Arch Capital Group Ltd.

This conference is scheduled to begin shortly. Please continue to stand by. Thank you for your patience. Thank you. Thank you. Thank you. Good day, ladies and gentlemen. And welcome to the third quarter 2021 Arch Capital Group earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct the 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 Grandison and Mr. Francois Morin. Sirs, you may begin.

Thank you, Liz. Good morning and welcome to our third quarter earnings call. We are pleased to have delivered solid results this quarter as our operating units generated a 9.3% annualized operating return on equity in a 12.5% annualized net income ROE despite an active catastrophe quarter. Sorry, guys. Premium ratings and rate growth remain strong in our P&C unit. driving solid fundamental earnings, while our mortgage insurance unit again produced excellent results. The current market conditions allow us to demonstrate the value of our diversified platform and underwriting strength as they provide us with plenty of opportunities to deploy capital and generate an expected return on equity in the mid-teens. In the broader PNC arena, we continue to see the market hardening along with ample evidence that our industry is addressing the adequacy of pricing across most sectors. The trajectory and market acceptance of rate increases reinforce why we remain optimistic that improved economics in the PNC market will be sustainable for some time. As you know, the PNC industry is facing many degrees of uncertainty. Heightened catactivity in four of the last five years, rising inflation, COVID's ongoing influence on a global economy and enduring low interest rates. When faced with escalating risks, underwriters need both rate increases and conservative loss estimates in order to build adequate margins of safety into premium levels. With our agile underwriting, established teams, and strong capital position, we are well equipped to grow into this improving market. Turning now to our operating units. We'll begin with insurance, where our early focus on strengthening our underwriting capabilities and seizing recent market opportunities is working. Gross written premiums continue to grow substantially, up 32% over the same quarter in 2020, and our accident year combined ratio, XCAT, improved to 90.5%. This is another indication of the progress we have made in our specialty insurance business. We have been leaning into this hardening market for two years now, as rate increases remain well above the long-term lost cost trends and have spread to more lines than last year. Overall, 2021 rates are up around 10% compared to 2020, and we expect that the benefit of higher premium levels will be realized well into 2023, enhancing our expected returns for that period. This quarter had many bright spots, including positive rate increases have accelerated in lower limits account. These lines have previously lagged the increases in larger accounts. That is no longer the case. Two, our early focus on Lloyds and business in the UK has improved our scale and our economics in this market. Three, some of our business lines that were most impacted by COVID, like travel, are recapturing some of the lost volume as both business and consumer travel increases. In summary, our specialty insurance group is making the most of the current opportunities. Pivoting now to our reinsurance group. It delivered strong growth in the quarter with gross written premiums up nearly 25% over the same period in 2020. On a net basis, reported growth was only a modest 3% versus the same quarter in 2020 due to a catch-up in sessions to Watford following the purchase of the company with our partners at July 1st. Franco will provide more detail during his comments, but absent this one-off transaction, reinsurance net written premium growth was still very strong at 30%, and our outlook remains favorable as, similar to insurance, we're experiencing broad rate increases in our specialty and casualty reinsurance lines. In the quarter, our reinsurance segment reported a combined ratio of 106%, reflecting the effects of the third quarter caps, primarily IDA, and the central European floods, but reinsurance's accident year combined ratio, XCAT, is excellent at 83.2%. There are signs that property market rates could adjust higher due to CAT fatigue, as you've likely heard on other calls this quarter. The recent five-year period of elevated losses from catastrophes proves an important insurance adage. Losses don't know the level of the premium. There are also early indications that retrocessional and aggregate excess of loss protections are becoming increasingly hard to come by, and we believe that this will be reflected in higher property rates broadly. As you know, we were and remain judicious in the deployment of our CAAT PML, which was effectively flat in the third quarter. At less than 6% of our tangible equity, we remained underweight in net property cut exposure, and we will deploy more capital to the line if expected returns improve above our target. It's too early to make a call on a January 1st renewal process, but pricing in this sector is heavily influenced at the margins, and if ILS or other capacity phase, there is a possibility for significant rate corrections and increased engagement on our part. In the meantime, our reinsurance teams are demonstrating their agility and, like insurance, are leaning hard into the markets where returns are most attractive. Thirdly, our mortgage group continues to deliver exceptional returns. It generated $234 million of underlying profit in the third quarter and continues its impressive rebound from lost concerns associated with the pandemic. On September 30th, Insurance in force of $457 billion for the segment was up modestly. Further good news is that notices of default have declined to pre-pandemic levels at September 30th, which is a good indicator of improved conditions. Additionally, loans in forbearance continue to decline as federal programs conclude, and we remain cautiously optimistic that most of these loans will ultimately cure. Rising home prices have broadly increased homeowner equity, and you'll recall our position that equity levels are the best indication of whether a delinquency will ultimately result in a loss. We estimate that 98 percent of our loans and forbearance today have at least 10 percent equity, providing significant protection against potential losses. Overall, the EMI market remains competitive but rational and our business continues to generate returns on capital in the mid-teens. Mortgage originations continue at a pace similar to last year's record origination volume, and credit quality remains excellent. As you know, in all of our operations, we actively manage capital to enhance shareholder returns. The strong results in our mortgage segment have enabled us to optimize our capital structure via increased reinsurance sessions through our Bellamy Mortgage Insurance linked notes, as well as traditional reinsurance. Additional reinsurance purchases enable us to reallocate capital toward faster-growing areas in specialty, property, and casualty lines, while enhancing our return profile in MI by reducing required capital. MI remains a very attractive business for us. Now, a point of pride and interest to us, and perhaps to you all, is that last Saturday, October 23rd, ARCH celebrated its 20-year anniversary. So I want to say to our investors, thank you for believing in us, and to our employees, past and present, thank you for your contributions to ARCH for the last 20 years and our clients for showing support and conviction in our capacity to provide products to you. Finally, the PGA Tour is in Bermuda this weekend, so golf is top of mind. A golf tournament is interesting in that It takes place over several days and therefore consistency is critical. You have to be sure to pick your spot and lower your score. But if you want to make the cut, you have to limit the bogeys early so that you can play more aggressively in the stretch. And then once you get to the weekend, you can play with a bit more freedom and really try for the birdies and eagles. At this point in the cycle, we feel we've made the cut and now we're focused on really taking advantage of our positioning to make sure we end up at the top of the leaderboard. Francois?

Thank you, Mark, and good morning to you all on this first day of the Butterfield Bermuda Championship here in Bermuda. Thanks for joining us today. Before I provide more color on our solid third quarter results, you will have observed that while our earnings release still makes a distinction between core and consolidated for purposes of comparison to prior periods, there is no difference between the two presentations this quarter. As we discussed on the last call, the closing of the Watford transaction on July 1st gave rise to a reconsideration event, and as a result of our updated VIE analysis, we no longer consolidate the results of Watford in our financial results. Our 40% share of Watford's results is now reported in the income from operating affiliates line, and there is no longer a need to make a distinction between core and consolidated results in our financials. As Mark shared earlier, our after-tax operating income for the quarter was $294.7 million, or 74 cents per share, resulting in an annualized 9.3 percent operating return on average common equity. And book value per share increased to $32.43 at September 30th, up 1.3 percent in the quarter. a very solid result in light of the catastrophe activity that was much higher than the long-term average for this quarter, which we estimate at over $45 billion in insured losses for the P&C industry, approximately three times the average third quarter CAT losses observed over the last 10 years. This quarter, I wanted to first give you some additional detail on the results of our reinsurance operations, which were impacted by the want for an acquisition, especially on the top line. As part of the agreement signed at the beginning of the year with our co-investors in Watford, we committed to ceding varying percentages of the premium written by our Bermuda and U.S. treaty reinsurance operations to Watford, effectively enhancing the existing business model to also serve as a sidecar for ARCH. While the retrocession agreements were effective as of the start of the year, Their signing was contingent on the transaction closing, which delayed their recognition in our income statement until this quarter. As a result, the third quarter seeded written premium reflects a catch-up of approximately $161.2 million from the first half of the year. The impact of the premium catch-up adjustment on underwriting income for the reinsurance segment was minimal. Growth in gross written premium remained strong at 24.6% on a quarter-over-quarter basis, and growth in net written premium would have come in at 29.5%, adjusting for the Watford catch-up. The growth was observed across most of our lines, but especially in our casualty, other specialty, and property other than property catastrophe lines, where strong rate increases in growth and new accounts helped increase the top line. The segment's accident quarter combined ratio excluding CATs stood at 83.2 percent compared to 83.1 percent on the same basis one year ago. On a year-to-date basis, the ex-CAT accident year combined ratio has improved by approximately 250 basis points over the same period last year, reflecting the improving underwriting results in most of the lines in which we write. In the insurance segment, Net written premium grew 40 percent over the same quarter one year ago, and the segment's accident quarter combined ratio excluding CATs was 90.5 percent, lowered by approximately 360 basis points from the same period one year ago. Excellent results across the board, which demonstrate the progress our insurance segment has made over the last three-plus years in improving its performance, and provide us with optimism on the underlying quality of our franchise going forward. Losses from 2021 catastrophic events in the quarter, net of reinsurance recoverables and reinstatement premiums stood at $335.9 million for 17.4 combined ratio points compared to 12.5 combined ratio points in the third quarter of 2020. As noted in our pre-release, our P&C operations were impacted by Hurricane Ida, the European flooding events of July, as well as a series of other events across the globe. Our mortgage segment had an excellent quarter with a combined ratio of 26.2%, reflecting favorable prior development of $48.4 million, about half of which came from USMI, from better-than-expected cure activity in pre-pandemic delinquencies and recoveries on second lien loans. and the other half from our CRT portfolio and international MI. The decrease in net premiums earned on a sequential basis was primarily attributable to lower levels of single premium terminations in the quarter for USMI business and to a lower level of called CRT transaction than what was observed in the second quarter. Recall the second quarter benefited from higher earned premiums due to an unusually high number of CRT transactions being called, which we highlighted as effectively being a non-recurring event. The delinquency rate for our USMI book came in at 2.67% at the end of the quarter, a material reduction from the peak we observed at the end of the second quarter one year ago. We had another solid quarter in terms of production, mostly from the purchase market, and with refinance activity coming down from prior levels, the insurance in force for our USMI book grew slightly. The increase from last quarter in the insurance in force of our international mortgage unit is mostly the result of the acquisition of Westpac Lenders Mortgage Insurance Limited in early August. Although income from operating affiliates grew significantly to $124.1 million, It is worth noting that approximately $95.7 million of the total is attributable to a one-time operating gain resulting from the acquisition of a 40% stake in Watford, which was offset, in part, by a realized loss upon deconsolidation with a resulting net income gain of $62.5 million. The remainder of the operating income from affiliates represents our share of the net income generated this quarter by our operating affiliates, which consists primarily of Watford, COFAS, and Premier. Total investment return for our investment portfolio was de minimis on a U.S. dollar basis for the quarter. Net investment income was $88.2 million during the quarter, down by $1.2 million on a sequential basis this driven by lower coupons on fixed maturities and lower income on consolidated funds. The duration of our portfolio remains low at 2.68 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 produced $105.4 million during the quarter. more than half of the total income generated by our investment portfolio, and a key contributor to the growth in our book value. As we discussed on prior calls, we have increased our allocation to alternative investments in the last few years, and these funds now represent approximately 12 percent of our total portfolio at the end of the quarter. We are also very pleased with their performance so far this year, which stands at 13 percent year to date. Of note, Had we included income from funds using the equity method in our definition of operating income, our reported operating ROE would have increased by 3.2% on a year-to-date basis to 13.3%. While these funds' returns are potentially more volatile than core fixed income strategies, we believe the incremental returns they provide more than compensate for the liquidity constraints and volatility that are usually associated with them. The effective tax rate on pre-tax operating income was a benefit of 0.7 percent in the quarter, reflecting changes in the full-year estimated tax rate, the geographic mix of our pre-tax income, and an 8.2 percent benefit from discrete tax items in the quarter. The discrete tax items in the quarter primarily relate to a partial release in a valuation allowance on certain UK deferred tax assets. Now a quick comment on the two acquisitions we closed on this quarter, Westback and Somerset Bridge. You will have seen that in accordance with purchase gap, we established approximately 337.4 million of intangibles and goodwill this quarter, most of which will be amortized through our income statement going forward. To help with your modeling efforts, we now expect our amortization expense to be approximately 25 million in the fourth quarter of this year, and 21 million quarterly throughout 2022. On the capital front, we redeemed all of our outstanding Series E non-cumulative preferred shares for 450 million on September 30th. Separately, we repurchased approximately 9.7 million common shares at an aggregate cost of 386.9 million in the third quarter. If we include the additional common shares we have purchased in the fourth quarter, The year-to-date totals are now approximately 24 million shares, or 5.9% of the common shares outstanding at the beginning of the year, for $917.7 million. Some of the additional share repurchases in the fourth quarter were effectuated under the new share repurchase authorization of $1.5 billion approved by our Board of Directors earlier this month. As we have said since our formation 20 years ago, our core operating principles are anchored in active cycle and capital management. We believe this quarter 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 recent prices and with the prospect of improving returns, We believe buying back our shares continues to represent another compelling value proposition for our shareholders without compromising our capital flexibility nor lessening the quality and strength of our balance sheet. With these introductory comments, we are now prepared to take your questions.

Thank you. If you have a question at this time, please press the star, then the number one key on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. If you're using a speakerphone, please lift the handset. Our first question comes from Elise Greenspan with Wells Fargo.

Hi, thanks. Good morning. Good morning. My first question, Mark, you know, when you were talking about the mortgage business, you talked about buying more reinsurance. there was more capital for growth on the PNC side, which I found interesting. In the past, you've spoken about mortgage running at around a 15-plus return and PNC at kind of 10 to 12. Has the dynamics changed that that's caused you to kind of buy some more reinsurance to pursue more growth on the property casualty side?

Yeah, I think our opportunities on the PNC side have improved over the last couple of years, and I think we're even more convinced of the length and that has legs for the foreseeable future. So that makes us be more proactive, you know, to balance, if you will, the capital allocation between, you know, more than one unit. I mean, we did rely heavily on a capital deployed in MI for quite a while because the returns in P&C, as you know, at least weren't as attractive. But now that we have a new, attractive, and increase and improve returns in the P&C, it behooves us to balance the risk profile of the portfolio. That's one of the reasons why we would do some more reinsurance. And again, the reinsurance also helps our return on a net basis as well, which is also another benefit.

But are the return numbers I gave still kind of where you see the three businesses, so 15% plus and then 10 to 12? Yes.

I would say on the P&C side, at least, I would say it's getting up. It is north of that now. I think we have our prospects closing. The gap is closing between MI and P&C, if you will.

So north of higher than 12%.

I would agree. I would think it's the case, yes.

And then in terms of capital, you guys put in place a $1.5 billion authorization. It sounds like you bought back a little bit under that so far this quarter. Going through the end of next year, I know obviously what you buy back depends upon the market, also where your shares end up trading over the course of the next year. But when you put that in place, was that designed to set a mark of what you will buy back, or are there just other factors that could cause you to either – fully buy back that level or maybe come in lower? Just help us kind of think through that as we think about capital return through 2022.

Well, I mean, two things. I mean, we bought, you know, we're close to a billion dollars this year. So, you know, we don't want to go back to the board every three months and ask for more. So we thought, okay, what may we need, could we need by the end of 2022 over the next 15 months effectively to You know, $1.5 billion is just a number that, you know, nice round number, nothing special about it. But, you know, are we committed to that number? The answer is absolutely not. You know, if the market keeps improving and we have the ability to deploy our capital, you know, all the capital and then some in the business, we may not end up buying anything back. So it's really, again, a function of the market conditions. And vice versa, right? If the market doesn't, you know, really generate, give us a lot of opportunities to grow, we might be in a position where we buy back more than not. So it's really, again, it'll be a function of what we see in front of us over the next 15 months. And, you know, and if we end up going through the billion and a half sooner than the end of next year, then we'll do something else. So, again, it's very dynamic, very real time, I'd say, and we'll see where things take us.

Okay, thanks for the color.

Thanks. Thank you.

Our next question comes from Jimmy Buller with J.P. Morgan.

Hi, good morning. So first I have a question on just what you're seeing in terms of pricing, both on the insurance and the reinsurance side, and to what extent Do you think price increases are going to hold versus maybe, especially on the reinsurance market, it seems like things have been getting a little bit softer over through the course of the year. But how do recently high catastrophes affect your view of one-to-one renewals?

Right, Jimmy. If we bifurcate the market into property cap, I would tend to agree with you that the property cap rates did not increase as much as we had hoped. Collectively as an industry, I would say not only at ARCH, it's not a single ARCH phenomenon. Therefore, that's why you saw us write less property count over the last nine months, a certain reaction to those rate level. It's still early, like I said in my commentary, but I think we should have a repricing, definitely a repricing in Europe and in the U.S. even for the layers that have been impacted, that's for sure. And I think it would start to spill out even onto those that have not sustained a loss because I think there's a recognition of heightened connectivity And I think that the market is sort of bracing for that as we go forward. It's going to be a matter of degree. On the rest of the marketplace, I think that overall, since if you look at the liability lines in general, overall, you can think of in terms of a quarter share, if you write quarter share of casualty or liability lines, you are benefiting from the rate increases in the business, and I think that ceiling commissions, which were held high through 2020, are starting to come down a little bit. So there's a recognition that, so there's a bit of an improvement from that perspective on a quarter share. On the excess of loss, in general, for liability, the rates are stable to somewhat, more stable, but again, you apply those rates against a base that is increasing in premium levels, so they are also getting some price uplift. And I think that, I mean, the reinsurance market, Jimmy, feeds off of the insurance market, right, in a positive way. I want to make sure it's a positive message. We are on the receiving end of a portion of what the insurance market writes, and to the extent the insurance market writes premium at a higher level, we are benefiting from those rate increases. Okay. Okay.

And then can you quantify how much you've got in terms of COVID reserves, especially for business interruption? And I'm assuming they're mostly still IB&R, as you'd been quantifying last year. And just discuss what the process would be and the timeline would be for releasing these, given that for the most part, it seems like the courts have been siding with the insurance companies, at least thus far, in the U.S.? ?

Yeah, I'd say, I mean, we're still very much, you know, a lot of IB&R in our COVID reserves, more than half, 60% or so, I'd say, of our, call it COVID reserves on the P&C side are still IB&R. So, you know, and how quickly, you know, will we know or not know whether we'll need those reserves? Time will tell. I think it's where we sit, yes, I don't disagree that. So far, there have been a couple of positive developments from the courts, but it's going to take a while. I truly think this is a very complicated issue that will take years to resolve, so I wouldn't expect us to really take dramatic action on the level of COVID reserves on the P&C side for some time.

And, Jimmy, in our industry and insurance, you could win 95 lawsuits and lose 96th. and it changes everything. So there's a lot of uncertainty in our space. Even though we've been a good streak, one change could change everything.

And what is the rough dollar amount of reserves?

That's a good question. I don't have it in front of me. We can circle back with you. I know we booked a few hundred million dollars last year, and we paid some of that. I don't have the current figure, but we can give you that.

We haven't changed the ultimate, Jimmy, for the last three quarters.

But it's not something like it's more maybe 2023, 2024, as opposed to 2022 in terms of potential releases on these.

If there are releases, it will probably take another year, year and a half, and we might hold a little bit more longer for the reasons I just mentioned in terms of the core decisions.

Got it. Thank you.

Our next question comes from Mike Zaremski with Wolf Research.

Hey, great. Good morning. Afternoon. I guess in some of the prepared remarks when you guys were talking about the primary insurance segment, talked about kind of seeing rate acceleration actually in the lower limits, kind of the smaller commercial space. Any theories on why that's happening? Is it due to loss cost trend increasing? Because you're seeing a fading of rate a little bit or deceleration in the large account space. So kind of curious if you guys have any views maybe broadly too on kind of loss cost trend given all the uncertainty during the pandemic on the primary insurance side.

Right, the lost cost trend as we observe it, and it might change, is still roughly in the 3% to 5%. It depends on the lines of business, but we haven't really changed our view on this at this point in time. We had a lost reserve review, I believe, a couple months ago. So it's not changing, although we are putting in our loss ratio pick an extra level of margin of safety to make sure we wouldn't be missing, because it could be higher, as you know. Inflation is certainly another concern that we all have collectively as underwriters. In terms of my theory about why the smaller accounts get those rates right now, the market is a human psychology market, and the pricing gets more acutely needed in the larger capacity play. This is where the market starts focusing its first efforts as the market hardens. This is not unusual. This is a very, very normal phenomenon in hardening markets. You'll tend to try and fix those that are more important, meaning if you put a $10 million, $15 million, $25 million limit, these are the ones you're going to try to fix right away because presumably those will have caused you a bit more pain over the last two, three years. You were expecting more pain coming from that portfolio. And it's just a matter of time before people start looking sideways as to what other lines of business need rate, and then you start dipping down into your overall portfolio and seeing where the liability trends, for instance, might also be impacted. And this is sort of a second round, sort of a rippling effect from the main capacity-providing players into the ones who have lower players. And at the same time, to be fair and to be truthful, you also have development happening on the smaller account at the same time. It's just not as acute and as glaring and as obvious early as the larger capacity play. That's why.

That's interesting and helpful. Maybe switching gears to the mortgage segment, just curious, I know the forbearance levels continue to decrease. If you could remind us, I believe there's some extensions to the forbearance program or maybe even new kind of enhanced programs where the P&I could be reduced, the payment can be reduced by up to 25%. Is that correct? And if so, are you seeing your borrowers utilize those options?

Yeah, so right now the program is done, expires at 9.30, expired at 9.30 in terms of foreclosure, right? So, but the forbearance, I'm sorry. The foreclosure, it's still unclear, right? Because they could also come back and extend it further if things were to change. And the CFPB is also involved with the FHFA saying that we don't want to have any more, you know, there's a moratorium on the foreclosure process as well. So I think both federal entities are trying to push, to go back to your last point of the question, push the mortgage originator and provider of, you know, providing solutions to the borrowers who are still in forbearance or not current on their payment. And to your point, You know, a lot of it is going to be continuing the same payment. Most of it is going to be continuing the same payment as prior to the COVID forbearance program. And it's attaching at the end, towards the end, the lack of what wasn't paid or what was accrued as unpaid at the end of the loan. So this is roughly what it's going to look like. But it's going to be another three quarters before we have more visibility. Because even though the forbearance program stopped in 930, and people should come now to the banks and to the mortgage originator and try to remediate their position from a forbearance perspective, it's still going to take another six to nine months. And I think the agencies are watching carefully. So everything is heading towards a happy resolution, if you will, of the overall forbearance programs. Everybody is focusing on this at this point in time.

Okay, great. And one last one, sticking to mortgage, and I I could take this offline with Don and Vinay too, but just to want to, the increased seeded, premium seeded percentage of gross, is that due to Bellamede? And I guess if it is, can you guys continue to upsize the reinsurance usage in the segment if you thought opportunistically you wanted to shift more growth towards other lines of business.

Yeah, that's very much in that vein. I think Mark made the point earlier. We're always looking to optimize the portfolio and certainly a lot of that is focused on capital deployment. We, I think, made the point last call that we had increased our quota share percentages on the USMI book at 7.1. So that's starting to to play through, basically, and that is reflected. We also, we're still very active in the Bellamed space, so we're purchasing quite a lot there as well, and I'd say those two things combined really explain why we have more seeded premium starting this quarter.

There's more appetite if you decide to do more, either quota or Bellamed or both in the future, or you're kind of reaching kind of a max

I mean, I'd say we certainly do a lot of Bellamy as it is. So I don't want to say we wouldn't do more, but it's, I mean, we already are very active in that space and made big placements. So I wouldn't expect us to necessarily increase that vehicle or that, you know, that mechanism to transfer risk a whole lot. And on the quota share, I mean, we're, you know, yes, can we see more? We could, but then it's a risk return trade-off and, you know, whether the economics are reasonable or work in our favor, too. So right now we're happy where we're at, but if things change and the market gives us better opportunities, we could conceivably see it a bit more. Yes.

Thank you.

Yep. Welcome.

Our next question comes from Josh Shanker with Bank of America.

Yeah, good morning, everyone. This may not be the best math, but it's rough. I think you guys, the inventory of COVID era mortgage claims about 120,000. You've had about 90,000 cures. I'm estimating that you guys have about $20,000 up per notice right now in the portfolio. It may not be exact. Historically, you've had about an average of $5,000 up per notice. It seems like The reserves are stuffed, particularly as you tell us, that 90% of the claims have at least $10,000 in equity. So, I mean, I'm trying to rectify all this. Can you explain to me? I feel like I've asked this question before. I just don't understand what's going on there.

Yeah, I think the answer is going to be very similar. So very good question. Hopefully you're not chased by the police in the back here. If you look at the average case reserve per NOD, it's actually 23,500, I believe, is in the supplement. You can look into it. And you're right, it went up from last year. The run rate pre-COVID was roughly 10,000, 11,000, 12,000. So it did increase. And it was about 110,000 for COVID. claims that we got as well as COVID and the forbearance, and about 78% of them have cured so far, so we're about 20,500. So, be it as it may, we have about 31,770, I think is the number in terms of NODs outstanding. When you multiply by 23, you're right, it would look on the high side. A couple things I will say here. Number one is the average severity of the policies that are facing the COVID-19 you know, starting from 18-19, which have a higher phase than the one we had as NODs back in 2019, right? Those in 2019 were largely pre-2008. So you have to adjust for the level of coverage that has increased over the last 10-12 years. So that explains, one, why the 23 would be higher than the 11-13 historically. The second part of your question, which, well, where should it go? And this is where It's more art than science. Josh, we hear you. We're cautiously optimistic that it may not come to pass in terms of meeting the reserves, and hopefully some of it will cure better than we anticipated. But I just want to remind everyone on the call, as we remind ourselves all the time, it's that This is a political positioning, right? Things could change very quickly from the FHFA, the GSEs, or the housing department. So we need to be really careful, and we've never been through that kind of event. So we are arched, as you know, and we will take a cautious, prudent approach to reserving. And if we happen not to need those reserves, as we do typically, we'll be taking them by the hand from the liability side down to the capital side. We're not going to let them strand it But, again, so much, so many uncertainties, Josh. We understand you're puzzling. This is a very unusual situation for the industry. Therefore, we have to, and that's why we appear probably to be a little bit unusual in the way we're reserving it.

And my second question, unrelated, can you talk about the differential, I guess, the new business penalty between new business you're putting on the book and legacy customers who you have a deep sense of their potential? of the risk factors on those accounts. Is there a gap? Is the business that you're renewing at better margins, at least the way you're booking it, to new business, given that you know more about the business you already have? I believe, Josh, you're talking about P&C, right? Yeah, this is totally primary P&C, not more. Right, that makes sense to me.

So it's a really very astute question, Josh, because we're keeping track of the renewal rate versus the new business rate level. And symptomatic or, you know, as a representation of the hardening market, the pricing of the new business is coming higher than the renewal business. And that sort of speaks to the fact that, you know, they need a new home and they need to be repriced and people sort of get, you know, get tired of that relationship and it goes back, thrown back into either the ENF or the emitted market. So, right now we're still seeing, on average, the new business price better than renewal business. Okay. Good to know. Thank you. Thank you, Josh.

Our next question comes from Tracy Benyiki with Barclays.

Thank you. Just a big picture question. I've seen this quarter with you and your closer peer group is that the insurance growth is outpacing the more primary market-focused players without reinsurance arms. Are you seeing a lot of market dislocation where you feel like you just do a better job assuming displaced risks that still meet your risk-adjusted return hurdles?

We'd like to think we're better than the average guy out there, but Tracy, I think overall the dislocation was much larger in 2020. I think you are still seeing some dislocation right now. It's certainly not There's still some repositioning of limit provided to the market by a lot of players still as we speak. And I think what explains our ability to grow is, first, we have a really well-established presence, and we were really on the wait, Tracy, historically. We're a really, really good market for people that want a good security for products such as D&O, for instance. We're a really good home. for someone to take on new as an insurer. And we're definitely benefiting from that as an incumbent with a good quality, good reputation as we do. And also, I think the other thing that I want to mention, we had said that last year we were suffering a little bit from some of the travel and lack of traveling that impacted our travel portfolio. So that certainly helps, right, Tracy, the fact that the economy is reopening and people are traveling a bit more. That also helps explain why we're able to grow a bit more than probably meets the average, than the average would. Lastly, I would say that beyond just new business, finding new homes, I think there are programs. We're also growing in programs. As you see, this is very specialty, smaller risk. I think that, again, another example of programs, finding a new home, going away from the existing incumbent possibly because of bad results and funding in your home, and we definitely are the receiving end of that relationship.

Yeah, and one thing I'll add quickly, I think both, you know, depending on the mix of business of what you call the more established and the traditional insurers, I mean, workers' comp and commercial auto typically will make up bigger shares of their portfolio. Auto is moving up nicely, but I would say that certainly comp had a really good period of excellent results. So rate increases on the comp side have been pretty flattish. So, again, probably worth adjusting for comp because it's such a big line for some of these carriers.

And I'm wondering how much of that is structural in nature. Like are others raising attachment points and you're lowering attachment points or offering lower deductibles?

No, we don't do that. No, we don't play that game. I think we would just be replacing most of our play, typically on specialty lines, Tracy, is mid-access, first or second access. This is sort of what we play a lot of times, and high access, of course, in certain areas. So, for the record, Tracy, we're not seeing any of the deductible being played out in the marketplace. In fact, there are deductible increases, if anything else. We just see a lot of shortening of limit in the stacking. We saw that in 2020. It's ongoing as we speak. Instead of having a stretch of 25, I'm talking about the larger placements, you'll have, you know, stretches of 10 or 5 or, you know, 5 or 10 really and 15 perhaps still staying. But there's a lot more players needed to fill up the towers. That's definitely happening more so and still continuing to some extent, less so than 2020.

Okay. And then just shifting to reinsurance, where are you seeing your favorable reserve development coming from?

Yeah. I mean, the vast majority, and we'll, we'll talk to it in the queue at vast majority is in short tail lines. I mean, I'd say probably 80% is in short tail lines. Um, mostly property, uh, other than cat, uh, where, you know, we've grown a lot in the last couple of years and, you know, uh, While the tail is always a bit longer than we think it should be, we have a pretty good idea two, three years out after writing the policy or the account, and we're seeing a lot of that coming through in this quarter. A bit of favorable development on prior year accounts as well, and a bit on trade credit and surety from a few years ago where we had some reserves that, you know, proved out to be a bit, you know, weren't required. So we released those this quarter.

Thank you.

Sure. You're welcome.

Our next question comes from Meyer Shields with KPW.

Thanks. This is a cycle management question, I guess, for Mark. When, if ever, do we decide that there's never going to be an appropriate hard market and property can't just get out of the line?

I think that by virtue of, well, first, I'm an optimist, right? I've always been an optimist. I've heard so many times over the last 27 years from some of our own underwriters that there will never be a hard market again. And when I hear this, it's music to my ears because that means we're cruising for bruising. So I think that things will get better and get at some point. It may not be this quarter, Meyer, but at some point, you know, numbers speak for themselves. If you lose money every year, people just get disenchanted and just walk away from it. It happened after the 90 storms in Europe, 92 Andrews, earthquake in California in 94, you know, terrorist attack, you know, Katrina, Richard Wilma. I mean, there's always changes. And it's not, I rattled like five or six of them. And you got to believe that the world is a dangerous place, Meyer. So I think something will happen. And again, losses don't necessarily change the market pricing, but perception of risk will and would. So maybe we're in this place where people say, you know what, why bother? And if that's the case, then the demand for CAT, as you know, protection, is inelastic. So if supply shrinks, then demand will stay as is and pricing will therefore increase. So I'm an optimist. I'm not sure when it's going to happen, but I believe it will happen at some point. Okay, no, I just thought that's exactly what I was looking for.

Thank you. Sure.

Our next question comes from Brian Meredith with UBS.

Yeah, thanks. A couple of quick questions here for you. First, Mark, I just want to follow up on the comment about new business pricing better than renewal pricing. And I've heard that from other carriers. But I'm just curious, when you actually go to book the margin on that new piece of business, are you booking a better margin than perhaps that renewal piece of business? Or do you have to build in some level of cushion because it is new?

Well, it's a very good point. I think the latter part is what we would do, but we would also take a higher level of cushion or margin of safety, if you will, in our reserving, even in our renewal business. I think that we're, as you know, reserving-wise and loss ratio pick-wise at Arch, we tend to be more conservative and hope for the best, and hopefully good news comes down later. We're trying to figure out a way to have as much cushion as we can early on so that we're not surprised down the road, and that's not changing anymore. I would say it's the same approach, renewal or new business, Brian. It's not much of a change.

Not much of a change. Gotcha. Okay. Second, just a quick question here. Are we still seeing admitted markets shed business to the E&S markets, or is that slowed?

It's slowed down a little bit, but it's still happening. We're not seeing a return back to the admitted market quite yet. It's going to take a little bit longer, we think.

Gotcha. Gotcha. And then one kind of bigger, I guess, philosophical question for you. I think with the MI business, clearly you've demonstrated that it is not as big of a volatility business as maybe some had perceived, just given the results we've seen through this recent crisis. If that is indeed the case, and the amount of cash that business throws off because it's not a growth business, I guess I see you guys using share buyback as your means of capital management, and I completely get that where your stock is trading now. But what about a dividend? And maybe remind us about your philosophy with respect to a dividend.

Well, I mean, I'll take that, Brian. I think it's something we talk about with the board and between ourselves all the time. We had a pretty long discussion at our last board meeting on that. It's always on the table. I'd say right now, I mean, the share buybacks that we went through this quarter were you know, very attractive to us. The economics were very much, I think, you know, they're easy to justify. But, you know, could we ever introduce a dividend? Certainly that's on the table. I'm not saying it's imminent, but it's something that we evaluate pretty much, you know, definitely regularity, and we'll keep looking at it.

Great. Thank you.

Thanks, Mike. You're welcome.

Our next question comes from Elise Greenspan with Wells Fargo.

Hi, thanks. Just one additional question. Do you guys spend time highlighting that session to Watford in the quarter, given that that transaction closed? So my sense is they're going to become more arch-like in terms of the business that you're ceding to them versus prior to this transaction. So as you think about your 40% date, can you just help us think about the earning stream there? Because I would think that as we go through next year that that could become a meaningful contributor to your earnings as the underwriting income of Watford could pick up from what we're used to?

Yeah, I think the 40% share would grow at an average sort of re-interest market results, right, because we are writing business on the balance sheet of Watford, so you would expect that. I think that what you would also see is our collecting fees for our efforts, compensation for our efforts for Watford's, that would be for the 100%. So I think that the overall return would be slightly better, even though, at least as you can appreciate with the accounting rules, it might not show as such. But I think that our results will be As good, I would hope, or if not better than our overall results. So it's definitely an accretive return generator for our reinsurance platform. This is going to be hard to speak.

But that should pick up within that other income line as we move through next year?

Yeah, so a couple – yeah, the 40% correct. The other income line is – well, the fees are picked up by the reinsurance segment because it's for the underwriting services they provide to Watford. But you're correct in saying that the net equity pickup of the 40% that we own in Watford, if you're modeling what kind of combined ratio is it going to operate at, what kind of premium are you going to see in terms of the volume? You're right. I mean, it's probably more and more over time is going to look more and more like archery, the reinsurance segment. The percentages we see to Watford are not uniform across all our divisions, but directionally, I think that's a good way to think about it. And the other thing, too, which has somewhat been an issue with Watford is the performance of the investments, right? And that's being addressed as we speak. I think there's a process underway to reduce the volatility from the investment portfolio or the investment strategy at Watford. So think of it more as a more less volatile stream of income with more reliance on underwriting income and less so on investment income. And, you know, hopefully that gets you in a good place to start modeling out how Wofford's going to play out for us, or the 40% for ARCH going forward.

And then maybe I'll squeeze one last in. I'm not sure if you provided an updated tax guidance, and so I missed it. If you could just let us know that. And then we've heard about some potential tax changes whether in the U.S. and also abroad in relation to Bermuda. Do you guys have just any kind of prospective tax thoughts on just some of, you know, what we're hearing in the market and how that could impact ARCH?

Yeah, I'd say, first of all, that question, you know, fourth quarter, we're still in the 9% to 11% kind of tax rate for, you know, for ARCH in the fourth quarter. For 2022 and beyond, and Mark will chime in, it's way too early. Unfortunately, we track it. We look at all developments very carefully. We're on top of things. And the reality is they change daily. So it's very hard for us at this point to give you any kind of guidance or any expectations of what we think 2022 is going to look like. We'll be more than happy to have, you know, good discussion on the next call. But for now, it's We feel it's just premature to, because we really don't know.

And at least just to make the point about daily, literally last night, you know, our tax director this morning just sent us, like, there's a new proposal on the Hill that brings back SHIELD and then corrects other things and then dispenses of other areas of the tax proposal from the OECD. So, again, a moving target. It's politics. We'll react to it when we do, when we see it.

Okay. Thanks for the color.

Thanks, Lee. You're welcome.

Our next question comes from Matt Carletti with JMP.

Thanks. Good morning. I just want to circle back on the discussion about pandemic reserves and Mark, you're pretty clear on the PNC side in terms of, you know, you get 95 good outcomes, but the 96 can change everything. How about MI? I mean, you know, kind of follow up to Josh's line of questioning, like things look pretty conservative there. Can you help us with, a little bit of a timeline by which if things can kind of continue to unfold well, the timing by which we might see things unwind?

Well, let me start. I'd say, you know, we may see a little in the fourth quarter, but that will be, I don't think everything will be resolved. I truly think that the first half of 22 is when you'll see most of the of the movement or the corrections and our assumptions and the, you know, cure rates and mediation. So I'd say we're going to start seeing some data, you know, as early as this month internally and the number of cures and people moving out of forbearance. But, you know, the way it's going to flow through our numbers, again, given some of the uncertainties that Mark talked about, I think we'll be first half of 22. And the reason also, Matt, it has to be said and understood is that

they had 18 months of forbearance worth when you get into forbearance earlier in 2020. And some of them went into forbearance, came out of forbearance, and went back in again. But they still get to benefit from 18 months worth of forbearance. That's why some of them, coming out of their 18 months, you know, in the fourth quarter, and many of them in the first and second quarter next. So it seems like some of them were able to get back current for four or five months and went back to the forbearance program. That's why we have this lengthy adjustment period.

All right. Thank you. That's very helpful. Thanks.

Thank you, Matt. Thank you.

I'm not showing any further questions. I would now like to turn the conference over to Mr. Mark Grandison for closing remarks.

Thank you so much for being here. We're going to be watching some golf, Francois and I, and happy 20th, and have a good weekend, everyone. Thank you.

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