Arch Capital Group Ltd.

Good day, ladies and gentlemen, and welcome to the Q4 2019 Arch Capital Group Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. 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 host for today's conference, Mr. Mark Randerson and Mr. Francois Morin. Sir, you may begin.

Thank you, Crystal, and good morning to you. Ours completed 2019 on strong footing as the mortgage insurance market remains healthy and our property and casualty operations are well positioned for the pricing improvements taking place in many areas of the market. Our operating income produced an annualized return on common equity of 11.7% for the fourth quarter and 12% for the full year, while book value per share grew 3.2% for the quarter and nearly 23% for the year. While property and category rates are increasing in several lines of business, we believe the market remains in a transitioning phase between soft and harder conditions. Given the uncertainty of current claim trends, we believe our industry needs further rate increases to provide a more clear risk-reward proposition. In this transitional environment, risk selection and thoughtful capital allocation remain critical to generating superior returns. As we discussed last quarter, strengthening market conditions are evident to us from both the rise in our submission activity and our ability to achieve significant rate increases. This location is ongoing as some industry participants de-risk by tightening underwriting standards and by actively managing down their exposures. We believe that these conditions are likely to continue in a foreseeable future due to the continuing uncertainty regarding losses from the recent soft policy years. While there are some lines of business where the rise and loss costs can be tied to social inflation, in our view, a large component of the stress on the P&C industry's performance is due to prolonged soft market conditions and optimistic loss picks over the last three to four policy years. But reported capital levels are still high. Combined ratios are still below 100. Therefore, the duration of the transition or hardening market is unpredictable. Within our insurance segment, conditions for growth improve throughout the year, as indicated by 29% growth in our fourth quarter 2019 net written premiums. About one quarter of our premium growth came from recent acquisitions, while 50% was created organically through new opportunities, and the rest coming from rate improvements. Following three years of elevated property losses in both the U.S. and internationally, property rate increases, particularly E&S risk, in cat-exposed area in the US are up more than 25%. We have also seen rate increases ranging from 10 to 20% in large commercial general liability and public company D&O policies. But as we discussed previously, rates are not rising in all lines, and in some areas, rates are not rising enough. Switching now to our reinsurance business. Pricing in that segment tends to follow primary insurance, and we have observed some signs of discipline returning to the reinsurance market. In our facultative reinsurance business, we are seeing increasing submission levels and much improved pricing. FAC reinsurance has been a leading indicator of 3D market conditions historically, and we like the positive signal FAC is giving us at this point. On the 3D side, we are beginning to see modest improvements in terms and conditions, including declines in ceiling commissions ranging from one to three percentage points. Seating commissions remain elevated, however, and are 500 bps above the level seen in the last hard market. Focusing on the January 1st reinsurance renewals for a minute, rate increases in what is primarily a property cap reinsurance renewal period created a few opportunities for our reinsurance group, but we remain underweight cat risk. As a reminder, Our self-imposed internal risk limitation is 25% of equity capital. At this point, our 1 and 250-year PML stand at only 6% of equity capital. Turning now to our mortgage insurance segment, RTI continued to perform well. As I mentioned earlier, the operating environment is characterized by strong credit quality and a healthy housing environment. In addition, lower interest rates led to strong new mortgage originations in the quarter. Accordingly, our new insurance written at Arch MIUS was strong at roughly $24 billion in the quarter. Overall, our U.S. insurance in-force was $287 billion at quarter end, and the underwriting quality of recent originations remained very high. On a macro basis, lower interest rates and high employment have made housing more affordable. At the same time, demographic forces in the U.S. are creating a tailwind as millennials move into their prime household formation years. Lower interest rates also led to greater refinancing activity in the quarter, which explains a decline in our persistency rate in the fourth quarter down to 76%. From a historical perspective, this level remains high, and along with good mortgage origination activity, supported growth, in our insurance enforcement accord. With respect to our investment operations, interest rates have returned to historically low levels. As in our underwriting approach, we have maintained our focus on risk-adjusted total return, which contributed to our growth in book value per share in this quarter and the year. In summary, Archer's position following years of deemphasizing the most commoditized and soft business lines in property casualty markets is favorable. We have the human and financial capital to grow should the market continue its favorable trajectory into 2020. And with that, I'll hand over the call to Francois.

Thank you, Mark, and good morning to all. Before I give you some comments and observations on our results for the fourth 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 segments. i.e., the operations of Watford Holdings Limited. In our filing, the term consolidated includes Watford. After-tax operating income for the quarter was $308.4 million, which translates to an annualized 11.7% operating return on average common equity and $0.74 per share. Book value per share grew to $26.42 at December 31st a 3.2% increase from last quarter, and a 22.8% 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 $30.4 million, or 2.2 combined ratio points, compared to 9.7 combined ratio points in the fourth quarter of 2018. These losses impacted both our insurance and range segments and were primarily due to typhoon Hagibis and a series of smaller events. As for prior period net loss reserve development, we recognized 54.7 million of favorable development in the fourth quarter, net of related adjustments, or 4.0 combined ratio points compared to 6.1 combined ratio points in the fourth quarter of 2018. All three of our segments experienced favorable development at $2.8 million, $19.1 million, and $32.8 million for the insurance, reinsurance, and mortgage segments, respectively. We had solid net written premium growth in the insurance segments. of 28.7% over the same quarter one year ago. The insurance segments accident quarter combined ratio excluding cats was 101.6% higher by 330 basis points from the same period one year ago. Approximately 220 basis points of the difference is due to an elevated level of large attritional claims in the quarter primarily from our surety unit, which can experience some volatility from quarter to quarter. The balance is primarily due to a higher expense ratio driven by investments we are making in the business and the integration of our UK regional book and other smaller acquisitions. Now, moving on to our reinsurance operations where we had a relatively stable quarter. Net premium growth was at 4.3% from the same quarter one year ago, And the accident quarter combined ratio excluding cats stood at 92.3% compared to 96.2% on the same basis one year ago. The difference is mostly attributable to the presence of a large attritional casualty loss arising from the California wildfires in the same quarter one year ago. Our expense ratio remained essentially unchanged at 26.9%. The mortgage segment's accident quarter combined ratio improved by 200 basis points from the fourth 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 0.9% is lower by 120 basis points than the result recorded in the same quarter one year ago, mostly as a result of better than expected claim experience. The benefit to the loss ratio from current year favorable development was 510 basis points, in addition to the 940 basis points related to prior years. The expense ratio was 20.7%, consistent with the results from the same period one year ago. Total investment return for the quarter was a positive 107 basis points on a U.S. dollar basis, as our high-quality portfolio continued to perform well. For the 12-month period, our portfolio returned 7.3%, an excellent result driven by particularly strong returns across our fixed income and equity investments. The duration of our investment portfolio at December 31st was down slightly to 3.40 years from 3.64 years at September 30th and was overweight relative to our target allocation as we continue to expect a lower for longer global interest rate environment. The corporate effective tax rate in the quarter on pre-tax operating income was 6.9% and reflects the geographic mix of our pre-tax income and a 30 basis point benefit from discrete tax items in the quarter. The 2019 fourth quarter effective tax rate on operating income includes an adjustment to interim period taxes recorded at an annualized rate. This adjustment increased the company's after tax results on pre-tax operating income available to Arch Common shareholders by 12.4 million, or 3 cents per share. As always, the effective tax rate could vary depending on the level and location of loss or income and varying tax rates in each jurisdiction. Turning briefly to risk management, with the recent improvements in catastrophe pricing, we have increased our natural cap PML to 612 million as of January 1, which, at slightly more than 6% of tangible common equity on a net basis, remains well below our internal limits at the single-event 1 in 250-year return level. This change demonstrates our ability to deploy incrementally more capital in an improving market to opportunities that offer adequate returns on an expected basis. In our mortgage segment, as mentioned on our prior earnings call, we completed our 10th Bellamy transaction in the fourth quarter with coverage of $577 million. As of the year end 2019, the Infor's Bellamy structures provide aggregate reinsurance coverage of approximately $3.3 billion. With respect to capital management, we did not repurchase shares this quarter. Our remaining authorization, which expires in December 2021, stood at $1 billion at December 31st. Our debt to total capital ratio stood at 13.1% at quarter end, and debt plus preferred to total capital ratio was 19%, down 350 basis points from year end 2018. Finally, as you know, we closed on the Barbican acquisition in November of last year. The integration of their platform is well underway. For the 2020 calendar year, we expect to incur approximately $65 million of intangible amortization across all acquisitions we have made prior to December 31, 2019. With these introductory comments, we are now prepared to take your questions.