Arch Capital Group Ltd.

Good day, ladies and gentlemen, and welcome to the third quarter 2022 Archsoft 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 be given at that time. As a reminder, this call may be 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 meanings 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.

Thank you, Michelle. Good morning and welcome to ARCH's third quarter earnings call. our investors know that with arch you're getting a diversified time-tested active capital allocator that understands that how you navigate cycles is crucial for long-term success hurricane ian gave us a stark reminder of the importance of insurance and our hearts go up first to all those lost lives or properties As we turn to 2023, our agility is never more important. As an insurer, we provide protection for our clients during times of uncertainty. The reality for our industry is that big events like Ian almost always result in opportunities for the company that actively managed their capital and have the ability and decisiveness to act when markets need their capacity. ARCH is one of those companies. The current environment presents us with the opportunity to enhance its relationships with clients as they seek out insurance and reinsurance solutions in these uncertain times. The cat activity in the third quarter has significantly increased pressure on property cat markets, which could have ripple effects across all property and county lines as we approach the 2023 renewals. Over the last several years, we've maintained that property cap rates have been inadequate. Now the market recognizes this as well. The events of the past 18 months, significant interest rate hikes, repricing of investments, ongoing general inflation concerns, and the increasing cost of capital all point to the need for a higher margin of safety in the premium, with property being the poster child. We're pleased that the underlying discipline of our insurance and reinsurance segments limited Ian's impact to a quarterly earning event. As we have said before, our proactive approach to cycle management enables us to protect our capital over the long term. From our standpoint, as other insurers are reducing their overall participation, we have an opportunity to showcase our outstanding team, strong balance sheet, underwriting acumen and creative thinking. Our positioning should reward our shareholders with superior risk-adjusted returns in the near term. I want to take a few minutes to call your attention to areas in each operating segment where we continue to make positive strides. In the third quarter, our insurance and reinsurance segments continued to grow premium and delivered solid current accident year X cap combined ratios. $89.5 for insurance and $85.5 for reinsurance. In our insurance operations, we continue to see strong net premium written growth in the third quarter, up approximately 19% in the same period in 2021. Some of the most significant growth came from professional liability, including cyber, as well as a strong increase in travel lines. Our excess and surplus lines business, both property and casualty, also continue to achieve rate increases above trend, and we are optimistic about the opportunity for further growth in 2023. Competition in P&C is robust but rational, and the markets are taking a more technical approach to pricing, an approach that suits Arches' underlying philosophy. Cyber insurance has become increasingly important to our insurers globally, And we have substantially increased our support because, quite simply, we believe that today's cyber market has changed for the better. The most important development over the past several quarters is that the alignment between clients and insurance companies has significantly improved as insurers have become more vigilant in their efforts to mitigate cyber risk. Additionally, insurance terms and conditions have sufficiently tightened, retentions have increased, and rates have reached a level where we believe we have an opportunity to earn an appropriate return for the assumption of risk. Next, our reinsurance segment once again delivered excellent top line growth across an array of specialty businesses, including property, property fact, and other specialty lines. Since inception, a hallmark of our reinsurance group has been its ability to quickly adapt to changing markets and reallocate capital to earn better risk-adjusted returns. Excellent market conditions and the likelihood of capacity constraints will likely create an eventful January 1 renewal period, and our teams are actively planning to meet the demands of our clients. Now to the mortgage group, or as I call it, our beautiful business. They once again provided proof of their sustainable earnings model by delivering $299 million of underwriting income that is essentially uncorrelated with our P&C operations. Although higher interest rates affected new origination volume, they also improved the persistency of our portfolio. which rose 4% in the quarter to 75.4%. It allowed us to grow our U.S. primary mortgage insurance in-force to nearly $295 billion. Our embedded in-force book is in great shape. Credit quality remains excellent. Unemployment is still at historical lows, and the average borrower has a superior FICO score of 748. Homeowner's equity, a key factor in protecting against claims, is very high, with 90% of policies having at least 15% equity in their home. In addition, the MI market is being proactive, increasing rates to adjust to the evolving environment. We continue to be thoughtful in how we manage our mortgage portfolio, and because of our diversified model, we have the ability to take a measured view of the business as just one component of our diversified enterprise. In the near term, better returns will most likely come from our property and kennel segment, and we would expect that our capital allocation will bear this out. Although investment returns were challenged again in the third quarter, it's important to know that rising investment yields, even after adjusting for claims inflation, should help boost our return on equity. Obviously, with the Fed attempting to tame inflation, we may continue to see negative investment markdowns, a significant amount of which we would expect to recover as our fixed income securities mature over the next several years. Ultimately, the relatively high quality and short duration of our portfolio combined with strong cash flows provide an opportunity for us to reinvest in new money yields that are substantially higher than our current book yield. In conclusion, outperforming in the P&C insurance market is always a challenge. And the most recent paradigm where the property cap market was supported by cheaper alternative capital had increased the level of difficulty. However, many of the investors in ILS funds have recently seen their returns underperform and are beginning to leave the market. Without an obvious source of cheaper capital, our industry is nearing an inflection point. There appears to be a shortage of players with the capacity and willingness to participate, creating possible supply shortfalls. Fortunately for our shareholders, we have both the capacity and the willingness to deploy more capital in that space for as long as the reward justifies the risk. We're optimistic with regards to the opportunities ahead of us in the fourth quarter and into 2023. We talk about our principles of cycle management and capital allocation at almost every opportunity because they're truly part of our DNA. We have remained disciplined over time and kept our focus on fundamentals when it came to underwriting. The market needs companies like us to rise to meet their needs. And as I like to say to our team, ARCH is open for business. With that said, I'll turn it over to Francois to go through some of our financials in detail before returning to answer your questions.

Francois? Thank you, Mark, and good morning to all. Thanks for joining us today. As we communicated in our release early last week, our third quarter results were adversely impacted by the effects of Hurricane Ian and other global catastrophe events. In spite of the severe nature of Ian, which we believe will end up being the largest single loss in our history, we reported after-tax operating income of 28 cents per share, resulting in an annualized operating return on average common equity of 3.8%. Year-to-date or annualized operating ROE is 11.6%. This result demonstrates, once again, the value and the resilience of our diversified platform. Now on to catastrophe losses, where we wanted to provide a bit more color on our assessment of Hurricane Ian. We all know it's still very early in the claim adjusting process, And the final determination of our ultimate loss exposure will likely not be known for quite some time. Our initial estimate of the ultimate losses is based on an industry loss of 50 to 60 billion. We believe this range is appropriate at this time given the unknown impacts of inflationary trends, potential supply demand, imbalances in labor and material costs. the newly introduced Florida property insurance reforms, and the extent to which storm surge claims may end up being covered by insurers, among others. Overall, we believe our estimated market share of the event will be comparable to prior large events of a similar nature. In the insurance segment, net written premium grew 18.6% over the same quarter one year ago, as our underwriting teams continue to find new business that meets our return expectations. Overall, underwriting performance was excellent with an accident year combined ratio excluding caps of 89.5%, a 100 basis point improvement over the third quarter of 2021. In line with the last few quarters commentary, an ongoing shift in our business mix and structure of our returns programs 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 73.6% over the same quarter last year. It's worth pointing out that in the third quarter of 2021, we had a catch-up in seeded premium to summer's REIT, significantly reducing our net written premium. Absent this impact, The year-over-year increase in net written premium would have been 37.9%, and much like the insurance group, reflects an environment where we are better able to write business that meets our return thresholds. The segment produced a next-cap accident year combined ratio of 85.5%, 230 basis points higher than the same quarter one year ago, as a result of an elevated number of large attritional claims in our property other than property catastrophe books, and also an increase in our expense ratio due to an ongoing shift from excess of loss to more proportional business. We believe this movement in the loss ratio is well within our expectations of the inherent variability of the underlying claims activity in our book of business. Our mortgage segment had an other excellent quarter with a combined ratio excluding prior development of 39.9%. Net premiums earned decreased on a sequential basis as we continue to see the effects of high recessions on our USMI book and lower levels of single premium policy terminations. Persistency of our in-force insurance now stands at 75.4% at the end of the quarter. It has continued to increase due to the rise in mortgage rates which considerably reduces the attractiveness of mortgage refinancing for most borrowers. We recognize 126 million of favorable prior development across the mortgage segment this quarter, as delinquencies continue to cure at a higher rate than expected. Over 80% of the favorable claim development came from our first lien insured portfolio at USMI, mostly related to the 2020 and 2021 accident years. The remainder of the favorable development came from recoveries on second lien loans and better-than-expected claim development in our Australian operation and our CRT portfolio. Income from operating affiliates stood at $8.5 million and was generated from consistent results at COPAS, offset in part by underwriting losses at Summers Reef due in part to Hurricane Ian. Net investment income was $0.34 per share of 21% from the second quarter of 2022 and 55% from the third quarter of 2021 on a per share basis. The strong positive cash flow from operations, over $2.8 billion a year to date, combined with the proceeds from maturities and sales of securities, Deployed in a rapidly rising yield environment underpinned this improving result. Going forward, with new money rates above 5% and a growing base of invested assets, we should have a good opportunity to further enhance our operating income through solid investment income results. Total investment return for the investment portfolio was negative 3.01% on a US dollar basis for the quarter. in a challenging environment of rising interest rates and weak equity markets. We remain cautious relative to our duration, credit, and equity risk with our investment portfolio, and this defensive strategy helped minimize the mark-to-market hit to book value. Our investment duration remains relatively unchanged compared to one year ago and is slightly underweight relative to our liability duration. Turning to risk management, our natural cap PML on a net basis stood at $851 million as of October 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 a minimal amount of shares this quarter, approximately 236,000 common shares at an aggregate cost of 10.1 million. As our prospects of seeing meaningful opportunities in the business remain very good for the remainder of the year and into 2023. With these introductory comments, we are now prepared to take your questions.