Arch Capital Group Ltd.

Good day, ladies and gentlemen, and welcome to the Q3 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 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 securities laws. These statements are based upon management's current assessments and assumptions and are subject to a number of risks and uncertainties. Consequently, actual results may differ materially from those expressed or implied. For more information on the risks and other factors that may affect future performance, Investors should review periodic reports that are filled 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 hosts for today's conference. Mr. Mark Grandison, and Mr. Francois Morin. Sirs, you may begin.

Thank you, Gigi. Good morning, and thank you for joining our third quarter earnings call. I hope everybody is safe and well. Yesterday, we reported another excellent quarter highlighted by strong performances from each of our three operating segments that resulted in an annualized operating return of 25%. and a 4% increase in book value per share. Overall, our teams capitalized on good underwriting conditions and relatively light catastrophe losses to produce an outstanding $721 million of underwriting income in the quarter. Our property casualty teams continued to lean into favorable market conditions to write $3 billion of net premium, up 26% from one year ago. mortgage insurance once again delivered impressive, high-quality underwriting earnings that we redeployed into our P&C segments where opportunities abound. Broadly, we continue to achieve rate increases above loss trend in most sectors of the P&C market. Although rate increases are slowing in some lines, they are reaccelerating in others, which is a good reminder that there is not a single insurance cycle but many. As always, ARCH is well positioned to navigate across these many cycles by reallocating capital to the segments with the best risk-adjusted returns. One of our core differentiating principles is that our underwriters are aligned with our shareholders through our unique compensation structure. Our underwriting teams are always seeking to maximize opportunities as long as they meet our shareholders' targets. As we near the end of 2023 and look ahead to 2024, I believe that although the dynamics may shift, this hard market will continue to support profitable growth. Let's take a moment to recap the current state of the market and where we are likely headed. I see it as a play in three acts. The first act, the current hard market, started in primary liability insurance in 2019 and then has a unique circumstance of a two-year pause in claims activity due to a global pandemic. The second act introduced Hurricane Ian as a main character, where property reinsurers had to adjust both their pricing and risk appetite. In addition, capital got more expensive and the industry had to respond to meet new expectations from investors. While property has been the most recent driver of this market as we move into Act 3, We are faced with increasing evidence that casualty rates, widely underpriced and oversold during the last half market, need to increase. We expect this third act of the extended hard market, already one of the longest in memory, to persist until the industry's reserving issues are resolved and until casualty rates generate positive results. ARCH is well positioned to capitalize on this operating environment. As new hard market underwriting opportunities arise, our incredibly nimble reinsurance group allows us to grow more quickly and significantly than in our reinsurance group, and is therefore where we are most likely to deploy capital first. Today, market trends point to a reinsurance-driven GL hard market, and we stand ready to act. The third act has barely started, but things are very promising for ARCH. Now some color on our operating segments. Our reinsurance group has once again driven our growth with third quarter net premium written of 1.6 billion up 45% from the same quarter in 2022 and 60% over the last 12 months. Underwriting performance in the reinsurance group was excellent with a combined ratio of 80% for the quarter. Our expectation is that we will continue to see hard property market conditions through next year's renewal cycle, as uncertainty and lost activity remains elevated. As noted above, we expect increased opportunities in liability as well. Our insurance group also remains in growth mode in both our North American and international units. While net premium written in the insurance segment up 16% over the last of the past 12 months are more modest than in reinsurance. They are more broad-based because of our focus on small and medium-sized specialty accounts. Underwriting income continues to build with increased earned premium and a strong combined ratio of 90.9%. Today, there are still plenty of opportunities to grow profitably in insurance. Property and short-tail lines pricing and terms and conditions remain very strong with rate increases in excess of 15%. The NS casualty pricing is increasing in response to overall casualty trends in the market and our programs unit continues to achieve rate increases above trend. Professional liability rates softened in a quarter, with net premiums written down 9% in the third quarter of 22. We share the marketplace sentiment about the D&O segment, where both IPO and NNA activity decreased, at the same time as rigged pressures from competition and security staff action activity increased. However, returns in that segment are still strong. In the same vein, we maintain a positive outlook on cyber pricing on an absolute basis despite rate decreases in the 15% range. Our outstanding mortgage group continues to deliver quality earnings for our shareholders as higher persistency of our in-force portfolio helped offset the slight decrease in NIW, which has been affected by lower mortgage originations. Although we tend to focus our comments on the U.S. primary MI market, it is worth noting that nearly 40% of our mortgage segment underlying profits this quarter came from non-U.S. operations, compared to just over 10% in 2017. International business represents a significant growth opportunity for the mortgage group at ARCH, and our strategic decision to diversify our mortgage operations is yielding positive results that further differentiate ARCH from our competitors. We are currently in a positive cycle on the investment side of our business, where increasing cash flows from growth are being invested into today's higher yield environment. New money rates are well in excess of our book yield, which should continue to boost our investment income over time and provide us with an additional ongoing tailwind. It's late October, which for baseball fans means it's time for the World Series. Baseball is somewhat unique in that it's one of the few team sports that isn't limited to a specific length of time. You can score as many runs as possible until the other team gets three outs. To me, the current hard market feels like a baseball game. We know there's only nine innings to be played, but we have no idea how long those innings will take. we've got a great lineup we're happy to keep hitting our singles doubles and occasional home runs until the inning is over at arch we remain committed to being good stewards of the capital entrusted to us we do that by following a tried and true data-driven approach that maximizes the capability of our diversified platform diligently adheres to its cycle management philosophy and is centered around superior selection and prudent preserving all the while our underwriters are fully aligned with our shareholders these principles are foundational to our playbook and underscore our long-term commitment to superior value creation as we close out 2023 we have significant momentum in all three of our businesses and a reliable and high quality earnings engine in our mortgage group that are helping fuel our growing investment base all the pieces are fitting together nicely and we're well positioned for the future Now I'll call Francois up from the on-deck circle, and we'll return to answer your questions shortly.

Francois? Thank you, Mark, and good morning to all. Thanks for joining us today. To add to the baseball theme, I would also emphasize that while this long winning streak has certainly been fueled by a timely and dynamic offense, we're also very much aware that team defenses play an important role in our success. We've been working hard not to waste any offensive production with careless errors, and by executing well at the plate and on the field, we've produced exceptional third quarter results from high quality earnings across all our platforms. The highlights of this team effort are numerous and include after-tax operating income of $2.31 per share, for an annualized operating return on average common equity of 24.8%, and a book value per share of $38.62 as of September 30, up 4.3% in the quarter and 18.4% on the year-to-date basis. Similar to last quarter's results, our reinsurance segment grew net written premium by 45% over the same quarter last year, led by the property other than catastrophe line, which was 73% higher than the same quarter one year ago. As for our property catastrophe business, it's worth mentioning that the net written premium in the third quarter one year ago included approximately $34 million of reinstatement premiums, mostly as a result of Hurricane Ian. If we adjust for the impact of reinstatement premiums, our growth in net written premium for this line would have been approximately 64% year-over-year. The quarterly bottom line for the segment was excellent with a combined ratio of 80%, 73.5% on the next year ex-cap basis, producing another running profit of $310 million. The insurance segment had another very strong quarter with third quarter net premium written growth of 11% over the same quarter one year ago. Similar to last quarter's results, we experienced good growth in most lines of business, with the main exception being professional lines, where the market remains competitive, particularly in public directors and officers' liability. If we exclude professional lines, net written premium would have been 20% higher this quarter compared to the same quarter one year ago. Overall, market conditions for our insurance and reinsurance segment remain attractive, and we expect the returns on the business underwritten this year to exceed our long-term targets. by a solid margin for some business units. Profitable growth during periods of favorable market conditions is one of the hallmarks of our cycle management strategy, and the current hard market is definitely giving us the opportunity to deploy meaningful capital in many areas. Our mortgage segment's batting average has consistently been a lead leader, and this quarter was no different with a 4.7% combined ratio. Net premiums earned were in line with the past few quarters across each of our lines of business. Included in our results was approximately $98 million of favorable prior reserve development in the quarter net of acquisition expenses, with over 75% of that amount coming from USMI and the rest from other underwriting units. Our delinquency rate at USMI remains low based on historical averages. and close to 85% of our net reserves at USMI are from post-COVID accident periods at the end of the quarter. Across our three segments, our underwriting income reflected $152 million of favorable prior development on a pre-tax basis for 4.7 points on the combined ratio, and it was observed across all three segments driven by short deadlines. Current accident year catastrophe losses across the group were 180 million, approximately half of which are related to U.S. severe convective storms, with the rest coming from the Lahaina wildfire, Hurricane Adalia, and other global events. Pre-tax net investment income was 71 cents per share, up 11% from last quarter, as our pre-tax investment income yield was up by approximately Total return for our investment portfolio was a negative 40 bps on a US dollar basis per quarter as our fixed income portfolio was impacted by the increase in interest rates during the quarter and most other asset classes and negative returns in line with broader financial market indices such as the S&P 500, which was down approximately 3.7% in the quarter. Net cash flow from operating activities has been very strong so far this year. in excess of $4 billion, which has helped grow our invested asset base by approximately 20% in the last 12 months. With new money rates in our fixed income portfolio comfortably above 5%, we should see continued meaningful tailwinds in our net investment income. Turning to risk management, as of October 1 on a net basis, our peak zone natural account PML for a single event, 1 in 250 return level, remained basically unchanged on the dollar basis from July 1, and now stands at 10.1% of tangible shareholders' equity, well below our internal limits. Our capital base grew and got stronger during the quarter and now stands at $18 billion. Our leverage ratio, represented as debt plus preferred shares to total capital, is currently under 20%, as opportunities arise. With these introductory comments, we are now prepared to take your questions.