Arch Capital Group Q2 2023 Earnings Call Transcript

Quartr
Provided by Quartr
July 27, 2023

There are 12 speakers on the call.

Operator

Good day, ladies and gentlemen, and welcome to the Q2 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 filed by the company with the SEC from time to time. Additionally, certain statements contained in the call that are not based on Historical facts are forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The company intends the forward looking statements in the call to be subject to the Safe Harbor created thereby.

Operator

Management also will make reference to certain non GAAP measures of financial performance. The reconciliations to GAAP for each non GAAP financial measure can be found in the company's Current report on Form 8 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. Marc Grandisson and Mr. Francois Moren.

Operator

Sirs, you may begin.

Speaker 1

Thank you, Josh. Good morning, and welcome to our Q2 earnings call. We're more than halfway into 2023, and Through our commitment to underwriting acumen, prudent reserving and cycle focused capital allocation, we were able to deliver another quarter of profitable growth. In the Q2, our results were primarily driven by our willingness and ability to deploy capital into lines with superior risk adjusted returns. Our operating results in the quarter were stellar With an annualized operating return on average common equity of 21.5 percent, that drove a 4.8% increase in Arch's book value per common share for the quarter.

Speaker 1

As you know, book value per share growth is our primary focus on our road to creating long term value for our shareholders. Each segment generated over $100,000,000 of underwriting income in the quarter. These outstanding returns reflect our ability to effectively execute in each segment. We're really operating in our sweet spot. I also want to commend our employees for the continued exceptional growth that delivered in the quarter, most notably a 32% increase in property and casualty net premium written compared to the same quarter a year ago.

Speaker 1

This hard P and C market is proving to be one of the longest we've experienced and we are in an enviable position as we look to 2024 and beyond. We often refer to the insurance clock developed by Paul Ingray to help illustrate the insurance cycle. You can find the clock on the download tab for this webcast or on our corporate website. If you can't do the clock right now, just picture a traditional clock dial. For some time, we've been hovering at 11 o'clock, which is when we expect most companies in the market to show good results as rate adequacy improves and loss trends stabilize.

Speaker 1

Last year, a popular topic on earnings calls was whether rate increases were slowing or whether rates were even decreasing. These are classic signs of the clock hitting 12 when returns are still very good, but conditions begin to soften. Yet here we are in mid-twenty 23 and conditions in most markets remain at 11 o'clock. We have even checked the batteries in the clock and they're just fine. The clock isn't broken.

Speaker 1

It's just that the current environment dictates an extended period of rate hardening. So what's sustaining this hard market? Well, I believe it's a relatively simple combination. Heightened uncertainty is driving an imbalance of supply and demand for insurance coverage. Since this hard market's inception in 2019, we've had COVID, the war in Ukraine, increased cat activity and rising inflation, all of which create significant economic uncertainty.

Speaker 1

Underwriters have had to account for more unknowns. Beyond those macro factors, industry dynamics also play a role in sustaining the hard Okay. Generally inadequate pricing and overly optimistic loss trend assumptions during the soft market years of 2016 through 2019 have led to inadequate returns for the industry. The impact of these factors should cause insurers to raise rates and purchase more reinsurance in a capacity constrained market with limited new capital formation. Put it all together, and it may be a while before the clock strikes 12 and we begin to move beyond this hard market.

Speaker 1

I'll now share a few highlights from our segments. First, P and C. In the Q2, the Reinsurance Group was successful again at seizing growth opportunities. In particular, The MIBDA property and property cat minerals saw significant improvement in rates adequacy and our underwriters were ready, willing and able to provide valuable capacity to our clients. Our PML or exposure to a single event in a 1 in 2 50 year return period went up in the quarter, while our premium income grew substantially.

Speaker 1

At July 1, our peak zone exposure rose to 10.5% of tangible equity. Overall exposure to property cat risk remained well within our threshold and because of our diversified portfolio and broad set of opportunities, we retain the flexibility to pursue the most attractive returns across lines and geographies. Although there are lines where pricing has declined, Last large public D and O comes to mind. P and C markets continue to see rate changes above loss trends. Even with those few lines with weakening rates, The compounded rate increases over the past several years continue to be earned and are generating attractive returns.

Speaker 1

Overall, we like the range of opportunities in front of us and we continue to lean into the current market. Next is mortgage, which keeps generating meaningful underwriting income and risk adjusted returns. Housing and credit conditions remain favorable, although high mortgage interest rates tampered demand for mortgage originations and limit refinancing options. The lack of refinancing has led to a historically high persistency rate of 83%. Hy Persistency stabilizes our insurance in force, which, as many of you know, drives mortgage insurance earnings.

Speaker 1

Our disciplined underwriting process and risk based pricing model have helped us to build a healthy risk reward profile for the business we write. The composition of the overall book with high FICO scores and low loan to value and debt to income ratios remains one of the best risk profiles in the industry. International growth, along with our GSE credit risk transfer business enabled us to profitably manage risk better than more in line U. S. Only companies, a key differentiator of our Mi Global platform.

Speaker 1

Mortgage Insurance plays a valuable role in our diversified business model and continues to generate capital that is and can be deployed into the most attractive opportunities across the enterprise. Moving on to investments now. Since our Q2 call last The Federal Reserve has increased, as we all know, the rate 8 times for a total of 3.75 basis points. Given our short duration portfolio, these hikes have positively affected our net investment income, which is up approximately 22% over the Q1 of 2023. New money rates exceed our book yield, which along with our strong cash flow sets the stage for further growth and book value creation.

Speaker 1

I've had tennis on the brain after watching the incredible Wimbledon final a couple of It was an epic match up. 20 year old sensation Carlos Alcaraz taking on all time great Novak Djokovic. It was a back and forth match that lasted nearly 5 hours before Alcaraz emerged victorious. There was one pivotal moment that will be remembered for years. In the 3rd set, a single game, something that usually takes about 3 to 5 minutes, instead lasted 26 minutes.

Speaker 1

The game included 13 deuces and 7 breakpoints. It was an incredible display of tenacity and athleticism. Not to mention the mental strength required to remain focused. It was insane. But what really struck with me was that kind of like this hard market, The game simply refused to end.

Speaker 1

There were many times where a single winning shot could have ended the game, but it just kept going. About 15 minutes in, it became clear that we just needed to enjoy what we were watching and not focused on the end point. So that's what we're doing with this hard market, returning where the market serves us with gusto. As always, our goal remains to generate strong Risk adjusted returns in order to create long term value for our shareholders at lower volatility. The exceptional profitable growth over the last several years has fortified our market presence and helped us achieve one of the most profitable quarters in our company's history.

Speaker 1

This is a type of well rounded quarter We've always envisioned the sweet spot, if you will, and we look forward to building on this momentum in upcoming quarters. I'll state the court now to Francois, and then we'll return to answer your questions.

Speaker 2

Thank you, Mark, and good morning to all. Thanks for joining us today on this gorgeous day in Bermuda. As Mark highlighted, our underwriting and investment teams delivered excellent results across Effective areas in the 2nd quarter, which resulted in a performance that exceeded that from our very strong Q1. For the quarter, we reported after tax operating income of $1.92 per share for an annualized operating return on average common equity of 21.5%. Book value per share was $37.04 as of June 30, up 4.8% in the quarter and 13.5% on a year to date basis.

Speaker 2

Turning to the operating segments, Net premium written by our Reinsurance segment grew by 47% over the same quarter last year, And this growth was observed in most lines of business. Growth was particularly strong in the property catastrophe and property other than catastrophe lines, With net written premium being 205% and 53% higher respectively than the same quarter 1 year ago, a reflection of the fact that market conditions in these lines remain very attractive. As a result, the quarterly bottom line for the segment was excellent with a combined ratio of 81.9 percent producing an underwriting profit of $245,000,000 The accident year ex cat combined ratio was 77.4%. The insurance segment also performed well with 2nd quarter net premium written growth of 18% over the same quarter 1 year ago and an accident quarter combined ratio excluding cats of at 89.8%. Except for professional lines, which saw a slight decrease in net written premium in our public directors and officers business Due to a more competitive market, all our underwriting units in insurance, both in the U.

Speaker 2

S. And internationally, saw good growth in the quarter as market conditions remain excellent. Our mortgage segment had another excellent quarter with strong performance across all units, leading to a combined ratio of 15%. Net premiums earned were in line with the past few quarters, reflecting a high level of persistency in our insurance in force during the quarter at USMI, partially offset by lower levels of terminations in Australia and higher levels of ceded premium. Benefiting our results was approximately $84,000,000 in favorable prior reserve development in the quarter, Net of acquisition expenses with over 75% of that amount coming from USMI and the rest spread across our other underwriting units.

Speaker 2

QR activity at USMI was again very strong this quarter and our delinquency rate stood at 1.61%, its lowest level since the onset of the COVID pandemic. At the end of the quarter, over 80% of our net reserves at USMI are from post COVID accident periods. Overall, our underwriting income reflected $116,000,000 of favorable prior year development on a pre tax basis or 3.9 points on the combined ratio and was observed across all three segments, mainly in short tail lines. Current accident year catastrophe losses across the group were $119,000,000 over half of which are related to U. S.

Speaker 2

Severe convective storms that have occurred so far this year. Pretax net investment income was $0.64 per share, up 21% from the Q1 of 2023 as our pre tax investment income yield was almost up 50 basis points since last quarter. Total return for our investment portfolio was 0.56% on a U. S. Dollar basis for the quarter with most of our strategies delivering positive returns.

Speaker 2

Our interest rate positioning with a slightly shorter duration helped minimize the impact of the increase in interest rates during the quarter. We remain comfortable with our commercial real estate and bank exposure, which is of high quality and short duration. Net cash flow from operating activities was strong in excess of $1,100,000,000 this quarter and continues to provide our investment team with additional resources to deploy into the higher interest rate environment. With new money rates in our fixed income portfolio is still in the 4.5% to 5% range, we should see further improvement in our net investment income in the coming quarters, arising primarily from positive cash flows and the rollover of maturing lower yielding assets. Turning to risk management, our natural cat PML on a net basis at this single event 1 in 2 50 year return level stood at $1,460,000,000 as of July 1 or 10.5 percent of tangible shareholders' equity, again well below our internal limits.

Speaker 2

In light of the improved market conditions in the property market, we were able to deploy more capacity, which resulted in Significant premium growth for property lines in both our insurance and reinsurance segments. This growth was well diversified across multiple zones. Our view is that the current in force portfolio with a broader spread of risk across many zones is well positioned to deliver attractive returns. Our capital base remains very strong with $17,400,000,000 in capital and a debt plus preferred to capital ratio of 20.5%. Even though the results of the past quarter set a high watermark for us on many fronts, We believe the continued hard work and dedication from our teams, serving the needs of our clients every single day, Along with our steadfast commitment as disciplined and dynamic capital allocators sets us up very well for future success.

Speaker 2

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

Operator

Thank Our first question comes from Elyse Greenspan with Wells Fargo. You may proceed.

Speaker 3

Hi, thanks. Good morning. My first question, And Mark, can you quantify the supply demand imbalance that you're seeing within the reinsurance market? And how much of that Do you think could transpire from an additional pickup in demand potentially at Oneonetwenty 24?

Speaker 1

I think, yes, good question. Good morning again, Elyse. I think the numbers we've seen for the amount $50,000,000,000 to $70,000,000,000 is not a crazy number. So I think that where we still have this imbalance occurring, I think that market has found a way to Due to the reinsurance transaction and by coverage, but indeed there was also a there could have been more to be had from the reinsurance perspective, But we believe and you heard it on the calls that interest companies also had to had a sticker shock of sort and had to evaluate what they can buy and how much they could afford based on what the pricing level was. So I think that this imbalance right there on the reinsurance is also I believe we also believe that imbalance in the Terms and conditions in the overall broad industry that needs to be a bit more of a function.

Speaker 1

On one hand, you could create capacity for cat exposure through 3rd party capital or reinsurance protection, but at the same time, you could also Do it through improving terms and condition at the insurance level. And I think that's also something that will help bridge the gap and that we believe that's going to be one of the key elements as well for the 18 to 24 months.

Speaker 3

And then the 77.4 Francois, the accident Your underlying combined ratio within reinsurance, is that a good run rate level Or maybe you could get better as we think about some rate earning into the cap book or is there anything one off in that number in the quarter?

Speaker 2

Well, I wouldn't say there's anything one off. It's certainly a very good quarter. I think our view as we said in the past when we had Quarters where there's a little bit more activity as we think it's better to look at it on a 12 month kind of forward looking view. So is this quarter going to repeat in the future? Maybe, we just don't know.

Speaker 2

I mean, but I'll say it's certainly good. There's room for further improvement, but again recognizing that there's going to be volatility in the reinsurance segment from quarter to quarter, I'd say it's So I'll let you make your pick from there.

Speaker 3

Thanks. And then Mark, one more for you. I mean, Your stock has done really well. So you have a problem that a good problem that any CEO would want and that you have an extremely valuable currency. We sit here with a hard market.

Speaker 3

You guys obviously have a lot of organic growth opportunities. What would you need to see from an M and A perspective To consider using your stock as currency to enter into any type of transaction?

Speaker 1

Well, many things are needed. Obviously, you need it takes through the time, though, as well as you can appreciate in this world. But I think at a high level, Elyse, we're not focused on M and A at this point in time. We're really focusing on growing the book organically. We're also maintaining pretty well EMI as well as other non property exposure.

Speaker 1

So we do we are seeing a lot of opportunities broadly. And this is where what our shareholders are paying us to do and this is what we're doing. And this represents really A once in a little while opportunity to really deploy and really get access to the market in a bigger way and provide more capacity To our clients, we don't want to miss that. I mean, an M and A would have to strategically fit for us beyond the money. I think right now, our efforts in time is better Focused on organic growth though at this point in time.

Speaker 1

And this is where I think we have plenty of opportunities on our own.

Speaker 3

Thanks Mark.

Operator

Thanks. Thank you. One moment for questions. Our next question comes from Tracy Banghigian with Barclays. You may proceed.

Speaker 4

Thank you. You mentioned that your $1,250,000,000 PML to tangible equity was 10.5% at 7.1%, which was up from 8.1% at 4.1%. And I recognize your upper tolerance is 25%. It almost feels to me like you have a supplement below the 25%. Is it fair to assume that getting closer to 25% requires an even higher ROE hurdle rate or pricing?

Speaker 4

Like, could we just be theoretical? What would you need to see in order to get more comfortable taking on more volatility of your book where you can get closer over time to that 25%?

Speaker 1

Well, I think the we're first, the one thing about the PML, which is so interesting to us is it's we're in the early innings of where it's So we have to be careful the way we talk about this even internally ourselves. These are the earnings of a market getting much And as I mentioned, terms and conditions, we believe also improving and really helping to manage cat and the cat related risk better as an industry. So we'll see how that develops over time, Tracy. I think that we're also a different animal than we were way back when. We have grown up Our capital faster than the growth and exposure needed.

Speaker 1

So the $25,000,000 before is probably a lesser number. I think you're quite right. And we also have to balance the overall portfolio risk profile. But as you said all this, there's plenty of room To go from 10.5 to wherever we're going to end up, we don't know where that's going to be assuming conditions say they are even improve further. It certainly will It will mean more PML growth.

Speaker 1

I think that It would have to be substantially better. We actually have a very, very solid construct within our overall capital allocation that will dictate what kind of market share we would have in the market. And all I would say is there's always a place to go to the lab numbers you talk about, but we'll see if we get there. And I will also remind everyone that it's not a bad place to start the video line index of 1 of the major broker as you all know That shows us that the ROL the pricing for the cat is the highest it's ever been since 1990, even before Andrew. There's a lot of room and we're excited to see where that takes us.

Speaker 1

And one final thing I would say, Tracy, if you look back at the 'five, 'six, 'seven, 'eight, If you go back on this, if you have enough memory of a good document retention policy or a bad one in your company, you'll see that our PML grew In 'six, 'seven, 'eight, 'nine. So we kept on accumulating and growing the P and L. So it's just a start. Yes. There's one thing I'll add on that.

Speaker 2

Just going back to Mark's early point about supply and demand imbalance. Florida is obviously a big market. It was a big renewal in 6.1. And the reality is even if we wanted to deploy more capital, I think Our capacity, I mean the buyers or the seeding companies just don't have the resources or the money To buy the coverage that we think they should be buying. So there's a little bit of wait and see whether it'll take it'll be a full year before They reprice their product and then it gives them more money potentially to spend on resource protection, which we again assuming the pricing Stays at the current levels, we would deploy more capital, but certainly the demand is a big factor in our ability to grow PML.

Speaker 4

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

Speaker 1

Well, we don't have a view and a view that while we have a view with Centrna, we have a meteorologist who would evaluate the sea surface temperature. I'm sure everybody's seen those numbers. We expect average to maybe slightly above average last time you gave us a presentation. But as you know, Tracy, it moves With 2 weeks, we'll see when we get there. We're a little bit almost starting the season, so we'll see how that develops.

Speaker 1

But We tend to take a longer term view, Tracey, of the frequency and the severity of the hurricane season. So We believe that the pricing as it is right now accounts for a lot of deviation from the long term expected and even if you had a little bit Above average, I think that the market will be in a really, really good place. Not only us as Arch, I think the market is on the reinsurance side has priced the business With that long term expected, which had, as we all know, a little bit of that increased frequency in February of late. So that is reflected in The modeling that all companies are using.

Speaker 4

Very helpful. Thank you.

Speaker 1

Good.

Operator

Thank you. One moment for questions. Our next question comes from Jimmy Bhullar with JPMorgan. You may proceed.

Speaker 5

Hey, good morning. First, just a question on your comments on supply demand. And besides the absolute price, Obviously, terms and conditions have improved as well. And where we can see the data, it seems like most of the primary insurers are absorbing more of the first dollar loss. But obviously, we don't the data from all of them.

Speaker 5

But how broad based is this? And do you think there's sort of been a little bit of a transfer of risk cat risk from the reinsurers to the primary companies given changes in terms and remissions?

Speaker 1

I think the last part It's a true statement. I think the Q2 numbers, you saw for some other some of our clients actually and competitors I demonstrate that there's a little bit more retained and this is a kind of question. I mean, if you can't buy the coverage, you have to retain it yourself. The terms and conditions change, this is what's fascinating for this market. It is not only the property cat terms and condition change, it is It was a very broad based property, terms and conditions and price and improvement that has sought A lot of companies.

Speaker 1

I think the market globally has the psychology is squarely, like I said, Last quarter is coiling the camp of having to mend and optimize and reshape and re underwrite the portfolio. And one of the key thing that we See that evidence is that, is that our facultative team in our E and S property have an increased amount of submission this first half of the year. And what's interesting, the E and S property on the interest obviously has some cat exposure, fair amount of it, but it's not only that. Our facultative book of business Not necessarily. It's actually not the cat heavy portfolio, which is an indication as cyclothetically in any market is a good indication for where the market psychology is.

Speaker 1

So beyond the cap, when they provide a fire protection, the pricing and the conditions are improving there as well. So it's very much a broad base and in the early stages. And I will say, remind everyone and we have to remind ourselves of this is that This is the 2nd or 3rd year property rates in terms of insurance that we approved. So it's not the first shot at it. It's an ongoing process and I think that And just got repositioning top of mind after he and certainly the Q2 this year, we believe will help maintain a bit of that going forward.

Speaker 5

And then on the MI business, you've had obviously very sizable reserve releases over the past couple of years. How much of the forbearance related reserves that you'd put up, are those mostly released or is there more room to go there?

Speaker 2

I mean, they're mostly gone. I think we've released a fair amount of the reserves that we put up in the early 2020 During the early days of the pandemic, as I mentioned, like a lot of the cures that we're seeing now are from 2021 2022. So That's good news. And as you know, I mean, the reserve base has shrunk Quite substantially from the peak of 2020, late 2020. So we were still very prudent.

Speaker 2

We still look at the data every single month As the new delinquencies come in and how quickly we cure and all of that, but We're still very comfortable with our reserve position there.

Speaker 5

And if I could just ask one more on In the past when the market's been really good, we've seen some companies go out and raise equity, try to take advantage of that. And a couple of your peers have done that as well, obviously not to a very large extent, but what do you think about your sort of desire to do that if the demand really picks up and your business continues to grow?

Speaker 1

Well, it will be a function

Speaker 2

of the market. I mean, it's We've been able to grow quite substantially the last few years without raising any additional capital. As I've I've told many people over the last few months, we have the luxury of having a mortgage a unit that provides a source of capital that we have been able to redeploy in the P and C space. So assuming similar conditions where P and C It started to stay very hard and mortgage still does very well, but isn't growing substantially. We still think there'll be we'll be able to generate capital internally.

Speaker 2

But again, Hard to have the crystal ball on what 2024 will look like. So we're as I mentioned, we got plenty of capacity. We are low leverage, so that we got a lot of tools in the toolbox and we'll react to the market as it presents itself.

Speaker 1

Thank you.

Operator

Thank you. One moment for questions. Our next question comes from Michael Zaremski with BMO. You may proceed.

Speaker 6

Hey, great. Good afternoon. Maybe just wanted to learn more about market conditions in the Primary Insurance segment, John, I definitely heard your comments about rate change, but loss trend and Pieces of where overall we are in the underwriting lifestyle clock. But just curious, we're seeing Kind of different data points from companies on pricing power levels, some are showing flattish pricing power, some are showing deceleration. I know you guys operate in lots of different pockets, but when you say overall pricing in the primary insurance Segments is accelerating or maybe it's worth bifurcating between casualty versus Property as well?

Speaker 1

Yes. You have to bifurcate the market. It's a good question. I think the overall statement I will say is that From our perspective, we look at our portfolio, as you just mentioned by all these 50 lines and most of them still getting rate increases and actually get had a bit more They have been rate increase over the last quarter or 2, which was a good thing to see and the right thing to see obviously. But I think the workers' comp is a good example for rates not going up still and that's the reason for it.

Speaker 1

It's been historically well Performing and performing better than all the initial picks from all the folks out there. So I can see why there is some You know, validity or his reason behind that. This is what I would tell you. The word that we use for the insurance industry right now in the U. S.

Speaker 1

Specifically is rationality. It's a very rational market. There's a reason for things to happen. The reason for things happen are economically based and not growth and market share or making a marketing driven. Companies are really, really doing the best they can to underwrite the best and being appropriate, right, in Getting price increase to a certain degree to lines that needed more than others.

Speaker 1

I think the market is fairly rational as we speak.

Speaker 7

Okay.

Speaker 6

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

Speaker 1

I think we've grown our portfolio, right. I mean, you can see that the exposure growth. I think the proxy for market share is probably better to use The delta in the P and L, even though that's only one zone. But as Francois mentioned in his remarks, we do have we have an increased Participation in a much more wider set of property cat exposure that we used to have before. But the market share that We said anywhere from historically from 0.5 to 0.8 is going up

Operator

a little bit. And I think

Speaker 1

I would use a P and L as

Speaker 5

a proxy. That's the best thing I

Speaker 1

can tell you right now. Sorry, they're done by zone.

Speaker 6

Okay. That makes sense. I'll stop there. Thank

Speaker 1

you. Okay.

Operator

Thank you. One moment for questions. Our next question comes from Josh Shanker with Bank of America. You may proceed.

Speaker 8

I've read the Paul Ingray reinsurance clock, but it doesn't really relate to something that Paul actually knew about, which I don't, which is how to make money in the late 1970s in the insurance industry. Given where you see loss trends are And given that pricing is going up over a extended period of time, is there an element that we just don't know really what the loss cost trend is and we need an extra padding in there Compared with our historical appraisals and is it possible to put a supplemental Ambiguous loss trend on top of what you think the loss trends currently and still get new business attractively?

Speaker 1

Yes. So very good question. I think, it's been breaking in parts. I think that, yes, We do as you know, as a reserving practice, we're very keen on reserving being prudent. We do reserve to a higher level a trend that is embedded in the pricing of what we even observed in the data to make sure that we're accounted for this.

Speaker 1

I think as a result of that uncertainty and the need to get a bit more cushion and the uncertainty that it generates, I mean, you heard us on the other call, I think it does generate that need to get higher price for that reason. But there's a need there's a recognition in the industry that we need to be A little bit on this side of the decimal to create some kind of margin of safety. So I do believe that Companies are pricing for a higher inflation ratio going forward and also adding a little bit and that's what helps and sustain the hard market as we speak.

Speaker 8

Is Arch padding more now than it has as a company standard practice in the past?

Speaker 1

Not really. I think we've like we talked about this, Josh, on calls the last 2, 3 years. I think we've been consistent. We it is a little bit of art, right? It's not only science, not as granular as you might think it is.

Speaker 1

You do the reserving process, you do the reserving process and then look at what your expectations are versus what the actual is emerging and you adjust your loss ratio. There's 2 things going on right now. There's a tendency to sort of pick a higher loss ratio than Otherwise, it would be indicated because we have still see through that underwriting year develop. And it's been very consistent. If you look at our IBNR ratios and the way we booked the business on our insurance Portfolio has been consistent for the last 3 years.

Speaker 1

So we tend to want to make sure that we see data emerge That allows us to release some of that before we do. So we have not changed a whole lot. And it's not It's quite a bit of way above the expected or the actual emergence of the losses, but inflation It was in the future, so it's an appropriate thing to do, I think, at the early stages. Francois, I think.

Speaker 2

Yes. And I'd add, like COVID certainly threw a wrench in the whole Process, right. I'd say it's the way we think about the business today, the way that the environment is today is different than it was 5 years ago, is different than it was 10 years ago. So great question, Josh, but it's no two periods are alike. And right now, Back to Mark's point, I'd say the reaction or how do we think about courts closing and courts reopening and coverages and Everything that came with COVID, I think, we're still kind of working through that.

Speaker 2

So that's why I think it would suggest So we're we like to be prudent and maybe even more so in this environment.

Speaker 8

And then on Theresa's PML question, I've you kind of ribbed into Francois, I'm down on this a little bit, but the corporate charter says you're willing to put 25% of the company's equity capital at risk for 1 250 year event. You're nowhere near that and I don't really expect there's any market where Arch at this point given how big it is would really put 25% of its equity capital at risk for a 1 and 2 50 year event. How what's the reasonable feeling on how much cat risk you'd be willing to take In the best cat market ever?

Speaker 2

I'd say, I mean, we think we're in a good market. We know we're in a good market, but We don't know what tomorrow holds. So I mean, the rates could go up again by a factor of Quite substantially next year, again, I don't want to speculate, but there could be some markets kind of pulling back. And then I think I agree that in what we know today, it's unlikely that we would hit 25%, but we don't just don't know where the future holds. So I think We're cognizant that there could be better opportunities at some point down the road.

Speaker 8

Okay. Thank you for all the answers.

Speaker 1

Thank you. You're welcome.

Operator

Thank you. One moment for questions. Our next question comes from Ryan Tunis with Autonomous Research. You may proceed.

Speaker 9

Hey, thanks. Good morning. I guess my first question is in MI, it's Kind of a follow-up on Jimmy's. But on Page 21 of the supplement, it looks like you guys give reserves, loss reserves like by vintage year. And the dollar amount of reserves in 20 'twenty one, 'twenty two looks pretty similar to what it was at the end of last year.

Speaker 9

Against that, you continue to release quite a few, over 100,000,000. So I guess I was just trying to square that a bit like where exactly have these releases been coming from?

Speaker 2

Well, just to clarify, I'd say, Ryan, that the reserves, we don't disclose the reserves by year. We show the risk in force. We give you the total dollar amount of reserves as of $403,000,000 at the end of the quarter And the same at the end of the year, but there are some shifts between what happened at year end versus now. I will say that most of the reserves that we've the reserve releases in the first 6 months of the year have been coming primarily from the 2021 to 2022 years, I mean, and a little bit of 2020 as well.

Speaker 1

And Martin, what you're saying is also recognition by the MI I grew that there were more uncertainties and potential recession fears with all things going on. So The assumptions when you do reserving in the long term at that time, you'll tend to increase could have been increased level of risk. So I think that That also could explain why well after 2 or 3 quarters, what we don't need them all is because things are also as we know changing for the better as we speak on the EMI. So that could explain a little bit why it's a little bit higher this quarter.

Speaker 9

Got it. And maybe just some perspective on kind of where the ultimate loss ratios on those years Are not trending yet?

Speaker 2

Well, they are I mean, They turned out to be really, really good. I mean, the reality is with even with COVID and kind of what transpired after For that and the forbearance, etcetera, I'd say, again, we've talked historically about, Call it a long term average loss ratio in the 20% to 25% range, we're certainly going to be below that. Still a little bit, we're not there yet. I mean, there still has to be we need more clarity on how the remaining delinquencies are going to That'll or whether they're going to cure or not, but where we're at today, I'd say we're going to be below the long term average.

Speaker 9

Got it. And then as a follow-up Go ahead, sorry.

Speaker 1

Right. So just to let you know, in terms of loss emergence in MI, it takes a little while, right, it takes 2 or 3 years For losses to start emerging, so it takes a little while to get to know what the ultimate is going to be. So I just want to make sure you know it's not like a one and done. It's You generate an underwriting year, it's 2 or 3 years for losses start and merge, right, Situations, family situation, economic situation and the borrowers evolve over time. Just want to make sure you know that it's not just Nothing has happened.

Speaker 1

Yes, I'm still trying to figure this

Speaker 9

business out, so appreciate it. Follow-up, I guess, for Mark, just on P and C. I'm not sure there's ever been a cycle where like when rates started to decelerate, they reaccelerated.

Speaker 1

Yes.

Speaker 9

Why hasn't that happened before Well,

Speaker 1

no, it's happened before, right? It's happened before. From 'ninety nine to 2000 and one, we had 2,002, 'three, 'four actually we had A hardening market on liability side in the U. S. We had new lines of business such as terror and aviation going through the wringer.

Speaker 1

So we had that going. And I remember a period of time when Arch was underway cat for the 1st 2, 3 years of its existence and we were sort of going against the grain. Most people weren't shying away from casualty and doing more property. And then we ran into KRW in 2005 and then we had a hard market as well in property. And I think it helped maintain even the business on the liability lines a bit longer.

Speaker 1

If you look back, the years 6 or 7, 08 were still very, very good and the price decrease were not as probably as high as they could have been otherwise. I think the one factor with these kinds of hardening market and property side is competing. It's competition for capital. And I think it also helps buffer or paying down the rate decrease that would have otherwise have happened. And that's an important or We're stabilizing more than just going out for it.

Speaker 1

So we've had this before. We've had this before.

Speaker 9

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

Speaker 1

It hasn't changed a whole lot. We hear from our 3rd party capital team and the market. I mean, you hear from other market. I think that there's a General more leveling off of capacity has been deployed than we would have expected from the existing incumbent, which helps explain a lot of the price increase that we've seen in our ability to flex into this. We're not seeing or hearing Supply increasing for a while.

Speaker 1

I think that there's still a it's very much The money that was there before that presumably was requiring lower returns is not returned back to the table. And even if they were to come back to table, what we hear is their return expectations like ours have increased dramatically. So we'll see what that hands up. I guess just lastly, I would say,

Speaker 9

what are you paying the closest attention to thinking Like looking forward into 1.1, kind of what might drive pricing when you get to

Speaker 1

the end of the year? Well, activity, cat activity, of course, and demand increasing. Demand people, like we said before, needing to buy more or having to bite the bullet And do the right thing at the same time as they're improving their insurance portfolio. That's the big tail for us. Thank you.

Operator

Thank you. One moment for questions. Our next question comes from Brian Meredith with UBS. You may proceed.

Speaker 7

Hey, thanks. Couple of questions here for First, just on your PML, what is your peak zone right now? Is this still Northeast?

Operator

Florida.

Speaker 7

Where is it? Pardon me? Florida? Florida.

Speaker 2

Yes. My Tri County Dade, Miami Dade, the area Broward.

Speaker 7

Okay. And then on the PML question, just curious, you gave us 1 in 250, but how is your kind of 115, 1 in 100 Kind of increased over since, call it, the beginning of the year. Is it they increased more or less About the same amount, just trying to get a sense of where you're playing in programs?

Speaker 1

Yes. From a big zone perspective, it's going up Similarly in terms of percentage. It's a very similar increase.

Speaker 7

Got you. That's helpful. And then Mark, just curious, I know there was a lot of one off type transactions, top up programs that happened in the Q2. Can you give maybe some perspective How much of that contributed to your growth here in the Q2 and how much is kind of continuing here going forward? Just so we can get a sense of how is this growth sustainable here for the remainder of the year, maybe into 2024?

Speaker 1

We've had a couple of we've had a couple of programs for instance on the issue that we won And we've had a couple of big trends. But I don't think this quarter is necessarily a large transaction quarter, Brian, the way you make it sound. I think it was More regular growth, a couple of transactions here and there, but nothing to the extent that when we talk on the call that Prosper mentioned in his remarks And it has to highlight a specific report. I don't think there's nothing really to highlight in this quarter actually.

Speaker 7

Good. Thanks. And then I guess last one just quickly here. One of your competitors talked about reducing market Share in the MI business because of some concerns about potentially recession here going forward. Maybe give us your kind of perspective on what you're seeing right now in your MI and kind of outlook and potential for some higher loss ratios there if we do go into recessions and look into 2024?

Speaker 1

Yes, I think pricing has improved over the last 2 years and credit quality stays really Beautiful. And so it's one among the best, we're if we go back to 2013, 2012 in terms of quality of origination. So As you know, credit is not readily available. The availability of credit is still pretty tied up there. So from a credit quality perspective, Brian, It sounds good.

Speaker 1

It's a really, really solid marketplace. I think the market share question, which we never We don't lose sleep over this, as you know, Brian. I think a couple of things. And the market share that we're trying to do in terms of Shaping the portfolio in the Mi is trying to get the higher quality, like I mentioned in my remarks, lower FICO higher FICO or lower LTV And also geographically go to the places where there's less perceived inflation or an overvaluation. And also there's some different programs that have different returns, meaning they're less than we would have hoped for them to be, And they just don't meet our threshold.

Speaker 1

And especially, Brian, if you overlay the opportunity set that we have on the property side, It just makes for our fellow folks and MI willing to take the earnings that they generate and give it to us on the P and T side to generate even better returns. So really good return business, Brian. It's just also for us a matter of comparative ROEs as well as No, absolutely. Great. Thank you.

Speaker 1

Sure.

Operator

Thank you. One moment for questions. Our next question comes from Meyer Shields with Keefe, Breandan Woods. You may proceed.

Speaker 1

Thanks. Quick question to start. The level of reserve releases in reinsurance was lower than it's been in recent quarters.

Speaker 10

Can you give us some color? Is that because you're assuming higher loss trends or are there other factors that may have played into the quarter's results?

Speaker 2

No, I'd say it's I mean, we will look at the data, right? So I think some quarters there's evidence That we can release a bit more this quarter, maybe not as much. It's a process that we go through every quarter. So I think our underwriters and our actuaries kind of Sit down and take a look at the respective treaties and come up with a point of view on whether there's Enough evidence to release reserves. So I wouldn't read too much into it right now.

Speaker 2

I think it's a just another quarter, still we think Healthy reserves, healthy reserve releases, but not as much as you said as in prior quarters.

Speaker 10

Okay. No, that's fair. Second question, and I'm really not sure how to ask this, but there's a lot of chaos right now in U. S. Personal lines.

Speaker 10

And Arch has always been really opportunistic. And I was wondering if there's a way that in a line of business so dominated by major players, but you do have this level of instability.

Speaker 1

Is there an opportunity for Arch? I think it's a hard one, Maher. I think that our shareholders I mean, we could always see what we could do there. But from our perspective, I think we're more of a B2B and more of a commercial provider of insurance and specialty provider of insurance. Certainly on the reinsurance side, we're helpful.

Speaker 1

Our companies a lot of companies are homeowners, homeowners and writers and we do provide significant capacity for them Being on a quarter share basis, so I guess a loss and also beyond property. So I think our game plan on homeowners is more to support clients that we have because I think on the long term basis, it has a set

Operator

of characteristics as

Speaker 1

we all know and focus that is not necessarily core to what we do every day, Refiling and everything else in between is a bit of a different animal for us.

Speaker 10

Okay. Understood. Thanks so much.

Speaker 8

Great.

Operator

Thank you. One moment for questions. Our next question comes from Yaron Kinar with Jefferies. You may proceed.

Speaker 11

Thank you. Good morning. With most of my questions already asked and answered, I figured I'd maybe focus on a couple of more esoteric items. Thanks. So first on ag covers, can you maybe talk about how much you're still writing in 23 versus 2022?

Speaker 1

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

Speaker 11

And Is the client base there? Has that changed at all? Can you maybe talk about the mix between large globals, smaller regionals?

Speaker 1

We said well, we had the way we grew, of course, in Florida was, as you know, It's a different kind of animal because of all the top sellers, small companies out there. But in general, I would say that our portfolio Well, opportunistically grow into the larger global companies. We tend to think that They're relatively not as this has transparency of visibility into what they write. So our tendency is to be more of a super regional in businesses and more ones that have a lesser footprint in terms of state, we think we can better allocate capital. This is sort of a high level philosophy that we've had for years that hasn't really changed our own.

Speaker 1

I think that we prefer to grow with these clients over time. But I think that all this opportunistically being on a core share basis of excess of loss, if there's a large corporate, we definitely were able to provide more capacity because they needed it. As we speak in the price, we believe reflected the higher level of risk that they have. So I think I would say Same as before with a little bit opportunistically on a larger quarter, larger companies.

Speaker 11

Got it. And Then if I put this together then and we look at the very large cat activity that has really been incurred much more by the primaries here. With the changes in terms of conditions and maybe tighter or more limited cover per peril, ultimately, how does that Impact ag covers later in the year, if let's say the primaries had a lot of cat losses on payroll, secondary perils that are now no longer covered By reinsurers, at least not per event, ultimately, does that also flow into the ad covers that will not be breached on Reinsurance level because of that.

Speaker 1

Yes. So I think that excess of loss is very similar to the occurrence. If you do change terms and conditions and cut the Coverage at the underlying portfolio level, it will have a leverage impact into your aggregate excess or occurrence, meaning it will definitely Cut down the loss expectations heavily into these layers. But what I would tell you, everyone, is we're not there yet, right? This is the earnings like I mentioned to you before Recall that we're going to have the phenomena you just talked about, we'll have much better And view on this and the impact it's going to have on the losses next year and into 2025.

Speaker 1

I think right now, we still have a portfolio that hasn't gone through quite 100%, right, of all these things that you and I expect to happen, I think, in the marketplace. So the aggregate of losses, For that reason, probably still a bad bet in 20 4 and 20 3, right? So we probably need to see this underlying change In terms of conditions on the insurance portfolio, we can see this being a potential viable product.

Speaker 11

Makes sense. Great. I appreciate the answers.

Speaker 1

Sure.

Operator

Thank you. And I'm not showing any further questions at this time. I would now like I turn the conference over to Mr. Mark Grandisson for closing remarks.

Speaker 1

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

Operator

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

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Earnings Conference Call
Arch Capital Group Q2 2023
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