Q2 2022 Arch Capital Group Ltd Earnings Call

July 28, 2022

Good day, ladies and gentlemen, and welcome to the second quarter 2022 Arch Capital Group 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.

<unk> 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 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 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 on 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. Mark Grandison, Mr. Francois Morin Sirs, you may begin.

Thanks, Elizabeth Good morning, and welcome to our earnings call.

Arch delivered strong results this quarter headlined by an operating return on equity of 17%.

Our results were driven by excellent underwriting performance across all three operating segments. As we continued our focus on growth opportunities. During this hard market as demonstrated by the 27% increase in P&C net premium written over the same quarter one year ago.

These results demonstrate how our company is positioned to capitalize on market opportunities across many lines that we underwrite.

We've said it before but it bears repeating we are committed to agile cycle management.

Predicated by our focus on risk adjusted returns and it has enabled us to accelerate our growth through the deployment of meaningful capacity to our clients.

Because we invested in capabilities and preserve capital during the soft market years.

We are in the enviable position of being able to maximize these opportunities.

Increasingly are seen as a provider of choice by our distribution partners and clients, which allows us to take on leadership positions.

And the industry retrench.

P&C rate hardening continues in many lines. It is important to keep in mind that for the vast majority of the P&C lines, we've been able to achieve compounded rate increases meaningfully above loss cost trends for the last two or three annual renewals and as such <unk>.

Margins of safety have been created we believe this attractive level of expected returns should remain in place for the next few years.

Offer a few highlights on our business units.

In the quarter, our insurance and reinsurance segments, both had excellent operating results largely because of how we leaned hard into the improving market early on.

We also have invested in improving our data analytics, while broadening our market presence and our North American insurance operations premium growth was broad based with net premiums written up 29% from the same period in 2021.

Some of the most significant growth came from our E&S lines, both property and casualty.

<unk> professional lines, including Ciber, and a resurgent travel and accident sector.

All our lines of business, where we believe risk adjusted returns are most attractive.

Our specialty international insurance business, which includes our Lloyd's and UK regional businesses.

Also delivered strong growth in the quarter.

With net premium written up 23% from the same period last year, driven primarily by specialty casualty and property.

Our investment in building the UK regional small business is gaining traction as well.

When looking at the improved results of our insurance business, it's apparent that the work of our teams over the past several years is paying off.

We have developed a platform that respond swiftly to opportunities presented by the hard market. While at the same time building more sustainable position positions in lines that are less cyclical.

We have the capital the people and the desire to lead in today's environment as long as attractive opportunities are available arch will be there to write them.

Our reinsurance segment continued to deliver excellent top line growth and bottom line earnings this quarter because of the diversified and specialty focus of our reinsurance business.

Strong growth reflects our increased writings of quota share treaties, which allow us to participate in the rate increases experienced by our seasons.

The six 107, one renewals showed a property cat market and transition and while I agitate to make predictions. We are cautiously optimistic that this momentum will continue into one $1 23.

The general psychology of the market appears to have shifted to requiring substantial rate increases to accept cat exposure. As an example in Florida, where capacity remains constrained property cat rates were up in excess of 30% in our P&L and a one.

250 year event increased as we selectively expanded our writings.

Rate pressure was evident also beyond Florida. However, we will need a few more quarters to confirm we are facing a heart property cat marketplace.

Turning to our mortgage segment. The group continues to deliver the consistent underwriting results. We projected when we began building our MA business a decade ago.

Our embedded book of high credit quality risks as well as continued on price increases have been key elements to our exceptional return on this quarter.

Although rising mortgage interest rates have slowed the volume of new new originations the purchase market remains strong.

As housing demand continues to outstrip new supply.

Rising rates also mean that persistency is increasing.

Which allowed <unk> to grow its U S primary mortgage insurance in force to 292 billion, an all time high.

The forbearance programs continued to roll off.

And cures have brought our delinquency rate down to 177%, which is consistent with what we experienced before COVID-19.

Last and perhaps most important the credit quality of homebuyers remains excellent and we believe our portfolio is well positioned for a variety of economic scenarios.

We will continue to be deliberate in managing our mortgage portfolio.

Benefiting from our diversified business model that gives us the flexibility to focus on credit quality and profitability not on volume.

Briefly on investments were rising interest rates and market volatility are setting the stage for additional investment income contributions over the next several quarters.

We're seeing the benefits of not chasing yield during the past several years as well as the work done to reposition our portfolio in response to the changing interest rate environment earlier this year, our investment team reduced our equity exposure in our fixed income portfolio is shorter duration has allowed us.

To quickly move our investments into higher rate securities that provide further cushion against potential inflation impacts.

This year surge of inflation has been a call to arms to underwriting teams across the industry and by and large the industry has proactively incorporated higher trends into its models, we believe that the uncertainty surrounding future inflation should keep upward pressure on rates.

At arch, we manage inflation by business segment as we've said before we believe inflation is a net benefit to our mis portfolios performance, while our P&C exposure to inflation is mitigated by many tools available to US overall, we're very pleased with our underwriting results and returns in a quarter and we are optimistic about.

The rest of 'twenty two went into 'twenty three.

As always our objective remains to generate profitable growth and deliver long term value for our shareholders and this quarter's results are another example of our ability to do just that I want to thank the arch team for everything they've done this past quarter and over the last several years, our people have made art into an employer.

An insurer of choice and have us well positioned to sustain our growth trajectory into 'twenty three and beyond.

Crosswalk.

Thank you Mark and good morning to all thanks for joining us today.

As you will have seen by now we had a very strong quarter and with very few unusual items to discuss our highlight to you I've kept my prepared remarks relatively brief to allow for more time for the Q&A session. So here we go.

For the quarter, we reported after tax operating income of $1 34 per share, resulting in an annualized operating return on average common equity of 17, 1% to excellent results in.

In the insurance segment net written premium growth of 27, 5% over the same quarter, one year ago combined with excellent underwriting performance resulted in an accident year combined ratio, excluding cats of 90%.

A 140 basis point improvement over the same quarter one year ago.

Like last quarter, a change in our business mix 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 25, 7% over the same quarter one year ago.

The segment produced an X cat accident year combined ratio of 82, 8%.

430 basis points lower than the same quarter, one year ago.

Here also a reduction in the accident year ex cat loss ratio was partially offset by a slight increase in the expense ratio due to our growth in areas with slightly higher acquisition expenses and targeted personnel expansion to support our growth.

Losses from 2022 catastrophic events net of reinsurance recoverable and reinstatement premiums stood at $82 4 million or three five combined ratio points compared to $2 four combined ratio points in the second quarter of 2021.

The losses were split approximately 80% of reinsurance and 20% to our insurance segment.

It's worth noting that approximately two thirds of the estimated losses came from events outside the U S, including Australian floods, South African floods, a retro storm in Canada, and other miscellaneous natural catastrophe events.

Our mortgage segment had an excellent quarter with a combined ratio excluding prior year development of 39, 2%.

Net premiums earned increased on a sequential on a sequential basis due to increased persistency of our in force insurance, which now stands at 71, 3% at the end of the quarter and growth in our CRT portfolio.

Production levels also increased from last quarter consistent with the seasonality of the business.

We recognized $118 1 million of favorable prior year development across the segment this quarter, a meaningful benefit to our bottom line as delinquencies cured secured at a higher rate than expected.

Close to 80% of the favorable claim development came from our first lien insured portfolio with U S semi mostly related to the 2020 accident year.

The remainder of the favorable development came from recoveries on second lien loans and better than expected claim development in our CRT portfolio in our international operations.

In all our segments, we maintain a prudent approach in setting loss reserves, considering the uncertainty we face in a variety of factors such as macroeconomic conditions inflation, both monetary and social and lags in settling longer tail liabilities as COVID-19 related delays get work.

Through the legal systems.

Income from operating affiliates stood at $4 6 million. It was generated from good results at Colfax, mostly offset by the negative mark to market impacts on the summer's portfolio for those securities that are accounted under the fair value option method.

Gross investment income before investment expenses increased 20% from the first quarter of 2022 to $123 6 million.

Driven by the Reinvestments at higher yields of proceeds from the maturities and sales of investments and securities and the presence of floating rates investor floating rate investments in our portfolio.

Total investment return for our investment portfolio was a negative 3.0% to 2% on a us dollar basis for the quarter hurt by Mark to market losses, due to rising interest rates and weak equity markets.

As you know it is worth remembering that while mark to market impacts are fully reflected in our financials. A significant portion of this decrease hasnt been crystallized through the selling of securities and has the potential to reverse itself over time in particular for our fixed maturity investments as they mature.

As we discussed on the first quarter call. The defensive investment strategy, we have employed for a number of quarters with high quality investments and a short portfolio duration has helped minimize the impact of rising interest rates and the mark to market hit to book value.

Our investment duration remained slightly below three years at the end of the quarter and slightly underweight relative to our liability duration target.

The performance of our alternative investments remained very solid this quarter as we benefited from the returns generated by a number of funds that outperformed broad market indices.

So turning briefly to risk management or a natural cap P&L on a net basis stood at $888 million as of July one or seven 7% of tangible shareholders' equity.

<unk> well below our internal limits at the single event, one in 250 year return level.

Our peak zone P&L is currently the Florida Tri County region.

On the capital front, we repurchased approximately $7 1 million common shares at an aggregate cost of $320 7 million in the second quarter.

Our remaining share authorization, we're currently stands at $606 million.

With these introductory comments, we are now prepared to take your questions.

Thank you if you have a question at this time. Please press the Star then the one key on your Touchtone telephone.

If you are using a speaker phone please lift the handset.

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

Hi.

My first question.

And the rate versus trend discussion, which you've had a lot. So far this earnings season.

Mark can you started off the conversation by saying continue to see hardening in many lines.

Would you please.

When you think about your insurance business, where do you place price and loss trend and how do you think that could go from here as we think about higher inflation levels.

Yes, I think the pricing nice hearing from you at least I think the pricing in the market is definitely clearing the loss trends you've heard us on some of the call that we would concur with that conclusion.

Okay.

And do you think as Youre thinking out the next year or do you think that with me.

Ladies especially by your comments on what you've heard about right on top of right on top of rate.

I do see you see dynamic.

Keep talking about that for that.

For the next year or so.

I see what you mean, I think I would answer by saying that.

The perceived risk in the marketplace has actually increased.

On the property Cat, which I mentioned briefly in my comments and also on the liability side as well I think that the uncertainty about the social inflation.

And what it could mean.

<unk>.

The other is no geopolitical risk is a lot of stuff going on in the world I would expect this to continue well into 2023, but I've been wrong before so I have to be careful the way.

I would tell you this.

And then on the investment side, we're putting new fixed income money to work in terms of rates and then how much of the portfolio is turning over over the next 12 months.

Yeah.

So good question I think we don't plan specifically how much is.

How much of it where we're going to turn it over but we have been less than that our investment team has been pretty active trying to make sure that a first of all we did take a lot of investments we off risk in the first half of the year.

And then it will all be about how much of what kind of opportunities we see is.

With the environment, we're in but.

We certainly with a short duration that were at three years, you could certainly think that a meaningful amount of it there is going to turn over the next 12 months.

And then what's the news today.

Well no I want to be a little bit careful we are certainly corporates you've heard it we're at call. It four four approaching 45% in some places in the corporate investments.

Investments in corporate Securities that we made in the month of July .

With the fed announcement yesterday, I mean, the risk free of the treasuries I think everything is going to move up a little bit from there. So that's.

That's kind of where what we're seeing today.

To evolve as we move forward in that.

Compares to an embedded book yield.

Two 2% or so at the end of the quarter. So it's meaningfully higher than what were what would the portfolio has been asked.

Okay. Thanks for the color.

Yep.

Thank you.

Our next question comes from Jimmy Buhler with Jpmorgan. Your line is now open.

Yeah.

Hi, Good morning. So first just had a question on the mortgage insurance business.

How are you what's your view on the operating environment in the business.

The threat of a potential recession, and then and its impact on margins and then just.

With the higher interest rates and how thats going to affect top line growth in the business.

Lastly, a quick one I think.

Before I answer it a bit more specifically I think that as I mentioned in my comments that we mentioned more than once on the call that you're going to hear from the other I believe competitors is that the credit quality of the borrowers that we see right now is exceptional.

By and large the credit quality is actually improved suite of pandemic. So we're very very pleased with this and I'm, saying this because.

The biggest driver of default.

The stress is a credit quality of the borrower is by far.

It overwhelms the risk possibility. We also are in a position where we have.

So substantial equity buildup in the housing stock. So thats also helpful.

So we are very comfortable with the way the portfolio's positioned and I think it's.

We're not recession proof, but I think we have a lot going for us if there were to be a recession on the top line as you know if there is less production and there is some indication that third quarter might be a bit slower than usual.

Then that would mean production thats less than possibly for the industry in that quarter, but the impact on our premium will take a little bit longer to be.

Felt because as you know monthly premiums are written through a longer period of time and most of what we write and earn at this point in time comes from.

Prior underwriting years, 2000, 22021 and 2019 so.

We're not going to see.

Impact immediate impact, it's not like a property casualty.

Portfolio. So again, it's a somewhat of a tempered impact on top line we believe.

Okay.

And then on sure.

Sure sure buybacks, you've spent I think it was the $321 million this quarter $2 55 last quarter and if I look over the past year and a half they've averaged almost $300 million a quarter do you expect to be at the same pace going forward or should we assume.

A slowdown.

That's a good question I think yes, we've been active I think we.

Part of our evaluation of all the alternatives in front of us when we buy back stock compared to how we deploy that.

The capital in the business.

The one thing that I want to make sure as you're aware I mean realizes and were bullish on the market right. We think the market.

We see today is strong and has some potential for even getting better and time will tell we certainly in the <unk>.

Odds on that but the reality is if it gets better and we have the ability to deploy more capital in the business at one one.

We will certainly want to do that so the yes.

We will reevaluate that daily and weekly like we always do but I could see a scenario, where we have to pull back a little bit on the share buybacks.

Really just to have the capital base that we need to fully execute on the on deploying the capital in the business in the three segments, which are as you see all humming and growing at a very good clip make sure that we can execute on that opportunity in 'twenty three and beyond.

Okay. Thank you.

Youre welcome.

Thank you.

Our next question comes from Tracy <unk> with Barclays. Your line is now open.

Good morning, I also had a loss churn question Mark you said in the past that your view of loss trend here is roughly 250 basis points above CPI and for excess layers.

Higher.

Can you just share your latest take on that I think when you talked about weak levels CPI rates below 2%.

Yes, I think it's.

So on a long term basis right. These surge in inflation may create distortion in that spread over this but over the long haul I still maintain this and seen another statistics recently that concurs with that sort of analysis.

I think that.

The CPI.

Right now in a shorter lines of business shorter tail lines of business with property specifically as you know we've had all collectively a lot of labor and cost material that went through.

Very significantly I think in some lines of business, we're not seeing evidence of yet.

Trend.

Above that CPI significantly above the CPI. So I think our position has been to maintain as we've said before Tracey a longer term view of the loss trend and when we had indication perhaps of zero to 1% in certain years, we bought it.

Amber higher from a longer term perspective, so that helps on accumulative basis, when you buy the business not having to do as much catch up it keeps you a little bit more balanced through.

So changes in inflation, so as we see right now.

Okay Mark.

Thank.

Thank you Renee.

Correct.

Starting a conversation yesterday on the investment.

Investment yield and combined ratio target.

Typically confirmation target can you share with underwriters is informed by our ROE.

And I believe you guys. When you come up with these target Youre actually looking at new money yield on a breakup fee duration matched speedway to knock our portfolio yield are those the right puts and takes of your pricing model I guess ultimately could hire new manille risk free in your case.

And you indicated rate need.

Yes, it's a great question Tracy I liked we've rebuilt our compensation scheme for our underwriting team.

Actually self correcting and self self adjusting as we go forward number one when the price of the business. This is our underwriting underwriters. They actually look the use of look in the Wall Street journal or the three or five year equivalent treasury rate and Thats, what they would ascribe to the cash flow in terms of investment income that he could earn on the premium that we.

Could earn the premiums so its really a treasury return.

This is what you get.

What do you get credit for their for their compensation plans, so as well as <unk>.

Interest rate go up their interest yield go up on their on their own.

<unk> that the credo of help generate for arch from the insurance perspective, but as a counterpart to that we're targeting.

Target is also influx it actually moves in lockstep with that Treasury equivalent right, we have actually set.

Our target at 950 bps above treasury for the target so while at the same time, they are getting more investment income and can see a higher margin.

To have a higher threshold on on the on the targets out there that theyre looking at and we do this continuously I know our reinsurance folks because its portfolio base, it's almost a daily occurrence. They actually look at it look it up every day on their own insurance on the insurance basis, we actually look at it through a portfolio on a quarterly basis unless.

The big change that we just saw then there'll be like immediate.

Changes made to the pricing models. So everything is is linked together.

So interest rates go up yes, you get more investment income, but hey guess, what we need to have a higher return.

Okay that was excellent color if I could just sneak in this is really quick what is your new insurance written and am I go up this quarter sequentially.

Can you repeat the question again.

Sequentially sequentially alluded to your view in Sherman.

Written for mortgage insurance went up yet.

Okay.

Yes.

Three.

Yeah.

It's $23 5 billion versus 20 billion in the first quarter and largely as you know Tracy it's a very seasonal market place a lot more origination takes place in the second quarter of it people. The school year finishes people move the size of summer gets around Thats why theres a lot of people moving and buying houses.

And refinancing even not so much but certainly purchasing houses in the second quarter. So historically, the first and fourth quarter are about the same they're lower than the middle two quarters. So that's sort of a it's just by virtue of the market origination that theres nothing in our pricing our appetite has changed in the quarter.

Thank you.

Okay.

Thank you.

Our next question comes from Brian Meredith with UBS. Your line is now open.

Yes. Thanks, a couple of them here for you first Mark I'm just curious.

Big growth in Florida property Cat, how do you get comfortable.

Insuring some of the kind of less creditworthy companies down in Florida.

Yes, we have very good question, Brian I think probably like other <unk>.

Competitors of ours, we have a very.

A very extensive list of clients and we've done auditing of all of them, even if they are not our clients throughout the years.

Two aspects right.

Look at the claims paying ability how good they are adjusting claims because as you can appreciate Brian is very important and secondly, we look at the financial situation. So we have a rank order them in two or three buckets, and we actually tend to focus our limit than the ones health.

<unk> and the ones that we believe have.

Better claims adjustment processes and teams and expertise.

So if you were a few but having said this doesn't mean that we won't do a business with someone who is a bit more fragile from a financial.

Prospective but you probably heard it already that there are conditions that put into contracts such as prepaying reinstatement premium to make sure that we don't have to run after the credit risk.

A lot of things you can bells and whistles. So we treat we treat different lines different way based on our assessment of claims paying ability and then expertise and.

Credit worthiness.

Got you. Thanks, and then second question I'm, just curious professional liability premium Youre assurance is still really strong growth. That's the one area. We've actually been hearing some concern from some companies maybe not concerns is the right word for it but but youre seeing some competitive pressures in the public market D&O area, maybe talk a little bit about what's in that professional liability line for you for you all.

And are you seeing the same type of trends.

Yes, the excess D&O I think is a little bit.

Put more stable more sideways. Some go down some go up but it's clearly not as high.

As.

As heated as it was three or four years ago, but one thing I want to mentioned, Brian that people forget raised in excess D&O or two to three four times, what they were three or four years ago. So it's extremely still a very very healthy marketplace.

I think we would argue that capacity is stable there's no no.

No longer any dislocations.

Just think that Florida for the right company for the right experience with no claims or very good quality. The dependency there is a willingness from the market base to give them more credit to to see.

Those companies, which is sort of normal and given where we are in the market. After four years of extreme rate pressure I think on the second question, where our growth a lot of our growth is and isn't a cyber products.

We actually have put ciber in the professional lines and Thats, one area, which we said before we're very keen to develop and grow as we are seeing really great opportunities there as well and much needed capacity is much needed in that market place actually.

Makes sense. Thank you.

Sure.

Thank you.

Our next question comes from Joshua Shanker with Bank of America. Your line is now open.

Yes. Thank you.

Im understanding your answer to Tracy correctly.

Over the long term view of inflation and the changes in inflation will cause you to change your.

Sure.

Inflationary outlook embedded in your in your reserves.

Now if that's correct does that mean some years youre going to run off.

A little hot because inflation will be higher than you expect and then some.

Some years, lower and would you need would you or any other insurer.

Take a charge in order to shore up higher inflation foreign extended period.

No I think that what I say is one there is lower interest rates lower inflation rates loss trend we see.

Tend to take a longer term view and as you know Josh we had multiple years of of I would argue depress loss cost trend, which was great for the industry, but we still maintain a healthy skepticism as to how we can less than over the long haul so that makes us maintain our pricing actually higher during times of.

I would argue softer softer times.

I think it means is that our bright line as to where we think we can make a great return or a good return it doesn't move as much around.

We go forward because we have a probably we believe we want to have a healthier or more conservative. If you will view of the loss cost trend as we price our business going forward.

So your loss cost trend assumptions.

Already higher and inflation.

Inflation is meeting the loss trend you already assumed.

Yes, I think Thats fair.

A bit more on your question I think Josh specifically on reserves.

That's where the feedback that comes into play where we do start with more long term assumptions around trend.

And as Mark said, we've been through a period, where inflation has been pretty benign. So we effectively over time, because we've been pretty.

I guess were slow to react to good news has been thats been arched Ken that philosophy for a number of years forever really.

We effectively end up building a little bit of a cushion.

That may come in handy if.

If things do pick up again, if theres a bit of a spike in inflation, which.

Depending on the lines of business in some lines of business property short tail. No question that we're seeing a little bit of higher inflation on labor and in goods and materials and some other lines of business. We're just not seeing it. So it doesn't mean, it's not there it doesn't mean that it won't happen, but for the time being.

We have built up this again buffer that we would call or a little bit of cushion in their reserve base, which.

Would prevent us or would actually Canada, we use up first before ever having to take a charge, which in our 20 year history, we've never had to take charges and we certainly hope to keep it that way.

Okay that makes sense.

I'm trying to understand mechanics, so you have a high.

And I don't mean to repair.

Hi assumption going in nothing has changed that assumption if something were to happen that would change the assumption by definition that would mean you would need to carry more reserves, but you have a buffer in there and so you don't need to.

On the on the old years, New year's we include right. So the new the new business that we price today, we will.

Increase we have increased and again it varies by line, but in some lines of business. No question that we've raised our assumptions our pricing assumptions on loss cost trends. So implicitly that when we reserved those new those new years 'twenty, two and moving forward. They will start at a higher level, reflecting the inflation assumptions that we.

Put in place today, when we worry about reserves on the old in force or the old years, right 21, and prior and the fact that we priced them with more conservative assumptions on loss cost trends gives us that buffer that we think will be a mechanism to absorb some of the volatility.

And in terms of buffers could you update us on your IBM.

<unk> for Covid.

Our IVF, our total reserves for Covid are still at $160 million, 75% of which are either IBM <unk> within our reinsurance segment.

That's very complete thank you.

Youre welcome.

Okay.

Thank you.

Our next question comes from Ryan Tunis with Autonomous Research. Your line is now open.

Hey, Good afternoon, just one question from me.

Can you talk a little bit about the impacted global minimum tax would have on the tax rate.

Yes.

It's premature Ryan to analyze all of it is so many moving parts of these global minimum tax right now whether it's going to take place where there is going to happen with country music onto enacted so way too premature I mean of course, our tax folks are working always every week. There is a new Nielsen something new coming from all the various governments and a.

<unk> and treasuries around the world, but right now it is still a moving target too early too premature to say.

What it would mean for us.

Understood. Thank you.

Thanks.

Okay.

Thank you.

Our next question comes from Meyer Shields with K B W.

Great. Thanks.

To follow up on Brian's question, if I can not so much in terms of the quality.

Companies in Florida.

Given the sort of bizarre.

Litigation environment, there, how do you get comfortable that even the good companies are with reinsurance.

It's a very good question I think that in general.

That's why we actually ask and want a higher margin of safety in Florida. So I think if you look at the.

Our expected pricing in Florida reflects all of these and we need a healthier margin than you'll find at the margin in Florida is higher than most other.

Jurisdictions around and I think we have increasingly been in Florida. We know we didn't go as you guys mentioned the P&L went up slightly in the Florida Tri County area, but these.

These price the prices, we saw as well Myers at some point.

They're not necessarily sort of.

Standard market, there might be sort of.

The harder to place or a layer that needs to be finalized so the pricing will be quite.

Quite a bit better than you would expect.

And then the average market would be.

<unk> there is no guarantee the slides specifically in insurance as you know I think we we tend to think about having a higher margin of safety in Florida, and several deals give us that opportunity this year.

Okay perfect.

Second question, if I can look over your shoulder on the reinsurance side, you talked a little bit about the industry recognizing faster rate.

<unk>, how much of that Barry when you look at potential feed.

Wildly it varies wildly I think now we probably have more consensus building in the industry, but it does vary wildly because to be fair to our clients. They have different books of business that different lines to have different focus geographically or line size. So it does.

Burial up but there is clearly among our clients that we can see and sense that there is and there is development coming there is some of that inflation picking up a little bit which they have by and large already understood and appreciated would come.

But I think.

It's I would say it varies by seeding company the level, but I think the general direction of pricing for more and recognizing more is there an ICT company.

Clearly they are very big they are being very very proactive at most of them if not all of them.

Okay excellent. Thank you very much.

Yes.

I'm not showing any further questions I'd now like to turn the conference over to Mr. Mark Grandison for closing remarks.

Thank you very much everyone. We're looking forward for the second half of this year and we'll talk to you soon.

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

The conference will begin shortly to raise Johan during Q&A you can dial one one.

[music].

Okay.

Yes.

Okay.

[music].

Yes.

[music].

Okay.

Sure.

Yes.

[music].

Sure.

[music].

Good day, ladies and gentlemen, and welcome to the second quarter 2022 Arch Capital Group 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.

These statements are based upon management's current assessments and assumptions and are subject to a number of risks and uncertainties.

<unk> 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.

The company intends to 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.

I would now like to introduce your host for today's conference Mr. Mark Grandison and Mr. Friends, Walmart, Sir you may begin.

Thanks, Elizabeth Good morning, and welcome to our earnings call.

<unk> delivered strong results this quarter headlined by an operating return on equity of 17%.

At the same quarter, one year ago.

These results demonstrate how our company is positioned to capitalize on market opportunities across many lines that we underwrite.

We've said it before but it bears repeating we are committed to agile cycle management.

Predicated by our focus on risk adjusted returns and it has enabled us to accelerate our growth through the deployment of meaningful capacity to our clients because we invested in capabilities and reserved capital during the soft market years.

We are in the enviable position of being able to maximize these opportunities.

Increasingly are seen as a provider of choice by our distribution partners and clients, which allows us to take on leadership positions.

And the industry retrench.

Margins of safety have been created we believe this attractive level of expected returns should remain in place for the next few years.

Offer a few highlights on our business units.

In the quarter, our insurance and reinsurance segments, both had excellent operating results largely because of how we leaned hard into the improving market early on.

Some of the most significant growth came from our E&S lines, both property and casualty.

<unk> professional lines, including Ciber, and a resurgent travel and accident sector.

All our lines of business, where we believe risk adjusted returns are most attractive.

Our specialty international insurance business, which include our Lloyd's and UK regional businesses also delivered strong growth in the.

With net premium written up 23% from the same period last year, driven primarily by specialty casualty and property.

Our investment in building the UK regional small business is gaining traction as well.

When looking at the improved results of our insurance business, it's apparent that the work of our teams over the past several years is paying off.

We have developed a platform that respond swiftly to opportunities presented by the hard markets. While at the same time building more sustainable position positions in lines that are less cyclical.

We have the capital the people and the desire to lead in today's environment as long as attractive opportunities are available arch will be there to write them.

Our reinsurance segment continued to deliver excellent top line growth and bottom line earnings this quarter because of the diversified and specialty focus of our reinsurance business.

Strong growth reflects our increased writings of quota share treaties, which allow us to participate in the rate increases experienced by our seasons.

6171 renewals showed a property cat market and transition and while as you say to make predictions. We are cautiously optimistic that this momentum will continue into one $1 23.

250 year event increased as we selectively expanded our writings.

Pressure was evident also beyond Florida, However, we will need a few more quarters to confirm we are facing a hard property cat marketplace.

Turning to our mortgage segment. The group continues to deliver the consistent underwriting results. We projected when we began building our MA business a decade ago.

Our embedded book of high credit quality risks as well as continued on price increases have been key elements to our exceptional return on this quarter.

Although rising mortgage interest rates have slowed the volume of new new originations the purchase market remains strong.

Housing demand continues to outstrip new supply.

Rising rates also mean that persistency is increasing.

Which allowed <unk> to grow its U S primary mortgage insurance in force to 292 billion, an all time high.

The forbearance programs continued to roll off.

<unk> have brought our delinquency rate down to 177%, which is consistent with what we experienced before COVID-19.

Lastly, and perhaps most important the credit quality of homebuyers remains excellent and we believe our portfolio is well positioned for a variety of economic scenarios.

We will continue to be deliberate in managing our mortgage portfolio.

Benefiting from our diversified business model that gives us the flexibility to focus on credit quality and profitability not on volume.

Briefly on investments were rising interest rates and market volatility are setting the stage for additional investment income contributions over the next several quarters.

We're seeing the benefits of not chasing yield during the past several years as well as the work done to reposition our portfolio and our response to the changing interest rate environment earlier. This year, our investment team reduced our equity exposure in our fixed income portfolio is shorter duration has allowed us.

To quickly move our investments into higher rate securities that provides further cushion against potential inflation impacts this.

<unk> about the rest of 'twenty two went into 'twenty three as.

An insurer of choice and have us well positioned to sustain our growth trajectory into 'twenty three and beyond.

Crosswalk.

Thank you Mark and good morning to all and thanks for joining us today.

For the quarter, we reported after tax operating income of $1 34 per share, resulting in an annualized operating return on average common equity of 17, 1% to excellent results in.

A 140 basis point improvement over the same quarter one year ago.

Like last quarter, a change in our business mix 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 25, 7% over the same quarter one year ago.

This segment produced an X cat accident year combined ratio of 82, 8%.

430 basis points lower than the same quarter, one year ago.

<unk> also a reduction in the accident year ex cat loss ratio was partially offset by a slight increase in the expense ratio due to our growth in areas with slightly higher acquisition expenses and targeted personnel expansion to support our growth.

The losses were split approximately 80% of reinsurance and 20% to our insurance segment.

Our mortgage segment had an excellent quarter with a combined ratio excluding prior year development of 39, 2%.

Production levels also increased from last quarter consistent with the seasonality of the business.

We recognized a $118 1 million of favorable prior year development across this segment this quarter, a meaningful benefit to our bottom line as delinquencies cured secured at a higher rate than expected.

Close to 80% of the favorable claim development came from our first lien insured portfolio in the U S Army.

Mostly related to the 2020 accident year.

The remainder of the favorable development came from recoveries on second lien loans and better than expected claim development in our CRT portfolio in our international operations.

And all of our segments, we maintain a prudent approach in setting loss reserves, considering the uncertainty we face in a variety of factors such as macroeconomic conditions inflation, both monetary and social and lags in settling longer tail liabilities as COVID-19 related delays get worked through.

Through the legal systems.

Gross investment income before investment expenses increased 20% from the first quarter of 2022 to $123 6 million.

Driven by the Reinvestments at higher yields of proceeds from the maturities and sales of investments and securities and the presence of floating rates investment floating rate investments in our portfolio.

Total investment return for our investment portfolio was a negative three zero to 2% on a us dollar basis for the quarter hurt by Mark to market losses, due to rising interest rates and weak equity markets.

Our investment duration remained slightly below three years at the end of the quarter and slightly underweight relative to our liability duration target.

The performance of our alternative investments remained very solid this quarter as we benefited from the returns generated by a number of funds that outperformed broad market indices.

So turning briefly to risk management, our natural cat P&L on a net basis stood at $888 million as of July one or seven 7% of tangible shareholders' equity.

<unk> well below our internal limits at this single event, one in 250 year return level.

Our peak zone P&L is currently the Florida Tri County region.

On the capital front, we repurchased approximately $7 1 million common shares at an aggregate cost of $320 7 million in the second quarter.

Our remaining share authorization, we're currently stands at $606 million.

With these introductory comments, we are now prepared to take your questions.

Thank you.

Have a question at this time. Please press the Star then the one key on your Touchtone telephone.

If you're using a speaker phone please lift the handset.

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

Hi.

My first question.

On the rate versus trend discussion, which you've had a lot. So far this earnings season.

Mark can you started off the conversation by saying continue to see hardening in many lines.

Would you please.

And you think about your insurance business, where do you place price and loss trend and how do you think that could go from here as we think about higher inflation levels.

Yes, I think the pricing nicely even.

From your at least I think the pricing in the market is definitely clearing the loss trends you've heard us on some of the calls that we would concur with that conclusion.

Okay.

And do you think as Youre thinking out the next year or do you think that.

Okay, especially right to your comments on what you've heard about right on top of right on top of rate.

Do you see dynamics.

Keep talking about that for the for.

For the next year or so.

So I think I would answer by saying.

The perceived risk in the marketplace has actually increased.

On the property cap, which I mentioned briefly in my comments and also on the liability side as well I think that the uncertainty about the social inflation.

And what it could mean.

And also other.

No geopolitical risk is a lot of stuff going on in the world I would expect us to continue well into 2023, but I've been wrong before so I have to be careful the way I.

I would tell you this.

And then on the investment side, we're putting new fixed income money to work in terms of rates and then how much of that portfolio is turning over over the next 12 months.

So good question I think we don't plan specifically how much is.

How much of it where we're going to turn it over but we've been listen that our investment team has been pretty active trying to make sure that a first of all we did take.

A lot of investments we off risk in the first half of the year.

And then it will all be about how much of what kind of opportunities we see is with.

The environment, we're in but.

We certainly with a short duration that were at three years, you could certainly think that a meaningful amount of it there is going to turn over the next 12 months.

And then what's the news today.

Well I want to be a little bit careful we are certainly corporates you've heard it we're at call. It four four approaching four 5% in some places in the corporate <unk>.

<unk> corporate securities that we made in the month of July .

With the fed announcement yesterday, I mean, the risk free of the treasuries I think everything is going to move up a little bit from there. So that's.

That's kind of where what we're seeing today is going to evolve as we move forward and that compares to an embedded book yield of.

Two 2% or so at the end of the quarter. So it's meaningfully higher than what were what were the portfolio has been asked.

Okay. Thanks for the color.

Yes.

Thank you.

Our next question comes from Jimmy Buhler with J P. Morgan Your line is now open.

Hi, Good morning, So first just a question on the mortgage insurance business.

How are you what's your view on the operating environment in the business, but.

The threat of a potential recession, and then and its impact on margins and then.

With the higher interest rates and how thats going to affect top line growth in the business.

Lastly, a quick one I think.

Quite answered a bit more specifically I think that as I mentioned in my comments that we mentioned more than once on the call that you're going to hear from the other I believe competitors is that the credit quality of the borrowers that we see right now is exceptional.

By and large the credit quality is actually improved suite of pandemic. So we're very very pleased with this and I'm, saying this because.

The biggest driver of default in the stress is a credit quality of the borrower it's by far.

It overwhelms the risk possibility. We also are in a position where we have.

So substantial equity buildup in the housing stock. So thats also helpful.

So we are very comfortable with the way the portfolio position and I think it's.

Then that would mean no production that is less than possibly for the industry in that quarter, but the impact on our premium will take a little bit longer to be.

<unk> felt because as you know monthly premiums are written through a longer period of time and most of what we write and earn at this point in time comes from.

Prior underwriting years, 2000, 22021 and 2019 so.

We're not going to see.

Impact immediate impact, it's not like a property casualty.

Portfolio. So again, it's a somewhat of a tempered impact on top line we believe.

Okay.

And then on sure.

Share buybacks you spent I think it was the $321 million this quarter $2 55 last quarter and if I look over the past year and a half they've averaged almost $300 million a quarter do you expect to be at the same pace going forward or should we assume.

Slow down.

That's a good question I think yes, we have been active I think it.

It's part of our evaluation of all the alternatives in front of us when we buy back stock compared to how we deploy the capital.

On the business.

The one thing that I want to make sure as you're aware I mean realizes we're.

We're bullish on the market right. We think the market that we see today is as strong and has some potential for even getting better and time will tell we certainly in the <unk>.

Odds on that but the reality is if it gets better.

And we have the ability to deploy more capital in the business at one one.

We will certainly want to do that so the.

Yes.

We'll reevaluate that daily and weekly like we always do but I could see a scenario, where we have to pull back a little bit on the share buybacks.

Really just have the capital base that we need to fully execute on.

On deploying the capital in the business in the three segments, which are as you see all humming and growing.

At a very good clip make sure that we can execute on that opportunity in 'twenty three and beyond.

Okay. Thank you.

Youre welcome.

Yes.

Thank you.

Our next question comes from Tracy <unk> with Barclays. Your line is now open.

Good morning, I also had a loss churn question Mark you've said in the past that your view of loss trend here is roughly 250 basis points above CPI and for excess layers.

Sure.

Can you just share your latest take on that I think when you talked about weak levels CPI rate.

Thanks.

Yes, I think it's.

I think that.

The CPI.

Hitting it right now and a shorter lines of business shorter tail lines of business with property specifically as you know we've had all collectively a lot of labor and cost material that went through.

Very significantly.

And some lines of business, we're not seeing evidence of yet.

Of trend.

Amber or higher from a longer term perspective, so that helps on accumulative basis, when you buy the business not having to do as much catch up Keith.

So you're a little bit more balanced through.

So changes in inflation, such as what we see right now.

Okay.

From here not what Youre seeing.

Correct.

Starting a conversation yesterday on the <unk>.

Investment yield and combined ratio target.

Typically confirmation of target you can share with underwriters is informed by our ROE.

And I believe you guys. When you come up with these target Youre actually looking at new money.

The duration matched speedway so not your portfolio yield are those the right puts and takes of your pricing model I guess ultimately could hire new money yield risk free in your key change you indicated rate need.

Yes, it's a great question Tracey and I like the way, we've built our compensation scheme for our underwriting team.

Could earn the premiums so its really a treasury return this.

This is what you get.

What do you get credit for their for their compensation plans, so as well as <unk>.

Interest rate go up their interest yield go up on their on their own.

Flow that the credo of help generate for arch from the insurance perspective, but as a counterpart to that.

Our target is also influx it actually moves in lockstep with that Treasury equivalent right, we have actually said.

At 950 bps above treasury for the target so while at the same time, they are getting more investment income and can see a higher margin.

Going to have a higher threshold on on the on the targets out there that theyre looking at and we do this continuously I know our reinsurance folks because its portfolio base, it's almost a daily occurrence. They actually look at it look it up every day on their own insurance on the insurance basis, we actually look at it through the portfolio on a quarterly basis unless.

It is a big change that we just saw then there'll be like immediate.

No changes made to the pricing models. So everything is is linked together. So interest rates go up yes, you get more investment income, but hey guess, what we need to have a higher return.

Okay that was excellent color if I could just sneak in this is really quick what is your new insurance written and am I go up this quarter sequentially.

Could you repeat the question again.

Sequentially sequentially I noticed here in <unk> and <unk>.

Written for mortgage insurance went up yes.

Okay.

Yes.

Three.

Yeah.

It's $23 $5 billion versus 20 billion in the first quarter and largely as you know Tracy it's a very seasonal market place a lot more origination takes place in the second quarter of it people. The school year finishes people move the size of summer gets around Thats why theres a lot of people moving and buying houses.

And refinancing even not so much but certainly purchasing houses in the second quarter. So historically, the first and fourth quarter are about the same that are lower than the middle two quarters. So that's sort of a it's just by virtue of the market origination that there's nothing in our pricing our appetite has changed in the quarter.

Thank you.

Okay.

Thank you.

Our next question comes from Brian Meredith with UBS. Your line is now open.

Yes. Thanks, a couple of them here for you first Mark I was just curious.

Big growth in Florida property Cat, how do you get comfortable re insuring some of the kind of less creditworthy companies down in Florida.

Yes, we have a very good question, Brian I think probably like other competitors of ours, we have a very.

A very extensive list of clients and we've done auditing of all of them, even if they are not our clients throughout the years.

Two aspects right.

<unk> and the ones that we believe have.

Better claims adjustment processes and teams and expertise.

So if you were a few but having said this doesn't mean that we won't do a business with someone who is a bit more fragile from a financial.

Prospective but you probably heard already that there are conditions that put into contracts such as prepaying reinstatement premium to make sure that we don't have to run after the credit risk.

A lot of things you can bells and whistles. So we treat we treat different lines different way based on our assessment of claims paying ability and expertise in.

Credit worthiness.

Got you. Thanks, and then second question I'm, just curious professional liability premium you assurance is still really strong growth. That's the one area. We've actually been hearing some concern from some companies maybe not concerns is the right word for it but but youre seeing some competitive pressures in the public market D&O area, maybe talk a little bit about what's in that professional liability line for you for you all.

And are you seeing the same type of trends.

Yes, the excess D&O I think is a little bit.

For more stable more sideways. Some go down some go up but it's clearly not as.

As.

As heated as it was three or four years ago, but one thing I want to mentioned, Brian that people forget racing exited D&O or two to three four times, what they were three or four years ago. So it's extremely still a very very healthy marketplace.

I think we would argue that capacity is stable there's no no.

No longer any dislocations.

Just think that for the for the right company for the right experience with no claims or very good quality desert. The dependency there is a willingness on the market base to give them more credit to to those companies, which is sort of normal and given where we are in the market. After four years of extreme rate pressure I think.

And the second question will our growth a lot of our growth is and isn't a cyber products.

We actually have put ciber in the professional lines, that's one area, which we said before we're very keen to develop and grow as we are seeing really great opportunities there as well and much needed capacity is much needed in that market place actually.

Makes sense. Thank you.

Sure.

Thank you.

Our next question comes from Joshua Shanker with Bank of America. Your line is now open.

Yes. Thank you.

Im understanding your answer to Tracy correctly.

Over the long term view of inflation and the changes in inflation will cause you to change.

Sure.

Inflationary outlook embedded in your in your reserves.

Now if that's correct does that mean some years youre going to run off.

A little hot because inflation will be higher than you expect and in some years lower and would you need would you or any other insurer need to take a charge in order to shore up higher inflation foreign extended period.

No I think that what I say is one there is lower interest rates lower inflation rates loss trend, we tend to take a longer term view and as you know Josh we had multiple years of.

I would argue depress loss cost trend, which was great for the industry, but we still maintain a healthy skepticism as to how we can less than over the long haul so that makes us maintain our pricing actually higher during times of.

I would argue softer softer times, what I think it means is that our bright line as to where we think we can make a great return or a good return it doesn't move as much around as we go forward right. Because we have a probably we believe we want to have a healthier or more conservative. If you will view of the loss cost trend as we price.

The business going forward.

So your loss cost trend assumptions.

Already higher and inflation.

Social inflation is meeting.

The loss trend you already assumed.

Yes, I think Thats fair.

I mean, a bit more on your question I think Josh specifically on reserves.

That's where the feedback that comes into play where we do start with more long term assumptions around trend and as Mark said, we've been through a period, where inflation has been pretty benign. So we effectively over time, because we've been pretty.

I guess were slow to react to good news has been thats been.

<unk>, Ken that philosophy for a number of years forever really.

We effectively end up building a little bit of a cushion.

That may come in handy if.

If things do pick up again right there if theres a bit of a spike in inflation, which.

We have built up this again buffer that we would call or a little bit of cushion in their reserve base, which.

Okay that makes sense.

Trying to understand mechanics, so you have a high.

Want me to repeat it you have a high assumption going in nothing has changed that assumption.

If something were to happen that would change the assumption by definition. It would mean you'd need to carry more reserves, but you have a buffer in there and so you don't need to.

On the on the old years, New year's we include the price of the new <unk>, the new business that we price today, we will.

<unk> put in place today, when we worry about reserves on the older in force or the old years, right 21, and prior and the fact that we priced them with more conservative assumptions on loss cost trends gives us that buffer that we think we.

Bill will be a mechanism to absorb some of the volatility.

And in terms of buffers could you update us on your <unk>.

Reserves for Covid.

Our idea our total reserves for Covid are still at $160 million, 75% of which are either IBM <unk> within our reinsurance segment.

That's very complete thank you.

Our next question comes from Ryan Tunis with Autonomous Research. Your line is now open.

Can you talk a little bit about the impacted global minimum tax would have on the tax rate.

Yes.

It's premature Ryan to analyze all just so many moving parts of these global minimum tax right now whether it's going to take place where there is going to happen with country music onto enacted so way too premature I mean of course, our tax folks are.

Working always every week there is a new notion something new coming from all the various governments and agencies and treasuries around the world, but right now it's still a moving target too early too premature to say.

What it would mean for us.

Understood. Thank you.

Thanks.

Okay.

Thank you.

Our next question comes from Meyer Shields with K B W.

Great. Thanks.

Want to follow up on Bryan's question, if I can not so much in terms of the quality.

Companies in Florida.

Given the sort of bizarre.

Litigation environment, there, how do you get comfortable that even the good companies are with reinsurance.

It's a very good question, Mike I think that in general.

That's why we actually ask and want a higher margin of safety in Florida. So I think if you look at the our expected pricing in Florida reflects all of these and we need a healthier margin than you will find that the margin in Florida is higher than most other.

Jurisdictions around and I think we have increasingly been in Florida. We know we didn't go as you guys mentioned.

<unk> mentioned, the P&L went up slightly in the Florida Tri County area, but these.

These price the prices, we saw as well Myers at some point.

They are not necessarily sort of.

Standard market, there might be sort of.

The harder to place or a layer that needs to be finalized so the pricing will be quite.

Quite a bit better than you would expect.

And then the average market would be.

There is no guarantee this slide specifically in insurance as you know I think we we tend to think about having a higher margin of safety in Florida, and several deals give us that opportunity this year.

Okay, no that makes perfect sense.

The second question, if I can look over your shoulder on the reinsurance side, you talked a little bit about the industry recognizing faster rates of inflation, how much of that Barry when you look at potential feed.

Wildly it varies wildly I think now we probably have more consensus building in the industry, but it does vary wildly because to be fair to our clients. They have different books of business different lines. They have different focus geographically or line size. So it does.

Burial up but theres clearly among our clients that we can see and sense that there is and there was development coming there is some of that inflation picking up a little bit which they have by and large already understood and appreciated would come.

But I think.

I would say it varies by seeding company the level, but I think the general direction of pricing for more and recognizing more is there an ICT company.

Clearly they are very big they are being very very proactive at most of them if not all of them.

Okay excellent. Thank you very much.

I'm not showing any further questions I'd now like to turn the conference over to Mr. Mark Anderson for closing remarks.

Thank you very much everyone. We're looking forward for the second half of this year and we'll talk to you soon.

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

Q2 2022 Arch Capital Group Ltd Earnings Call

Request a DemoDemo

ACGL

Arch Capital Group

Earnings