Arch Capital Group Ltd.

Good day, ladies and gentlemen, and welcome to the Q2 2023 Arch Capital 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 conference call is being 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 risk 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 meaning 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 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 to 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. Francois Morin. Sirs, you may begin.

Thank you, Josh. Good morning and welcome to our second quarter earnings call. We're more than halfway into 2023 and Through our commitment to underwriting acumen, prudent reserving, and cycle-focused capital allocation, we were able to deliver another quarter of profitable growth. In the second quarter, our results were primarily driven by our willingness and ability to deploy capital into lines with superior risk-adjusted returns. Our operating results in the quarter were stellar, with an annualized operating return on average common equity of 21.5% that drove a 4.8% increase in Archer's book value for common share for the quarter. As you know, book value for share growth is our primary focus on our road to creating long-term value for our shareholders. Each segment generated over $100 million of underwriting income in a quarter. These outstanding returns reflect our ability to effectively execute in each segment. We're really operating in our sweet spot. I also want to commend our employees for the continued exceptional growth they've delivered in the quarter, most notably a 32% increase in property and category net premium written compared to the same quarter a year ago. This hard P&C market is proving to be one of the longest we've experienced, and we are in an enviable position as we look to 2024 and beyond. We often refer to the insurance clock developed by Paul Ingres to help illustrate the insurance cycle. You can find the clock on the download tab for this webcast or on our corporate website. If you can't view the clock right now, just picture a traditional clock dial. For some time, we've been hovering at 11 o'clock, which is when we expect most companies in the market to show good results as rate adequacy improves and loss trends stabilize. Last year, a popular topic on earnings calls was whether rate increases were slowing or whether rates were even decreasing. These are classic signs of the clock hitting 12 when returns are still very good, but conditions begin to soften. Yet here we are in mid 2023 and conditions in most markets remain at 11 o'clock. We've even checked the batteries in the clock and they're just fine. The clock isn't broken. It's just that the current environment dictates an extended period of rate hardening. So what's sustaining this hard market? Well, I believe it's a relatively simple combination. Heightened uncertainty is driving an imbalance of supply and demand for insurance coverage. Since this hard market inception in 2019, we've had COVID, the war in Ukraine, increased catactivity and rising inflation, all of which creates significant economic uncertainty. Underwriters have had to account for more unknowns. Beyond those macro factors, industry dynamics also play a role in sustaining the hard market. Generally, inadequate pricing and overly optimistic loss trend assumptions during the soft market years of 2016 through 2019 have led to inadequate returns for the industry. The impact of these factors should cause insurers to raise rates and purchase more reinsurance in a capacity-constrained market with limited new capital formation. Put it all together, and it may be a while before the clock strikes 12 and we begin to move beyond this hard market. I'll now share a few highlights from our segments. First, P&C. In the second quarter, the reinsurance group was successful, again, at seizing growth opportunities. In particular, the mid-year property and property cap renewal saw significant improvement in rates adequacy, and our underwriters were ready, willing, and able to provide valuable capacity to our clients. Our PML, or exposure to a single event in a one in 250-year return period, went up in a quarter, while our premium income grew substantially. At July 1st, our peak zone exposure rose to 10.5% of tangible equity. Overall exposure to property cat risk remained well within our threshold, and because of our diversified portfolio and broad set of opportunities, we retained the flexibility to pursue the most attractive returns across lines and geographies. Although there are lines where pricing has declined, Large public D&O comes to mind. P&C markets continue to see rate changes above lost trends. Even with those few lines with weakening rates, the compounded rate increases over the past several years continue to be earned and are generating attractive returns. Overall, we like the range of opportunities in front of us, and we continue to lean into the current market. Next is mortgage, which keeps generating meaningful underwriting income and risk-adjusted returns. Housing and credit conditions remain favorable, although high mortgage interest rates temper demand for mortgage originations and limit refinancing options. The lack of refinancing has led to a historically high persistency rate of 83%. High persistency stabilizes our insurance in force, which, as many of you know, drives mortgage insurance earnings. Our discipline underwriting process and risk-based pricing model have helped us to build a healthy risk-reward profile for the business we write. The composition of the overall book, with high FICO scores and low loan-to-value and debt-to-income ratios, remains one of the best risk profiles in the industry. International growth, along with our GSC credit risk transfer business, enabled us to profitably manage risk better than more online U.S.-only companies. a key differentiator of our MI global platform. Mortgage insurance plays a valuable role in our diversified business model and continues to generate capital that is and can be deployed into the most attractive opportunities across the enterprise. Moving on to investments now. Since our second quarter call last year, the Federal Reserve has increased, as we all know, the rate eight times for a total of 375 basis points. Given our short-duration portfolio, these hikes have positively affected our net investment income, which is up approximately 22% over the first quarter of 2023. New money rates exceed our book yield, which, along with our strong cash flow, sets the stage for further growth and book value creation. I've had tennis on the brain after watching the incredible Wimbledon final a couple of weeks ago. It was an epic matchup. 20-year-old sensation Carlos Alcaraz taking on all-time great Novak Djokovic. It was a back-and-forth match that lasted nearly five hours before Alcaraz emerged victorious. There was one pivotal moment that will be remembered for years. In the third set, a single game, something that usually takes about three to five minutes, instead lasted 26 minutes. The game included 13 deuces and seven breakpoints. It was an incredible display of tenacity and athleticism, not to mention the mental strength required to remain focused. It was insane. But what really struck with me was that, kind of like this hard market, the game simply refused to end. There were many times where a single winning shot could have ended the game, but it just kept going. About 15 minutes in, it became clear that we just needed to enjoy what we were watching and not focus on the end point. So that's what we're doing with this hard market. Returning with the market serves us with gusto. As always, our goal remains to generate strong risk-adjusted returns in order to create long-term value for our shareholders at lower volatility. The exceptional profitable growth over the last several years has fortified our market presence and helped us achieve one of the most profitable quarters in our company's history. This is a type of well-rounded quarter we've always envisioned, the sweet spot, if you will, and we look forward to building on this momentum in upcoming quarters. I'll cede the court now to Francois, and then we'll return to answer your questions.

Thank you, Mark, and good morning to all. Thanks for joining us today on this gorgeous day in Bermuda. As Mark highlighted, our underwriting and investment teams delivered excellent results across their respective areas in the second quarter, which resulted in a performance that exceeded that from our very strong first quarter. For the quarter, we reported after-tax operating income of $1.92 per share for an annualized operating return on average common equity of 21.5%. Book value per share was $37.04 as of June 30th. up 4.8% in the quarter and 13.5% on a year-to-date basis. Turning to the operating segments, net premium written by your reinsurance segment grew by 47% over the same quarter last year, and this growth was observed in most lines of business. Growth was particularly strong in the property catastrophe and property other than catastrophe lines. with net written premium being 205% and 53% higher respectively than the same quarter one year ago, a reflection of the fact that market conditions in these lines remain very attractive. As a result, the quarterly bottom line for the segment was excellent, with a combined ratio of 81.9%, producing an underwriting profit of $245 million. The accident year XCAT combined ratio was 77.4%. The insurance segment also performed well, with second quarter net premium written growth of 18% over the same quarter one year ago, and an accident quarter combined ratio excluding CAATs of 89.8%. Except for professional lines, which saw a slight decrease in net written premium in our public director's and officer's business due to a more competitive market, all our underwriting units in insurance, both in the US and internationally, saw good growth in the quarter as market conditions remained excellent. Our mortgage segment had another excellent quarter with strong performance across all units, leading to a combined ratio of 15%. Net premiums earned were in line with the past few quarters, reflecting a high level of persistency in our insurance and force during the quarter at USMI, partially offset by lower levels of terminations in Australia and higher levels of seeded premiums. Benefiting our results was approximately $84 million in favorable prior and reserve development in the quarter, net of acquisition expenses, with over 75% of that amount coming from USMI and the rest spread across our other underwriting units. Cure activity at USMI was again very strong this quarter, and our delinquency rate stood at 1.61%, its lowest level since the onset of the COVID pandemic. At the end of the quarter, over 80% of our net reserves at USMI are from post-COVID accident periods. Overall, our underwriting income reflected $116 million of favorable prior redevelopment on a pre-tax basis, or 3.9 points on the combined ratio, and was observed across all three segments, mainly in short tail lines. Current accident year catastrophe losses across the group were $119 million, over half of which are related to U.S. severe convective storms that have occurred so far this year. Pre-tax net investment income was $0.64 per share, up 21% from the first quarter of 2023, as our pre-tax investment income yield was almost up 50 basis points since last quarter. Total return for our investment portfolio was 0.56% on the US dollar basis for the quarter, with most of our strategies delivering positive returns. Our interest rate positioning with a slightly shorter duration helped minimize the impact of the increase in interest rates during the quarter. We remained comfortable with our commercial real estate and bank exposure, which is of high quality and short duration. Net cash flow from operating activities was strong. in excess of $1.1 billion this quarter and continues to provide our investment team with additional resources to deploy into the higher interest rate environment. With new money rates and our fixed income portfolio is still in the 4.5 to 5% range, we should see further improvement in our net investment income in the coming quarters arising primarily from positive cash flows and the rollover of maturing lower yielding assets. Turning to risk management, our natural cap PML on a net basis at the single event one in 250-year return level stood at $1.46 billion as of July 1, or 10.5% of tangible shareholders' equity, again, well below our internal limits. In light of the improved market conditions in the property market, we were able to deploy more capacity, which resulted in significant premium growth for property lines in both our insurance and reinsurance segments. This growth was well diversified across multiple zones. Our view is that the current in-force portfolio with a broader spread of risk across many zones is well positioned to deliver attractive returns. Our capital base remains very strong with $17.4 billion in capital and a debt plus preferred to capital ratio of 20.5%. Even though the results of the past quarter set a high watermark for us on many fronts, we believe the continued hard work and dedication from our teams, serving the needs of our clients every single day, along with our steadfast commitment as disciplined and dynamic capital allocators sets us up very well for future success. With these introductory comments, we are now prepared to take your questions.