The US ART Market in the Current Economic Environment

1. The US ART Market in the Current Economic Environment

2. The US ART Market in the Current Economic Environment • Moderator – Gavin Collery President & COO Alternative Re Limited • Speaker 1 – Stephen D. Standing Vice President Kirkway International Limited • Speaker 2 – Richard Stock Senior Vice President Arch Insurance Company

3. The US ART Market in the Current Economic Environment The Market Cycle Merriam-Webster’s Online Dictionary: 1cy·cle Pronunciation: \sī-kəl\ Function: noun 1:an interval of time during which a sequence of a recurring succession of events or phenomena is completed <a 4-year cycle of growth and development>2 a: a course or series of events or operations that recur regularly and usually lead back to the starting point b: one complete performance of a vibration, electric oscillation, current alternation, or other periodic process c: a permutation of a set of ordered elements in which each element takes the place of the next and the last becomes first d: a takeoff and landing of an airplane3: a circular or spiral arrangement: as a: an imaginary circle or orbit in the heavens b:ring 10 4:a long period of time:

5. The US ART Market in the Current Economic Environment Dealing with the Insurance Cycle (From Wikipedia, the free encyclopedia) Whilst many underwriters believe that the cycle is out of their hands, Lloyd’s is trying to push for more proactive management of the ups and downs of the industry. In 2006 they published their ‘Seven Steps’ to managing the insurance cycle: 1. Don’t follow the herd. Insurers need to be prepared to walk away from markets when prices fall below a prudent, risk-based premium. 2. Invest in the latest risk management tools. Insurers must push for continuous improvement of these tools based on the latest science around issues such as climate change, and make full use of them to communicate their pricing and coverage decisions. 3. Don’t let surplus capital dictate your underwriting. An excess of capital available for underwriting can easily push an insurer to deploy the capital in unsustainable ways, rather than having that capital migrate to other uses such as hedge funds and equities, or returning it to shareholders.

6. The US ART Market in the Current Economic Environment 4. Don’t be dazzled by higher investment returns. Don’t let higher investment returns replace disciplined underwriting as base rates creep up on both sides of the Atlantic. Notionally, splitting the business into insurance and asset management operations, and monitoring each separately, is one way to achieve this. 5. Don’t rely on “the big one” to push prices upwards. The spectacular insured loss should not be used as an excuse to raise prices in unrelated lines of business. Regulators, rating agencies, and analysts - not to mention insurance buyers – are increasingly resisting such behaviour. 6. Redeploy capital from lines where margins are unsustainable. There is little that individual insurers can do to alter overall supply-and-demand conditions. But insurers can set up internal monitoring systems to ensure that they scale back in lines in which margins have become unsustainable and migrate to other lines. 7. Get smarter with underwriter and manager incentives. Incentives for key staff should be structured to reward efficient deployment of capital, linking such rewards to target shareholder returns rather than volume growth.[5]

7. The US ART Market in the Current Economic Environment - A Broker’s Perspective Stephen D. Standing Kirkway International Limited

8. The Dow Jones Industrial Average June 2008 – June 2009

9. September 2008 September 13, 2008: IKE hits Texas; $20bn Loss September 15, 2008: Lehman Brothers file bankruptcy September 16, 2008: AIG Bailout

10. 2008: Year in Review 2nd Costliest year ever with $50bn in insured losses (Swiss Re) $43bn from Cats $7bn from man-made events 240,000 deaths Policy Holder Surplus down by 11.3% (AM Best) Shareholder Equity down by 15% (AM Best)

11. Vaporized Capacity Retrocessional Capacity Diminishes – Retro increases will drive the reinsurance market which will trickle down to the insurance market. Cat Bond Market 2007: Record setting year. 2008: Decline of 62% in volume and 52% transaction size.

12. Vaporized Capacity cont. Currency Effect - Pound falls as Dollar climbs Credit Crunch – No way to recharge balance sheets due to contraction of capital markets. $3.5tr in losses tied to US Banking System. (John Mauldin)

13. Vaporized Capacity cont. Limited Number of Start-Ups Post 9/11: Close to $7bn capital raised between October and December 2001 (CD&P) Arch, AWAC, AXIS, Endurance, Montpelier Post Katrina: 53 new start-ups/Side-Cars/CAT Bonds with $21.4bn of capital Lancashire, Validus, Ariel, Harbor Point, Flagstone, Ironshore $12bn in Capital Additions from existing entities 2008 & 2009 Activity Torus, Iris Re, Timicuan Re II, Jubilee, W.R. Berkeley, Ren Re

14. Financial results for Selected Insurance Entities Source: Bermuda Insurance Update 2009 Vol. 1

15. Current Fronting Companies

16. Captive and RRG Growth

17. Domestic and Off Shore Captive Domiciles

18. Growth Prospects “Difficulties in the capital and credit markets may drive increased need to manage insurance risk finance through captive insurance vehicles for expense savings; also, anticipate hard market in the traditional insurance sector.” (Delaware) “With the economy in the state that it is in, companies are looking for cost-saving measures. Forming a captive insurance company is a strategy to achieve below market premiums and control company losses/claims over time through loss prevention efforts and enhanced risk management efforts.” (Hawaii) “These tough economic times have taken their toll on the traditional insurance companies’ balance sheets and their ability to properly service their customers. As a result, captives emerge as a solution to uncertainty, instability, and lack of service in the traditional market.” (South Carolina) “The economy will have bottomed out (hopefully), and the insurance market is expected to harden. We have already seen an increase over last year to date.” (Vermont)

19. Growth Prospects cont. 900 new captives incorporated worldwide in 2008 - 50% of growth came from middle market companies (US Captive, April 09) Health Benefits - Average cost savings of 5-10% as compared to the commercial insurance market (Business Insurance, March 09) 24.4% hike urged in California Workers’ Comp rates US Cat reinsurance rates may rise 20% on 7/1 (Munich Re) - Signs of things to come?

20. Buying Strategies Review security of fronting carriercarefully. Insist on buying Reinsurance separately - divide & conquer. Deeper analysis of reinsurance security; Avoid weak balance sheets, legacy issues and companies with no long term capital commitment. Stick with trusted reinsurers that you have built a “bank” of premium with. Buy Long; Multi Year contracts where ever possible, with built in reinstatements to avoid renegotiating mid crisis. Lock in aggregate protection to protect against adverse developments from rising loss ratios across all lines.

21. The US ART Market in the Current Economic Environment – A Carrier’s Perspective Richard Stock SVP – Alternative Markets – Arch Insurance Group

22. Agenda – Carrier Perspective • Overview of Arch Alternative Markets • Captive Marketplace Background • Impact of current economic condition on captives • Collateral • Viability and Interest in Captive Approach • Fronting carriers • Investments • Credit Risk to Insureds • Impact of current insurance marketplace on captives • Hard or Soft Market • Perception, reality, and expectations

23. Arch Alternative Markets • Target Markets • Group Programs including Start-ups • Individual Account Programs at lower-end of large account marketplace. • Work Comp, General Liability, and Auto Liability • Potential expansion into other lines of business • Distribution is mainly regional captive specialists • Claim Handling and Risk Control is unbundled • Deal with both rent-a-captive facilities and stand alone captives

24. Captive Marketplace Background • Major Concerns of Captive Participants • Collateral • Expanded utilization • Service • Fronting carriers • Cost of reinsurance • Investments • Tax Regulations • Other Concerns • Group captive credit concerns • Still a growing marketplace

25. Impact of Current Economic Environment Collateral • Gap collateral requirements a bigger disincentive to entering into a captive arrangement • Less financial flexibility for most firms • Credit is less available and more expensive • Movement to Reinsurance Trusts vs. LOCs • LOC is most common form of collateral used • LOCs, even those asset backed, are becoming more expensive • Other alternatives also being explored • 3rd party investor • Credit risk products • A bigger push to release collateral and distribute profits from captive programs

26. Impact of Current Economic Environment Viability and Interest in Captive Approach • Most companies are seeing a decline in revenue and payroll with certain industries, such as residential construction, seeing a significant impact • Premiums no longer at a level where a captive program is viable • Certain companies are in survival mode and can no longer take a long term view • Company focusing on ‘core’ business and less willing to invest time and capital in new areas

27. Impact of Current Economic Environment Viability and Interest in Captive Approach (Cont.) Impact • Some captive programs have been discontinued • 3 out of 10 of our CA focused programs have been discontinued. • One group program focusing on CA residential contractors had over 1/3 of its members discontinue operations. This along with significant exposure decreases and rate competition saw the program dissolve. • Another individual entity program saw its premium decrease by 95% due to exposure and rate decreases, thus making a individual captive program no longer viable. • More difficult to attract new members, all else being equal, although perception of hard market is resulting in more interest • Accounts looking to close-out programs to release profits and collateral • For many of the programs in run-off, we have been contacted concerning a commutation

28. Impact of Current Economic Environment Investments • A large percentage of captives are revisiting their investment approach • Some are deciding to become more conservative • Others are seeing this as an opportunity to invest in high-grade corporate securities

29. Impact of Current Economic Environment Fronting Carriers • Captive community generally view availability and cost as reasonable • However, fronting carriers are impacted by the economic environment, some more than others • Many fronting companies have seen staff reductions which may impact service and current relationships

30. Impact of Current Economic Environment Credit Risk to Insureds • Insurer or Captive bankruptcy – Some discussions occurring • Group member bankruptcy • Understanding of who pays • Little discussion to-date, but could have significant impact on certain groups

31. Impact of Current Insurance Marketplace Assessment of Current Insurance Marketplace • Numerous discussions about hardening market, but limited ‘true’ evidence • Rates have flattened, but no general increase in rates • Most rate increases are for accounts with exposure decreases • Flat or lower premium, but higher rates on a per exposure basis • Concerns over certain carriers • Perception is that market will harden, it just is not happening yet • Significant CA work comp rate increases on the horizon • State fund just filed for a 15% rate increase • Bureau recommended rate change of +25% • Medical trends and reverse of negative trends may start to drive Work Comp rate increases elsewhere • More signs of hardening market in the large account arena

32. Impact of Current Insurance Marketplace Impact • More insureds exploring captive options. • Perception and some early signs of a hardening market are driving this • For one of our CA Work Comp captives, we saw three new members in 2009, which were the first new members in over a year • Start-up captives are still happening, but difficult to get the focus of key start-up members • Collateral issues, competitive rates, and general economic conditions are driving this

33. Summary • Captive options generally viewed as a valuable tool in overall risk management • Captive market is growing, but growth has been slowed by • Economic Environment • Insurance Marketplace • Early signs of pending hard market increasing interest level in captive alternatives • Hardening market seems to be starting in large accounts, but little sign in mid-sized accounts • Expect more activity as economy stabilizes and insurance ‘hard’ market starts to take hold

34. Questions Questions?

35. Forward looking statement • The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward−looking statements. This presentation or any other written or oral statements made by or on behalf of Arch Capital Group Ltd. and its subsidiaries 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 presentation 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. A non-exclusive list of the important factors that could cause actual results to differ materially from those in such forward-looking statements includes the following: adversegeneral economic and market conditions;increased competition;pricing and policy term trends;fluctuations in the actions of rating agencies and ourability to maintain and improve our ratings;investment performance;the loss of key personnel;the adequacy of our loss reserves,severity and/or frequency of losses, greater than expected loss ratios and adverse development on claim and/or claim expense liabilities;greater frequency or severity of unpredictable natural and man-made catastrophic events;the impact of acts of terrorism and acts of war; changes in regulations and/or tax laws in the United States or elsewhere;our ability to successfully integrate, establish and maintain operating procedures as well as integrate the businesses we have acquired or may acquire into the existing operations;changes in accounting principles or policies;material differences between actual and expected assessments for guaranty funds and mandatory pooling arrangements;availability and cost to us of reinsurance to manage our gross and net exposures;the failure of others to meet their obligations to us; andother factors identified in our filings with the U.S. Securities and Exchange Commission. • 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. 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. We undertake no obligation to publicly update or revise any forward−looking statement, whether as a result of new information, future events or otherwise. • This information is intended for use by licensed insurance producers and not for public distribution. This information is qualified in its entirety by reference to periodic reports filed by Arch Capital Group Ltd. (“ACGL”) with the SEC, including, without limitation, the risks and other factors set forth therein. ACGL and its subsidiaries undertake no obligation to publicly update or revise any information contained herein. Not all insurance coverages or products offered by the subsidiaries of ACGL are available in all jurisdictions. ACGL and its subsidiaries undertake no obligation to publicly update or revise ay information contained herein. • Insurance coverage is underwritten by one or more member companies of Arch Insurance Group in North America, which consists of Arch Insurance Company (a Missouri corporation, NAIC # 11150), Arch Specialty Insurance Company (a Nebraska corporation, NAIC # 21199), Arch Excess & Surplus Insurance Company (a Nebraska corporation, NAIC # 10946) and Arch Indemnity Insurance Company (a Nebraska corporation, NAIC #30830).  Executive offices are located at One Liberty Plaza in New York City 10006.  Not all insurance coverages or products are available in all jurisdictions.  Coverage is subject to actual policy language. This information is intended for use by licensed insurance producers.