Arch Capital Group Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
October 31, 2023

There are 13 speakers on the call.

Operator

Good day, ladies and gentlemen, and welcome to the Q3 2023 Arch Capital Earnings Conference Call. At this time, all participants are in a listen only mode. Later, we will conduct a question and answer session and instructions will follow at that time. As a reminder, this conference call is being recorded. Before the company gets started with 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.

Operator

These statements are based upon management's current assessments and assumptions and are subject to a number of risks and uncertainties. Consequently, actual results may differ materially from those expressed or implied. For more information on the risks and other factors that may affect future performance, investors should review periodic reports that are filled by the company with the SEC from time to time. Additionally, certain statements contained in the call that are not based on historical facts are forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The company intends the forward looking statements in the call to be subject to the Safe Harbor created thereby.

Operator

Management also will make reference to certain non GAAP measures of financial performance. The reconciliations to GAAP Each non GAAP financial measure can be found in the company's current report on Form 8 ks furnished to the SEC yesterday, which contains the company's earnings press release and is available on the company's website and on the SEC's website. I would now like to introduce your host for today's conference, Mr. Mark Grandison and Mr. Francois Morin.

Operator

Sirs, you may begin.

Speaker 1

Thank you, Gigi. Good morning and thank you for joining our Q3 earnings call. I hope everybody is safe and well. Yesterday, we reported another excellent quarter highlighted by strong performances from each of our 3 Operating segments that resulted in an annualized operating return of 25% and a 4% increase in book value per share. Overall, our teams capitalized on good underwriting conditions and relatively light catastrophe losses to produce an outstanding $721,000,000 of underwriting income in the quarter.

Speaker 1

Our property casualty teams continued Mortgage Insurance once again delivered impressive high quality underwriting earnings that we redeployed into our P and C segments Broadly, we continue to achieve rate increases above loss trend in most sectors of the P and C market. Although rate increases are slowing in some lines, they are reaccelerating in others, which is a good reminder that there is not a single insurance cycle, but many. As always, Arch is well positioned to navigate across these many cycles by reallocating capital to the segments with the best risk adjusted returns. 1 of our core differentiating principle is that our underwriters are aligned with our shareholders through our unique compensation structure. Our underwriting teams are always seeking to maximize opportunities As long as they meet our shareholders' targets.

Speaker 1

As we near the end of 2023 and look ahead to 2024, I believe that Although the dynamics may shift, this hard market will continue to support profitable growth. Let's take a moment to recap the I see it as a play in 3 acts. The first act, The current hard market started in primary liability insurance in 2019 and then has a unique circumstance of a 2 year pause in claims activity due to a global pandemic. The second act introduced Hurricane Ian as a main character where property reinsurers had to adjust both their pricing and risk appetite. In addition, capital got more expensive and the industry had to respond to meet new expectations from investors.

Speaker 1

While property has been the most recent driver of this market as we move into Act 3, We are faced with increasing evidence that casualty rates widely underpriced and oversold during the last soft market need to increase. We expect this 3rd act of the extended hard market, already one of the longest in memory, to persist until the industry's reserving issues results and until capital rates generate positive results. Arch is well positioned to capitalize on this operating environment. As new hard market underwriting opportunities arise, our incredibly nimble reinsurance group allows us to grow more quickly And significantly that in our reinsurance group and is therefore where we are most likely to deploy capital first. Today market trends point to a reinsurance driven GL hard market and we stand ready to act.

Speaker 1

The 3rd act has barely started, But things are very promising for Arch. Now some color on our operating segments. Our Reinsurance Group has once again Driven our growth with 3rd quarter net premium written of $1,600,000,000 up 45% from the same quarter in 2022 And 60% over the last 12 months. Underwriting performance in the reinsurance group was excellent with a combined ratio of 80% for the quarter. Our expectation is that we will continue to see hard property market conditions through next year's renewal cycle as uncertainty and loss activity Remains elevated.

Speaker 1

As noted above, we expect increased opportunities in liability as well. Our insurance group also remains in growth mode in both our North American and international units. While net premium written in the insurance segment up 16% over the last of the past 12 months are more modest than in reinsurance. They are more broad based because of our focus on small and medium sized Specialty accounts. Underwriting income continues to build with increased earned premium and a strong combined ratio of 90.9%.

Speaker 1

Today, there are still plenty of opportunities to grow profitably in insurance. Property and short tail lines pricing and terms and conditions We remain very strong with rate increases in excess of 15%. E and S casualty pricing is increasing in response to overall casualty trends In the market, in our programs unit continues to achieve rate increases above trend. Professional liability rates softened in the quarter With net premiums written down 9% in the Q3 of 2022, we share the marketplace sentiment about the D and O segment where both IPO and N and A activity decreased at the same time as rate pressures from some competition and securities satisfaction activity increased. However, returns in that segment are still strong.

Speaker 1

In the same vein, we maintain a positive outlook on cyber pricing On an absolute basis despite rate decreases in the 15% range. Our outstanding mortgage group Continued to deliver quality earnings for our shareholders at higher persistency of our in force portfolio Help offset the slight decrease in NII value, which has been affected by lower mortgage originations. Although we tend to focus our comments on the U. S. Primary MI market, it is worth noting that nearly 40% of our mortgage Underwriting profit this quarter came from non U.

Speaker 1

S. Operations compared to just over 10% in 2017. International business represents a significant growth opportunity for the mortgage group at Arch and our strategic decision to diversify our mortgage operations We are currently in a positive cycle on the investment side of our business, where increasing cash flows from growth are being invested into today's higher yield environment. New money rates are well in excess of our book yield, which should continue to boost our investment income over time and provide us with an additional Ongoing tailwind. It's late October, which for baseball fans mean it's time for the World Series.

Speaker 1

Baseball is somewhat unique in that it's one of the few team sports that isn't limited to a specific length of time. You can score as many runs as possible until the other team gets 3 outs. To me, the current hard market feels like a baseball game. We know there's only 9 innings to be played, but we have no idea how long those innings will take. We've got a great lineup.

Speaker 1

We're happy to keep hitting our singles, doubles and occasional home runs until the inning is over. At Arch, we remain committed to being good stewards of the capital entrusted to us. We do that by following a tried and true data driven approach It maximizes the capabilities of our diversified platform, diligently adheres to a cycle management philosophy and is centered around superior risk selection and prudent reserving. All the while, our underwriters are fully aligned with our shareholders. These principles are foundational to our playbook and underscore our long term commitment to superior value creation.

Speaker 1

As we close out 2023, we have significant momentum in all three of our businesses and a reliable and high quality earnings engine Mortgage Group that are helping fuel our growing investment base. All the pieces are fitting together nicely and we're well positioned for the future. Now I'll call Francois up on an on deck circle and we'll return to answer your questions shortly.

Speaker 2

Francois? Thank you, Mark, and good morning to all. Thanks for joining us today. To add to the baseball theme, I would also emphasize that while this long winning streak has Certainly been fueled by a timely and dynamic offense. We're also very much aware that team defense has played an important role in our success.

Speaker 2

We've been working hard not to waste any offensive production with careless errors and by executing well at the fleet and on the field, We produced exceptional 3rd quarter results from high quality earnings across all our platforms. The highlights of this team effort are numerous and include after tax operating income of $2.31 per share for an annualized operating return on average common equity of 24.8 percent and a book value per share of $38.62 as of September 30, Up 4.3% in the quarter and 18.4% on a year to date basis. Similar to last quarter's results, our Reinsurance segment grew net written premium by 45% over the same quarter last year, led by the property other than catastrophe line, which was 73% higher than the same quarter 1 year ago. As for our Property Catastrophe business, it's worth mentioning that the net written premium in the Q3 1 year ago Included approximately $34,000,000 of reinstatement premiums, mostly as a result of Hurricane Ian. If we adjust for the impact of reinstatement premiums, our growth in net written premium for this line would have been approximately 64% year over year.

Speaker 2

The quarterly bottom line for the segment was excellent with a combined ratio of 80%, 73.5% on an accident year ex GAAP basis, producing an underwriting profit of $310,000,000 The Insurance segment had another very strong quarter With 3rd quarter net premium written growth of 11% over the same quarter 1 year ago. Similar to last quarter's results, We experienced good growth in most lines of business with the main exception being professional lines where the market remains competitive, Particularly in Public Directors and Officers' Liability. If we exclude professional lines, net written premium would have been 20% higher this Overall, market conditions for our insurance and reinsurance segment remain attractive And we expect the returns on the business underwritten this year to exceed our long term targets by a solid margin for some business units. Profitable growth during periods of favorable market conditions is one of the hallmarks of our cycle management strategy And the current hard market is definitely giving us the opportunity to deploy meaningful capital in many areas. Our mortgage segment's batting average has consistently been a lead leader and this quarter was no different with a 4.7% combined ratio.

Speaker 2

Net premiums earned were in line with the past few quarters across each of our lines of business. Included in our results was $98,000,000 of favorable prior year reserve development in the Q4 net of acquisition expenses With over 75% of that amount coming from USMI and the rest from other underwriting units. Our delinquency rate at USMI remains low based on historical averages and close to 85% of our net reserves at USMI Our underwriting income reflected $152,000,000 of favorable prior year development on a pre tax basis or 4.7 points on the combined ratio It was observed across all three segments driven by short deadlines. Current accident year catastrophe losses across the group were 180,000,000 Approximately half of which are related to U. S.

Speaker 2

Severe convective storms with the rest coming from the line of Wellliner, Hurricane Nadalia and other global events. Pretax net investment income was $0.71 per share, up 11% from last quarter As our pre tax investment income yield was up by approximately 18 basis points since last quarter, in line with broader financial market indices such as the S and P 500, which was down approximately 3.7% in the quarter. Net cash flow from operating activities has been very strong so far this year in excess of $4,000,000,000 which has helped grow our Asset base by approximately 20% in the last 12 months. With new money rates in our fixed income portfolio comfortably above 5%, We should see continued meaningful tailwinds in our net investment income. Turning to risk management, as of October 1 on a net basis, Our peak zone natural cap PML for a single event 1 in 2 50 year return level remain basically unchanged on a dollar basis from July 1 It now stands at 10.1 percent of tangible shareholders' equity well below our internal earnings.

Speaker 2

Our capital base grew and got stronger during the quarter and now stands at $18,000,000,000 Our leverage ratio Represented as debt plus preferred shares to total capital is currently under 20%, which provides us with significant flexibility

Operator

And if you are using a speakerphone, please lift the handset. Our first question comes from the line of Elyse Greenspan from Wells Fargo.

Speaker 3

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

Speaker 1

Hi, Elyse. I think it's still early. We have a lot of movement in the marketplace and capital and people are, As you can appreciate positioning at all the conferences, but our general consensus in the team when we talk to underwriters is that We'll still have improvements in 1onetwenty 4, not as big as 1onetwenty 3, but we're still going to get slight improvement On the reinsurance side of things, what is also I mentioned before, this is not really fully reflecting What we believe has been the re underwriting and the reallocating of capacity by our clients and that remains to be seen how it's going to be We're excited and we'll depend on the clients frankly. But overall, we still expect a very healthy, very robust 1124,000,000 property.

Speaker 3

And then on your casualty comments, Mark, right, you alluded to that being the 3rd act and really leaning in there on the reinsurance I was hoping you could just give us a sense of timing on how that will play out. And if that's a 'twenty four event, do you see The reinsurance book shifting more to casualty or do you think it's an environment where they both on property and casualty offer good growth opportunities for the company?

Speaker 1

It's a great question. I think the we have a big plain property as you saw between the property cat on the reinsurance side that And the property other than capital, the quarter shares and things in between. So I think we're still Very much keen on that line of the business. Liabilities are a bit harder to evaluate right now because I think the first order is going to have to be Looking at our plan for 2024, looking at our reserve or development that there are any, this is talking about our clients. So it's going to take a little bit more time for people to figure out what it is that they have and what they want to do with it going forward in 2024.

Speaker 1

So we'll have probably some of us think that we may have a renewal a little bit more, but not as stable as it once was. So I think we'll probably see the early innings to go back to my baseball analogy of that liability possibly at oneone. The one beautiful thing about GL or the one bad thing depending on the side of the market you're in is that it's a longer term development On the softening and on the hardening, the GL can it will take a little bit longer to get to where it needs to get to because it It takes time for you to get the losses reflected in the reserving and we have a good sense for where the ultimate results are from your prior year to adjust and help inform the pricing you're So this is going to be a lot much more protracted 3rd act than second act was.

Speaker 3

That's helpful. Thanks for the

Operator

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

Speaker 4

Hey, good morning. So first, just staying on casualty. There's been a lot of concern about reserves and obviously Casualty is a fairly broad market category, but what are your thoughts on overall industry reserves and casualty, your reserves? And then Maybe any color on the lines within casualty where you think there might be inadequacies and sort of the drivers of that or what's driven those nerve issues?

Speaker 2

That's a great question, Jimmy. I think there's as you said, it's a broad market. Certainly, we've seen some pressure in our own results. I think we see so you see both on insurance and reinsurance. On the reinsurance side, we see some of our clients recognizing adverse and The latency of some things being reported to us, I think, is coming through.

Speaker 2

We like to think we've been Proactive in addressing those issues, but you never quite know for sure until everything comes through. But Some of the subsets, definitely umbrella is an area that is something that we're watching carefully. The good thing I think with our book is again we weren't big players in that space in the soft market here. So we're seeing some pain, but not to the same level we think that The other as well and but it's a hot topic and we're going to keep looking at it.

Speaker 1

The one thing I would add Jimmy to what Francois just mentioned is that we're You're hearing from the call that it's going to be more acute, more of a pressure point on the larger accounts than the smaller accounts. I think that the limits deployed there and the uncertainty and the combination of all these years developing is a little bit More probably more of a Chris, there's more of an urgency in that sector. So we expect the larger accounts, which we don't do a lot of on the insurance side To be the first one to really feel the pressure.

Speaker 4

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

Speaker 1

Well, I made the comment

Speaker 2

close to 85% Of our reserves at USMI are from post COVID years. So that would mean 2020 after, but Let's remember that when we were coming out of COVID, we saw just a lot of changes in home prices, Full price appreciation and potential overvaluation, right. So when we were setting reserves in the last Few years, 2021, 2022 even up until early 2023, that was a concern of ours. So we were somewhat as you would expect us to do, Somewhat more prudent, I'd say, in setting our reserves. How that plays out when the delinquencies cure, We don't know.

Speaker 2

Could there be further favorable development? Maybe. But, I'd say for the most part, what's What's really been happening in the last couple of years is just a, I'd say, very much again a function of the housing market, which has been just exploded and then We needed a different set of kind of data points that we're trying to analyze and that's how we based our reserves on. So hopefully that gives you a bit of color on the question here.

Speaker 1

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

Speaker 1

It's in really good place. Thank you.

Operator

Our next question comes from the line of Tracy Bangui from Barclays.

Speaker 5

Hey, while you posted double digit insurance premium growth this quarter, the pace has decelerated a bit over the last years. It looks like peak insurance premium growth was in mid-twenty 1 and that might be a tough benchmark given you've grown a ton in professional liability And you are shrinking there as you pointed out. Could we expect insurance premium growth at double digits to be sustainable going forward? Or should we see it Fall to high single digits because of the professional lines headwind. And I'm just wondering if it's fair to assume that you prefer deploying capital into reinsurance now, All else being equal.

Speaker 1

Yes. In terms of return expectations, I think your instinct is right on. I think reinsurance is providing right now very, very healthy returns. We expect this to continue into 2024 and 2025 to be honest. But the insurance group, I think it's 1 quarter, there are a couple of moving parts to this, some accounting thing timing and stuff And there sometimes, but as Francois mentioned, the growth in the line that we like to see growth into, I'm very pleased to see because this is where I would expect the team to grow into the market conditions are great there.

Speaker 1

And I would expect Even some of those non professional lines to actually maybe carry the day a bit more going forward. I wouldn't be surprised that we could go back above 10% Next quarter in 2020 and through 2024. So I'm not I don't see 1 quarter as a trend to be honest.

Speaker 5

All right. Very helpful. You slightly shortened the duration of your asset portfolio in September to 2.97 years from 3 point 3 years in June. It feels like you're taking durational asset mismatch because the MI liabilities are much longer derated. Given the shape of the yield curve is beginning to show signs of steepening, I mean, it's a tad bit less inverted.

Speaker 5

Going Would you consider lengthening your asset duration or you feel comfortable with the sub-three year duration level?

Speaker 2

Good point. I think the duration is probably the lowest it's been in a long, long time and that's just Our investment professionals here again make their decisions and there's obviously a little bit of tactics that's involved in kind of Where they want to play at a certain point in time, but for sure, absolutely, if interest rates we think The longer end of the curve end up being a bit more attractive. I mean, we certainly consider extending the duration a little bit And we got a bit of room there anyway to match with our the liabilities and make sure that we're not mismatched there. So that's certainly something that We'll look at it in the coming months and quarters, yes.

Operator

Thank you. Thank you. One moment for our next question. Our next question comes from the line of Yaron Kinar from Jefferies.

Speaker 6

Thank you. Good morning. First question, it sounds like you are pretty constructive looking into 1,124. Can you maybe talk about Have your prioritization of capital and maybe give us a way to think about maybe potential available capital you have to Deploy into the insurance and reinsurance markets?

Speaker 2

Well, yes, we are constructive on 11. I think we Mark and I both said, I think it's a really good market. In totality, there's some pockets that are certainly better than others. We think that the internal capital generation we've been able to generate In the last few quarters, it gives us the ability to really grow and take advantage of the opportunities that we think Have a good chance of being there. Again, we don't make the market, we participate in the market.

Speaker 2

So If the market is as positive as we think it can be, then we'll be happy to step in and take a bigger share of it. But I think the fact that we've got capital flexibility has always been one of the and has one of the Maybe one of the most important things in our strategy all along is we want to make sure that we have plenty of capital to deploy when the market is right And so far we've been able

Speaker 1

to do that. So Yaron, if I look at the high level, the way we think about we think about it is different Perhaps and even our underwriting units, meaning that they already they were doubling how much capital is allocated to them at the beginning of the period. I want to remind everyone that People write the business, our underwriting team writes the business. And then we after that charge them with the capital they've been using. And based on the planning and all the expectations that we have, our message to the group has been there is no capital constraint or issue concerns that Thanks to you guys.

Speaker 1

If you see the market being better and even get better than we saw, feel free to deploy more capital if you wish to do so. So there's definitely this all hands on deck go forward if we can invite the business. That's one thing that's really nice and we'll Then attribute the capital up as we have written the business. That's what we do every year. On the property cat side, which is probably more interesting one for this work to you, We're about 85% allocated to the reinsurance group in terms of our P and L that Francois mentioned.

Speaker 1

And I think it's because the returns are there are a little bit more favorable on the reinsurance side. And then we have that discussion at the group level. That's one exception. So when we have an acute or a specific area of the capital, we'll sit down with the insurance group and reinsurance group with Nicholas facilitating the whole discussion and we'll sort of decide roughly broadly where we want to allocate capital.

Speaker 6

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

Speaker 2

Yes. I mean, we certainly, we have some capital. We have plenty of capital available. We just don't know what the market will look like at 1:1. So that's where I'd say, you're right, probably

Speaker 1

I have to wait and see a little bit, see how one on ones play out and

Speaker 2

then we'll have the ability To do something with the excess capital, if any.

Speaker 6

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

Speaker 1

Yes. Our returns expectation on both these lines, cyber And DNO is still very, very healthy. Thank you. Yes.

Operator

Thank you. One moment for our next question. Our next question comes from the line of Joshua Shanker from Bank of America.

Speaker 7

Yes. Thank you for taking my question. With the higher retentions This quarter in terms of premium ceded, can you go maybe line by line or dig in a little bit About which lines of business you're retaining more? And is that a signal that you've gotten to the point Where you have enough information that you love the profitability more and want to keep it yourself? Or if you're looking at your capital and saying, we have the capital deployed, so let's eat a bigger slice of the pie.

Speaker 7

How did that all come together?

Speaker 1

I think you answered the question beautifully. I mean, by asking the question, you gave the answer. I think that all these things you said are true. I'll get to the lines in a second, but to your point, it's exactly right. We're growing through this hard market and we make We still value reinsurance.

Speaker 1

You cannot go without reinsurance. You still need it for various reasons, limits management, risk management and also Information, right? Reinsurers are providing us on the insurance side with valuable information about what the market is and the state of the market. So we don't want to be And I'll allow you out there. So it's always good to have this as an additional value proposition from the reinsurance companies.

Speaker 1

In terms of What we decided to do after 3 years, you're quite right. We have been building, as Francois mentioned, a significant amount of capital through our mortgage earnings. So that's certainly something that It was helpful and available to deploy in other areas and that also helps being able to maintain and retain more net. I think if you were at a high level, I think that the patterns of buying, we're buying a fair amount less on the liability lines, specifically those that Going through the first act and really had a lot of good uplift. So we definitely saw that happening on the property.

Speaker 1

Even though the property is very hard as we all know since last year, this is a much more volatile line of business. So we still maintain our excess of loss It's meant to be the balancing act between providing relief or volatility protection to some extent and information. You're quite right. Having more capital definitely helped us take more net on our balance sheet.

Speaker 7

And Switching gears a little bit, when you have a 25% ROE quarter, you're making a lot of money and you have a Large team that has contributed to that result. I assume they'd like to be paid for their good work. How should we think We've not seen a quarter like this in a long time in a year like this. How should we think about the pattern and the cost of discretionary comp, Where it hits the P and L and how it should compare with prior years?

Speaker 2

Great question. Zari, We just again, in terms of timing, right, our incentive compensation decisions Our made in the Q1 of will be made in February of next year. But no question that Throughout the year, we accrue expected bonuses based on what we think that Something we're keeping an eye on. So I don't know if there'll be an early adjustment in the Q4 or not, something we'll be looking at Carefully, so that we don't get to distort too much the Q1 next year. Obviously, the Board has final say in how much Money will be available to pay our troops.

Speaker 2

So that's a little bit of we don't want to We want to be reasonable and not introduce too much volatility in the numbers on the OpEx side, but that's certainly something that we'll take a look at in the Q4 to

Speaker 7

Thank you very much and congratulations.

Speaker 2

Thank

Operator

you. One moment for our next question. Our next question comes from the line of Alex Scott from Goldman Sachs.

Speaker 8

Hi, good morning. First one I have for you is on the attritional loss ratio in the reinsurance segment. I was just wondering if you could give us a little more color around just What's driving this year, favorable performance year over year? And if there's anything new on us we should be thinking about Perfect. Just the pricing environment being as strong as it is.

Speaker 2

Yes. Two quick things there. One is We said it before and it goes both ways. We think of reinsurance as a line of business or a segment that We think it's better analyzed on the trailing 12 months basis. We think looking at it quarterly, there'll be some good, there'll be some bad.

Speaker 2

And We've said in past quarters where we have elevated attritional claim activity, we said don't panic, I don't overthink it in the same way here, I think. So we would certainly encourage everybody here to look at it on a trailing 12 month basis to have a better view of the long term kind of prospects of the segment. The other thing I'd say is also, obviously, We've grown a bit more in property than relative to Dental Line. So by nature, right, our ex CAF combined ratio should probably come down and it has as a result of again the growth, the significant growth we've had both in property cat and property other than cat.

Speaker 8

Got it. Very helpful. I wanted to ask a follow-up on the comments you made on casualty reinsurance. And Yes. I'm just interested in what is changing that's causing more of this Commentary to sort of bubble to the surface.

Speaker 8

I mean, we've heard it from some of the European reinsurers as well. Is it I mean, is it truly just that they're starting to see reserves develop in a poor way for some companies? Or Is there something that's changed about the social inflation environment? I mean, what do you think is the underlying driver or drivers?

Speaker 1

Yes, I think the industry is there's a couple of things going on at the same time and they Unfortunately, don't go in the right direction for both of for all our industry if you have within casualty. First, We have a and I mentioned in my comments, we had a bit of a slowdown in activity, including core activity, settlement activity. And we also have, as you as we all know, there's a lot of litigation funding, there's a bit more aggressiveness coming from the planet bar and that's certainly something that you could describe to be Social inflation, but that's not really something new. But there was sort of a lull in this market. There was sort of a sort of a respite, if you will, between 2020, 2021 to really middle of this year, early of this year.

Speaker 1

So I think right now you have sort of a refresh Re updating all the information about the losses of where we are and what could happen with the demand being updated And made more current, at the same time, we have priced that business as an industry in 2019 with inflation of 2%. Now inflation is north of 5, 6, 7 depending on where you look at. So at the same time as courts reopen, things are being adjudicated, reanalyzed, You have to account for a higher inflation number. And that is a classic case of having a couple of things going against you. Nothing that the industry did on its own.

Speaker 1

It's just the economy and the environment and the riskiness of the environment. So I think that we're facing all collectively as an industry That phenomenon and what I like about the industry's capability is it's reacting and that's what you hear and that's something that we should be Very, very happy for Collective as an industry. The other calls that you heard this quarter recognize it. And once you recognize an issue and a problem, People are very good and very adept at addressing it. And I think that's what's going on.

Speaker 1

So I think the couple combination coming in very, very short order Because of the surrounding environment, I think this is what largely drives what's going on right now.

Speaker 9

Thanks for

Speaker 1

all the detail. Sure.

Operator

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

Speaker 10

Hey, morning. Switching gears to the investment portfolio. So The net realized losses were somewhat outsized again this quarter. I know they run below the line, but any color are those You actually crystallizing to take advantage of the higher rates or is there noise in there from Unrealized stuff or maybe the LPT transactions in the past? Yes.

Speaker 2

I mean, it's mostly around kind of crystallizing some losses. I think it's a process we go through for each security on the fixed income side where we make the determination. Is it Perfect to sell some of those and redeploy the proceeds at higher yields and our investment team does that. So yes, There are going to be some realized losses coming through the fixed income. Obviously, the equity portfolio, which is not huge, but still there's FBO Securities like fair value option securities including equities that are effectively mark to market and that comes through the realized gains So those are the 2 big items.

Speaker 2

There's a little bit of other stuff going on that It's a little bit of the week, so I wouldn't want to go there, but that's directionally hopefully that's just normal course of action.

Speaker 10

Okay. And lastly, on, it's my understanding for me to put out, there's A second comment letter, maybe different, they call it something else, but on the potential tax changes That will take place. Are any way you could offer us some color on what's how things are going to Play out base case over the coming year or 2 or does the step up if everything goes as planned, Does the step up in tax rate happen in 2024 or is it a 2025 event or both?

Speaker 2

Yes. It's again very early, so too early unfortunately to give clear kind of views on what we think Could happen because they're still developing the laws and we expect more progress on that before the end of the year. But at a high level, it doesn't start it wouldn't start if it goes through until 2025. So there's no impact for 2024. And we will be evaluating the kind of made public some target tax rate that they will I'll try to get to, but again more to come.

Speaker 2

I think we'll do our best to keep you apprised of how we think about it probably on the next call. But Until we have more finality, more clarity on where it's going to land, I think it's a bit premature to give you too much too many details here.

Speaker 11

Okay. Thank you.

Speaker 10

Thanks.

Operator

Thank you. One moment for our next question. Our next question comes from the line of Meyer Shields from Keith, Bruin and Woods.

Speaker 11

Sorry, great. Thanks so much. First question on, I guess, casualty reinsurance. This year, like January 2023, we saw not only significant increases in property capital, we saw changes in program structures with higher attachment points. Is there anything analogous to that that we should see on the casualty reside in 2024?

Speaker 11

Or is it just going to be a rate story?

Speaker 1

Probably more of a rate story. The buying pattern on GL is mostly on a quarter share. There's a lot of quarter share being purchased That's also something we prefer to focus our capacity on. Those of you who followed us for years, Well, this is where we prefer to focus our capacity. On the excess of loss, Meyer, people don't really buy a whole lot.

Speaker 1

People don't put out Let's say like $60,000,000 $80,000,000 $100,000,000 limit. So we don't have a similar kind of risk, the risk vertical is not as big. And in terms of event, like a cat portfolio, you could see where things accumulating can generate 100 and 100 and 100 and 100 of dollars of exposure. In the liability side, it's not the same. You don't really have a necessarily a 1 or 2 event that could really impact Such a wide area of your GL.

Speaker 1

So I think we'll see a lot more sort of an insurance or more on a quarter share basis and some of the Accessible love here and there. It's not very similar it's not at all similar to the property market.

Speaker 11

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

Speaker 1

I think it's elaborate, Mario. I mean, there's a bit of the former, to be honest with you, but people will have to We recognize those losses if they have them. I do believe as we talk about Mario, you know that as well as we do, you're actually yourself the reserving process feeds into the pricing And clearly, if we have a reserving that's a bit higher than you would expect it, it will help inform your loss ratio historically. You have to put a trend on them, The on level analysis that helps get you to the price increase that you're looking at. So the past as it's developing will Inevitably leads you to having to charge more.

Speaker 1

And the reason we don't do a whole lot of large GL for that matter is precisely because of your 2nd point, which was it's been historically a little bit one thing on the rate level side.

Speaker 11

Okay. That's No worries about recent years for the industry, but that's very helpful. Thank you.

Speaker 1

Thank you.

Operator

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

Speaker 12

Hi, thank you. Congratulations on the quarter. Just Quick question on your insurance segment loss ratio. Year on year loss ratio improved for about 30 bps. But just given just the strong E and S pricing environment, shouldn't we expect Little bit better improvement in loss ratio.

Speaker 12

Is there anything in the loss trends that probably differed from how you thought about your loss ticks in the past? Just see if there are any comments around that?

Speaker 2

Maybe I mean, I think the answer is really around like us being prudent and saying initial loss picks. We don't want to get into Again, I'm being overly optimistic. There's still a lot of risk out there. There's still a lot of uncertainty when we price the business, Well, there again, we've just been talking about casualty loss trends in particular. That's an area that we're watching carefully.

Speaker 2

So we'd rather

Speaker 1

That's been

Speaker 2

our model for many, many years is, pick a realistic and a bit more conservative Initial loss pick on when we book the business and then react to the data when it comes in. So We're hopeful there could be good news down the road, but for the time being, we're very happy with our loss picks.

Speaker 12

Okay. Thank you for that. My second question is a follow-up on the reinsurance core combined ratio. Obviously, it was very strong. And I think you mentioned that a lot of it is due to business mix shift, right, shifting towards property.

Speaker 12

And then because of that, and then you I have an improving loss ratio there. Just curious, if we were to think about going forward the run rate Combined ratio for your Reinsurance segment, based on the comments so far, is it fair to sort of assume that It's going to be closer to what you printed over the last two quarters and probably better than the prior quarters. Is that a way to think about it just from a modeling perspective?

Speaker 2

Again, I mentioned like the thinking around trailing 12 months, This is where I would start to help you kind of with assumptions. I would if you're going to we think about it in totality around the combined ratio, but If you're breaking down the loss and the expense ratio, yes, maybe there's a given the growth, maybe there's potentially the latest quarter of OpEx is probably more sustainable given we've been able to generate that premium, that growth with the same level of resources. But on the loss ratio side, I think it's just I would be careful not to over I mean Give too much weight to the latest quarter.

Speaker 12

Okay. Thank you and congrats again on the quarter.

Speaker 2

Thank you. Thank you.

Operator

Thank you. One moment for our next question. Our next question comes from the line of Brian Meredith from UBS.

Speaker 6

Thanks. A couple

Speaker 9

of questions here. First, just on the Mi segment. I know there's clearly some market pressures, but NIW definitely down year over year. And it looks like Just looking at some of the stats, you all have been losing some market share in the Mi segment. Is that intentional?

Speaker 9

Are you any concerns about The outlook here on the Mi as far as delinquencies or is it more related to perhaps just better use of capital elsewhere?

Speaker 1

It's more the latter than the former. I would actually say tell you Brian that the market is better this year than it was even last year. So One would argue that we might change the way we travel the market over the next 12 to 24 months. But certainly, At heart, we have been saying that to you historically and hasn't changed last quarter, which in terms of relative returns based on the 3 segments on the underwriting segments. MI is the 3rd one, but a very strong one, I would say, at this point in time.

Speaker 1

But again, it's more of a reflection of the Relative opportunity between the units than anything else. In the market, Brian, I'll tell you the market is very, very disciplined. We're very impressed The industry or the MI industry.

Speaker 9

That's good to hear. And then I guess my second question, Mark, is I think about This next leg is coming through the 3rd act on the casualty reinsurance side. I guess that probably comes through a lot on the ceding commission side if you get better ceding commissions. Should we continue to see kind of the acquisition kind of expense ratios on the reinsurance side kind of moving down here as we head through 2024 given What's going on with the Casa reinsurance part, particularly since you play quota share?

Speaker 1

Well, the yes, I think The City commissions are about a story of 3 right now. We'll see where that ends up. There might be slight change or we'll see how it's also going to be dependent on how the underlying market is improving As a reinsurance player. But I think what's our acquisition cost right now reinsurance? It's mid low-20s.

Speaker 1

So I think if you have More of a portfolio, even if the this is argued it's a 30% ceding commission. So you might see actually the acquisition going up a little bit.

Speaker 10

But again, I also mentioned,

Speaker 1

Marcia, and I all the time talk about when we have these questions about expense ratio and loss ratio, but not as certain to return And whether the combined ratio lends ourselves to return and whether it comes from losses of expenses, we're now already losing seats here. So I think this is

Speaker 9

Fair point.

Speaker 1

Yes. Yes. And I was going

Speaker 9

to say that I guess maybe the right way to think about it is that as you're leaning more into the GL, the underlying combined ratios may actually move up some here. Exactly.

Speaker 1

But it

Speaker 9

may have a different return profile.

Speaker 1

Exactly right.

Speaker 2

You're right.

Speaker 9

Good. Thank you.

Speaker 1

Thank you. Welcome.

Operator

Thank you. One moment for our next question. Our next question comes from the line of Scott Heleniak from RBC Capital Markets.

Speaker 9

Yes, good morning. Just on the MI unit, wondering if you could expand on The growth opportunity internationally, you referenced in your commentary. I know Australia is a big market for you, but where else are you focused outside of the U. S? Or is it mostly just Australia that you're referring to?

Speaker 1

Great question. I think in a non U. S. Base is also the CRT, which is Granted exposed to the USMI, the excess of loss program that the GSEs have developed over the last 11, 12 years. Internationally, so that's a piece of it, you see it in our financial supplement.

Speaker 1

Internationally, we have Australia. As you know, we have a good size, great relationship and Great presence there. We're very pleased with it. We're also getting a little bit more market share there even though the mortgage origination has Slow down there as well. The other piece that's really in development is the international with European specifically SRTs, which are 90% mortgage backed credit risk transfer, they look a lot like the CRT business that we have in the U.

Speaker 1

S. Most of it is done because banks need to release capital that Basel III led The transactions and we've been doing it for a little while and we partnered up actually with another European company who's very steep in that area. So That's a growing area right now because I think the there's a lot more need for capital. As you know, Scott, not only in the U. S.

Speaker 1

And the Bank of Europe have similar Consideration, so it helps us be there for them to provide more capital relief

Speaker 11

and that's already something

Speaker 1

that we're focusing more efforts on.

Speaker 9

Okay, that's helpful. And then just the risk profile on the credit quality and the default ratios on those, I would assume those are very favorable, but how does that all Compared to outside of the U. S. And internationally versus the U. S.

Speaker 9

Book.

Speaker 1

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

Speaker 9

All right. Appreciate it. Thanks.

Speaker 1

Welcome.

Operator

Thank you. At this time, I would now like to turn the conference over to Mr. Mark Grandison for closing remarks.

Speaker 1

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

Operator

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

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Earnings Conference Call
Arch Capital Group Q3 2023
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