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 March 31, 2003
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 jurisdict
ion of (I.R.S. Employer Identification No.)
incorporation or organization)

WESSEX HOUSE, 45 REID STREET
HAMILTON HM 12 BERMUDA
(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 by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes /X/ No ______

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

CLASS OUTSTANDING AT APRIL 30, 2003
----- -----------------------------
Common Shares, $0.01 par value 27,979,277

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ARCH CAPITAL GROUP LTD.

INDEX

PAGE NO.
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PART I. FINANCIAL INFORMATION

ITEM 1 -- CONSOLIDATED FINANCIAL STATEMENTS

Report of Independent Accountants 2

Consolidated Balance Sheets 3
March 31, 2003 and December 31, 2002

Consolidated Statements of Income 4
For the three months ended March 31, 2003 and 2002

Consolidated Statements of Changes in Shareholders' Equity 5
For the three months ended March 31, 2003 and 2002

Consolidated Statements of Comprehensive Income 6
For the three months ended March 31, 2003 and 2002

Consolidated Statements of Cash Flows 7
For the three months ended March 31, 2003 and 2002

Notes to Consolidated Financial Statements 8

ITEM 2 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS 20

ITEM 3 -- QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 43

ITEM 4 -- CONTROLS AND PROCEDURES 43

PART II. OTHER INFORMATION

ITEM 1 -- LEGAL PROCEEDINGS 44

ITEM 5 -- OTHER INFORMATION 44

ITEM 6 -- EXHIBITS AND REPORTS ON FORM 8-K 44

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 March 31, 2003, and the related
consolidated statements of income for each of the three month periods ended
March 31, 2003 and 2002, and the consolidated statements of comprehensive
income, changes in shareholders' equity, and cash flows for each of the three
month periods ended March 31, 2003 and 2002. 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, 2002, 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 19, 2003, 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, 2002, is fairly stated in all material
respects in relation to the consolidated balance sheet from which it has been
derived.

/s/ PricewaterhouseCoopers LLP
New York, New York
May 5, 2003

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

Arch Capital Group Ltd. ("ACGL") is a Bermuda public limited liability
company which provides insurance and reinsurance on a worldwide basis through
its wholly owned subsidiaries.

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 ACGL and its subsidiaries (together with
ACGL, the "Company"). 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 and assumptions. 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, 2002, including the Company's audited
consolidated financial statements and related notes and the section entitled
"Business--Risk Factors."

To facilitate period-to-period comparisons, certain amounts in the 2002
consolidated financial statements have been reclassified to conform to the 2003
presentation. Such reclassifications had no effect on the Company's net income,
shareholders' equity or cash flows.

2. STOCK OPTIONS

The Company has adopted the provisions of Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB No. 25"), and
related interpretations in accounting for its employee stock options.
Accordingly, under APB No. 25, compensation expense for stock option grants is
recognized by the Company to the extent that the fair value of the underlying
stock exceeds the exercise price of the option at the measurement date. As
provided under Statement of Financial Accounting Standards ("SFAS") No. 123,
"Accounting for Stock-Based Compensation," the Company has elected to continue
to account for stock-based compensation in accordance with APB No. 25 and has
provided the required additional pro forma disclosures.

8

2. STOCK OPTIONS (Continued)

If compensation expense for stock-based employee compensation plans had
been determined using the fair value recognition provisions of SFAS No. 123, the
Company's net income and earnings per share would have instead been reported as
the pro forma amounts indicated below:

3. ACCOUNTING PRONOUNCEMENTS

In January 2003, the Financial Accounting Standards Board ("FASB") issued
FASB Interpretation No. 46, "Consolidation of Variable Interest Entities -- an
interpretation of ARB No. 51" ("FIN 46"), which requires the consolidation of
certain entities considered to be variable interest entities ("VIEs"). An entity
is considered to be a VIE when it has equity investors which lack the
characteristics of a controlling financial interest or its capital is
insufficient to permit it to finance its activities without additional
subordinated financial support. Consolidation of a VIE by an investor is
required when it is determined that the investor will absorb a majority of the
VIE's expected losses or residual returns if they occur. FIN 46 provides certain
exceptions to these rules, including qualifying special purpose entities subject
to the requirements of SFAS No. 140, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities." VIEs created after January
31, 2003 must be consolidated immediately, while VIEs that existed prior to
February 1, 2003 must be consolidated as of July 1, 2003. Certain ceding
companies may meet the definition of a VIE due to the protection provided to the
ceding company's equity investors from the absorption of expected losses. The
Company is currently evaluating this standard.

On April 30, 2003 the FASB issued SFAS No. 149, "Amendment of Statement 133
on Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under SFAS
No. 133. SFAS No. 149 is effective for contracts entered into or modified after
June 30, 2003 and for hedging relationships designated after June 30, 2003. The
Company is currently evaluating this standard.

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4. SEGMENT INFORMATION

The determination of the Company's business segments is based on how the
Company monitors the performance of its underwriting operations. The Company
classifies its businesses into two underwriting segments - reinsurance and
insurance - and a corporate and other segment (non-underwriting). The Company
does not manage its assets by segment and, accordingly, investment income is not
allocated to each underwriting segment. In addition, other revenue and expense
items are not evaluated by segment. Management measures segment performance
based on underwriting income or loss. The accounting policies of the segments
are the same as those used for the preparation of the Company's consolidated
financial statements. Inter-segment insurance business is allocated to the
segment accountable for the underwriting results in accordance with SFAS No.
131, "Disclosures about Segments of an Enterprise and Related Information."

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

The insurance segment consists of the Company's insurance underwriting
subsidiaries which primarily write on a direct basis. The insurance segment
consists of eight profit centers, including casualty, programs, property,
executive assurance, healthcare, professional liability, construction and
surety, and other (primarily non-standard auto and collateralized protection
business).

The corporate and other segment (non-underwriting) includes net investment
income, other fee income and other expenses incurred by the Company, net
realized investment gains or losses, net foreign exchange gains or losses and
non-cash compensation. The corporate and other segment also includes the results
of the Company's merchant banking operations.

Certain prior period information has been reclassified to conform to the
current presentation.

10

4. SEGMENT INFORMATION (Continued)

The following table sets forth an analysis of the Company's underwriting
income by segment, together with a reconciliation of underwriting income to net
income for the three months ended March 31, 2003:

(1) Reinsurance segment results include $47.9 million of 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 policy-related fee
income.

11

4. SEGMENT INFORMATION (Continued)

The following table sets 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 three months ended March 31, 2002:

(1) Reinsurance segment results include $18.8 million of 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 policy-related fee
income.

12

4. SEGMENT INFORMATION (Continued)

Set forth below is summary information regarding net premiums written and
earned by major line of business and by client location for the reinsurance
segment for the three months ended March 31, 2003 and 2002:

(1) Reinsurance segment results include premiums written and earned assumed
from the insurance segment of $47.9 million and $21.8 million, respectively,
for the 2003 first quarter and premiums written and earned of $18.8 million
and $2.6 million, respectively, for the 2002 first quarter.

13

4. SEGMENT INFORMATION (Continued)

Set forth below is summary information regarding net premiums written and
earned by major line of business and by client location for the insurance
segment for the three months ended March 31, 2003 and 2002:

(1) Insurance segment results exclude premiums written and earned ceded to the
reinsurance segment of $47.9 million and $21.8 million, respectively, for
the 2003 first quarter and premiums written and earned of $18.8 million
and $2.6 million, respectively, for the 2002 first quarter.

14

5. REINSURANCE

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

The following table sets forth the effects of reinsurance on the Company's
reinsurance and insurance subsidiaries with unaffiliated reinsurers:

6. DEPOSIT ACCOUNTING

Certain reinsurance contracts included in the Company's non-traditional
business are deemed, for financial reporting purposes, not to transfer insurance
risk, and are accounted for using the deposit method of accounting. For those
contracts that contain an element of underwriting risk, the estimated profit
margin is deferred and amortized over the contract period and such amount is
included in the Company's underwriting results. The Company recorded $1.9
million and $40,000 on such contracts for the three months ended March 31, 2003
and 2002, respectively, in its underwriting results. On a notional basis, the
amount of "premiums" attaching to such contracts was $110.0 million and $2.3
million for the three months ended March 31, 2003 and 2002, respectively.

15

7. INVESTMENT INFORMATION

The following tables summarize the Company's fixed maturities and equity
securities:

16

8. EARNINGS PER SHARE

The following table sets forth the computation of basic and diluted
earnings per share:

9. 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.

17

9. INCOME TAXES (Continued)

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.

The Company's effective tax rate, which is based upon the expected annual
effective tax rate, fluctuates from year to year consistent with the relative
mix of income reported by jurisdiction due primarily to the varying tax rates in
each jurisdiction. For the three months ended March 31, 2003 and 2002, the
Company's income tax provision resulted in effective tax rates of 13.0% and
5.4%, respectively.

10. TRANSACTIONS WITH RELATED PARTIES

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 Robert Clements and John Pasquesi, Chairman and
Vice Chairman of ACGL's board of directors, respectively, each hold 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 $449,000 under such arrangements through March
31, 2003.

During 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 held ownership interests until March 2003. The
aggregate rental payments related to such lease were approximately $247,000
through March 31, 2003. In addition, Tri-City, as broker, has placed business
with the Company's insurance operations and the Company has incurred commission
expenses of approximately $1.1 million under such arrangements for the three
months ended March 31, 2003. In March 2003, the Company's merchant banking
subsidiary, Hales & Company Inc., received a fee of $1.25 million from Tri-City
for advisory services in connection with the sale of Tri-City to non-affiliated
persons.

11. CONTINGENCIES RELATING TO THE SALE OF PRIOR REINSURANCE OPERATIONS

On May 5, 2000, the Company sold the prior reinsurance operations of Arch
Reinsurance Company ("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"). Folksamerica Reinsurance Company assumed
Arch Re U.S.'s liabilities under the reinsurance agreements transferred in the
asset sale and Arch Re U.S. transferred to Folksamerica Reinsurance Company
assets estimated in an aggregate amount equal in book value to the book value of
the liabilities assumed. 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
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

18

11. CONTINGENCIES RELATING TO THE SALE OF PRIOR REINSURANCE OPERATIONS
(Continued)

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, 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. 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 a certain managing underwriting
agency. 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.

19

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

The following discussion and analysis contains forward-looking statements
which involve inherent risks and uncertainties. All statements other than
statements of historical fact are forward-looking statements. These statements
are based on our current assessment of risks and uncertainties. Actual results
may differ materially from those expressed or implied in these statements.
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
in our periodic reports filed with the Securities and Exchange Commission
("SEC").

GENERAL

THE COMPANY

We are a Bermuda public limited liability company with approximately $1.5
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. 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 capital that is unencumbered by significant
exposure to pre-2002 risks have enabled us to establish a strong presence in an
attractive insurance and reinsurance marketplace.

CRITICAL ACCOUNTING POLICIES, ESTIMATES AND RECENT ACCOUNTING PRONOUNCEMENTS

The preparation of consolidated financial statements requires us to make
many estimates and judgments that affect the reported amounts of assets,
liabilities (including reserves), revenues and expenses, and related
disclosures of contingent liabilities. On an ongoing basis, we evaluate our
estimates, including those related to revenue recognition, insurance and
other reserves, reinsurance recoverables, investment valuations, intangible
assets, bad debts, income taxes, contingencies and litigation. We base our
estimates on historical experience, where possible, and on various other
assumptions that we believe to be reasonable under the circumstances, which
form the basis for our judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Estimates and
judgments for a relatively new insurance and reinsurance company, like our
company, are even more difficult to make than those made in a mature company
since very limited historical information has been reported to us through
March 31, 2003. Actual results will differ from these estimates and such
differences may be material. We believe that the following critical
accounting policies require our more significant judgments and estimates used
in the preparation of our consolidated financial statements.

RESERVES FOR LOSSES AND LOSS ADJUSTMENT EXPENSES

We are required by applicable insurance laws and regulations and GAAP to
establish reserves for losses and loss adjustment expenses that arise from the
business we underwrite. These reserves are balance sheet liabilities
representing estimates of future amounts required to pay losses and loss
adjustment expenses for insured or reinsured claims which have occurred at or
before the balance sheet date.

Insurance loss reserves are inherently subject to uncertainty. The period
of time from the occurrence of a loss through the settlement of the liability
may extend many years into the future. During this period, additional facts and
trends will become known and, as these factors become apparent, reserves will be
adjusted in the period in which the new information becomes known. While
reserves are established based upon available information, certain factors, such
as those inherent in the political, judicial and legal system, including
judicial and litigation trends and legislation changes, could impact the
ultimate liability. Changes to our prior year loss

20

reserves can impact our current underwriting results by (1) reducing our
reported results if the prior year reserves prove to be deficient or (2)
improving our reported results if the prior year reserves prove to be redundant.
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 ratio experience and loss development
patterns to assist in the establishment of appropriate loss reserves. Even
actuarially sound methods can lead to subsequent adjustments to loss reserves
that are both significant and irregular due to the nature of the risks written,
potentially by a material amount.

For reinsurance assumed, case reserves are based on reports received from
ceding companies, supplemented by our estimates of reserves for which ceding
company reports have not been received. For our insurance operations, generally,
claims personnel determine whether to establish a case reserve for the estimated
amount of the ultimate settlement of individual claims. The estimate reflects
the judgment of claims personnel based on general corporate reserving practices
and the experience and knowledge of such personnel regarding the nature and
value of the specific type of claim and, where appropriate, advice of counsel.
Our insurance operations also contract with a number of outside third party
administrators in the claims process who, in certain cases, have limited
authority to establish case reserves. The work of such administrators is
reviewed and monitored by our claims personnel. 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 reported or case reserves may be made as
additional information regarding the claims is reported or payments are made. In
accordance with industry practice, we also maintain incurred but not reported
("IBNR") reserves. Such reserves are established to provide for incurred claims
which have not yet been reported to an insurer or reinsurer as well as to
actuarially adjust for any projected variance in case reserving.

Even though most insurance policies have policy limits, the nature of
property and casualty insurance and reinsurance is such that losses can exceed
policy limits for a variety of reasons and could very significantly exceed the
premiums received on the underlying policies. We 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 method for
2002 and 2003 was primarily the expected loss method, which is commonly applied
when limited loss experience exists. We select the initial expected loss and
loss adjustment expense ratios based on information derived by our underwriters
and actuaries during the initial pricing of the business. These ratios consider,
among other things, rate increases and changes in terms and conditions that have
been observed in the market. Any estimates and assumptions made as part of the
reserving process could prove to be inaccurate due to several factors, including
the fact that very limited historical information has been reported to us
through March 31, 2003 due to our start-up nature. As actual loss information is
reported to us and we develop our own loss experience, our reserving methods
will also include other actuarial techniques. 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.

Under GAAP, we are only permitted to establish loss and loss adjustment
expense reserves for losses that have occurred on or before the financial
statement date. Case reserves and IBNR reserves contemplate these obligations.
No contingency reserve allowances are established to account for future loss
occurrences. Losses arising from future events will be estimated and recognized
at the time the losses are incurred and could be substantial.

21

PREMIUM REVENUES AND RELATED EXPENSES

Insurance premiums written are recorded at the policy inception and are
primarily earned on a pro rata basis in accordance with the terms of the
policies. Unearned premium reserves represent the portion of such premiums
written that relates to the unexpired terms of in-force insurance policies.

Reinsurance premiums written include amounts reported by the ceding
companies, supplemented by our own estimates of premiums for which ceding
company reports have not been received. Premiums on our excess of loss and pro
rata reinsurance contracts are estimated when the business is underwritten. For
excess of loss contracts, the minimum premium, as defined in the contract, is
generally recorded as an estimate of premiums written as of the date of the
treaty. Estimates of premiums written under pro rata contracts are recorded in
the period in which the underlying risks are expected to incept and are based on
information provided by the brokers and the ceding companies. For multi-year
reinsurance treaties which are payable in annual installments, only the initial
annual installment is included as premiums written at policy inception due to
the ability of the reinsured to commute or cancel coverage during the term of
the policy. The remaining annual installments are included as premiums written
at each successive anniversary date within the multi-year term.

As actual premiums are reported by the ceding companies, management
evaluates the appropriateness of the premium estimates, and any adjustment to
these estimates is recorded in the period in which it becomes known. Adjustments
to original premium estimates could be material and such adjustments could
directly and significantly impact earnings in the period they are determined
because the subject premium may be fully or substantially earned. A significant
portion of amounts included as premiums receivable, which represent estimated
premiums written, net of commissions, is not currently due based on the terms of
the underlying contracts.

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

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

We also write certain 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. The terms and conditions of these contracts may include
additional or return premiums based on loss experience, loss corridors,
sublimits and caps. Examples of such business include aggregate stop-loss
coverages and financial quota share coverages.

Certain reinsurance contracts included in our non-traditional 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, the estimated profit margin is deferred and
amortized over the contract period and such amount is included in our
underwriting results. For those contracts that do not transfer an element of
underwriting risk, the estimated profit is reflected in earnings over the
estimated settlement period using the interest method and such profit is
included in investment income.

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Under GAAP, acquisition expenses and other expenses that vary with, and are
directly related to, the acquisition of business in 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 are
reflected net of ceding commissions received from unaffiliated 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.

COLLECTION OF INSURANCE-RELATED BALANCES

We are subject to credit risk with respect to our reinsurance ceded because
the ceding of risk to reinsurers or retrocessionaires does not relieve us of our
liability to the clients or companies we insure or reinsure. If the financial
condition of our reinsurers or retrocessionaires deteriorates, resulting in an
impairment of their ability to make payments, we will provide for probable
losses resulting from our inability to collect amounts due from such parties, as
appropriate. We 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.
In addition, we write program business on a risk-sharing basis with managing
general agents or brokers, which may be structured with commissions which are
contingent on the underwriting results of the program. While we attempt to
obtain collateral from such parties in an amount sufficient to guarantee their
projected financial obligations to us, there is no guarantee that such
collateral will be sufficient to secure their actual ultimate obligations. We
provide for probable losses resulting from our inability to collect amounts due
from managing general agents, brokers and other clients.

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. We have
considered future taxable income and feasible tax planning strategies in
assessing the need for a valuation allowance. In the event we 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, a benefit would be recorded
to income in the period in which such determination was made.

INVESTMENTS

We currently classify all of our publicly traded fixed maturity
investments, 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. Short-term
investments comprise securities due to mature within one year of the date of
issue. Short-term investments include certain cash equivalents which are part of
our investment portfolios under the management of external investment managers.
Investments included in our private portfolio include securities issued by
privately held companies. 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 investment is revalued based on substantive events
or other factors which could indicate a diminution or appreciation in value. We
apply Accounting Principles Board ("APB") Opinion No. 18, "The Equity Method of
Accounting for Investments in Common Stock," for privately held equity
investments accounted for under the equity method, and we record our percentage
share of the investee company's net income or loss.

23

In accordance with SFAS No. 115, "Accounting for Certain Investments in
Debt and Equity Securities," we periodically 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 have adopted the provisions of APB Opinion No. 25, "Accounting for Stock
Issued to Employees," and related interpretations in accounting for employee
stock options because the alternative fair value accounting provided for under
SFAS No. 123, "Accounting for Stock-Based Compensation," requires the use of
option valuation models that we believe were not developed for use in valuing
employee stock options. 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.

For restricted shares granted, we record deferred compensation equal to the
market value of the shares at the measurement date, which is amortized and
primarily 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--Non-Cash Compensation."

RECENT ACCOUNTING PRONOUNCEMENTS

See note 3, "Accounting Pronouncements," of the notes accompanying our
consolidated financial statements.

RESULTS OF OPERATIONS

The following table sets forth net income and earnings per share data:

Due to the significant number of preference shares outstanding in 2003 and 2002,
basic earnings per share data is not meaningful. The increase in diluted average
shares outstanding in the 2003 first quarter compared to the 2002 first quarter
is primarily due to the effect of the issuance of (i) 7,475,000 common shares in
connection with an offering completed by us in April 2002, (ii) 3,706,930
preference shares issued in 2002 pursuant to post-closing purchase price
adjustments to investors who provided our November 2001 capital infusion and
(iii) 3,748,946 common shares upon the exercise of warrants from August to
September 2002.

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The following table sets forth an analysis of underwriting income or loss,
together with a reconciliation of underwriting income or loss to net income or
loss for the 2003 first quarter and 2002 first quarter. Certain prior period
information has been reclassified to conform to the current presentation.

The following table sets forth the components of premiums written:

Our underwriting results for the 2003 first quarter reflect the significant
growth achieved by our reinsurance segment over the past fifteen months as well
as the expansion of our insurance segment into additional lines of business,
which occurred primarily during the second half of 2002. Results for the 2002
first quarter were primarily related to our reinsurance segment. See "--Segment
Information" for a discussion regarding the underwriting results of our
insurance and reinsurance segments.

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GROSS PREMIUMS WRITTEN

Gross premiums written for the 2003 first quarter were $860.1 million,
compared to $304.8 million for the 2002 first quarter. Our reinsurance segment
provided $562.7 million, or 65.4%, of gross premiums written for the 2003 first
quarter and $264.9 million, or 86.9% of gross premiums written for the 2002
first quarter. Our insurance segment provided $297.4 million, or 34.6%, of gross
premiums written for the 2003 first quarter and $39.9 million, or 13.1%, of
gross premiums written for the 2002 first quarter.

NET PREMIUMS WRITTEN

Net premiums written for the 2003 first quarter were $776.9 million,
compared to $280.7 million for the 2002 first quarter. Our reinsurance segment
provided $547.5 million, or 70.5%, of net premiums written for the 2003 first
quarter and $264.9 million, or 94.4%, of net premiums written for the 2002 first
quarter. Our insurance segment provided $229.4 million, or 29.5%, of net
premiums written for the 2003 first quarter and $15.8 million, or 5.6%, of net
premiums written for the 2002 first quarter.

COMBINED RATIOS

The combined ratio represents a measure of underwriting profitability (and,
therefore, excludes investment income) and is the sum of the loss ratio and
underwriting expense ratios. A combined ratio under 100% represents an
underwriting profit and a combined ratio over 100% represents an underwriting
loss.

(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 policy-related fee
income.

UNDERWRITING RESULTS

Our underwriting income was $40.1 million for the 2003 first quarter,
compared to $3.8 million for the 2002 first quarter. The combined ratio, on a
GAAP basis, was 90.6% for the 2003 first quarter, compared to 94.3% for the
2002 first quarter. The loss ratio was 65.1% for the 2003 first quarter,
compared to 74.8% for the 2002 first quarter. The acquisition expense ratio
for the 2003 first quarter was 18.5%, compared to 9.1% for the 2002 first
quarter. A significant portion of the decrease in the loss ratio and increase
in the acquisition expense ratio in 2003 was due to the higher percentage of
reinsurance segment net premiums earned relating to pro rata contracts.
Typically, pro rata business is written at lower loss ratios and higher
acquisition expense ratios than excess of loss business. In addition, during
the 2003 first quarter, the Company recorded lower loss ratios on business
that is primarily exposed to catastrophic events based on a lower than
expected level of such events. The other operating expense ratio was 7.0% for
the 2003 first quarter, compared to 10.4% for the 2002 first quarter. While

26

aggregate other operating expenses were higher for the 2003 first quarter
compared to the 2002 first quarter, the other operating expense ratio decreased
primarily due to the significant growth in net premiums earned.

NET INVESTMENT INCOME

Net investment income was $18.4 million for the 2003 first quarter,
compared to $9.2 million in the 2002 first quarter. The increase in net
investment income in the 2003 first quarter was due to the significant increase
in our invested assets resulting from (1) cash flow from operations in 2003 and
2002 and (2) proceeds received from the public offering of our common shares in
April 2002 and the exercise of warrants in September 2002.

Our pre-tax and after-tax investment yields, respectively, for the 2003
first quarter were 3.5% and 3.1%, compared to 3.6% and 3.2% for the 2002 first
quarter. These yields were calculated based on the amortized cost of the
portfolio. Yields on future investment income may vary based on economic
conditions, investment allocation decisions and other factors.

NET REALIZED GAINS OR LOSSES ON INVESTMENTS

Following is summary of net realized investment gains (losses) for the 2003
and 2002 first quarters:

Net realized gains in our fixed income portfolio during the 2003 first quarter
resulted from the sale of certain securities to reduce credit exposure, and from
sales related to rebalancing the portfolio. We sold one privately held security
during the 2003 first quarter which resulted in a realized gain. Also, we
recorded a realized gain, shown as "Other" in the table above, on proceeds
received from a class action lawsuit related to a publicly traded equity
security which we previously owned and for which we had recorded a significant
realized loss in a prior year.

OTHER

Other fee income, net of related expenses, represents revenues and expenses
provided by our non-underwriting operations. Other income is generated by our
investments in privately held securities. At March 31, 2003, we held five
investments in privately held securities. Three of such investments are
accounted for under the equity method of accounting. Under the equity method, we
record a proportionate share of the investee company's net income or loss based
on our ownership percentage in such investment, which amounted to $1.1 million
for the 2003 first quarter, compared to $0.8 million for the 2002 first quarter.
Other expenses primarily represent certain holding company costs necessary to
support our growing worldwide insurance and reinsurance operations and costs
associated with operating as a publicly-traded company.

NET FOREIGN EXCHANGE GAINS OR LOSSES

Net foreign exchange gains for the 2003 first quarter of $1,050,000
consisted of a net unrealized gain of $595,000 and net realized gains of
$455,000. The net unrealized gain resulted from the translation of foreign
denominated monetary assets and liabilities at March 31, 2003, as defined and
required under GAAP. Foreign

27

exchange gains and losses vary with fluctuations in currency rates. Accordingly,
these gains and losses could add significant volatility to our net income in
future periods.

NON-CASH COMPENSATION

Non-cash compensation results primarily from restricted shares granted in
connection with our 2001 underwriting initiative. Non-cash compensation expense
for the 2003 first quarter was $4.3 million, compared to $4.1 million for the
2002 first quarter. Absent significant additional restricted share grants during
the remaining three quarters of 2003, non-cash compensation expense is currently
expected to be approximately $3.5 million, $3.4 million, and $2.6 million,
respectively.

INCOME TAXES

Our effective tax rate fluctuates from year to year consistent with the
relative mix of income reported by jurisdiction due primarily to the varying tax
rates in each jurisdiction. Our tax provision for the 2003 first quarter is
based upon the expected annual effective tax rate on net income of 13.0%,
compared to 5.4% for the 2002 first quarter. The increase in the effective tax
rate for the 2003 first quarter compared to the 2002 first quarter is due to the
higher expected contribution of U.S. source income to our total income in 2003.
The effective tax rate, excluding the effect of certain non-cash compensation,
net realized investment gains or losses, net foreign exchange gains or losses
and other income, was approximately 12.5% for the 2003 first quarter, compared
to 8.0% in the 2002 first quarter.

ACGL changed its legal domicile from the United States to Bermuda in
November 2000. Under current Bermuda law, we are not obligated to pay any taxes
in Bermuda based upon income or capital gains. We have received a written
undertaking from the Minister of Finance in Bermuda under the Exempted
Undertakings Tax Protection Act of 1966 that in the event legislation is enacted
in Bermuda imposing tax computed on profits, income, gain or appreciation on any
capital asset, or tax in the nature of estate duty or inheritance tax, such tax
will not be applicable to us or our operations until March 28, 2016.

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. 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.

SEGMENT INFORMATION

We classify our businesses into two underwriting segments, reinsurance and
insurance. SFAS No. 131, "Disclosures About Segments of an Enterprise and
Related Information," requires certain disclosures about operating segments in a
manner that is consistent with how management evaluates the performance of the
segment. For a description of our underwriting segments, refer to note 4,
"Segment Information," of the notes accompanying our consolidated financial
statements. Segment performance is evaluated primarily based on underwriting
income or loss.

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REINSURANCE SEGMENT

The following table sets forth our reinsurance segment's underwriting
results for the 2003 first quarter and 2002 first quarter:

(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. The reinsurance segment's underwriting income, on a
GAAP basis, was $33.2 million for the 2003 first quarter, compared to $3.8
million for the 2002 first quarter. The combined ratio for the reinsurance
segment, on a GAAP basis, was 88.2% for the 2003 first quarter, compared to
93.1% for the 2002 first quarter. The components of the reinsurance segment's
underwriting income are discussed below.

PREMIUMS WRITTEN. Gross and net premiums written for our reinsurance
segment were $562.7 million and $547.4 million, respectively, for the 2003 first
quarter, compared to gross and net premiums written of $264.9 million for the
2002 first quarter. For the 2003 first quarter, 57.0% of net premiums written
were generated from pro rata contracts and 43.0% were derived from excess of
loss treaties. For the 2002 first quarter, 29.8% of net premiums written were
generated from pro rata contracts and 70.2% were derived from excess of loss
treaties. Typically, pro rata business is written at lower loss ratios and
higher acquisition expense ratios than excess of loss business.

We are currently retaining substantially all of our reinsurance premiums
written. We do, however, 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. We will continue to
evaluate our retrocessional requirements.

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Set forth below is summary information regarding the reinsurance segment's
net premiums written and earned by major line of business for the 2003 first
quarter and 2002 first quarter:

For information regarding net premiums written produced by geographic
location for the reinsurance segment, refer to note 4, "Segment Information," of
the notes accompanying our consolidated financial statements.

NET PREMIUMS EARNED. For the 2003 first quarter, approximately 48.6% of the
reinsurance segment's net premiums written were earned, compared to 21.0% for
the 2002 first quarter. Due to the significant growth in premiums written in the
2003 first quarter compared to the 2002 first quarter, there is a significant
difference between written and earned premiums for such periods. For the 2003
first quarter, 64.6% of net premiums earned were generated from pro rata
contracts, while 35.4% of net premiums earned were generated from excess of loss
treaties. For the 2002 first quarter, 20.6% of net premiums earned were
generated from pro rata contracts, while 79.4% of net premiums earned were
generated from excess of loss treaties.

OTHER UNDERWRITING-RELATED FEE INCOME. Certain reinsurance contracts
included in our non-traditional business are deemed, for financial reporting
purposes, not to transfer insurance risk, and are accounted for using the
deposit method of accounting. For those contracts that contain an element of
underwriting risk, the estimated profit margin is deferred and amortized over
the contract period. We recorded $1.9 million on such contracts for the 2003
first quarter, which is included in other underwriting-related fee income. On a
notional basis, the amount of "premiums" attaching to such contracts was $110.0
million.

LOSSES AND LOSS ADJUSTMENT EXPENSES. Reinsurance segment losses and loss
adjustment expenses incurred for the 2003 first quarter were $163.9 million, or
61.6%, of net premiums earned, compared to $40.9 million, or

30

73.7%, for the 2002 first quarter. The decrease in the loss ratio in the 2003
first quarter was due, in part, to the increased percentage of net premiums
earned from pro rata contracts. In addition, during the 2003 first quarter,
the Company recorded lower loss ratios on business that is primarily exposed
to catastrophic events based on a lower than expected level of such events.
For a discussion of the reserves for losses and loss adjustment expenses,
please refer to the section above entitled "--Critical Accounting Policies,
Estimates and Recent Accounting Pronouncements--Reserves for Losses and Loss
Adjustment Expenses."

UNDERWRITING EXPENSES. The acquisition expense ratio for the 2003 first
quarter was 24.3%, compared to 13.1% for the 2002 first quarter, and the other
operating expense ratio for the 2003 first quarter was 2.3%, compared to 6.3%
for the 2002 first quarter. The increase in the acquisition expense ratio in the
2003 first quarter was due, in part, to the increased percentage of pro rata
business earned in the 2003 first quarter. The decrease in the other operating
expense ratio primarily resulted from the significant increase in net premiums
earned in the 2003 first quarter. Since the staffing and infrastructure building
of the reinsurance segment has been substantially completed, the anticipated
operating expense ratio for 2003 currently is expected to be stable, given
current market conditions, although no assurances can be given to that effect.

INSURANCE SEGMENT

The following table sets forth our insurance segment's underwriting results
for the 2003 first quarter and 2002 first quarter:

For information regarding net premiums written produced by geographic
location for the insurance segment, refer to note 4, "Segment Information," of
the notes accompanying our consolidated financial statements.

NET PREMIUMS EARNED. For the 2003 first quarter, approximately 60.4% of the
insurance segment's net premiums written were earned, compared to 75.7% for the
2002 first quarter. The lower percentage of net premiums earned in the 2003
first quarter is due to the significant amount of new business written in the
insurance segment's specialty lines of business.

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POLICY-RELATED FEE INCOME. Policy-related fee income, such as billing,
cancellation and reinstatement fees, is primarily recognized as earned when
substantially all of the related services have been provided. Policy-related fee
income will vary in the future related to such activity and is earned primarily
in our non-standard automobile business.

LOSSES AND LOSS ADJUSTMENT EXPENSES. Insurance segment losses and loss
adjustment expenses incurred for the 2003 first quarter were $99.2 million, or
71.6%, of net premiums earned, compared to $9.6 million, or 80.3%, for the 2002
first quarter.

UNDERWRITING EXPENSES. The acquisition expense ratio for our insurance
segment is calculated net of certain policy-related fee income and is influenced
by, among other things, (1) the amount of ceding commissions received from
unaffiliated reinsurers and (2) the amount of business written on a surplus
lines (non-admitted) basis. The acquisition expense ratio was 7.4% for the 2003
first quarter (net of 2.3 points of policy-related fee income), compared to
(9.3%) for the 2002 first quarter (net of 9.7 points of fee income). The
increase in the acquisition expense ratio in the 2003 first quarter primarily
resulted from the higher percentage of business retained by the insurance
segment.

The other operating expense ratio for the 2003 first quarter was 15.9%,
compared to 29.2% for the 2002 first quarter. While aggregate operating expenses
increased significantly due to the buildup in our insurance group's
infrastructure, the operating expense ratio decreased primarily due to the
growth in net premiums earned.

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 funds affiliated
with Warburg Pincus LLC ("Warburg Pincus Funds"), funds affiliated with Hellman
& Friedman LLC ("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.

On a consolidated basis, our aggregate invested assets, including cash and
short-term investments, totaled approximately $2.3 billion at March 31, 2003. As
of such date, ACGL's readily available cash, short-term investments and
marketable securities, excluding amounts held by our regulated insurance and
reinsurance subsidiaries, totaled $15.1 million.

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. Under Bermuda law, Arch Reinsurance Ltd. ("Arch Re
Bermuda") is required to maintain a minimum solvency margin (i.e., the amount by
which the value of its general business assets must exceed its general business
liabilities) equal to the greatest of (1) $100,000,000, (2) 50% of net premiums
written (being gross premiums written by us less any premiums ceded by us, but
we may not deduct more than 25% of gross premiums when computing net premiums
written) and (3) 15% of loss and other insurance reserves. Arch Re Bermuda is
prohibited from declaring or paying any dividends during any financial year if
it is not in compliance with its minimum solvency margin. In addition, Arch Re
Bermuda is prohibited from declaring or paying in any financial year dividends
of more than 25% of its total statutory capital and surplus (as shown on its
previous financial year's statutory balance sheet) unless it files, at least
seven days before payment of such dividends, with the Bermuda Monetary Authority
an affidavit stating that it will continue to meet the required margins. In
addition, Arch Re Bermuda is prohibited, without

33

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, 2002, Arch Re Bermuda had statutory capital and
surplus as determined under Bermuda law of $1.2 billion (including ownership
interests in its wholly owned subsidiaries). Accordingly, 15% of Arch Re
Bermuda's capital, or approximately $179 million, is available for dividends
during 2003 without prior approval under Bermuda law, as discussed above. Our
U.S. insurance and reinsurance subsidiaries, on a consolidated basis, may not
pay any significant dividends or distributions during 2003 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.

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 provided by operating
activities was $300.5 million for the 2003 first quarter, compared to $48.3
million for the 2002 first quarter. The increase in cash provided by operating
activities resulted from the significant growth in our operations over the past
fifteen months.

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 underwriting activities and investment income and
proceeds on the sale or maturity of our investments. We have an effective shelf
registration statement with the SEC. 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. The unused
portion of our shelf registration is approximately $309 million. Any additional
issuance of common shares by us could have the effect of diluting our earnings
per share and our book value per share.

At March 31, 2003 and December 31, 2002, our consolidated shareholders'
equity was approximately $1.5 billion and $1.4 billion, respectively. The
increase in consolidated shareholders' equity was primarily attributable to the
effects of net income for the 2003 first quarter and 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. Estimating loss reserves is inherently difficult,
which is exacerbated by the fact that we are a new company with relatively
limited historical experience upon which to base such estimates. We utilize
actuarial models as well as available historical insurance industry loss ratio
experience and loss development patterns to assist in the establishment of
appropriate loss reserves. Actual losses and loss adjustment expenses paid will
deviate, perhaps substantially, from the reserve estimates reflected in our
financial statements. See the section above entitled "--Critical Accounting
Policies, Estimates and Recent Accounting Pronouncements--Reserves for Losses
and Loss Adjustment Expenses."

34

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 2003 first
quarter, ceded premiums written represented approximately 10% of gross premiums
written, compared to 15% for the year ended December 31, 2002. The decrease is
primarily due to an increased retention of our insurance segment premiums
written during 2003.

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 mitigate risk through reinsurance and
retrocessional arrangements. Further, we are subject to credit risk with respect
to our reinsurers and retrocessionaires 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 March 31, 2003,
approximately 76% of our reinsurance recoverables on paid and unpaid losses of
$263.0 million (not including prepaid reinsurance premiums) were due from
carriers which had an A.M. Best rating of "A-" or better. We had no amounts
recoverable on unpaid losses from a single entity or group of entities that
exceeded 5% of our total shareholders' equity.

The following table details our reinsurance recoverables at March 31, 2003:

(1) The financial strength ratings are as of May 11, 2003 and were assigned by
A.M. Best based on its opinion of the insurer's financial strength as of such
date. An explanation of the ratings listed in the table follows: ratings of
"A++" and "A+" are designated "Superior"; the "A" and "A-" ratings are
designated "Excellent"; the "B" rating is designated "Fair"; and the "C++"
rating is designated "Marginal." Additionally, A.M. Best has five
classifications within the "Not Rated" or "NR" category. Reasons for an "NR"
rating being assigned by A.M. Best include insufficient data, size or operating
experience, companies which are in run-off

35

with no active business writings or are dormant, companies which disagree with
their rating and request that a rating not be published or insurers that request
not to be formally evaluated for the purposes of assigning a rating opinion.

(2) In connection with our acquisition of Arch Specialty Insurance Company
("Arch Specialty") in February 2002, the seller, Sentry Insurance a Mutual
Company ("Sentry"), agreed to reinsure or otherwise assume all liabilities
arising out of Arch Specialty Insurance Company's business prior to the closing
of the acquisition. The balance due from Sentry includes all such amounts.

(3) Includes amounts recoverable from separate cell accounts in our
alternative markets unit.

(4) The A.M. Best group rating of "A-" (Excellent) has been applied to all
Lloyd's of London syndicates.

(5) The following table provides a breakdown of the "All other" category by
A.M. Best rating:

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, and
severe winter weather and fires. 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.

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. Therefore, claims
for natural and man-made catastrophic events could expose us to large losses and
cause substantial volatility in our results of operations, which could cause the
value of our common shares to fluctuate widely.

In certain instances, we specifically insure and reinsure risks resulting
from terrorism. Even in cases where we attempt to exclude losses from terrorism
and certain other similar risks from some coverages written by us, we may not be
successful in doing so. Moreover, irrespective of the clarity and inclusiveness
of policy language, there can be no assurance that a 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 business, we seek to limit the amount of
exposure we will assume from any one insured or reinsured and the amount of the
exposure to catastrophe losses in any geographic zone. We monitor our exposure
to catastrophic events, including earthquake, wind and specific terrorism
exposures, and periodically reevaluate the estimated probable maximum pre-tax
loss for such exposures. Our estimated probable maximum pre-tax loss is
determined through the use of modeling techniques, but such estimate does not
represent our total potential loss for such exposures. We seek to limit the
probable maximum pre-tax loss to a percentage of our total shareholders' equity
for severe catastrophic events. Currently, we generally seek to limit the
probable maximum pre-tax loss to approximately 25% of total shareholders' equity
for a severe

36

catastrophic event in any geographic zone that could be expected to occur once
in every 250 years. There can be no assurances that we will not suffer pre-tax
losses greater than 25% of our total shareholders' equity from one or more
catastrophic events due to several factors, including the inherent uncertainties
in estimating the frequency and severity of such events and the margin of error
in making such determinations resulting from potential inaccuracies 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 insurance and 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 business.

For 2003 exposures, our insurance operations have entered into a
reinsurance treaty which provides coverage for catastrophe-related losses equal
to 95% of the first $70 million in excess of a $50 million retention of such
losses. In the future, we may seek to purchase additional catastrophe or other
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 or by investing in securities denominated in local (foreign)
currencies. 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

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 11, "Contingencies Relating to the Sale of Prior Reinsurance
Operations," of the notes accompanying our consolidated financial statements.

37

INDUSTRY AND 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 Reinsurance Company ("Arch Re U.S.") and Arch
Reinsurance Ltd. ("Arch Re Bermuda"), and our insurance subsidiaries, Arch
Insurance Company, Arch Specialty and Arch Excess & Surplus Insurance Company,
each currently have financial strength ratings of "A-" (Excellent) from A.M.
Best. With respect to our non-standard automobile insurers, American Independent
Insurance Company ("American Independent") has a financial strength rating of
"C++" (Marginal) from A.M. Best, and Personal Service Insurance Company ("PSIC")
has a financial strength rating of "A-" (Excellent) from A.M. Best.

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. 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 to ensure that such counterparties are permitted to take credit
for reinsurance obtained from our reinsurance subsidiaries in United States
jurisdictions where such subsidiaries are not licensed or otherwise admitted
as an insurer, as required under insurance regulations in the United States.
If such subsidiaries are unable to post security in the form of letters of
credit or trust funds when required under such regulations, the operations of
our reinsurance subsidiaries could be significantly and negatively affected.

When issued under the facility, such letters of credit are secured by a
portion of our investment portfolio. In addition, the letter of credit facility
also requires the maintenance of certain financial covenants, with which we were
in compliance at March 31, 2003. At such date, we had approximately $109.3
million in outstanding letters of credit which were secured by investments
totaling $125.7 million. 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.

This facility expires July 14, 2003. 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 amount of
letters of credit issued is driven by, among other things, the timing and
payment of catastrophe losses, loss development of existing reserves, the
payment pattern of such reserves, the further expansion of our business and the
loss experience of such business. 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.

38

INVESTMENTS

At March 31, 2003, consolidated cash and invested assets totaled
approximately $2.3 billion, consisting of $264.4 million of cash and short-term
investments, $2.0 billion of publicly traded fixed maturity securities and $27.9
million of privately held securities. At March 31, 2003, our fixed income
portfolio, which includes fixed maturity securities and short-term investments,
had an average Standard & Poor's quality rating of "AA-" and an average duration
of 2.5 years. Our fixed income investment portfolio is currently managed by
external investment advisors under our direction in accordance with investment
guidelines provided by us. Our current guidelines stress preservation of
capital, market liquidity and diversification of risk.

The following table summarizes the estimated fair value and carrying value
of our fixed maturity securities and equity securities to amortized cost at
March 31, 2003:

The following table presents the Standard & Poor's credit quality
distribution of our fixed maturity securities at March 31, 2003:

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 currently 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 privately held equity securities consist of 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. The risk
of investing in such securities is generally greater than the risk of investing
in securities of widely held, publicly traded companies. At March 31, 2003, our
private equity portfolio consisted of five investments totaling $27.9 million in
fair value, with additional investment portfolio commitments in an aggregate
amount of

39

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 7, "Investment Information," of the notes accompanying our consolidated
financial statements.

We have not invested in derivative financial instruments such as futures,
forward contracts, swaps or options or other financial instruments with similar
characteristics such as interest rate caps or floors and fixed-rate loan
commitments. Our portfolio includes mortgage-backed securities which contain
embedded options. Our investments in mortgage-backed securities, which amounted
to approximately $379.1 million at March 31, 2003, or 16.3% of cash and
invested assets, are classified as available for sale and are not held for
trading purposes.

BOOK VALUE PER SHARE

The following book value per share calculations are based on shareholders'
equity of approximately $1.5 billion and $1.4 billion at March 31, 2003 and
December 31, 2002, respectively. Book value per share excludes the effects of
stock options and Class B warrants. Diluted per share book value at March 31,
2003 increased to $22.16 from $21.20 at December 31, 2002. The increase in
diluted per share book value was primarily attributable to our net income for
the 2003 first quarter and an increase in unrealized appreciation of
investments.

(1) Book value per common share at March 31, 2003 and December 31, 2002 was
determined by dividing (i) the difference between total shareholders' equity and
the aggregate liquidation preference of the Series A convertible preference
shares of $815.7 million, by (ii) the number of common shares outstanding.
Restricted common shares are included in the number of common shares outstanding
as if such shares were issued on the date of grant.

Pursuant to the subscription agreement entered in connection with the
November 2001 capital infusion (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 thereunder) 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 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 our 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

40

exercise of the Class A warrants). 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, 2002. (See section captioned
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Market Sensitive Instruments and Risk Management" included in our
2002 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 March 31, 2003, material changes
in market risk exposures that affect the quantitative and qualitative
disclosures presented as of December 31, 2002 are as follows:

INTEREST RATE RISK

The aggregate hypothetical loss generated from an immediate parallel,
adverse shift in the treasury yield curve of 100 basis points would have
resulted in a decrease in market value of approximately $55.2 million on our
fixed income portfolio, including short-term investments, as of March 31, 2003.
Such amount would have, on a pre-tax basis, decreased diluted book value per
share by approximately $0.83 as of March 31, 2003.

FOREIGN CURRENCY EXCHANGE RISK

Foreign currency rate risk is the potential change in value, income, and
cash flow arising from adverse changes in foreign currency exchange rates. A 10%
depreciation of the U.S. dollar against other currencies under our outstanding
contracts at March 31, 2003 would have resulted in unrealized losses of
approximately $15.9 million, and would have decreased diluted net income per
share by approximately $0.24 for the 2003 first quarter. For further discussion
on foreign exchange activity, please refer to "--Results of Operations--Net
Foreign Exchange Gains or Losses."

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 our periodic
reports filed with the SEC, and include:

- our ability to successfully implement our business strategy, as
described herein;

- 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 inflation, interest
rates and foreign currency exchange rates) and conditions specific to
the reinsurance and insurance markets in which we operate;

41

- 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, financial and other data and develop and implement
actuarial, financial and other models and procedures;

- the loss of key personnel;

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

- estimates and judgments, including those related to revenue
recognition, insurance and other reserves, reinsurance recoverables,
investment valuations, intangible assets, bad debts, income taxes,
contingencies and litigation, for a relatively new insurance and
reinsurance company, like our company, are even more difficult to make
than those made in a mature company since very limited historical
information has been reported to us through March 31, 2003;

- 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 our insurance and reinsurance
subsidiaries;

- 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, political unrest and other hostilities or other
unforecasted and unpredictable events;

- losses relating to aviation business and business produced by a
certain managing underwriting agency for which 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 and the cost of such reinsurance;

- 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 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

- rating agency policies and practices.

In addition, 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.

42

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

Within the 90 days prior to the date of filing this Form 10-Q, our
management, including the Chief Executive Officer and Chief Financial Officer,
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.

43

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 March 31,
2003, 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 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 2003 first quarter, the Audit Committee approved engagements of
PricewaterhouseCoopers LLP for the following permitted non-audit services: tax
services, tax consulting and tax compliance.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) EXHIBITS.

EXHIBIT NO. DESCRIPTION
- ----------- ----------------------------------------------------------------

10.1 Amendment to Letter of Credit Agreement, dated as of March 27,
2003, by and among Arch Reinsurance Ltd., Arch Reinsurance
Company, Alternative Re Limited, Arch Insurance Company and
Fleet National Bank.

10.2 Amendment to Retention Agreement, dated as of April 10, 2003, by
and among ACGL, Arch Capital Group (U.S.) Inc. and Robert
Clements.

15 Accountants' Awareness Letter (regarding unaudited interim
financial information).

99.1 Certification of Chief Executive Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.

99.2 Certification of Chief Financial Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.

(b) REPORTS ON FORM 8-K.

ACGL submitted following reports on Form 8-K during the 2003 first quarter
on: (1) February 25, 2003 to furnish the 2002 fourth quarter earnings release
issued by ACGL; and (2) March 31, 2003 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. ACGL also submitted a report
on Form 8-K on May 12, 2003 to furnish the 2003 first quarter earnings
release issued by ACGL. Since these reports contain information that was
furnished, they are not incorporated by reference herein.

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: May 14, 2003 Peter A. Appel
President and Chief Executive Officer
(Principal Executive Officer) and Director

/s/ John D. Vollaro
-----------------------------------------------
Date: May 14, 2003 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: May 14, 2003

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: May 14, 2003

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

47

EXHIBIT INDEX

EXHIBIT NO. DESCRIPTION
- ----------- ----------------------------------------------------------------

10.1 Amendment to Letter of Credit Agreement, dated as of March 27,
2003, by and among Arch Reinsurance Ltd., Arch Reinsurance Company,
Alternative Re Limited, Arch Insurance Company and Fleet National
Bank.

10.2 Amendment to Retention Agreement, dated as of April 10, 2003, by
and among ACGL, Arch Capital Group (U.S.) Inc. and Robert Clements.

15 Accountants' Awareness Letter (regarding unaudited interim
financial information).

99.1 Certification of Chief Executive Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.

99.2 Certification of Chief Financial Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.