Arch Capital Group Ltd.

Good day, ladies and gentlemen, and welcome to the Q3 2019 Arch Capital Group 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. If anyone should require assistance during the conference, please press star then zero on your touchtone telephone. As a reminder, this conference call is being recorded. Before the company gets started with its update, management wants to first remind everyone that certain statements in today's press release and discussed on this call may constitute forward-looking statements under the federal securities laws. These statements are based upon management's current assessments and assumptions and are subject to a number of risks and uncertainties. Consequently, actual results may differ materially from those expressed or implied. For more information on the risks and other factors that may affect future performance, Investors should review periodic reports that are filed by the company with the SEC from time to time. Additionally, certain statements contained in the call that are not based on historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The company intends the forward-looking statements in the call to be subject to the safe harbor created thereby. Management also will make reference to some non-GAAP measures of financial performance. The reconciliation to GAAP and definition of operating income can be found in the company's current report on Form 8K, furnished to the SEC yesterday, which contains the company's earnings press release and is available on the company's website. I would now like to introduce your hosts for today's conference, Mr. Mark Grandison and Mr. Francois Morin. Sirs, you may begin.

Thank you, Crystal, and good morning to you. Our diversified business model of specialty insurance, reinsurance, and mortgage lines of business produced good growth and acceptable risk-adjusted returns for our shareholders in the third quarter. Operating earnings generated an annualized return on common equity of 10% for the third quarter as our book value per share grew 3.9% and more than 21% on a trading 12-month basis. Before I discuss market conditions in a broader P&C sector, I would like to address a topic that is currently getting a lot of attention, namely the increased claims inflation or loss trend. In this part of the cycle, we are not surprised to hear about adverse claims development that some in the P&C industry are experiencing. We have discussed our view of loss trends on these calls over the past several years, and I'd like to remind our shareholders that at ARCH, we approach pricing our products and establishing our reserves with a bias towards conservative loss trend estimates. As I have mentioned before, history teaches us that, on average, the PNC industry experiences claim inflation rates about 200 basis points above the CPI, although this can fluctuate over time. It seems to us that the premium rate declines seen by the industry over the past several years should have led to higher current loss picks. It is important to bear in mind that in many lines of business, it takes three to five years before an accurate level of trend can be confirmed. We believe that this gap between the estimated and actual loss trend has contributed to the uncertainty in reserve development. This uncertainty helps fuel both disruption and dislocation in several areas of insurance, which we have been and are capitalizing on. This location is evident in the rise in our submission activity this year, and it is also reflected by the fact that we are achieving higher rate levels on new business than on renewal business in several segments. To give you some sense of the data, our submission activity in the third quarter was up more than 20 percent in E&S property and 15 percent each of E&S casualty and professional lines specifically D&O. However, to date, we believe that these disruptions are more indicative of a transitional market than a traditional hard market as we have not yet seen rate increases and hardening across the board. Risk selection is still paramount. Across all lines in our insurance group, renewal rate changes averaged a positive 3.5% for the quarter as net premium grew 22% in the third quarter above the same period in 2018. About 30% of that growth came out of an acquisition we completed earlier this year in the UK small commercial line space. Rate increases contributed a quarter of the overall segment's growth, while new business opportunities generated the balance. It is worth reminding you that we expect to close on our acquisition of the Barbican Group in the fourth quarter, And we believe that the enhanced presence and scalability of our Lloyd's operation will provide us with further opportunities. Now turning to the reinsurance market. Reinsurance pricing tends to follow that of the primary insurance industry, but with a few twists. Catastrophe and large attritional losses can disproportionately affect reinsurance results, creating localized opportunities in areas such of the reinsurance business. Property Fact and Marine are examples of improving markets. Over the past several years, we have significantly reduced our net exposure to property cat risk in response to the declining level of risk-adjusted rates. The occurrence of Japanese typhoons in both the third and fourth quarter of this year has impacted global reinsurance industry results and should support the ongoing need for additional rate improvement. Turning to our mortgage insurance segment, ArchMI continues to perform well, and market conditions continue to be characterized by strong credit quality and a healthy housing environment. In terms of new production, our third quarter new insurance written, or NIW, grew 18% over the same period a year ago. That production was driven by growth in the mortgage insurance market due to a broad increase in mortgage originations, combined with an increase in the level of mortgage insurance purchased from private mortgage insurers. Overall, insurance in force grew about 2% sequentially in the quarter at ArchUSMI as higher prepayment activity was more than offset by new MI originations. We continue to be pleased with the credit quality of our insurance in force as key risk metrics in our USMI portfolio remain at historically favorable levels. Notwithstanding the good market conditions in the EMI sectors, we continue to mitigate our downside risk from an economic cap event through the purchase of insurance-linked notes. With respect to our investment operations, we have maintained our focus on total returns and continuously repositioned the portfolio to adjust to financial markets conditions, which contributed significantly to our growth in book value per share this quarter. And with that, I'll hand the call over to Francois.

Thank you, Mark, and good morning to all. Before I give you some comments and observations on our results for the third quarter, I wanted to remind you that, consistent with prior practice, These comments are on a core basis which corresponds to ARCH's financial results, excluding the other segment, i.e., the operations of Watford Holdings Limited. In our filings, the term consolidated includes Watford. After-tax operating income for the quarter was $261 million, which translates to an annualized 10.3% operating return on average common equity and $0.63 per share. Book value per share grew to $25.61 at September 30th, a 3.9% increase from last quarter and a 21.1% increase from one year ago. This result reflects the effect of strong contributions from both our underwriting and investment operations. Starting with underwriting results, losses from 2019 catastrophic events in the quarter Net of reinsurance recoverables and reinstatement premiums stood at 68 million or 5.2 combined ratio points. These losses impacted both our insurance and reinsurance segments and were primarily due to Hurricane Dorian and Typhoon Faxai. As for prior period net loss reserve development, we recognized approximately 51.7 million of favorable development in the third quarter, net of related adjustments, or 3.9 combined ratio points, compared to 6.7 combined ratio points in the third quarter of 2018. All three of our segments experienced favorable development at 3.9 million, 14.7 million, and 33 million for the insurance, reinsurance, and mortgage segments, respectively. We had solid net written premium growth in the insurance segment, 22% over the same quarter one year ago, While approximately 30% of that growth comes from the UK regional book of business we acquired earlier this year, we also had a strong quarter of new business and an improving renewal rate environment in most of our lines of business. The insurance segment's accident quarter combined ratio excluding cats was 100.3%, essentially unchanged from the same period one year ago. Some of the pricing and underwriting actions we have taken over the last several years have begun to filter through the loss ratio, while our expense ratio remains slightly elevated, primarily as a result of investments we are making in the business. In particular, as discussed on prior calls, the integration of our UK regional book and other smaller acquisitions is ongoing and increased the overall insurance segment expense ratio this quarter by approximately 130 basis points. Investments in our underwriting claims and IT operations explain most of the remainder of the increase in the expense ratio. We continue to expect that the expense ratio for this segment will remain higher than the long-term run rate until the growth in net written premium we achieved over the last few quarters, both organically and from acquired businesses, is fully earned. Now, moving on to our reinsurance operations where we also had solid growth this quarter, with net written premium up 40 percent over the same quarter one year ago. Over 60 percent of the growth came from the casualty segment, where we were able to write select new opportunities in distressed sectors of the market, including a multi-year treaty that represented approximately 65 percent of the growth for this line of business. As we have said in the past, some of these opportunities can be lumpy and distort quarter-over-quarter comparisons. Property excluding property cap and property cap make up most of the rest of the increase in net written premium. The reinsurance segment's accident quarter combined ratio excluding cap stood at 92.8% compared to 92.5% on the same basis one year ago. Part of the large attritional loss activity we experienced this quarter includes some exposure to the Thomas Cook collapse. Our expense ratio remained satisfactory at 26%, down 140 basis points since the same quarter one year ago. The mortgage segments accident quarter combined ratio improved by 290 basis points from the third quarter of last year as a result of the continued strong underlying performance of the book, particularly within our U.S. primary MI operations. The calendar quarter loss ratio of 3.8% is higher by 60 basis points than the result observed in the same quarter one year ago, although last year's loss ratio benefited from favorable prior development that was approximately 320 basis points higher than what was observed this quarter. The expense ratio was 20.8%, lower by 60 basis points than in the same period one year ago. Total investment return for the quarter was a positive 100 basis points on a U.S. dollar basis, as our high-quality portfolio continued to perform well. Our investment portfolio duration is overrate relative to our target allocation, up slightly to 3.64 years at quarter end, as we continue to expect a continued slowdown in economic growth and a lower for longer global interest rate environment. The corporate effective tax rate in the quarter on pre-tax operating income was 11.7% and reflects the geographic mix of our pre-tax income and a 40 basis point benefit from discrete tax items in the quarter. Excluding this benefit, the effective tax rate on pre-tax operating income was 12.1% this quarter. At this time, we believe it's still reasonable to expect that the effective tax rate on operating income will be in the range of 11 to 14% for the full year. As always, the effective tax rate could vary depending on the level and location of income or loss and varying tax rates in each jurisdiction. Turning briefly to risk management, despite the recent increases in catastrophe pricing, our natural CAT exposures on a net basis remain at historically low levels at October 1, with the Northeast still representing our peak zone at slightly more than 4% of tangible common equity at the 1 in 250-year return level. We remain committed to deploying more capacity in this segment if rates and expected returns on catastrophe-exposed accounts continue to improve over time. In our mortgage segment, we recently completed our 10th Bellamy transaction earlier this month with coverage of $577 million. Currently, the enforced Bellamy structures provide aggregate pre-insurance coverage of over $3.7 billion. With respect to capital management, we did not repurchase any shares this quarter. Our remaining authorization, which expires in December 2019, stood at 161 million at September 30th, 2019. Our debt-to-capital, our debt-to-total capital ratio stood at 13.5% at quarter end, and debt plus preferred to total capital ratio was 19.5%, down 300 basis points from year end 2018. In terms of fourth quarter activity, We expect to use resources on hand to fund the Barbican acquisition and closing once we receive regulatory approvals. With these introductory comments, we are now prepared to take your questions.