Arch Capital Group Ltd.

Good day, ladies and gentlemen, and welcome to the second 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. 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 on 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, Elizabeth. Good morning and welcome to our earnings call. ARCH delivered strong results this quarter, headlined by an operating return on equity of 17%. Our results were driven by excellent underwriting performance across all three operating segments, As we continued our focus on growth opportunities during this hard market as demonstrated by the 27% increase in PNC net premium written over the same quarter one year ago. These results demonstrate how our company is positioned to capitalize on market opportunities across the many lines that we underwrite. We've said it before, but it bears repeating. We are committed to agile cycle management. predicated by a focus on risk-adjusted returns, and it has enabled us to accelerate our growth through the deployment of meaningful capacity to our clients. Because we invested in capabilities and preserved capital during the soft market years, we are in the enviable position of being able to maximize today's opportunity. Increasingly, ARTS is seen as a provider of choice by our distribution partners and clients, which allows us to take on leadership positions as some in the industry retrench. P&C rate hardening continues in many lines. It's important to keep in mind that for the vast majority of the P&C lines, we've been able to achieve compounded rate increases meaningfully above lost cost trends for the last two or three annual renewals, and as such, healthy margins of safety have been created. We believe this attractive level of expected returns should remain in place for the next few years. I'll now offer a few highlights on our business units. In the quarter, our insurance and reinsurance segments both had excellent operating results, largely because of how we leaned hard into the improving market early on. We also have invested in improving our data analytics while broadening our market presence. In our North American insurance operations, premium growth was broad-based, with net premium written up 29% from the same period in 2021. Some of the most significant growth came from our E&S lines, both property and casualty, professional lines, including cyber, and a resurgent travel and accident sector. All are lines of business where we believe risk-adjusted returns are most attractive. Our specialty international insurance business which includes our Lloyds and UK regional businesses, also delivered strong growth with net premium written up 23% from the same period last year, driven primarily by specialty, casualty and property. Our investment in building the UK regional small business is gaining traction as well. When looking at the improved results of our insurance business, it's apparent that the work of our teams over the past several years is paying off. We have developed a platform that responds swiftly to opportunities presented by the hard markets while at the same time building more sustainable positions in lines that are less cyclical. We have the capital, the people, and the desire to lead in today's environment. As long as attractive opportunities are available, ARCH will be there to right them. Our reinsurance segment continued to deliver excellent top line growth and bottom line earnings this quarter. because of the diversified and specialty focus of our reinsurance business. The strong growth reflects our increased writings of quarter share treaties, which allow us to participate in the rate increases experienced by our students. The 6-1 and 7-1 renewals showed a property cut market in transition. And while I hesitate to make predictions, we are cautiously optimistic that this momentum will continue into 1-1-23. The general psychology of the market appears to have shifted to requiring substantial rate increases to accept cat exposure. As an example, in Florida, where capacity remains constrained, property cat rates were up in excess of 30%, and our PML in a 1-in-250-year event increased as we selectively expanded our writings. Rate pressure was evident also beyond Florida. However, we will need a few more quarters to confirm we are facing a hard property cut marketplace. Turning to our mortgage segment, the group continues to deliver the consistent underwriting results we projected when we began building our MI business a decade ago. Our embedded book of high credit quality risks as well as continued home price increases have been key elements to our exceptional return this quarter. Although rising mortgage interest rates have slowed the volume of new originations, the purchase market remains strong as housing demand continues to outstrip new supply. Rising rates also mean that persistency is increasing, which allowed ARCH to grow its U.S. primary mortgage insurance in force to $292 billion, an all-time high. The forbearance programs continue to roll off, and cures have brought our delinquency rate down to 1.77%, which is consistent with what we experienced before COVID. Last and perhaps most important, the credit quality of homebuyers remains excellent, and we believe our portfolio is well positioned for a variety of economic scenarios. We will continue to be deliberate in managing our mortgage portfolio, benefiting from a diversified business model that gives us the flexibility to focus on credit quality and profitability, not on volume. Briefly on investments, where rising interest rates and market volatility are setting the stage for additional investment income contributions over the next several quarters. We're seeing the benefits of not chasing yield during the past several years, as well as the work done to reposition our portfolio in response to the changing interest rate environment. Earlier this year, our investment team reduced our equity exposure and our fixed income portfolios shorter duration has allowed us to quickly move our investments into higher rate securities that provide further cushion against potential inflation impacts. This year's surge of inflation has been a call to arms to underwriting teams across the industry. And by and large, the industry has proactively incorporated higher trends into its models. We believe that the uncertainty surrounding future inflation should keep upward pressure on rates. At ARCH, we manage inflation by business segment. As we've said before, we believe inflation is a net benefit to our MIS portfolio's performance. while our P&C exposure to inflation is mitigated by many tools available to us. Overall, we're very pleased with our underwriting results and returns in the quarter, and we are optimistic about the rest of 2022 and into 2023. As always, our objective remains to generate profitable growth and deliver long-term value for our shareholders, and this quarter's results are another example of our ability to do just that. I want to thank the ARCH team for everything they've done this past quarter and over the last several years. Our people have made ARCH into an employer, an insurer of choice, and have us well positioned to sustain our growth trajectory into 23 and beyond. Francois?

Thank you, Marc, and good morning to all. Thanks for joining us today. As you will have seen by now, we had a very strong quarter. And with very few unusual items to discuss or highlight to you, I have kept my prepared remarks relatively brief to allow for more time for the Q&A session. So here we go. For the quarter, we reported after-tax operating income of $1.34 per share, resulting in an annualized operating return on average common equity of 17.1%, two excellent results. In the insurance segment, net written premium growth of 27.5% over the same quarter one year ago, combined with excellent underwriting performance, resulted in an accident year combined ratio excluding cats of 90%, a 140 basis point improvement over the same quarter one year ago. Like last quarter, a change in our business mix resulted in a slightly different split between the loss and expense ratios, compared to the same quarter one year ago. In the reinsurance segment, net written premium grew by 25.7 percent over the same quarter one year ago. The segment produced an XCAT accident year combined ratio of 82.8 percent, 430 basis points lower than the same quarter one year ago. Here also, a reduction in the accident year XCAT loss ratio was partially offset by a slight increase in the expense ratio due to growth in areas with slightly higher acquisition expenses and targeted personnel expansion to support our growth. Losses from 2022 catastrophic events, net of reinsurance recoverables and reinstatement premiums stood at 82.4 million, or 3.5 combined ratio points, compared to 2.4 combined ratio points in the second quarter of 2021. The losses were split approximately 80 percent to reinsurance and 20 percent to our insurance segment. It's worth noting that approximately two-thirds of the estimated losses came from events outside the U.S., including Australian floods, South African floods, a derecho storm in Canada, and other miscellaneous natural catastrophe events. Our mortgage segment had an excellent quarter with a combined ratio excluding prior development of 39.2 percent. Net premiums earned increased on a sequential basis due to increased persistency of our in-force insurance, which now stands at 71.3 percent at the end of the quarter, and growth in our CRT portfolio. Production levels also increased from last quarter, consistent with the seasonality of the business. We recognized $118.1 million of favorable prior development across the segment this quarter, a meaningful benefit to our bottom line, as delinquencies cured at a higher rate than expected. Close to 80% of the favorable claim development came from our first lien insured portfolio at USMI, 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 in our international MI operations. In all our segments, we maintain a prudent approach in setting loss reserves, considering the uncertainty we face in a variety of factors such as macroeconomic conditions, inflation, both monetary and social, and lags in settling longer-tail liabilities as COVID-related delays get worked through the legal systems. Income from operating affiliates stood at $4.6 million. It was generated from good results at COFAS, mostly offset by the negative mark-to-market impacts on the summer's portfolio for those securities that are accounted under the fair value option method. Gross investment income before investment expenses increased 20% from the first quarter of 2022 to $123.6 million, driven by the reinvestment that higher yields of proceeds from the maturities and sales of investments and securities and the presence of floating rate investments in our portfolio. Total investment return for our investment portfolio was a negative 3.02% on a U.S. dollar basis for the quarter, hurt by mark-to-market losses due to rising interest rates and weak equity markets. As you know, it is worth remembering that while mark-to-market impacts are fully reflected in our financials, a significant portion of this decrease hasn't been crystallized through the selling of securities and has the potential to reverse itself over time, in particular for our fixed maturity investments as they mature. As we discussed on the first quarter call, The defensive investment strategy we have employed for a number of quarters with high-quality investments and a short portfolio duration has helped minimize the impact of rising interest rates and the mark-to-market hit to book value. Our investment duration remains slightly below three years at the end of the quarter and slightly underweight relative to our liability duration target. The performance of our alternative investments remained very solid this quarter, as we benefited from the returns generated by a number of funds that outperformed broad market indices. Returning briefly to risk management, our natural cap PML on a net basis stood at $888 million as of July 1, or 7.7% of tangible shareholders' equity, again well below our internal limits at 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 7.1 million common shares at an aggregate cost of 320.7 million in the second quarter. Our remaining share authorization currently stands at $600.6 million. With these introductory comments, we are now prepared to take your questions.