Arch Capital Group Ltd.

Good day, ladies and gentlemen, and welcome to the Q1 2023 Arch Capital Group Learning Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session, and instructions will follow at that time. As a reminder, this 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 forward-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, 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 calls that are not based on historical facts are forward-looking statements within the meaning of the Private Security Litigation Reform Act of 1995. The company enters the forward-looking statements in the call to be subject to the safe harbor created thereby. Management also may make reference to certain non-GAAP measures of financial performance. The reconciliations to GAAP for each non-GAAP financial measure can be found in the company's current report on form 8K furnished on the SEC yesterday, which contains the company's earnings press release and is available on the company's website and on the SEC's website. I would now like to introduce your host for today's conference, Mr. Mark Grandison and Mr. Fontoy Martin. Sirs, you may begin.

Thank you, Lisa. Good morning and welcome to ARCS's earnings call for the first quarter of 2023. I'm pleased to report that as a direct result of our premium growth momentum from the past few hard market years, we reported an excellent start to the year. Financial highlights include book value per share growth of 8.4% in the quarter and an annualized operating ROE of 20.7%. Our P&C underwriting teams continue to lean into attractive market conditions where excellent risk-adjusted returns remain available, growing net premiums written by 35% over the same period last year. A key element of cycle management is to respond aggressively when you see conditions change. Since 2019, we have seen the market psychology pivot to underwriting disciplines, and our underwriting teams were prepared to become a more willing provider of capacity. The current property cap dislocation has resulted in us targeting growth in property lines, and this should further improve our return as we continue to benefit from the cumulative effect of improved rates, terms, and conditions. The $327 million of underwriting income generated from our two PNC segments this quarter is a testament to our commitment in the improved market. Our mortgage segment operates on a different cycle than the PNC, but it remains a significant contributor to earnings, generating a healthy $243 million of underwriting income in a quarter as our high-quality insurance-enforced portfolio remained stable at $513 billion. And in our P&C growth, I want to emphasize that Arch is, first and foremost, an underwriting company. Being an effective underwriting cycle manager means that our underwriters know that they have degrees of freedom in choosing to deploy capital across our diversified, specialty-focused platform. Because we have a wide range of choices to allocate underwriting capital at any time, we can generate more consistent and stable underwriting incomes over the long run. Our growth in this hard market would not exist without our unwavering underwriting integrity. Our focus on underwriting leads to profit stability and better reserving visibility. And over time, these more stable results lead to greater balance sheet strength, which in turn enables us to more aggressively deploy capital when we see market conditions change in our favor. At ARCH, we're deeply committed to the art and science of underwriting because we know that underwriting integrity over time solidified our conviction and agility to proactively respond to changing walking conditions. I'll now share a few highlights from our segment. First with PNC. Overall, the P&T environment continues to offer plenty of opportunities as evidenced by our growth. As you see in our premium numbers, the reinsurance market in particular is very attractive right now. Reinsurance typically reacts more quickly to the changing environment than primary insurance, and we are witnessing this phenomenon in these early stages of improvement in the property market. In our insurance segment, we continue to take advantage of favorable market conditions. For the past few quarters, property has seen significant rate escalation, which supported our 37% net premium written growth in that line of business during the first quarter of 23. The property market is still broadly dislocated, and we believe it will take further rate improvement before it finds equilibrium. Elsewhere, general liability rates are picking up again, and large account D&O is one of very few P&C lines that has decelerating rates. Overall, the market remains disciplined in its behavior, and we continue to obtain rates above trend. On our last earnings call, we noted property cap reinsurance dislocation of the 1-1 renewals, which led to significant effective rate increases. For the first quarter, arrangement cap net premiums written roughly doubled over the same period in 22. From our perspective, the improved conditions at 1-1 are a positive leading indicator as we prepare for the mid-year renewals, where peak zone capacity remains tight. We are well positioned to take advantage of this opportunity. ARCH is an increasingly prominent provider of choice in the property and category space. This is to be expected over time because of our differentiated cycle management strategy. To execute our strategy, we continuously invest in improving our capabilities. We hire and retain top-tier talent and teams, and we seek to enhance our tools and technology with the aim of becoming a more intelligent, stable, and able provider of insurance products for our clients. Finally, our compensation structure rewards underwriting performance first and foremost. This is the powerful glue that aligns strategy with execution. Now let me move to mortgage. Our mortgage segment continues to generate solid underwriting income and risk-adjusted returns, largely because our portfolio was shaped with a focus on credit quality and data-driven risk selection. Credit quality in our mortgage portfolio is excellent, as demonstrated by our 1.65% delinquency rate, the lowest since March of 2020. Our discipline underwriting approach has produced a portfolio with a more favorable risk profile, including higher FIFO scores and both lower loan-to-value and debt-to-income ratios than our peers in the sector. Typical seasonality and tempered demand for housing in the first quarter affected new insurance written. However, production was in line with our expectations given the housing market's conditions. We're seeing pricing discipline across the MI industry as rates have increased over the past year. The MI industry's underwriting discipline is encouraging and allows us to maintain our focus on risk selection to achieve adequate risk-adjusted returns. The MI industry is competitive, but faced with the current risk factors and the broader economy is acting rationally. As a result, our MI team continues to have opportunities to deploy Catholics. It isn't football season yet, but with the NFL draft beginning tonight, football was on my mind. Back in the 1960s, a football team from a small Wisconsin town dominated the sport, winning five championships in a decade. The team, as you all know, was the Green Bay Packers, and their coach was Vince Lombardi, widely regarded as one of the greatest coaches of all time in AD sports. One thing that made Lombardi a great leader was his obsession with excellence and execution. During their dominance, a key part of their offense was a very simple play called the power sweep. The quarterback would hand the ball to the running back, who ran the ball to one side of the offensive line, and then the offensive line acted as blockers, allowing the running back to plow ahead. No frills, no surprises. Opponents knew what was coming, but because this management nobody could stop it we talk a lot about cycle management and underwriting discipline on these calls and for good reason it's hardwired into how we operate the company they are not novel concepts they're actually quite simplistic the key like with lombardi's green bay hackers is conviction and execution excellence so day after day and year after year we line up and essentially run the same thing. Write a lot of business when rates are high and a lot less when rates are low. Francois?

Thank you, Mark, and good morning to all. Thanks for joining us today. As Mark highlighted, we kicked off 2023 with excellent underwriting results across all segments, and our investment income continued its upward path, benefiting from a higher interest rate environment and strong operating cash flows. For the quarter, we reported after-tax operating income of $1.73 per share for an annualized operating return on average common equity of 20.7%. Book value per share was up 8.4% in the quarter to $35.35, reflecting not only our strong results, but also the unwinding of approximately $350 million of unrealized losses on our fixed income portfolio net of taxes. Turning to the operating segments, net premium written by our reinsurance segment remained on its strong trajectory and grew by 51.5% over the same quarter of last year. This growth occurred across most of our lines of business with a particular emphasis on property lines, marine and aviation, and other specialties. The overall bottom line of the segment was also very good, with a combined ratio of 84.3% and a relatively small impact of $59 million from current action year catastrophe losses. It's worth mentioning that our top line reflects the impact of some larger transactions, which are not uncommon during periods of significant market dislocation. We cannot tell whether the frequency and size of these transactions will recur in future but we are optimistic that market conditions will remain attractive for the foreseeable future. The insurance segment also performed well, with first quarter net premium written growth of 19.1% over the same quarter one year ago, and an accident quarter combined ratio excluding caps of 89.8%. There were a handful of items affecting our top line more significantly this quarter, such as a large transaction in the lenders and the warranty line of business, and very strong market conditions in the property, energy, and marine line of business, both positives, which were partially offset by the headwinds of weaker foreign currencies against the US dollar compared to a year ago. We estimate that on a constant dollar basis our net written premium growth would have been approximately 230 basis points higher than reported in our financials. Most of our lines of business still benefit from excellent market conditions both in the U.S. and internationally and we remain positive about our ability to grow and write business at expected returns that meet our ROE targets as we approach the second half of the year. Our mortgage segment had another excellent quarter with a combined ratio of 20% from strong performance across all our units. Net premiums earned were up slightly on a sequential basis, reflecting the increased persistency of our insurance and force during the quarter at USMI and good growth in our units outside of USMI. We recorded approximately $73 million of favorable prior to reserve development in the quarter, with approximately two-thirds coming from USMI and the rest spread across our other units. Cure activity this quarter at USMI was particularly strong as we benefited from the highest first quarter cure rate we have seen in the past six years, excluding 2020. At the end of the quarter, over 80% of our net reserves at USMI are from post-COVID accident periods. Overall, our unwriting income reflected $126 million of favorable prior year reserve development on a pre-tax basis, or 4.3 points on the combined ratio, and was observed across all three segments. Quarterly income from operating affiliates stood at $39 million and was generated from good results at COFAS, Summers, and Premier. As you may already know, COFAS recently declared a dividend of $1 Euro 52 per share, which should result in a 68 million Euro dividend to ARCH in late May, subject to COFAS shareholder approval. Although this amount will not benefit our income statement next quarter, we believe it reflects very well on COFAS' results and prospects for the period ahead. Pre-tax net investment income was 53 cents per share, up 10% from the fourth quarter of 2022. as our pre-tax investment income yield exceeded 3% for the first quarter since 2011. With new money rates in our fixed income portfolio holding relatively flat in the 4.5% to 5% range, we should see further improvement in our net investment income return in the coming quarters. Total return for our investment portfolio was 2.54% on a US dollar basis for the quarter, with all our strategies delivering positive returns. The contribution to the overall result was primarily led by our fixed income portfolio, which benefited from slight downward pressure on interest rates during the quarter. While fixed income market volatility was elevated intra-quarter because of the stress in the U.S. and Swiss banking systems and the implications for monetary policies at central banks, spreads at quarter end were generally consistent with those at year-end 2022. The overall position of our investment portfolio remains neutral relative to our target allocation, and we are well positioned to capitalize should there be further dislocation in the capital markets. Of interest, our commercial real estate exposure is distributed across a variety of strategies, accounts for only 6% of ARCH's investment portfolio, is highly rated as a low loan-to-value ratio, and is more concentrated in multifamily housing investment with minimal positions in office properties. On the other side, positions are concentrated with large money center banks with no significant exposure to U.S. regional banks. Turning to risk management, our natural cap PML on a net basis stood at $1,069,000,000 as of April 1, or 8.1% of tangible shareholders' equity, again well below our internal limit at the single event 1 in 250-year return level. Our peak zone PML is currently the U.S. Northeast and reflects some pockets of increased capacity we deployed at April 1 in response to good market opportunities ahead of the more active renewal period of June 1 and July 1. In summary, we remain very positive on the current market and the opportunities ahead of us across all our segments. At the current expected returns, we believe deploying meaningful capacity in our businesses currently represents our best option to maximize returns for the benefit of our shareholders. Our commitment to be active yet disciplined capital allocators remains a core principle of ours that should lead to long-term value creation and success. With these introductory comments, we are now prepared to take your questions.