The following is a discussion and analysis of our financial condition and results of operations. This should be read in conjunction with our consolidated financial statements included in Item 1 of this report and also our Management's Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended December 31, 2011 ("2011 Form 10-K"). In addition, readers should review "Risk Factors" set forth in Item 1A of Part I of our 2011 Form 10-K. Tabular amounts are in U.S. Dollars in thousands, except share amounts, unless otherwise noted.

Arch Capital Group Ltd. ("ACGL" and, together with its subsidiaries, "we" or "us") is a Bermuda public limited liability company with approximately $5.24 billion in capital at March 31, 2012 and, through operations in Bermuda, the United States, Europe and Canada, writes 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 focus on writing specialty lines of insurance and reinsurance. It is our belief that our underwriting platform, our experienced management team and our strong capital base that is unencumbered by significant pre-2002 risks have enabled us to establish a strong presence in the insurance and reinsurance markets.

Current Outlook

The broad market environment continues to show improvement across the board. From a rate standpoint, almost all lines of business moved into positive territory in the 2012 first quarter with rate increases slightly above loss cost trends. In our insurance business, rates were up approximately 2% on a weighted basis. We experienced favorable rate movement on primary lines such as general liability, umbrella liability, auto liability and workers' compensation. Two exceptions to the overall rate trends were in large account healthcare which experienced rate reductions and executive assurance which remained flat during the 2012 first quarter. However, even with this improvement in the rate environment, additional rate increases are needed in many lines in order for us to achieve adequate returns given the current interest rate environment. In our reinsurance business, rates continued to improve significantly, on a risk adjusted basis, in property and property catastrophe business, with the best increases to date reflected in international, catastrophe exposed businesses. Such improvements were driven, in part, by the impact of the higher level of catastrophic activity in 2010 and 2011. All other lines remained basically unchanged although our reinsurance operations benefited from the underlying rate increases in primary lines noted above. Our underwriting teams continue to execute a disciplined strategy by emphasizing small and medium-sized accounts over large accounts and focusing more on short-tail business.

Our objective is to achieve an average operating return on average equity of 15% or greater over the insurance cycle, which we believe to be an attractive return to our common shareholders given the risks we assume. We continue to look for opportunities to find acceptable books of business to underwrite without sacrificing underwriting discipline and continue to believe that the most attractive area from a pricing point of view remains catastrophe-exposed business. We expect that catastrophe-exposed business will continue to represent a significant proportion of our overall book, which could increase the volatility of our operating results.

The current economic conditions could continue to have a material impact on the frequency and severity of claims and, therefore, could negatively impact our underwriting returns. In addition, volatility in the financial markets could continue to significantly affect our investment returns, reported results and shareholders' equity. We consider the potential impact of economic trends in the estimation process for establishing unpaid losses and loss adjustment expenses and in determining our investment strategies.

In addition, the impact of the continuing weakness of the U.S., European countries and other key economies, projected budget deficits for the U.S., European countries and other governments and the consequences associated with possible additional downgrades of securities of the U.S., European countries and other governments by credit rating agencies is inherently unpredictable and could have a material adverse effect

on financial markets and economic conditions in the U.S. and throughout the world. In turn, this could have a material adverse effect on our business, financial condition and results of operations and, in particular, this could have a material adverse effect on the value of securities in our investment portfolio.

Natural Catastrophe Risk

We monitor our natural catastrophe risk globally for all perils and regions, in each case, where we believe there is significant exposure. Our models employ both proprietary and vendor-based systems and include cross-line correlations for property, marine, offshore energy, aviation, workers compensation and personal accident. Currently, we seek to limit our 1-in-250 year return period net probable maximum pre-tax loss from a severe catastrophic event in any geographic zone to approximately 25% of total shareholders' equity. We reserve the right to change this threshold at any time. Based on in-force exposure estimated as of April 1, 2012, our modeled peak zone catastrophe exposure is a windstorm affecting the Gulf of Mexico, with a net probable maximum pre-tax loss of $860 million, followed by windstorms affecting the Northeastern U.S. and Florida Tri-County with net probable maximum pre-tax losses of $826 million and $608 million, respectively. Based on in-force exposure estimated as of January 1, 2012, our modeled peak zone exposure was a windstorm affecting the Gulf of Mexico, with a net probable maximum pre-tax loss of $881 million, followed by windstorms affecting the Northeastern U.S. and Florida Tri-County with net probable maximum pre-tax losses of $842 million and $638 million, respectively. Our exposures to other perils, such as U.S. earthquake and international events, are less than the exposures arising from U.S. windstorms and hurricanes. As of April 1, 2012, our modeled peak zone earthquake exposure (New Madrid earthquake) represented less than 50% of our peak zone catastrophe exposure, and our modeled peak zone international exposure (Japan earthquake) is substantially less than both our peak zone windstorm and earthquake exposures. Net probable maximum pre-tax loss estimates are net of expected reinsurance recoveries, before income tax and before excess reinsurance reinstatement premiums. Loss estimates are reflective of the zone indicated and not the entire portfolio. Since hurricanes and windstorms can affect more than one zone and make multiple landfalls, our loss estimates include clash estimates from other zones.

The loss estimates shown above do not represent our maximum exposures and it is highly likely that our actual incurred losses would vary materially from the modeled estimates. There can be no assurances that we will not suffer a net loss 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 and inadequacies in the data provided by clients and brokers, the modeling techniques and the application of such techniques or as a result of a decision to change the percentage of shareholders' equity exposed to a single catastrophic event. Actual losses may also increase if our reinsurers fail to meet their obligations to us or the reinsurance protections purchased by us are exhausted or are otherwise unavailable. See "Risk Factors-Risk Relating to Our Industry" and "Management's Discussion and Analysis of Financial Condition and Results of Operations-Natural and Man-Made Catastrophic Events" in our 2011 Form 10-K.

Financial Measures

Management uses the following three key financial indicators in evaluating our performance and measuring the overall growth in value generated for ACGL's common shareholders:

Book Value per Common Share

Book value per common share represents total common shareholders' equity divided by the number of common shares outstanding. Management uses growth in book value per common share as a key measure of the value generated for our common shareholders each period and believes that book value per common share is the key driver of ACGL's share price over time. Book value per common share is impacted by, among other factors, our underwriting results, investment returns and share repurchase activity, which has an accretive or dilutive impact on book value per common share depending on the purchase price.

Book value per common share was $33.33 at March 31, 2012, compared to $31.76 at December 31, 2011. The 4.9% change for the 2012 first quarter was generated through operating results and total return on investments for the period. We adopted new accounting guidance effective January 1, 2012 concerning the accounting for costs associated with acquiring or renewing insurance contracts. This guidance was adopted retrospectively and has been applied to all prior period financial information. The adoption of the new accounting guidance reduced the reported book value per common share by $0.27 at December 31, 2011. See Note 2, "Recent Accounting Pronouncements," of the notes accompanying our consolidated financial statements for additional information.

Operating Return on Average Common Equity

Operating return on average common equity ("Operating ROAE") represents after-tax operating income available to common shareholders divided by the average of beginning and ending common shareholders' equity during the period. After-tax operating income available to common shareholders, a "non-GAAP measure" as defined in the SEC rules, represents net income available to common shareholders, excluding net realized gains or losses, net impairment losses recognized in earnings, equity in net income or loss of investment funds accounted for using the equity method and net foreign exchange gains or losses, net of income taxes. Management uses Operating ROAE as a key measure of the return generated to common shareholders and has set an objective to achieve an average Operating ROAE of 15% or greater over the insurance cycle, which it believes to be an attractive return to common shareholders given the risks we assume. See "Comment on Non-GAAP Financial Measures."

Our Operating ROAE was 10.4% for the 2012 first quarter, compared to 0.7% for the 2011 first quarter. The higher Operating ROAE for the 2012 first quarter resulted from improved underwriting results which reflected a lower level of catastrophic events than in the 2011 period.

Total Return on Investments

Total return on investments includes net investment income, equity in net income or loss of investment funds accounted for using the equity method, net realized gains and losses and the change in unrealized gains and losses generated by our investment portfolio. Total return is calculated on a pre-tax basis and before investment expenses and includes the effect of financial market conditions along with foreign currency fluctuations. Management uses total return on investments as a key measure of the return generated to common shareholders on the capital held in the business, and compares the return generated by our investment portfolio against benchmark returns which we measured our portfolio against during the periods. The benchmark return is a weighted average of the benchmarks assigned to each of our investment managers and vary based on the nature of the portfolios under management.

The benchmark return index is a customized combination of indices intended to approximate a target portfolio by asset mix and average credit quality while also matching the approximate estimated duration and currency mix of our insurance and reinsurance liabilities. Although the estimated duration and average credit quality of this index will move as the duration and rating of its constituent securities change, generally we do not adjust the composition of the benchmark return index. The benchmark return index should not be interpreted as expressing a preference for or aversion to any particular sector or sector weight. The index is intended solely to provide, unlike many master indices that change based on the size of their constituent indices, a relatively stable basket of investable indices.

At March 31, 2012, the benchmark return index had an average credit quality of "Aa1" by Moody's, an estimated duration of 3.44 years and included weightings to the following indices:

                                                                      Weighting

Merrill Lynch Unsubordinated U.S. Treasuries/Agencies, 1-10 Years
Index                                                                     30.875 %
Merrill Lynch U.S. Corporates and All Yankees, 1-10 Years Index           20.875 %
Merrill Lynch Mortgage Master Index                                       11.875 %
Barclays Capital CMBS, AAA Index                                          10.000 %
Merrill Lynch Municipals, 1-10 Years Index                                 7.125 %
MSCI World Free Index                                                      5.000 %
Merrill Lynch U.S. Treasury Bills, 0-3 Months Index                        4.750 %
Merrill Lynch U.S. High Yield Master II Constrained Index                  2.375 %
Barclays Capital U.S. High-Yield Corporate Loan Index                      2.375 %
Merrill Lynch U.K. Gilts, 1-10 Years Index                                 2.375 %
Merrill Lynch EMU Direct Government 1-10 Years Index                       2.375 %
Total                                                                    100.000 %

The following table summarizes the pre-tax total return (before investment expenses) of our investment portfolio compared to the benchmark return against which we measured our portfolio during the periods:

                                                         Arch        Benchmark
                                                     Portfolio (1)    Return

Pre-tax total return (before investment expenses):
2012 first quarter                                            1.87 %      1.56 %
2011 first quarter                                            1.50 %      0.92 %

For the 2012 first quarter, total return on our portfolio reflected tightening credit spreads on our investment grade and high yield fixed income portfolios and favorable returns on our equities and alternative assets. These returns more than offset the effect of modestly higher U.S. Treasury yields. Our portfolio outperformed the benchmark return by 31 basis points for the 2012 first quarter, due in part to an overweighting in certain sector allocations to the benchmark return. Excluding foreign exchange, total return was 1.60% for the 2012 first quarter, compared to 1.14% for the 2011 first quarter.

Comment on Non-GAAP Financial Measures

Throughout this filing, we present our operations in the way we believe will be the most meaningful and useful to investors, analysts, rating agencies and others who use our financial information in evaluating the performance of our company. This presentation includes the use of after-tax operating income available to common shareholders, which is defined as net income available to common shareholders, excluding net realized gains or losses, net impairment losses recognized in earnings, equity in net income or loss of investment funds accounted for using the equity method and net foreign exchange gains or losses, net of income taxes. The presentation of after-tax operating income available to common shareholders is a "non-GAAP financial measure" as defined in Regulation G. The reconciliation of such measure to net income available to common shareholders (the most directly comparable GAAP financial measure) in accordance with Regulation G is included under "Results of Operations" below.

We believe that net realized gains or losses, net impairment losses recognized in earnings, equity in net income or loss of investment funds accounted for using the equity method and net foreign exchange gains or losses in any particular period are not indicative of the performance of, or trends in, our business. Although net realized gains or losses, net impairment losses recognized in earnings, equity in net income or loss of investment funds accounted for using the equity method and net foreign exchange gains or losses are an integral part of our operations, the decision to realize investment gains or losses, the recognition of net impairment losses, the

recognition of equity in net income or loss of investment funds accounted for using the equity method and the recognition of foreign exchange gains or losses are independent of the insurance underwriting process and result, in large part, from general economic and financial market conditions. Furthermore, certain users of our financial information believe that, for many companies, the timing of the realization of investment gains or losses is largely opportunistic. In addition, net impairment losses recognized in earnings on our investments represent other-than-temporary declines in expected recovery values on securities without actual realization. The use of the equity method on certain of our investments in certain funds that invest in fixed maturity securities is driven by the ownership structure of such funds (either limited partnerships or limited liability companies). In applying the equity method, these investments are initially recorded at cost and are subsequently adjusted based on our proportionate share of the net income or loss of the funds (which include changes in the market value of the underlying securities in the funds). This method of accounting is different from the way we account for our other fixed maturity securities and the timing of the recognition of equity in net income or loss of investment funds accounted for using the equity method may differ from gains or losses in the future upon sale or maturity of such investments. Due to these reasons, we exclude net realized gains or losses, net impairment losses recognized in earnings, equity in net income or loss of investment funds accounted for using the equity method and net foreign exchange gains or losses from the calculation of after-tax operating income available to common shareholders.

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

RESULTS OF OPERATIONS



The following table summarizes, on an after-tax basis, our consolidated
financial data, including a reconciliation of after-tax operating income
available to common shareholders to net income available to common shareholders:



                                                              Three Months Ended
                                                                  March 31,
                                                              2012          2011

After-tax operating income available to common
shareholders                                              $    113,660   $     7,576
Net realized gains, net of tax                                  40,873        21,585
Net impairment losses recognized in earnings, net of
tax                                                             (1,023 )      (2,680 )
Equity in net income of investment funds accounted for
using the equity method, net of tax                             24,826        29,673
Net foreign exchange losses, net of tax                        (20,541 )     (37,142 )
Net income available to common shareholders               $    157,795   $    19,012

The increase in after-tax operating income in the 2012 first quarter compared to the 2011 period primarily resulted from improved underwriting results which reflected a lower level of catastrophic loss activity. Our 2012 first quarter results included losses for current year catastrophic events of $23.0 million, net of reinsurance and reinstatement premiums, compared to $178.7 million in the 2011 first quarter.

Segment Information

We classify our businesses into two underwriting segments - insurance and reinsurance - and corporate and other (non-underwriting). Management measures segment performance based on underwriting income or loss. We do not manage our 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.

Insurance Segment



The following table sets forth our insurance segment's underwriting results:



                                         Three Months Ended March 31,
                                         2012         2011      % Change

Gross premiums written                $   688,113   $ 634,583        8.4
Net premiums written                      490,680     449,291        9.2

Net premiums earned                   $   441,740   $ 407,591        8.4
Fee income                                    530         778
Losses and loss adjustment expenses      (303,164 )  (297,723 )
Acquisition expenses, net                 (73,870 )   (61,415 )
Other operating expenses                  (73,370 )   (74,629 )
Underwriting loss                     $    (8,134 ) $ (25,398 )      n/m




                                                % Point
Underwriting Ratios                             Change
Loss ratio                       68.6 %  73.0 %    (4.4 )
Acquisition expense ratio (1)    16.6 %  14.9 %     1.7
Other operating expense ratio    16.6 %  18.3 %    (1.7 )
Combined ratio                  101.8 % 106.2 %    (4.4 )

The components of the insurance segment's underwriting results are discussed below.

Premiums Written.



The following table sets forth our insurance segment's net premiums written by
major line of business:



                                            Three Months Ended March 31,
                                               2012               2011
                                          Amount        %     Amount      %

Programs                                $    81,616     17   $  74,396    17
Property, energy, marine and aviation        79,819     16      76,418    17
Professional liability                       70,561     14      59,385    13
Executive assurance                          68,378     14      56,068    12
National accounts                            35,438      7      40,191     9
Construction                                 33,653      7      31,509     7
Casualty                                     26,973      5      30,134     7
Travel and accident                          22,836      5      21,501     5
Lenders products                             22,415      5      21,074     5
Surety                                       12,134      2       9,734     2
Healthcare                                   10,635      2       9,117     2
Other (1)                                    26,222      6      19,764     4
Total                                   $   490,680    100   $ 449,291   100

Increases in professional liability, executive assurance and program business were partially offset by reductions in casualty lines. The growth in professional liability premiums primarily reflected new business written in small and medium sized accounts in the U.K. while the increase in executive assurance business primarily resulted from small and medium sized accounts in the U.K. and the U.S. The increase in program business primarily reflected growth in existing accounts. The reduction in casualty lines was due, in part, to the loss of one account in the national accounts line.

Net Premiums Earned.



The following table sets forth our insurance segment's net premiums earned by
major line of business:



                                            Three Months Ended March 31,
                                               2012               2011
                                          Amount        %     Amount      %

Property, energy, marine and aviation   $    78,494     18   $  73,599    18
Programs                                     73,998     17      67,018    16
Professional liability                       63,256     14      67,400    17
Executive assurance                          58,766     13      54,570    13
Lenders products                             32,153      7      18,236     4
Construction                                 31,808      7      28,391     7
Casualty                                     29,065      7      28,427     7
National accounts                            19,136      4      21,162     5
Travel and accident                          16,713      4      15,599     4
Surety                                       10,560      2       9,779     2
Healthcare                                    8,898      2       8,652     2
Other (1)                                    18,893      5      14,758     5
Total                                   $   441,740    100   $ 407,591   100
. . .