Operator:

Good day, ladies and gentlemen, and welcome to the Q2 2024 Arch Capital Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. As a reminder, this conference call is being recorded. Before the Company gets started with its update, management wants to first remind everyone that certain statements in today's press release and discussed on this call may constitute forward-looking statements under the federal securities laws. These statements are based upon management's current assessments and assumptions and are subject to a number of risks and uncertainties. Consequently, actual results may differ materially from those expressed or implied. For more information on the risks and other factors that may affect future performance, investors should review periodic reports that are filed by the Company with the SEC from time to time. Additionally, certain statements contained in the call that are not based on historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The Company intends the forward-looking statements in the call to be subject to the Safe Harbor created thereby. Management also will make reference to certain non-GAAP measures of financial performance. The reconciliations to GAAP for each non-GAAP financial measure can be found in the Company's current report on Form 8-K, furnished to the SEC yesterday, which contains the Company's earnings press release and is available on the Company's website at www.archgroup.com and on the SEC's website at www.sec.gov. I would now like to introduce your host for today's conference, Mr. Marc Grandisson and Mr. Francois Morin. Sirs, you may now begin.

Francois Morin:

Thank you, Marc, and good morning to all. As you know by now, we reported excellent second quarter results last night with after-tax operating income of $2.57 per share, up 34% from the second quarter of 2023 for an annualized operating return on average common equity of 20.5%. Book value per share was $52.75 as of June 30, up 6.9% for the quarter and 12.4% on a year-to-date basis. Once again, our three business segments delivered outstanding results, highlighted by $762 million in underwriting income and a 78.7% combined ratio, 76.7% on an underlying ex cat accident year basis. We continue to benefit from strong market conditions across our businesses as the pricing environment remains disciplined, giving us confidence in our ability to generate solid returns over the coming quarters. Our underwriting income reflected $124 million of favorable prior development on a pretax basis or 3.5 points on the combined ratio across our three segments. We recognize favorable development across many lines of business, but primarily in short tail lines in our Property and Casualty segments and in Mortgage due to strong cure activity. Catastrophe loss activity was in line with our expectations as we were impacted by a series of events across the globe, generating current accident year catastrophe losses of $196 million for the group in the quarter. Approximately 70% of our catastrophe losses this quarter are related to U.S. secondary perils with the rest coming from a series of international events. As of July 1, our peak zone natural cat PML for a single event one-in-250-year return level on a net basis declined slightly and now stands at 7.9% of tangible shareholders' equity, well below our internal limits. For the Mortgage segment, since this is the first quarter end since we acquired RMIC Companies, Inc. and the subsidiaries that together comprised a runoff mortgage insurance business of Old Republic, there are certain items that I'd like to highlight. First, the acquired book of business represented $3.6 billion or a 1.2% increase to our U.S. primary mortgage insurance in force at the end of the quarter. Second, given the risk and forces from older vintages and has been in runoff since 2011, its makeup resulted in an incremental 19 basis points to our reported delinquency rate at U.S. MI. Absent this transaction, our reported delinquency rate would have improved slightly since last quarter. On the investment front, we earned a combined $531 million pretax from net investment income and income from funds accounted using the equity method or $1.39 per share. Total return for the portfolio came in at 1.33% for the quarter. Cash flow from operations remained strong. And a $3.1 billion on a year-to-date basis, we have seen material growth in our investable asset base, which should result in an increasing level of investment income. Our effective tax rate on a pretax operating income was an expense of 9.5% for the second quarter, with our current expected range of 9% to 11% for the full-year 2024. As disclosed last week, we now expect an August 1 close of the transaction to acquire the U.S. MidCorp and Entertainment insurance businesses from Allianz. At this time, we do not have new information to share on the estimated financial impact of the transaction beyond what we provided in early April. Starting next quarter, we expect to update this information to help in developing a forward-looking view of the insurance segment's results, including this new business. All in, our balance sheet is in excellent health with our common shareholders' equity approaching $20 billion, a net debt plus preferred to capital ratio was slightly above 15%. We are well positioned to take advantage of opportunities that may arise as we move forward. Before I conclude my remarks, I also wanted to take a moment to build on Marc's comments and share a word of sincere appreciation for the impact Dinos had on Arch, its employees and many others across the industry. While he will certainly be remembered for his energetic personality and his ability to captivate an audience, we are truly grateful for his guidance, vision and leadership during his career at Arch. Thank you, Dinos. Marc?

Operator:

Thank you. [Operator Instructions] Our first question comes from Elyse Greenspan from Wells Fargo.

Marc Grandisson:

Well, like I said – well, good morning, Elyse. I think the point we made last quarter, the quarter before is that the casualty turn and realizing actually how much well or bad you're doing in casualty line takes a while. It has a tail to it. It could take five or six years. So I think we're seeing the – we start to see the early signs of more recent years being a bit more impacted by the inflation that we saw of late. And I think that it will take a while. People are trying to adjust. We're trying to look at the numbers in the triangles that are actually not as good as they used to be. So there's a lot of uncertainty in the space. And I think it will take us several quarters to come to a more stable or a better view of the industry. So the last hard market in casualty started to turn in 2000. And it took until about 2004 to really see the impact and sort of running out of – having to price and rate increase after that point. So it takes several years. Unlike the property cat right at least 2022 something happened at the bottom in the fall, will right away that people are adjusting because the cost of goods sold or losses are known. So this is not surprising to me. I'm expecting a bit more – we're expecting a bit more. We're seeing it through our reinsurance emissions. I think people are slowly, but surely recognizing some of these bad years, but it takes a while.

Marc Grandisson:

Well, as you know, Elyse, we report the numbers as we see it based on the data that we see. That sort of seems to be the emerging sort of rough average over the last couple of years. There's also a mix going on, Elyse. So things are shifting, as you know, from time to time. So it's hard to compare combined ratio. But right now, based on where we are, it's well within the expectation of getting the returns. And our returns on insurance, we believe are in excess of our long-term target.

Francois Morin:

Great question. I think – I mean, I and many others have been wrong about taking a forward-looking view of releases on – or favorable development on mortgage in general. I think, right, stepping back, I'd say that early in 2020 – late 2022, early 2023, we are more cautious about the state of the economy and took a view about new notices and average reserves that we are attaching to these notices that was a bit more that didn't turn out to be the case, right? They turnout to be better than what we had expected at that time. The fact that we just had another quarter of more – better cure activity. I don't think a lot of these cures this quarter were related to the 2023 accident year. So we're more positive, I think, I'd say in general about the housing market. So the level of reserving that we're attaching to the new delinquencies is a bit lower than it was a year ago. So maybe directionally, we would not expect to have the same level of reserve releases going forward. But again, not knowing for sure how quickly people are going to cure unemployment, et cetera, I mean, that will be – that will have an impact on the level of reserve releases.

Francois Morin:

Welcome.

Jamminder Bhullar:

Hi. So first, just a question on reserves. You had favorable development overall, and so did many of your peers. But a lot of the competitors had adverse development in casualty for both older and recent years. It doesn't seem like you had that, but maybe you could go into detail a little bit on the development in the second quarter. And then also, why do you feel that you're not as susceptible as some of the competitors do all the casualty issues, either in your book or maybe in the Watford block that you inherited?

Marc Grandisson:

And what I would add to what Francois just said, and as you know, Jimmy, we're a cycle manager. We also didn't write as much in even the year that we believe are now still very soft year. So that also prevents you from having to – to having outsized no surprise.

Francois Morin:

Yes. I mean that – the philosophy has not changed, right? I'd say, certainly, we are on track to close the Allianz acquisition tomorrow, so that will certainly be a draw on that capital base that we have. We are also entering the active wind season, so we'll want to take a look at what – how that develops. But absolutely, going forward, the fact that we historically have been very – I think, very good stewards of capital, we like to deploy it in the business where we can. But if there are no opportunities beyond what we – what's in front of us, in the coming months, we'll do what we've always done is return that capital, and it could be in the form of share buybacks or dividends or any other method.

Operator:

Our next question comes from Josh Shanker from Bank of America.

Marc Grandisson:

Yes. Well, first, Josh, is I'd probably raised my memory what we did wrong in 2004 and 2005, but thanks for reminding me. What I would tell you, Josh, is we talk about this at underwriting meetings. Our underwriters and our underwriting executives are acutely aware of that phenomenon. We also have to remind ourselves that pricing is going up as we talked about, specifically non-casualty, which seems to be the more acute area. I think it will take a longer time to go down or it takes longer to take down, right. It goes up in an elevator and goes on an escalator. So that's probably why we would expect the market to be. I think we're aware of this. Now we have more data, we have more experience, we have an existing platform, underwriters. Many of them have been there through those years. So very confident that we will be more judicious, if you will, in terms of holding the line when the market gets a little bit softer. In terms of growth, we still have like close to 11% growth in P&C, which is a big feat. It's still – it's a very, very good growth. But as I said in my comments, and you probably heard already, Josh, the market is a little bit more reaching equilibrium in terms of supply and demand for the risk. So the question that we have to ask ourselves all the time is, if we push too hard, we might dilute the broader margin and return expectations in the marketplace. So we take this. And not only us, by the way, I think the market is broadly very, very widely behaving the same way. People want to make sure that they get it right and nobody wants to be the first one running out and doing something that will probably jeopardize or not jeopardize, but maybe take down the returns expectations. So it's just that kind of the market, Josh. The equilibrium on the supply and demand for capacity is just coming back more to a more normal level. It's still on the side of the underwriters, but it's clearly moving in a more equilibrium state.

Francois Morin:

Well, I mean, first, on the Allianz transaction, we disclosed that we were – the rough numbers of capital that we were going to deploy in that transaction is $1.8 billion, which is the premium we're paying to acquire the asset and also the capital that we need to deploy to support the LPT that's coming our way immediately and then the ramp-up of the new business or the renewals that will end up on our balance sheet. So sizable number. And that is so far – I mean, as far as we know, I mean, there's – things are on track to be kind of at that level. To your point, yes, we – I mean, returns have been excellent, and we're very – we're proud of that. But we're not going to accumulate capital just that we can't deploy forever. So the reality is if you give us another couple of quarters maybe, but I mean, we'll definitely have a better view of where things stand by later this year. And then Marc has been talking about the casualty can pick up potentially. So if that accelerates in the third and fourth quarters and early next year, then we want to have the capital ready to deploy there. So that's certainly how we think about a big picture, but it's an ongoing discussion we have here.

Marc Grandisson:

Thanks, you too.

Michael Zaremski:

Thanks. I'll keep with the theme on casualty and social inflation, especially since we do value your thoughts on this. I guess, can you remind us, two part, I believe you've said in the past that Arch's casualty reserve reviews are more geared towards the summer months. And related, now that you've been studying your book and the industry a little bit more. I recall last year, not just – and Marc, you had said, but others have said too that they thought that the casualty pressures would be more large accounts kind of than small accounts. But the data we see so far appears to be that the small account players have really added to the reserves more so. So I don't know if there's any thoughts there? Thanks.

Francois Morin:

Yes. The one quick thing just to add on reserving, we monitor actual versus expected experience quarterly. That's a big part of the process. And not only do we do it against our own expectations but we monitor against our external actuaries expectations. So we got two views of how independent groups of actuaries think business or the reserves should develop over time. And that certainly informs the action we take every quarter. And to Marc's point, that's done in all the business units regularly.

Marc Grandisson:

I think – yes. No, I think – no, again, repeating what we said before, and it's always hard to appreciate from your perspective, I'm sure, is that the Reinsurance has more volatility into it. So we tend to look at this on a longer-term average. So sometimes, we have a quarter – I remind everyone here, sometimes we have a quarter where the combined – the current accident year, ex-cap combined ratio and reinsurance goes up a little bit and people say it's a trend, but it's very hard to see this in Reinsurance. Sometimes it's above, sometimes it's below. I think this quarter, frankly, we had no lower attritional losses across the Reinsurance portfolio. And this is what – this what explains that. But if you look on a 12-month basis, it's not as drastic of a move.

Michael Zaremski:

Okay. That's helpful. And I'll sneak one last quickly on Mortgage just on a macro perspective. Would – if home price appreciation continues at a healthy pace or I guess, resumes at healthy pace with that, is that any factor in kind of the reserve release as maybe it was unexpected? Is there anything there from a very high level we can think about?

Michael Zaremski:

Thank you.

Operator:

Our next question comes from David Motemaden from Evercore.

Marc Grandisson:

Yes. It's a pretty small increase. And this is – we don't want to ascribe any more precision to those numbers. They're judgment call quite often times. I think it's just a reflection of the mix and perhaps one on the business, the actuaries may take a little bit more of a conservative or a prudent stance and put a bit more – increase the loss ratio for a certain year or certain line of business or product line. That's really all there is to it. I think the variability around this even on an insurance level, we're a specialty writer. So there's a lot of things going on all at once in our portfolio. It's not very – it's not as predictive, I guess, as we wish we could be. But this is also why we believe we can attract higher returns because there's a lot more uncertainty in selecting the loss ratio pick. I would just attribute it to noise that happens from time to time as well as mix. Francois, anything to add?

David Motemaden:

Great. Thanks. And then Francois, you had mentioned the actual to expected. Wondering if we could just get a little bit more color on that for the quarter? And then if you guys have changed your view of expected losses, just given it appears like claims payment patterns have been extending. So I'm wondering if that's been reflected as well in your expected – expectations?

David Motemaden:

Great. Thank you.

Operator:

Our next question comes from Charlie Lederer with Citigroup.

Marc Grandisson:

I'm going to say this is one of the easiest answer, yes and yes to both of your questions, yes and yes. Yes, yes, we believe we took a conviction that there was a heightened – higher likelihood of frequency of events. And you're right, and it could change. This will be a short-term perspective, and this will help inform whatever new vision or new projection and new belief we have will help us make a decision as we get into 1/1 2025 after the wind season is over. Mind you, the business is still very good even with our increased frequency. So it's still a very, very good book of business. We just wanted to have the right balance.

Marc Grandisson:

Yes, well, on the CrowdStrike, I mean we're still gathering information on our units, want to figure out what's out there and it's not only the – necessarily the cyber, but there might be some other lines of business. So we're just going through it as we speak. It's still kind of hard to disentangle. I mean some people are claiming some losses. They're not insured. So there's a lot of things going on. I think we tend to agree broadly with the market view that $500 million, $600 million to $1.2 billion. That's sort of – it's still a wide range at this point in time. It's going to take a while to know how it develops. I think I would want to – I mean it's not a big number in terms of loss ratio points for all the premium worldwide for cyber, but it's certainly a reminder that there's risk in the portfolio. And it's early now, we haven't seen them any renewals, but I would expect rates could still go down a little bit, but probably not as fast as they were going down. And people are going to probably take a bit of a more of a pause, if you will, to evaluate what it looks like. It can go either way, right? If CrowdStrike does not create a big loss, that might reinforce to believe that it's not as risky. Although, having that event, which was not malicious, happened out of nowhere, and we were all like out of – unable to work for a day, I think it's a good reminder of people that there's still uncertainty and there's some loss potential there.

Marc Grandisson:

Welcome.

Andrew Kligerman:

Hey. Thank you. Good morning.

Andrew Kligerman:

So I was interested in the net written premium there in professional lines. It looked like you were pretty much flattish this quarter year-over-year at $345 million. Could you share some of the puts and takes? Was public D&O awful lot? Did you see a pickup or a decrease in cyber? What were some of the big lines? And how do they move?

Andrew Kligerman:

Got it. And along the same lines in reinsurance, property ex catastrophe, it was up quite a bit at $585 million versus $457 million last year. What did you like in the property area in reinsurance?

Francois Morin:

Yes. And I'll add to that quickly. Just on the accounting side, it's important to remember that the property cat line of business is mostly on an XOL basis where we write all the premium on day one versus this property other than property cat line where the component that is on a quota share basis, the premium is written evenly throughout the exposure period. So they could very well be – there's accounts that we wrote at 1/1, for example, that the ramp-up of that premium is taking place over the four quarters of 2024 as we write the premium. So a little bit of a different kind of accounting policy on those types of reinsurance agreements, and that certainly has an impact on how it shows up in the quarterly numbers.

Francois Morin:

Well, the investments that we made through this quarter are not related to that, right? So they are other opportunities, other efforts that we have underway that were predictive analytics, some tech companies that we've invested in. So we feel it's the right time for us to make those investments given how strong the returns are. And we'll see how those develop over time, maybe they slow down the road. But for now, we're very comfortable with the level of investments we're making. In terms of Allianz, just we'll give you more information as we move forward, but there will certainly be some integration expenses that will come through in the insurance segment, specifically going forward. Some of those expenses that will be kind of onetime, and we'll probably report those as part of a transaction cost and others. So that will clarify that for everybody once we close and after we have a time to – some time to digest it. But yes, the investments so far this quarter are for other initiatives.

Marc Grandisson:

Welcome.

Brian Meredith:

Yes. Thanks. A couple of them for you guys. The first, I'm just curious, do you all still stand by the three-year payback period for share buyback when it comes to book value dilution?

Brian Meredith:

Got you. That's helpful. Thank you. And then, I guess, my next question, thinking about M&A here, it looks like you probably have the financial capacity to still do a reasonable amount of M&A. But do you have the kind of, call it, management and strategic – or call it, management capacity at this point as you're integrating the Allianz business or Fireman's Fund business over the next, call it, six to 12 months to do anything? You're going to kind of take a pause here for a while?

Francois Morin:

I mean these opportunities were – I mean, actually geography-specific and segment specific. So the Allianz acquisition is purely insurance North America. So that absolutely has taken center stage. But if we were to do some other M&A in other parts of the world in the reinsurance segment, that could be a different team most likely that would contribute.

Francois Morin:

Not materially because it's not as much in our peak zone. The book is more diversified, more Midwest, more California, less Florida, which is our peak zone. So in terms of the 1-in-250, marginal impact.

Operator:

Our next question comes from Meyer Shields from KBW.

Marc Grandisson:

No, I think that if you look at a high level, I think our exposure was – is more stable. It may have grown a little bit even on a gross basis, but what happened is we just shaped it through retrocession purchases. That's really what we did. And that's how we got back to a more reasonable and more acceptable level of PML.

Marc Grandisson:

Not really. I mean the third-party capital that we hear – again, even those third parties, there's a healthy level of rationality in the behavior. So we haven't seen, like I said before, crazy players or mavericks in the marketplace. It's a pretty well-behaved marketplace.

Marc Grandisson:

Sure, Meyer.

Marc Grandisson:

Thank you very much, everyone. We'll talk to you again in October.

Operator:

Good day, ladies and gentlemen, and welcome to the Q1 2024 Arch Capital Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. As a reminder, this conference call is being recorded. Before the company gets started with its update, management wants to first remind everyone that certain statements in today's press release and discussed on this call may constitute forward-looking statements under the federal securities laws. These statements are based upon management's current assessments and assumptions and are subject to a number of risks and uncertainties. Consequently, actual results may differ materially from those expressed or implied. For more information on the risks and other factors that may affect future performance, investors should review periodic reports that are filed by the company with the SEC from time to time. Additionally, certain statements contained in the call that are not based on historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The company intends the forward-looking statements in the call to be subject to the Safe Harbor created thereby. Management will also make reference to certain non-GAAP measures of financial performance. The reconciliations to GAAP for each non-GAAP financial measure can be found in the company's current report on Form 8-K, furnished to the SEC yesterday, which contains the company's earnings press release and is available on the company's website at www.archgroup.com and on the SEC's website at www.sec.gov. I would now like to introduce your host for today's conference, Mr. Marc Grandisson and Mr. Francois Morin. Sirs, you may begin. Marc Grandisson Thank you. Good morning, and welcome to Arch's First Quarter Earnings Call. We are pleased to report a terrific start to the year. In the first quarter, we posted $736 million in underwriting income and a 5.2% increase in book value per share as we realized the benefits from several years of strong and profitable premium growth. Underwriters in our P&C units continued to lean into hard market conditions, writing $5.6 billion of gross premium in the quarter, a 26% increase from the same quarter last year. Overall, rate changes are exceeding loss trends, and absolute returns remain above our long-term targets, positive indicators in our continued efforts to deliver superior results to our shareholders. Broadly, we are seeing incremental signs of increased underwriting appetite in the market, but this is not surprising, given the favorable conditions that exist. It is still an underwriter's market where Arch can thrive. At the beginning of this hard market, as other providers pull back, Arch sought to establish itself as a key trading partner, aiming to solidify relationships and remain top of mind when it comes to addressing our clients' increased needs. Our success in establishing deeper client connections continues to pay dividends in this extended, yet increasingly competitive hard market. The first quarter served as a reminder of our risky world when an active catastrophe quarter concluded with a major industry loss, as the Dali cargo ship collided with the Francis Scott Key Bridge in Baltimore. Although we recognized a loss related to this event, the virtue of having multiple lines of business with improved and positive expected margins, made this event manageable for Arch. Incidents like this reinforce the importance of our core tenants. One, we practice disciplined underwriting that builds a meaningful margin of safety into our pricing. Two, we take a long-term view of risk and a conservative approach to reserving. And three, we operate a diversified global business that we believe maximizes our total return by mitigating volatility in any one line of business. Capital management has been a key differentiator for Arch and is integral to how we operate our company. Effective capital management requires that we allocate resources to the most profitable underwriting opportunities, while retaining the flexibility to invest in our platform when we find attractive opportunities. One of those prospects came to fruition earlier this month, when we announced our intent to acquire Allianz's US. middle market and entertainment businesses. We see this as a unique opportunity to quickly build scale in the $100 billion-plus US. middle market, a long-term strategic area of underwriting interest for us. Increasing our middle market presence will further diversify our North American insurance platform by adding stable businesses with recurring premiums that can generate attractive returns over the cycle. As a cycle manager, we like having many ponds to fish in, and this acquisition will significantly expand our opportunities in the middle market pond for years to come. I'll now share a few highlights from our segments. As you know, The Property and Casualty market cycle is evolving, but still offers attractive growth opportunities at good returns, particularly for our skilled specialty underwriters, who can use their expertise and experience to differentiate Arch. The first quarter results from our Reinsurance segment were outstanding. Underwriting income for the segment was $379 million, while gross premium written grew by 41% over the same quarter last year. While there is some developing competition, we're observing an increased flight to quality and fully expect to capitalize on that trend as the cycle ages. Our Reinsurance segment is in an enviable position. The in-force book constructed over the last several years is strong and allows us to exercise our underwriting acumen. When opportunities emerge, whether from dislocation in the casualty market or by offering value that others cannot, Arch is there to provide solutions and financial strength to its clients. In our Insurance segment, growth tapered from the highs of the past few years as rate increases slowed and some of the dislocations were met by additional capacity. Overall, conditions remained strong and the market is behaving rationally, two important factors that continue to support growth and strong profit. In the first quarter, we fund growth opportunities in several lines, including Property and Casualty E&S and other specialty lines. Across most of our specialty lines, pricing remains very healthy, and we are able to deploy capital in order to deliver attractive returns above our long-term target of 15%. Like Reinsurance, our Insurance segment has made strong efforts to establish itself as a first-choice provider for its clients, and that manifests in seeing more opportunities. In life, you have to play to win, and in insurance, if you don't see the business, you can't write it. And now let's pivot from P&C to Mortgage, which to borrow from a famous ad campaign just keeps on going and going and going. Our Mortgage segment continues to generate solid underwriting income and risk-adjusted returns from its high-quality portfolio. While Mortgage originations remain tempered by high mortgage interest rates, the persistency of our in-force book remains a healthy 83.6%, while the delinquency rate is near all-time lows. New insurance written is in line with our appetite given market conditions. When the mortgage market picks up again, we're prepared to increase our production. However, if the status quo persists, we're content with our current situation that has extended the duration over which we earn mortgage insurance premium. Competition within the MI industry remains disciplined, which means we are in a good place. Finally, our Investments portfolio grew to $35.9 billion, generating $327 million of net investment income in the quarter. The extraordinary premium growth from our P&C segments continues to increase our float, which provides a significant tailwind to our overall earnings through the next several quarters. In the US, the NFL conducted its annual draft this past weekend. Traditionally, the team that finished last season with the worst record gets the first pick, a chance to select the best college player, while the champions pick last. The player selected with the top picks are expected to be immediate difference makers, even though they are typically selected by a team with multiple deficiencies, making success far from guaranteed. If you're a talented quarterback has nobody to throw the ball to, it can ruin the player's confidence, and the pressure can quickly sabotage a career. Compare this with teams drafting at the end of the round coming off successful seasons with talented rosters in place. They often have the luxury of selecting an excellent player who doesn't need to contribute right away. Instead, these teams select players who can fill a specific short-term role and be given time to grow into a difference maker. Our acquisition of the Allianz MidCorp business is like adding a solid player to a winning team. We already have established all-stars, a winning talent-dense culture in a favorable schedule in the years ahead. Adding the MidCorp team to our diversified franchise makes us better today and tomorrow, and that's a winning proposition. I'll now turn it over to Francois to provide some more color on our financial results from the quarter, and then we'll return to take your questions. Francois?

Operator:

[Operator Instructions] Our first question comes from the line of Elyse Greenspan from Wells Fargo.

Marc Grandisson:

Yes. The casualty market is going through, I wouldn't say repricing, but not re-underwriting as thorough because it has been already getting -- was hard, getting harder for the last several years. We may have some respite in terms of price increase middle of last year. But I think that the development of the prior year, as we all know, has created a little bit more uncertainties, and inflation is not ebbing. So right now, what we're seeing is people still being very, very careful and disciplined in how they underwrite the business, which leads Arch and gives us opportunity to lean into this even more so. We have grown our casualty book of business on the insurance side quite a bit. Our casualty book is E&S, as we all know, and very specialized in specialty. But sorry, I thought there was some technical difficulties here. Elyse, are you still there? I just want to make sure you can hear me.

Marc Grandisson:

Okay. Thank you, you. Thank you, you're a trooper. So the casualty market on the insurance side, we're growing, but I think now we're having more opportunities to grow. I think that there's some kind of -- not repricing, but definitely a focus on that line of business on the Insurance side. On the Reinsurance side, I think we're starting to see some of the renewals that came through and anecdotally it's creating a little bit more friction in terms of renewal of the casualty quota share, for instance. So what we expect right now is the early stages. We don't know how long it's going to last and where it's going to go, but there's clearly a psychological belief within the human system and the human interaction in the casualty that people need and know that we need to get more rate to make up for all the risks and potentially some of the misses that we had in the past.

Marc Grandisson:

Yes. We have a long list of things we'd like to acquire or have part of our arsenal. We talk about Allianz as an acquisition, and that's an important one and a significant one and a very good one for us. We're very pleased with that one. But what we also would want to tell our shareholders is, as you know, Elyse, we've also added teams along the way. So acquisition, a pure acquisition of a company is not the only thing that we're able to do. We've acquired some teams to do contingency, some more terror and everything in between. So we're always on the lookout. Again, as a cycle manager, Elyse, what you want is as many areas to deploy your capital, depending on the market conditions, creates a much more stable enterprise, much less volatility to the bottom line. And again, the more -- the market cycles are not monolithic, they are in multi phases and multi places. So we also have a little bit of an inside baseball. We -- our executive team is always -- almost every other month -- we have a list, a wish list that I will not share with you on this call, but it's a wish list of things that we know for a fact would be accretive and additive to our diversification of our portfolio, and we're always on the lookout for those. Mid market was on the list. And this is what -- so opportunities met the willingness to do it, and this is where we are.

Jamminder Bhullar:

Hi, good morning. So, just a question on the Baltimore bridge loss that you reported in Insurance and Reinsurance. And I recognize your results were pretty strong overall. But the number seems fairly high that you reported relative to what some of your peers have talked about and also what the industry losses seem to be? So I'm just wondering, I'm assuming most of this is IBNR, but just wondering sort of -- is this because of how much conservatism there was baked into the number? Or maybe the market is underestimating what the losses from the event are eventually going to end up being?

François Morin:

Yes. I mean again, we can't speculate or comment on how others may or may not be reserving for this event. For us, it's not unusual. And I'd say that we've taken a very conservative view of the loss and still a lot to be determined, obviously, in terms of who's going to end up paying for it. But -- and the last point you asked last question is, yes, for us right now, it's all IBNR, I mean we don't really have all the specifics to establish case reserves. So we booked it as IBNR and we'll see how things develop.

François Morin:

Well, part one of your question, there was really no material development on long-tail casualty lines of business across all years. So both pre-2015 to '19 years and '21 to '23. So we're very comfortable with that. I think our reserves are holding up nicely. And I know there's been some concerns around the more recent years where there's been some signs of adverse in the industry. We're not seeing that. Actually, our metrics or our actuaries are commenting that our actual development is coming in more favorable than expected. Again, very early to declare victory, but that's certainly for us a positive sign, and we'll keep monitoring and see how things develop for the rest of the year.

Andrew Kligerman:

Hey, thank you and good morning. Marc, you mentioned that the MI market is going and going and going. How do you think about the favorable prior year developments? I mean last year in the first quarter, it was 25 points this year. In the first quarter, it's another 25 points. I mean does that still continue going forward as well?

Andrew Kligerman:

Pretty amazing stuff. And then my follow-up question is around the Allianz acquisition. And I love your analogy about the NFL draft and picking the high-quality players. Some have criticized Allianz as maybe I'll say they weren't a first round draft choice. So with that, what will Arch be able to do to kind of turn them into a first round type player? I mean I know I've heard about data and analytics, but can that help overnight? So I'd like to know what you're going to do there to really enhance that operation?

Operator:

Our next question comes from the line of Michael Zaremski from BMO.

François Morin:

Mike, I'd say it's just the nature of the business we're in. I think there's going to be some ebbs and flows. There are going to be some -- I wouldn't call them unusual or unexpected developments. There could be 1 or two claims that surfaced in the quarter. We booked them, we recognized adverse or bad news early on and see how things play out. So there's really nothing to say that we want -- that needs to be highlighted. It's really part of the course. And yes, absolutely, this quarter, it turns out that the ex GAAP kind of underlying loss ratio was up, I'd say, 30 bps. And that's just the reality of the world we're in, and we think it's still an excellent result.

François Morin:

Well, the comment I made last quarter was -- yes, for the full year on the overall ACGL premium, 6% to 8%. We don't see that changing at this point. I think that was based on our view of how the year had a chance to play out. That's why we gave you a range. We were very happy with the 1/1 renewals. 401s went pretty much as expected and 6/1 so far are holding up nicely. I mean still a little bit of time to go before that gets finalized. But big picture, again, that's the 6% to 8% range for the year in terms of cat load is holding up nicely.

François Morin:

Total company-wide, ACGL total.

Dean Criscitiello:

My first question was on the net to gross ratio in reinsurance. I saw that it ticked down about 5 points year-over-year. I was wondering, is that a function of buying more reinsurance? Or is there anything else going on there?

Dean Criscitiello:

Okay. And then the next thing, shifting back to the insurance business, I was a bit surprised to see solid growth within Professional lines given the rate environment there. So can you maybe talk about the market dynamics or the opportunities that you're seeing in that? And is that growth coming from D&O? Or is that within other professional lines?

Operator:

Our next question comes from the line of David Motemaden from Evercore ISI.

Marc Grandisson:

Yes. I think right now, what we're seeing is more a higher appetite, cyber is one of them. That's for sure, Insurance and Reinsurance, that would also -- I mean, can run the gamut, there are many of them. Typically, right now, what we are the lines that are more short-tail in nature. You can see a little bit more willingness to take some more risk from the competition. And how we react to it is, we have many things we do. We typically will tend to first look at the overall [indiscernible] if the rates go down or if the rates stay as is, with the new conditions, you actually price the business as if it's a new piece of business and what kind of return it will get to you. And if it's a little bit not as much -- or not too close for comfort, we might just decrease our participation. And we also might just stay on the clients that we believe have a better chance to really maneuver through that a little bit sideways market, if you will. It's really an underwriters' market at this time.

François Morin:

Yes. I mean it's a great market, right? And we've been saying that for a few quarters. I think and we've said it before, I think we encourage you all to look at results on a trailing 12-month basis. I think it's a bit more reliable, I think, less prone to volatility that is sometimes hard to predict. But yes. I mean, we -- and Marc said it. I think the quality of the book that's in force right now is excellent, and we're going to earn that in. But whether how -- was this quarter a little bit better than maybe the long-term run rate? Maybe, we don't know. But again, as you try to look ahead, I'd say more of a trailing 12 month, again, view is probably a bit more reliable.

Joshua Shanker:

On the other income which doesn't get enough attention, that's Somers and Coface. It was a weak quarter for Coface stock return in 4Q '23, yet the other was quite strong and maybe I'm misunderstanding how to model this, but I bring this up because Coface had an excellent quarter this past 1Q '24. And I'm wondering if that presages a very, very strong other income return for the company as we head into 2Q '24?

Joshua Shanker:

In theory, there should be -- I guess, if you're saying some correlation between Reinsurance segment underwriting income and Somers, which appears in that other line?

Joshua Shanker:

And if one other numbers question post the S&P Model, the change from a few months ago, is there any way to think smartly about how much excess capital you think you're sitting on or the possibility if you find other interesting M&A items, the ability to quickly deploy?

Operator:

Our next question comes from the line of Brian Meredith from UBS.

François Morin:

Yes, big picture, it's a $2 billion [indiscernible] with dollar for dollar, right? So we get $2 billion in cash, and we were spending $450 million that goes out back to them for the cash consideration. So net-net, it's $1.5 billion of incremental cash that we will get. And the rest on the new business, then it's, call it, it's the premium flow with as we write that business, that's the overall -- over time, that will be the incremental investment income or invested assets that we will get.

François Morin:

A lot of it is third-party capital, right? We -- last year was a very light or a good year for the performance of that book. So some of those agreements, many of them actually pay us a commission that is -- there's a base and then there's a variable aspect to it, then that was kind of a lot -- a large part of that. So that's effectively performance-based commissions on property cat or property business.

Marc Grandisson:

Yes. So I think the -- Francois mentioned the actual is expected, which is sort of consistent in both insurance and reinsurance on the more recent policy or accident year, which having the right starting point means that you don't really have to correct frequently. So I would say that we're not surprised on the Reinsurance about what we see. But as I said earlier, I think there is anecdotally and some heavy -- a lot of more friction, I would say, between Insurance and Reinsurance companies to make sure that people get an agreement as to what the ultimate book is going to be. So we're hearing this going in the marketplace. Of course, we participate in that, but we're not seeing this as being a big issue for us. And the other years that would have been pre-2020 and 2021, I want to remind everyone that we were very defensive. We do not have a whole lot of those premium and those harder-in-developing areas that people are talking about. So I will say that we see opportunities to write more of those, and we expect to see more opportunities to write more of those types of deals this year, but I wouldn't say that we are the most present in those worst years, if you will.

Cave Montazeri:

I only have one question today on the Florida market. The total reform implemented over a year ago seems to have had some positive impact on the primary carriers, and Reinsurance capital seems to be coming back. This is a market that you guys know very well. Do you have any color you can share with us on the state of the market in Florida?

Operator:

Our next question comes from the line of Bob Huang from Morgan Stanley.

Marc Grandisson:

No, it doesn't change. I mean cycle management is a core principle of ours. And if anything, we'd like to be able to do -- it's going to be a matter of degree perhaps. Some lines of business have more acute cycle management because they're probably more heavily commoditized. I would expect the cycle management to be much softer in the Allianz and the US. MidCorp business. And that's also what's attractive about it, right, because it creates more stability for the portfolio.

François Morin:

I mean there's no one answer to that. I think there's always -- I mean, and we talk about M&A, but M&A doesn't happen that often. So there's a size that matters, how much could we need -- would we need to raise in terms of using our own stock? Certainly, in terms of dilution, it's always, we think better to kind of use our cash. But there's many considerations we look at, trying to optimize as best we can all the options. We've got plenty of capacity in raising debt too, if need be. So it's very much a function of each specific circumstance, each specific opportunity. We look at it on its own and go from there.

François Morin:

I mean that's been the preference historically. But I mean, again, it's hard to speculate on what could be the next thing. So yes, historically, but things change over time, too.

Michael Zaremski:

Just a quick follow-up. You mentioned fee income earlier. Arch has a lot of diversified sources of income. Is there a way you can update us on kind of what percentage of your earnings maybe last year was derived from these kind of fee income type arrangements at a high level?

Operator:

Thank you. I would now like to turn the conference over to Mr. Marc Grandisson for closing remarks.

Operator:

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may all disconnect.

Operator:

Good day, ladies and gentlemen, and welcome to the Q4 2023 Arch Capital Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, this conference call is being recorded. Before the company gets started with this update, management wants to first remind everyone that certain statements in today's press release and discussed on this call may constitute forward-looking statements under the federal securities laws. These statements are based upon management's current assessments and assumptions and are subject to a number of risks and uncertainties. Consequently, actual results may differ materially from those expressed or implied. For more information on the risks and other factors that may affect future performance, investors should review periodic reports that are filled by the company with the SEC from time to time. Additionally, certain statements contained in the call that are not based on historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The Company intends the forward-looking statements in the call to be subject to the Safe Harbor created thereby. Management will also make reference to certain non-GAAP measures of financial performance. The reconciliations to GAAP for each non-GAAP financial measure can be found in the Company's current report on Form 8-K furnished to the SEC yesterday, which contains the Company's earnings press release and is available on the company's website at www.archgroup.com and on the SEC's website at www.sec.gov. I would now like to introduce your host for today's conference, Mr. Marc Grandisson and Mr. François Morin. Sirs, you may begin.

François Morin:

Thank you, Marc, and good morning to all. Thanks for joining us today. As Marc mentioned, we closed the year on a high note with after-tax operating income of $2.49 per share for the quarter for an annualized operating return on average common equity of 23.7%. Book value per share was $46.94 as of December 31, up 21.5% for the quarter and 43.9% for the year aided by the establishment of a net deferred tax asset related to the recently introduced Bermuda Corporate Income Tax, which I will expand on in a moment. Our excellent performance resulted from an outstanding quarter across our three business segments highlighted by $715 million in underwriting income. We delivered strong net premium written growth across our insurance and reinsurance segments, a 22% increase over the fourth quarter of 2022 after adjusting for large non-recurring reinsurance transactions we discussed last year, and an excellent combined ratio of 78.9% for the Group. Our underwriting income reflected $135 million of favorable prior year development on a pretax basis or 4.1 points on the combined ratio across our three segments. We observed favorable development across many units, but primarily in short day lines in our property and casualty segments and in mortgage due to strong cure activity. While there were no major catastrophe industry events this quarter, a series of smaller events that occurred across the globe throughout the year resulted in current accident year catastrophe losses of $137 million for the Group in the quarter. Overall, the catastrophe losses we recognize were below our expected catastrophe load. As of January 1, our peak zone natural cat PML for a single event, one in 250-year return level on a net basis increased 11% from October 1 but has declined relative to our capital and now stands at 9.2% of tangible shareholders equity, well below our internal limits. On the investment front, we earned $415 million combined from net investment income and income from funds accounted using the equity method, up 27% from last quarter. This amount represents $1.09 per share. With an investable asset base approaching $35 billion, supported by a record $5.7 billion of cash flow from operating activities in 2023 and new money rates near 5%, we should see continued positive momentum in our investment returns. Our capital base grew to $21.1 billion with a low leverage ratio of 16.9%, represented as debt plus preferred shares to total capital. Overall, our balance sheet remains extremely strong and we retain significant financial flexibility to pursue any opportunities that arise. Moving to the recently introduced corporate -- Bermuda Corporate Income Tax. As mentioned in our earnings release and in connection with the law change, we recognized a net deferred tax asset of $1.18 billion this quarter, which we have excluded from operating income due to its non-recurring nature. This asset will amortize mostly over a 10-year period in our financials, reducing our cash tax payments in those years. All things equal, we expect our effective tax rate to be in the 9% to 11% range for 2024, with a higher expected rate starting in 2025. As regards our income from operating affiliates, it's worth mentioning that approximately 40% of this quarter's income is attributable to non-recurring items such as Coface adoption of IFRS 17 and the establishment of a deferred tax asset at summers in connection with the Bermuda Corporate Income Tax. With these introductory comments, we are now prepared to take your questions.

Elyse Greenspan:

Thanks. Marc, my first question, I wanted to expand on some of your introductory comments just on the casualty side, right? We've started to see some reserve additions this quarter, and I think you alluded to that last quarter as being what was going to drive the market turn. So how do you see it playing out from here? I know you said it should play out over the next several years. Could you just give us a little bit of a roadmap in how you think about this opportunity emerging for Arch?

Elyse Greenspan:

Thanks. And then, my second question, second quarter in a row, right, we've seen the underlying loss ratio within your reinsurance business come in sub-50, and you guys are obviously earning in like cat business written at strong rates last year. How should we think about the sustainability of a sub-50 underlying loss ratio within your reinsurance book?

Elyse Greenspan:

And then, just one last one on capital, right? I believe on there was some pushes and pulls from the S&P capital changes on your capital but should be positive relative to your mortgage business. Can you just help us think through your capital position and relative to just organic growth opportunities you see at hand over the next year.

Operator:

Thank you. One moment for our next question. Our next question comes from the line of Andrew Kligerman from TD Cowen.

Marc Grandisson:

Yes. On the M&A front, we're very prudent and careful when we do -- if we do anything. And I think historically, our historical track record is probably the best way to look at this. We'll look for something where our opportunities to earn a return is with a proper margin of safety is fairly healthy. We're not -- there's no desire to grow for growth sake in this company. It really has to do with the return on capital. And as François mentioned, the fact that we have opportunities to above 15% opportunities in this marketplace certainly makes it a little more harder. Having said all this, we might make not exceptions, but there might be some other considerations as it relates to maybe a strategic, maybe a different kind of product, maybe a geography, or maybe -- and we prefer that, maybe a new team that can really bring the expertise on an underwriting basis. So it's a very, very disciplined approach to M&A that we take. And we have the luxury because we have plenty of organic growth available to us. So something has to be very compelling for us to engage in those and also other risks, as you all know, that we don't want to take on necessarily the number one is the culture. Now we're very, very adamant about keeping top culture the way it is, and that's really something. And that quite oftentimes the thing that makes the most, and then -- probably the one that makes the most difference in whether or not we'll entertain an M&A or not.

François Morin:

Yes, well, there's no, I'd say offsets. I mean, we look at each line on its own. There's always going to be pluses and minuses on that every single quarter. We look at the data, we react to the data. I think, as you can imagine, or I mean, very much a function of the type of business that we've written the last few years we -- in reinsurance in particular, we've grown a lot in property. We've taken our usual -- used our same methodology, same approach to reserve, and that generated a little bit of redundancies or releases this quarter on the short tail side. There's always a little bit of noise on any line of business. Yes. Did we have a couple of sublines or kind of sales in casualty where we had a little bit of adverse? Absolutely, but it's not -- I wouldn't call it an offset. I mean, we booked every single line on its own. We reacted to data, and then when numbers come up is what we end up with.

Andrew Kligerman:

Maybe if I could sneak one quick one in. You mentioned during the call that one of the growth areas in insurance was national accounts. What type of limits do you write on national accounts?

Operator:

Thank you. One moment for our next question. Our next question comes from the line of Jimmy Bhullar from JPMorgan.

Marc Grandisson:

Yes, I think our comfort -- great question. Our comfort on the casualty, on liability in general, more general liability, right, if you exclude professional lines, I think we're -- the market is turning or has more pressure on the primary side. So I think that our focus right now is really on the primary, as you can see on our reinsurance, what we did in reinsurance for the last year, we think the reinsurance market is a little bit delayed in reacting to what happened, as in some of the development that we see and some of the increase in inflation. And of course, for your point that we mentioned. So I think that we'll probably see first an insurance market that really takes it to hard, like I mentioned, all the remediation that they need to do. And I think the reinsurance market will probably follow suit with their own -- possibly their own way to look at this, if the prior hard markets are any indication. On the reinsurance side, one thing that's a little bit beneficial at this point in time, and there's a reason why reinsurers are not reacting possibly as abruptly as they probably should as in regards to city and commission is that we collectively understand as an industry that our clients are trying to make those changes, so we're trying to go along with them and help them, support them in their efforts. We'll see whether that's enough. Our team is a little bit waiting to see whether that develops, but I do expect this to also come around and also provide another opportunity for us to grow.

Marc Grandisson:

Great question. I say reserve releases this year in general were somewhat driven by our -- the views we had on the housing market at the start of the year, right? So if you rolled back the tape a year, we were more concerned about home prices dropping fairly rapidly, recession, no soft landing, et cetera. So those reserves we set, call it a year ago were very much a function of those assumptions, and they just didn't materialize throughout the year. So throughout the year, we saw very strong or very well performing housing market. People are hearing their delinquencies much higher than we'd actually forecasted. Home prices are holding up. Unemployment remains relatively low. So you put it all together, I mean it's really, what transpired in 2023 is very much a function of the reserve releases reflect kind of how things -- how much better they played out relative to what we thought a year ago. Where we are today at the start of 2024 is certainly a bit more, I wouldn't call it optimistic in the sense that we see good home prices and a solid housing market for 2024. So on a relative basis, the reserves that we're holding today are not as high as they were a year ago. So if you extrapolate from that, is there room for as much in reserve releases going forward? Probably not, but we just don't know. I mean, the data will again play out as it does and we'll react to it, but hopefully that helps you kind of compare and understand how, where we sit today versus a year ago.

Marc Grandisson:

That's an easy one. Watford, really the underwriting is managed by our team here. So the reserving and approach [Technical Difficulty] okay.

Operator:

Thank you. One moment for our next question. Our next question comes from the line of Michael Zaremski from BMO.

François Morin:

Well, I'd say the short answer is yes, in the sense that the contingency reserves. You're right, we will start releasing a bit more progressively, starting in 2024 and 2025. That will be -- and we already had some of that in the fourth quarter this year. So if you look at our PMI's ratio, why it dropped in the quarter, the fourth quarter was very much a function of a dividend that we were able to extract from our regulated USMI Company to the Group. So that we think, well, should the plan and is scheduled to keep, we should keep having dividends in 2024 and beyond. But the one point I want to touch on is, and we touched on it in the past is while on a regulatory basis, yes, it's released, we would argue that capital is already somewhat being deployed in the business. So it's not -- that it's just sitting there not being deployed in the business. It's already been used to other sources because the regulators and the rating agencies look at the aggregate Arch Cap Group kind of level of capital. So yes, on the statutory basis, the goal here is to put the capital in the better location. But overall, it's somewhat not as big an impact as you might imagine.

François Morin:

Yes, you're right. I didn't put a number, and we're not going to start putting a number, but it's a net positive. No question that, yes, mortgage charges, diversification benefit were reductions in capital requirements, but we also -- the final rulings on debt was not as favorable, right? So S&P and their new rules, they no longer treat $1.75 billion of our debt as being capital. So that's a significant offset. But all things considered, all in, it's a positive. But again, what I want to remind everyone is it's not the only thing we look at, it's just one thing among many and other rating agencies matter. And more importantly, again, is how we think about the capital we need to run the business.

Marc Grandisson:

It's a great question. I mean, again, the way we talk, we don't provide guidance because I don't know, we don't know what the market conditions will be this year. But in terms of capabilities and capital and talent and everything else in between, absolutely, we have -- we could do more. Yes, we could. If the opportunities are there, we'll do more, both on insurance or reinsurance for that matter.

Josh Shanker:

Hey, everyone, I think there might be a problem with the phones. We heard Jimmy and Mike just fine, but we couldn't hear your answers to the questions. I don't know. So -- and I hear you. I don't know if anyone can hear me. Let me ask my team. Can you guys hear me on the phone? They hear me. So somehow it's been corrected. Okay, so I don't know what --

Josh Shanker:

Okay, very good.

Josh Shanker:

So yes, I’ve got a couple of quick ones. So it's the lowest quarter of new insurance written in the mortgage insurance business since acquiring UGC. And yet it looks like the capital utilization went up, at least the risk to capital, and the premiers capital ratio went up. Can you sort of talk about the moving pieces that are driving that?

Josh Shanker:

Yes, that's obviously what it is. Yes, definitely that makes sense.

Josh Shanker:

And another easy one, it looks to me from quarter end 2000, September 30 to year-end, Coface stock was about flat, although it round tripped through the quarter. And yet you had very strong other income in the quarter. There's some summers in that. There's other things in there. Can you talk about the moving pieces?

Josh Shanker:

Okay. And just so I'm getting a lot of inbound call volume or e-mails from people right now. Nobody can hear these answers that you're giving me. It may be being recorded. They hear me, but they don't hear you.

François Morin:

What's happening now?

Josh Shanker:

Okay. So just so that I don't know. Anyway, they're addressing it. People can't hear the Arch team. But for people who are emailing you right now saying they can't hear the Arch team, they're working on addressing it.

Yaron Kinar:

Hey, good morning, everybody. Should I ask the questions or should we wait till this issue is fixed?

François Morin:

There will be a replay.

Yaron Kinar:

Yes. No problem. So I guess first question, when you set loss fix into a year, do you update those other than for bad news or frequency? And what I'm trying to get at here is when we look at the reinsurance loss ratios, are they already incorporating the step change in the reinsurance market that we saw in 2023, or were those losses or the loss ratio essentially a reflection of your expectations heading into 2023 and we should therefore see another step up in margins over the course of 2024?

Yaron Kinar:

Got it. And then my second question Marc, I think in your prepared comments you'd said that casualty may be collectively worse than expected for the industry. And I'm curious that comment, is that really referencing kind of the soft market years of 2013 through 2018 or 2019? Or do you think there could also be some of that emerging for the more recent accident years, where market conditions were clearly good, but maybe the expectations of inflationary trends were still a bit lower than what they ended up being?

Yaron Kinar:

Right. But I guess the question would be, even if they weren't as soft and you were getting a lot of piece, the industry was getting a lot of rate at that point, if the expectation was for a inflationary trend of five and it ended up being seven, you could still see some deterioration of very profitable years nonetheless.

Yaron Kinar:

Got it. I'll just end by saying I think you disappointed a lot of swifty fans, including my daughter, by referencing rest of world football instead of U.S. football this quarter.

Operator:

Thank you. One moment for our next question. Our next question comes from the line of Bob Jian Huang from Morgan Stanley.

Marc Grandisson:

It’s the longest 11 o'clock I’ve ever seen in my life is what I’m going to tell you. So I think we’re still roughly around the 11 o'clock , which again, that clock is never like a one year after the other, right? You can stay 11:00. Unfortunately, you can stay into the 3 o'clock and 4 o'clock or where that you would want. So I think that it’s still roughly around that level the 11 o'clock , 11:30, perhaps in some cases, but, yes, roughly in that range.

Marc Grandisson:

Yes.

Marc Grandisson:

That's a great question. I think I mean the MGAs emerge, as we all know, when there’s a dislocation where there's need for capacity. And I think we see it more acutely in the professional lines and some of them in property. But again, between the supply and demand on the professional lines, I think now that the capacity is probably more plentiful than. It's not more probably, it is more plentiful than it was. So I think it has some impact at the margin. Of course it does. I think the answer to your second part of the question, which is, how do we react? Well, we do it, the same way we always do it, which is if the pricing is going down and the returns are not as good. We will tend to deemphasize or pick or select the better clients that we have in our portfolio and still react the same way we would do in cycle management. On the property side, we also have similar MGAs and MGUs, right? But I think these guys, there’s an acute need for property coverage and capacity. And I think it sort of feels that we need all the capacity we can get our hands on a property at this point in time. So we're not seeing that much of as much of an impact. The property market is still very strong.

Marc Grandisson:

Yes, that's right.

Meyer Shields:

Hi, I think we're in the same situation where people can only hear the answers to their specific questions. So I'm hoping that comes through here as well. Similar question to Bob, we've seen, obviously, a number of companies report some reserve problems in the fourth quarter. And I'm wondering, when you look at the book of sedans that you have within reinsurance, is what we're seeing in the public companies a good representation of overall trends, or is it something different in the non-public world?

Meyer Shields:

Yes, that's perfect. Thank you.

Meyer Shields:

Okay. I'm sorry, go ahead.

Meyer Shields:

Yes, no, I'm still here. Similar question, I guess, obviously what we've seen here is a lot of domestic concerns over liability lines on the international casualty side, is that concern worsening as well, or should we think of that as just a domestic concern?

Operator:

Thank you. One moment for our next question. Our next question comes from the line of Elyse Greenspan from Wells Fargo.

Marc Grandisson:

Well, it depends on line of business, Elyse, but I think the numbers you hear around 7, 8, 9, 10, sometimes it's 5. It depends on line of business, depends on the attachment point, it depends on the limit that you provide, depends on the size of risk. But the numbers you hear -- the numbers that are heard around the marketplaces, we see the similar phenomenon. I think we've said it historically, it's coming -- it's happening as we speak, that the insurance trend in liability generally will out pay the CPI increase. And we're seeing this coming back, so with 200, 300 basis points above. So we’re largely consistent with those kinds of pick.

Marc Grandisson:

Oh, again, depending on line of business, but we're low to mid-teens, I would say right now.

Marc Grandisson:

Yes, I appreciate. I appreciate, Elyse. Thank you. Yes.

François Morin:

Well, certainly up from 2023, right. I'd say for the year, we’re looking at somewhere loss ratio points, right? Call it 7% or so of like 6% to 8% of like our premium would be kind of like the cat load.

Marc Grandisson:

Thanks, Elyse.

Operator:

Thank you. One moment for our next question. Our next question comes from the line of Cave Montazeri from Deutsche Bank.

Marc Grandisson:

Good morning.

François Morin:

Are you talking about property?

François Morin:

Yes. I think -- well, I think what we’ve seen is we continue to see is that a lot of lower layers historically for the last four or five years turn out to be just swapping money, trading dollars back and forth. And there was a lot more activity, perhaps of frequency, as you mentioned, and the reinsurance market was willing to take on. So there was a natural tendency to try to increase a premium at those level but then at some point it breaks down in a sense that the client is buying the reinsurance protection, is paying more for things than they actually realize they should be retaining. That's why you've seen retention go up. Now in a sense, by virtue of having a higher retention, then they have to turn on and then that's what we've seen, they’re turning onto their own portfolio and try to manage and make it better and improving the aggregate loss that they have there. I'm sorry about this. I think that what we're seeing on the cat excessive loss right now is that people are buying more on top because they also are appreciating and evaluating the total level of exposure capacity needed in PML. So I think what people -- what we're seeing is people trading away the bottom layers and buying more on top. And I think we're going to see that a bit more as we go into 2024, which totally makes sense.

Marc Grandisson:

Yes, mortgage, absolutely, we would be. I think that -- yes, the answer is we would be more than happy. We have capacity, capital to be able to deploy and I think we would be very, very pleased to do more. Absolutely.

Operator:

Thank you. One more for our next question. Our next question comes from the line of David Motemaden from Evercore.

Marc Grandisson:

It's a very, very good question. And I think this is where the Arch comes into play; right, in experience and knowing some of the markings of a hardening market, a lot of it also has to do with things you won't hear, right, is our underwriting team sitting down with clients, potential clients, and try to understand, how do you think about the risk? I've talked about reinsurance now specifically, and we also have a very healthy database like everyone else, but we also have our own, and we have our own view of claims and how it develops. And we have, again, experience over 20 years of data and information. And this is what we use to hopefully get the compass in the right order. But if I can't be sitting here and tell you and pretend that we're going to get everything right 100%, it's a little bit more art and science. And I would think that as I'm getting older, the psychology of the market is becoming way more important, feels to me, than even the numbers. And that's probably what compelled me or what made me ask the team to lean into 2019. And you don't know for a fact until it's done, but there are markings or signs in the overall market that help you and support your decision to lean into it heavily. That's all I can tell you, because it's really not a one for one. There’s no like one number one spreadsheet I can point to that will tell you the answer.

David Motemaden:

Yes, no, understood. That makes sense. And then Marc, you had mentioned that at 1/1 the property market continued to improve, property cat reinsurance market. I guess as we sit here today and sort of looking forward at the sustainability of that as we move through 2024, what's your view now on that and the growth opportunities in property cat?

David Motemaden:

Got it. Understood. And I know in the past you've said alternative capital, or ILS can -- has the ability to swing the market one way or the other. What exactly are you seeing there?

Operator:

Thank you. Arch Capital Group answers have been captured and will be available in the replay. I would now like to turn the conference over to Mr. Marc Grandisson for closing remarks.

Operator:

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may all disconnect.

Operator:

Good day, ladies and gentlemen, and welcome to the Q3 2023 Arch Capital Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, this conference call is being recorded. Before the Company gets started with this update, management wants to first remind everyone that certain statements in today's press release and discussed on this call may constitute forward-looking statements under the federal securities laws. These states are based upon management's current assessments and assumptions and are subject to a number of risks and uncertainties. Consequently, actual results may differ materially from those expressed or implied. For more information on the risks and other factors that may affect future performance, investors should review periodic reports that are filled by the Company with the SEC from time to time. Additionally, certain statements contained in the call that are not based on historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The Company intends the forward-looking statements in the call to be subject to the safe harbor created thereby. Management also will make reference to certain non-GAAP measures of financial performance. The reconciliations to GAAP for each non-GAAP financial measure can be found in the Company's current report on Form 8-K furnished to the SEC yesterday, which contains the Company's earnings press release and is available on the Company's website and on the SEC's website. I would now like to introduce your host for today's conference, Mr. Marc Grandisson and Mr. François Morin. Sirs, you may begin.

François Morin:

Thank you, Marc, and good morning to all. Thanks for joining us today. To add to the baseball team, I would also emphasize that while this long winning streak has certainly been fueled by a timely and dynamic offense, we're also very much aware that team defense has played an important role in our success. We've been working hard not to waste any offensive production with careless errors and by executing well actively and on the field. We produced exceptional third quarter results from high-quality earnings across all our lines. The highlights of this team effort are numerous and include after-tax operating income of $2.31 per share for an annualized operating return on average common equity of 24.8% and a book value per share of $38.62 as of September 30, up 4.3% in the quarter and 18.4% on a year-to-date basis. Similar to the quarterly results, our reinsurance segment grew net written premium by 45% over the same quarter last year, led by the property other than catastrophe line which was 73% higher than the same quarter one year ago. As for our property catastrophe business, it's worth mentioning that the net written premium in the third quarter one year ago included approximately $34 million of reinstatement premiums, mostly as a result of Hurricane Ian. If we adjust for the impact of reinstatement premiums, our growth in net written premium for this line would have been approximately 64% year-over-year. The quarterly bottom line for the segment was excellent with a combined ratio of 80%, 73.5% on an accident year ex cat basis, producing an underwriting profit of $310 million. The Insurance segment had another very strong quarter, with third quarter net premium roving growth of 11% over the same quarter one year ago. Similar to last quarter's results, we experienced good growth in most lines of business with the main exception being professional lines where the market remains competitive, particularly in public directors and officers liability. If we exclude professional lines, net written premium would have been 20% higher this quarter compared to the same quarter one year ago. Overall, market conditions for our insurance and reinsurance segment remained attractive and we expect the returns on the business underwritten this year to exceed our long-term targets by a solid margin for some business units. Profitable growth during periods of favorable market conditions is one of the hallmarks of our cycle management strategy and the current hard market is definitely giving us the opportunity to deploy meaningful capital in many areas. Our Mortgage segment's banning average has consistently been a league leader, and this quarter was no different with a 4.7% combined ratio. Net premiums earned were in line with the past few quarters across each of our lines of business. Included in our results was approximately $98 million of favorable prior year reserve development in the quarter, net of acquisition expenses with over 75% of that amount coming from U.S. MI and the rest from other underwriting units. Our delinquency rate at U.S. MI remains low based on historical averages and close to 85% of our net reserves at U.S. MI are from post-COVID accident periods at the end of the quarter. Across our three segments, our underwriting income reflected $152 million of favorable prior year development on a pretax basis or 4.7 points on the combined ratio was observed across all three segments, driven by short cat lines. Current accident year catastrophe losses across the group were $180 million, approximately half of which are related to U.S. severe convective storms with the rest coming from the Lahaina wildfire, Hurricane Idaliaand other global events. Pretax net investment income was $0.71 per share, up 11% from last quarter as our pretax investment income yield was up by approximately 18 basis points since last quarter. Total return for our investment portfolio was a negative 40 bps on a U.S. dollar basis for the quarter as our fixed income portfolio was impacted by the increase in interest rates during the quarter and most other asset classes and negative returns in line with broader financial market indices, such as the S&P 500, which was approximately 3.7% in the quarter. Net cash flow from operating activities has been very strong so far this year in excess of $4 billion, which has helped grow our invested asset base by approximately 20% in the last 12 months with new money rates in our fixed income portfolio comfortably above 5%, we should see continued meaningful tailwinds in our net investment income. Turning to risk management. As of October 1, on a net basis, our peak zone natural cat PML for a single event 1- to 250-year return level remain basically unchanged on a dollar basis from July 1 and now stands at 10.1% of tangible shareholders' equity well below our internal earnings. Our capital base grew and got stronger during the quarter and now stands at $18 billion. Our leverage ratio represented as debt plus preferred shares to total capital is currently under 20%, which provides us with significant flexibility as we look to deploy capital as opportunities arise. With these introductory comments, we are now prepared to take your questions.

Elyse Greenspan:

My first question was, hoping to get some thoughts on the January 1 property cat renewals on the reinsurance side. So where do you think rates end up next year on a risk-adjusted basis?

Elyse Greenspan:

And then on your casualty comments, Marc, right, you alluded to that being the third act and really leaning in there on the reinsurance side. I was hoping you could just give us a sense of timing on how that will play out. And if that's a '24 event, do you see the reinsurance book shifting more to casualty? Or do you think it's an environment where they both on property and casualty offer good growth opportunities for the Company?

Operator:

Our next question comes from the line of Jimmy Bhullar from JPMorgan.

François Morin:

That's a great question, Jimmy. I think there's -- as you said, it's a broad market. Certainly, we've seen some pressure in our own results. I think we see -- so you see both on insurance and reinsurance. On the reinsurance side, we see some of our clients recognizing adverse and the latency of some clients being reported to us, I think is coming through. We like to think we've been proactive in addressing those issues, but you never quite know for sure until everything comes through. But some of the subsets, definitely umbrella is an area that it's something that we're watching carefully. The good thing, I think, with our book is, again, we are big players in that space in the soft market years. So we're seeing some pain but not to the same level we think that may be other as well. And -- but it's a hot topic, and we're going to keep looking at it.

Jimmy Bhullar:

Okay. And then on mortgage insurance, I would have thought, and I think most investors thought that at some point, you would see sort of a step down in your results, still strong earnings, but maybe not as strong as they had been the years following COVID because of the release of COVID related reserves. Just wondering how we can sort of get an idea on how much of the COVID-related reserves are still on your books and could be released versus maybe an ongoing benefit from that in the next few quarters?

Marc Grandisson:

I'll just add one thing to me on the industry. The industry is extremely disciplined again, a very nice thing to see around us. So from an ongoing perspective, putting the reserve for one second, if I can talk to the -- our expectations. And we think that there's still risk on the horizon, but the credit quality of our portfolio the housing supply imbalance that you hear fromFrançois and the fact that we have a lot of healthy equity into a policies in force is it looks really, really good. And when we say that our mortgage growth is also doing very well, and that's what we mean. It's in a really good place.

Tracy Benguigui:

While you posted double-digit insurance premium growth this quarter, the pace has decelerated a bit over the last two years. It looks like peak insurance premium growth was in mid-'21, and that might be a tough benchmark given you've grown a ton and professional ability and you are shrinking error, as you pointed out. Could we expect insurance premium growth at double digits to be sustainable going forward? Or should we see it fall to high single digits because of the professional lines headwind? And I'm just wondering if it's fair to assume that you prefer deploying capital into reinsurance now, all else being equal?

Tracy Benguigui:

Right very helpful. You slightly shortened the duration of your asset portfolio in September to 2-point, nine, seven years from 3.03 years in June. It feels like you're taking durational asset mismatch because the MI liabilities are much longer dated. Given the shape of the yield curve is beginning to show signs of steepening, I mean to tad bit less inverted. Going forward, would you consider lengthening your asset duration? Or you feel comfortable with the sub-3-year duration level?

Operator:

Our next question comes from the line of Yaron Kinar from Jefferies.

François Morin:

Well, yes, we are constructive on 1/1. I think we -- Marc and I said it, I think it's a really good market in totality. There's some pockets that are certainly better than others. We think that the internal capital generation, we've been able to generate in the last few quarters gives us the ability to really grow and take advantage of the opportunities that we think have a good chance of being there. Again, we don't make the market. We participate in the market. So if the market is as positive as we think it can be, then we'll be happy to step in and take a bigger share of it. But I think the fact that we've got capital flexibility has always been one of the -- and on a onetime things and our strategy all along is we want to make sure that we have plenty of capital to deploy when the market is right. And so far, we've been able to do that.

Yaron Kinar:

I appreciate that. And then certainly, I think the capital availability and the appetite to deploy is a very important part of the or story. And I guess from that perspective, is there anything you can offer us in terms of an attempt to quantify the available capacity? Or is that something that we'll just have to watch and see?

Yaron Kinar:

Okay. And then my other question, just on public D&O and cyber, where we're clearly seeing a little bit of pressure and competitive pressure there. Do you still view rates as adequate there? And are they clearing the loss cost trends?

Operator:

Our next question comes from the line of Joshua Shanker from Bank of America.

Marc Grandisson:

I think you answered the question beautifully. I mean by asking a question to give the answer, I think that all those things you said are true. I'll get to the lines in a second. But to your point is exactly right. We're going to this hard market and we make -- we still value reinsurance. You cannot go without a reinterest. You still need for various reasons, limits management, risk management and also information, right? Reinsurers are providing us on the insurance side with valuable information about what the market is and the state of the market. So we don't want to be an outlier out there. So it's always good to have this as an additional value proposition from the reinsurance companies. In terms of what we decided to do over three years, you're quite right, we have been building, asFrançois mentioned, a significant amount of capital through our mortgage earnings. So that's certainly something that was helpful and available to deploy in other areas, and that also helps being able to maintain and retain more net. I think if you at a high level, I think that the patterns of buying, we're buying a fair amount of less on the liability lines, specifically those that went through the first act and really had a lot of good uplift. So we definitely saw that happening on the property, even though the property is very hard, as we all know, since last year, this is a much more volatile line of business, so we still maintain our loss on the cat side and still by a quota share, a significant quota share on that business as well. So I think overall, it's meant to be the balancing act between providing relief or volatility protection to some extent and information. But you're quite right, having more capital definitely helped us take more net on our balance sheet.

François Morin:

Great question, sorry. We -- just again, in terms of timing, right, our incentive compensation decisions are made in the first quarter will be made in February of next year. But no question that throughout the year, we accrue expected bonuses based on what we think that our performance might look like, and there's effectively a true-up that takes place in the first quarter when the final amounts are determined. Something we're keeping an eye on. So I don't know if there'll be an early adjustment in the fourth quarter or not something we'll be looking at carefully, so that we don't go to distort too much the first quarter next year. Obviously, the Board has final say in how much money will be available to pay our troop. So that's -- it's a little bit of -- we don't want to front run it. We want to be reasonable and not introduce too much volatility in the numbers on the OpEx side. But that's certainly something that we'll take a look at in the fourth quarter to make sure we're not missing anything here.

Alex Scott:

First one I had is on the attritional loss ratio in the reinsurance segment. I was just thinking if you could give us a little more color around just what's driving this year, favorable performance year-over-year? And if there's anything new as we should be thinking about or if it's just the pricing environment being as strong as it is?

Alex Scott:

Got it. Very helpful. I wanted to ask a follow-up on the comments you made on casualty reinsurance. And I'm just interested in what is changing that's causing more of this commentary to sort of bubble to the surface? I mean, we've heard it from some of the European reinsurers as well. Is it I mean, is it truly just that they're starting to see reserves develop in a poor way for some companies? Or is there something that's changed about the social inflation environment? I mean what do you think is the underlying driver or drivers?

Operator:

Our next question comes from the line of Michael Zaremski from BMO Capital Markets.

François Morin:

Yes. I mean it's mostly around kind of crystallizing some losses. I think it's a process we go through for each security on the fixed income side, where we make the determination. Is it appropriate to sell some of those and redeploy the proceeds and higher yields and our investment team does that. So yes, there are going to be some realized losses coming through the fixed income. Obviously, the equity portfolio, which is not huge, but still there's FBO securities like fair value option securities, including equities that are effectively mark to market, and that comes through the realized gains of losses line in the income statement. So those are the two big items. There's a little bit of other stuff going on that is a little bit of the wheat. So, I wouldn't want to go there, but that's directionally hopefully that's just normal course of action.

François Morin:

Yes. It's, again, very early. So too early, unfortunately, to give clear or kind of views on what we think could happen or because they're still developing the laws and we expect more progress on that before the end of the year. But at a high level, it doesn't start at one start if it goes through until 2025. So, there's no impact for 2024 and we will be evaluating the and may publish some target tax rate that they will try to get to. But again, more to come, I think we'll do our best to keep you apprised of how we think about it probably on the next call. But until we have work to now any more clarity on where it's going to land, I think it's a bit premature to give you too much do any details here.

Meyer Shields:

First question on, I guess, casualty reinsurance. This year, like January 2023, we saw not only significant increases in property capital. We saw changes in program structures with higher attachment points. Is there anything analogous to that, that we should see on the casualty reside in 2024? Or is it just going to be a great story?

Meyer Shields:

Okay. That's very helpful. And second question, and hopefully, I can ask this in a way that makes sense. When we talk about reserve problems from older accident years, ultimately driving casualty rate increases to accelerate. Is that the industry can over earn in 2024 and backfill? Or is it because the recalculated full year's losses mean that current rates are actually not as adequate as we thought?

Meyer Shields:

Okay. That's worrisome about recent years for the industry, but that's very helpful.

Bob Huang:

Congratulations on the quarter. Just a quick question on your insurance segment's loss ratio year-on-year loss ratio improved for about 30 bps. But just given just the strong E&S pricing environment, shouldn't we expect a little bit better improvement in loss ratio. Is there anything in the loss trends that probably differed from how you thought about your loss picks in the past, just see if there are any comments around that?

Bob Huang:

Okay. My second question is a follow-up on the reinsurance core combined ratio. Obviously, it was very strong and I think you mentioned that a lot of it is due to business mix shift, right, shifting towards property and then because of that and then you naturally have an improving combined rate -- loss ratio there. Just curious if we were to think about going forward, the run rate combined ratio for your reinsurance segment, based on the comments so far, is it fair to sort of assume that it's going to be closer to what you printed over the last two quarters and probably better than the prior quarters. Is that a fair way to think about it just from a modeling perspective?

Operator:

Our next question comes from the line of Brian Meredith from UBS.

Marc Grandisson:

It's more the latter than the former. I would actually say tell you, right, that the market is better this year than it was in last year. So, I would argue that we might change the way we intent the market over the next 12 to 24 months. But certainly, at heart, we have been saying that to you historically it hasn't changed last quarter, which in terms of relative returns based on the three segments on the underwriting segments. MI is a third one, but a very strong one, I would say, at this point in time. But again, it's more a reflection of the relative opportunity between the units than anything else. In the market, Brian, I'll tell you the market is very, very disciplined. We're very impressed by the industry or the MI industry.

Marc Grandisson:

Well, yes, I think the ceding commissions about store three right now we'll see what that ends up. There might be a slight change or we'll see how -- it's also going to be dependent on how the underlying market is improving as a reinsurance player. But I think what's our acquisition comes right now reinsurance is mid-low, low 20s. So, I think if you have more of a portfolio even if that's argued, it's a 30% ceding commission. So you might see actually, the acquisition going up a little bit. But again, as Franco mentioned, all the time talk about when we have these questions about the expense ratio and loss ration but not restarted the return and whether the combined ratio lends ourselves to return when it comes from losses of expenses we have already losing sleep here. So, I think this is…

Operator:

Our next question comes from the line of Scott Heleniak from RBC Capital Markets.

Marc Grandisson:

Great question. I think in non-U.S. base is also the CRT, which is granted exposed to the U.S. MI, the excess of loss program that the GSEs have developed over that and we have developed over the last 11, 12 years. Internationally -- so that's a piece of it, you see it in our financial supplement. Internationally, we have Australia. As you know, we have a good size, great relationship and a great presence there. We're very pleased with it. We're also getting a little bit more market share there even though the mortgage origination is a slowdown there as well. The other is really in development is the international with European specifically, SRT, which are 90% mortgage-backed credit risk transfer, they look a lot like the CRT business that we have in the U.S. Most of it is done because banks need to release capital that Basel III led the transactions. And we've been doing it for a little while, and we've partnered up, we actually with another European company who's very steep in that area. So that's a growing area right now because I think the -- there's a lot more need for capital. As you know, Scott, not only in the U.S. [indiscernible] has a similar consideration. So, it helps us be there for them to provide more capital relief and it's certainly something that we're focusing more efforts on.

Marc Grandisson:

I don't want to say too much because you're going to get more competition in the segment. High level of comparable and sometimes better than the CRT we see, but we still a little bit more work to be done there, those who are trying to get in the business. I think you should talk to us, first of all, help you hit in the business.

Marc Grandisson:

Thank you so much, everyone, for listening to our commentary this quarter. Looking forward to the end of the year. Happy Halloween. See you next time.

Operator:

Good day, ladies and gentlemen, and welcome to the Q2 2023 Arch Capital Earnings Conference Call. [Operator Instructions]. As a reminder, this conference call is being recorded. Before the company gets started with its update, management wants to first remind everyone that certain statements in today's press release and discussed on this call may constitute forward-looking statements under the federal securities laws. These statements are based upon management's current assessments and assumptions and are subject to a number of risks and uncertainties. Consequently, actual results may differ materially from those expressed or implied. For more information on the risks and other factors that may affect future performance, investors should review periodic reports that are filed by the company with the SEC from time to time. Additionally, certain statements contained in the call that are not based on historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The company intends to be forward-looking statements in the call to be subject to the safe harbor created thereby. Management also will make reference to certain non-GAAP measures of financial performance. The reconciliations to GAAP for each non-GAAP financial measure can be found in the company's current report on Form 8-K furnished to the SEC yesterday, which contains the company's earnings press release and is available on the company's website and on the SEC's website. I would now like to introduce your host for today's conference, Mr. Marc Grandisson and Mr. Francois Morin. Sir, you may begin.

Francois Morin:

Thank you, Marc, and good morning to all. Thanks for joining us today on this gorgeous day in Bermuda. As Marc highlighted, our underwriting and investment teams delivered excellent results across their respective areas in the second quarter, which resulted in a performance that exceeded that from our very strong first quarter. For the quarter, we reported after-tax operating income of $1.92 per share for an annualized operating return on average common equity of 21.5%. Book value per share was $37.04 as of June 30, up 4.8% in the quarter and 13.5% on a year-to-date basis. Turning to the operating segments. Net premium written by our Reinsurance segment grew by 47% over the same quarter last year, and this growth was observed in most lines of business. Growth was particularly strong in the property catastrophe and property other than catastrophe lines with net written premium being 205% and 53% higher, respectively, than the same quarter 1 year ago, a reflection of the fact that market conditions in these lines remain very attractive. As a result, the quarterly bottom line for the segment was excellent, with a combined ratio of 81.9%, producing an underwriting profit of $245 million. The accident year ex cat combined ratio was 77.4%. The Insurance segment also performed well, with second quarter net premium written growth of 18% over the same quarter 1 year ago and an accident quarter combined ratio, excluding cats of 89.8%. Except for professional lines, which saw a slight decrease in net written premium in our public directors and officers business due to a more competitive market, all our underwriting units in insurance, both in the U.S. and internationally, saw good growth in the quarter as market conditions remain excellent. Our Mortgage segment had another excellent quarter with strong performance across all units, leading to a combined ratio of 15%. Net premiums earned were in line with the past few quarters, reflecting a high level of persistency in our insurance in force during the quarter at U.S. MI, partially offset by lower levels of terminations in Australia and higher levels of premium. Benefitting results was approximately $84 million in favorable prior year reserve development in the quarter, net of acquisition expenses, with over 75% of that amount coming from U.S. MI and the rest spread across our other underwriting units. [Indiscernible] activity at U.S. MI was again very strong this quarter, and our delinquency rate stood at 1.61%, its lowest level since the onset of the COVID pandemic. At the end of the quarter, over 80% of our net reserves at U.S. MI are from post-COVID accident periods. Overall, our underwriting income reflected $116 million of favorable prior year development on a pretax basis or 3.9 points on the combined ratio and was observed across all 3 segments mainly in short-term lines. Current accident year catastrophe losses across the group were $119 million, over half of which are related to U.S. severe convective storms that have occurred so far this year. Pretax net investment income was $0.64 per share, up 21% from the first quarter of 2023 as our pretax investment income yield was almost up 50 basis points since last quarter. Total return for our investment portfolio was 0.56% on a U.S. dollar basis for the quarter with most of our strategies delivering positive returns. Our interest rate positioning with a slightly shorter duration helped minimize the impact of the increase in interest rates during the quarter. We remain comfortable with our commercial real estate and bank exposure, which is a high quality and short duration. Net cash flow from operating activities was strong in excess of $1.1 billion this quarter and continues to provide our investment team with additional resources to deploy into the higher interest rate environment. With new money rates in our fixed income portfolio is still in the 4.5% to 5% range, we should see further improvement in our net investment income in the coming quarters, arising primarily from positive cash flows and the rollover of maturing lower-yielding assets. Turning to risk management. Our natural cat PML on a net basis of the single event 1-in-250-year return level stood at $1.46 billion as of July 1 or 10.5% of tangible shareholders' equity, again, well below our internal limits. In light of the improved market conditions in the property market, we were able to deploy more capacity, which resulted in a significant premium growth for property lines in both our Insurance and Reinsurance segments. This growth was well diversified across multiple zones. Our view is that the current in-force portfolio with a broader spread of risk across many zones is well positioned to deliver attractive returns. Our capital base remains very strong with $17.4 billion in capital and a debt plus preferred to capital ratio of 20.5%. Even though the results of the past quarter set the high watermark for us on many fronts. We believe the continued hard work and dedication from our teams, serving the needs of our clients every single day, along with our steadfast commitment as disciplined and dynamic capital allocators, sets us up very well for future success. With these introductory comments, we are now prepared to take your questions.

Elyse Greenspan:

My first question, Marc, can you quantify the supply-demand imbalance that you're seeing within the reinsurance market? And how much of that do you think could transpire from an additional pickup in demand potentially at 1/1 2024?

Elyse Greenspan:

And then the , Francois, the accident year underlying combined ratio within reinsurance. Is that a good run rate level or maybe you could get better as we think about some rate earning into the . Is there anything one-off in that number in the quarter?

Elyse Greenspan:

And then, Marc, one more for you. I mean your stock has done really well. So you have a problem, a good problem that any CEO would want in that you have an extremely valuable currency. We sit here with the hard market. You guys obviously have a lot of organic growth opportunities. What would you need to see from an M&A perspective to consider using your stock as currency to enter into any type of transaction?

Operator:

Our next question comes from Tracy Benguigui with Barclays.

Marc Grandisson:

Well, I think the -- we're -- first, the one thing about the PML, which is so interesting to us is that we're in the early innings of where it's going to go. So we have to be careful that when we talk about this even internally ourselves, these are the early innings of our market getting much better. And as I mentioned, terms and conditions, we believe, also improving and really helping to manage cat and the cat-related risk better as an industry. So we'll see how that develops over time, Tracy. I think that we're also a different animal than we were way back when. We've grown up our capital faster than the growth in exposure and needed. So the 25% before is probably a lesser number. I think you're quite right. And we also have to balance the overall portfolio risk profile. But having said all this, there's plenty of room to go from 10.5% to wherever we're going to end up. We don't know where that's going to be, assuming conditions say as they are or even improve further, it certainly will mean more PML growth. I think that it would have to be substantially better. We actually have a very, very solid construct within our overall capital allocation that will dictate what kind of market share we would have of the market. And all I would say is there's always a place to go to the numbers you talk about, but we'll see if we get there. And I will also remind everyone that it's not a bad to start the index of one of the major brokers, as you all know, it shows us that the pricing for the cat is the highest it's ever been since 1990, even before Andrew. There's a lot of room, and we're excited to see where that takes us. And one final thing I will take is if you look back at the '05, '06, '07, '08, if you go back on this, if you have enough of a memory or a good document retention policy or a bad one in your company, you'll see that our PML grew in '06, '07, '08, '09. So we kept on accumulating and growing the PML. So it's just a start.

Tracy Benguigui:

Got it. I would say that if you do change your threshold and I get it's very fluid and the demand equation is also different, that you would provide an update to the market on that. Real quick, do you have a house view on how this year's hurricane season will shape up. There was talk about average hurricane season and now people are talking about above average. How do you see that playing out this year?

Operator:

Our next question comes from Jimmy Bhullar with JPMorgan.

Marc Grandisson:

I think the last part is a true statement. I think the Q2 numbers you saw for some of the other -- some of our clients actually and competitors demonstrate that that's a little bit more retained. And these are the kind of question. I mean if you get quite a coverage, you have to retain it yourself. The terms and conditions change, this is what fastening for this market, it is not only a property cat terms and condition change. It is a very broad-based property terms and conditions and price improvement that is sought by a lot of companies. I think the market globally has the like I said last quarter's scoring the camp, but having to mend and optimize and reshape and re-underwrite the portfolio. And one of the key things that we see that evidence is that, is that a facultative team in our property have an increased amount of submission this first half of the year. And what's interesting, the E&S property on the insurance obviously has some kind of exposure, a fair amount of it, but it's not only that. Our [indiscernible] data book of business is not necessarily. It's actually not cat-heavy portfolio, which is an indication as fact that it is typically in any market is a good indication for where the market psychology is. So beyond the cat when they provide fire protection, the pricing and the conditions are improving there as well. In very much a broad base and in the early stages. And I will say and remind everyone, and we have to remind ourselves of this is that this is a second or third year of property rates in terms of consumer loan approval. So it's not the first shot at it. It's an ongoing process. And I think that it just got -- we position in top of mind to and certainly in the second quarter. This year, we believe will help maintain a bit of that going forward.

Francois Morin:

I mean they're mostly gone. I think we've released a fair amount of the reserves that we put up in the early, in 2020, effectively during the early days of the pandemic. As I mentioned, like a lot of the cures that we're seeing now are from '21 and '22. So that's good news. And as you know, the reserve base has shrunk quite substantially from the peak of 2020 or late 2020. So we were still very prudent. We still look at the data every single month as the new delinquencies come in and how quickly we cure and all of that, but we're so very comfortable with our reserve position there.

Francois Morin:

Well, it will be a function of the market. I mean it's -- we've been able to grow quite substantially in the last few years without raising any additional capital. As I've told many people over the last few months, we have the luxury of having a mortgage unit that provides a source of capital that we have been able to redeploy in the P&C space. So assuming similar conditions where P&C start stays very hard and mortgage still does very well, but isn't growing substantially, we still think there'll be -- we'll be able to generate capital internally. But again, hard to have the crystal ball on what 2024 will look like. So we're -- as I mentioned, we got plenty of capacity. We have low leverage, so that we got a lot of tools in the toolbox, and we'll react to the market as it presents itself.

Michael Zaremski:

Great. Maybe just wanted to learn more about market conditions in the primary insurance segments. I definitely heard your comments about rate change both loss trend and pieces of where overall we are in the underwriting lifestyle clock. But just curious, we're seeing kind of different data points from companies on pricing power levels. Some are showing flattish pricing power, some are showing deceleration. I know you guys operate in a lot of different pockets. But would you say overall pricing in the primary insurance segment is accelerating? Or maybe it's worth bifurcating between casualty versus property as well?

Michael Zaremski:

Okay. Switching gears a bit to the reinsurance side of the marketplace. Would you say there's been a lot of terms and conditions changes and just even changes too, especially in Florida. Would you say that if there is a major event, should we be looking at historical market shares that the reinsurers in Arch have had and then care cutting it? Would that be like the right exercise to do given we're or kind of in hurricane season?

Operator:

Our next question comes from Josh Shanker with Bank of America.

Marc Grandisson:

Yes. So a very good question. I think this may break it in parts. I think that, yes, we do, as you know, as a reserving practice, we're very keen on the reserving being prudent. We do reserve to a higher level of trend that is embedded in the pricing or what we even observed in the data to make sure that we're accounting for this. I think as a result of that uncertainty and the need to get a bit more cushion and the uncertainty that it generates. I mean, you heard us on the other call, I think it does generate that need to get higher price for that reason. But there's a -- there's a recognition in the industry that we need to be a little bit on this side of the decimal, create some kind of margin of safety. So I do believe that companies are pricing for a higher inflation ratio going forward and also adding a little bit, and that's what helps and sustain the hard market as we speak.

Marc Grandisson:

Not really. I think we've -- like we talked about this, Josh on calls for the last 2, 3 years. I think we've been consistent. We -- it is a little bit of art , it's not only science, not as granular as you might think it is. You do the reserving process, you do the reserving process and then you look at what your expectations are versus what the actual is emerging and you adjust your loss ratio. These 2 things are right now has a tendency to sort of take a higher loss ratio than otherwise will be indicated because we have to still see through that underwriting year developed, and it's been very consistent. And if you look at our IBNR ratios and that we book the business on our insurance portfolio, it's been consistent for the last 3 years. So we tend to want to make sure that we still emerge that allows us to reduce some of that before we do. So we have not changed a whole lot. And it's not -- so it's quite a bit a way above you expected there will be actual emergent or losses. But inflation developed in the future. So it's an appropriate thing to do. I think, at the early stages, Francois?

Joshua Shanker:

And then on Tracy's PML question, you kind of ripped into Francois down on this a little bit. But the corporate charter says you're willing to put 25% of the company's equity capital at risk for a 1-in-250-year event. You're nowhere near that, and I don't really expect there's any market where Arch at this point, given how big it is, would really put 25% of its equity capital at risk for a 1-in-250-year event. How -- what's the reasonable feeling on how much cat risk you'd be willing to take in the best cat market ever?

Operator:

Our next question comes from Ryan Tunis with Autonomous Research.

Francois Morin:

Well, just to clarify, I'd say, Ryan, that the reserves, we don't disclose the reserves by year. We show the risk in force. We give you the total dollar amount of reserves as of -- $403 million at the end of the quarter and the same at the end of the year, but there are some shifts between what was at year-end versus now. I will say that most of the reserves that we've -- the releases in the first 6 months of the year, have been coming primarily from the '21 to '22 years, I mean, and a little bit of '20 as well.

Ryan Tunis:

Got it. And maybe just some perspective on kind of where the ultimate loss ratios on those years are now trending at?

Ryan Tunis:

Got it. And then just a follow-up -- go ahead, sorry.

Ryan Tunis:

Yes. I'm still trying to figure this business out, so I appreciate it. A follow-up, I guess, for Marc, just on P&C. I'm not sure there's ever been a cycle where like when rates started to decelerate, they reaccelerated? Why hasn't that happened before in your...

Ryan Tunis:

And then so after Katrina, correct me if I'm wrong, there was like 1 year of really good rate. There's quite a bit of supply that came in, and now it's kind of [indiscernible]. I'm just kind of trying to contrast from a reinsurance standpoint, how the supply-demand balance looks today sort of a year after in versus how it did a year after Katrina.

Ryan Tunis:

What are you paying the purest attention to thinking like looking forward into 1/1, kind of what might drive pricing when you get to the end of the year?

Operator:

Our next question comes from Brian Meredith with UBS.

Francois Morin:

[Indiscernible], Florida.

Francois Morin:

Florida. Miami Day.

Marc Grandisson:

Yes. So from a big zone perspective, it's gone up similarly in terms of percentage. It's a very similar increase.

Marc Grandisson:

We've had a couple of -- we've had a couple of programs, for instance, in the Asia that we won, and we've had a couple of big but I don't think this quarter is necessarily a large transaction quarter right to where you make it sound. I think it was more regular growth. A couple of transactions here and there, but nothing to the extent that when we talk on the call as Francois mentioned in his remarks, that it has to highlight it specifically before. I don't think there's nothing really to highlight in this quarter, actually.

Marc Grandisson:

Yes. I think pricing has improved over the last 2 years and credit quality stays really beautiful. And it's why among the best, I think we go back to 2013, 2012 in terms of quality of origination. So it's -- as you know, credit is not readily available. The availability of credit is still pretty tight out there. So from a credit quality perspective, Brian, it's as good. It's a really, really solid marketplace. I think the market share question, which we never -- we don't lose sleep with this, as you know, Brian. I think -- I'll -- couple of things in the market share that we're trying to do in terms of shaping the portfolio in the MI is trying to get the higher quality, like I mentioned in my remarks, lower FICO -- higher FICO, lower LTV and also geographically go to the places where there's less perceived inflation or overvaluation and also, there's some different programs that have different returns, meaning they are less than we would have hoped for them to be and they just don't [indiscernible] threshold and especially, Brian, if you overlay the opportunity set that we have on the property side, it just makes for our fellow folks and MI willing to take the earnings that they generate and give it to us on the P&C side to generate even better returns. So really good return business, Brian, it's just also for us a matter of comparative ROEs as well as absolute.

Meyer Shields:

A quick question to start. The level of reserve releases in reinsurance was lower than it's been in recent quarters. I was hoping you can give us some color. Is that because you're assuming higher loss trends? Or are there other factors that may have played into the quarter's results?

Meyer Shields:

Okay. No, that's fair. Second question, and I'm really not sure how to ask this, but there's a lot of chaos right now in U.S. personal lines and [indiscernible] always been really opportunistic. I was wondering if there's a way that in a line of business that's so dominated by major players, but you do have this level of instability. Is there an opportunity for Arch?

Operator:

Our next question comes from Yaron Kinar with Jefferies.

Marc Grandisson:

We've cut our ad book significantly over the last 12 months. You see even in 2022, we started cut already as we saw this. And again, it's a matter of opportunity, right? I mean we do some but we've cut the book heavily because of the better -- frankly, better opportunities on the excess of loss occurrence, much better, yes.

Marc Grandisson:

We -- well, we had a -- when we grew at in Florida was, as you know, is a different kind of animal because of all the [indiscernible] small companies out there. But in general, I would say that our portfolio will opportunistically grow into the larger global companies. We tend to think that relatively not as the transparency of visibility into what they write. So our tendency is to be more of a super regional businesses and more ones that have a lesser footprint in terms of stake. We think we can better allocate capital. This is sort of a high-level philosophy that we've had for years. That hasn't really changed our one. I think that we prefer to grow with these clients over time. But having that all this opportunistically, being on a core share basis of excess of if it's a large corporate, we definitely were able to provide more capacity, but they needed. As we speak and the price, we believe, reflected the higher level of risk that they have. So I think I would say same as before, we're a little bit opportunistically on larger companies.

Marc Grandisson:

Yes. So I think that excess of loss is very similar to the current, if you do change terms and positions and cut the coverage at the underlying portfolio level, it will have a leverage impact into your aggregate excess or occurrence, meaning it will definitely cut down the loss expectations heavily into these layers. But what I would tell you on is we're not there yet, right? This is the early innings like I mentioned to you before on the call is that we're going to have -- the phenomenon just talked about will have a much better perspective and view on this and the impact it's going to have on the losses next year and through '25. I think right now, we still have a portfolio that hasn't gone through quite 100%, right, of all these [indiscernible] that you and I expect to happen, I think, in the marketplace. So the aggregate of losses for that reason, probably still bad bet in 2023, right? So we probably need to see this underlying change in terms of conditions on the insurance portfolio before we can see this being a potential viable product.

Marc Grandisson:

So from Pembroke, Bermuda, I want to wish everybody a good month of August, and we'll see you in the fall. Thanks for your support.

Operator:

Good day, ladies and gentlemen, and welcome to the Q1 2023 Arch Capital Group Earnings Conference Call. [Operator Instructions]. Before the company gets started with this update, management wants to first remind everyone that certain statements in today's press release and discussed on this call may constitute forward-looking statements under the federal securities laws. These statements are based upon management's current assessments and assumptions and are subject to a number of risks and uncertainties. Consequently, actual results may differ materially from those expressed or implied. For more information on the risks and other factors that may affect future performance, investors should review periodic reports that are filed on the company -- excuse me, filed by the company with the SEC from time to time. Additionally, certain statements contained in the call that are not based on historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The company intends the forward-looking statements in the call to be subject to the safe harbor created thereby. Management also may make reference to certain non-GAAP measures of financial performance. The reconciliation to GAAP for each non-GAAP financial measure can be found in the company's current report on Form 8-K furnished on the SEC yesterday, which contains the company's earnings press release and is available on the company's website and on the SEC's website. I would now like to introduce your host for today's conference, Mr. Marc Grandisson and Mr. Francois Morin. Sirs, you may begin.

Francois Morin:

Thank you, Marc, and good morning to all, and thanks for joining us today. As Marc highlighted, we kicked off 2023 with excellent underwriting results across all the segments, and our investment income continued its upward path, benefiting from a higher interest rate environment and strong operating cash flows. For the quarter, we reported after-tax operating income of $1.73 per share for an annualized operating return on average common equity of 20.7%. Book value per share was up 8.4% in the quarter to $35.35, reflecting not only our strong results, but also the unwinding of approximately $350 million of unrealized losses on our fixed income portfolio net of taxes. Turning to the operating segments. Net premium written by our reinsurance segment remained on its strong trajectory and grew by 51.5% over the same quarter last year. This growth occurred across most of our lines of business with a particular emphasis on property lines, marine and aviation and other specialties. The overall bottom line of the segment will also very good with a combined ratio of 84.3% and a relatively small impact of $59 million from current accident year capacity lawsuits. It's worth mentioning that our top line reflects the impact of some larger transactions which are not uncommon during periods of significant market dislocation. We cannot tell whether the frequency and size of these transactions will recur in future periods, but we are optimistic that market conditions will remain attractive for this foreseeable future. The Insurance segment also performed well with first quarter net premium revenue growth of 19.1% over the same quarter 1 year ago and an [indiscernible] quarter combined ratio, excluding cat of 89.8%. There were a handful of items affecting our top line marked significantly this quarter, such as a large transaction in the lenders and the warranty line of business and very strong market conditions in the property, energy and marine lines business, both positives, which were partially offset by the headwinds of weaker foreign currencies against the U.S. dollar compared to a year ago. We estimate that on a constant dollar basis, our net written premium growth would have been approximately 230 basis points higher than reported in our financials. Most of our lines of business still benefit from excellent market conditions both in the U.S. and internationally, and we remain positive about our ability to grow and write business at expected returns that meet our [indiscernible] as we approach the second half of the year. Our Mortgage segment had another excellent quarter with a combined ratio of 20% from strong performance across all our units. Net premiums earned were up slightly on a sequential basis reflecting the increased persistency of our insurance in force during the quarter at U.S. MI and good growth in our units outside of U.S. MI. We recorded approximately $73 million of favorable prior reserve development in the quarter, with approximately 2/3 coming from U.S. MI and the rest spread across our other units. [indiscernible] activity this quarter in U.S. MI was particularly strong as we benefited from the highest first quarter cure rate we have seen in the past 6 years, excluding 2020. At the end of the quarter, over 80% of our net reserves at U.S. MI are from post-COVID accident periods. Overall, our underwriting income reflected $126 million of favorable prior year reserve development on a pretax basis or 4.3 points on the combined ratio and was observed across all 3 segments. Quarterly income from operating affiliates stood at $39 million and was generated from good results at Coface, Somers and Premia. As you may already know, Coface recently declared a dividend of EUR 1.52 per share, which should result in a EUR 68 million dividend to Arch and link May, subject to Coface shareholder approval. Although this amount will not benefit our income statement next quarter, we believe it reflects very well on Coface's results and prospects for the periods ahead. Pretax net investment income was $0.53 per share, up 10% from the fourth quarter of 2022 as our pretax investment income yield exceeded 3% for the first quarter since 2011. With new money rates in our fixed income portfolio holding relatively flat in the 4.5% to 5% range, we should see further improvement in our net investment income returns in the coming quarters. Total return for our investment portfolio was 2.54% on a U.S. dollar basis for the quarter with all our strategies delivering positive returns. The contribution to the overall result was primarily led by our fixed income portfolio, which benefited from slight downward pressure on interest rates during the quarter. While fixed income market volatility was elevated intra-quarter because of the stress in the U.S. and Swiss banking systems and the implications for monetary policies of central banks, spreads at quarter end were generally consistent with those at year-end 2022. The overall position of our investment portfolio remains neutral relative to our target allocation and we are well positioned to capitalize should there be further dislocation in the capital markets. Of interest, our commercial real estate exposure is distributed across a variety of strategies. Accounts are only 6% of Arch's investment portfolio is highly rated as a low loan-to-value ratio and is more concentrated in multifamily housing investments with minimal positions in the office properties. [indiscernible] the acquisitions are concentrated with large money central banks with no significant exposure to U.S. regional banks. Turning to risk management. Our natural cat PML on a net basis stood at $1.69 billion as of April 1 or 8.1% of tangible shareholders' equity, again, well below our internal limits at the single event 1 in 250-year return level. Our peak zone PML is currently the U.S. Northeast and reflects some pockets of increased capacity we deployed at April 1 in response to good market opportunities ahead of the more active renewal period at June 1 and July 1. In summary, we remain very positive on the current market and the opportunities ahead of us across all the segments. As the current expected returns, we believe deploying meaningful capacity in our businesses currently represents our best option to maximize returns for the benefit of our shareholders. Our commitment to being active yet disciplined capital allocators, remain a core principle of ours that should lead to long-term value creation and success. With these introductory comments, we are now prepared to take your questions.

Elyse Greenspan:

My first question, Marc, in your introductory comments, you said that we're in the early stages of improvement in the property market, right? We've seen strong rates at January 1 that have persisted into April 1. And my sense is could persist through the midyear. So could you just comment on what you mean by early stages and how you could see this playing out in -- during the rest of 2023 and into 2024.

Elyse Greenspan:

That's helpful. Then could you give us a sense if in your margins in both insurance and reinsurance, did social inflation or financial inflation that impact on how you booked the current accident year in both insurance and reinsurance?

Elyse Greenspan:

And maybe just one more, sticking there, Marc, right? In the reinsurance segment, right, the -- the growth, exceptional really strong, but the underlying loss ratio, right, was did tick up from last year. And I think part of that, there's always noise in each quarter, and it does take time to earn in this business for January 1. But can you help us kind of put that all together and just give us a sense of the margin profile of the reinsurance business over the balance of the year.

Operator:

And the next question is coming from Jimmy Bhullar of JPMorgan.

Marc Grandisson:

Yes. So the last numbers we heard is a good question. Last number we heard on the primary side, we're looking at pricing depending on the cat exposed, obviously, is more acute, but rate increases 40% to 50% plus, definitely, and a little bit less if you're intercoastal, if you win in land, it's many 10% to 15% increase. But it's clearly, clearly a push for rate increase. But what's not really fully reflected and you should hear there are other things going on underneath the terms and conditions, deductibles are going up. That's also a really important factor also helps if you're a reinsurer of this portfolio. There's a statement of value, which pretty much states that any company now providing coverage needs to have an up-to-date valuation of the property you're trying to ensure. And that is a big deal because the industry has been frankly lacked in updating these numbers. And once you have the right exposure, it actually makes the pricing that much more effective and accurate. So this is the whole market is moving in that direction. And thirdly, I think that's also important, which creates more dislocation there is a shrinking of capacity at the individual players. So when people were putting $25 million, $30 million worth of capacity on even a cat exposed. So these are [indiscernible] going down $2.5 million to -- $2.5 million, maybe $10 million on an exceptional basis. So I think that the -- so the insurance portfolio, the rates are going up for a lot of reflection, echo back to questions about an inflation on the property side that is reflected the statement of value. So we're definitely clearing that one. So depending on where you are in working , lesser get exposed to , cat exposed. On the reinsurance side, it's a little bit similar, although it's a bit more of a monolithic marketplace. The rates are going in a more slower narrow range. It's almost like more commoditized, if you will. It's a little bit between to 50 pretty much broadly across. Of course, there will be differences. We'll see what the doing reserve for us. But the more acute the cat need, the more acute in the key zones of capacity demand the higher the pricing. But the general -- the overall general pricing is in sync. The insurance one will be able to grab those increased rates and improve time on condition over the next 12 months. The reinsurance or were able to get there quicker.

Francois Morin:

Well, we still have -- we definitely do have still some delinquencies that are in forbearance programs. I quote 80% of our loss reserves are from post COVID periods. We don't have all the detail around how much or by year, et cetera. But just hopefully, that gives you a flavor of like what maybe could potentially be down coming down the pike in terms of more releases if able to secure. I think the fact that unemployment levels are still performing very well. I think that's a good sign, right? I mean that's there's some pressure on home prices, et cetera. But for the in-force book, we think, again, the credit quality has been excellent, and we think there is performing well. And when we go to cure those delinquencies over time, hopefully, that should help the bottom line.

Tracy Benguigui:

I'm trying to understand mechanically why an LPT type of transaction could add noise to your underlying loss ratio on the reinsurance side. Is it that you're not imposing a loss corridor and you're assuming losses would attach at inception? Or is it accounting on the premium recognition? If you could explain the mechanics, that would be helpful.

Tracy Benguigui:

Okay. Also, and maybe a little bit early, but can you discuss how June 1 and July 1 renewals are shaping up at this point? Like how would you compare pricing to what you saw in January?

Tracy Benguigui:

So how would that compare and you see momentum the same or better since January?

Operator:

The next question is coming from Yaron Kinar of Jefferies.

Francois Morin:

Yes, 3 things I'd say, a, is I mean we focus on return. And while the obviously, what's in front of you is just the underwriting part of it. We focus on overall returns, which is the first thing. Second thing I'd say is you've got to give us a little bit of a chance to earn the premium. I mean, the market was solid in '22 and get better at 1/1/23. We're a quarter into the year. I think there's more benefit or more improvements that come, but it doesn't all sell up initially. And third thing, as Marc said earlier, I think we'll be proven. I mean, the math may suggest that, a, if you did this on that, that the combined ratio of losses should be yes. But we are proven in how we look at things. And when the data tells us that maybe we were a bit high, we'll be more than happy to release those reserves. But we're not going to declare victory quite yet.

Francois Morin:

Yes. I mean it's small ticket items. I think the biggest one for us was we had $25 million loss in Turkey, which is kind of what we do. It's not a huge deal, but that was the biggest item. Yes, we had some kind of participations in New Zealand with the cyclone and also some floods. And in the U.S., kind of the normal[indiscernible] tornados, [indiscernible] storms that hit -- that was mostly insurance, but a little bit of noise there as well in reinsurance so it's -- call it a hunch punch of small things, but the biggest one was -- for us this quarter was a Turkey.

Francois Morin:

Yes. Yes. Turkey was only reinsurance. Yes. Okay. And so -- I mean both of them are only reinsurances..

Joshua Shanker:

Yes. I was looking at the investment return. I mean, there's a lot of ways to measure yield. Let me just take the investment income divided by the float. I'm getting about 2.76% for the quarter, which makes Arch the lowest burner on its float in your peer group. I know you guys have a more conservative portfolio that's also allowed you to redeploy pretty quickly, but with new money yields maybe in the 5% range without taking any equity risk or whatnot, you have an opportunity to increase that yield of are you still seeing some powder drive? You still think it's time to be fairly conservative in seeking yield less points?

Marc Grandisson:

We're also just thinking about the overall risk, right, about the enterprise, right? So we have a lot of underwriting push and growth. So that's also factored in our risk -- now that we're -- sorry, but just it's all one of the other part of the equation that we have to factor in as well.

Francois Morin:

We're to.

Marc Grandisson:

So from a rate acuity perspective, I mean, this is sort of a system that's well establishing our company. I don't know how many kind of reverify the assumptions and projections beat the individual underwriter level, group level in segment level corporate between the holding company, including the Board. I mean there's a lot of vetting going on comparing to and triangulating. So we're pretty confident. We wouldn't be growing that level if we didn't think that the returns were in our favor. Does that mean that we're going to get all the returns that we expect precisely to the decimal, most likely enough, Josh, we're in uncertain world, and we're making a bet on the longer term expected and that's the best thing that we can do right now. We are a fans of thinking about the rate as being by far the most important place to start to make sure that you have enough -- you put the odds in your favor and the rates going up, a lot of lines -- rates go up 60%, 80%, 70%, even some of them went to 2x and even if there's some of it decrease goes to 1.9x. While we also look at the history of the industry and the industry was printing 5 or 6 years ago, 60%, 65% loss ratio, even if they were on a reserving level grows to 80% and you put all the factor in the trend and you put a cumulative rate impact, I think that there's no certainty, but there's certainly a level of margin safety that you build within the price and that's what makes us feel that much more comfortable. Now in terms of our reduction in the marketplace, how we're able to lean in and see that business. First, we were early in the 2019 to really lean into it. A lot of people were pulling back, and that creates void and vacuum for our clients. And we were the ones the beacon in the storm, if you will, able to give them capacity. And that goodwill for lack of a better word, really builds upon itself. So it really creates more relationship build relationships that, frankly, has been a little bit less strong because of our defensive mode prior to 2019, but we rebuilt it very, very nicely. We're always there, but we rebuild, we kindle them in a much major way because I talk to our producers, they'll tell you that we're a great partner of theirs, and that makes a big difference. So when the next piece of business comes in, you look at the people who could write that business, and we've heard this from insurance group. Well, we can look at kind of markets. The market that wants the business right now was on 4 years ago, they'll probably not have the first bit at it. We probably has to first look at it because we were there for 4 or 5 years. Also, I would add that we're an E&S player. And as you heard, the E&S market is growing. So the market is also going towards the tailwind going from our perspective on that note. And we're pretty good security, Josh. We're a pretty good company. People want to deal with us, we're good for their money. We have a good expertise and good teams that really can't buy the client. I think we spent a lot of time not only providing coverage and policies but finding clients and being a good market leader right now. And certainly, that growth for the last 3 or 4 years have created its own momentum and inertia. So the gravity, if you will, that it's increasing has been pretty nice. It helps. It helps grow further even in that marketplace. And even the market gets a bit more competitive. I would argue that we'll be able to hold on to a lot of good business that we've written for the last 4, 5 years.

Operator:

Next question is coming from Brian Meredith of UBS.

Francois Morin:

Combined ratio was 1.1 point. 2.2 in the loss ratio and all that cap, and the premium was $118 million.

Marc Grandisson:

But the second part -- Brian, the second part of your question is easier. I think we're much more of a excess of loss in the library floor. We believe it's a better play for us at this point in time. And that seems to be sort of well also where the market is slowly migrating towards at least from the first indication. The second part -- the first part of your question which is the most interesting one is we're in Florida, we might well be in Missouri. You did show me state, but we stole to see and as evidence that those to reform will take hold. It's going to take a while. As we all know, we've got through a claims when before the 1st of April, 1st of May [indiscernible] of claims to make sure that we -- that they take advantage of the last resonance of the weaker toward area there. But that's going to take a while to work through. It also might mean that some of the losses from prior years are developing adversely, which is not necessarily useful and helpful for those who try to renew for on an ongoing basis, why if you have more losses from that on the prior years, the acceleration of losses you may have to make up for a lot of that or some of that, it's not a lot of it is pure value of reinsurance. So I think overall, I think the market will take sort of a view that it's not there at 100% and they'll probably sort of factor in who is more -- is more or less exposed to those, but they get credit those more or less exposed. But you're not going to get -- like everything else, we'll need to see it through to get full credit. I think the market will get some credit, but not the full extent of it. There's no way at least not at this time. Maybe in 2 years or next year or 2 years time, but don't take a while because we need to show and see what's happening for.

Meyer Shields:

I have one, I guess, a technical question on the LPT side of things. Is it fair to assume that this is 100% combined ratio business as you write it? Or does the fact that it pertains to -- well, let me stop there.

Marc Grandisson:

Because the contribution to profit and margin is square a lot more on the investment income side than it is on the pure rating income side.

Marc Grandisson:

Yes. I think the market is focusing on it because I think that -- and also if you add on top of it the reopening of the court post-COVID, there's a lot of uncertainty. We've heard about inflation, financial inflation and social inflation. So there's a lot of scrutiny. And the rates were much lower then. So there is definitely less banked for those years to get the right number, the right loss ratio pick. So yes, definitely, people are looking as we are as well and where we -- on the reinsurance side, if you're treated we can see not anything or some companies have development that adverse in those periods. Some of them don't. But yes, it's definitely a point of discussion, which I think [indiscernible] helps explain why we had the -- we continue to have this price increase in the GL, for instance. I do believe that people are realizing it and understanding that for their recasting, right, the long-term trend and long-term loss ratio projection on a level basis how that works. So I think really that people are reflecting. And that's also why we have this. We don't have massive combined ratio above across the industry. We do have still a healthy level of price increase because of that [indiscernible].

Marc Grandisson:

Yes, the liability lines are -- of course, a lot of it has been historically led by auto, specifically on the umbrella. But the GL is clearly picking up again and it's late it's also international. And we have a low book of business as well as our insurance portfolio in the U.S. I think that there's also a dislocation going on the GL side, people are reevaluating the lines of business, the areas and the industry that they're providing coverage for. So this is happening probably a bit more -- it sort of slowed down a little bit towards the second half of 2022. And I think that's reoptimizing or re-underwriting or refocus on the underwriting and price for the GL and it also led, as you can appreciate, might some increase in trend, specifically in the excess layers because it's levered. So I think that's what we're seeing some of that prior year coming through. We're having to recast the pricing, which you wouldn't have had or would have seen necessarily in 2020, '21 because those years '16 to '19 were probably too young to really get the development coming out. So you probably can see that the duration of development of GL coming through and people reacting to it.

Michael Zaremski:

Maybe a question or 2 on the catastrophe levels this quarter. I mean, Marc, you brought up terms and conditions changes. I think it probably blows certain people's minds that the valuations on property are just getting up to date and it seems kind of antiquated, but that's just, I guess, the way that the reinsurance maybe -- or sorry, the overall marketplace works. But just curious to the piece, yes, cat loss levels for the industry in the U.S. were way above a normal 1Q. I know you guys aren't right? That's not the best guy for Arch. But it looks like Arch's cat levels were normal-ish, but you can correct me if I'm wrong. Any read-throughs on the terms and conditions changes that have taken place that are -- is there any read through there that there are some good things coming through?

Michael Zaremski:

And as a follow-up, when we're hearing about the substantial rate increases, especially in property, does that take into account the terms and condition changes? Or is that -- are these kind of risk-adjusted rate increases that you're speaking to on some industry participants are speaking to?

Michael Zaremski:

Got it. And maybe lastly, switching gears a bit. I believe Arch write a decent amount of professional lines. That's one marketplace that we've seen some stats pointing it to being more of a softer marketplace. Maybe you can comment if that's the case for Arch as well. And I don't know if you gave commentary also just on overall kind of rate increases on your primary insurance book this quarter.

Operator:

We have a follow-up question from Jimmy.

Francois Morin:

Well, we think -- yes, just a quick reminder, I think zones for us right now, we're kind of Northeast [indiscernible], we also have like Florida Tri-County, which is kind of at the same level. The 1/1 renewals were more international, more national. So national accounts, not really Southeast specific where we expect to see more activity at 6/1 and 7/1. So no question that we think it will go up. I mean if the market stays as it is right now, could it go up 10%, 12%, we think so, and I think it's a reasonable scenario. But obviously, we'll have to wait and see and figure out and see how the renewals -- how everything gets lined up, but then directionally, I think that's kind of where we think we might be at July 1.

Marc Grandisson:

Thank you, everyone, for listening to our story. It's a great one, and we are looking forward to get even more good news in the July call. So thank you for everything then.

Operator:

Good day, ladies and gentlemen. And welcome to Arch Capital Group Fourth Quarter 2022 Earnings Call. At this time, all participants are in a listen only mode. Later we will conduct a question-and-answer session, and instructions will follow at that time. As a reminder, this conference call is being recorded. Before the company gets started with its update, management wants to first remind everyone that certain statements in today's press release and discussed on this call may constitute forward-looking statements under the federal securities laws. These statements are based upon management's current assessments and assumptions and are subject to a number of risks and uncertainties. Consequently, actual results may differ materially from those expressed or implied. For more information on the risks and other factors that may affect future performance, investors should review periodic reports that are filed in the company with the SEC from time to time. Additionally, certain statements contained in the call that are not based on historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The company intends the forward-looking statements in this call to be subject to the safe harbor created thereby. Management also will make reference to some non-GAAP measures of financial performance. The reconciliation to GAAP and definition of operating income can be found in the company's current report or Form 8-K furnished to the SEC yesterday, which contains the company's earnings press release and is available on the company's Web site. I would now like to introduce your host for today's conference, Mr. Marc Grandisson and Mr. Francois Morin. Sir, you may begin.

Francois Morin:

Thank you, Marc, and good morning to all. Thanks for joining us today. I'm very pleased to share that once again, Arch had an excellent quarter on virtually every front. The year concluded with fourth quarter aftertax operating income of $2.14 per share for an annualized operating return on average common equity of 28%. Book value per share was up 9.9% in the quarter to $32.62 and down only 2.8% on the year, a great result considering the impact raising interest rates had on our fixed income portfolio with a difficult year in equity markets and the elevated catastrophe activity we experienced this year. Turning to the operating segments. Net premium written by our reinsurance segment grew by an exceptional 118% over same quarter last year. Although this quarter, we had a few large one off transactions that impacted our results and contributed $407 million to our net written premium. Adjusting for these transactions, our net premium written growth was still elevated at 61% for the quarter. These transactions are yet another example of the dislocated state of the uninsurance market where our strong balance sheet provides a significant advantage as we look to deploy meaningful capital to support ceding companies at terms that meet our target return expectations. More importantly, the underlying performance of the segment this quarter was very good with an ex-cat accident year combined ratio of 82.9% and a de minimis impact from current accident year capacity losses. Reflecting ongoing hard market conditions, the insurance segment also closed the year on a very good note with fourth quarter net premium written growth of 17.4% over the same quarter one year ago in an accident quarter combined ratio, excluding caps of 89.6%. Most of our lines of business still benefit from excellent market conditions, both in the US and internationally, and our expectations for the coming year remain very positive. Our mortgage segment continued its run of quarters with results better than long term averages as claim activity for the business remain low. While production volumes were down due to the lower level of originations in the market, we remain positive on the return prospects for this business. Net premiums earned were up slightly on a sequential basis as the persistency of our in-force insurance at 79.5% at the end of the quarter continued to increase. The combined ratio, excluding prior year development, was 45% for the quarter and reflects our prudent approach to loss reserving, one of our key operating principles. Our underwriting income reflected $270 million of favorable prior year development on a pretax basis across all segments this quarter, which represents approximately $0.66 per share after tax. While most of this favorable prior year development, $211 million, came from the mortgage segment, mostly on claim reserves set up for COVID related delinquencies in the 2020 and 2021 accident years at US MI, it is worth pointing out that our P&C reserves also contributed to the overall results. Of note, both our insurance and reinsurance segments had another quarter of favorable reserve development, and the 2022 calendar year phase two incurred ratio for our P&C operations was 58.7%, its lowest level in more than five years. Both these metrics provide some insight into the adequacy of our loss reserves, which constitute an important element in the quality of our balance sheet. Quarterly income from operating affiliates stood at $36 million and was generated from good results [indiscernible] in summers. Pretax net investment income was $0.48 per share, up 41% from the third quarter of 2022. Cash flow from operations, over $3.8 billion for the year, was strong and when combined with the proceeds from maturities and sales of securities in a rapidly rising yield environment, and hence, the underlying contribution from our investment portfolio. Going forward, with new money rates in our fixed income portfolio in the 4.5% to 5% range and a growing base of invested assets, we are well positioned to deliver an increasing level of investment income to help fuel our bottom line. Total return for our investment portfolio was 2.6% on a US dollar basis for the quarter with all of our strategies delivering positive returns. The contribution to the overall result was primarily led by our fixed income portfolio, which benefited from relatively stable interest rates and tightening credit spreads. The overall position of our investment portfolio remains relatively unchanged as we remain cautious relative to duration, credit and equity risk. Turning to risk management. Our natural cat PML on a net basis stood at $970 million as of January 1 or 8% of tangible shareholders' equity. Again, well below our internal limits at the single event one in 250 year return level. Our peak zone PML remains at Florida Tri-County region. And as Marc mentioned, the PMLs we report represent a point in time estimate of the exposure from our in-force portfolio and the premium associated with the January 1 renewals will get reported in our financials starting next quarter. On the capital front, we did not repurchase any shares this quarter as our assessment of the market opportunity in 2023 remains very positive, one where we should be able to deploy meaningful capital into our business at attractive returns for the benefit of our shareholders. Finally, as Marc mentioned in his remarks, the results we enjoyed this year across our operations were achieved through a thoughtful and deliberate execution of our cycle management strategy and a strong culture of allocating capital to the most profitable markets and opportunities. These results, which were an important contributor to us joining the S&P 500, were only made possible by the ongoing hard work and dedication of our over 5,000 employees across the globe. They deserve a tremendous amount of credit for making us who we are today, an industry leader with a stellar 20 plus year track record that is ready for the opportunities and challenges ahead of us. With these introductory comments, we are now prepared to take your questions.

Tracy Benguigui:

Your one in 250 PML to tangible equity of 8% as of 1/1 wasn't too dissimilar to your 7.7% as of September 30th. So I'm wondering what made you pause to incrementally take more exposure? Did that have anything to do with less retro capacity or your view of ROEs based on pricing for that incremental cat exposure?

Tracy Benguigui:

So as you look through the year, even though 25% is your maximum threshold, where do you think you could realistically land based on your risk appetite?

Tracy Benguigui:

And also really quickly on the reinsurance side, in recent times, you focused more on quota share over XOL. So with hard pricing, where do you see the best opportunities? I'm thinking about lower ceding commissions on quota shares and the higher rate online on the XOL side?

Operator:

Our next question comes from the line of Michael Zaremski with BMO.

Marc Grandisson:

I think we're just experiencing, in the fourth quarter, that will probably change in '23, I think opportunities are going to resurface more broadly than we even had in the fourth quarter, right? I think it took a little bit to the market to digest in and to what it means for the overall market. I think another market, it's clearly in the camp up making -- doing what it needs to do to improve the return on the pricing on the property, which I think also you heard in other calls, I think will impact broader set of line business beyond the property exposure. But if we’re to go back, so if you look at the 70% growth, I mean 70% growth over, premium is about 3 times the size three, four years ago, we did have a lot of growth in the beginning of our market. So as you get into the late stages, I think 70% could be equivalent to another 50% increase in 2021 or 2020, when we started to lean into the market. So I think this is a natural phenomenon that after a while, you have -- now that you mined everything, but you really have pushed as hard as you could, and we're still pushing hard. Even 70% to me is about 3 times the average growth in the premium in the industry, that tells me that we're still seeing a lot of opportunities. But again, like I said, we're later in the stage of the [indiscernible]. And I think that we'll see a rejuvenation, if you will, of that growth possibly because the insurance companies are going to have to increase, as we all know, their pricing. One is the property cap and the higher retention why they have more risk retaining. And we're participating like the other guys on the insurance market, so we expect market to sort of getting a second bite of the apple, if you will, of a hardening market.

Marc Grandisson:

I think we said a few things about the combined ratio. The 95% was meant as a target back in '16, '17 when interest rates were quite a bit lower, and it went down further. As you know, that meant that we needed to have a lower combined ratio targets, which we targeted over last two, three years, that's where you see the impact to us. I think from our perspective, low 90s is still what -- or high 80s is sort of what we're still pushing for because within the interest rates, they may revert back and come down after a while in a year, year and half from now. So you don't want to be rushing to recognize all the various interest rates, although we are currently -- we are pricing into our business, but we tend to take a longer view like we do on the trend on our inflation. And we're thinking the rates might come back down. So I think we would still target a lower 90s to high 80s to get the returns that we think we deserve.

Jamminder Bhullar:

First, I had a question on the reinsurance business. If you look at your premium growth, even excluding the sort of large transactions, onetime transactions, you mentioned the number is extremely strong and obviously, doesn't have the impact of 1/1 renewals in it. So what's really driving that and do you expect some of those factors that drove the strong growth to continue into '23 as well?

Jamminder Bhullar:

And then just shifting on to MI. Your loss ratio is obviously very good, but I think the loss pick did pick up a little bit in the fourth quarter. So is that more sort of national driven or is it more regional to where you're starting to see some maybe softening in the market in certain regions or states?

Operator:

Our next question comes from the line of Brian Meredith with UBS.

Francois Morin:

I mean the ones we reported really a couple more regions. We don't have -- I don't have those handy. I think the most of my -- to Marc's point, I think a lot of the growth that we saw, at least at 1/1, will come through in regions that were, I'd say, we were probably a little bit underweight in the past. So that's going to show up in Q1 premium and for the rest of the year, but in terms of P&L, it really doesn't have an impact.

Marc Grandisson:

I don't know the answer to that. I like the comparison to ‘02 or ‘03. I would actually like to compare probably more like a combination of ‘02, ‘03, maybe ‘04 in liability and maybe ‘06 or ‘07 on the property side. So I don't know what that means. We haven't blended growing the combined ratio that we had in this year, but that probably would be close to what we can do. I mean, look, there's a lot of things that are different this time around. The interest rates are lower than they were before internationally. More specifically, we're an international diversified reinsurance company. Hard to tell, but it's certainly going in a way of getting above our long term ROE targets that's for sure, and that's really what, in the end, what really drives us, as you know.

Yaron Kinar:

My first question, just looking at the ROE profile of the company, clearly, there's upwards momentum here. Can you maybe talk about, A, what the target would be and B, if you'd see it coming more from -- or the expansion from here on coming more from NII or more from underwriting?

Yaron Kinar:

And then my second question, just looking at the insurance business, it sounds like you think that there maybe some inflection to accelerating growth again in '23. Can you maybe help us think about the impact of the reinsurance market, kind of available capacity, cost of reinsurance, how that plays into the potential growth that you see for net premiums written in '23 in insurance?

Yaron Kinar:

And I apologize, I'm going to try and sneak one more in here. A clarification, when you talked about kind of targeting low 90s, high 80s combined ratio, was that a reported combined ratio in the insurance segment?

Yaron Kinar:

Because I think you've been running at kind of mid-90s. So where is that improvement coming from, is it mostly just better rates and in risk selection?

Operator:

Our next question comes from the line of Ryan Tunis with Autonomous.

Francois Morin:

The cat ratio or cat? I mean, in terms of…

Francois Morin:

Dollars of cap, yes, we think will go up. No question. We've been targeting, we’re targeting -- I mean our cat load in '22 was, call it, $80 million a quarter. Now it's probably between $100 million and $120 million for the first quarter of '23 based on what we wrote, right? And we'll see how that develops for the rest of the year. I mean, depending on how the 41, 61, 71 renewals, how those kind of materialize, there is, I'd say, a good probability that it will keep going up throughout the year. But based on the in-force portfolio that we have currently for the first quarter, I mean, that's kind of how we see the exposure to cat losses.

Marc Grandisson:

I think the one thing with an event such as Ukraine, which is a war event, there's actually a specific market for those kinds of risks. So it's not like it's included part of the overall coverages for cat or whatever else out there. There was some -- there definitely is a result of that event in attempt to exclude a lot of these war events and bring them back into the proper -- aviation war, on marine war market, for instance. So yes, there is a lot of -- obviously, a lot of activity there, a lot of rate increases there. We're participating in there, but those markets are to begin with pretty small. So that's why I think you'll see some improvement, but it may not be necessarily enough to move the needle for the industry, even though it's a very, very healthy proposition that rates have gone through the roof as you can appreciate for the right reasons in those types of business.

Francois Morin:

I don't think it's going to move a whole lot from where it's been. I think there's been a lot of shifts in the mix of business over the years, right, as particularly as our insurance book in the UK has grown, that's a bit higher acquisition ratio, different kind of that reinsurance purchasing decision. So there's a long list of reasons or explanations as to why it is where it is now. And obviously, what we focus about -- what we're focused on is the bottom line returns whether -- if we're going to pay a bit more acquisition, we certainly think we're going to get a lower loss ratio and that has been the case. But for your modeling, we kind of, I think, exercise. I assume something pretty similar to '22 as a starting point, and we'll keep you updated as the year goes on.

Elyse Greenspan:

My first question, I guess, is going back to the reinsurance margin discussion that came up earlier. So you guys have a flat PML and you guys are seeing 30% to 50% rate increases in cat. Wouldn't that triangulate into margin improvement coming through in the reinsurance book in 2023?

Elyse Greenspan:

Would you say, building on that, Marc, would you say that of all your business lines as you sit here today, the line with the best expected return in '23 would be catastrophe reinsurance?

Elyse Greenspan:

And then you said, on the PML discussion, you had mentioned, right, that we need to kind of see how things come together at June 1 that, that could also be a good opportunity. What could derail this, is it just alternative capital and more capital coming into the reinsurance space as you think leading up to June 1? And even when we think beyond that, what are you guys concerned about that could derail the uplift that we've seen in the catastrophe reinsurance market?

Operator:

Our next question comes from the line of Meyer Shields with KBW.

Francois Morin:

I mean to keep it at a fairly high level, those are general -- I mean, I consider them to be kind of capital relief, capital support transactions for a variety of reasons. Companies that have grown a lot under some rating agency pressures, aiming capital relief, companies trying to put some exposures behind them, et cetera. But just to clarify those are not retroactive so they're all insurance accounted transactions, insurance or reinsurance accounting, so that flows through our premium. They are across -- you saw it in our line of business, they did hit multiple of our lines of business. Some were other specialties, some were casualty, some are a little bit of property. So it's a spread. But it's all in a vibrant market. I mean there's a lot of pain that some companies are experiencing right now, and they're working for solutions. And again, we think we have strong balance sheet and capital to support them. So I think -- we don't know if they're going to happen again, those are lumpy. But if and when they are presented to us, we're happy to consider them and once in a while, we end up writing a few of them.

Francois Morin:

Well, it's a great question, which is becoming harder and harder to answer, because in the early days, no question that we had adjusted our -- because so many loan, the delinquencies that were in our inventory were in forbearance and trying to make the distinction between kind of forbearance and non-forbearance delinquencies and how much of that worth was -- a new concept or new kind of reality we were basing. Over time, I mean it's been three years now. I think the reality is like the inventory is somewhat kind of commingled. So we don't really think of loans and forbearance kind of that differently than we look at the other loans, even though we know there's still a few of them in the inventory. So I mean long story to say that it's not something we tend to quantify directly every quarter anymore, but we still perceive that there's a bit of risk with COVID related reserves, and that's why we've been holding on to the reserves up to the point where we think we just don't need them. And right now, this quarter was an example where I think the data kind of suggested that we were -- it is the right time to really that there are no other reserves that were set up in those years.

Operator:

We have a follow-up question from the line of Tracy Benguigui with Barclays.

Marc Grandisson:

Tracy, would you -- do you include D&O there, or you just wanted the ex-D&O, which lines specifically -- professional lines is a really broad market…

Marc Grandisson:

D&O, okay. So D&O, we expect similar trends that we saw in the last fourth quarter, it may change a little bit as a result of the overall thing that's happening in the marketplace. But the trend in the large commercial, for instance, have been neutral to negative, actually, for the last three, four years. So I would say that even though we may hear -- you hear, I know rate decreases on our D&O for large commercial, there's rationality behind it. So we expect rationality specific to this. It’s not -- there's a lot of data that points to -- that validates what kind of price points we're seeing on the D&O side. On the smaller D&O side, which we do a fair amount of -- to remind you, we do fair amount of D&O. We still see a very, very stable, very good marketplace. But again, the smaller D&Os are not the big ticket items that you would expect, but a lot of them are going to be not for profit small policy. So minimum premium is really -- a lot of times what happens and that 5% increase might be $50, right? So these are the kind of things that we do [indiscernible] and we have grown dramatically over the last four or five years, it's becoming a big section of what we do. That market is healthy from a [change] perspective, right, to go back where it said about the large commercial, the SCAs are down 25%, 30% over the last four years. So it's a pretty good market to be there. The IPO market has stabilized. It was pretty hot for a while, pricing got crazy. We took advantage of a lot of opportunity that's not crazy, but it was a very acute needing capacity. We expect this to sort of renormalize again. So I think I would say, D&O is normalizing for the large commercial, sort of a Stage four. I meant Stage 3 we’re recognizing some of the overreaction, but the smaller D&O is probably early stage or Stage 3, which is still very profitable and a little bit of decrease here and there or a slight increase.

Marc Grandisson:

Well, spend a good day with your loved ones, and we will see you in the next quarter. Thanks for listening, guys.

Operator:

Good day, ladies and gentlemen. And welcome to the Third Quarter 2022 Arch Soft Capital Group Earnings Conference Call. At this time, all participants are in listen-only mode. Later we will conduct the question-and-answer session. And instructions will be given at that time. As a reminder, this call may be recorded. Before the company gets started with its update, management wants to first remind everyone that certain statements in today's press release and discussed on this call may constitute forward-looking statements under the federal securities laws. These statements are based upon management's current assessments and assumptions and are subject to a number of risks and uncertainties. Consequently, actual results may differ materially from those expressed or implied. For more information on the risks and other factors that may affect future performance, investors should review periodic reports that are filed by the company with the SEC from time to time. Additionally, certain statements contained in the call that are not based on historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The company intends the forward-looking statements in the call to be subject to the safe harbor created thereby. Management also will make reference to some non-GAAP measures of financial performance. The reconciliation to GAAP and definition of operating income can be found in the company's current report on Form 8-K furnished to the SEC yesterday, which contains the company's earnings press release and is available on the company's website. I would now like to introduce your host for today's conference, Mr. Marc Grandisson and Mr. Francois Morin. Sir, you may begin.

Operator:

Yes.

Francois Morin:

Thank you, Marc, and good morning to all. Thanks for joining us today. As we communicated in our release earlier last week, our third quarter results were adversely impacted by the effects of Hurricane Ian and other global catastrophe events. in spite of the severe nature of Ian, which we believe will end up being the largest single loss in our history, we reported after-tax operating income of $0.28 per share resulting in an annualized operating return on average common equity of 3.8%. Year-to-date, our annualized operating ROE is 11.6%. This result demonstrates once again the value and the resilience of our diversified platform. Now on to catastrophe and losses, where we wanted to provide a bit more color on our assessment of Hurricane Ian. We all know it's still very early in the claim adjusting process, and the final determination of our ultimate loss exposure will likely not be known for quite some time. Our initial estimate of the ultimate losses is based on an industry loss of $50 billion to $60 billion. We believe this range is appropriate at this time given the unknown impacts of inflationary trends, potential supply and demand imbalances and labor and material costs. The newly introduced Florida Property Insurance Reforms and the extent to which storm search claims may end up being covered by insurers, among others. Overall, we believe our estimated market share of the event will be comparable to prior or large events of a similar nature. In the insurance segment, net written premium grew 18.6% over the same quarter one year ago as our underwriting teams continue to find new business that meets our return expectations. Overall, underwriting performance was excellent with an excellent year combined ratio excluding cat of 89.5%, a 100 basis point improvement over the third quarter of 2021. In line with the last few quarters commentary, an ongoing shift in our business mix and structure of our reinsurance programs resulted in a slightly different split between the loss and expense ratios compared to the same quarter one year ago. In the reinsurance segment, net written premium grew by 73.6% over the same quarter last year. It's worth pointing out that in the third quarter of 2021, we had a cat up in seeded premium the Somers REIT, significantly reducing our net written premium. Absent this impact, the year-over-year increase in net written premium would have been 37.9% and much like the insurance group reflects an environment where we are better able to write business that meets our return thresholds. The segment produced a next cat accident year combined ratio of 85.5%, 230 basis points higher than the same quarter one year ago as a result of an elevated number of large attritional claims in our property other than property catastrophe book and also an increase in our expense ratio due to an ongoing shift from excess allowance to more proportional business. We believe this movement in the loss ratio is well within our expectations of the inherent variability of the underlying claims activity in our book of business. Our mortgage segment had an other excellent quarter with a combined ratio excluding prior year development of 39.9%. Net premiums earned decreased on a sequential basis as we continue to see the effects of higher recessions on our U.S. MI book and lower levels of single premium policy terminations. Persistency of our in-force insurance now stands at 75.4% at the end of the quarter. It has continued to increase due to the rising mortgage rates which considerably reduces the attractiveness of mortgage refinancing for most borrowers. We recognized $126 million of favorable prior year development across the mortgage segment this quarter as delinquencies continue to cure at a higher rate than expected. Over 80% of the favorable claim development came from our first lien insured portfolio at U.S. MI mostly related to the 2020 and 2021 accident years. The remainder of the favorable development came from recoveries on second lien loans and better-than-expected claim development in our Australian operations and our CRT portfolio. Income from operating affiliates stood at $8.5 million and was generated from consistent results of offset in part by underwriting losses at Somers Hurricane Ian. Net investment income was $0.34 per share, up 21% from the second quarter of 2022 and 55% from the third quarter of 2021 on a per share basis. The strong positive cash flow from operations over $2.8 billion year-to-date, combined with the proceeds from maturities and sales of securities, deployed in a rapidly rising yield environment underpinned this improving results. Going forward, with new money rates above 5% and a growing base of invested assets, we should have a good opportunity to further enhance our operating income through solid investment income results. Total investment return for the investment portfolio was negative 3.01% on a U.S. dollar basis for the quarter in a challenging environment of rising interest rates and weak equity markets. We remain cautious relative to our duration, credit and equity risk with our investment portfolio, and this defensive strategy helped minimize the mark-to-market hit to book value. Our investment duration remains relatively unchanged compared to one year ago and is slightly underway relative to our liability duration. Turning to risk management. Our natural cat PML on a net basis stood at $851 million as of October 1 or 7.7% of tangible shareholders' equity, again, well below our internal limits at the single event 1-in-250-year return level. Our peak zone PML is currently the Florida Tri-County region. On the capital front, we repurchased a minimal amount of share this quarter, approximately 236,000 common shares at an aggregate cost of $10.1 million. As our prospects of seeing meaningful opportunities in the business remain very good for the remainder of the year and into 2022. With these introductory comments, we are now prepared to take your questions.

Jamminder Bhullar :

Hey. Good morning. So first, I just had a question on -- obviously, on pricing in the reinsurance market. Obviously, cat pricing hardening a lot with after Ian, how do you think it will affect pricing in non-cat lines? And where do you see the best opportunities for growth for Arch?

Jamminder Bhullar :

And then how do you think about capital? Because a lot of companies, total equity has come down a lot because it marks on AOCI. And I noticed you bought back very little stock this quarter. Not sure if that has anything to do with capital or just preserving capital ahead of cat season. But how do you think about capital overall for the industry as well as for you guys and specifically, how that's affected by declining total book values?

Francois Morin :

Yeah. The one thing, Jimmy, I'll add to specific to our Trey, and that's really part of our history. We've always operated with the principle that we wanted to have a strong and conservative balance sheet, right? And why have we done that? Why are we thinking that route? It was always with a mindset that we wanted to have optionality. We wanted to be able to take advantage of improving market conditions when and if they come around, right? . And what I mean consistent and strong and conservative balance sheet, it's, a, the investment portfolio, you saw that in our markdowns, we got some like everybody else, but I think we're probably more on the low side. And also in terms of leverage, we don't have a very levered balance sheet. Even today at 9/30, we're below 25% the right at 25% on a just-to-capital basis. So those are the reasons why we feel like that's -- again, that's been our strategy. And this may be a moment in our history that tells us that and we'll be able to enjoy the benefits or reap the rewards of maintaining such a strategy. So I think we're in a really, really good position. We're positive. We're optimistic about the market going forward. We're still not there yet, and we'll see what happens at one to one, but at least from the balance sheet point of view, we're in a really good position.

Francois Morin :

Well, again, it's twofold. I'd say, a, we typically don't do a whole lot in the third quarter ahead of the hurricane season. So that's very consistent with our history. There's always -- the stock price matters, always, as you know, in the short and stock buybacks. So going into the quarter, we just wanted to see how things played out. And also with the expectation that we would -- the hard market, even before Ian, we still thought that the hard market would be -- go well into 2023. And that was one of the reasons why we felt maintaining the capital base that give us the ability to write on that business in '23 was critical to us.

Operator:

Our next question comes from Elyse Greenspan with Wells Fargo. Your line is open.

Marc Grandisson :

At a really good question, Elyse. And I think it's obviously dependent on the risk-adjusted return that we would see in there. Like I just want to remind everyone that we're underweight at 7.7%. So we have room to grow if we see the opportunity. We did grow a little bit in 2022, seeing opportunities. We would do the same thing if we were to be presented with the same situation. I think we have the capital, the appetite and the expertise to really participate in the upcoming market hardening. I think at least the -- if it continues to shape up the way it's designing itself, we're going to be part of a solution. We're going to be part of creating new solutions and providing meaningful capacity to our clients. What I like about what we are is we have a diversified platform. As you know, it is a lot of flexibility and as Francois Morin mentioned, we're in a very good position. What I could say is, if you tell me what the returns were, I would tell you how much we would be willing to take. But you would expect to hear from Arch that the way we think about building up the risk in the tower is incrementally as we would go up on the PML, we would the expected return to increasingly improve over that period. So it will be really, really highly depend on how much the rates go. And you might -- I think it's too early to tell. What it's going to be, right now, what we think it could change, but it should be significant.

Marc Grandisson :

Yes. Well, I'll tell you, Elyse, if you look at this is the beauty of our platform, right? When you had a reinsurance company and an insurance company, was to participate in the upswing of the market that is reinsurance is a really, really quick and proactive way to do. So we think in the early stages of this hard market gets there, that we would be deploying more capital more quickly into our reinsurance unit because it's also what I think most of the need is going to do, right, on the insurance portfolio, at least as you know, fiscal year to turn over our portfolio, whereas a reinsurance portfolio could be done much quicker. So I think it's going to be in steps like it always has been. It's the same in 2002 when we were formed. We were really, really reactive and very quick to market on the reinsurance side as we saw our insurance business building up and getting traction and take via a hard market. So I think over time, we then where does it land in 2024 and beyond if we have this opportunity, again, as I mentioned, then it will be relative returns. It will depends who gets a better risk-adjusted return. They will have to go in front of Francois and I and argue their case. These are our prospective units. And this is what we're going to go through. We go through this on a quarterly basis to make sure we're keeping all the returns in the same -- the most optimal as possible.

Francois Morin :

Yeah. I think that's the third way to think about it. I mean, we've said before, I think looking at loss ratios on a quarterly basis is not something. It's not how we think about it. We like to take more rolling 12 months or even maybe longer periods to have a view of the long-term performance of the book. Again, I was just making a point that just to let everybody know that we're not worried about this little blip in our quarter, very much part of the normal volatility of our business. But going forward, if the market ends up being very constructive, let's say, on the short-term lines. Specifically, yes, the loss ratio presumably could come down a little bit.

Operator:

Our next question comes from Michael Zaremski with BMO. Your line is open.

Francois Morin :

Yes. I mean I think we -- many of us thought we haven't answered all those questions by now. The model proposals that they perform were substantial and broad. So I think it impacted most -- I mean most types of companies, Europeans, North Americans, life B&T, et cetera. They did get a lot of feedback. So the current thinking and what they just let the world know recently that there -- call it, their second version of their proposal will be out in the first quarter. So there's a little bit of uncertainty there as to what changes they may make to what they suggested initially. We've had discussions with them. Many others have as well, specifically in the Bermuda debt issue. We'd like to think that's going to get resolved reasonably well. We don't have finality on that. But we're somewhat positive that we'll get a good resolution there. So from that point of view, I'd say our capital base is strong, and we don't see a need to make any changes to it at this point.

Michael Zaremski :

Okay. Understood. Appreciate it. Maybe switching to your primary insurance operations, which I know are diversified among a number of businesses. But I guess a lot of good commentary in the prepared remarks. Could you give us an update on kind of where pricing has been trending? And maybe just a broad question on the primary insurance marketplace and maybe it's just -- maybe it's tough to put a paint with a broad brush. But if we thought about the angry insurance life cycle clock. Just kind of curious where you -- what time you think it is?

Michael Zaremski :

And maybe -- I think you brought up the excess in surplus lines marketplace. Any maybe you can remind us how large of a business that is for you all? And is that -- is that -- are the dynamics different in that marketplace versus kind of the picture you painted in terms of the primary insurance marketplace clock?

Michael Zaremski :

Thank you. Best of luck.

Yaron Kinar:

Good morning. My first question is with regards to the changing reinsurance market. do you see that leading to changing retention rates in both insurance and reinsurance? And if so, what impact do you see that having not only on the top line but also on potentially lowering the attritional loss ratio and increasing the acquisition costs?

Yaron Kinar:

Right, but do you think, I guess if we focus on the entrance segment for a second, so ultimately, I would think with maybe lower or higher retentions maybe you actually see some improvement in the attritional loss ratio, but at the same time, some headed to the acquisition ratio.

Yaron Kinar:

Okay. And then a follow-up statement you made earlier on the marks, I had always thought of rating agencies as largely looking through interest rate related marks, maybe with some exception with S&P. And I also thought that stat accounting doesn't really account for interest part. So why would that led or become an industry capital issue?

Yaron Kinar:

Got it? Thank you.

Tracy Benguigui :

Thank you. I have follow-up questions on your ability to grow prop cat risk and capitalization. So I feel like your 25% target of 1 and 250 PML at tangible equity is an easy way to communicate your appetite to the Street. But I realized a large consideration is allocating capital on a risk-adjusted basis. So can you remind us, how do you view diversification credit or covariance between MI and catastrophes? Or said another way, does your risk adjusted capital consumption from MI restrict your ability to take on prop cat risks even if there is diversification credit?

Tracy Benguigui :

Yes, thank you for reviewing the process. I was just trying to get at, do you think that gives you an advantage to grow property CAT risk given the diversification credits?

Tracy Benguigui :

Okay, and also want to go back to the conversation on negative mark and capital in a way, why does it matter? I know, S&P would penalize you for that. But don't you have access of up to $1.3 billion line of credit, so you shouldn't actually crystallize any unrealized losses by being a forced seller? Is that fair? I'm just wondering if investors should pay more attention to liquidity.

Francois Morin:

And Tracy, the argument, that you're pushing us, I mean, you could take it to the extreme, right, because the way they handled was up by 80%. But at some point, it starts to matter. It's not as important as 5% or 10%. It's more important at 30% and becomes progressively more important, because in the end we have to pay our policyholders. And then once we're out of reserves did a cat loss, we need to take care of our capital. And it does matter in the big world. So I think it's --I'm not saying it shouldn't matter 100% now, because at some mark and it's still capital available. But it has to make a difference somehow over time, because the argument would fall, right, at what point do you think it starts to matter, 50, 60, 80? I think it's matters just a different degree through the capital stack.

Marc Grandisson :

Well, I mean, there's -- we've done some rough math. I mean, you can kind of look at it like portfolio, turning over in the following two years on average. So let's call it eight quarters. And you can do get a rough now by that. But the reality is, we're going to also I think we're going to get -- we do have plenty of free cash flow coming through. And that's going to be reinvested at pretty significant levels. So we think that overall, the book value should start growing pretty quickly beyond just the recovery of the markets.

Marc Grandisson :

You are welcome.

Josh Shanker:

Yes, thank you. I wonder if you can give a little outlook on the mortgage insurance sector? Are we at the bottom of the issuance cycle here for opportunities? Does this last for a little while? Are there even fewer mortgages that are going to be purchasing insurance over the next year? Where do we stand right now?

Josh Shanker:

Yes, primary, MI. I'm clearly like new home sales are down. And so obviously, we're going to expect less flow. Is it going to continue to decline from here? Or is this kind of what a -- I guess a holiday from mortgage issuance looks like for the MI business?

Marc Grandisson :

And on the INW, which Francois just mentioned about new production, if you look at the NBA numbers, the purchase market, which is by far the most important one, for the MI business, is a lot more stable, there's not as much of a decrease. So we're still fairly positive, that we're still going to get some nice production from our team over the next several quarters. And again, I remind everyone that as you know mortgages is up north of 7%. So it does make it a bit hard to get into a home. But fact is, there's still pent up demand for housing if the purchase market should stay pretty active for the next several quarters, which bodes well for our INW, just forward-looking.

Francois Morin:

Yeah, I think I just mentioned it in my comments, the industry always like everyone else here on the call talking about what's happening around the world, some uncertainties, discussions, whatever else. The potential thing that could happen and the industry is raising rates is right, is raising premium rate as we speak on the mortgage, the mortgage sector, which is good news, which speaks I believe, volume for the new environment, that we have in MI, an industry that, is a lot more disciplined and deliberate in what it's doing. It's something we would have expected, but it's good to see it happen in life, in real life case like that we are seeing right now.

Francois Morin:

Right now we have a lot of discussions about this. Right now. We believe that our P&C operations are slightly gaining and getting ahead of it, don't tell our MI group that. But it seems that the ENC units are squarely taking the lead.

Francois Morin:

You are welcome.

Michael Phillips :

Thanks, good morning, everybody. Just looking -- the questions on the no discount in the current times we're in with property, cat and massive hurricane on the heels of what's going on with interest rate environment and everything else and mark to markets. But and even lots of movements around property cat pricing, obviously. But to what extent do you think we're in a period, very early innings of more respect for property cat, and this will continue actually, over the long term, which clearly has not happened in a very long time?

Michael Phillips :

Yeah, that's kind of what I was alluding to. But okay, perfect. Thank you. That's all I had.

Operator:

Our next question comes from Yaron Kinar with Jefferies. Your line is open.

Marc Grandisson :

Yeah, so the answer the great question, yeah, I think number one is we're partnering up with guys who are cutting edge really, on top of the latest technology, and latest forensic work for our clients. And that's a really good place to be. We also have a team. But funny enough, a lot of our teams were on the tech side for cyber risk are not part of the underwriting team. So we have a lot of people within the underwriting units who are actually more IT people than cyber specialists, and they themselves also contract with other third party vendors as well to make sure that we're on top of it. In addition to other third party vendor that we have ourselves within the company, so we also want to look out and understand it more and more. It's a big investment.