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spk02: 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.
spk11: 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.
spk08: 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.
spk02: If you'd like to ask a question, please press star 1 1.
spk03: Our first question comes from Juminder Bular with JP Morgan.
spk02: Your line is open.
spk05: Good morning. So first, just had a question on pricing in the reinsurance market. Obviously, CAT pricing is hardening a lot after Ian. How do you think it will affect pricing in non-CAT lines, and where do you see the best opportunities for growth for ARCH?
spk11: Thank you for the question. I think it's still early. I think the EN is one part of the equation. This is where I think we should probably see an impact on other lines of business because aside from EN, we also have the markdowns and inflation concerns and whatever else is out there. It would be reasonable to expect, you know, rippling effect through the other lines of business. I also want to remind everyone that the market has gone through a hardening outside of cap for the last three to four years. So, I'm not sure what we would see a similar, you know, furthering or hardening the same level that we saw, but we're at a really, really good level right now. So, anything that is incremental above that is hugely accretive to us as an industry, certainly at ARCH.
spk05: And then how do you think about capital? Because a lot of companies, total equities come down a lot because of marks on AOCI. And I noticed you bought back very little stock this quarter. Not sure if that had anything to do with capital or just preserving capital ahead of cat season. But how do you think about capital overall for the industry as well as for you guys and specifically how that's affected by declining total book values?
spk11: I'll start with the overall industry and I'll turn to Francois for our specifics for ARCH. I think that the capital going out of the industry is a big deal. We are an industry that writes against a surplus and unlike 2008 when the markdowns recovered pretty quickly, we don't seem to be right now at this point in time at least in a position where it will recover soon. So there's going to be pressure on the capital in terms of how you write the business and how much you're allowed to write for the rating agencies or the regulatory agencies. So I think it will create pressure, and that pressure is not going to be short term. We think it's going to last for a while. And as an underwriter, capital is one of the main ingredients you have. to create underlying decisions and provide service to your clients. So it's a big deal. And we're talking some companies losing 20, 30, 35%. These are big changes. And I would add, as you know, Jimmy, that in addition to this, we have an environment where there are a lot of uncertainties, inflation, recession, and whatever else is out there. And I think we're all collectively bracing for interesting several quarters ahead of us.
spk08: Yeah, the one thing, Jimmy, I'll add to specific to ours, right, and that's really part of our history. We've always operated with the principle that we wanted to have a strong and conservative balance sheet, right? And why have we done that? Why have we taken that route? It was always with a mindset that we wanted to have optionality. We wanted to be able to take advantage of improving market conditions when and if they come around. And what I mean consistent and strong and conservative balance sheet is, A, the investment portfolio. You saw that in our markdowns. We got some like everybody else, but I think we're probably more on the low side. And also in terms of leverage. We don't have a very levered balance sheet. Even today at 930, we're below 25%. They're right at 25% on that. That's the capital basis. So those are the reasons why, you know, we feel like, you know, that's, you know, again, that's been our strategy. And this may be a moment in our, you know, in our history that, you know, tells us that, you know, and we'll be able to enjoy the benefits or reap the rewards of maintaining such a strategy. So I think we're in a really, really good position. You know, we're positive, we're optimistic about the market going forward. You know, we're still not there yet, and we'll see what happens at 1-1, but at least, you know, from the balance sheet point of view, we're in a really good position.
spk05: And any color on the sort of minimal buyback this quarter?
spk08: Well, again, it's twofold. I'd say, A, we typically don't do a whole lot in the third quarter ahead of the hurricane season. So that's very consistent with our history. There's always, you know, the stock price matters always, as you know, in the stock buyback. So, you know, going into the quarter, we just wanted to see how things played out. And, you know, Also, with the expectation that we would, you know, the hard market, even before Ian, we still thought that the hard market would be, go well into 2023. And that was one of the reasons why we felt, you know, maintaining the capital base to give us the ability to write on that, you know, that business in 23 was critical to us. Thank you.
spk05: You're welcome.
spk02: Our next question comes from Elise Greenspan with Wells Fargo. Your line is open.
spk04: Thanks. Given, you know, your expectations for pretty strong price increases at January 1, obviously, you know, we have some time, right, until Florida and other business renews later next year. But where would you think, based on the growth you think you could see in reinsurance, you know, where do you think your PML will shake out next year?
spk11: What's a really good question, Elise, and I think it's obviously dependent on the risk adjustment return that we would see in this, right? I just want to remind everyone that we're underweight at 7.7%, so we have room to grow if we see the opportunity. We did grow a little bit in 2022, seeing opportunities. We would do the same thing if we were to be presented with the same situation. I think we have the capital, the appetite, and the expertise to re-participate in the upcoming market hardening. I think at least the need, if it continues to shape up the way it's designing itself, we're going to be part of a solution. We're going to be part of creating new solutions and providing meaningful capacity to our clients. What I like about what we are is we have a diversified platform, as you know, gives us a lot of flexibility. And as Franco mentioned, we're in a really good position. All I could say is, you know, if you told me what the returns were, I would tell you how much we would be willing to take. But you would expect to hear from Arch that the way we think about building up no risk in the tower is incrementally as we would go up on the PML, we would expect the expected return to increasingly, you know, improve over that period. So it will be really, really highly dependent on how much the rates go. I think it's too early to tell. But it's going to be right now what we think. It could change, but it should be significant.
spk04: So based on what you think could transpire and you think about putting your capital to use next year, insurance, reinsurance, mortgage, I mean, it sounds like more will be on the PNC side. And then do you see more going to reinsurance versus insurance? Because it sounds like you guys are still seeing some good opportunities on the insurance side as well.
spk11: Yeah, well, I'll tell you, if you look at this is the beauty of our platform, right? When you have a re-insurance company and an insurance company like to participate in the up swing of a marketplace, re-insurance is a really, really quick and proactive way to do. So I was thinking in the early stages of this hard market get there, that we would be deploying more capital more quickly into our re-insurance units. Because it's also where I think most of the need is going to be, right? On the insurance portfolio, at least, as you know, it takes a year to turn over a portfolio there, whereas a reinsurance portfolio could be done much quicker. So I think it's going to be in steps like it always has been. It's the same in 2002 when we were formed. We were really, really reactive and really quick to market on the reinsurance side as we saw our insurance business building up. and getting traction and taking advantage of the hard market. So I think over time, then where does it land in 2024 and beyond? If we have this opportunity again, as I mentioned, then it will be a relative return. It will depend who gets the better risk-adjusted return. They will have to go in front of Francois and I and argue their case. These are our respective units. And this is what we're going to go through. We go through this on a quarterly basis to make sure we're We're keeping all the returns in the most optimal as possible.
spk04: And then one numbers one, Francois, you pointed to 230 basis points in the reinsurance segment, I think, from elevated property claims. So if we're thinking about that kind of the run rate, I'm assuming we should X out that 230 and then assume as the business shifts more towards property and property CAT. that there would be underlying loss ratio improvement driven off of mix and rate in that business?
spk08: Yeah, I think that's a fair way to think about it. I mean, we said before, I think looking at loss ratios on a quarterly basis is not something, it's not how we think about it. We like to think more in rolling 12 months or even maybe longer periods to have a view of the long-term performance of the book. Again, I was just making the point that just to let everybody know that we're not worried about this little blip in our quarter, very much part of the normal volatility of our business. But going forward, if the market ends up being very constructive, let's say, on the short tail lines, specifically, yes, the loss ratio presumably could come down a little bit.
spk04: Thank you.
spk08: You're welcome.
spk02: Our next question comes from Michael Zurimski with BMO. Your line is open.
spk06: Hey, good morning. I guess just sticking with capital, I know I don't want to spend too much time about this S&P capital model, but I remember checking my notes from the spring when we were all using them as a punching bag, or at least I was. they were supposed to release a new version soon before year end, I thought. And there was, you know, always the issue of kind of the Bermuda senior debt, maybe not getting credits. I don't know. Any thoughts? Is that something you guys are thinking about? Or is that issue kind of, you know, not a tail risk we should, or anything we should be thinking about?
spk08: Yeah, I mean, I think we, many of us thought we, you know, we have an answer to all those questions by now. You know, the model proposals that they put forward were substantial and broad, so I think it impacted most, I mean, most types of companies, Europeans, you know, North Americans, life, etc. They did get a lot of feedback, so the current thinking and what we, you know, they just let the world know recently that their, call it their second version of their proposal will be out in the first quarter. So, you know, there's still a little bit of uncertainty there as to what changes they may make to what they suggested initially. We've had discussions with them, many others have as well specifically in this Bermuda, you know, debt issue. We like to think that's going to get resolved reasonably well. We don't have finality on that, but we're somewhat, you know, positive that we'll get a good resolution there. So from that point of view, I'd say, you know, our capital base is strong and we don't see a need to make any changes to it at this point.
spk11: If I may add, Mike, one of our key things on capital and we're, you know, Allocate capital on an economic basis is definitely an important piece of the puzzle, but it's not the only thing that drives it. So we're carefully paying attention to it, and we'll see what happens.
spk06: Okay. Understood. Appreciate it. Maybe switching to your primary insurance operations, which I know are diversified among a number of businesses, but I guess – A lot of good commentary in the prepared remarks. Could you give us an update on kind of where pricing has been trending? And maybe just a broad question on the primary insurance marketplace, and maybe it's tough to paint it with a broad brush, but if we thought about the angry insurance lifecycle clock, just kind of curious what time you think it is.
spk11: It's a great question. I look at the clock many times a year, and I looked at it last week. We're about 12 noon, 11.30, 12 noon on the PNC side, I would say, and probably 8 o'clock-ish on the property cap space. But the clock can be turned back, so I'm not sure that 11.30 is going to stick. That would be my comment. It sort of alludes to the first question I answered. I think that overall, most lines are getting rate over trends. We're still seeing plenty of offers. The fact that this is a broad statement, right? You rightfully point that we're a specialty, you know, product company with many different products and everyone, every one of these products has different characteristics, different exposure base, different, you know, attachment point, different geographies. Broadly speaking, most lines are still getting way over trying. I think some others have said that in other calls this week. But I think that as in every hard market, this is what we're sort of observing in a few areas, there's been a lot of, for the last three years, almost overcorrection in some certain pockets. And I think that appropriately and rationally, people are looking at the history and the experience, and they think that the experience has much improved. One example is XSD and OPA. I think it's a line or two here and there that have smaller rate increase or smaller rate decreases. The thing is it gets recorded broadly. It gets a lot of headline in the papers, but it's just not really a true reflection of the wider market. I think that by virtue, if you look at the way we operate on the insurance and reinsurance on the PNC, mortgage for that matter, We're really focused on risk-adjusted returns, and if you see us grow, it's because the risk-adjusted returns and the profit is there. So I think overall the market is still very, very presenting us with a lot of opportunity, both on insurance, P&C, and reinsurance.
spk06: Maybe I think you brought up the excess and surplus lines marketplace. Maybe you can remind us how large of a business that is for you all, and is that Is that are the dynamics different in that marketplace versus kind of the picture you painted in terms of the primary insurance marketplace clock?
spk11: No, I think that no, actually not. It's actually an area that is still very, very active and very interesting for a lot of our growth actually come from those. E&S property and category lines of business. But to be selective, not all one line and all one monolithic sub-line, as you can appreciate, but certainly we're participating in the ones where we like the risk return. Our E&S premium right now in the US, because hard to decipher what's in London, you know, but in the US, it's about 28% of our premium that we write at ENF is almost double for what it was three or four years ago. So we have really leaned heavily into that marketplace and continue to do so. I think that what's happening with Ian, in the acute need for capacity specific and property should mean more E&S property opportunity and potentially some E&S casualty opportunities as well. I want to remind everyone this is a beautiful business to have as a specialty insurance company because you have a little bit more freedom of form and freedom of rate. And I think this is where really our underwriting acumen and underwriting expertise can showcase itself.
spk06: Thank you. Best of luck. Thanks.
spk02: Our next question comes from Aaron Kinnar with Jefferies. Your line is open.
spk09: Thank you. Good morning. My first question is with regards to the changing reinsurance market. Do you see that leading to changing retention rates in both insurance and reinsurance? And if so, what impact do you see that having not only on the top line but also on potentially lowering the attritional loss ratio and increasing the acquisition costs?
spk11: It's a broad question. It's a great question. And I think we're all observing it and intently observing. I think maybe the best way to, if you allow me for one second to sort of draw a parallel with Katrina and the way it evolved back in 2005. It's not exactly like 2005, but Let's go there for one second and go back in time again, turning back the clock, as I just said before. After the 05 turn in the market, portfolios have to be reprized at the insurance level. The insurance companies took a long time, took a year and a half to really repurpose and re-underwrite and reform, reshape their insurance portfolio to make sure that it was better approved and not as risky. So risk, not risk off, but readjusting the risk that the insurance companies are taking is something that I believe they will be doing for the next 12 to 18 months. But as I said before, it takes a long time to do so. In the meantime, you still have the exposure. So typically what happens is the reinsurance companies come in, say well we're going to need more returns for the for the capital for the capacity that we're providing to you the portfolio hasn't changed uh without two months it'll take a little while we want to see what in fact what you're going to do in the portfolio that was the o5 right yeah so and then what happened as you get into the new year as a buyer where our insurance group is no exception you still need to buy reinsurance and cat reinsurance uh it's still a volatility that it's appropriate and prudent to purchase. So the purchasing still occurs. There might be some push and pull on the retention. Presumably, retention would have to go up somewhat. Maybe constraints, there's a constraint on what limit is available. So I think if you put it all back together, there'll be shifting and changes in the re-insurance side, more likely at 1.1, as I mentioned, and as we lead towards Florida renewal in the year. the insurance portfolio will sort of be reacting to what the reinsurance market is telling them that it's more costly from a cap perspective. It's going to take a long time to develop. I mean, it's not like a one renewal and done. Like 05.
spk09: Right. But do you think, I guess, if we focus on the insurance segment for a second, so ultimately I would think with maybe lower or higher retentions, maybe you actually see some improvement in the attritional loss ratio, but at the same time, some head to the acquisition ratio.
spk11: Yeah, sorry, you had a question, I apologize. So the answer is exactly to your point. As you see the reinsurance price get more expensive, if you change the way perhaps you even buy reinsurance, the insurance team now know that they need to charge more to make up for what they lost or to get the protection because the reinsurance market is also telling them something very, very, very informative as to what is the price of cat charge that you need to charge for cat risk. So you're right. So overall, we'll have pricing increase on the primary insurance portfolios, which, to your point, should lead to a lower traditional loss ratio because it's the same kind of losses from the traditional perspective with a higher premium. So yes, that is a fair assessment, fair expectations.
spk09: Okay. And then a follow-up to the statement you made earlier on the marks. I'd always thought of rating agencies is largely looking through interest rate related marks, maybe with some exception with S&P. And I also thought that stat accounting doesn't really account for interest marks. So why would that lead or become an industry capital issue?
spk08: Well, I think it's, you know, there's the official kind of pronouncement or the official view of how people look at certain things, but Let's be honest here, I don't think anybody totally puts it to the side and doesn't consider it at all. There's companies that have lost 20 plus percent of their capital base so far this year. If rates go up another 100, 200 basis points over the next 12 plus months, at some point, you can't write a diversified book P&C business at three or four or five to one. I mean, that's just, you know, people are going to push back and you got to have a plan to either remediate or, you know, have a view on when those marks are going to revert back. So, You know, rating agencies are, I think, in that camp. I think they, you know, they'll give us and others some latitude, but it's not infinite. It's not like they don't consider it at all. So that's really our point here is that, you know, like it or not, you know, some capital has evaporated, not permanently, but for the time being, it's something we need to work through.
spk09: Got it. Thank you.
spk08: Okay.
spk02: Our next question comes from Tracy Ben Guigui with Barclays. Your line is open.
spk01: Thank you. I have follow-up questions on your ability to grow prop cat risk and capitalization. So I feel like your 25% target of 1 in 250 PML of tangible equity is an easy way to communicate your appetite to the street. But I realize a large consideration is allocating capital on a risk-adjusted basis. So can you remind us, How do you view diversification credit or covariance between MI and catastrophes? Or said another way, does your risk-adjusted capital consumption from MI restrict your ability to take on PropCat risk, even if there is diversification credit?
spk11: I'll start with a very good question, but we won't divulge what our economic model is. But if you look at the economic model, there is a large amount of lack of correlation between MI and the P&T. It doesn't mean that they can't go bad at the same time, but it's some non-correlation between the two. There's also a lot of correlation benefits that we derive from being in multitudes around the world. So we have a very diverse portfolio. I think the way that we look about this is, you know, the way you look at the curve, your economic curve, you know, again, we have to be careful. It's a mathematical exercise. We're not beholden to only mathematics. But we look at the way you flex the PML, if you put the pressure on it, increase the curve and see what could happen if, due to what its scenario is. but you always have the eye of a maximum downside that you want to take combining both of these or two or three of these really like 45 curves that we have. um that's that's i'm gonna leave it at that for now i think that this is an exercise that we we do all the time we're going through it right now and it's ever changing because pricing is moving and it's one thing that is i want to i want to remind everyone is that we uh you know we don't only look at the loss itself you have to look at what premium you charge for the risk that's what really is important A combined ratio and a profit level is very, very important, and every time you have a line of business that provides more profit, more margins improve or increase, it helps the overall balance sheet, the overall portfolio that you have on the insurance risk. Having said all this, we're having a proper, you know, hard stop on a downside potential. We don't want to bet, as Francois just mentioned, the balance sheet because we still want to be able to take advantage of the next market if and when it does present itself. On the mortgage side, I will remind everyone that we buy a fair amount of quarter shares, so that sort of protects some of our downsides. It's also part of our consideration. We buy quarter share, we also buy excessive loss, so we have some protection. That's also a good example of how we manage the risk, even if we like, we still very much like the MI risk, but we are still very prudent in making sure some of the downside is somewhat protected, again, for the same reasons that Francois mentioned earlier on the call. Francois, anything else to add?
spk01: Yeah, thank you for reviewing the process. I was just trying to get at, do you think that gives you an advantage to grow and profit at risk given the diversification credit?
spk11: Absolutely. There's no doubt in my mind. But it's not, again, it's not diversification, it's diversification. We always are conscious, as I mentioned, to make sure the profit is is improving and i guess on the property cap the one thing that should be clear i mean we it's it's riskier so now the charges that's what we talk about you know having a higher need for you know higher charge need uh to take a commensurate or you know similar risk that we would take let's say in uh you know trade credit for us we need to be cognizant of those things and i think yes it is uh it is really a fact that in addition to earnings power, to your point, I mean, that's what you're sort of alluding to, the fact that we have earnings coming from MI definitely help us as we redeploy capital into the other opportunities that we think we see ahead of us.
spk01: Okay. And I also want to go back to the conversation on negative marks and capital. In a way, why does it matter? I know S&P would penalize you for that, but Don't you have access of up to $1.3 billion line of credit, so you shouldn't actually crystallize any unrealized losses by being a for-seller? Is that fair? I'm just wondering if investors should pay more attention to liquidity.
spk08: Well, I mean, it's a fair point. I mean, we, again, we're not constrained. I think that's the most important thing. You know, leverage ratio is down, but we also have access to other forms of capital. Our line of credit is one that you mentioned. There are others. So, you know, if the opportunity is there for a, you know, additional growth in our P&C lines and, you know, and maybe mortgage, whatever. We'll see as we move forward. You know, I think, you know, my view is that it's hard to write on all that, you know, capital that's just not on the balance sheet, right? So it's got to be in the balance sheet somehow. And our view is, you know, yes, we see recovery in the unwinding of that mark-to-market hit so far, but, you know, the capital base, you know, has to show, you know, that it's, real and solid to get credit and right on it.
spk11: And Tracy, you know, because the argument you're pushing us on, I mean, you could take it to the extreme, right? We could say, well, what if the capital goes up by 80%? What does it matter? But at some point, it starts to matter. It's not as important when it's 5% or 10%. It's more important with 30 and becomes progressively more important because in the end, we have to pay our policyholders. And once we're out of reserves, there's a cap loss, we need to take care of our capital. And it does matter in the big world. So I think it's, I'm not saying it shouldn't matter 100% now because, you know, there's some marks and it's still capital available, but it has to make a difference somehow over time. Because the argument would fall, right? At what point do you think it starts to matter? I think it's not, or it's just a different degree through the capital step.
spk01: Okay, just one last one really quickly. Given the higher reinvestment rates, how long will it take Arches Marks to creep back to book value?
spk08: Well, I mean, there's, you know, we've done some rough math. I mean, you can, you know, kind of look at it like a portfolio turning over in all its two years on average, so that's all at eight quarters, and you can do kind of rough math by that. But, you know, the reality is we're going to also, you know, I think we're going to get, you know, we do have plenty of free cash flow coming through, and that's going to be reinvested at pretty significant levels. So we think that overall the book value should start growing pretty quickly beyond just the recovery of the marks.
spk03: Thank you.
spk02: Our next question comes from Josh Shanker with Bank of America. Your line is open.
spk07: Yes, thank you. I wonder if you can give a little outlook on the mortgage insurance sector. Are we at the bottom of the issuance cycle here for opportunities? Does this last for a little while? Are there even fewer mortgages that are going to be purchasing insurance over the next year? Where do we stand right now?
spk08: Sorry, Josh. In what sense? And on the primary side of MI?
spk07: Yeah, primary MI. I'm clearly like, you know, new home sales are down. And so obviously we're going to expect less flow. Is it going to continue to decline from here? Or is this kind of what a, you know, I guess a holiday from mortgage issuance looks like for the MI business?
spk08: Well, you know, we've said it before, I think, you know, and it still holds. I mean, the enforced book is where we're going to generate most of our underwriting income for the foreseeable future, right? For the next two to three years, doesn't matter really, you know, materially whether production is stable, declining, increases, increasing, you know, the enforced book is going to drive the underwriting income for the next three years or so. And we are, very comfortable with the level, the performance of that book right now, because as we know, and as we've said before, home price appreciation is a big part of that. Refinancing, you know, refinance activities coming down, so persistencies up, et cetera. So there's a lot of things pointing us in the direction of saying, yes, that Infor's book is doing well and will keep doing well, we think. You know, over time, no question that if, old production, new production kind of keeps declining to levels, you know, very low levels for an extended period, then it maybe starts to show in the numbers, but we don't think that's anytime soon.
spk11: And on the NIW, which you just mentioned about new production, If you look at the MBA numbers, the purchase market, which is by far the most important one for the MI business, is a lot more stable. There's not as much of a decrease. So we're still fairly positive that we're still going to get some nice production from our team over the next several quarters. and again i remind everyone that you know that as you know the mortgage is is up you know seven percent so it does make it a bit harder to get into a home but um fact is there's still hence of demand for housing uh for the purchase market should stay uh pretty active for this next you know several quarters which goes well for right now just forward looking and as as premium yield declines on insurance and force
spk07: I mean, is there a bottom that we should be expecting or does it continue to tick down in the coming years?
spk11: Yeah, I think I just mentioned it in my comments. The industry, you know, is like everyone else here on the call, talking about what's happening around the world, you know, some uncertainties, recessions, whatever else, potential things that could happen. And the industry is raising rates, is raising premium rates as we speak on the mortgage sector. which is good news, which speaks, I believe, volume for the new environment that we have in MI, an industry that is a lot more disciplined and deliberate in what it's doing. It's something we would have expected, but it's good to see it happen in life, in a life case like we're seeing right now.
spk07: Depending what happens at 1.1, is mortgage insurance still the highest ROIC of your opportunity?
spk11: Right now we have a lot of discussions about this. Right now we believe that our P&C operations are slightly gaining and getting ahead of it. Don't tell our MI group that, but it seems that the P&C units are squarely, you know, taking the lead.
spk07: Thank you very much.
spk11: You're welcome.
spk10: our next question comes from michael phillips with morgan stanley your line is open thanks good morning everybody um the question is no discounting the current times we're in with property cat and you know massive hurricane on the heels of what's going on with interest rate environment everything else and mark to markets but uh and leading to a lot of exuberance around property gap pricing obviously but But to what extent do you think we're in a period, the very early innings of more respect for property cap, that this will continue actually over the long term, which clearly has not happened in a very long time?
spk11: Well, the answer is we don't know, right? I mean, this is protecting the future. I mean, there's a lot of modeling out there that is trying to address it, and we certainly are on the cutting edge ourselves with meteorologists and, you know, everyone else we have on the staff to make sure we're on top of it. But again, it's like everything else. It's a... you know, it's a prediction. And you try to put as much cushion or a little bit of, you know, extra level of conservativeness to make sure that you're on the right side of the equation. And if things keep on going, you know, and getting worse and getting better, then you adjust and you're flapping the last data point into your next year's expectation. I think that if you take a step back, I talked about it on my comment, What is also going on is that we sort of disregarded the true expected CAAT losses. If you were to just allocate without putting a lot of weight or a lot of increase into some of the factors and parameters that go to CAAT pricing, we as an industry should have priced more, should have charged more for the CAAT risk, and we didn't. And I'm always reminded of the large, large numbers, which says over the long run, you get what you deserve in the results. It's not far from my mind to think that perhaps, just perhaps, it's not necessarily a change in climate change. That could be the case, but it could also be just by virtue of not charging enough over time that you sort of get, you reap the reward of that mispricing.
spk10: Yeah, that's kind of what I was alluding to, but okay, perfect. Thank you. That's all I had. Appreciate it. Thank you.
spk03: Our next question comes from Yiren Kinnar with Jefferies.
spk02: Your line is open.
spk09: Thanks. Yeah, I thought I'd take this opportunity to follow up on something you mentioned in the script, cyber. So maybe two questions there. First, on the attritional side, my understanding is that it's really about active management, so not just the annual questionnaire at the time of renewal, but really identifying and managing real-time vulnerabilities. As a traditional insurer, what capabilities do you have on that front from a tech angle, or are you partnering with third-party vendors to achieve this?
spk11: Yeah, so the answer is a great question. I think number one is we're partnering up with guys who are cutting edge really on top of this data technology and really do forensic work for our clients and that's a really good place to be. We also have a team, funny enough, a lot of our teams who are on the tech side for cyber risk are not part of the underwriting team. So we have a lot of people within the underwriting units who are actually IT people and cyber specialists and they themselves also contract with other third-party vendors as well to make sure that we're on top of it. In addition to all the third-party vendors that we have ourselves within the company, we're also on the lookout and understand it more and more. It's a big investment of ours.
spk09: Got it. Then the other question I had on cyber, actually one of your competitors was talking about this today as well, the need to get more comfortable with the tail before really pursuing more significant growth in this line. So how are you thinking about the tail, and are there actions you're taking in order to manage it and allow yourself to get the comfort to grow?
spk11: That's a very good question. This is harder to manage at the technical level, as you can appreciate, right? You go to the cloud and other outside platforms. systems, I think that what we do right now is, instead of, in lieu of having this technical structure, infrastructure, which we think at some point should come or will come, is let's be truthful and realistic about what our worst case downside scenario can be. And we have various scenarios that we run every quarter to make sure that we're on top of it. And again, there's the downside to everything we do in life. But again, we're weighing it with the returns that we're seeing. And we think the risk-reward is fairly in our favor. We like the odds of that business.
spk08: And one thing I'll add to that, Ron, is to us, we think of it as an earnings event, not a capital event. So we think pretty severe, widespread events would not hurt our capital base.
spk09: But that's probably also because the book is still relatively small in the overall portfolio. If it does grow, that could become a capital event unless you have proper exclusions or risk protection and so on.
spk11: Yeah. We also have reinsurance that we buy and other things that we can do there as well. So, yeah, right now.
spk09: Okay. Okay. Thank you. Best of luck. Thank you.
spk02: I'm not showing any further questions. I'd like to turn the call back over to Mark Grandison for closing remarks.
spk11: Thank you very much for your listening to our call. Looking forward to talk to you again in the new year with perhaps more exciting news. We'll see what the market gives us. Thank you very much.
spk02: In today's conference, this concludes the program. You may now all disconnect. Everyone, have a great day.
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