Arch Capital Group Ltd.

Good day, ladies and gentlemen, and welcome to the first quarter 2022 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 Grandison and Mr. Francois Morin. Sirs, you may begin.

Thank you very much. Good morning and welcome to ARCH's earnings call for the first quarter of 2022. ARCH delivered a strong first quarter. as our dynamic capital allocation and cycle management strategy, combined with strong underwriting skills, delivered a 13.6 annualized operating ROE. This past quarter provided yet another reminder that we live in a world of uncertainty. The war in Ukraine has affected countless lives and initiated a humanitarian crisis that is still unfolding, and the pandemic continues now into year three. In addition to the war in Ukraine, global inflation and supply chain issues pushed interest rates up, which in turn led to investment markdowns in the quarter. In spite of these headwinds for our industry, we demonstrated the effectiveness of our diversified platform as one, we grew premium above market average again, two, we purchased 5.6 million shares, and three, generated a strong operating ROE. Our objective remains, as always, to deliver long-term value for our shareholders using all the levers available to us. The underlying fundamentals of our businesses continue to improve as we benefit from better market conditions in the P&C industry and execute our cycle management strategy where we actively allocate capital to the most attractive sectors of our business. Our P&C operations generated $2.3 billion of net written premium in the quarter, which represents an increase of 18% from the same quarter in 2021 and speaks to our confidence in the improving underwriting conditions in our P&C operations. Mortgage insurance contributed substantial underwriting profit in the quarter and insurance-enforced grew modestly again, highlighting that mortgage remains a positive differentiator of our business model. Now, inflation is top of mind for everyone in the PNC industry, which, to its credit, has historically been adept at adequately responding to inflation trends. Inflation is not a new phenomenon, and in fact, it permeates discussions in evaluating claims all the time, in an insurance company. As such, our focus is always on proactively incorporating new data into our reserving and pricing. We believe that this focus, in addition to increased future investment returns and reserving prudently, will help mitigate inflation's impact. As far as our mortgage business is concerned, inflation mainly has a positive effect as it increases homeowner equity, which again, mitigates potential losses. I'll now share a few highlights from our segment. Across most lines, our P&C units remain in a growth phase of the underwriting cycle, according to Paul Ingrid's insurance clock. In a quarter, our P&C net premium earned grew by 25% over the first quarter of 2021, as we continue to earn in the rate increases of the past 24 months. our data indicates that we are still experiencing average rate increases in excess of expected loss cost. In specialty insurance, underwriting conditions remain very good, as pricing discipline, terms and conditions, and limit management are stable across most markets. This stability, combined with the uncertainties I mentioned at the beginning of this call, should help keep the market disciplined and sustain rate increase. Our specialty business in Lloyds and our UK regional business delivered strong growth in the quarter, as our European insurance operations now represent 30% of ARCH Insurance's total net written premium, up from 20% pre-pandemic. We are pleased to see the positive results of the investments we made into this platform prior to 2020. We also created meaningful growth across our U.S. operations in the quarter. primarily in professional liability, including cyber, as well as travel, where we believe relative returns are attractive. On the reinsurance side of our business, the emphasis remains on quarter share treaties over excess of loss reinsurance. This allows ARCH to participate in the rate increases on primary insurance while improving the balance between the risk and the return. Overall, in our reinsurance group, growth opportunities remain strong. Since it's been a talking point on prior calls, it's worth noting that although property cap rates have improved in response to elevated loss activity in the past few years, we have remained disciplined and have not allocated material additional capital to this line as we maintain our view that other lines of business have better risk-adjusted returns. Turning now to the mortgage segment, which once again delivered excellent underwriting results, as we continue to benefit from strong housing demand and excellent credit conditions. Delinquency rates on our MI portfolio continue to trend to historically low levels, and cures on delinquent mortgages in our portfolio resulted in favorable prior development in the quarter. The increase in mortgage interest rates, currently at 5% for 30-year fixed-rate mortgages, is a steeper rise than we have seen in decades. These higher rates have dramatically curtailed refinancing. However, our MI business is far more geared to the purchase market, which continues to benefit from strong demand and limited housing supply. Of note, the decline in refinancing activity improves persistency, which in turn should improve returns on our in-force portfolio. While the rise in mortgage rates may ultimately cool demand and slow the rapid home price appreciation of the last year. So far, we have yet to see demand weaken, and we expect home prices to continue to rise, albeit at a slower pace. Again, as mentioned earlier, rising home prices increase equity for homeowners, which ultimately reduces the risk of claim in mortgage insurance. So, our perspective is that this expected future equity buildup and the strong credit profiles of borrowers should strengthen the resilience of our enforced mortgage portfolio. Moving forward, our diversified platform and cycle management philosophy will enable our MI team to continue to make measured, responsible decisions with our capital. Our MI group has the flexibility to grow or moderate the business they choose to write based on their view of market conditions. A few brief notes on investments. Where net investment income was done from last quarter as we reduced risk positions, primarily equities, given increasing market volatility. Rising interest rates also cause mark-to-market losses in a quarter. However, the relatively short duration of our investment portfolio as well as our healthy cash flow will naturally allow us to reinvest at higher interest rates, which should be reflected in future quarters. In closing, even with current uncertainties, opportunities exist. In a quarter, ARCH was able to deliver strong results with with positive growth across its businesses, and we're well positioned to sustain our growth trajectory in this favorable P&C market. We've consistently demonstrated our ability to allocate capital effectively to the areas of our business with the most attractive returns. As you know, with Arch, we are constantly looking for and seizing the opportunities that offer the best returns for our shareholders. Francois?

Thank you, Mark, and good morning to all. Thanks for joining us today. As Mark shared earlier, our P&C units remained on their path of underlying margin improvement, while the mortgage group delivered another quarter of strong underlying performance, which was supplemented by solid cure activity in their insured loan portfolio. Overall, our results translated into an after-tax operating income of $1.10 per share for the quarter, and an annualized operating return on average common equity of 13.6%. In the insurance segment, net written premium grew 21.3% over the same quarter one year ago. Growth was particularly strong within our professional liability and travel business units and was achieved both in North America and internationally. Underwriting performance was excellent. with an accident quarter combined ratio excluding cats of 90.8 percent, a 250 basis point improvement over the same quarter one year ago. Similar to last quarter, a change in our business mix as a result of more pronounced growth in lines of business with lower loss ratios helps explain some of the 470 basis point improvement we observed in our underlying loss ratio. This benefit was slightly offset by a higher acquisition expense ratio. Increased contingent commission accruals on profitable business and lower levels of seated business for lines with higher seating commission offsets also slightly increased the expense ratio. As we have said before, our focus remains on improving our expected returns through a variety of levers, and we are encouraged to see that our efforts are paying off for our shareholders. In the reinsurance segment, it's worth mentioning that reinsurance agreements that were put in place at the time of the closing of the summer's acquisition in the third quarter of last year make comparisons from the current to prior periods imperfect. For example, while our reported growth in net written premium remained solid at 14 percent on a quarter-over-quarter basis, it would have been 26.6 percent after adjusting for the summer's session. The growth came primarily in our casualty and other specialty lines where rate increases, new business opportunities, and growth in existing accounts helped increase the top line. The segment produced an ex-cat accident year combined ratio of 82.7%, an excellent result as we continue to enjoy healthy underwriting conditions in most of the lines we write. Losses from first quarter catastrophic events Net of reinsurance recoverables and reinstatement premiums stood at 85.8 million, or 4.0 combined ratio points, compared to 10.5 combined ratio points in the first quarter of 2021. Approximately two-thirds of the estimated losses came from the Russia invasion of Ukraine, with the rest coming from other global natural catastrophe events, including the Australian floods. Our mortgage segment had an excellent quarter with a combined ratio of 3.1 percent, due in large part to favorable prior year development of 105.6 million. In line with last quarter's results, net premiums earned decreased on a sequential basis due to a combination of higher levels of seeded premiums, a lower level of earnings from single premium policy terminations, and reduced U.S. primary mortgage insurance monthly premiums, primarily from recent originations, which remain of excellent credit quality. Production levels were down slightly from last quarter, but certainly in line with seasonal trends in new purchases and diminishing refinancing opportunities for borrowers. As we have discussed on prior calls, one of the benefits of higher interest rates is an improving persistency rate, which now stands at 66.9 percent, and should continue to increase throughout 2022. Ultimately, higher persistency benefits are insurance in force and should result in a stable base of premium income to help drive underwriting income for the rest of the year and beyond. With respect to claim activity, approximately three quarters of the favorable claim development came from our first lien insured portfolio at USMI as we benefited from better than expected cure activity mostly related to the 2020 accident year. The remainder of the favorable development came from recoveries on second lien loans and better than expected claim development in our CRT portfolio and our international MI operations. We maintain a prudent approach in setting loss reserves in light of the uncertainty we are facing with borrowers exiting forbearance programs and moratoriums on foreclosures. Income from operating affiliates stood at $24.5 million and was generated from good results across our various investments, including COFAS, Summers REIT, and PREMIA. Total investment return for our investment portfolio was a negative 3.07 percent on a U.S. dollar basis for the quarter, which explains the decrease in our book value per share to $32.18 at March 31st, down 4.1 percent in the quarter. The decrease was primarily due to the mark-to-market impact for our available for sale fixed maturities portfolio, resulting in a $1.55 hit to our book value per share. This quarter, the meaningful increase in interest rates and negative returns in the equity markets contributed to the negative total return. As you know, we have maintained a relatively short duration in our investment portfolio for some time, and this strategy helped temper the mark-to-market hit to book value in the first quarter. While still relatively short, we have extended our duration slightly to 2.93 years at the end of the quarter in order to get closer to our duration target. The change in net investment income this quarter on a sequential basis was mostly due to a lower level of dividends as we shifted out of some equity positions and higher investment expenses related to incentive compensation payments, as is normal for us in the first quarter of the year. Going forward, we would expect net investment income to increase over the next few quarters as our portfolio gets reinvested at higher yields. At the end of the quarter, new money yields were approximately 145 basis points higher than the embedded book yield in our fixed income portfolio. Alternative investments, representing approximately 15 percent of our total portfolio, returned 1.4 percent in the quarter. The performance of our alternative investments is generally reported on a one-quarter lag. I wanted to spend a brief moment on corporate expenses and what you should expect for the rest of the year. As you know, the first quarter is always elevated relative to the other quarters due to the timing of incentive compensation accruals. This year, you should also expect a slightly higher amount in the second quarter again due to our accounting policy for non-cash compensation for retirement-eligible employees. As a result, we expect corporate expenses to be approximately $25 million in the second quarter before coming down to a level closer to the 2021 amounts for the third and fourth quarters. Turning briefly to risk management, our natural cap PML on a net basis stood at $768 million as of April 1, or 6.4 percent of tangible shareholders' equity, again, well below our internal limits of the single-event 1-in-250-year return level. Our peak zone PML is currently the Florida tri-county region. On the capital front, we repurchased approximately 5.6 million common shares at an aggregate cost of $255 million in the first quarter. Our remaining share repurchase authorization currently stands at $927.2 million. With these introductory comments, we are now prepared to take your questions.