Q3 2020 Arch Capital Group Ltd Earnings Call
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Ladies and gentlemen, todays conference is scheduled to begin shortly please continue to standby. Thank you for your patience.
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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 they are filed by the company with the FCC 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 1985.
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 FCC yesterday.
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., France lumber in Sir you may begin.
Good morning, Liz and welcome to our third quarter earnings call on Halloween Eve.
You're in for a treat.
You know results you can see tangible evidence of the advantages of the arch model.
By protecting our capital during the soft market years well.
We are well positioned at each of our segments these into improving market conditions.
Our underwriters are making the most of the hardening property and casualty market, while our mortgage insurance segment is benefiting from record mortgage origination activity this quarter.
This year for the first time in nearly a decade.
We've been able to grow significantly and deploy more capital in our PNC businesses that provides acceptable expected returns and due to our strong financial position.
We have accomplished this while maintaining a strong presence in the <unk>, which continues to deliver meaningful returns.
Our ability to continually rebalanced got that told amongst our diverse businesses enhances our total underwriting returns. It also should decrease earnings volatility over time since.
Since our inception, we had believed in cycle management and this strategy brings an added margin safety to our collective underwriting activity.
Allow me to elaborate on our third quarter results by touching on three key themes.
One growth.
To margin improvement and three capital allocation.
First.
Let's talk about growth.
In this quarter net written premiums in our PNC units grew 25% and totaled 17% in insurance and 38% in reinsurance over the same period a year ago.
This growth was driven by rate improvements, but also reflects our ability to increase our participations where clients needed additional capacity.
In the instruments segment, we continue to obtain strong rate increases in areas like property. The INO, one casualty group wide our rate increase for the third quarter averaged over 11% and we believe this trend of increasing rates should continue through 2021.
At arch, we have always follow the simple rule our participation in that business should follow the direction of premium rates as rates improve we write more business.
When rates decreased as they did over the past several years, we write less.
This strategy takes courage, you will often appear an outlier to the market.
But being intellectually honest discipline and applying our cycle management techniques is what we're all about at arch.
Obviously, the PNC market is broad.
And all opportunities are not created equal they.
They are areas, such as workers comp where premium rates or conditions are not improving to the levels. We believe are needed for an adequate return and in those instances, we manage our appetite accordingly.
Despite headwinds from the pandemic, although growth in insurance lines like DNS property casualty and professional lines are Great example of our platforms ability to flex into improved underwriting conditions.
Our reinsurance unit has been able to lean into this hardening market both earlier and with more vigor then our primary operations. There are two main reasons for this first.
When a market transitions needed rate increases compound up the insurance supply chain reinsurance is often a leading indicator of what's to come more broadly.
Second reinsurance can provide capacity quicker and a larger amount system can put since it can put capital to work through clients platforms.
Of course.
Sheer growth is only one part of the equation of growing returns, let's turn now to margin improvement. We all know that mathematically rate increases in excess of loss trends lead to margin improvement the marketplace seems to be supporting the momentum of continued rate increases we are in the early stages of seeing.
The benefit of rate on rate increases you know operating results simply stated, adding the two parts growth and margin will lead to better returns.
Many factors are driving today's BNC market. These include elevated natural cat loss activity in each of the past four years weak.
Weekend reserve positions from soft market years.
Lower investment yield and a rising claim inflation.
Add in a global pandemic that is still ongoing and it's not surprising that market conditions are changing.
No.
Pivoting to EMI.
Our 33 billion of Eni W. in the U.S. in the quarter was a record for arch low interest rates are producing.
Huge refinance activity and not surprisingly some churn in our in force business. However.
My premium rates remain above pre corporate level and the continued high credit quality of borrowers is generally better than it was brand that pre pandemic Rick.
We continue to face uncertainties, such as the economy is health and how the pandemic may ultimately affect individual borrowers. However, we are optimistic that among other positive factors.
Recent trends in the U.S. housing market will mitigate the effects of the pandemic.
Finally arches ability and willingness to allocate and manage capital remains a key competitive advantage, we always think about balancing our capital deployment over five pillars.
Into the insurance.
Reinsurance.
My into our investment portfolio, and lastly into our stock repurchase.
Our job is to optimize risk adjusted returns through capital allocation across these pillars, we see monetizing the five pillars.
Being similar to coaching a basketball team.
We're constantly looking at how we can distribute the ball I eat our capital to the right players.
The past several years, we've been able to feed the big seven foot seven am I guide down low and rely on him to get easy Ducks.
Now as a playing field are you the market changes.
We've adjusted our tactics slightly and are increasingly relying on our two hot shooters reinsurance and insurance.
Am I will still score its fair share a point, where the PNC players are getting more open three point looks and layoffs in short our a game is becoming more complete and diversified.
Our ability to adapt to the new conditions is what makes us stronger as a team.
The market dynamics take me back in time.
We have talked about pulling gray's underwriting clock that helps track and measure the phases of the instrument cycle, it's been central to our management philosophy since the beginning and as a helpful reference to understand the underlying underwriting lifecycle and assist us.
Engaging our risk appetite.
I recently at our underwriting teams, where we were on the Ingrate clock and the most common response was around eight o'clock. If you take a look at the clock in our most recent the recent annual report you will see that it's a very nice time to be at arch as a buzz among our underwriters because we've become the first call for so many of our clients.
They know that we have the capacity.
The expertise and the desire to serve them.
Now I will turn the coaches whistle over to Francois as he goes into more detail on our quarterly results and I look forward to responding to your questions afterwards Francois.
Thank you Mark and good morning to all we at arch Hope that you are in good health.
On to the third quarter results as a reminder, and consistent with prior practice. The following comments are on a core basis, which corresponds to arches financial results. Excluding the other segment.
The operations of Watford Holdings limited.
In our filings the term consolidated includes Watford.
After tax operating income for the quarter was $120.3 million, which translates to an annualized 4.2% operating return on average common equity.
And 29 cents per share.
Book value per share increased to $28.75 at September thirtyth.
4.1% from last quarter, and 12.2% from one year ago.
The increase in the quarter was fueled by the continued strong performance of our investment portfolio and good underwriting results taking into consideration the elevated catastrophe activity in the quarter and.
And the uncertainties surrounding the current pandemic.
Our property casualty teams continued on their path of solid growth and improved performance.
As we continue to see strong positive pricing momentum in their markets.
Losses from 2020 catastrophic events in the quarter, including COVID-19.
Net of reinsurance Recoverables and reinstatement premiums stood at 203.3 million or 12.5 combined ratio points compared to 5.2 combined ratio points in the third quarter of 2019.
The losses impacted both our insurance and reinsurance segments and include 191.4 million from a series of natural catastrophes in the quarter, including Hurricanes iOS lower in Sally.
The Midwest or in direct show cash.
California, wildfires and other smaller events.
As well as well as the 11.9 million for losses related to the coal that 19 pandemic.
The COVID-19 losses recorded in the quarter were small reflecting additional information that became available during the quarter.
And represent our current assessment and best estimate of the ultimate losses for occurrences through September 30.
Based on policy terms and conditions, including limits sub limits and deductibles.
As of September Thirtyth, the vast majority of our COVID-19 claims are yet to be settled or paid with close to 80% of the inception to date incurred loss amount per quarter, those incurred but not reported.
Ivy and our reserves or as additional case reserves within our insurance and reinsurance segments.
As regards the potential impact of COVID-19 on our mortgage segment.
We note that the delinquency rate at the end of the quarter was 4.69% down from 5.14% at June Thirtyth.
Our current expectation is that the delinquency rate should be in the 5% to 5.5% range at year end 2020.
While we would have seen many positive signs over the last few months that point us to a more favorable view of the ultimate performance of the USMLE book.
Many of the uncertainties, we identified on our last call remain.
In particular, the potential impact from a second wave of infections potential lockdowns.
And the lack of an additional fiscal stimulus package our risk factor is that we continue to monitor and evaluate on an ongoing basis.
For these reasons and consistent with our corporate reserving philosophy. We believe it is prudent to take a cautious approach in setting loss reserves, our cross or my book.
In the insurance segment net written premium grew 17.1% over the same quarter, one year ago, a strong result, demonstrating our ability to achieve profitable growth in this environment.
Adjusting for the net written premium decrease observed in our travel accident and health unit the year over year growth in net written premium would have been 26.5%.
The insurance segment's accident quarter combined ratio, excluding cats was 94.1% lower by 620 basis points from the same period, one year ago.
Approximately 300 basis points of the difference is due to a lower expense ratio.
Primarily from the growth in the premium base from one year ago and reduced levels of travel and entertainment expenses this quarter.
The lower ex cat accident quarter loss ratio reflects mix change and the benefits of rate increases achieved over the last 12 months.
Prior period net loss reserve development net of related adjustments was favorable at 1.1 million generally consistent with the level recorded in the third quarter of 2019.
As for our reinsurance operations.
We had strong growth of 38.4% in net written premiums on a year over year basis.
Which was observed across most of our lines and includes a combination of new business opportunities rate increases and the integration of the barbick in reinsurance business.
The segment's accident quarter combined ratio, excluding cats stood at 83.1% compared to 92.8% on the same basis, one year ago.
The year over year movement is primarily driven by a more normal level of large attritional losses compared to a year ago.
And rate change activity over the last 12 months.
Most of the remaining difference is explained by operating expense ratio improvements, primarily resulting from the growth in earned premium.
Favorable prior period net loss reserve development net of related adjustments was $40.8 million or 7.4 combined ratio points compared to 4.0 combined ratio points in the third quarter of 2019.
The development was mostly in short tail lines.
The mortgage industry had a record breaking quarter in terms of Eni W. And we certainly followed suit with this quarter's Eni doubled your 38 32.8 billion, a full 30% higher than our prior high watermark.
Offsetting this record level production was the high level of refinancing activity across our portfolio.
With the net result, being a slight reduction in our insurance in force.
The combined ratio was 64.2%, reflecting the lower delinquency rate observed during the quarter.
The trends we saw this quarter were favorable relative to last quarter, but the game is far from over.
The expense ratio was slightly lower over the same quarter, one year ago and prior period net loss reserve development was favorable at 4.5 million this quarter.
Total investment return for the quarter was positive 230 basis points on the U.S dollar basis as the strong recovery in the capital markets produced healthy returns across our entire portfolio.
Returns in our equity and alternative investments contributed approximately 40% of the total return for the quarter.
The duration of our investment portfolio remained basically unchanged from the prior quarter at 3.21 years.
The effective tax rate on pretax operating income was 4.8% in the quarter, reflecting a change in the full year estimated tax rate the geographic mix of our pre tax income and a 10 basis point benefit from discrete tax items in the quarter.
As always the effective tax rate could vary depending on the level and location of income or loss and varying tax rates in each jurisdiction we.
We currently estimate the full year tax rate to be in the 8% to 10% range for 2020.
Turning briefly to risk management, our natural cap PML on a net basis increased to 918 million.
As as of October one, which at approximately 8.4% of tangible common equity remains well below our internal limits at the single event, one and 250 year return level.
The growth in the PML. This quarter is attributable to our EPS property unit within the insurance segment, which increased its right, which increased its ratings in an improving marketplace.
On the capital front the increased interest expense. This quarter was mainly the result of the issuance of the $1 billion Senior notes, we issued in June 2020.
So far we have been able to fund our recent growth with our existing capital base and our balance sheet remains strong with a debt plus preferred leverage ratio of 23.1% there remains well within a reasonable range.
As for our use somebody operations the mortgage insurance linked notes market has recovered to a great extent from the lows we saw at the onset of the pandemic.
Earlier this week, we priced or third Bellamy transaction of the year at terms that are getting closer to what we saw in 2019, both in structure and price.
Our latest transaction will provide 6.5% of coverage in excess of a 2.5% attachment point, both as expressed as a percentage of the risk in force.
Including this transaction the Bellamy structure is currently provide approximately $3.9 billion of aggregate reinsurance coverage.
Coverage. The fact that this market has recovered as extensively as it has in just over seven months with investors more and more comfortable with the exposure there assuming is quite telling and provide support to our current assessment of the health of the using the us housing market.
With these introductory comments, we are now prepared to take your questions.
Thank you.
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Our first question comes from at least Greenspan with Wells Fargo.
The line is now open.
Hi, Thank you good morning, good morning.
My first question is on the capital allocation. So Mark you laid out hi, Hello.
I just wanted to confirm I guess any thoughts on.
Hi, you're talking sounds like share repurchase is lab.
Kind of on the team right now and again.
Because it seems like you have such good growth opportunities that you could put your capital to you.
Just basically to incrementally add to your insurance and reinsurance writings am I understanding that correctly.
So yes.
I didn't mean to put them in ranking order I think that they are probably all fairly equally.
Attractive at this point in time, I think that we're investigating as you know on a quarterly basis as to what the opportunities are in various lines of business I didn't mean to name a stock repurchase as a last one other rank ordering mechanism I think that it's also part and parcel of the of the discussion I think that for the first time in a while I would argue that.
Five players actually are.
Activity, making the 0.4 was hitting a ball the ball in the play play put before the game. So I would definitely say that and we're evaluating but certainly our game number one our focus number one is to allocate capital to the underwriting units. If the returns are there and that certainly is a relatively.
Easier place to deploy an easier way to see it at this point in time, but everything is up everything is split every every got everybodys laying on the field and the court so.
So.
Okay. That's helpful. And then my second question on your insurance on your mind.
Margin, 94% in the quarter aren't you had targeted debt can you kind of a need 90 odd yep.
Kind of there, but there is more you mentioned a lot of great I think 11% that you're getting in your book of business, which you have even earn that any yet.
Let me think about earning the rate you're getting today, plus what seems like incremental we get into 2021 do you have any target for that business or is there a way that you can think about that.
Margin profile, there, especially since you kind of hit that target that you laid out.
Yes, So let me go back to the 95, combined which I mentioned I think three years ago. Now I think there was meant to be there as an aspirational target and to to to shoot for at that point in time based on the mix of business and the opportunities that we had in the marketplace I.
I think this has changed right I think that now that we are obviously going in that direction in very nicely in the markets certainly helping us I think we still look very heavily into line by line and are really by line of business and I would argue at least at some lines of business would need less than a 95 combined and some might be to locate above 95, but.
Certainly what I would tell you with a combined ratio was operational we have to keep in mind that.
This still.
Equipment I think is still ongoing and second the interest rates have also been decrease have decreased significantly since two years ago. So.
Rate increases might be needed beyond the combined ratio just to make the returns equivalent to what they should be or would have been at a 95 historic so it's really an ongoing process of reflecting current investment yield. So there are no target on a combined ratio, but Sony targets on a return basis and I would argue with with a 140, 150% to 150 Bips.
Decrease in interest rate that the combined ratio with no presumably mathematically need to go down to make an equivalent return.
Okay. That's helpful. And then last question on you mentioned.
Cautious approach to reserving within your mortgage book.
And then I think you also laid out default.
Yes, yes, yes, five five and a half.
At the end of the year.
And Tom just fine.
I understand like add default.
I guess Rick.
<unk> up a little bit fit today.
I am assuming that we'll continue with the same conservative approach that we saw in the third quarter. So how should we think about kind of the combined ratio you've been giving some metrics for how that business.
And you've obviously come in better than expected in the second and the third quarter you have an expectation for how that could ultimately kind in the Q4 number if you want to provide additional color on 2021.
Yes.
I'll take that lease.
I mean, just to be pretty clear I think as you guys, Illinois.
Ill take the blame I did a pretty poor job of forecasting combined ratios are the.
Delinquency rates over the last two calls I think we are trying to minimize that was kind of bad forecasts, but.
Listen there is as we know there is a lot of uncertainty out there.
Yes, we're extremely pleased that the delinquency rates have come down.
Right, we had talked about.
Even just last quarter, we had said like somewhere around 8% by the end of the year. It doesn't look like we're going to it's going to be as bad as that.
Based on what we know today.
Still a few months to go but we definitely saw some encouraging signs this quarter.
So that's all well and good day.
Does that translate to.
What kind of combined ratio then translate to I mean, it's hard to know because again, we're facing is really we just don't know how long. This this pandemic is going to last and.
Ill.
The fact that the forbearance programs or.
At this point scheduled to end, but who knows if they get extended or not and how do people convert from Neil forbearance do a regular delinquency theres a lot of unknowns at this point that we feel are extremely hard to predict an estimate so those that were taking it one quarter at a time, we're happy with where things are at right now.
Again, it's it's reassuring, but we're not as I said were the gains far from over and in them and who knows maybe hopefully even my 5% to 5.5% forecast or expectation for delinquency is and ends up being a bit higher but we'll find out in a few months and and we will.
Reassess at that point.
Okay. Thank you very much I appreciate all the color.
Sure.
Our next question comes from Jimmy Bhullar with Jpmorgan.
Hi, Good morning, first I just had a question on.
How you are thinking about.
Racing reinsurance pricing as a buyer of reinsurance and how should we.
Think about the yours, so the overall exposure specially to catch as you're entering 2021 are you.
Given better pricing they can to hold more exposure or it may be.
It should be assumed that deal.
Keith yield retention sort of similar media buyer that go to that list prices.
Yes. The short answer is we don't know yet right I think we'll have to see where the one one brings to to to our reinsurance folks on the inward side and certainly on our DNS property.
We'll have to evaluate and assess what kind of exposure and what kind of margins we're getting there.
And then look back and say, okay. Now what is the because buying reinsurance as you know is like.
Raising the fact using capital. It's like you know we have to pay for that so we're going to go through a very straightforward analysis of capital usage and what we pay for it and we take a very very first economic view of the whole the whole the whole world and specifically as it relates to the insurance exposure we take on it.
Property cat exposure specifically.
But having said all this we also.
Tottenham balancing it or adding to that inflammation process is that we also are careful to not going over stretching the capital. So we'll always be buying reinsurance to some extent. The question is what level and how much and at what price, but clearly we are.
We we like stability and we always trading stability for that sometimes lesser margin and is going to be part of the mix, but clearly both markets.
Where we can be on the advantage.
We have gained go it's on both sides. So we can actually get rate increases on the insurance side found a way to buy reinsurance in is in a.
Good way and others and those on on the assumed basis, we actually are benefiting from the improvement in the market there as well so it's really a whole.
A holistic view of the cat exposure too early to tell what exactly is going to transpire, but everything is always up for discussion.
And then on Watford you raised the price there's pressure on you to raise it again.
And at what point does the deal becomes sort of uneconomic and or are you already there or any comments on how you're thinking about that situation.
Well, we I mean, we run rate are bright we did not raise the price right. We have an agreement we have a signed agreement with Watford that.
We're starting the process to get regulatory approvals et cetera, but.
Yeah, I mean, there's another party that has come in that Watford feels they have to.
Look into their potential offer and what it all means to them, but at this point, what's been announced as what is still valid.
Depending on what they end up deciding we may choose to do something different but at this point, we can't really say much more than that.
Okay. Thank you.
Our next question comes from Mike Zaremski with Credit Suisse.
Okay.
Thanks, Good afternoon.
Focusing on the reinsurance segments.
Robust growth thanks for that commentary bullish commentary.
If we look at the.
Underlying accident year loss ratio.
I mean actually expense ratio too. So just just a lot of improved on anything we should be thinking about anything you want to call out or is this just market conditions and operating leverage such that you're you're benefiting from.
Yes, so the reinsurance.
The reinsurance group has grown tremendously so the expense expense ratio going down or.
What it did Sony is explained by that in large part I think in terms of.
The loss ratio, what I would like and we said that on prior calls as wells as we tend to look at reinsurance performance on a 12 to 18 month basis. There is a lot more volatility in that segment in that sector knows there's also a lot of shift in the mix over time.
Reinsurance folks do.
Do not tend to have a they have stable relationships, obviously, but there's a lot of things moving on.
In terms of taking seizing the opportunities in the marketplace. So what I would look at the loss ratio is more like a you know this is.
Some quarters is is much better than others, and it's really due to the volatility in the reinsurance results I would say.
Okay. Okay got it so that the expense ratio some of that's going to roll. It then oh okay.
Follow up on the on the mortgage side.
I think I heard you say earlier that.
Hi, Len pricing kind of had improved a lot I guess I'm looking at we're trying to we have been trying to track overall, Ireland pricing and we kind of see still see it as double.
But it was pre pandemic, but maybe I'm, just looking maybe arches pricing is better or make indus incorrect.
Yeah, I mean, there's two parts to right. This is the structure, meaning in particular attachment points and then the pricing. So right. So this is our third one.
Our first one of the year early we were the first ones out of the gate after the pandemic.
The reality of that point there is appetite from the Investor is was not as good as what it as it was in the past than our attachment wing attachment point was much higher second one attachment point came down with slightly better pricing and with this new latest one were effectively back to the sales the 2.5% attachment.
Point that we had seen pre covance. So thats. So that's certainly a very good sign pricing ill with you at risk adjust for everything it's still up no question, it's not to the same level that it was pretty cold wet, but it's you know it's not double for sure so with CL much much better than that much lower than that and ill qual.
I read the book is better so how does it how does that get factored in and so there is couple of things that you it's hard to make it perfectly apples to apples, but directionally in and on an absolute basis as well, we're very happy with where things are going.
Okay got it that's helpful. Because it does I think that you're describing it's better than than what we had thought okay. Yes. It does.
Lastly, sticking on mortgage.
Hopefully you said you know the delinquency rate doesn't pick up as much as you thought but are you.
It's almost November now are you are you have you seen over the last few weeks delinquency rate tick up.
So last few weeks, it's been it's been actually keeping in the same general direction that we saw in the third quarter. So it hasn't picked up.
Flattish at call it and.
Now we got a couple of months to go we'll see how things play out but thats scana.
What we're seeing.
Understood. Thanks for the color.
Sure.
Thank you.
Our next question comes from Josh Shanker with Bank of America.
Yes. Thank you two questions one just to understand accounting and the other one is about Watford.
On the.
Accounting you've had a decline in delinquencies Judy.
Judy cures of 6000, approximately but you took up reserves.
You know I know you can't really reserved for losses that hasn't happened yet, but it looks like your reserving for these new claims at about 12 $13000 per claim compare to historical average of four to $5000 per claim am I doing the math correctly and can you explain sort of how you are.
Thinking about that in the books I think in first quarter. You also took up.
Reserves more than typical because you can only take them up when you have quite a bit can you walk through that a little bit.
Yes, I am.
No question that we bumped up reserves this quarter on effectively that delinquencies that we saw in the second quarter. So.
Your math is correct I mean, it's I mean, the reserves per delinquency you did the math right, but what you need to.
Adjust for I would say is.
Call. It a reserve strengthening exercise that we went through just the reassess where we were.
Heart every quarter, we take a hard look in our view is that might as well.
Not a BBB cautious knowing what we know and knowing what we don't know.
So think of about a 45 million dollar adjustment on on reserves in the third quarter for effectively Q2 delinquencies. So once you adjust for that I think you get back to.
Claim levels or severity is that you would be would be more in line with what maybe you would have expected.
So along those lines.
Is there a reason to believe that the severity of the losses are going to be different than historical severities I understand there's more frequently than you can't really take frequencies.
You get a claim but is there going to be more cautious surrounding severity in this pandemic, we don't see it with the or the only adjustment obviously that we're reporting in our supplement in terms of paid severities is lower than what we're seeing.
From the new delinquencies write new delinquencies, we mentioned that last quarter at about a 65000 or so dollar.
Per per and Odie this quarter, it's right around 60000, so I mean, it's certainly higher because its more recent.
More recent loans that were would that are going delinquent versus where we have the loans. We paid on in the quarter. So thats the only adjustment, but in terms of percentage of the of the insured value or the insurance in force.
The risk in force we don't at this point don't have reason to think that it's going to be materially different than what we spent in the past.
Okay, and then on Watford, we don't know, how it's going to turn out but.
Your own stock trades around book value. The offers for walk around 0.8 times book.
Not sure and maybe you have some some thoughts on whether Watford is a better investment at 0.8 times booked an arch is that one time book, but if you don't find Watford. It would suggest that you have a chunk of excess capital that you were already allocating towards financial Usas.
Can we expect that that your interest in buying business you already know.
It is attractive even given the market opportunity here.
I think we made the point clear by putting our offer up there and thats pretty much what we'll leave it as Josh I think we are we think still we still think that Watford is a is a good platform valuable platform.
Sales shipped out, but clearly our to the more valuable platform than Watford, if you're willing to buy and Watford stock should we be willing to buy an arts talk as well.
I think the answer is always yes, we're always looking at known to possibly of buying our stock and certainly like I said before in a five players in the court I think that the share repurchase the share repurchases is really is attractive as as you would expect me to say the CEO of the company.
All right, we'll keep watching thank you. Thank you.
Our next question comes from Yaron Kinar with Goldman Sachs.
Hi, good morning, Thanks for taking my questions I, just want to start by thanking you for giving me a basketball analogy. So I can actually understand what's going on is where you'd give a hockey analogy.
My first question.
Goes to.
The slight increase in Covance losses in the quarter can you maybe talk about what drove that.
Basically.
I guess, specifically what I want to get added doesn't have anything to do with the FDA Court case over and the UK.
And how youre thinking about your overseas business interruption exposure.
Yes, I mean, it's really two parts I think in the on the insurance side, it's very much. It's all basically related to our travel book in the U.S. So no no connection to the FCC ruling and the little bit we added in the.
In the reinsurance side is around property exposure is mostly.
Out of Europe, So, it's a little bit of a.
Can a little bit of a b angle to it but thats pretty much. It's I mean, it's I mean I call it a bit of just.
This new information coming in nothing no no nothing.
No material new information that came through that would have caused us to revisit our picks.
Yeah, and the FDA as we said we didn't change it and the ruling where it stands. It's we're still very much we had fully reserved for it than there is again the ruling doesn't change our position on that.
Okay. The rest of the portfolio and for what it's worth and we mentioned on prior calls is that we have.
No the vast majority almost the totality of our policies have the exclusions that would protect us somewhat from a deviation. So this is nothing in there to really think about.
Okay, all right Thats very helpful.
And then my second question when you talked about the improvement and the asking or loss ratio for insurance.
You Didnt talk about favorable frequency. So is it because you didnt see that or is it because you didnt book that.
It's a little bit of both actually we saw some of it some improvement on the frequency of claims possibly in the second quarter that was really a definitely a difference, but if you neutralize for the August lines of business where.
Claims would actually nationally go down so fast travel for instance over there with a lot less exposure or go up.
Then if you just like all of this we didn't see a discernible change through the nine month of this year, it's hard to see what the national rate would be but we don't see a discernible change in frequency to two to speak of and really we've put our reserve picking the last big based on long term trend not long term averages.
We're not looking at specific in one quarter at a time and one even accident year at a time, we do getting the mix of multiple years and project out.
Much more longer term expected so it will take a little while before we would recognize any significant improvement in frequency of claims if at all.
Got it.
And maybe one final very quick one on watch word if the deal does go through I, just want to confirm that the company wouldnt lose the fee income.
So far for its consolidated right.
Correct.
Okay.
Thank you Yep.
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Our next question comes from Ryan Tunis with Autonomous research.
Hey, thanks.
Good morning.
The one that I had was just was just on.
And I am thinking about low rate headwinds.
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Yes, it looks like you guys have almost 30% of your assets.
Uh huh.
Essentially government bonds, which of your portfolio yield this too we just heard another Bermuda competitor today, so they're new money yields 2%.
It would seem to me given how your allocated given your current portfolio yield that they actually wouldn't be that much incremental yes.
Yield headwind moving forward actually arguably is going to move out of some of the gabi and take some credit risk actions in that maybe to expand your portfolio yield.
It Doesnt sound like Thats right given your commentary I'm, just kind of trying to understand why why is ours continue to be incrementally exposed as low rate environment, given the fact that you guys.
We'll take it on the Chin in terms of where you are.
Yes.
Yeah, I mean Weve no question we've been.
Defensive on credit.
So yes, we have a bit more on the treasury side that you are right I mean unless rates keep going down but these team they seem to stabilize I guess for the time being.
You know our play in the last few quarters has been trying to.
As many others I'm sure have done the same is trying to find other opportunities that are.
But more the in the alternative space that provide us still.
Some some level of investment income without.
You know taking on too much risk so.
Something we keep looking at but it's.
It's.
It's a bit of a challenge is not a ton of opportunities out there. We're not we're worried a little bit we're defensive on credit still and Thats something that we look at carefully don't want to overstate as ourselves their users.
Well you guys have a new money.
Investment yield you'd call out.
Hendi is that you did in the third quarter well the Onest Colette in the last month, what we've been.
Well, we've been call it.
Putting our money to work is just above 2%.
So that's kind of where the latest information that we get we got from our investment guys.
Got it.
Thanks for the answer.
Thank you.
Our next question comes from Jeff Dunn with Dowling and partners.
Thank you good morning.
One of them.
Good morning first question.
I appreciate the added color around me on my reserving if we make the adjustment the math correctly.
Change your incidence assumption up for about 9%.
Close enough, 8% to 9%, yes, yes, and our view on that is that we feel like that the more recent.
And these are.
May may be prone to a bit more stress. So the fact that these.
These people took a bit longer to go into delinquency may may tell us that there may be again subject to more stress, but again time will tell.
And does that 9% is that a.
Just an overall number or is it a blend of just as an example, 6% on forbearance and 13% on non forbearance notices.
Can you delineate between the two or is that just more of a holistic approach. It's more of an aggregate approach that we take we take.
Yes, we don't separate that super as cleanly as you're suggesting.
We do look at all the new I want to make sure Jeff I want to make sure I understand that we also do look at.
Hi events by a cat events prior program to the sort, so and but if I'd use as you could appreciate to have is probably more art than science at this point in time.
Right.
With the new while land.
Little confusing in the documentation that looks like it applies for policies. After Gen 19.
But it looks primarily.
More recent low.
Owns over the last three four months what is it designed to do is it really the last quarter or so.
Yeah, they're part of the design to come underneath the 20 dash one no it's that delayed us the twenties dash three is very much you call. I mean, the vast majority is covering June July and August. So thats three months of production there is a little bit of kind of spillage of the 20 dash to that.
And also some 2019 loans that had Ghana.
Been late up being process, whatever it's just on and we were a little bit of a catch up on a few small things, but think of it as really.
June July August production.
All right great. Thank you.
Yes sure.
Our next question comes from Meyer Shields KBW.
Thanks Mark.
Mark a little country, but something that you said you were talking about the fives capital deployment opportunities and you cited the investment portfolio and I guess I would have thought that it's going to be writing more PNC or mortgage insurance then the supporting capital will be the investment portfolio anyway.
Yes. So you are saying that we should just repeat the question Marty.
So I'm trying to figure out how that capital flows into the investment portfolio is distinct from a capital deployment to either PNC mortgage okay. Now I see what you mean, so the way we look at the underwriting returns is we attribute to the unit the Treasury return will de risk free retire.
And we try to separate church and state, where we call. It internally, we actually credit the float on the instruments on the underwriting pieces at the treasury rate level, and then we allocate the capital for the excess over that.
To the investment portfolio. This is how we separate the capital usage between those between the underwriting unit and the investment unit.
Okay. Thanks, Thats got it yes.
Yes.
I'm trying to get a general sense of how.
How do you see.
Either profitability in property catastrophe in retro or your view as to whether the.
Vendor catastrophe models are conservative enough.
Based on recent years cat activity and the underlying trends.
Yes, a good question I think that our position on this we have we have in a weather scientist upstairs and we have a lot of the lengthy experience and an inflammation to look at Ah lisanti.
Listen, we actually augment and modify the vendor models.
As we see fit so there's not a model represents to us a solid starting point.
From where we can definitely had a lot of science into this one so we've been historically using them as a starting point and augmenting it and modifying it with our own view of the world, but I would I would caution everyone by saying that yes, we do have a view.
View theres barrels and various exposure around the world and we also try to factor in shorter term versus longer term, possibly no modification and what could happen out there but.
So it's hard to predict those things so what we tend to do is to hold ourselves to a higher return for those risks that are inherent in the way we underwrite the business that also helps explain why.
Where we've taken possibly somewhat of a more conservative approach of property cat exposure over the last four or five years as you've seen in our numbers.
So I think you know it so and it's a year on year analysis, but we would look at it and we'll evaluate I think.
You know in some of our discussion with El Nino El Nino and all these various discussions happening all the time and.
No we're not the largest.
Right or property cat, but we do have a very solid team looking into this but I think we make it up trying to make it up with holding ourselves to a higher level of returns.
Okay. That's very helpful. Thank so much.
Sure.
Our next question comes from sales to follow with Deutsche Bank.
Yes, good morning, just.
One most have been asked and answered one follow up on the M Pesa and thinking about the increase in the default rate I guess.
In my mind. There are there are three mechanisms to get there. It's it's either new defaults are increasing cures are slowing down or the denominator policies enforced is shrinking.
I mean, I'm, just curious how you're contemplating which of those levers is is contributing to the increase in the default rate Angela I think it helps us think about.
Does this come through as losses or premiums or maybe.
You know maybe development if it cures are right.
Okay. So Phil let me to me too I think this has a lot of quite a big question that a lot of parts. So first and foremost the denominator is heart is not changing a whole lot writes about a billion million to 50. That's what it is in terms of policy. The DQ rate has decreased this quarter right went from 5.1 to 24.7 this quarter. So this is.
What's the the number of policies are that the numerator that are.
In default and you divide by similar numbers. So it did go down I think what we're saying in terms of reserving you reserve for the new notices that you received in the quarter by we received 50050 into second quarter. We received 20000 this quarter and what we're telling you is we think that the the book of these 20000 new no.
Assesses.
The cures are the cure and will they go away from the overall balance if you will that we just mentioned which is a 4.7 for the new notices we reserve for those in the quarter. So we have to reserve in the quarter on those our newly notified this is what typically would do on reserving what we did in addition to this is we modified our view of what we should have.
Bookings for the second quarter put a new notices in that quarter.
I'm not sure I've tried to.
Putting help give you a picture a whole as a bigger picture hopefully that helps you understand how do we know that.
That makes sense from the reserving side, but thats the default the default rate is as loans in default that population over policies in force and if the policies in force isn't changing and the default rate is going up and then presumably there's an expectation that new defaults is going to increase this quarter and I guess I just wanted to make sure.
I was thinking about it correctly, because you get from 4.7 to five five and a half.
Must be an acceleration in new default weren't or cures, the slowing down I don't know thats kind of the question.
I mean thats.
Listen it's a it's a big I mean kind of top down view, it's hard to know whether or not you know we can't predict you don't have a crystal ball and whether here or is it going to accelerate or not then or slow down and same thing with new new notices again, what we're trying to.
Just provide a bit of color that we think the yield obviously, our knock on wood, we're not going to be an 8% delinquency rate by the end of the year.
We're we're certainly well below 5% does it go back above 5% by the end of the year.
Thats, what we think could happen, but again, we don't know so.
Yes, I think if everything stays the same.
The odds are probably that it won't be at 5%, but we.
Thats.
But Phil Youre right Youre right on your assessment that if we go from 4.7 and we tell you we're going to be 5.5 at the end that we'd have to have an increase in annuity or lesser Q.
I'm not sure we know we have.
Made enough assessment as to which is which I would argue that we have tended to be since may we have tended to.
At least the last two quarters, we have overstated the amount and the number of new antibodies that we received and that probably is what will drive the potential would you still don't know Foss was said that we we haven't been as good as we would have like to beat in predicting so I think the engine you annuities would be more.
More the place to look at having said this Phil you also know that we have to think going on less new annuity and higher cure rate. So that bodes actually help massive on any help accelerate and actually go no help explain why we had a projection of about in over 10% and dealer in the year too much less right now the two.
Moving parts.
Yeah, Yeah, no understood I guess I am I am I'm reminded us of this default rate might might continue to come down, but you know that well if the crystal ball is as I'm very cloudy at this point. Thank you guys.
Thank you.
Okay.
Our next question comes from Brian Meredith with TBS.
Thanks, Yeah, a couple of them for you just quickly first I was just curious given that you are getting 2% new money yields in your book yield is below that should we just expect that you book yields on your investment portfolio fixed income to kind of be stable going forward.
I think that the short term I think its reasonable yeah.
Okay. Good thats helpful.
She said question on the reinsurance because I'm just curious your.
Your your property mix is definitely increasing as a percentage of your overall book how much of the underlying combined ratio improvement that you're seeing there is actually driven by the mix shift versus just better loss picks.
Well then.
Boy I don't think we parse out this way it's still early in the game to see what is going to look like I would say that.
It's probably more mix at this point time, because our growth is large and property other than cabinet can excel. So we have a lot of them play in that in that sector right now.
It's probably more mix I would say Brian.
Yes, so the so it's not so much the rate activity, we're seeing what's the mix shifts thats driving it. Although we are you know as Brian for all these years. It will tend to go where the rates are the better.
The charter increase in margin. So that's sort of go hand in hand, so gotcha that makes sense.
Another one just quickly on watch sort of just curious.
Is it your guys' intentions to significantly increase your ownership and that ultimately are you going to buy the whole thing. It's just because the volatility of the investment portfolio, it's kind of just a different strategy.
Well.
What we said publicly is that we are certainly talking to other parties.
To bring into the fold to support us in this vehicle if it moves forward. If we closed on the acquisition. So the answer is yes, we would most likely increase our participation, but not to not 200%.
And then be much much less than that so.
You know increase a little bit but recognize that we it's a different model that we.
Others would want to participate on with us as well.
Got you so the net capital outlay for the transaction wouldn't be.
This big is it could okay that makes correct correct gotcha and.
And then last question just curious any updates with respect to the catalyst investment.
Where that stands or regular is going to ultimately make a decision on this.
Yes, I think where it's in process.
We are going through the regular process, it's and it's on track.
We are hopeful that we could get something done potentially in the first quarter or second quarter of next year. It takes a while as you know it is cold environment.
Government and regulators take a little while longer than than otherwise, but it's on track and they produced as you know the results.
So the value of this week or early late last week. So no. It's also looking much better for them, which is good for us.
Great. Thank you. Thanks bye.
Our next question comes from Jimmy Bhullar with Jpmorgan.
I just wanted to clarify your comments on not losing the fee income on what Bert.
Is that just because of the five years remaining on the contract. So there's sort of a finite life through it or was there something else that.
What's behind that comment.
Well I mean, the question was asked if we buy the vehicle do we still retain.
The fees.
The answer is yes, I mean no money.
Yes, that's it's anecdotal elevation them, but.
In case, it goes to somebody else than that fee arrangement Dave's and back to the core.
Yes, correct.
Okay, and then does your approach to underwriting overall and how much sort of you capacity you have and take on a given game change if you own order book third versus maybe if it doesn't end up being bought by a third party.
At a higher offer.
I think you know that.
Third party environment as you might think it's pretty clear that we need to take care of our of our brethren as well as well as we could think of ourselves. So our view is always to do the similar underwriting.
What would had a different investment profile, which allowed us to do.
Slightly different things, but at a high level. The underwriting is very very similar and that and I would remind everyone that whatever we do on Watford, we take 50% of it on a quarterly basis in the back we also are.
Participating on on the capital we have that we're up about 13% I believe in our shareholding. So we collectively on may 20% of the of the underwriting. So we do you know in cooking there as well, it's really important to us.
Okay.
Yes.
I'm not showing any further questions I would now like to turn the conference over to Mr., Marc Grandisson for closing remarks.
Thank you everyone looking forward to the last remaining couple of months in the year and I Hope you have a good one.
Ladies and gentlemen, thank you for participating in today's conference. This concludes the program you may all disconnect.
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