Arch Capital Group Ltd. Q2 FY2021 Earnings Call

Good day, ladies and gentlemen, and welcome to the second quarter 2021 Arch Capital Group Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we’ll conduct a question-and-answer session and instruction 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 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 will also 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 host for today's conference, Mr. Marc Grandisson and Mr. Francois Morin. Sirs, you may begin.

Thanks, Liz. Good morning, and thank you for joining our second quarter 2021 earnings call. At Arch, our playbook remains simple yet effective. We protect our capital through soft markets and unleash our underwriters during hard markets. We believe that this time-tested strategy gives us the best chance to generate superior risk-adjusted returns over time. You should expect then from us at this stage of the cycle comes straight from that playbook. As long as rate increases support returns above our threshold, we will continue to grow our writings. We have seen this video before in the hard market of 2002 through 2005, when P&C results generated a sustainable stream of earnings for several years after market prices peaked and were fully earned. So again this quarter, the power of Arch's diversified platform is evident in the strong underlying earnings in each of our operating segments. We delivered a 13% annualized operating return on equity (ROE) and, aided by good investment returns, an annualized net income ROE of 21% this quarter. One item that stands out this quarter was our strong P&C underwriting activity. Our P&C insurance results demonstrate significant improvement in underwriting performance. Better market conditions allowed our teams to expand their overall positioning and grow net written premiums substantially over the same quarter last year. We are now in the sixth consecutive quarter of rate increases at plus 10% this quarter, comfortably in excess of loss cost trend estimates. The higher level of premium earned from the post-2019 policy years is a primary driver of our improving underlying accident year combined ratio. About two-thirds of the combined ratio improvement was due to lower loss ratios, attributable to rate increases and underwriting actions we have taken over the past several years. The balance of the improvement was driven by a lower expense ratio. Production increased across most lines of business and geographical areas as pricing improvements spread. While rate increases have tapered off from previous highs in some lines, we're seeing increases in lines that had been immune to meaningful change. In lines where price increases have eased, we're still obtaining rate increases on improving margins. We estimate that approximately 30% of our insurance premium growth reflects rate increases. About 15% is from higher net retention levels, and the remaining growth comes from new business and exposure growth with existing clients. Both our international and U.S. insurance platforms continue to excel in the current market, with substantial growth in professional lines, programs, property, travel, and accident & health writings. Our reinsurance group also had a quarter of strong growth while producing strong underwriting results. A large portion of this growth results from our ability to leverage our expertise and historical experience as a writer of quota share business. When markets dislocate, our clients need capacity and capital as they seek to reshape their portfolios. That's why since 2019, we have been increasing our participation in side-by-side quota share arrangements. This has always been part of our reinsurance playbook, and based on historical patterns, we believe it's a good place to deploy our capital for the next few years. As you may have heard, this market is notable as rate increases in traditional excess of loss reinsurance lag the insurance rate increases. So our current preference is to be closer to the primary rate increases through quota share with our clients. Property catastrophe excess of loss is one of the few areas where we have reduced premium writings. They are down 26%, as we are not finding enough opportunities that meet our return expectations. However, as you can see in our supplement, premium writings grew substantially in property other than catastrophe and specialty segments. Casualty and marine also produced excellent levels of growth. As with insurance, we expect the ongoing rate improvements to be reflected in our underwriting results over the next several quarters. The Arch reinsurance story is one of providing creative capital solutions during hard markets that enables us to leverage our growth faster than in our primary insurance markets. We have considered this a core capability throughout our history. Our reaction to this market is no exception. All in all, it was a very satisfactory job of seizing hard market opportunities by our team. "Carpe diem," as they say. From a strategic standpoint, it's worth noting that we, along with our business partners, successfully completed the purchase of Watford at the beginning of the third quarter and are focused on working to build a sustainable reinsurance franchise. Allow me now to switch to inflation fears, which continue to be a hot topic for our industry. I want to reiterate our perspective on how we view inflation at Arch. As underwriters, we study inflation on a line-by-line basis to price the business and establish reserves. In some lines like workers' compensation, inflation remains low at this stage, I'd say 0% to 1%. However, in other lines like high excess general liability, we're estimating inflation to be in the 8% to 12% range. As a point of comparison, loss cost inflation from the ground-up has been in a 3% to 5% range for around five years broadly across our portfolio. It's important to consider line of business specifics when we discuss claims inflation. Second, it's worth noting that in every line of business, the inflation rate increases as you move up attachment points. The key in pricing or reserving for an excess policy is to start with the proper ground-up trend and then apply the best curve to select a range for the trend in the upper layers. As is often the case in insurance, we are estimating, and there is a lot of uncertainty around the correct number. Our philosophy is to keep this methodology consistent through the cycle. Third, we also supplement our analysis with some subjectivity. In the current environment and in certain lines, we had to try to account for increased uncertainty, including the possibility of the so-called social inflation. We are typically more willing to adjust the trend above our indications than we are to reduce it, all with creating a margin of safety in mind. This is not a new concept at Arch but a time-tested philosophy that has allowed us to navigate both soft and hard markets through our opportunistic cycle management approach. Let's turn now to our mortgage group, which continues to operate as a well-oiled machine, generating $250 million of operating earnings in the quarter. Our insurance in force remained steady at roughly $278 billion for U.S. primary mortgage insurance. Refinance activity has slowed, and we expect improving persistency throughout the remainder of the year and into 2022. Delinquency rates are decreasing across our portfolio, and we still expect a large portion of delinquencies to cure, based on many factors, including the strong equity position of our current inventory, where more than 95% of delinquent policies have over 10% of equity. New notices of default continue to decline and at 7,400 in the second quarter are better than pre-COVID levels. Outside of the U.S., we increased our writings in Australia as the housing market remains strong. We like the long-term opportunity in Australia, as demonstrated by our announcement to acquire Westpac's LMI business, which we now expect to close later this quarter. Pricing remains competitive, but rational across the mortgage insurance industry as rates have returned to 2019 levels. However, the credit quality of borrowers remains strong, similar to 2016, supporting our confidence in the continued earnings from our mortgage insurance portfolio. As I close my prepared remarks, this quarter I'll borrow from cricket, which is top of mind because this weekend marks Cup Match here in Bermuda, when the entire island goes cricket crazy for a four-day holiday weekend. I think of the current P&C market like being the first team to bat during a cricket test match. Test cricket is one of the few sports that isn't governed by a clock. Unlike games that must be completed in 60 or 90 minutes, test cricket is about scoring as many runs as possible, as long as you are getting favorable balls, or pitches for baseball fans, and for as long as it takes for all of your batsmen to be out. The details are not critical, but the idea is that similar to this market, we're waiting for the right ball and scoring as many runs as possible while we can. Rather than swinging aimlessly, we'll do what we always do, play defensively when we have to but become aggressive and score as many runs as possible when the opportunity arises. We're not worried about the clock running out. We'll just keep scoring runs. Now, I'll hand it over to Francois to run through the financials.

Thank you, Marc, and good morning to all on this first day of the Bermuda Cup Match Classic. Thanks for joining us today. Before I provide more detail on our excellent second quarter results, I should remind you that, 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 Ltd. In our filings, the term consolidated includes Watford. As you know, we closed earlier this month on the transaction we announced late last year to acquire Watford in partnership with Warburg Pincus and Kelso. Concurrent with the closing, we will be making changes going forward in how we report our equity interest in Watford's results, which I will share with you in a few minutes. As Marc shared earlier, we had an excellent quarter with each of the three legs of our stool performing very well, and our investment portfolio also producing solid results. After-tax operating income for the quarter was $407.2 million or $1 per share, resulting in an annualized 13% operating return on average common equity. Book value per share increased to $32.02 at June 30, up 4.8% in the quarter. In the insurance segment, net written premium grew 43.3% over the same quarter one year ago, 38.5% if we exclude the growth due to the COVID-related recovery in our travel, accident, and health unit from the same quarter one year ago. The insurance segment's accident quarter combined ratio excluding catastrophe events was 91.4%, lower by 470 basis points from the same period one year ago. The improvement in the ex-cat accident quarter loss ratio reflects the benefits of rate increases achieved over the last 12 months and changes in our mix of business. In addition, the expense ratio was lower by approximately 180 basis points since the same quarter one year ago, primarily due to the growth in the premium base. As for our reinsurance operations, we had strong growth of 63.6% in net written premiums on a year-over-year basis. The growth was observed across most of our lines, but especially in our casualty and other specialty lines, where strong rate increases and growth in new accounts helped increase the top line. The segment's accident quarter combined ratio excluding catastrophe events stood at 87.1% compared to 87.5% on the same basis one year ago. As we have discussed in the past, we believe the underlying performance of our reinsurance segment is better analyzed on a rolling 12-month basis, which typically smooths out the impact of certain large transactions and/or claims that can impact quarterly results. On that basis, the ex-cat accident year combined ratio stood at 84.3% over the last 12 months, lower by 660 basis points from the prior 12 months, where the improvement almost entirely reflects on the loss side as a result of the rate increases we have observed over the last six-plus quarters. Losses from 2021 catastrophic events in the quarter, net of reinsurance recoverables and reinstatement premiums, stood at $46.5 million or 2.4 combined ratio points, compared to 13.5 combined ratio points in the second quarter of 2020. The activity in the quarter was the result of a series of small events across the globe and some late reported claim activity from the North American winter storms Uri and Viola in February. Following up on the trends we have seen in the last few quarters, the ultimate impact of COVID-19 on our mortgage segment remains very manageable. In particular, the delinquency rate, which came in at 3.11% at the end of the quarter, is now close to 40% lower than it was when it reached its peak during the pandemic at the end of the second quarter one year ago. We had another solid quarter in terms of production. And with refinance activity coming down from prior levels, we saw the insurance in force for our U.S. mortgage insurance book remain relatively stable. Of note, this quarter was the exercise of call features by the government-sponsored enterprises (GSEs) on certain vintage credit risk transfer contracts, reducing the insurance in force for our non-U.S. mortgage insurance portfolio. The overall impact of these calls was an approximate one-time $31 million benefit to our underwriting income, approximately two-thirds of which came from the release of prior year loss reserves and the rest from the call premiums received. The combined ratio for this segment was 26.5%, reflecting the lower level of new delinquencies reported during the quarter. Income from operating affiliates was strong at $24.5 million, mostly driven by an excellent first quarter at Coface. As a reminder, we report our ownership interest in Coface's results on a quarter lag in our financial statements. As regards to Watford, the closing of the transaction on July 1 gave rise to a reconsideration event. As a result, we revisited our Variable Interest Entity (VIE) analysis. Based on the new governing documents of the entity, we have concluded that while we will attain significant influence, we will not control the entity going forward. Accordingly, we will no longer consolidate the results of Watford in our financial results starting with our third-quarter financials, and our 40% share of Watford's results will be reported in the income from operating affiliates line, along with our proportionate share of other operating affiliates, such as Coface and Premia. As a result of the closing of the transaction, we also expect to report a one-time nonrecurring gain of approximately $65 million in the third quarter. Total investment return for our investment portfolio was positive 150 basis points on a U.S. dollar basis for the quarter. Net investment income was $89.4 million during the quarter, up $10.7 million on a sequential basis, driven by lower investment expenses and interest received on funds withheld transactions. The duration of our portfolio remains at one of its lowest levels in our history, 2.31 years at the end of the quarter, reflecting our internal view of the risk and return trade-offs in the fixed income markets. Equity and net income of investment funds accounting for using the equity method returned approximately $122 million during the quarter, a key contributor to the growth in our book value. The effective tax rate on pretax operating income was 7.6% in the quarter, reflecting changes in the full-year estimated tax rate, the geographic mix of our pretax income, and a benefit from discrete tax items in the quarter. Turning briefly to risk management. Our natural catastrophe probable maximum loss (PML) on a net basis decreased to $676 million as of July 1 for the Northeast peak zone down to approximately 5.6% of tangible common equity and well below our internal limits at the single event 1-in-250-year return level. On the capital front, we issued $500 million of 4.55% perpetual fixed rate preferred shares in June. We expect to use the proceeds to redeem all or a portion of our outstanding Series E non-cumulative preferred shares in September 2021 and to use any remaining amounts for general corporate purposes. Separately, we repurchased approximately 7.8 million shares at an aggregate cost of $306 million in the second quarter, bringing our year-to-date share repurchases to over $485 million, or approximately 45% of our year-to-date net income, all while growing our book value and top line. As we have said since our formation 20 years ago, we are strong proponents of active cycle and capital management. We believe this quarter's results demonstrate our ability to execute on this philosophy and lead us to invest in opportunities where we believe the returns are most attractive. At current prices and with the prospect of improving returns, we believe buying back our shares represents another compelling value proposition for our shareholders without compromising our capital flexibility. With these introductory comments, we are now prepared to take your questions.

Thank you. Our first question comes from Elyse Greenspan with Wells Fargo.

Hi. Thanks. Good morning. My first question is about capital. Francois, you mentioned that you bought back less than half of your earnings at the start of the year. Going into the year, you believed you had more than enough capital to support your expected growth. Should we anticipate an increase in capital return in the second half of the year if that statement holds true? Also, can you provide an update on your willingness to actively buy back stock during the wind season, considering it appears you have a good amount of excess capital?

Sure. Regarding your second question, Elyse, yes. In our earlier years, particularly before the mortgage period, we were more cautious with share buybacks during wind season. However, now that we are more diversified, that limitation is less relevant than it once was. As we consider share repurchases and capital deployment in the second half of the year, we do believe that buying back more shares could be a possibility. Our main priority remains investing in and growing the business as effectively as possible. However, as demonstrated this quarter, we managed to achieve both objectives, and if conditions remain stable or reasonable, we anticipate continuing this trend in the latter half of the year.

Okay. And then, in terms of your insurance segment, so you guys still seem pretty positive, right? 30% of the growth came from rate increases in the quarter, positive on pricing, a little bit concern about that inflation, which we've heard throughout the industry. So broadly, as you guys are thinking about the pricing environment as well as just what's going on with inflation, do you have a sense of for how long you think pricing should continue to exceed loss trend, just broadly across insurance recognizing, obviously, its many different lines that come together?

There's a question that, if answered correctly, could lead us to financial success, Elyse. However, it's clear that market momentum is present. As you've heard in other calls, there's a shared push within the industry for rate increases and achieving better rate adequacy. There is an acknowledgment of past losses, including catastrophe losses, as well as uncertainties related to inflation and cyber risks, along with significant property catastrophe events that have taken place. With lower interest rates, there is a consensus that prices need to rise. I want to share a quick story: some of our team members are conducting file audits on the reinsurance side with our clients, who are also our competitors. The prevailing theme in these audits is that the underwriting community realizes that more action is necessary. This is evident in their discussions with brokers. Therefore, I'm confident that we have significant potential for continued pricing improvements.

And then one last one on the reinsurance side, it sounds like, Francois from your comments that the deterioration in the quarter was more just kind of one-off. I guess, as we think about going forward, my question more is, as we've seen the shift to more longer tail lines within that book and away from property, would you expect the underlying loss ratio to deteriorate, or was it just that there was just some one-off factors in the quarter, we could still see improvement in that on a go-forward basis?

Yeah. In terms of modeling, I think it will fluctuate. The numbers I mentioned regarding the rolling 12 months are a good starting point. There will be some variations in the business mix. We wrote more in casualty, but we also increased our specialty lines, which might have better combined ratios. It's difficult to predict exactly what will happen in the coming quarters, but I believe the rolling 12-month number I referenced is a solid point of reference.

Elyse, if I may add to that point. I mean, also bear in mind, at Arch, we tend to be prudent in reflecting all the margin improvement early on. So we'll have to wait and see where the data takes us. I just want to make sure we keep that in mind as we go forward.

Okay. That's helpful. Thanks for the color.

Thank you.

Thank you.

Our next question comes from Jimmy Bhullar with JPMorgan.

Hi. Good morning. I have a question about pricing. Your comments seem quite positive. Could you compare what you're observing in the primary market with the overall trends in reinsurance?

On the insurance side, there's significantly more activity and an increase in prices. This is why, on a quota share basis, although the seeding commissions haven't decreased as much as they might in other tough markets, if you're on a quota share basis, you're effectively participating with your clients in the rate increases. Therefore, the rate increase I mentioned regarding insurance can also be related to the quota share reinsurance participation. The excess of loss typically lags behind a bit. There is some benefit from the underlying rates since the pricing for excess of loss is usually a percentage of the underlying portfolio. So, when there's a rate increase at the primary level, the excess of loss should receive a larger percentage. However, it is reasonable to say that the softer markets resulted in less adequacy and more need for price increases in excess of loss generally. We anticipate that this situation will begin to change soon, with some recognition of the connection to a hardening market. I hope this clarifies things.

And are you equally optimistic, or are there signs because you mentioned, property catastrophe might be slowing down a little bit? But are you equally optimistic about the sustainability of the trend on pricing in both reinsurance and in insurance?

Yes on the excess of loss. Because like I said, if I go back to 2002, 2005 market, I think that the excess of loss market got probably a lot better. It took until like 2004 to get there. So you need a couple of years of primary rate increases to start to find their way onto the reinsurance excess pricing. It's a very normal hardening market. So I'm very encouraged, actually.

Okay. Lastly, you mentioned that credit quality in mortgage insurance is strong. Given the good labor market, how do you see high property prices and inflated home values affecting your view of the business you are currently writing?

If the market were balanced in terms of supply and demand or if supply were abundant, it would raise concerns similar to those we had in 2006 and 2007. However, the current housing supply and demand dynamics should support stable pricing for an extended period. We have a shortage of 1.5 million to 2 million homes in the market, and it will take time for them to become available. Additionally, there is a known issue of underbuilt housing. From our viewpoint, house prices are appreciating, and when analyzing over or undervaluation, our economist's metrics indicate that there are no significant national overvaluations, which is not a concern at this moment. Moreover, mortgage rates remain low at 3%, maintaining affordability relative to historical standards. All of these factors combined suggest a positive overall trend in the market.

Okay. Thank you.

You're welcome.

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

So I think I've asked the same question like from the last two conference calls. I'm going to ask it again. I look at the reserve releases in mortgage. And I look at the reserves per new case, in the 2Q 2021 numbers. And you're reserving more than ever for new defaults or delinquencies, as you're releasing the reserves. Yet the housing prices are appreciating. I'm trying to figure out what the math is about why the potential claim per loss keeps getting worse?

You're asking a very good question, Josh. Looking at the bigger picture, there are still many factors that need to be resolved before we have clarity on how the forbearance loans will turn out. We need to see whether they will cure or become claims, and that process takes 18 months. If we consider the peak months of April and May of last year, that 18-month timeline should conclude in the fourth quarter of this year, barring any changes. At that point, we will have a clearer view on whether our reserves were set too high or not. Currently, we are responding to the data, but we believe there is still much that needs to be addressed before we take any action regarding the current reserve levels. Regarding new delinquencies, there are always adjustments every quarter in terms of averages, incidence rates, and the severity and frequency assumptions we apply to the new delinquency reports. Since we are dealing with a smaller inventory of new delinquencies, there is more variability in how those numbers may play out. Overall, we remain confident in our reserve levels. While it’s possible that we have over-reserved, we will have more information in the second half of the year.

When I examine the reserves, the $55 million set aside for the current accident year period in the fourth quarter raises the question of whether this is an increase in average claims for the entire portfolio, or if we believe that the new claims reported in the second quarter of 2021 may be more severe than the average claims currently recorded.

I believe it's the latter. We did not make any adjustments regarding prior notices that were already in place before the quarter began. The reasoning for the new notices is that their becoming delinquent so late in the process could indicate that they might perform worse than the earlier ones, especially since forbearance programs have been available for over a year. That's part of the reasoning behind these numbers.

Okay. Thank you very much for the update.

Our next question comes from Ryan Tunis with Autonomous Research.

Hey, thanks. Good afternoon, guys. Marc, I guess my first question. Can you hear me?

Yes, we can. Go ahead.

Sorry about that. So I had a cycle management question with property cat. And I'm not being critical. I'm just curious. So a year ago, it looks like you wrote $118 million of premium. And this year you wrote $88 million. So you wrote less. I get that property cat is not the best place to be, but it feels like the rate environment was incrementally a little bit better. So I'm just I guess a little bit curious like what goes into the decision to, as conditions improve, actually decide that in 2Q of 2021, we don't want to write as much as we did in 2Q of 2020?

That's a really good question. Several factors come into play. Firstly, like everyone else, we have a different view on the risk associated with property catastrophe. For instance, we faced a windstorm in January, which influences how we assess non-model losses. Over the past couple of years, we've seen more non-model losses than we anticipated. This leads us to adjust our loss cost expectations and to require a greater margin of safety for returns, which is our primary concern. Another important factor is the allocation of capital. We constantly evaluate where capital can be better utilized. We weigh the risk-adjusted return of catastrophe insurance against other property or casualty options. These decisions are made frequently, almost daily. With a broader range of opportunities in reinsurance, we can manage and optimize our portfolio as we move forward, often looking a quarter or two ahead. It's important to keep an eye on portfolio returns without being overly ambitious. A lesson Paul shared with me long ago is the importance of avoiding bad luck. If you have many opportunities in property catastrophe, it may be wise for a manager to scale back slightly, especially if other lines currently look more attractive. So, we're keeping a cautious perspective on the situation.

Yeah, that makes sense. That's interesting. And then I guess just in mortgage insurance, seeing the attritional loss ratio, I mean yeah pretty much at pre-pandemic levels. I guess I was a little bit surprising just given there are some new notices and I felt like back in 2019 they're almost none. So is this sustainable, kind of, the 15% to 20% attritional, or is it something this quarter that was an unusual tailwind?

Well, I mean attritional excluding prior year development, that's how we think about it. Again I mentioned it in prior quarters where a 20% loss ratio is plus or minus that should be what you should get over the cycle. And there's a bit of noise with the credit risk transfer transaction. So I mean, there's moving parts within that. But yes, 20% is absolutely sustainable.

Got it. And then just lastly just out of curiosity, I was wondering if you guys would be willing to share like an internal view of what your excess capital position is?

Well, that's not something we've disclosed before. I think it's because it's constantly changing. We don’t know what the market will provide us. So while we could give you a number, it may be different tomorrow. We prefer to maintain that flexibility.

I hear you. I thought I'd try.

Yeah.

Our next question comes from Meyer Shields with KBW.

Thank you. I have two basic questions. First, there’s been a lot of discussion at Arch and elsewhere about whether the reserves are prudent given the current uncertainties regarding inflation. Let me rephrase that. Are you now releasing reserves more slowly than you would have in the past due to this issue, or is it related to a current accident year situation?

I believe you share my background as an actuary, so you understand how inflation affects both the current and prior accident years. It's an integral aspect of our reserve assessment. We aim to align historical trends, using a triangle methodology as much as possible, especially if they aren't reflected in our loss development factors. This influences our approach on both ends. Are we releasing reserves? Yes, it seems that we have historically been more cautious in determining our loss estimates. If you review our historical combined ratios within the insurance group, you'll notice that we typically operated at higher levels than many in the industry. This suggests that we were accounting for loss inflation at rates between 3% and 5%. Our perspective has largely remained unchanged, except for certain lines where a more flexible approach may be warranted.

Okay. No I think that's the right call and it makes a lot of sense. Second question, in reinsurance. How should we think about the catastrophe exposure in the non-property cat, property book?

Well, it's part of the $676 million that Francois mentioned. We're accounting for that but it's definitely less of a cat exposure. There is some in there but it's definitely not the driver of the exposure at all. So it depends on what kind of business you look at. The catastrophe load on these premium is anywhere from 5% to 10%, sometimes a bit higher depending on the quota share you're writing. But in a lot of our other specialty quota shares, you had some, but again much, much smaller. So I would say that still the larger contributor to our probable maximum loss is through the catastrophe excess of loss portfolio.

Okay. Thanks, Marc. Thank you so much.

You're welcome, Meyer. Thank you.

Our next question comes from Phil Stefano with Deutsche Bank.

Yes. Thanks and good morning.

Good morning.

One or two focused on the mortgage insurance business. So of the $44 million in favorable development, it seems like just shy of half of that was due to the GSEs and the cancellation of the CRT deal. The other $24 million, give or take, can you give us a sense of the vintage years associated with that, or what's driving that development?

I'll provide a bit more detail. You're correct that just under half of the total came from the GSE call deals. About a third of it relates to adjustments we made to our COVID assumptions, which we have lowered slightly across all our portfolios. This includes U.S. primary mortgage insurance, some CRT deals where we've adjusted reserves, and the international book as well. That gives you some context. Additionally, almost 20% comes from favorable development in runoff businesses such as second lien and student loans, which have been in runoff for a while. I hope this clarifies the breakdown and addresses your question, Phil.

Yes, that's great. Thanks. I think the PMIERs efficiency ratio is what we should discuss next.

No, you go.

Yes. So the PMIER's efficiency ratio is pushing up near 200%. Maybe you could talk to us about the ability to upstream capital? When the GSEs might let you do that, or do you go to the state regulators and contemplate getting permission for a special of some sort?

Yes. As we discussed last quarter, that's in progress. In the second half of the year, we have already started the process to upstream. As you mentioned, the dividend from our regulated entities to the holding company in the U.S. will include both extraordinary and ordinary dividends. We will need to have discussions with the regulators regarding this. I believe we can reassure them that given our current levels of total capital, with some being held in contingency reserves, we can meet their requirements and ours regarding the proposed levels of dividends. So stay tuned, but I am optimistic that we will be able to extract some dividends in the second half of the year.

If I can address for one second, Phil, the GSE. The GSEs are allowing you to do a dividend without any approval at 150% or above right now, PMIER. So at the end of the year, it's going to go down to 115%. So we think we have flexibility even from that perspective even if you consider them as another gatekeeper of that dividend payout.

Okay, Marc. Thank you.

Sure.

Our next question comes from Brian Meredith with UBS.

Yes, thanks. A couple of quick questions here. First, the decline you saw in your property cat reinsurance, I'm assuming that was just a reduction in Florida exposure. And I guess, on that question, what does your Southeastern kind of Gulf exposure look like today versus last year?

It's down compared to last year. Regarding Florida, we did see a decrease in flow. However, if you examine the premium, it's not a direct correlation, Brian. The reduction was also influenced by acquiring a few items to enhance the portfolio. So the decrease isn't solely due to market exposure adjustments aimed at achieving different returns; we also utilized some reinsurance purchases to manage this. Therefore, it isn't just a decline in Florida.

Got you. Got you. And then my second question, is now that the Watford deal is closed. It is in some private hands, no longer a public company. Any material or any meaningful changes in strategy here that you're anticipating with Watford here going forward, different types of business they could write, etc., etc.?

At a high level, while it's still early, I believe you should view Watford as more similar to the Arch Re business in terms of underwriting than it was before. Previously, Watford didn’t cover all the same classes of business and was primarily focused on longer-tail areas due to the higher expectations regarding investment returns. The new business model of Watford aligns more closely with the characteristics of the Arch Re portfolio.

Got you. So results should actually trend towards ultimately trend towards what Arch Re looks like?

Much more so, correct. Yes.

Got you. And then I'm just curious on Watford, is there ability or any contemplation of maybe kicking on some of your mortgage insurance exposure going forward?

We actually write some mortgage on Watford. Yes, there is some already existing. It's actually been one of the things they've done for quite a while. That's also something that the Watford shareholders were very pleased with giving them the opportunity to participate.

The issue with ratings is important, as it affects how comfortable GSE and regulators feel. They will be looking into this as well.

Great. Thank you.

Thank you.

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

Thanks for everyone to be here and listen to our call, and we're off to Cup Match and we'll talk to you next quarter. Thank you.

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