Good day, ladies and gentlemen, and welcome to the Third Quarter 2020 Arch Capital Group Earnings Call. Before the company gets started with its update, management wants to 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 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 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 8-K 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 hosts for today's conference, Mr. Marc Grandisson and Mr. François Morin. Sir, you may begin.

Good morning, Liz. And welcome to our third quarter earnings call on Halloween Eve. You are in for a treat. In our results, you can see tangible evidence of the advantages of the Arch model. By protecting our capital during the soft market years, we are well positioned as each of our segments leans into improving market conditions. Our underwriters are making the most of the hardening property and casualty market, while our mortgage insurance segment is benefiting from record mortgage origination activity this quarter. This year, for the first time in nearly a decade, we've been able to grow significantly and deploy more capital in our P&C businesses that provide acceptable expected returns. And due to our strong financial position, we have accomplished this while maintaining a strong presence in MI, which continues to deliver meaningful returns. Our ability to continually rebalance capital amongst our diverse businesses enhances our total underwriting returns. It also should decrease earnings volatility over time. Since our inception, we have believed in cycle management, and this strategy brings an added margin of safety to our collective underwriting activity. Allow me to elaborate on our third quarter results by touching on three key themes: one, growth; two, margin improvement; and three, capital allocation. First, let's talk about growth. In this quarter, net written premiums in our P&C units grew 25% in total, 17% in insurance and 38% in reinsurance over the same period a year ago. This growth was driven by rate improvements, but also reflects our ability to increase our participations where clients needed additional capacity. In the insurance segment, we continued to obtain strong rate increases in areas like property, D&O and casualty. Group-wide, our rate increase for the third quarter averaged over 11%, and we believe this trend of increasing rates should continue through 2021. At Arch, we have always followed a simple rule: our participation in the business should follow the direction of premium rates. As rates improve, we write more business. When rates decrease, as they did over the past several years, we write less. This strategy takes courage. It will often appear to be an outlier to the market, but being intellectually honest, disciplined, and applying our cycle management techniques is what we're all about at Arch. Obviously, the P&C market is broad, and all opportunities are not created equal. There are areas such as workers' comp where premium rates or conditions are not improving to the levels we believe are needed for an adequate return, and in those instances we manage our appetite accordingly. Despite headwinds from the pandemic, our growth in insurance lines such as E&S property, casualty, and professional lines are a great example of our platform's ability to flex into improved underwriting conditions. Our reinsurance unit has been able to lean into this hardening market both earlier and with more vigor than our primary operations. There are two main reasons for this. First, when the market transitions, needed rate increases compound up the insurance supply chain. Reinsurance is often a leading indicator of what's to come more broadly. Second, reinsurance can provide capacity quicker and in larger amounts, since it can put capital to work through clients' platforms. Of course, share growth is only one part of the equation of growing returns. Let's turn now to margin improvement. We all know that mathematically, rate increases in excess of loss trends lead to margin improvement. The marketplace seems to be supporting the momentum of continued rate increases. We are in the early stages of seeing the benefit of rate-on-rate increases in our operating results. Simply stated, adding the two parts, growth and margin will lead to better returns. Many factors are driving today's P&C markets. These include elevated natural catastrophe loss activity in each of the past four years, weakened reserve positions from soft market years, lower investment yield, and rising claim inflation. Add in a global pandemic that is still ongoing, it's not surprising that market conditions are changing. Now pivoting to MI. Our $33 billion of net insurance written in the U.S. in the quarter was a record for Arch. Low interest rates are producing huge refinance activity and unsurprisingly, some churn in our in-force business. However, MI premium rates remain above pre-COVID levels, and the continued high credit quality of borrowers is generally better than it was pre-pandemic. We continue to face uncertainties such as the economy's health and how the pandemic may ultimately affect individual borrowers. However, we are optimistic that, among other positive factors, recent trends in the U.S. housing market will mitigate the effects of the pandemic. Finally, Arch's ability and willingness to allocate and manage capital remains a key competitive advantage. We always think about balancing our capital deployment over five pillars: into insurance, reinsurance, MI, into our investment portfolio, and lastly into our stock repurchase. Our job is to optimize risk-adjusted returns through capital allocation across these pillars. We see managing the five pillars being similar to coaching a basketball team. We're constantly looking at how we can distribute the ball, i.e., our capital to the right players. For the past several years, we've been able to feed the big 7'7" MI guy down low and rely on him to get easy dunks. Now as a playing field, i.e., the market changes, we've adjusted our tactics slightly and are increasingly relying on our two hot shooters, reinsurance and insurance. MI will still score its fair share of points, but the P&C players are getting more open three-point looks and layups. In short, our game is becoming more complete and diversified. Our ability to adapt to new conditions is what makes us stronger as a team. The market dynamics take me back in time. We have talked about Paul Ingrey's underwriting clock that helps track and measure the phases of the insurance cycle. It's been central to our management philosophy since the beginning and is a helpful reference to understand the underwriting life cycle and assist us in gauging our risk appetite. I recently asked our underwriting teams where we were on the Ingrey clock, and the most common response was around 8:00. If you take a look at the clock in our most recent annual report, you'll see that it's a very nice time to be at Arch. There's a buzz among our underwriters because we've become the first call for so many of our clients, that we have the capacity, the expertise, and the desire to serve them. Now I'll turn the coach’s whistle over to François, as he goes into more detail on our quarterly results. And I look forward to responding to your questions afterwards.

Thank you, Marc, and good morning to all. We at Arch hope that you are in good health. On to the third quarter results. As a reminder and consistent with prior practice, the following comments are on a core basis, which corresponds to Arch's financial results excluding the other segment, i.e., the operations of Watford Holdings Limited. In our filings, the term Consolidated includes Watford. After-tax operating income for the quarter was $120.3 million, which translates to an annualized 4.2% operating return on average common equity and $0.29 per share. Book value per share increased to $28.75 at September 30, up 4.1% from last quarter and 12.2% from one year ago. The increase in the quarter was fueled by the continued strong performance of our investment portfolio and good underwriting results, taking into consideration the elevated catastrophe activity in the quarter and the uncertainty surrounding the current pandemic. Our property-casualty teams continued on their path of solid growth and improved performance as we continue to see strong positive pricing momentum in their markets. Losses from 2020 catastrophic events in the quarter including COVID-19, net of reinsurance recoverables and reinstatement premiums, stood at $203.3 million or 12.5 combined ratio points compared to 5.2 combined ratio points in the third quarter of 2019. The losses impacted both our insurance and reinsurance segments and include $191.4 million from a series of natural catastrophes in the quarter including Hurricanes Isaias, Laura and Sally, the Midwestern Tornado, California wildfires and other smaller events, as well as $11.9 million for losses related to the COVID-19 pandemic. The COVID-19 losses we recorded in the quarter were small, reflecting additional information that became available during the quarter and represent our current assessment and best estimate of the ultimate losses for occurrences through September 30 based on policy terms and conditions including limits, sub-limits, and deductibles. As of September 30, the vast majority of our COVID-19 claims are yet to be settled or paid, with close to 80% of the inception-to-date incurred loss amount recorded as incurred but not reported, i.e. IBNR reserves, or as additional case reserves within our insurance and reinsurance segments. As regards the potential impact of COVID-19 on our mortgage segment, we note that the delinquency rate at the end of the quarter was 4.69%, down from 5.14% at June 30. Our current expectation is that the delinquency rate should be in the 5% to 5.5% range at year-end 2020. While we have seen many positive signs over the last few months that point us to a more favorable view of the ultimate performance of the U.S. mortgage insurance book, many of the uncertainties we identified on our last call remain, in particular, the potential impact from a second wave of infections, potential lockdowns, and the lack of an additional fiscal stimulus package or risk factors that we continue to monitor and evaluate on an ongoing basis. For these reasons, and consistent with our corporate reserving philosophy, we believe it is prudent to take a cautious approach in setting loss reserves across our mortgage insurance book. In the insurance segment, net written premium grew 17.1% over the same quarter one year ago, a strong result demonstrating our ability to achieve profitable growth in this environment. Adjusting for the net written premium decrease observed in our travel, accident and health unit, the year-over-year growth in net written premium would have been 26.5%. The insurance segment's accident quarter combined ratio excluding catastrophes was 94.1%, lower by 620 basis points from the same period one year ago. Approximately 300 basis points of the difference is due to a lower expense ratio, primarily from the growth in the premium base from one year ago and reduced levels of travel and entertainment expenses this quarter. The lower ex-catastrophe accident quarter loss ratio reflects mix change and the benefits of rate increases achieved over the last 12 months. Prior period net loss reserve development net of related adjustments was favorable at $1.1 million, generally consistent with the level recorded in the third quarter of 2019. As for our reinsurance operations, we had strong growth of 38.4% in net written premiums on a year-over-year basis, which was observed across most of our lines and includes a combination of new business opportunities, rate increases, and the integration of the Barbican reinsurance business. The segment's accident quarter combined ratio excluding catastrophes stood at 83.1% and compared to 92.8% on the same basis one year ago. The year-over-year movement is primarily driven by a more normal level of large attritional losses compared to a year ago and rate change activity over the last 12 months. Most of the remaining difference is explained by operating expense ratio improvements, primarily resulting from the growth in earned premium. Favorable prior period net loss reserve development, net of related adjustments, was $40.8 million or 7.4 combined ratio points compared to 4.0 combined ratio points in the third quarter of 2019. The development was mostly in short-tail lines. The mortgage industry had a record-breaking quarter in terms of net insurance written, and we certainly followed suit with this quarter's net insurance written of $32.8 billion, a full 30% higher than our prior high-water mark. Offsetting this record level of production was the high level of refinancing activity across our portfolio, with the net result being a slight reduction in our insurance in force. The combined ratio was 64.2%, reflecting the lower delinquency rate observed during the quarter. The trends we saw this quarter were favorable relative to last quarter, but the game is far from over. The expense ratio was slightly lower over the same quarter one year ago. And prior period net loss reserve development was favorable at $4.5 million this quarter. Total investment return for the quarter was positive 230 basis points on a U.S. dollar basis as the strong recovery in the capital market produced healthy returns across our entire portfolio. Returns in our equity and alternative investments contributed approximately 40% of the total return for the quarter. The duration of our investment portfolio remained basically unchanged from the prior quarter at 3.21 years. The effective tax rate on pretax operating income was 4.8% in the quarter, reflecting a change in the full year estimated tax rate, the geographic mix of our pretax income, and a 10 basis point benefit from discrete tax items in the quarter. As always, the effective tax rate could vary depending on the level and location of income or loss and varying tax rates in each jurisdiction. We currently estimate the full year tax rate to be in the 8% to 10% range for 2020. Turning briefly to risk management. Our natural catastrophe P&L on a net basis increased to $918 million as of October 1, which, at approximately 8.4% of tangible common equity, remains well below our internal limits at the single event 1-in-250-year return level. The growth in the P&L this quarter is attributable to our E&S property unit within the insurance segment, which increased its writings in an improving marketplace. On the capital front, the increase in interest expense this quarter was mainly the result of the issuance of the $1 billion senior notes we issued in June 2020. So far, we have been able to fund our recent growth with our existing capital base. And our balance sheet remains strong, with a debt plus preferred leverage ratio of 23.1% that remains well within a reasonable range. As for our U.S. mortgage insurance operations, the mortgage insurance-linked notes market has recovered to a great extent from the lows we saw at the onset of the pandemic. Earlier this week, we priced our third Bellemeade transaction of the year at terms that are getting closer to what we saw in 2019, both in structure and price. Our latest transaction will provide 6.5% of coverage in excess of a 2.5% attachment point, both expressed as a percentage of the risk in force. Including this transaction, the Bellemeade structures currently provide approximately $3.9 billion of aggregate reinsurance coverage. The fact that this market has recovered as extensively as it has in just over 7 months, with investors more and more comfortable with the exposure they are assuming, is quite telling and provides support to our current assessment of the health of the U.S. housing market. With these introductory comments, we are now prepared to take your questions.

First question comes from Elyse Greenspan with Wells Fargo.

My first question is on the capital allocation, so what you laid out, five pillars. I just want to confirm, I guess, based off of how you were talking. It sounds like share repurchase is left kind of on the chain right now. And I guess because it seems like you have such good growth opportunities that you could put your capital to use just basically to incrementally add to your insurance and reinsurance writings? Am I understanding that correct?

I want to clarify that I don't mean to rank the options in any order. They all seem equally appealing at this time. We are continually exploring opportunities across various sectors of our business. I didn't intend to imply that stock repurchase is the least attractive option. Rather, it's part of the overall discussion. It seems that, for the first time in a while, all five players are actively seeking to be involved and contribute. I emphasize that our main priority is to allocate capital to our underwriting units, provided the returns are favorable. This is currently a simpler area for deployment. Overall, all options are in play, and everyone's engaged.

Okay, that's helpful. My second question is regarding your insurance underlying margin, which was 94% this quarter. Arch aimed for a mid-90s range, and it seems you have achieved that, but you also mentioned a rate increase of around 11% in your business. This suggests that you haven't fully realized that yet. As we consider how the current rate and potential additional rate increases could affect your margins in 2021, do you have a new target for that business? Also, how should we view the margin profile now that you've reached the target you set for the market?

Yes. Let me revisit the 95% combined ratio I mentioned about three years ago. That was intended as an aspirational target based on our business mix and market opportunities at the time. However, things have changed. We are moving in that direction positively, and the market is certainly aiding us. We continue to analyze each line of business and the return on equity for each. I would suggest that some lines may fall below the 95% combined ratio while others might perform better. The combined ratio was initially aspirational. We must remember that COVID-19 is still a factor, and interest rates have dropped significantly since three years ago. This means we may need additional rate increases beyond what the combined ratio suggests to achieve the returns we would have expected historically at 95%. This process involves continuously adapting to current investment yields. While there are no specific targets for the combined ratio, we do have targets based on returns. I would agree that with the 140 to 150 basis point decrease in interest rates, the combined ratio would likely need to decrease mathematically to yield equivalent returns.

Okay. That's helpful. And then last question, you mentioned taking a cautious approach to reserving within your mortgage book. And then I think you also laid out that default rate to get to 5% to 5.5 by the end of the year. And so I'm just trying to understand like as the default rate, I guess, your expectation is it will go up a little bit from where it sits today. And I'm assuming that you'll continue with the same conservative approach that we saw in the third quarter. So how should we think about kind of the combined ratio? You've been giving some metrics for how that business could trend. And you've obviously come in better than expected in the second and the third quarter. Do you have an expectation for how that could ultimately trend into Q4? And I imagine if you want to provide initial color on 2021.

Yes, I'll address that, Elyse. To be clear, I take responsibility for not forecasting combined ratios or delinquency rates effectively over the past two calls. We're trying to avoid poor forecasts. While we are pleased that delinquency rates have decreased, we previously mentioned an expectation of around 8% by year’s end, and it seems it will not be as severe based on current information. There are still a few months left, but we saw some positive indications this quarter. However, it's difficult to determine how this translates to the combined ratio since we are still uncertain about the duration of the pandemic. The forbearance programs are currently scheduled to end, but their extension is uncertain. Transitioning from forbearance to regular delinquency presents many unknowns, making predictions challenging. We're taking it one quarter at a time and are satisfied with our current situation. While this is reassuring, we acknowledge that the situation is ongoing. Hopefully, my forecast of 5% to 5.5% for delinquency will turn out to be high, but we'll reassess in a few months.

Our next question comes from Jimmy Bhullar with JPMorgan.

First, I just had a question on how you're thinking about pricing, reinsurance pricing as a buyer of reinsurance? And how should we think about your sort of overall exposure, especially to catastrophe as you're entering 2021? Are you, given better pricing, you can hold more exposure? Or maybe should we assume that you'll keep your retention sort of similar and be a buyer of record regardless of prices?

The short answer is that we don't know yet. We'll have to see what the renewal brings for our reinsurance team regarding inward placements, especially for our E&S property. We need to evaluate the type of exposure and margins we are receiving and then reassess what our strategy should be. Acquiring reinsurance is similar to raising capital; there are costs involved. Therefore, we will conduct a straightforward analysis of our capital usage and associated costs. Our approach is to take a comprehensive economic view, particularly concerning our property catastrophe exposure. However, we are also cautious about not overstretching our capital. We will always purchase reinsurance to some degree, but the key question is the level, quantity, and pricing. We prioritize stability, often trading it for slightly lower margins, which will be part of our strategy. We are positioned to benefit in both markets, looking for rate increases on the insurance side while finding ways to procure reinsurance effectively. Additionally, we are seeing improvements in the assumed market. It's too early to predict the exact outcomes, but everything remains open for discussion.

Okay. Regarding Watford, you increased the price. There's pressure to raise the yield again. At what point does the deal become unprofitable? Are you already at that point? Do you have any thoughts on how you're approaching this situation?

We did not raise the price. We have a signed agreement with Watford and are in the process of obtaining regulatory approvals. However, there is another party that Watford is considering, which they feel they need to evaluate. At this stage, the current announcement remains valid. Depending on their decision, we may decide to take a different approach, but for now, we cannot provide further details.

Our next question comes from Mike Zaremski with Crédit Suisse.

Yes. Focusing on the reinsurance segment, robust growth. Thanks for the commentary, bullish commentary. If we look at the underlying accident year loss ratio, I mean actually expense ratio too, so just a lot of improvement. Anything we should be thinking about? Anything to call out? Or is this just market conditions and operating leverage that you're benefiting from?

The reinsurance group has experienced significant growth, which largely explains the decrease in the expense ratio. Regarding the loss ratio, we typically assess reinsurance performance over a 12- to 18-month period due to the heightened volatility in that sector. The mix of business shifts over time, and while our reinsurance team maintains stable relationships, there are many factors at play including cede and market opportunities. Consequently, the loss ratio can vary significantly from quarter to quarter, primarily due to the volatility in reinsurance results.

I understand. Regarding the expense ratio, some of that will be reflected soon. As for the mortgage side, I believe you mentioned that ILN pricing has seen significant improvement. I'm trying to monitor overall ILN pricing, and it seems to still be about double what it was before the pandemic. However, it’s possible that Arch's pricing is better than what I'm perceiving, or perhaps I’m mistaken.

Yes, there are two aspects to consider: the structure, particularly the attachment points, and the pricing. This is our third transaction and the first one of the year. We were the first to take action after the pandemic. At that time, investor appetite was not as strong as it had been previously when our attachment point was significantly higher. In the second transaction, the attachment point decreased with slightly improved pricing. With our latest offering, we are back to the same 2.5% attachment point we experienced before COVID, which is intentional. When adjusting for risk, pricing is still up, but not at pre-COVID levels; it's certainly not double that amount and is much better than previous figures. Additionally, the quality of the portfolio has improved. It’s challenging to make a direct comparison, but overall and directionally, we are pleased with the progress we are making.

Okay, I understand. That’s helpful because it seems you're explaining it better than we assumed. Lastly, regarding mortgages, you mentioned that the delinquency rate hasn’t increased as much as expected. As we approach November, have you noticed any uptick in the delinquency rate over the past two weeks?

So last few weeks, it's been actually keeping in the same general direction that we saw in the third quarter. So it hasn't picked up. Flattish, I'd call it. We got a couple of months to go. We'll see how things play out, but that's kind of what we're seeing.

Our next question comes from Josh Shanker with Bank of America.

Two questions, one just to understand accounting and the other one is about Watford. On the accounting, you had a decline in delinquencies due to cures of 6,000 approximately, but you took up reserves. I know you can't really reserve for loss that hasn't happened yet, but it looks like you're reserving for these new claims at about $12,000, $13,000 per claim compared to a historical average of $4,000 to $5,000 per claim. Am I doing the math correctly? And can you explain sort of how you think about that in the books? I think in the first quarter, you also took up reserves more than typical because you can only take them up when you have claims. But can you walk through that a little bit?

Yes, we did increase our reserves this quarter primarily due to the delinquencies we experienced in the second quarter. Your calculations are accurate. However, it’s essential to consider that this was part of a reserve-strengthening exercise as we reassessed our position. Each quarter, we carefully evaluate our situation. Given what we know and what remains uncertain, we decided to be cautious. There was approximately a $45 million adjustment in reserves for the third quarter related to Q2 delinquencies. After factoring that in, you should see claim levels or severities that align more closely with what you might expect.

So along those lines, is there a reason to believe that the severity of the losses are going to be different than historical severities? I can understand because there's not frequencies and you can't really take frequencies until you get a claim. But is there reason to be more cautious surrounding severity in this pandemic?

We don't see it. The only adjustment obviously that what we're reporting in our supplement in terms of paid severities is lower than what we're seeing from the new delinquencies, right? New delinquencies, we mentioned it last quarter at about a $65,000 or so per notice of default. This quarter, it's right around $60,000. So I mean it's certainly higher because it's more recent loans that are going delinquent versus what the loans we paid on in the quarter. So that's the only adjustment. But in terms of percentage of the insured value or the insurance in force or the risk in force, we don't at this point believe that it's going to be materially different than what it's been in the past.

Okay. And then on Watford, we don't know how it's going to turn out. But your own stock trades around book value. The offers for Watford are around 0.8x book. I'm not sure, and maybe you have some thoughts on whether Watford is a better investment at 0.8x book than Arch is at 1x book. But if you don't buy in Watford, it would suggest that you have a chunk of excess capital that you were already allocating towards financial uses. Can we expect that your interest in buying business you already know is attractive, even given the market opportunities here?

I think we made our position clear by presenting our offer, and that’s where we will leave it, Josh. We still believe that Watford is a good and valuable platform.

But clearly Arch is a more valuable platform than Watford. If you're willing to buy in Watford stock, shouldn't you be willing to buy in Arch stock as well?

I think the answer is always yes. We're always looking at the possibility of buying our stock. And certainly, like I said before, five players on the court, I think that the share repurchase is really attractive, as you would expect me to say as the CEO of the company.

Our next question comes from Yaron Kinar with Goldman Sachs.

I do want to start by thanking you for giving a basketball analogy, so I can actually understand what's going on. I was worried you'd give a hockey analogy. And my first question goes to the slight increase in COVID losses in the quarter. Can you maybe talk about what drove that specifically? I guess specifically, what I want to get at is does it have anything to do with the FCA court cases over in the U.K. and how you're thinking about your overseas business interruption exposures?

Yes. It's really in two parts. On the insurance side, it mainly relates to our travel book in the U.S., with no connection to the FCA ruling. The slight increase in reinsurance is concerning property exposures, primarily from Europe. It has some aspects of business interruption, but that's essentially it. I would describe it as new information coming in, with nothing significant that would prompt us to revisit our decisions. As for the FCA, we haven't made any changes. The ruling remains as it is, and we have fully reserved for it, which doesn’t alter our position.

The rest of the portfolio, Yaron, for what it's worth, and we mentioned that on prior calls, is that we have the vast majority, almost totality of our parties have the exclusions that would protect us somewhat from a deviation. So this is nothing in there to really think about.

So listen, it's an excellent question, and we shouldn't shy away from it because we do think that it is really critical to most of our underwriters. And they have to be very much aware of various risks that are out there. And we keep working with our reinsurance brokers as well to adjust for potential spreads, right? That's something that we pay attention to heavily. But there's definitely a lot of work going on across all teams to ensure that we consider every layer of exposure potential.

And this is significantly more complicated than it has historically been. But I do think that we've worked hard to ensure we have the right coverage and the adequate reserve levels to account for the exposures we have in the market.

I’m not showing any further questions. I would now like to turn the conference over to Mr. Marc Grandisson for closing remarks.

Thank you, everyone. Looking forward to the last remaining couple of months in the year, and I hope you have a good one.

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may all disconnect.