing the reserves for losses and loss adjustment expenses, we
have made various assumptions relating to the pricing of our reinsurance
contracts and insurance policies and have also considered available historical
industry experience and current industry conditions. Our reserving process
reflects that there is a possibility that the assumptions made could prove to be
inaccurate due to several factors primarily relating to our start-up nature,
including the fact that very limited historical information has been reported to
us through September 30, 2002. It is possible that claims in respect of events
that have occurred could exceed our reserves and have a material adverse effect
on our results of operations in a particular period or our financial condition
in general.

COLLECTION OF INSURANCE-RELATED BALANCES

We maintain allowances for doubtful accounts for probable losses resulting
from our inability to collect premiums or amounts due from reinsurers. We are
subject to credit risk with respect to our reinsurance ceded because the ceding
of risk to reinsurers does not relieve us of our liability to the clients or
companies we insure. If the financial condition of our reinsurers or
retrocessionaires were to deteriorate, resulting in an impairment of their
ability to make payments, additional allowances may be required.

We are also subject to credit risk from our alternative market products,
such as rent-a-captive risk-sharing programs which allow a client to retain a
significant portion of its loss exposure without the administrative costs and
capital commitment required to establish and operate its own captive. In certain
of these programs, we participate in the operating results by providing excess
reinsurance coverage and earn commissions and management fees. We also write
program business on a risk-sharing basis with agents or brokers which is
achieved with a contingent commission structure based upon the program
underwriting results. While we attempt to obtain sufficient collateral from
managing general agents or other clients to guarantee their projected financial
obligations to us, there is no guarantee that such collateral will be sufficient
to secure their actual ultimate obligations.

VALUATION ALLOWANCE

We record a valuation allowance to reduce certain of our deferred tax assets
to the amount that is more likely than not to be realized. While we have
considered future taxable income and feasible tax planning strategies in
assessing the need for a valuation allowance, in the event we were to determine
that we would not be able to realize all or part of our deferred tax assets in
the future, an adjustment to the deferred tax asset would be charged to income
in the period such determination was made. In addition, if we subsequently
assessed that the valuation allowance was no longer needed, then a benefit would
be recorded to income in the period such determination was made.

INVESTMENTS

We currently classify all of our publicly traded fixed maturity, short-term
investments and equity securities as "available for sale" and, accordingly, they
are carried at estimated fair value. The fair value of publicly traded fixed
maturity securities and publicly traded equity securities is estimated using
quoted market prices or dealer quotes. Investments included in our private
portfolio include securities issued by privately held companies that are
generally restricted as to resale or are otherwise illiquid and do not have
readily ascertainable market values. Our investments in privately held equity
securities, other than those carried under the equity method of accounting, are
carried at estimated fair value. Fair value is initially considered to be equal
to the cost of such investment until the investments are revalued based on
substantive events or other factors which could indicate a

22

diminution or appreciation in value. In accordance with Accounting Principles
Board ("APB") Opinion No. 18 for privately held equity investments accounted for
under the equity method, we review the facts and circumstances surrounding our
ownership for each investment to determine the appropriate accounting method for
such investment and we record our percentage share of the investee company's net
income. The risk of investing in such securities is generally greater than the
risk of investing in securities of widely held, publicly traded companies. Lack
of a secondary market and resale restrictions may result in an inability by us
to sell a security at a price that would otherwise be obtainable if such
restrictions did not exist and may substantially delay the sale of a security we
seek to sell.

In accordance with SFAS No. 115, "Accounting for Certain Investments in Debt
and Equity Securities," we review our investments to determine whether a decline
in fair value below the amortized cost basis is other than temporary. If such
decline in fair value is judged to be other than temporary, we would write down
the investment to fair value as a new cost basis and the amount of the
write-down would be charged to income as a realized loss. The new cost basis
would not be changed for subsequent recoveries in fair value.

STOCK ISSUED TO EMPLOYEES

We follow APB Opinion No. 25, "Accounting for Stock Issued to Employees" and
related interpretations in accounting for employee stock options in accordance
with SFAS No. 123, "Accounting for Stock-Based Compensation." Accordingly, under
APB No. 25, compensation expense for stock option grants is recognized only to
the extent that the fair value of the underlying stock exceeds the exercise
price of the option at the measurement date. In addition, under APB No. 25, we
do not recognize compensation expense for stock issued to employees under our
stock purchase plan. See "Results of Operations--Analysis of 2002 Results--Non
Cash Compensation."

For restricted shares granted, we record deferred compensation equal to the
market value of the shares at the measurement date, which is amortized and
charged to income as non-cash compensation over the vesting period. These
restricted shares are recorded as outstanding upon issuance (regardless of any
vesting period). See "Results of Operations--Analysis of 2002 Results--Non-Cash
Compensation."

RECENT ACCOUNTING PRONOUNCEMENTS

In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets," which we adopted on January 1, 2002. SFAS No.
144 addresses the accounting and reporting for impairment of long-lived assets
to be held and used, as well as long-lived assets to be disposed of. The
standard requires that long-lived assets to be held and used will be written
down to fair value when they are considered impaired. Long-lived assets to be
disposed of are to be carried at the lower of carrying amount or fair value less
estimated cost to sell. SFAS No. 144 also broadens the presentation of
discontinued operations on the income statement to include a component of an
entity (rather than a segment of a business). The adoption of this standard did
not have a material effect on our financial position at September 30, 2002 or
results of operations for the 2002 third quarter and nine months ended September
30, 2002.

In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." SFAS No. 146 will be applied prospectively to
exit or disposal activities initiated after December 31, 2002 and requires
companies to recognize costs associated with exit activities when they are
incurred rather than at the date of a commitment to an exit or disposal plan. We
are currently evaluating this standard.

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RESULTS OF OPERATIONS

Comparisons of our 2002 and 2001 results of operations to each other and to
prior year periods are not relevant due to the changes in our business during
2001 and 2002, including (1) our 2001 acquisition activity, (2) our new
underwriting initiatives in insurance and reinsurance and (3) the capital
infusions in November 2001 and April 2002. In addition, because of these
factors, as well as the other factors described in this report, including those
noted below under the caption "--Cautionary Note Regarding Forward-Looking
Statements" and in the section entitled "Business--Risk Factors" included in our
Annual Report on Form 10-K for the year ended December 31, 2001, our historical
financial results do not provide you with a meaningful expectation of our future
results.

The following table presents the after-tax components of net income for the
2002 third quarter and nine months ended September 30, 2002 and 2001. Certain
prior period information has been reclassified to conform to the current
presentation.

(1) Due to the net loss for the 2002 third quarter, diluted average shares
outstanding for the 2002 third quarter do not include 39,304,796 shares of
dilutive securities since the inclusion of such securities would be
anti-dilutive. If such dilutive securities were included, operating income
would have been $0.37 per share for the 2002 third quarter. Since we
reported net income for the nine months ended September 30, 2002, the
computation of diluted average shares outstanding includes dilutive
securities for such year-to-date period.

The increase in diluted average shares outstanding from 2001 to 2002 was
primarily due to the issuance of convertible preference shares and Class A
warrants in connection with our capital infusion in November 2001 and the
issuance of 7,475,000 common shares in connection with an offering completed by
us in April 2002. Pursuant to a post-closing purchase price adjustment mechanism
under the subscription agreement entered into in connection with the capital
infusion in November 2001 (the "Subscription Agreement"), we issued 875,753
additional Series A convertible preference shares on June 28, 2002. From
August to September 2002, we issued 3,748,946 common shares in connection
with the exercise of all outstanding Class A warrants.

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Under SFAS No. 128, "Earnings Per Share," upon the satisfaction of all the
conditions necessary for the issuance of contingent shares, such shares are
required to be included in the denominator of the diluted earnings per share
calculation as of the beginning of the interim period in which the conditions
are satisfied. If the contingency provisions with respect to our contingently
issuable common shares described below under the caption "--Potential
Adjustments to Book Value Per Share" had been met as of January 1, 2002, pro
forma diluted weighted average shares outstanding for the nine months ended
September 30, 2002 would have been 60,645,624 shares and pro forma diluted net
income per share for the nine months ended September 30, 2002 would have been
$0.26. Under SFAS No. 128, once such shares have been issued following the
satisfaction of such conditions, those shares are required to be included in the
computation of basic earnings per share.

After-tax operating income is defined as net income or loss, excluding net
realized investment gains or losses, non-cash compensation charges, foreign
exchange gains or losses and equity in net income or loss of investees. As set
forth in the above table, after-tax operating income was $22.5 million for the
2002 third quarter and $46.3 million for the nine months ended September 30,
2002. The net loss for the 2002 third quarter was $7.7 million and we had net
income of $15.5 million for the nine months ended September 30, 2002. Operating
income for the 2002 third quarter and nine months ended September 30, 2002
reflect the underwriting results of our reinsurance and insurance segments, as
discussed below.

ANALYSIS OF 2002 RESULTS

The following table sets forth an analysis of our operating income, together
with a reconciliation of operating income to net income or loss for the 2002
third quarter and nine months ended September 30, 2002.

The net realized gain of $5.9 million for the nine months ended September
30, 2002 on our privately held securities resulted primarily from the
disposition of our investment in The ARC Group, LLC in April 2002 and the sale
of certain underlying holdings included in our Trident II, L.P. interest. The
net realized loss of $5.0 million for the nine months ended September 30, 2002
on our fixed maturity portfolio resulted from the sale of certain securities to
reduce credit exposure, and sales related to rebalancing the portfolio which is
managed on a total return basis.

NET FOREIGN EXCHANGE GAINS OR LOSSES

In the 2002 third quarter, net foreign exchange losses of $0.7 million
consisted of an unrealized loss of $2.3 million and realized gains of $1.6
million. Net foreign exchange gains for the nine months ended September 30, 2002
of $2.5 million consisted of an unrealized gain of $0.9 million and realized
gains of $1.6 million. The net unrealized gain resulted from the translation of
foreign denominated monetary assets and liabilities at September 30, 2002 as
required by GAAP. Foreign exchange gains and losses vary with fluctuations in
currency rates. As such, these gains and losses could add significant volatility
to our net income in future periods.

EQUITY IN NET INCOME OF INVESTEES

At September 30, 2002, we held seven investments in privately held
securities, of which one investment is held at no value. Four of our privately
held securities are accounted for under the equity method of accounting. Under
the equity method, we record a proportionate share of the net income or loss
based on our ownership percentage. Of the $1.8 million of pre-tax equity in net
income of investees for the nine months ended September 30, 2002, approximately
$0.6 million was generated from our investment in ARC, which was sold in April
2002. See note 8 under the caption "Investment Information" of the notes
accompanying our consolidated financial statements.

NON-CASH COMPENSATION

During 2001 and 2002, we made certain grants (primarily of restricted
shares) to new employees and the chairman of our board of directors under our
stock incentive plans and other arrangements. These grants were made primarily
in connection with our new underwriting initiative and resulted in an after-tax
provision for non-cash compensation of $28.9 million and $40.7 million,
respectively, for the three and nine month periods ended September 30, 2002.

During the 2002 third quarter, our board of directors accelerated the
vesting terms of certain restricted common shares granted to Robert Clements,
Chairman of the board, in connection with the November 2001 capital infusion,
and Mr. Clements agreed to repay the outstanding $13.5 million loan previously
made to him by

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us on or before November 12, 2002. Mr. Clements was granted 1,689,629 restricted
common shares which were initially scheduled to vest in five equal annual
amounts commencing on October 23, 2002. The vesting period and the amounts have
been changed as follows: 60% of the shares vested on October 23, 2002 and the
balance of the shares will vest in two equal annual amounts on October 23, 2003
and October 23, 2004.

Non-cash compensation expense recorded for the 2002 third quarter included
approximately $26.8 million related to Mr. Clements' award. Such amount includes
$12.0 million related to the immediate expensing of a portion of the award's
value, $9.8 million arising from the acceleration of the vesting terms and $5.0
million of amortization of the unearned portion of the award. Approximately
$12.1 million of non-cash compensation related to the award will be recorded
over the balance of the vesting period, as follows: $4.1 million in the 2002
fourth quarter, $5.9 million in calendar year 2003 and $2.1 million in calendar
year 2004. The accelerated recognition had no impact on our operating income or
shareholders' equity and will also have the effect of reducing non-cash
compensation expense in future periods.

As previously announced, the $13.5 million loan made by us to Mr. Clements
was used by him to pay income and self employment taxes. Under his retention
agreement, Mr. Clements receives additional compensation in cash in an amount
sufficient to defray the loan's interest costs. In order to facilitate the
repayment of the loan, we agreed to repurchase, at Mr. Clements' option, an
amount of his shares equal to the principal balance of the loan less any cash
payment made by Mr. Clements, for a price per share based on the market price
for the common shares as reported on the NASDAQ National Market on the date of
sale. In addition, we agreed to make gross-up payments to Mr. Clements in the
event of certain tax liabilities in connection with the repurchase. Pursuant to
such arrangements, Mr. Clements sold 411,744 common shares of Arch Capital Group
Ltd. ("ACGL") for an aggregate purchase price of $11.5 million. Mr. Clements
used all of such sale proceeds and $2.0 million in cash to repay the entire loan
balance on November 12, 2002. Our book value per diluted share decreased by
approximately $0.04 following such share repurchase. During the loan period, Mr.
Clements received payments of $638,000 from us under his retention agreement, of
which $364,000 was used by him to pay interest on the loan. The extinguishment
of the loan will result in approximately $2.1 million in total expense savings
to us through April 2007 related to compensation Mr. Clements would have
received to defray the loan's interest costs.

As provided under SFAS No. 123, we have elected to continue to account for
stock-based compensation in accordance with APB No. 25. If we had elected to
expense employee stock options under the fair value method of SFAS No. 123, our
basic net income per share for the nine months ended September 30, 2002 would
have been reduced by $0.71 and our diluted net income per share would have been
reduced by $0.23.

INCOME TAXES

For the nine months ended September 30, 2002, our income tax provision
resulted in an effective tax rate of 27.6%, excluding the reversal of the $7.4
million valuation allowance. Our remaining valuation allowance at September 30,
2002 is $2.1 million. Our effective tax rate will fluctuate based on the
relative amounts of our U.S.-sourced income and our worldwide income. The
effective tax rate on our net operating income for the nine months ended
September 30, 2002 was 5.4%, which was lower than our overall effective tax rate
due to the relative amounts of our U.S.-sourced income and our worldwide income.
See note 10 under the caption "Income Taxes" of the notes accompanying our
consolidated financial statements. During the 2002 second quarter, we reversed a
$7.4 million valuation allowance on certain of our deferred tax assets. The
valuation allowance reversal was based on our recently completed restructuring
of our U.S.-based insurance underwriting operations and our business plan.

ACGL will be subject to U.S. federal income tax only to the extent that it
derives U.S. source income that is subject to U.S. withholding tax or income
that is effectively connected with the conduct of a trade or business within the
U.S. and is not exempt from U.S. tax under an applicable income tax treaty with
the U.S. ACGL will be subject to a withholding tax on dividends from U.S.
investments and interest from certain U.S. taxpayers. ACGL does not consider
itself to be engaged in a trade or business within the U.S. and, consequently,
does not expect to be subject to direct U.S. income taxation. However, because
there is uncertainty as to the activities which constitute being engaged in a
trade or business within the United States, there can be no assurances that the
U.S. Internal Revenue Service will not contend successfully that ACGL or its
non-U.S. subsidiaries are engaged in a trade or business in the United States.
If ACGL or any of its non-U.S. subsidiaries were subject to

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U.S. income tax, ACGL's shareholders' equity and earnings could be materially
adversely affected. ACGL's U.S. subsidiaries are subject to U.S. income taxes on
their worldwide income.

ACGL changed its legal domicile from the United States to Bermuda in
November 2000. Legislation has been introduced which (if enacted) could
eliminate the tax benefits available to companies that have changed their legal
domiciles to Bermuda, and such legislation may apply to ACGL. In addition, some
U.S. insurance companies have been lobbying Congress to pass legislation
intended to eliminate certain perceived tax advantages of U.S. insurance
companies with Bermuda affiliates resulting principally from reinsurance between
or among U.S. insurance companies and their Bermuda affiliates. This
legislation, if passed, and other changes in U.S. tax laws, regulations and
interpretations thereof to address these issues could materially adversely
affect us.

SEGMENT INFORMATION

We classify our businesses into two underwriting segments, reinsurance and
insurance. For a description of our underwriting segments, please refer to note
6 under the caption "Segment Information" of the notes accompanying our
consolidated financial statements. Segment performance is evaluated based on
underwriting income or loss.

REINSURANCE SEGMENT

UNDERWRITING RESULTS. The following table sets forth an analysis of the
underwriting results for the reinsurance segment for the 2002 third quarter and
nine months ended September 30, 2002.

(1) The loss ratios for statutory and GAAP are based on earned premiums. The
statutory expense ratios are based on net premiums written, while the GAAP
expense ratios are based on net premiums earned.

UNDERWRITING INCOME. On a GAAP basis, the reinsurance segment generated
underwriting income of $13.0 million and $27.2 million for the 2002 third
quarter and nine months ended September 30, 2002, respectively. The combined
ratio of the reinsurance segment, on a GAAP basis, was 91.0% and 90.8% for the
2002 third quarter and nine months ended September 30, 2002, respectively. The
components of underwriting income are discussed below.

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NET PREMIUMS WRITTEN. For the 2002 third quarter, 64.2% of net premiums
written for our reinsurance operations were generated from pro rata contracts
and 35.8% were derived from excess of loss treaties. For the nine months ended
September 30, 2002, 50.2% of net premiums written were generated from pro rata
contracts and 49.8% were derived from excess of loss treaties. Of net premiums
earned recorded for the 2002 third quarter, 46.5% were generated from pro rata
contracts and 53.5% were derived from excess of loss treaties. For the nine
months ended September 30, 2002, 40.9% of net premiums earned were generated
from pro rata contracts and 59.1% were derived from excess of loss treaties.

During the period from January 1 to October 31, 2002, our reinsurance
subsidiaries entered into reinsurance treaties and other reinsurance
arrangements that are expected to provide approximately $1.1 billion of
annualized net reinsurance premiums, a substantial portion of which will be
recorded in calendar year 2002. Approximately 68% of the annualized premiums
written were generated from pro rata contracts and 32% were derived from excess
of loss treaties. The quarterly and year-to-date net premiums written differs
from the annualized net reinsurance premiums due to the timing of recording
premiums for contracts written on a pro rata and excess of loss basis.

We are currently retaining substantially all of our reinsurance premiums
written. We participate in "common account" retrocessional arrangements for
certain treaties. Such arrangements reduce the effect of individual or aggregate
losses to all companies participating on such treaties, including the reinsurer,
such as us, and the ceding company.

For information regarding net premiums written produced by geographic
location and by line of business for the reinsurance segment for the 2002 third
quarter and nine months ended September 30, 2002, refer to note 6 under the
caption "Segment Information" of the notes accompanying our consolidated
financial statements.

NET PREMIUMS EARNED. Reinsurance premiums written are recognized as earned
on a pro rata basis over the terms of the related reinsurance contracts.
Unearned premiums represent the portion of premiums written which is applicable
to the unexpired terms of policies in force. When a company is growing rapidly,
there will be a significant difference between written and earned premiums. For
the 2002 third quarter and nine months ended September 30, 2002, approximately
70% and 46% of the reinsurance segment net premiums written were earned,
respectively.

LOSSES AND LOSS ADJUSTMENT EXPENSES. Losses and loss adjustment expenses
incurred for the 2002 third quarter and nine months ended September 30, 2002
were 62.9% and 67.1%, respectively, of net premiums earned. Through September
30, 2002, actual loss experience, with respect to classes of business that are
primarily exposed to severe catastrophic activity, was better than anticipated.
The reserves for such classes of business established at September 30, 2002
reflect expected claim activity that is lower than the June 30, 2002 level. We
are continuing to review our experience on business exposed to severe
catastrophic activity and, based on such review, we may further adjust the
expected loss ratios for this type of business at December 31, 2002, as well as
in future periods. In addition, as described in "--Underwriting Expenses" below,
reserves on certain non-traditional contracts were reduced in the 2002 third
quarter and acquisition expenses were increased by an equivalent amount. For a
discussion of the reserves for losses and loss adjustment expenses, please refer
to the section above entitled "General--Critical Accounting Policies, Estimates
and Recent Accounting Pronouncements--Reserves for Losses and Loss Adjustment
Expenses."

UNDERWRITING EXPENSES. For the 2002 third quarter and nine months ended
September 30, 2002, acquisition expenses were 25.2% and 20.2%, respectively, of
net premiums earned. The acquisition expense ratio for the 2002 third quarter
was higher than the nine months ended September 30, 2002 due to three factors:
(1) based on the lack of claims activity on certain non-traditional contracts
during the nine months ended September 30, 2002, we accrued profit commissions
which increased acquisition expenses and reduced incurred losses by an
equivalent amount, (2) an increase in the percentage of pro rata business earned
during the 2002 third quarter, which is typically written at higher expense
ratios and lower loss ratios than excess of loss business; and (3) the effect of
a $2.5 million payment to terminate a non-competition covenant, as described in
note 5 under the caption "Contingencies Related to the Sale of Prior Reinsurance
Operation" of the notes accompanying our consolidated financial statements. For
the 2002 third quarter and nine months ended September 30, 2002, other operating
expenses were 2.9% and 3.5%, respectively, of net premiums earned. The lower
ratio for the 2002

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third quarter was partially due to the significant growth rate in net premiums
earned and the fact that we are deferring only a portion of underwriting
expenses.

INSURANCE SEGMENT

UNDERWRITING RESULTS. The following table sets forth an analysis of the
underwriting results for the insurance segment for the 2002 third quarter and
nine months ended September 30, 2002.

(1) The loss ratios for statutory and GAAP are based on earned premiums. The
statutory expense ratios are based on net premiums written, while the GAAP
expense ratios are based on net premiums earned.

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

UNDERWRITING INCOME (LOSS). On a GAAP basis, the insurance segment generated
an underwriting loss of $0.6 million and $4.0 million for the 2002 third quarter
and nine months ended September 30, 2002, respectively. The combined ratio of
the insurance segment, on a GAAP basis, was 101.4% and 105.8% for the 2002 third
quarter and nine months ended September 30, 2002, respectively. On a statutory
basis, the combined ratio was 95.3% and 98.2% for the 2002 third quarter and
nine months ended September 30, 2002, respectively. The components of
underwriting income are discussed below.

NET PREMIUMS WRITTEN. Our insurance segment increased production in a number
of specialty lines in the 2002 third quarter and commenced writing healthcare
business in the 2002 third quarter. We expect that premiums written in the
insurance segment will increase in the 2002 fourth quarter compared to the 2002
third quarter as we continue to expand in our new areas of focus.

For information regarding net premiums written produced by geographic
location and by line of business for the insurance segment for the 2002 third
quarter and nine months ended September 30, 2002, refer to note 6 under the
caption "Segment Information" of the notes accompanying our consolidated
financial statements.

NET PREMIUMS EARNED. Insurance premiums written are recognized as earned in
accordance with the terms of the underlying policies. Unearned premiums
represent the portion of premiums written which is applicable to

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the unexpired terms of policies in force. For the 2002 third quarter and nine
months ended September 30, 2002, approximately 35% and 39% of the insurance
segment net premiums written were earned, respectively.

LOSSES AND LOSS ADJUSTMENT EXPENSES. Losses and loss adjustment expenses
incurred for the 2002 third quarter and nine months ended September 30, 2002
were 73.9% and 75.8%, respectively, of net premiums earned. Losses and loss
adjustment expenses incurred included an increase in reserves of approximately
$2.4 million in the 2002 third quarter as a result of a preliminary actuarial
review of business written by us prior to the new underwriting initiative. For a
discussion of the reserves for losses and loss adjustment expenses, please refer
to the section above entitled "General--Critical Accounting Policies, Estimates
and Recent Accounting Pronouncements--Reserves for Losses and Loss Adjustment
Expenses."

UNDERWRITING EXPENSES. The acquisition expense ratio, which reflects the
benefit of commission income on business ceded to reinsurers and is calculated
net of certain policy-related fee income earned primarily by American
Independent, was 0.6% and (3.0%) for the 2002 third quarter and nine months
ended September 30, 2002, respectively. Excluding such fee income, the
acquisition expense ratio for the 2002 third quarter and nine months ended
September 30, 2002 was 7.0% and 6.3%, respectively. For the 2002 third quarter
and nine months ended September 30, 2002, other operating expenses were 26.9%
and 33.0%, respectively, of net premiums earned. We expect that operating
expenses will increase in the 2002 fourth quarter compared to the 2002 third
quarter as we continue to develop and expand our insurance operations.

LIQUIDITY AND CAPITAL RESOURCES

ACGL is a holding company whose assets primarily consist of the shares in
its subsidiaries. Generally, we depend on our available cash resources, liquid
investments and dividends or other distributions from our subsidiaries to make
payments, including the payment of operating expenses we may incur and for any
dividends our board of directors may determine. ACGL does not currently intend
to declare any dividends.

Pursuant to a shareholders agreement that we entered into in connection with
the November 2001 capital infusion, we have agreed not to declare any dividend
or make any other distribution on our common shares, and not to repurchase any
common shares, until we have repurchased from the Warburg Pincus funds, the
Hellman & Friedman funds and the other holders of our preference shares, pro
rata, on the basis of the amount of each of these shareholders' investment in us
at the time of such repurchase, preference shares having an aggregate value of
$250.0 million, at a per share price acceptable to these shareholders.

The ability of our regulated insurance and reinsurance subsidiaries to pay
dividends or make distributions is dependent on their ability to meet applicable
regulatory standards. Arch Reinsurance Ltd. ("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 an affidavit stating that it
will continue to meet the required margins. In addition, Arch Re Bermuda is
prohibited, without prior approval of the Bermuda Monetary Authority, from
reducing by 15% or more its total statutory capital, as set out in its previous
year's financial statements. At December 31, 2001 and September 30, 2002, Arch
Re Bermuda had statutory capital and surplus (as determined under Bermuda law)
of $508 million and $637 million, respectively. As of December 31, 2001, our
U.S. insurance and reinsurance subsidiaries may not pay any significant
dividends or distributions during 2002 without prior regulatory approval. In
addition, the ability of our insurance and reinsurance subsidiaries to pay
dividends could be constrained by our dependence on financial strength ratings
from independent rating agencies. Our ratings from these agencies depend to a
large extent on the capitalization levels of our insurance and reinsurance
subsidiaries.

ACGL, through its subsidiaries, provides financial support to certain of its
insurance subsidiaries and affiliates, through certain reinsurance arrangements
essential to the ratings of such subsidiaries. Except as described in the
preceding sentence, 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.

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On a consolidated basis, our aggregate invested assets, including cash and
short-term investments, totaled $1.6 billion and $1.0 billion at September 30,
2002 and December 31, 2001, respectively. As of September 30, 2002, ACGL's
readily available cash, short-term investments and marketable securities,
excluding amounts held by our regulated insurance and reinsurance subsidiaries,
totaled $108.6 million. Such amount consisted of $67.9 million of cash and
short-term investments and $40.7 million of fixed maturity investments. In
October 2002, ACGL contributed $74.3 million of such amount to Arch Re Bermuda.

Cash flow from operating activities on a consolidated basis are provided by
premiums collected, fee income, investment income and collected reinsurance
recoverables, offset by losses and loss adjustment expense payments, reinsurance
premiums payable and operating costs. Consolidated cash flow provided by
operating activities for the nine months ended September 30, 2002 and 2001 was
approximately $342.2 million and $3.7 million, respectively.

Our expanded underwriting activities will initially be supported by our
capital, and we expect that our other operational needs for the foreseeable
future will be met by our balance of cash and short-term investments, as well as
by funds generated from premiums and investment income and proceeds on the sale
or maturity of our investments.

We have an effective shelf registration statement with the Securities and
Exchange Commission. It permits us to issue various types of securities,
including unsecured debt securities, preference shares and common shares, from
time to time, up to an aggregate of $500 million. During April, we issued
7,475,000 of our common shares and received net proceeds of approximately $179
million, net of transaction costs. The net proceeds of the offering were
principally used to increase the surplus of our insurance and reinsurance
subsidiaries. The unused portion of our shelf registration is approximately $309
million following the offering in April. Any additional issuance of common
shares by us could have the effect of diluting our earnings and our book value
per share.

From August to September 2002, an aggregate of 3,748,946 common shares
were issued upon the exercise of all 3,842,450 outstanding Class A warrants,
which were exercisable for $20.00 per share and were scheduled to expire on
September 19, 2002. The proceeds from the exercise of Class A warrants on a
cash basis increased shareholders' equity by approximately $74.3 million. As
described above, in October 2002, ACGL contributed such proceeds to Arch Re
Bermuda.

At September 30, 2002 and December 31, 2001, our consolidated shareholders'
equity was $1.37 billion and $1.02 billion, respectively. The increase in
consolidated shareholders' equity was primarily attributable to the effects of
(1) the proceeds from the issuance of common shares in the stock offering in
April 2002, (2) the proceeds from the exercise of Class A warrants in August
and September 2002, (3) operating income for the nine months ended
September 30, 2002, and (4) an increase in unrealized appreciation of
investments.

CERTAIN MATTERS WHICH MAY MATERIALLY AFFECT OUR RESULTS OF OPERATIONS AND/OR
FINANCIAL CONDITION

RESERVES FOR LOSSES AND LOSS ADJUSTMENT EXPENSES

We establish reserves for losses and loss adjustment expenses 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. We utilize actuarial models as well as available
historical insurance industry loss development patterns to assist in the
establishment of appropriate loss reserves. Actual losses and loss adjustment
expenses paid may deviate, perhaps substantially, from the reserve estimates
reflected in our financial statements. See the section above entitled
"General--Critical Accounting Policies, Estimates and Recent Accounting
Pronouncements--Reserves for Losses and Loss Adjustment Expenses."

REINSURANCE PROTECTION AND RECOVERABLES

For purposes of limiting our risk of loss, 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. For the three and nine
month periods ended September 30, 2002, ceded premiums written represented
approximately 21.7% and 14.8%, respectively, of gross written premium. In 2002,
we are retaining a greater amount of our insurance premiums written as compared
to 2001 as a result of the new underwriting initiative and our improved
financial position.

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The availability and cost of reinsurance and retrocessional protection is
subject to market conditions, which are beyond our control. Currently, the
market for these arrangements is experiencing high demand for various products
and it is not certain that we will be able to obtain adequate protection at cost
effective levels. As a result of such market conditions and other factors, we
may not be able to successfully alleviate risk through reinsurance and
retrocessional arrangements. Further, we are subject to credit risk with respect
to our reinsurance and retrocessions because the ceding of risk to reinsurers
and retrocessionaires does not relieve us of our liability to the clients or
companies we insure or reinsure. Our failure to establish adequate reinsurance
or retrocessional arrangements or the failure of our existing reinsurance or
retrocessional arrangements to protect us from overly concentrated risk exposure
could adversely affect our financial condition and results of operations.

We monitor the financial condition of our reinsurers and attempt to place
coverages only with substantial, financially sound carriers. At September 30,
2002, approximately 88% of our reinsurance recoverables were due from carriers
which had an A.M. Best rating of "A-" or better. We had no amounts recoverable
from a single entity or group of entities that exceeded 5% of our total
shareholders' equity. At September 30, 2002, amounts due from the following
reinsurers represented approximately 44% of our reinsurance recoverables (with
A.M. Best ratings in parentheses): Hartford Fire Insurance Company ("A+"); GMAC
Insurance Group ("A+"); Swiss Re America Group ("A++"); Folksamerica Reinsurance
Company ("A-"); Odyssey Reinsurance Corporation ("A"); GE Reinsurance
Corporation ("A+"); Pennsylvania Lumbermens Mutual Insurance Company ("A-"); and
PMA Capital Insurance Company ("A"). We also have reinsurance recoverables from
Lloyd's of London syndicates (group rating of "A-") aggregating approximately
13% of our total. In addition, in connection with our acquisition of Arch
Specialty in February 2002, the seller, Sentry Insurance a Mutual Company, which
has an A.M. Best rating of "A+" (Superior), agreed to reinsure or otherwise
assume all liabilities arising out of Arch Specialty's business prior to the
closing of the acquisition. The amount of recoverables from Sentry under such
arrangements represents approximately 21% of our total recoverables.

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, but not limited
to, hurricanes, floods, windstorms, earthquakes, hailstorms, explosions, severe
winter weather and fires, and we may have losses which may result from acts of
war or acts of terrorism and political instability. Catastrophes can also cause
losses in non-property lines of 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.
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.

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 and recent
events may lead to increased frequency and severity of losses. 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
eliminate completely 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.

We specifically insure and reinsure risks resulting from terrorism. Although
we may 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 result-oriented court or arbitration panel
favoring the insured or ceding company will enforce the language as written;
such a tribunal may adopt a strained interpretation of the policy language,
invoke public policy to limit enforceability of policy language, ignore policy
language, make factual findings unwarranted by the evidence or otherwise seek to
justify a ruling adverse to us.

For our catastrophe exposed reinsurance business, we seek to limit the
amount of exposure we will assume from any one reinsured and the amount of the
exposure to catastrophe losses in any geographic zone. In our reinsurance
business, we monitor our exposure to catastrophic events, including earthquake,
wind and specific terrorism exposures, and continuously reevaluate the estimated
probable maximum pre-tax loss for such

34

exposures. With respect to our reinsurance business, 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. In
our reinsurance business, we seek to limit the probable maximum pre-tax loss to
a percentage of our total shareholders' equity for severe catastrophic events.
Currently, for our reinsurance business, we generally seek to limit the probable
maximum pre-tax loss to approximately 25% of total shareholders' equity for
severe catastrophic events that could be expected to occur once in every 250
years, which 25% does not include, for such purposes, business assumed directly
from our insurance subsidiaries. There can be no assurances that we will not
suffer pre-tax losses greater than 25% of our total shareholders' equity from a
catastrophic event 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 in the data
provided by clients and brokers, the modeling techniques and the application of
such techniques. In addition, depending on business opportunities and the mix of
business that may comprise our reinsurance portfolio, we may seek to limit the
probable maximum pre-tax loss to a higher percentage of our total shareholders'
equity for our catastrophe exposed reinsurance business.

Further, for our insurance business, which began operating in its new
specialty areas of focus in the 2002 second quarter, we also intend to monitor
and limit the amount of our exposure to catastrophic losses and, in that
connection, may seek to purchase catastrophe reinsurance protection. The
availability and cost of such reinsurance protection is subject to market
conditions, which are beyond our control. As a result of market conditions and
other factors, we may not be successful in obtaining such protection. See
"--Reinsurance Protection and Recoverables" above.

FOREIGN CURRENCY EXCHANGE RATE FLUCTUATION

We write business on a worldwide basis, and our results of operations may be
affected by fluctuations in the value of currencies other than the U.S. dollar.
Changes in foreign currency exchange rates can reduce our revenues and increase
our liabilities and costs, as measured in the U.S. dollar as our functional
currency. We have not attempted and currently do not expect to attempt to reduce
our exposure to these exchange rate risks by using hedging transactions. We may
therefore suffer losses solely as a result of exchange rate fluctuations.

MANAGEMENT AND OPERATIONS

As a relatively new insurance and reinsurance company, our success will
depend on our ability to integrate new management and operating personnel and to
establish and maintain operating procedures and internal controls (including the
timely and successful implementation of our information technology initiatives)
to effectively support our business and our regulatory and reporting
requirements, and no assurances can be given as to the success of these
endeavors.

SHAREHOLDERS AGREEMENT

In addition, the Warburg Pincus funds and the Hellman & Friedman funds
together control a majority of our voting power on a fully-diluted basis and
have the right to nominate a majority of directors to our board under the
shareholders agreement entered into in connection with the November 2001 capital
infusion. The shareholders agreement also provides that we cannot engage in
certain transactions, including mergers and acquisitions and transactions in
excess of certain amounts, without the consent of a designee of the Warburg
Pincus funds and a designee of the Hellman & Friedman funds. These provisions
could have an effect on the operation of our business and, to the extent these
provisions discourage takeover attempts, they could deprive our shareholders of
opportunities to realize takeover premiums for their shares or could depress the
market price of our common shares. By reason of their ownership and the
shareholders agreement, the Warburg Pincus funds and the Hellman & Friedman
funds are able to strongly influence or effectively control actions to be taken
by us. The interests of these shareholders may differ materially from the
interests of the holders of our common shares, and these shareholders could take
actions that are not in the interests of the holders of our common shares.

CONTINGENCIES RELATING TO THE SALE OF PRIOR REINSURANCE OPERATIONS

See note 5 under the caption "Contingencies Relating to the Sale of Prior
Reinsurance Operations" of the notes accompanying our consolidated financial
statements.

35

RESTRUCTURING OF U.S.-BASED INSURANCE OPERATIONS

In April 2002, we completed a restructuring of our U.S. insurance
subsidiaries after receiving all applicable regulatory approvals. As a result of
the restructuring, the statutory capital of Arch Reinsurance Company ("Arch Re
U.S.") was increased to approximately $350 million (as determined under U.S.
statutory accounting policies) and Arch Re U.S. has become the parent of our
U.S.-based insurance group. The names of our U.S.-based insurers were changed as
follows: First American Insurance Company was renamed Arch Insurance Company
("Arch Insurance"); Rock River Insurance Company was renamed Arch Specialty
Insurance Company ("Arch Specialty"); and Cross River Insurance Company was
renamed Arch Excess & Surplus Insurance Company ("Arch E&S"). The name changes
have been approved by the companies' respective states of domicile; however, the
name change approvals have not yet been obtained from all the other states.

INDUSTRY; RATINGS

We operate in a highly competitive environment, and since the September 11,
2001 events, new capital has entered the market. These factors may mitigate the
benefits that the financial markets may perceive for the property and casualty
insurance industry, and we cannot offer any assurances that we will be able to
compete successfully in our industry or that the intensity of competition in our
industry will not erode profitability for insurance and reinsurance companies
generally, including us. In addition, we can offer no assurances that we will
participate at all or to the same extent as more established or other companies
in any price increases or increased profitability in our industry. If we do not
share in such price increases or increased profitability, our financial
condition and results of operations could be materially adversely affected.

Financial strength and claims paying ratings from third party rating
agencies are instrumental in establishing the competitive positions of companies
in our industry. Periodically, rating agencies evaluate us to confirm that we
continue to meet their criteria for the ratings assigned to us by them. Our
reinsurance subsidiaries, Arch Re U.S. and Arch Re Bermuda, and our insurance
subsidiaries, Arch Insurance and Arch Specialty, each currently have financial
strength ratings of "A-" (Excellent) from A.M. Best. Arch E&S currently is rated
"NR-2" (Insufficient Size and/or Operating Experience) from A.M. Best and
American Independent has a financial strength rating of "C++" (Marginal) from
A.M. Best. We do not believe that American Independent's non-standard automobile
business is particularly ratings sensitive because its insureds purchase
insurance primarily to satisfy state and local insurance and financial
responsibility requirements.

Recently, rating agencies have been coming under increasing pressure as a
result of high-profile corporate bankruptcies and may, as a result, increase
their scrutiny of rated companies, revise their rating policies or take other
action. We can offer no assurances that our ratings will remain at their current
levels. A ratings downgrade, or the potential for such a downgrade, could
adversely affect both our relationships with agents, brokers, wholesalers and
other distributors of our existing products and services and new sales of our
products and services.

CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS

In April 2002, we established a letter of credit facility for up to $200
million with Fleet National Bank. This facility expires April 16, 2003. The
principal purpose of this facility 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. Such letters of credit
when issued will be secured by a portion of our investment portfolio. In
addition, the letter of credit facility also requires that the net worth of ACGL
be at least $750 million and that we maintain certain levels of collateral in
order for letters of credit to be issued. At September 30, 2002, we had
approximately $31.9 million in outstanding letters of credit. In addition to
letters of credit, we have and may establish insurance trust accounts in the
U.S. and Canada to secure our reinsurance amounts payable as required.

It is anticipated that the letter of credit facility will be renewed on
expiry, but such renewals are subject to the availability of credit from banks
which we utilize. In the event such support is insufficient, we could be
required to provide alternative security to cedents. This could take the form of
additional insurance trusts supported by our investment portfolio or funds
withheld using our cash resources. The value of letters of credit is driven by,
among other things, loss development of existing reserves, the payment pattern
of such reserves, the further

36

expansion of our business and the loss experience of such business. If we are
unable to post security in the form of letters of credit or trust funds when
required, our operations could be significantly and negatively affected.

INVESTMENTS

At September 30, 2002, consolidated cash and invested assets totaled
approximately $1.6 billion, consisting of $287.5 million of cash and short-term
investments, $1.3 billion of publicly traded fixed maturity securities and $31.5
million of privately held securities. Our fixed income portfolio, which includes
fixed maturity securities and short-term investments, had an average Standard &
Poor's Corporation quality rating of "AA-" and an average duration of 2.5 years
at September 30, 2002.

The following table provides information on the composition of our fixed
maturity investments at September 30, 2002:

The following table presents the credit quality (using Standard & Poor's
ratings) distribution of our fixed maturity securities at September 30, 2002:

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. Our investment portfolio is managed on a total return
basis. The total return approach may result in realized gains or losses in any
given period as the portfolio is adjusted to reflect perceived changes in
relative value.

Our current investment guidelines stress preservation of capital, market
liquidity and diversification of risk. To achieve this objective, our current
fixed income investment guidelines provide for an average credit quality of
"Aa3" and "AA-" as measured by Moody's Investors Services and Standard & Poor's,
respectively. Notwithstanding the foregoing, our investments are subject to
market-wide risks and fluctuations, as well as to risks inherent in particular
securities.

37

At September 30, 2002, our private equity portfolio consisted of seven
investments, with additional investment portfolio commitments in an aggregate
amount of approximately $0.4 million. We do not currently intend to make any
significant investments in privately held securities over and above our current
commitments. See note 8, "Investment Information," of the notes accompanying our
consolidated financial statements.

BOOK VALUE PER SHARE

Diluted per share book value at September 30, 2002 increased to $21.37 from
$19.59 at December 31, 2001. The increase was primarily attributable to the
effects of (1) operating income for the nine months ended September 30, 2002,
(2) an increase in unrealized appreciation of investments, (3) the issuance of
common shares in the stock offering completed by us in April 2002, and (4) the
issuance of common shares upon the exercise of Class A warrants. These increases
were partially offset by the effects of the issuance on June 28, 2002 of 875,753
additional Series A convertible preference shares pursuant to a post-closing
purchase price adjustment mechanism under the Subscription Agreement. The
diluted per share book value reflects our outstanding convertible preference
shares, but does not take into account certain potential adjustments. If such
potential adjustments were triggered, the diluted pro forma book value at
September 30, 2002 would have been reduced by $0.92 per share. The calculation
of our book value per share amounts and the potential adjustments to book value
per share are described below.

CALCULATION OF BOOK VALUE PER SHARE

The following actual book value per share calculations are based on
shareholders' equity of $1,370,908 at September 30, 2002 (unaudited) and
$1,020,369 at December 31, 2001 (audited).

(1) Book value per common share at September 30, 2002 and December 31, 2001 was
determined by dividing (i) the difference between total shareholders' equity and
the aggregate liquidation preference of the Series A convertible preference
shares of $767.8 million and $749.4 million, respectively, by (ii) the number of
common shares outstanding.

(2) Includes preference shares that were issued on November 20, 2001 in exchange
for $763.2 million of cash. The number of preference shares issued was based on
the estimated per share price of $21.38. The estimated per share price was based
on (i) total shareholders' equity as of June 30, 2001 (adjusted for certain
amounts as described in the Subscription Agreement entered into in connection
with the November 2001 capital infusion), divided by (ii) the total number of
common shares outstanding as of June 30, 2001, which was 12,863,079. In
addition, the amount of preference shares at September 30, 2002 includes 875,753
preference shares that were issued by us on June 28, 2002 pursuant to a
post-closing purchase price adjustment mechanism under the Subscription
Agreement. Each preference share is convertible at any time and from time to
time at the option of the holder thereof into one fully paid and nonassessable
common share, subject to possible adjustment.

(3) Includes the net number of common shares that would be issued under the
Class A warrants, primarily issued in connection with the capital infusion
transaction, calculated using the treasury stock method. Class A warrants

38

to purchase an aggregate of 5,401,707 common shares were outstanding as of
December 31, 2001. Class A warrants were exercisable at $20 per share and were
scheduled to expire on September 19, 2002. In April 2002, 446,608 common shares
were issued upon the exercise of 1,559,257 Class A warrants on a cashless basis.
From August to September 2002, 3,748,946 common shares were issued upon the
exercise of all 3,842,450 remaining outstanding Class A warrants. Of such
amount, 35,839 common shares of ACGL were issued upon the exercise of 129,343
Class A warrants on a cashless basis. The proceeds from the exercise of Class
A warrants on a cash basis increased shareholders' equity by approximately
$74.3 million.

(4) Represents restricted common shares issued in connection with the November
2001 capital infusion transaction. These restricted common shares are included
in common shares at September 30, 2002.

POTENTIAL ADJUSTMENTS TO BOOK VALUE PER SHARE

The following are potential adjustments to book value per share at September
30, 2002 and December 31, 2001, excluding the effects of stock options, that
could be made if certain future events described below occur.

(1) Amount at December 31, 2001 represented an estimate of the amount of
additional Series A convertible preference shares to be issued to the new
investors pursuant to a post-closing purchase price adjustment mechanism under
the Subscription Agreement. The per share price was based on (i) total
shareholders' equity as of June 30, 2001 as set forth on the audited balance
sheet, adjusted for certain items as described in the Subscription Agreement,
divided by (ii) the total number of common shares outstanding as of June 30,
2001. Consistent with such estimate, 875,753 preference shares were issued to
the new investors on June 28, 2002 and are reflected in the amount of preference
shares at September 30, 2002.

(2) Represents an estimate of the amount of additional Series A preference
shares that would be issued under the Subscription Agreement in the event that
on or prior to September 19, 2005 (1) the closing price of our common shares is
at least $30 per share for at least 20 out of 30 consecutive trading days or (2)
a change in control occurs (either case, a "Triggering Event"). Pursuant to the
Subscription Agreement, we have agreed to issue to the new investors additional
Series A preference shares such that the per share price is adjusted downward by
$1.50 per preference share.

(3) Includes the number of common shares that would be issued under the Class B
warrants for purposes of calculating diluted book value per share under the
treasury stock method. Class B warrants to purchase an aggregate of 150,000
common shares were outstanding as of September 30, 2002 and December 31, 2001
and expire September 19, 2005. Class B warrants are exercisable at $20 per share
when (1) the closing price of our common shares is at least $30 per share for at
least 20 out of 30 consecutive trading days or (2) a change in control occurs.

Pursuant to the Subscription Agreement, a post-closing purchase price
adjustment will be calculated in November 2003 (or such earlier date as agreed
upon by us and the investors) based on an adjustment basket. The adjustment
basket will be equal to (1) the difference between value realized upon sale and
the GAAP book value

39

at the closing of the capital infusion (November 2001) (as adjusted based on a
pre-determined growth rate) of agreed upon non-core businesses; plus (2) the
difference between GAAP net book value of the insurance balances attributable to
our core insurance operations with respect to any policy or contract written or
having an effective date prior to November 20, 2001 at the time of the final
adjustment and those balances at the closing; minus (3) reductions in book value
arising from costs and expenses relating to the transaction provided under the
Subscription Agreement, actual losses arising out of breach of representations
under the Subscription Agreement and certain other costs and expenses. If the
adjustment basket, which will be calculated by our independent auditors, is less
than zero, we will issue additional preference shares to the investors based on
the decrease in value of the components of the adjustment basket. If the
adjustment basket is greater than zero, we are allowed to use cash in an amount
based on the increase in value of the components of the adjustment basket to
repurchase common shares (other than any common shares issued upon conversion of
the preference shares or exercise of the Class A warrants). If the adjustment
basket is less than zero and in the event that a Triggering Event occurs, we
agreed to issue additional preference shares to the investors as a further
adjustment. In addition, on the fourth anniversary of the closing, there will be
a calculation of a further adjustment basket based on (1) liabilities owed to
Folksamerica (if any) under the Asset Purchase Agreement, dated as of January
10, 2000, between us and Folksamerica, and (2) specified tax and ERISA matters
under the Subscription Agreement.

MARKET SENSITIVE INSTRUMENTS AND RISK MANAGEMENT

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, 2001. (See section captioned
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Market Sensitive Instruments and Risk Management" included in our
2001 Annual Report on Form 10-K.) Market risk represents the risk of changes in
the fair value of a financial instrument and is comprised of several components,
including liquidity, basis and price risks. At September 30, 2002, there have
been no material changes in market risk exposures that affect the quantitative
and qualitative disclosures presented as of December 31, 2001.

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

The Private Securities Litigation Reform Act of 1995 provides a "safe
harbor" for forward-looking statements. This report or any other written or oral
statements made by or on behalf of us may include forward-looking statements,
which reflect our current views with respect to future events and financial
performance. All statements other than statements of historical fact included in
or incorporated by reference in this report 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 our 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, elsewhere in this report and in the section
entitled "Business--Risk Factors" included in our Annual Report on Form 10-K for
the year ended December 31, 2001, and include:

- our management's ability to successfully implement its business
strategy, including implementing procedures and internal controls
(including the timely and successful implementation of our information
technology initiatives) to support the value of our business and our
regulatory and reporting requirements;

- acceptance of our products and services and security by brokers and
insureds;

- acceptance of our business strategy, security and financial condition by
rating agencies and regulators;

- general economic and market conditions (including as to inflation and
foreign currency exchange rates) and conditions specific to the
reinsurance and insurance markets in which we operate (including the
extent and duration of the current favorable reinsurance and insurance
markets);

40

- competition, including increased competition, on the basis of pricing,
capacity, coverage terms or other factors;

- our ability to successfully integrate new management and operating
personnel and to establish and maintain operating procedures to
effectively support our new underwriting initiatives and to develop
accurate actuarial data and develop and implement actuarial models and
procedures;

- the loss of key personnel;

- the integration of businesses we have acquired or may acquire into our
existing operations;

- greater than expected loss ratios on business written by us and adverse
development on reserves for losses and loss adjustment expenses related
to business written by us;

- severity and/or frequency of losses;

- claims for natural or man-made catastrophic events in our insurance or
reinsurance business could cause large losses and substantial volatility
in our results of operations;

- acts of terrorism, other hostilities or other unforecasted and
unpredictable events;

- losses relating to aviation business and business produced by a certain
managing underwriting agency for which we may be liable to the purchaser
of our prior reinsurance business or to others in connection with the
May 5, 2000 asset sale;

- availability to us of reinsurance to manage our gross and net exposures;

- the failure of reinsurers, managing general agents or others to meet
their obligations to us;

- the timing of loss payments being faster or the receipt of reinsurance
recoverables being slower than anticipated by us;

- changes in the financial environment, including interest rates;

- changes in accounting principles or the application of such principles
by accounting firms or regulators;

- 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 government
provision or back-stopping of insurance (including for acts of
terrorism); and

- rating agency policies and practices.

In addition to the risks discussed in the section entitled "Business--Risk
Factors" included in our Annual Report on Form 10-K for the year ended December
31, 2001, other general factors could affect our results, including: (a)
developments in the world's financial and capital markets and our access to such
markets; (b) changes in regulation or tax laws applicable to us, our
subsidiaries, brokers or customers; and (c) the effects of business disruption
or economic contraction due to terrorism or other hostilities.

All subsequent written and oral forward-looking statements attributable to
us or persons acting on our 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. We undertake no
obligation to publicly update or revise any forward-looking statement, whether
as a result of new information, future events or otherwise.

41

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Reference is made to the information appearing above under the subheading
"Market Sensitive Instruments and Risk Management" under the caption
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," which information is hereby incorporated by reference.

CONTROLS AND PROCEDURES

Our management, including the Chief Executive Officer and Chief Financial
Officer, have conducted an evaluation of the effectiveness of disclosure
controls and procedures pursuant to Exchange Act Rule 13a-14. Based on that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that the disclosure controls and procedures are effective in ensuring that all
material information required to be filed in this quarterly report has been made
known to them in a timely fashion. There have been no significant changes in
internal controls, or in factors that could significantly affect internal
controls, subsequent to the date the Chief Executive Officer and Chief Financial
Officer completed their evaluation.

42

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

We, in common with the insurance industry in general, are subject to
litigation and arbitration in the normal course of our business. As of September
30, 2002, we were not a party to any material litigation or arbitration other
than as a part of the ordinary course of business in relation to claims
activity, none of which is expected by management to have a significant adverse
effect on our results of operation and financial condition and liquidity.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

From August to September 2002, we issued an aggregate of 3,748,946 common
shares upon the exercise of all 3,842,450 outstanding Class A warrants, which
were exercisable for $20.00 per share and were scheduled to expire on
September 19, 2002. Of such amounts, 35,839 of our common shares were issued
upon the exercise of 129,343 Class A warrants on a cashless basis. The proceeds
from the exercise of Class A warrants on a cash basis increased shareholders'
equity by approximately $74.3 million. Exemption was claimed under
Section 3(a)(9) or Section 4(2) under the Securities Act. The following table
provides information about the issuance of these common shares:

43

ITEM 5. OTHER INFORMATION

In accord with Section 10a(i) (2) of the Exchange Act, we are responsible
for disclosing non-audit services to be provided by our independent auditor,
PricewaterhouseCoopers LLP, which are approved by the Audit Committee of our
board of directors.

During the second half of 2002, the Audit Committee approved additional
engagements of PricewaterhouseCoopers LLP for the following permitted non-audit
services: tax services, tax consulting and tax compliance and risk management
and internal control advisory services.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) EXHIBITS.

(b) REPORTS ON FORM 8-K.

ACGL filed reports on Form 8-K during the 2002 third quarter on (1) August
12, 2002 for the purpose of furnishing the 2002 second quarter earnings release
issued by ACGL, (2) August 14, 2002 for the purpose of providing the
certifications of the President and the Chief Financial Officer of ACGL under
Section 906 of the Sarbanes-Oxley Act of 2002 and (3) September 25, 2002 to
report the cash exercise of ACGL's Class A warrants by principal shareholders.
ACGL also filed a report on Form 8-K on November 7, 2002 for the purpose of
furnishing the 2002 third quarter earnings release issued by ACGL and to report
that ACGL had entered into amendments to restricted share agreements with Robert
Clements, the Chairman of the board, and that ACGL and Mr. Clements had entered
into a share repurchase agreement.

44

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

ARCH CAPITAL GROUP LTD.
------------------------------------------
(REGISTRANT)

/s/ Peter A. Appel
------------------------------------------
Date: November 14, 2002 Peter A. Appel
President and Chief Executive Officer
(Principal Executive Officer) and Director

/s/ John D. Vollaro
------------------------------------------
Date: November 14, 2002 John D. Vollaro
Executive Vice President, Chief Financial
Officer and Treasurer (Principal Financial
and Accounting Officer)

45

Certification
of Chief Executive Officer
Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002

I, Peter A. Appel, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Arch Capital Group
Ltd.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a. all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.

Date: November 14, 2002

By: /s/ Peter. A. Appel
-------------------
Name: Peter A. Appel
Title: President and Chief Executive Officer

46

Certification
of Chief Financial Officer
Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002

I, John D. Vollaro, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Arch Capital Group
Ltd.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
d. all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
e. any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.

Date: November 14, 2002

By: /s/ John D. Vollaro
-------------------
Name: John D. Vollaro
Title: Executive Vice President, Chief Financial Officer and Treasurer

47

EXHIBIT INDEX