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.

Thank you.

Ladies and gentlemen, if you have a question at this time, please press star one one on your touch tone telephone and wait for your name to be announced. That's star one one to ask the question. If your question has been answered yourself from the queue, please press star one one again. Please stand by while we compile the Q&A roster.

Our first question comes from the line of Tracy Benjigi with Barclays.

Your line is open.

Thank you. Good morning. Your 1 in 250 PML to tangible equity of 8% as of 1-1 wasn't too dissimilar to your 7.7% as of September 30th. So I'm wondering what made you pause to incrementally take more exposure? Did it have anything to do with less retro capacity or your view of ROEs based on pricing? for that incremental cat exposure?

Yes, I think that this number, interestingly, this number is one region, one area, one feed zone. Not seen in the numbers, and we'll have more thorough discussion after the Q1 call, is that we've increased cat exposure across a wider range of subzones. And that doesn't really come across through that tri-county. And I remind you, Tracy, that the tri-county renewal is going to be more important and more apparent at the June 1 renewal. So it's also one first step into it. So if we had grown a European exposure because the racecourse was pretty good there significantly, it would not show up into that one single number, right? It belies sort of the true increase in allocated capital to catastrophe. If you look at the aggregate number, which is a better reflection, there is indeed an increase. that will be commensurate. You'll see the premium increase and the cap allocation increase, they will make sense to you.

Okay, that's very helpful. So as you look through the year, even though 25% is your maximum threshold, where do you think you could realistically land based on your risk appetite?

This is a great question, Tracy. Our typical answer is you tell me what the rate levels are like and we'll tell you what we think we can do. We have a plan based on certain, you know, various levels of rate changes, intent and condition changes, by zone, by region. and our team, as you can appreciate, is willing and able to operate on that basis. If you take a step back, I think the overall capital position of the company is we have plenty of opportunities to deploy. It's hard for us right now to see going all the way to 25, but certainly we have room to grow, and we have the capital and the relationships to do so.

Okay, and also really quickly on the reinsurance side, in recent times you've focused more on quota share over XOL. So with hard pricing, where do you see the best opportunities? I'm thinking about lower seating commissions on quota shares and the higher rate online on the XOL side.

So I think it's across the board. You just mentioned that we have improved economics both on the quota share and the excess of loss. I think that the numbers you see in Q4, a lot of it has to do with our recent growth in the quota share. That we've written, I think, by virtue of the cat excel, as you, as we just talked about in 5 minutes ago. Increasing, I think that we would be in a position to increase our excess of loss. Contributions to the bottom line, but when a hard market is around, which we still see on the reinsurance side and the insurance and the BNC side that we have a tendency to migrate towards. a quarter share, there's a few reasons for that. Number one, one of the big reasons that we like to talk about is you inherit some diversification within that portfolio that you otherwise would not necessarily get from an excess of loss perspective. And we really, really like this. And we like to be closer to the rate change, right? When you're on a quarter share basis, you're side by side with the client. As opposed to an excess of loss, you need to be relying on your sole pricing to make it work. So over time, when the market gets It's harder, I think you will expect us and as part of the cycle management to underwrite more or share versus. Excessive loss this year, though, both are pretty good.

Thanks thanks. Thank you. Please stand by for our next question.

Our next question comes from the line of Michael Zerminsky with BMO. Your line is open.

Hey, good morning. Thanks. I'll stick with the primary insurance segment, given I feel like most of the questions will probably be on reinsurance. You know, the growth has been decelerating there a bit. You know, Mark, we heard your prepared remarks. I'm like, you know, you're still excited, but maybe you can kind of talk about our, you know, what's, What's driving the deceleration? What are you guys seeing? I don't know if it's worth bifurcating between E&S, excess surplus lines, versus non-E&S. I'm just curious if the discipline there is dissipating a bit more versus reinsurance. Thanks.

Yeah, I think we're just experiencing on the fourth quarter. That will probably change in 23. I think opportunities are going to resurface more broadly than we did. even had in the fourth quarter, right? I think it took a little while for the market to digest in and see what it means for the overall market. I think now the market is clearly in the camp of, you know, making, doing what it needs to do to improve the return on the pricing on the property, which I think also, you heard in other calls, I think will impact a broader set of line of business beyond the property exposure. Before I go back, so if you look at the 70% growth, I mean, 70% growth over a premium that's about three times the size three, four years ago, you know, we did have a lot of growth in the beginning of our market. So as you get into the late stages, having a 70%, could be equivalent to another 50% increase in 2021 when we started to lean into the market. So I think this is a natural phenomenon that after a while, not that you've mined everything, but you really have pushed as hard as you could. And we're still pushing hard. Even 17% to me is about three times the average growth in the premium. in the industry, that tells me that we're still seeing a lot of opportunities, but again, like I said, we're later in the stage of the hard cycle. And I think that we'll see a rejuvenation, if you will, of that growth possibly because the insurance companies are going to have to increase, as we all know, their pricing One is the property cap and the higher retention, right? They have more risk retained. And we're participating, like the other guys, on the insurance market, so we expect markets to, you know, sort of getting a second bite of the apple, if you will, of a hardening market.

And as a follow-up, sticking with the primary insurance segment, so it sounds like the opportunities – might fall within the property space, if I'm interpreting your comments correctly. And when we're thinking about the segments combined ratio, I feel like looking at my older notes, it was kind of mid-90s was the goal. Is that still what you're thinking? Or has time been so good in terms of the market cycle that we should be thinking lower 90s is the more near-term goal?

I think we said a few things about a combined ratio. The 95 was meant as a target back in 16-17 when interest rates were quite a bit lower. They went down further, as you know, that meant that we needed to have lower combined ratio targets, which we targeted over the last two, three years. That's what you see the impact of. I think from our perspective, low 90s or high 80s is what we're still pushing for because within the interest rates, they may revert back and come down after a while, in a year, year and a half from now, so you don't want to be rushing. to recognize all the various interest rates. Although we are currently, we are pricing into our business, but we tend to take a longer view like we do on the trend on our inflation. And we're thinking the rates might come back down. So I think we would still target a lower 90s, high 80s to get the returns that we think we deserve.

Understood. Thank you.

Thank you. Please stand by for our next question. Our next question comes from the line of Jam Minder Buller with J.P.

Morgan. Your line is open.

Hi. First, I had a question on the reinsurance business. If you look at your premium growth, even excluding the sort of large transactions, one-time transactions you mentioned, the number is extremely strong and obviously doesn't have the impact of one-on-one renewals in it. So what's really driving that, and do you expect some of those factors that drove the strong growth to continue into 23 as well.

Yeah, I mean, the one thing that, you know, right from the get-go, I think you need to appreciate the, you know, the quarter share business is something that we, you know, we might have written a deal in January 1 of 22, and, you know, the premium gets written over the four quarters. So, we're benefiting from that. That's showing up in each of the four quarters. If the underlying Rate increases also from the seeding companies are higher than what we might have expected at the start. That gets adjusted throughout the year. So a couple of factors were basically, you know, we're just following effectively the fortunes of the companies. But still, I think our teams deserve a lot of credit for going after these opportunities, you know, being responsive to the client needs. being, you know, providing good capacity with, you know, good ratings, et cetera. Does that continue on in 2023? We think so. We think the market is there, and we saw, like, that growth was not only one line of business. It was pretty much in every single line of business. I know property and property scanners have gotten a lot of attention in the last few weeks, but still, I mean, all lines of business, other specialty, casualty, marine, aviation, you name it, All lines are, I think, in a position to really keep growing at a good question point.

Okay. And then just shifting on to MI, your loss ratios are obviously very good, but I think the loss did pick up a little bit in the fourth quarter. So is that more sort of national driven or is it more regional to where you're starting to see some maybe softening in the market in certain regions or states?

Well, we've navigated through the regional differences in our pricing, so I think we have constructed a portfolio that we're very happy with, stayed away from what we perceive to be the more dangerous areas and underpriced areas. So I think that's kind of showing up in our performance over time. In terms of reserving, I'd say two things. One, the delinquency rates are still very low. So it's not like we're really seeing pressure at this point in terms of a higher level of delinquencies being reported. And the loss ratio pick is really more a function of us being a bit more prudent. I think there's a little bit of uncertainty with Is there, you know, home prices, are they about to come down? Does that create some potential pressure? We think we're very, you know, very, you know, aware of that, whether there's a recession, et cetera. But, you know, we're still very, very positive on this segment. It's just, you know, a realization that, hey, this is maybe a slightly riskier environment than we were in like a year or two years ago, and our reserves are going to reflect that.

Okay, thank you. You're welcome.

Thank you. Please stand by for our next question. Our next question comes from the line of Brian Meredith with UBS. Your line is open.

Yeah, thank you. A couple of them here for me. First, Marco Francois, you guys typically provide in your 10Qs the 1 and 250 for the other regions as well, Northeast and Gulf of Mexico, UK. I'm wondering if you could have those statistics so we can get a better sense of what type of growth you're going to see at 1.1 renewals and maybe focus also on Europe because I know Europe has got a good operation there and a lot of opportunities there.

Yeah, I mean, the ones we report are usually a couple more regions. We don't have – I don't want to have those handy. I think, yeah, the most – at the March point, I think a lot of the growth, you know, that we saw at least at 1-1, you know, will come through in regions that were – I'd say we were probably a little bit underweight in the past. So that's going to show up in the Q1 premium for the rest of the year. But in terms of P&Ls, it really doesn't have an impact.

Gotcha. Okay. And then second question, I'm just curious, Mark, if I take a look back and I'm going to date myself a little bit here, you know, if I look back at what your, you know, underlying kind of combined ratios looks like back in 2003, 2004, after the last hard market, you're getting pretty close there in the reinsurance business. Are we getting to the point where we're kind of seeing max margins in that business? Maybe you get a little bit more in 2023, but how much more do you think you really get here?

It's a really good question, Brian. I don't know the answer to that. I like the comparison to O2, O3. I would actually like to compare probably more like a combination of O2, O3, maybe O4 and liability, and maybe O6 or O7 on the property side. So I don't know what that means. I haven't blended, Brian, the combined ratio that we had in those two years, but that probably would be close to what we can do. I mean, look, there's a lot of things that are different this time around. The interest rates are lower than they were before internationally. Specifically, we're an international diversified reinsurance company. Hard to tell, but it's certainly going in the way of getting above a long-term and ROE target. That's for sure. And that's really what, in the end, what really drives us, as you know. Great. Thank you. You're welcome.

Thank you. Please stand by for our next question.

Our next question comes from the line of Yaron Kinnar with Jefferies.

Your line is open.

Thank you. Good morning, everybody. My first question, just look at the ROE profile of the company. Clearly, there is upwards momentum here. Can you maybe talk about, A, what the target would be, and, B, if you'd see it coming more from or the expansion from here on coming more from NII or more from underwriting?

Yeah, I like to think we've got room to grow, but you're right. I think the biggest probably opportunity is NII, just with the leverage and the correction or the increase in interest rates we saw last year. I think that's going to take still a little bit of time to show up in the numbers, but as we look forward over the next 12 to 24 months, I'd like to think that that that there's leverage there that can show up in the numbers. In terms of the segments, you know, results, I think they can all, you know, mortgage, you know, again, the reported results, I mean, significant reserve releases, which certainly help the bottom line in the ROEs that are reported, but we think the segments, the fundamentals underlying each of the three segments are still very good, and they can actually still deliver very healthy results.

Great. And then my second question, just look at the insurance business. It sounds like you think that there may be some inflection to accelerating growth again in 23. Can you maybe help us think about the impact of the reinsurance market, kind of available capacity, cost of reinsurance, how that plays into the potential growth that you see for net premiums written in 23 in insurance?

Great question, Yaron, because I think what we're going to see through 23 is a recognition. I mean, it's already there, but it's going to be really coming home and the rules for us as a sitting company, right? I mean, our clients and sitting companies that need more needs to be charged to be insured that they can in turn pay the reinsurance they need to buy, even if they went there, right? We heard that a lot of increasing retention. There's still more volatility that's absorbed by those insurance carriers, which should lead to, again, needing a higher rate, everything else being equal. So I think what we're seeing is, what we'll see is gradually, and again, on the reinsurance, like I said, last year on, you can just renew your business one-to-one and everything changed on a dime, right, on one stroke of a pen. On the insurance side, it takes a 12-month period to transition and transform and then reprice the whole business. So that's what I think we're going to be seeing That's why I'm also fairly optimistic is because we're going to have that repricing occurring throughout 2023 and beyond. And alongside with those, between all of us here, terms and conditions are also going to be on the table, on the docket for companies to present to find a way to not curtail, but find a way to have a better risk sharing with their insured customers. when it comes down to other policies. So I guess for that reason, that's what underlies is that sticker shock, not sticker shock, but a good increase in insurance at the beginning of the year that we'll have to filter through all the plans and budgeting for all the insurance companies, including ourselves, as we go forward in 2023. So it's going to be a slow motion, but it's still going to happen. That's why I'm optimistic.

Got it. And I apologize. I'm going to try and sneak one more in here. clarification. When you talked about targeting low 90s, high 80s combined ratio, was that a reported combined ratio in the insurance segment?

That's policy year target. It's expected, right? It's plus or minus, as you know, in our space, there's volatility around the expected numbers, but it's long-term expected.

Because you've been running at kind of mid-90s, so where's that improvement coming from? Is it mostly just better rates and risk selection?

Well, we're running about 90 now, and I think that we still continue to see improvement in pricing. So that should help us get there somehow. Okay. Thank you.

Thank you. Please stand by for our next question. Our next question comes from the line of Ryan Tunis with Autonomous. Your line is open.

Hey, thanks. Good afternoon. First question, I guess, following up on Tracy, could you give us some indication of, I guess, how you're viewing your overall CAT budget this year relative to 21 based on what you saw at the one-run renewal? Should we expect to kind of the expected cat ratio to be higher?

The cat ratio or cat, I mean, in terms of cat load, cat load, dollars of cat, yeah, we think we'll go up, no question. You know, we've been targeting or targeting, I mean, our cat load in 22 was call it $80 million a quarter. Now it's probably between $100 and $120 for the first quarter, $43, based on what we wrote. Right? And we'll see how that develops for the rest of the year. I mean, depending on how the 4-1, 6-1, 7-1 renewals, how those kind of materialize. there is, you know, I'd say, you know, a good probability that it will keep going up throughout the year, but based on the enforced portfolio that we have, you know, currently for the first quarter, I mean, that's kind of how we see the exposure to cat losses.

Perfect. That's helpful. And then I had one from Mark, I guess, more on the man-made cat side, which isn't something we've talked about too much, but I would think that's, that's one of the better markets right now on the reinsurance side. And I guess just trying to size that and whether or not, you know, maybe some of the rate increases post Ukraine, if that can move the needle relative to property capital, just looking at your Marine and aviation premium, it's actually pretty chunky relative to property cat. So if you could just give us some indication of, you know, Can that move the needle? Is that something that we should be paying more attention to in terms of the markets we're seeing that are getting incremental firming that could help our

It's a good question, Ryan. I think the one thing with an event such as Ukraine, which is a war event, there's actually a specific market for those kinds of risks. So it's not like it's included part of the overall coverages for CAP or whatever else out there. There were some, but there definitely is a result of that event in an attempt to exclude a lot of these war events and bring them back into the proper aviation war or marine war market, for instance. So, yeah, there is a lot of, obviously, a lot of activity there, a lot of rate increases there when participating in there. But those markets are, to begin with, pretty small. So that's why I think, you know, you'll see some improvement, but it may not be necessary enough to move the needle for the industry, even though it's a very, very healthy proposition of rates have gone through the roof, as you can appreciate, for the right reasons in those types of business.

Yeah, makes sense. And then just lastly... The acquisition expense ratio has been kind of hard to pin down at ARCH over the past few years, but it's gone up. Obviously, it sounds like there are some changes in terms of seating commission structures, things like that at 1-1. Is there anything directional you can say about, you know, maybe how the acquisition expense ratios could move in 23 versus 22, or do we just kind of expect something relatively similar?

Yeah, I don't think it's going to move a whole lot from where it's been. I think, you know, there's been a lot of, you know, shifts in the mix of business over the years, right? Particularly as our insurance book in the UK has grown, it's a bit higher acquisition ratio, different kind of reinsurance purchasing decisions. So there's You know, there's a long list of reasons or explanations as to why it is where it is now. And obviously, you know, what we focus about, what we focus on is the bottom line returns, whether, you know, if we're going to pay a bit more acquisition, we certainly think we're going to get a lower loss ratio, and that has been the case. So, but for year modeling, we've got to, I think, exercise, I think, assume something pretty similar to 22 as a starting point, and we'll We'll keep you updated as the year goes on. Thanks to both. Thank you.

Thank you.

Please stand by for our next question.

Our next question comes from the line of Elsie Greenspan with Wells Fargo. Your line is open.

Hi, thanks. Good morning. My first question, I guess, is going back to the reinsurance margin discussion that came up earlier. So you guys have a flat PML and you guys are seeing 30 to 50 percent rate increases in CAT. Wouldn't that triangulate into margin improvement coming through in the reinsurance book in 2023?

well just if I could just isolate first we wonder where you were so good to see you there second I think the if you look at the property character at least I think it's the returns of dramatically improved but as you know for us it's going to be incrementally of course accretive to our bottom line but we're not you know it's not a the biggest line of business for us so that's what allows and room to grow the way we think we could grow in 2023. So it's hard to say how much more, but the property can excel market itself has significant marginal improvement.

Would you say, building on that, Mark, would you say that of all your business lines, as you sit here today, the line with the best

expected return in 23 would be catastrophe reinsurance it's up there but there are others that uh we don't advertise too much that are really really healthy and getting better as we speak and they're as big if not as big but some of them right are as big as the property cat export uh property cat writing so now we have quite a few who are giving us pretty high returns but this is up there it's up there though at least let's be honest i mean you heard all the calls This is a good time to write property CAD Excel. It's a really good time.

And then you said, right, on the PML discussion, you had mentioned, right, that we need to kind of see how things come together, you know, at June 1, that that could also be a good opportunity. What could derail this? Is it just alternative capital and more capital coming into the reinsurance space, as you think, you know, leading up to June 1? And even when we think beyond that, what – You know, what are you guys concerned about that could derail the uplift that we've seen in the catastrophe reinsurance market?

I mean, it's hard to imagine, Elise. I think the third-party capital you mentioned, they still were in a wait-and-see attitude. The U.S. renewal, as we all know, is a small portion of the overall cap writing in the year. So more has to happen. And as we all know, and in line with what our tri-county, which is Florida, Florida is the biggest, So it's hard to tell what could derail it. I mean, I'm trying to think out loud, you know, third party cattle coming in. I don't see it being a case. No cat in the first half of the year. Well, we better have no cat. It would be great for our industry to at least take advantage of less cat activity. Now, it's hard to see anything, because I think that the psychology of the market is squarely of the camp of remediating, you know, what needs to be remediated in a property cap space at all levels, you know, from the C-suite all the way down to the underwriting and system desk. I think it's clearly a recognition that we need more. I think the only thing I could say is, you know, the one thing that I could say just to help you out here, I think that will make sense to you, that we may have a bit less than perhaps some people have budgeted, or maybe a bit more than budgeted price increase. We may have a delta around what we see. But in terms of core capital needs and supply and demand, I don't see a major shift. That was a long question because I was thinking out loud here, but there you go.

No, that was great. Thanks, Mark. Appreciate the color.

Sure.

Thank you.

Please stand by for our next question. Our next question comes from the line of Mario Shields with KBW. Your line is open.

Great. Thanks so much for taking the time. I hope this wasn't covered. I missed about a minute of the call. But I was hoping we could dig into the non-recurring transactions in reinsurance. I'm assuming those are retroactive reinsurance. I was hoping you could talk about specifically the sort of risks or the lines of business that you're assuming and maybe give us an update on what that market looks like now.

Yeah, I mean, to keep it, again, fairly high level, those are general, I mean, I consider them to be kind of capital relief, capital support transactions for a variety of reasons. Companies that have grown a lot, you know, under some rating agency pressure, they need capital relief. Companies trying to put some exposures behind them, et cetera. But just to clarify, those are not retroactive, so they're all insurance-accounted transactions, all insurance or insurance accounting, so that flows through our premium, et cetera. They are across, you saw it in our lines of business, they did hit multiple of our lines of business. Other specialties, some are casualty, some are a little bit of property, so it spreads. But it's all in a vibrant market. I mean, there's a lot of pain that some companies are experiencing right now, and they're looking for solutions. And again, we think we have strong balance sheets and capital to to support them. So I think, you know, we don't know if they're going to happen again. Those are lumpy, but if and when they are presented to us, we're happy to consider them. And once in a while, we end up writing a few of them.

Okay. No, that's helpful. Thank you. Second question on mortgage insurance. And I don't even know how to phrase this, but you put up very conservative reserves for mortgage insurance over the course of COVID. And I'm wondering how much of that unusual reserve is still there because clearly, speaking at least for myself, we haven't done a great job of forecasting reserve releases in that unit.

Well, it's a great question which is becoming harder and harder to answer because In the early days, no question that we had adjusted our, you know, because so many loan delinquencies that were in our inventory were in forbearance and trying to make a distinction between kind of forbearance and non forbearance delinquencies. And how much is that worth was. you know, a new concept or new kind of reality we were facing. Over time, I mean, you know, it's been three years now, I think the reality is like the inventory is somewhat kind of co-mingled. So, you know, we don't really think of loans and forbearance kind of that differently than we look at the other loans, even though we know there's still a few of them in the inventory. I mean, long story to say that, you know, it's not something we kind of quantify directly every quarter anymore, but we still perceive that there's a bit of risk with, you know, COVID-related reserves, and that's why we've been, you know, holding on to the reserves up to the point where we think we just don't need them. And right now, this quarter was an example where, you know, I think the data kind of suggested that we were, well, it was the right time to relate the fair amount of the reserves that were set up in those years.

Mario, quickly, I think what Franco is saying is true for all lines of business in the authority, but we'll try to take a proven stance on research to make sure we have enough, and we let data speak for itself. And this one is very unusual, Mario, right? The dynamic was something unlike anything else. If we have another one, we'll have a better playbook to use, but we just didn't know, and we still don't know. It's still not over, you know, one-sixth of our NODs are forbearance driven, so it's still coming back into place. It's not That's what leads us to be that much more. From the outside, it looks like we're conservative, but we think we've been prudent, and the data speaks for itself. And we'll see if it happens that we don't need it, then we'll adjust it based on the data we see.

Okay. Understood. Thank you very much.

Great. Thanks. You're welcome.

Thank you.

Please stand by for our next question. We have a follow-up question from the line of Tracy Benjiji with Barclays.

Your line is open.

Thank you for taking me back in the queue. I'm wondering what your outlook is on professional lines within your insurance segment, and particularly what stage you would classify that business in when you went through your stages.

Tracy, do you include DNO there, or do you just want to pick the ex-DNO? Which line specifically? Professional lines are really broad markets.

Yeah, okay, so my focus is more on D&O.

D&O, okay, so D&O, we expect similar trends that we saw in the last fourth quarter. It may change a little bit as a result of the overall thing that's happening in the marketplace, but the trend on the large commercial, for instance, have been neutral to negative, actually, for the last three or four years, so I would say that Even though we may hear, you hear, I know, rate decreases in the DNA for large commercial, there's rationality behind it. So we expect rationality to still exist. It's not. There's a lot of data that points to, that validates what kind of price change we're seeing on the DNA side. On the smaller D&O side, which we do a fair amount of, to remind you, we do a fair amount of D&O, we still see a very, very stable, very good marketplace. But again, the smaller D&Os are not the big-ticket items that you would expect, right? A lot of them are going to be, you know, not-for-profit, small policies. So minimum premium is really, you know, a lot of times what happens, and that 5% increase might be $50, right? So these are the kinds of things that we do a fair amount of growth, and we've grown dramatically over the last four or five years. It's becoming addictive. section, what we do. The market is healthy from a change perspective, right? To go back to what I said about the large commercial, the STAs are down 25, 30% over the last four years. So it's a pretty good market to be there. The IPO market has stabilized. It was pretty hot for a while. Pricing got crazy. We took advantage of a lot of opportunities. Not crazy, but it was a very acute needing capacity. We expect this to renormalize again. So I think I would say D&O is normalizing for the large commercial. Sort of a stage four, I meant. Stage three, we're, you know, recognizing some of the overreaction. But the smaller D&O is probably, you know, early stage of stage three, which is still very profitable. And, you know, a little bit of decrease here and there or a slight increase.

Thank you. Sure. Thank you. I'm not showing any further questions in the queue. I would now like to turn the conference back over to Mr. Mark Grandison for closing remarks.

Well, spend a good day with your loved ones, and we will see you the next quarter. Thanks for listening, guys.

Ladies and gentlemen, that concludes today's conference call. Thank you for your participation. You may now disconnect.