Arch Capital Group Ltd.

Good day, ladies and gentlemen, and welcome to Arch Capital Group fourth quarter 2022 earnings call. At this time, all participants are in 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 this update, management wants to first remind everyone that certain statements in today's press release and discussed on this call may constitute court-looking statements under the federal security laws. These statements are based upon management's current assessments and assumptions and are subject to a number of risks and uncertainties. Consequently, action results may differ materially from those expressed or implied. For more information on the risk and other factors that may affect future performance, investors should review periodic reports that are filed in the companies with the SEC from time to time. Additionally, certain statements contained in the call that are not based on historic facts or forward-looking statements within the meaning of the Private Security Litigation Reform Act of 1995. The company intends the forward-looking statements in this 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 Redison and Mr. Francois Morin. Sir, you may begin.

Thank you, Tawanda. Good morning and welcome to the fourth quarter earnings call for Arch Capital Group. Happy Valentine's Day to all. I'm pleased to share that for the fourth quarter of 2022, each of our three underwriting segments produced exceptional results. Our quarter's results were buoyed by a lower than average cut loss experience, a significant favorable development in mortgage reserves, and a higher level of profitable earned premiums from our recent growth. This quarter demonstrates the power of our strategy, namely our management of the underwriting cycle across a diversified specialty portfolio with a prudent reserving and underwriting stance. Our PNC insurance underwriting teams continue to lean into hard market conditions And our mortgage team delivered record under-earning income, which is, again, a direct result of our years as the established market leader there. For the full year of 2022, ARCH generated over $1.8 billion of operating income with an operating return on equity of 14.8%. 2022 was our third consecutive year of sustained premium and revenue growth, supporting stronger and more stable earnings power for the near term. The net premium written growth from our PNC units was exceptional. Reinsurance segments and NPW grew 51% for 2022 as the team seized on market dislocations, while our insurance segment grew a robust 21% on the year. We continue to see a broad array of opportunities to allocate capital where rates and terms and conditions allow for growth and attractive returns. Taking stock of where we are in the current market cycle, it's important to note that we've recorded premium growth significantly above the long-term industry average. Over the last four years, we've grown property and category net premium written threefold to nearly $10 billion from less than $3.6 billion in 2018, while overall rates increased cumulatively by over 40%. As we have stated previously, our cycle management strategy dictates that we maximize premium volume when rates are rising, which is precisely what we've done. While we expect to continue to allocate more capital to the P&C segments for the next several years, I wish to remind our shareholders that we've capitalized on the attractive return opportunities in our MI segment to the tune of $5.4 billion of underwriting income since 2017. These profits allowed us to redeploy capital into more creative uses, including $2 billion worth of share repurchases since 2018 and the substantial growth in profitable P&C premiums. MI has been vital to our ability to propel our P&C underwriting growth. Underwriting cycle management is core to our culture and I want to take a brief detour into how we think about the underwriting cycle here at Arch. Here is a simplification of Paul Ingray's insurance clock split into four stages. Stage 1, at the onset of the hard market, we see rates increase dramatically and capacity withdraw. Results from the previous soft market results only begin to show up in claims activity. Stage 2, this is the beginning of the restoration phase, which is indicated by second and sometimes third round of rate increases, along with some improvements for the insurers in the terms and conditions as the industry adjusts its appetite and underwriting policies. Much of the focus during this stage is also geared to filling gaps in and replenishing reserve shortfalls from the soft years while showing tepid improvements. Stage three, that next period is where rates gradually decrease, often as a result of overreactions in stage two. Underwriting profits from the hard market years gradually show up in the results. The stereo can be lengthy and it usually allows for still profitable growth, especially for the disciplined underwriters. And finally, stage four, famous stage four is where the industry forsakes underwriting discipline and overly focuses on top line growth, even as rate decreases accelerate. This is where ARCH's culture of underwriting discipline is most apparent as we cut exposure and prepare for the return of Stage 1. Right now, we are at Stage 2 in most lines. Some, for instance, property are back to Stage 1 since the fourth quarter. Understanding where you are at each point of the cycle for every product line and the nuances within each stage is critical to the timely allocation of capital to the areas of greatest opportunity. One of ARCH's key sustainable advantages is the breadth of its capabilities across many specialty insurance lines, enhancing greatly our cycle management capabilities. Of course, strategic candidate ARCH is that underwriting acumen and discipline through the cycle drives superior risk-adjusted returns. Now I'd like to share some highlights from our underwriting unit. We'll kick it off with reinsurance. For the fourth quarter, net premium written in the reinsurance segment was $1.5 billion. That's more than double the same quarter one year ago. Francois will cover the details, but much of this growth is because we were well positioned to capitalize on broad market opportunities as well as several one-off opportunities resulting from market dislocations emerging in the fourth quarter. It is worth noting that the fourth quarter growth does not include the January 1 property and property cap renewals, which will be reflected in our next quarter's results. As you've heard, pricing for the January 1 renewals was strong. Cap pricing and terms both improved, leading to effective rate changes in the plus 30 to plus 50% range. We anticipate these trends will continue at the mid-year property cap renewal and should translate to strong property cap premium growth in 2023 for ARCH. Moving now to our insurance segment, where we continue to reap the benefits of the investments we've made in enhancing our specialty businesses in the UK and in the US. On the year, we rolled over $5 billion of NPW, net premium written, compared to $4.1 billion in 2021, with growth coming from a diverse mix of business. Underwriting performance continues to be excellent, with an XCAT Accent Year Combined Ratio of 89.6%. Rate increases, with a few exceptions, remain above last-cost trend, and we expect this strong momentum to continue for 2023. the insurance market remains rational and disciplined. We expect also continued opportunities due to the ongoing global uncertainty and remain optimistic that this disciplined behavior that we saw in the P&C industry for the last three years will persist as we move through stage two of the cycles. Next, our mortgage team again had an exceptional quarter, capping off an excellent year. as we benefited from earnings from our embedded book as well as from favorable reserve development as cures on delinquencies exceeded our expectations. The mortgage segment delivered $374 million of underwriting income in a quarter and $1.3 billion for the year, an excellent contribution in a year where higher mortgage interest rates slowed new origination. Our insurance in force, the earnings foundation of the mortgage segment, grew to $513 billion at year-end 22, as persistency increased due to higher mortgage rates. As expected, higher mortgage rates led to reduced NRW, as mortgage rates touched 7% of the highest rates in 20 years. Looking broadly at the MI industry's health, we have borrower credit quality, which is outstanding, and excess housing demand above supply. The US unemployment rate is near historic lows, and the borrowers' equity in their homes remain at very healthy levels. One thing worthy of mention is that the MI industry is acting in a disciplined and responsible manner. In the face of these economic uncertainties, premium rates are increasing. while underwriting quality remains strong. Finally, the interest rate increases we've seen in the last 12 plus months should help fuel our net investment income through 2023. We are poised to benefit from a higher reinvestment rate coupled with the growth in invested assets. I've had auto racing on my mind lately, and when I look at our industry, I can't help but think that ours is one of the best cars on the track. We know that winning a race comes down to more than having a great driver or the fastest car. There is much preparation, analysis, and looking at the conditions on the track as well as monitoring the other drivers. By recognizing the stock market conditions in 2017 and 2018, We avoided the mistakes others made early in the race, when they might have burned tires or overheated their engines. As pricing began to improve in 2019, we were able to take advantage of some of our competition's bad pit stops and engine problems, and we took the opportunity to take more of a lead on the track by increasing substantially our ridings. And then, once we saw some clear track ahead of us, we were able to accelerate even faster. Today, we're firing on all cylinders, and I know we've got the right crew to bring it home. Let's hand the wheel over to Francois before coming back to answer your questions. Francois?

Thank you, Mark, and good morning to all. Thanks for joining us today. I'm very pleased to share that, once again, ARCH had an excellent quarter on virtually every front. The year concluded with fourth quarter after-tax operating income of $2.14 per share. for an annualized operating return on average common equity of 28%. Book value per share was up 9.9% in the quarter to $32.62, and down only 2.8% on the year, a great result considering the impact rising interest rates had on our fixed income portfolio, the difficult year in equity markets, and the elevated catastrophe activity we experienced this year. Turning to the operating segments, net premium written by our reinsurance segment grew by an exceptional 118% over the same quarter last year. Although this quarter we had a few large one-off transactions that impacted our results and contributed $407 million to our net written premium. Adjusting for these transactions, our net premium written growth was still elevated at 61% for the quarter. These transactions are yet another example of the dislocated state of the reinsurance market, where our strong balance sheet provides a significant advantage as we look to deploy meaningful capital to support CD companies at terms that meet our target return expectations. More importantly, the underlying performance of the segment this quarter was very good, with an XCAT accident year combined ratio of 82.9%, and a de minimis impact from current accident year capacity losses. Reflecting ongoing hard market conditions, the insurance segment also closed the year on a very good note, with four quarter net premium written growth of 17.4% over the same quarter one year ago, and an accident quarter combined ratio excluding caps of 89.6%. Most of our lines of business still benefit from excellent market conditions, both in the U.S. and internationally, and our expectations for the coming year remain very positive. Our mortgage segment continued its run of quarters with results better than long-term averages, as claim activity for the business remained low. While production volumes were down due to the lower level of originations in the market, we remain positive on the return prospects for this business. Net premiums earned were up slightly on the sequential basis as the persistency of our in-force insurance at 79.5% at the end of the quarter continued to increase. The combined ratio excluding prior development was 45% for the quarter and reflects our prudent approach to loss reserving, one of our key operating principles. Our unwriting income reflected $270 million of favorable prior year development on a pre-tax basis across all segments this quarter, which represents approximately 66 cents per share after debt. While most of this favorable prior development, $211 million, came from the mortgage segment, mostly on claim reserves set up for COVID-related delinquencies in the 2020 and 2021 accident years at USMI, It is worth pointing out that our P&C reserves also contributed to the overall result. Of note, both our insurance and reinsurance segments had another quarter of favorable reserve development, and the 2022 calendar year phase two incurred ratio for our P&C operations was 58.7%, its lowest level in more than five years. Both these metrics provide some insight into the adequacy of our loss reserves, which constitute an important element in the quality of our balance sheet. Quarterly income from operating affiliates stood at $36 million and was generated from good results at COFAS and Summers. Pre-tax net investment income was $0.48 per share, up 41% from the third quarter of 2022. Cash flow from operations, over $3.8 billion for the year, was strong, and when combined with the proceeds from maturities and sales of securities in a rapidly rising yield environment, enhanced the underlying contribution from our investment portfolio. Going forward, with new money rates in our fixed income portfolio in the 4.5% to 5% range, and a growing base of invested assets, we are well positioned to deliver an increasing level of investment income to help fuel our bottom line. Total return for our investment portfolio is 2.6% on the U.S. dollar basis for the quarter, with all of our strategies delivering positive returns. The contribution to the overall result was primarily led by our fixed income portfolio, which benefited from relatively stable interest rates and tightening credit stress. the overall position of our investment portfolio remains relatively unchanged as we remain cautious relative to duration, credit, and equity risk. Turning to risk management, our natural cap PML on a net basis stood at $970 million as of January 1, or 8% of tangible shareholders' equity, again well below our internal limits at the single event one and 250-year return level. Our peak zone PML remains a Florida tri-county region. And as Mark mentioned, the PMLs we report represent a point-in-time estimate of the exposure from our imports portfolio and the premium associated with the January 1 renewals will get reported in our financials starting next quarter. On the capital front, we did not repurchase any shares this quarter as our assessment of the market opportunity in 2023 remains very positive One where we should be able to deploy meaningful capital into our business and attractive returns for the benefit of our shareholders. Finally, as Mark mentioned in his remarks, the results we enjoyed this year across our operations were achieved through a thoughtful and deliberate execution of our cycle management strategy and a strong culture of allocating capital to the most profitable markets and opportunities. These results, which were an important contributor to us joining the S&P 500, were only made possible by the ongoing hard work and dedication of our over 5,000 employees across the globe. They deserve a tremendous amount of credit for making us who we are today, an industry leader with a stellar 20-plus year track record that is ready for the opportunities and challenges ahead of us. With these introductory comments, we are now prepared to take your questions.