Arch Capital Group Ltd.

good day ladies and gentlemen and welcome to the second quarter 2021 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 gap 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.

Thanks, Liz. Good morning, and thank you all for joining our second quarter 2021 earnings call. At Arch, our playbook remains simple yet effective. We protect our capital through soft markets and unleash our underwriters during hard markets. We believe that this time-tested strategy gives us the best chance to generate superior risk-adjusted returns over time. What you should expect then from us at this stage of the cycle comes straight from that playbook. As long as rate increases support returns above our threshold, we will continue to grow our writings. We have seen this video before in the hard market of 2002 through 2005 when P&C results generated a sustainable stream of earnings for several years after market prices peaked and were fully earned. And so, again this quarter, the power of ARCH's diversified platform is evident in the strong underlying earnings in each of our operating segments. We delivered a 13% annualized operating ROE and aided by good investment returns, an annualized net income ROE of 21 percent this quarter. One item that stands out this quarter was our strong P&C underwriting activity. Our P&C insurance results demonstrate significant improvement in underwriting performance. Better market conditions allowed our teams to expand their overall positioning and grow net written premiums substantially over the same quarter last year. We are now in the sixth consecutive quarter of rate increases at plus 10 percent this quarter, comfortably in excess of lost cost trend estimates. The higher level of premium earned from the post-2019 policy years is a primary driver of our improving underlying accident year combined ratio. About two-thirds of the combined ratio improvement was due to lower loss ratios attributable to rate increases and underwriting actions we have taken over the past several years. the balance of the improvement was driven by a lower expense ratio. Production increased across most lines of business and geography areas as pricing improvements spread. While rate increases have tapered off from previous highs in some lines, we're seeing increases in lines that have been immune to meaningful changes. And in lines where price increases have eased, we're still getting rate-on-rate increases and improving margins. We estimate that approximately 30% of our insurance premium growth reflects rate increases, about 15% is from higher net retention level, and the remaining growth comes from new business and exposure growth with existing clients. Both our international and U.S. insurance platforms continue to excel in the current market with substantial growth in professional lines, programs, property, and travel and A&H writings. Our reinsurance group also had a quarter of strong growth while producing strong underwriting results. A large portion of this growth results from our ability to leverage our expertise and historical experience as a writer of quarter share business. When markets dislocate, our clients need capacity and capital as they seek to reshape their portfolio. That's why, since 2019, we have been increasing our participation in side-by-side quarter share arrangements. This has always been part of our reinsurance playbook, and based on historical patterns, we believe a good place to deploy our capital for the next few years. As you may have heard, this market is notable as rate increases in traditional XOL reinsurance lag the insurance rate increases. So our current preference is to be closer to the primary rate increases through quarter share with our clients. Property CatXL is one of the few areas where we have reduced premium writings. They are down 26%, as we are not finding enough opportunities that meet our return expectations. However, as you can see in our supplement, premium writings grew substantially in property other than cat and specialty segments. Casualty and marine also produced excellent levels of growth. As with insurance, We expect the ongoing rate improvements to be reflected in our underwriting results over the next several quarters. The Archer Insurance story is one of providing creative capital solutions during hard markets that enables us to leverage our growth faster than in our primary insurance markets. We have considered this a core capability throughout our history. Our reaction to this market is no exception. All in all, It was a very satisfactory job of seizing hard market opportunities by our team. Carpe diem, as they say. From a strategic standpoint, it's worth noting that we, along with our business partners, successfully completed the purchase of Watford at the beginning of the third quarter and are focused on working to build a sustainable reinsurance franchise. Allow me now to switch to inflation fears, which continues to be a hot topic for our industry. I want to reiterate our perspective on how we view inflation at ARCH. As underwriters, we study inflation on a line-by-line basis to price the business and establish reserves. In some lines, like workers' comp, inflation remains low at this stage at, say, 0% to 1%. However, in other lines, like high excess general liability, we're estimating inflation to be in the 8% to 12% range. As a point of comparison, lost cost inflation from the ground up has been in a 3 to 5 percent range for around five years broadly across our portfolio. It's important to consider line-of-business specifics when we discuss claims inflation. Second, it's worth noting that in every line of business, the inflation rate increases as you move up attachment points. The key in pricing or reserving for an access policy is to start with a proper ground-up trend and then apply the best curve to select a range for the trend in the upper layers. As is often the case in insurance, we are estimating and there is a lot of uncertainty around the correct number. Our philosophy is to keep this methodology consistent through the cycle. Third, we also supplement our analysis with some subjectivity. In the current environment and in certain lines, we have to try and account for the increased uncertainty, including the possibility of the so-called social inflation. We are typically more willing to adjust the trend above our indications than we are to reduce it, all with creating a margin of safety in mind. This is not a new concept at Arch, but a time-tested philosophy that has allowed us to navigate both soft and hard markets through our opportunistic cycle management approach. Let's turn now to our mortgage group, which continues to operate as a well-oiled machine, generating $250 million of operating earnings in the quarter. Our insurance and force remain steady at roughly $278 billion for U.S. primary MI. Refinance activity has slowed, and we expect improving persistency throughout the remainder of the year and into 2022. Delinquency rates are decreasing across our portfolio, and we still expect a large portion of delinquencies to cure based on many factors, including the strong equity position of our current inventory, where more than 95% of delinquent policies have over 10% of equity. New notices of default continues to decline and at 7,400 in the second quarter are better than pre-COVID levels. Outside of the U.S., we increased our writings in Australia as the housing market remains strong. We like the long-term opportunity in Australia as demonstrated by our announcement to acquire Westpac's LMI business which we now expect to close later this quarter. Pricing remains competitive but rational across the EMI industry as rates are back to 2019 levels. However, the credit quality of borrowers remains strong, similar to 2016, supporting our confidence in the continued earnings from our mortgage insurance portfolio. As I close my prepared remarks, this quarter I'll borrow from Cricut, which is tough of mind because this weekend marks Cup match here in Bermuda when the entire island goes cricket crazy for a four-day holiday weekend. I think of the current PNC market like being the first team to bat during a cricket test match. Test cricket is one of the few sports that isn't governed by a clock. Unlike games that must be completed in 60 or 90 minutes, test cricket is about scoring as many runs as possible as long as you are getting favorable balls. or pitches for baseball fans, and for as long as it takes for all of your batsmen to be out. The details are not critical, but the idea is that, similar to this market, we're waiting for the right ball and scoring as many runs as possible while we can. Rather than swinging aimlessly, we'll do what we always do, play defensively when we have to, but become aggressive and score as many runs as possible when the opportunity arises. We're not worried about the clock running out. We'll just keep scoring runs. Now I'll ball it over to Francois to run through the financials.

Thank you, Mark, and good morning to all on this first day of the Bermuda Cup Match Classic. Thanks for joining us today. Before I provide more color on our excellent second quarter results, I should remind you that, consistent with prior practice, the following 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. As you know, we closed earlier this month on the transaction we announced late last year to acquire Watford in partnership with Warburg Pincus and Kelso. Concurrent with the closing, we will be making changes going forward in how we report our equity interest in Watford results, which I will share with you in a few minutes. As Mark shared earlier, we had an excellent quarter with each of the three legs of our stool performing very well in our investment portfolio, also producing solid results. After-tax operating income for the quarter was $407.2 million, or $1 per share, resulting in an annualized 13 percent operating return on average common equity. Book value per share increased to $32.02 at June 30th, up 4.8 percent in the quarter. In the insurance segment, net written premium grew 43.3% over the same quarter one year ago, 38.5% if we exclude the growth due to the COVID-related recovery in our travel, accident, and health unit from the same quarter one year ago. The insurance segment's accident quarter combined ratio excluding CATs was 91.4%, lower by 470 basis points from the same period one year ago. The improvement in the XCAT accident quarter loss ratio reflects the benefits of rate increases achieved over the last 12 months and changes in our mix of business. In addition, the expense ratio was lowered by approximately 180 basis points since the same quarter one year ago, primarily due to the growth in the premium base. As for our reinsurance operations, We had strong growth of 63.6% in net written premiums on a year-over-year basis. The growth was observed across most of our lines, but especially in our casualty and other specialty lines, where strong rate increases and growth in new accounts helped increase the top line. The segment's accident quarter combined ratio, excluding CATs, stood at 87.1%, compared to 87.5% on the same basis one year ago. As we have discussed in the past, we believe the underlying performance of our reinsurance segment is better analyzed on a rolling 12-month basis, which typically smooths out the impact of certain large transactions and or claims that can have an impact on quarterly results. On that basis, the XCAT Accident Year Combined Ratio stood at 84.3 percent over the last 12 months, lower by 660 basis points from the prior 12 months, with the improvement almost entirely reflected on the loss side as a result of the rate increases we have observed over the last six plus quarters. Losses from 2021 catastrophic events in the quarter net of reinsurance recoverables and reinstatement premiums stood at 46.5 million or 2.4 combined ratio points compared to 13.5 combined ratio points in the second quarter of 2020. The activity in the quarter was the result of a series of small events across the globe and some late reported claim activity from the North American winter storms, Yuri and Viola in February. Following up on the trends we have seen in the last few quarters, the ultimate impact of COVID-19 on our mortgage segment remains very manageable. In particular, the delinquency rate, which came in at 3.11% at the end of the quarter, is now close to 40% lower than it was when it reached its peak during the pandemic at the end of the second quarter one year ago. We had another solid quarter in terms of production, and with refinance activity coming down from prior levels, we saw the insurance in force for our USMI book remain relatively stable. Of note this quarter was the exercise of call features by the GSEs on certain vintage credit risk transfer contracts, reducing the insurance in force for our non-USMI portfolio. The overall impact of these calls was an approximate one-time $31 million benefit to our underwriting income, approximately two-thirds of which came from the release of prior year loss reserves and the rest from the call premiums received. The combined ratio for this segment was 26.5%, reflecting the lower level of new delinquencies reported during the quarter. Income from operating affiliates was strong at $24.5 million, mostly driven by an excellent first quarter at COFAP. As a reminder, we report our ownership interest in COFAS' results on a quarter lag into our financial statements. As regards to Watford, the closing of the transaction on July 1st gave rise to a reconsideration event, and as a result, we revisited our VIE analysis. Based on the new governing documents of the entity, we have concluded that while we will attain significant influence, we will not control the entity going forward. Accordingly, we will no longer consolidate the results of Watford in our financial results, starting with our third quarter financials, and our 40% share of Watford's results will be reported in the income from operating affiliates line, along with our proportionate share of other operating affiliates, such as COFAS and PREMIA. As a result of the closing of the transaction, we also expect to report a one-time non-recurring gain of approximately $65 million in the third quarter. Total investment return for our investment portfolio was positive 150 basis points on a U.S. dollar basis for the quarter. Net investment income was $89.4 million during the quarter, up $10.7 million on a sequential basis. driven by lower investment expenses and interest received on funds without transactions. The duration of our portfolio remains at one of its lowest levels in our history, 2.31 years at the end of the quarter, reflecting our internal view of the risk and return tradeoffs in the fixed income markets. Equity and net income of investment funds accounted for using the equity method returned approximately $122 million during the quarter, a key contributor to the growth in our book value. The effective tax rate on pre-tax operating income was 7.6 percent in the quarter, reflecting changes in the full-year estimated tax rate, the geographic mix of our pre-tax income, and the benefit from discrete tax items in the quarter. Turning briefly to risk management, our natural cap PML on a net basis decreased to $676 million as of July 1 for the Northeast Peak Zone, down to approximately 5.6% of tangible common equity and well below our internal limits at the single event one and 250-year return level. On the capital front, we issued $500 million of 4.55% perpetual fixed rate preferred shares in June. We expect to use the proceeds to redeem all or a portion of our outstanding Series E non-cumulative preferred shares in September 2021 and to use any remaining amounts for general corporate purposes. Separately, we repurchased approximately 7.8 million shares at an aggregate cost of $306 million in the second quarter, bringing our year-to-date share repurchases to over $485 million. or approximately 45 percent of our year-to-date net income, all while growing our book value and top line. As we have said since our formation 20 years ago, we are strong proponents of active cycle and capital management. We believe this quarter's results demonstrates our ability to execute on this philosophy and leads us to invest in opportunities where we believe the returns are most attractive. At current prices and with the prospect of improving returns, we believe buying back our shares represent another compelling value proposition for our shareholders without compromising our capital flexibility. With these introductory comments, we are now prepared to take your questions.