Arch Capital Group Ltd.

Good day, ladies and gentlemen, and welcome to Arch Capital Group's fourth quarter 2021 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 this 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 risk and other factors that may affect future performance, investors should review periodic reports that are filed by the company with the FCC from time to time. Additionally, certain statements contained in the call that are not based on historical fact are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The company intends the four 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 by the FCC 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, Lateef. Good morning, and welcome to our fourth quarter earnings call. We ended a good year with a great quarter. On the year, ARCH generated a return on net income of 16.7%, and importantly, Book value per common share grew by 10.7%, with net earnings per share of $5.23. We accomplished these results despite elevated CAT activity and the short-term effect that substantial share repurchases had on our book value per share. Our ability to effectively allocate capital also contributed to our 2021 results, whether opportunistically investing more resources into the most profitable pockets of our business, or buying back $1.2 billion worth of our common shares, fully 7.7% of the shares outstanding at the start of the year, we remain committed to a capital management strategy that creates value for shareholders. I'd like to begin by sharing some highlights from our operating units. In our P&C insurance segment, Net written premium grew 24 percent and earned premium grew 34 percent over the fourth quarter of 2020 as we earned in the rate increases of the past several quarters. Growth occurred across many lines with professional lines and travel exhibiting the strongest advances. Overall submission activity and rate momentum remained healthy, and rate increases were above lost trend. A change in business mix led to a slightly higher acquisition expense in the quarter. However, we believe that this increase belies the underlying return potential of the segment. More accurately, it is a reflection of the insurance group's outstanding job of positioning itself to act on the better opportunities available in today's market. Turning now to reinsurance. Our shareholders continue to benefit from the extraordinary talents of this group, which grew gross written premium by 88% and net written premium by nearly 45% from a year ago. On whole, the reinsurance group grew in nearly every line, a reflection of our diversified specialty mix of business and our larger participation in quarter share reinsurance, which allows us to participate in the improved premium rates of cedents more directly. Briefly on renewals at January 1st. While property CAT rates were up broadly, the increases were not enough for us to deploy more capital into our peak zones. However, we found many opportunities to grow in the other 93 percent of our reinsurance business that is specialty in nature, including property ex-CAT. Finally, on to the mortgage segment. which again delivered excellent underwriting results, even as written premiums declined in the quarter. Seasonally, the fourth quarter, as you know, is slower for mortgage originations and rising interest rates further depressed refinance activity, reducing new insurance written. However, our insurance and force, the ultimate driver of earnings, still grew modestly in the quarter, mainly due to that lower refinancing activity. Credit conditions remain excellent in the U.S., with a strong housing market and demand for housing continuing to exceed supply. As most of you already know, home price appreciation remains robust across most of the country. This is a net positive for mortgage insurers, as increasing borrower equity ultimately leads to a lower risk of default. Competition in this sector remains robust but stable, and we believe that the better credit quality of our recent originations compensates for marginally lower premium yields. We continue to focus on the more stable returns available in higher credit quality business instead of broadly chasing top-line growth, a luxury afforded to us by our diversified model. Turning to the fourth leg of our stool, Investment income contributions were upped materially for the year, primarily due to alternative investments accounted under the equity method. These investments are primarily fixed income in nature, but because of the structure of our investments, their contributions are excluded from net investment income and our definition of operating income. Notwithstanding, these investments contributed $366 million, or 92 cents per share, for the full year. Over the past five years, below the line investment returns have added between 75 to 125 bps to our net ROE. Taking a step back to get more of a big picture view, we like the way our businesses are currently positioned. Within our P&C segments, we believe that P&C pricing and returns have more room to grow in this part of the cycle, and in the mortgage segment, insurance in force is benefiting from both solid credit conditions and good house price appreciation. Underwriting income for our P&C insurance and reinsurance segments expanded significantly in the fourth quarter. It's worth noting that if we were to include components of investment income that relate to the flow generation from underwriting, P&C and MI's contribution to ARCH's earnings were roughly in balance. We believe that this balance improves the risk-adjusted returns for our shareholders. Our corporate culture of being patient in soft markets while maintaining an agile mindset is a key to our success and allows us to seize opportunity when the odds for success are more in our favor. Because different sectors have their own cycles, our disciplined, defensive underwriting during the softer parts of the cycles is what has enabled us to grow faster than many of our peers in a current environment. we have begun to reap the benefits of the strong defensive posture we maintained from 2016 through 2019. The Winter Olympics are on the way, and I found an analogy to our business in a somewhat unexpected place, the most exquisite and exciting game of curling. You may or may not be aware that curling has been dubbed chess on ice and, like insurance, is much more strategic than the uninformed may realize. Curling is played over 10 long ends or rounds. A defensive strategy is most common, patiently waiting for an opening to pivot to offense. Unfortunately, defending is not exciting. It's about minimizing your opponent's scoring opportunities and avoiding mistakes. But like insurance, patience is often handsomely rewarded because when her opponent makes an error, The skip knows that now is the time to pounce. And all of a sudden, patience is out the door and action is in. Most games are won in that one crucial reversal of fortune. That's how we play the insurance cycle. One year at a time, patiently waiting for the market to give us that opening. And once we see it, we're all in. Just like the last two and a half years and counting. Don't ever let anyone tell you that curling or insurance are not exciting. For 20 years, we've been committed to taking the long-term view of the insurance cycle, being thoughtful and balanced with our capital management strategy, and differentiating ourselves by being committed to a specialty model, all with the aim of enhancing shareholder value over the long term. Although every year is different and markets aren't always predictable, we've demonstrated that we can succeed in any market. So we're looking forward to what 2022 has in store for us. Francois?

Thank you, Mark, and good morning to all. Thanks for joining us today. As Mark shared earlier, our after-tax operating income for the quarter was $493.3 million, or $1.27 per share, resulting in an annualized 15.6% operating return on average common equity. Book value per share increased to $33.56 at December 31st, up 3.5% in the quarter. For the year, our operating return on equity stood at 11.5%, while our net return on equity was 16.7%. Excellent results indeed. In the insurance segment, net written premium grew 23.7% over the same quarter one year ago, and the accident quarter combined ratio excluding CATs was 91.2 percent, lower by approximately 240 basis points from the same period one year ago. The growth was particularly strong in North America, where a combination of new business opportunities and rate increases supported this profitable growth. One item to note this quarter for the insurance segment relates to the acquisition expense ratio. which was higher than in both the prior quarter and the same quarter one year ago. As we mentioned in the earnings release, some of this increase is related to premium growth in lines of business with higher acquisition costs, such as travel, but it also reflects increased contingent commission accruals on profitable business, as well as lower seeded premiums in lines with higher seeding commission offsets. As we have said before, our focus remains on the returns we are able to generate from all our businesses, and we remain positive on the current pricing environment and the opportunities that should be available to us in 2022. For the reinsurance segment, growth in net written premium remains strong at 44.5 percent on a quarter-over-quarter basis. The growth was driven by increases in our casualty, property other than property catastrophe, and other specialty lines where new business opportunities, strong rate increases, and growth in new accounts helped increase the top line. For the full 2021 year, the XCAT accident year combined ratio was 84.4%, improving by approximately 160 basis points over the 2020 year, a reflection of the underwriting conditions we have seen in most of the lines we write. Losses from 2021 catastrophic events in the quarter, net of reinsurance recoverables and reinstatement premiums stood at 72.3 million, or 3.5 combined ratio points, compared to 9.4 combined ratio points in the fourth quarter of 2020. The losses came from a combination of fourth quarter events, including the December U.S. tornadoes and other minor global events, as well as some development on events that occurred earlier in the year. Our estimate of our ultimate exposure to COVID-related claims decreased by approximately 3 million during the quarter. We currently hold approximately 195 million in reserves for this exposure, two-thirds of which are recorded either as ACRs or IBNR. Our mortgage segment had an excellent quarter with combined ratio of 11.7%, due in part to favorable prior year development of $72.9 million. The decrease in net premiums earned on a sequential basis was attributable to a combination of higher levels of premiums seeded, a lower level of earnings from single premium policy terminations, and lower U.S. primary mortgage insurance monthly premiums due to lower premium yields from recent originations, which were of excellent credit quality. While approximately two-thirds of the favorable claim development came from USMI, related to better than expected cure activity and recoveries on second lien loans, we also saw favorable prior development across our other mortgage units, including our CRT portfolio and our international MI operations. Consistent with historical practice, we maintain a prudent approach in setting loss reserves, especially in light of the uncertainty we are facing with borrowers exiting forbearance programs and moratoriums on foreclosures. The delinquency rate for our USMI book came in at 2.36 percent at the end of the quarter, more than 50 percent lower than the peak we observed at the end of the second quarter of 2020. Production levels were down from last quarter, certainly a typical outcome given the seasonality in new purchases, and also partially as a result of the lower level of refinance activity due to higher interest rates. Offsetting lower origination activity in the quarter is the improving persistency rate, now at 62.4 percent. We expect persistency to keep improving throughout 2022. on the heels of lower refinance activity. This bodes well for our insurance-enforced portfolio and, accordingly, the returns we can generate on our mortgage business. Income from operating affiliates stood at $40.6 million, again, an excellent result, primarily as a result of contributions from COFAS and Summers Re. We are pleased with the returns these investments have generated for us so far. Total investment return for our investment portfolio was 39 basis points on a U.S. dollar basis for the quarter, and net investment income was 90.5 million this quarter, up slightly, in part due to slightly higher dividends on equity investments. The duration of our portfolio remains low at 2.7 years at the end of the quarter, basically unchanged from last quarter, and reflecting our internal view of the risk and return tradeoffs in the fixed income markets. Alternative investments representing just under 15 percent of our total portfolio performed well this year, returning 12.6 percent. The portfolio we have constructed has a slightly heavier bent towards debt strategies and should produce, we believe, returns that are relatively less volatile over time, given the level of diversification across sectors and geographies. Amortization of intangibles was $33.1 million, up sequentially as a result of the acquisition of Westpac LMI and Somerset Bridge Group Limited, which were completed in the third quarter. For your modeling purposes, we are currently forecasting an amortization expense of $110 million for the full 2022 year, which is expected to be recognized evenly throughout the year. The effective tax rate on pre-tax operating income was 4.7% in the quarter, reflecting the geographic mix of our pre-tax income and a 2% benefit from discrete tax items in the quarter. The discrete tax items in the quarter primarily relate to a partial release in evaluation allowance on certain international deferred tax assets. For 2022, we would expect our tax rate on pre-tax operating income to be in the 8% to 10% range based on current tax laws. Turning briefly to risk management, our natural cap PML on a net basis stood at $748 million as of January 1, or 5.9% of tangible common equity, which remains well below our internal limits at the single event 1 in 250-year return level. Our peak zone PML is currently in the northeast U.S. On the capital front, we repurchased approximately 8.7 million common shares at an aggregate cost of $362.1 million in the fourth quarter. And as Mark mentioned, we repurchased almost 31.5 million shares at an average price of $39.20 in 2021. Our remaining share repurchase authorization currently stands at $1.18 billion. Finally, I wanted to take a quick moment to thank our over 5,000 colleagues around the globe in what has certainly been a challenging period. Without their ongoing commitment to ARCH and its constituents, we certainly wouldn't have been able to generate and report record earnings today as we close the books on our 20th year. Your efforts and dedication are truly appreciated. With these introductory comments, we are now prepared to take your questions.