Arch Capital Group Ltd. Q1 FY2022 Earnings Call

Good day, ladies and gentlemen, and welcome to the First Quarter 2022 Arch Capital Group 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 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 host for today's conference, Mr. Marc Grandisson and Mr. Francois Morin. Sirs, you may begin.

Thank you very much. Good morning, and welcome to Arch's earnings call for the first quarter of 2022. Arch delivered a strong first quarter, as our dynamic capital allocation and cycle management strategy combined with strong underwriting skills delivered a 13.6% annualized operating ROE. This past quarter provided yet another reminder that we live in a world of uncertainty. The war in Ukraine has affected countless lives and initiated a humanitarian crisis that is still unfolding and the pandemic continues now into year three. In addition to the war in Ukraine, global inflation and supply chain issues pushed interest rates up, which in turn led to investment markdowns in the quarter. In spite of these headwinds for our industry, we demonstrated the effectiveness of our diversified platform as: one, we grew premium above market average again. Two, repurchased 5.6 million shares; and three, generated a strong operating ROE. Our objective remains as always to deliver long-term value for our shareholders using all the levers available to us. The underlying fundamentals of our businesses continue to improve as we benefit from better market conditions in the P&C industry and execute our cycle management strategy where we actively allocate capital to the most attractive sectors of our business. Our P&C operations generated $2.3 billion of net written premium in the quarter, which represents an increase of 18% from the same quarter in 2021 and speaks to our confidence in the improving underwriting conditions in our P&C operations. Mortgage insurance contributed substantial underwriting profit in the quarter and insurance in force grew modestly again highlighting that mortgage remains a positive differentiator of our business model. Now, inflation is top of mind for everyone in the P&C industry, which to its credit has historically been adequately responsive to inflation trends. Inflation is not a new phenomenon and in fact it permeates discussions in evaluating claims all the time in an insurance company. As such, our focus is always on proactively incorporating new data into our reserving and pricing. We believe that this focus in addition to increased future investment returns and reserving prudently will help mitigate inflation's impact. As far as our mortgage business is concerned, inflation mainly has a positive effect, as it increases homeowner equity, which again mitigates potential losses. I'll now share a few highlights from our segments. Across most lines our P&C units remained in a growth phase of the underwriting cycle according to the falling rates insurance clock. In the quarter, our P&C net premiums earned grew by 25% over the first quarter of 2021, as we continue to earn in the rate increases of the past 24 months. Our data indicates that we are still experiencing average rate increases in excess of expected loss costs. In Specialty Insurance, underwriting conditions remain very good, as pricing discipline, terms and conditions and limits management are stable across most markets. This stability combined with the uncertainties I mentioned at the beginning of this call should help keep the market discipline and sustain rate increases. Our specialty business in Lloyds and our UK regional business delivered strong growth in the quarter as our European insurance operations now represent 30% of Arch's total net written premium, up from 20% pre-pandemic. We are pleased to see the positive results of the investments we made into this platform prior to 2020. We also created meaningful growth across our U.S. operations in the quarter, primarily in professional liability, including cyber, as well as travel where we believe relative returns are attractive. On the reinsurance side of our business, the emphasis remains on quarter share treaties over excess of loss reinsurance. This allows Arch to participate in the rate increases on primary insurance while improving the balance between risk and return. Overall in our Reinsurance Group, growth opportunities remain strong. Since it's been a talking point on prior calls, it’s worth noting that although property cat rates have improved in response to elevated loss activity in the past few years, we have remained disciplined and have not allocated materially additional capital to this line as we maintain our view that other lines of business have better risk-adjusted returns. Turning now to the mortgage segment, which once again delivered excellent underwriting results as we continue to benefit from strong housing demand and excellent credit conditions. Delinquency rates on our MI portfolio continue to trend to historically low levels and cures on delinquent mortgages in our portfolio resulted in favorable prior development in the quarter. The increase in mortgage interest rates currently at 5% for 30-year fixed-rate mortgages is a steeper rise than we have seen in decades. These higher rates have dramatically curtailed refinancing. However, our MI business is far more geared to the purchase market, which continues to benefit from strong demand and limited housing supply. Of note, the decline in refinancing activity improves persistency which in turn should improve returns on our in-force portfolio. While the rise in mortgage rates may ultimately cool demand and slow the rapid home price appreciation of the last year, so far, we have yet to see demand weaken and we expect home prices to continue to rise, albeit at a slower pace. Again, as mentioned earlier, rising home prices increase equity for homeowners, which ultimately reduces the risk of claim in mortgage insurance. So our perspective is that this expected future equity buildup and the strong credit profiles of borrowers should strengthen the resilience of our in-force mortgage portfolio. Moving forward, our diversified platform and cycle management philosophy will enable our MI team to continue to make measured responsible decisions with our capital. Our MI Group has the flexibility to grow or moderate the business they choose to write based on their view of market conditions. A few brief notes on investments, where net investment income was down from last quarter, as we reduced risk positions primarily equities given increasing market volatility. Rising interest rates also caused mark-to-market losses in the quarter. However, the relatively short duration of our investment portfolio, as well as our healthy cash flow will naturally allow us to reinvest at higher interest rates, which should be reflected in future quarters. In closing, even with current uncertainties, opportunities exist. In the quarter, Arch was able to deliver strong results with positive growth across its businesses and we're well-positioned to sustain our growth trajectory in this favorable P&C market. We've consistently demonstrated our ability to allocate capital effectively to the areas of our business with the most attractive returns. As you know, with Arch, we are constantly looking for and seizing the opportunities that offer the best returns for our shareholders.

Thank you, Marc, and good morning to all. Thanks for joining us today. As Marc shared earlier, our P&C units remained on their path of underlying margin improvement, while the Mortgage Group delivered another quarter of strong underlying performance, which was supplemented by solid cure activity in their insured loan portfolio. Overall, our results translated into an after-tax operating income of $1.10 per share for the quarter and an annualized operating return on average common equity of 13.6%. In the insurance segment, net written premium grew 21.3% over the same quarter one year ago. Growth was particularly strong within our professional liability and travel business units and was achieved both in North America and internationally. Underwriting performance was excellent with an accident quarter combined ratio, excluding catastrophes, of 90.8%, a 250 basis point improvement over the same quarter one year ago. Similar to last quarter, a change in our business mix as a result of more pronounced growth in lines of business with lower loss ratios helps explain some of the 470 basis point improvement we observed in our underlying loss ratio. This benefit was slightly offset by a higher acquisition expense ratio. Increased contingent commission accruals on profitable business and lower levels of ceded business for lines with higher ceding commission offsets also slightly increased the expense ratio. As we have said before, our focus remains on improving our expected returns through a variety of levers, and we are encouraged to see that our efforts are paying off for our shareholders. In the reinsurance segment, it’s worth mentioning that reinsurance agreements that were put in place at the time of the closing of the Somers acquisition in the third quarter of last year made comparisons from the current to prior periods imperfect. For example, while our reported growth in net written premium remained solid at 14% on a quarter-over-quarter basis, it would have been 26.6% after adjusting for the Somers session. The growth came primarily in our casualty and other specialty lines where rate increases, new business opportunities and growth in existing accounts help increase the top line. The segment produced an ex-cat accident year combined ratio of 82.7%, an excellent result, as we continue to enjoy healthy underwriting conditions in most of the lines we write. Losses from first quarter catastrophic events, net of reinsurance recoverables and reinstatement premiums stood at $85.8 million or 4.0 combined ratio points, compared to 10.5 combined ratio points in the first quarter of 2021. Approximately two-thirds of the estimated losses came from the Russia invasion of Ukraine, with the rest coming from other global natural catastrophe events including the Australian floods. Our mortgage segment had an excellent quarter with a combined ratio of 3.1%, due in large part to favorable prior year development of $105.6 million. In line with last quarter's results, net premiums earned decreased on a sequential basis, due to a combination of higher levels of ceded premiums, a lower level of earnings from single premium policy terminations and reduced US primary mortgage insurance monthly premiums, primarily from recent originations, which remain of excellent credit quality. Production levels were down slightly from last quarter, but certainly in line with seasonal trends and new purchases and diminishing refinancing opportunities for borrowers. As we have discussed on prior calls, one of the benefits of higher interest rates is an improving persistency rate, which now stands at 66.9% and should continue to increase throughout 2022. Ultimately, higher persistency benefits our insurance in-force and should result in a stable base of premium income to help drive underwriting income for the rest of the year and beyond. With respect to claim activity, approximately three-quarters of the favorable claims development came from our first lien insured portfolio at USMI as we benefited from better than expected cure activity mostly related to the 2020 accident year. The remainder of the favorable development came from recoveries on second lien loans and better-than-expected claim development in our CRT portfolio in our International MI operations. We maintain a prudent approach in setting loss reserves in light of the uncertainty we are facing with borrowers exiting forbearance programs and moratoriums on foreclosures. Income from operating affiliates stood at $24.5 million and was generated from good results across our various investments, including Coface, Somers Re and Premium. Total investment return for our investment portfolio was a negative 3.07% on a U.S. dollar basis for the quarter, which explains the decrease in our book value per share to $32.18 at March 31st, down 4.1% in the quarter. The decrease was primarily due to the mark-to-market impact for our available for sale fixed maturities portfolio, resulting in a $1.55 hit to our book value per share. This quarter, the meaningful increase in interest rates and negative returns in the equity markets contributed to the negative total return. As you know, we have been maintaining a relatively short duration in our investment portfolio for some time and this strategy helps temper the mark-to-market hit to book value in the first quarter. While still relatively short, we have extended our duration slightly to 2.93 years at the end of the quarter in order to get closer to our duration target. The change in net investment income this quarter on a sequential basis was mostly due to a lower level of dividends as we shifted out of some equity positions and higher investment expenses related to incentive compensation payments as is normal for us in the first quarter of the year. Going forward, we would expect net investment income to increase over the next few quarters as our portfolio gets reinvested at higher yields. At the end of the quarter, new money yields were approximately 145 basis points higher than the embedded book yield in our fixed income portfolio. Alternative investments, representing approximately 15% of our total portfolio, return to 1.4% in the quarter. The performance of our alternative investments is generally reported on a one-quarter lag. I wanted to spend a brief moment on corporate expenses and what you should expect for the rest of the year. As you know, the first quarter is always elevated relative to the other quarters due to the timing of incentive compensation accruals. This year you should also expect a slightly higher amount in the second quarter, again due to our accounting policy for non-cash compensation for retirement eligible employees. As a result, we expect corporate expenses to be approximately $25 million in the second quarter before coming down to a level closer to the 2021 amounts for the third and fourth quarters. Turning briefly to risk management, our natural cat PML on a net basis stood at $768 million as of April 1 or 6.4% of tangible shareholders' equity, again well below our internal limits at the single event, one in 250 year return level. Our peak zone PML is currently the Florida Tri-County region. On the capital front, we repurchased approximately 5.6 million common shares at an aggregate cost of $255 million in the first quarter. Our remaining share repurchase authorization currently stands at $927.2 million. With these introductory comments, we are now prepared to take your questions.

Thank you. Our first question comes from Jimmy Bhullar with J.P. Morgan.

Hey, good morning. So I had a question first just on the expense ratio. And I guess if you could discuss a little bit more how much of it is just because of a mix shift in the business where some of the lines that entail a higher loss ratio or lower loss ratio, but higher expense ratios are growing faster versus incentive comp or other expenses that might sustain through the rest of the year.

To approach this, consider focusing on operating expenses, as this is where all the incentive compensation payments or expenses will be reflected. Our track record over the past year shows that in Q1, these expenses are higher, and then they stabilize from the second to the fourth quarters. This pattern should help you project future expenses. Furthermore, when considering loss and acquisition, it's important to view them together, as there are offsets between the two that we account for in our business decisions. Ultimately, we assess our underwriting performance through the combined ratio, which I recommend you keep in mind.

From the perspective of acquisition expense, the mix has shifted over the last couple of years. Therefore, I would consider the last one or two quarters as indicative of future trends since our mix is heading in that direction. As a result, we are seeing the expectations for the loss ratio decrease, which aligns with what Francois mentioned.

And then on your cat losses, I think you mentioned that the majority of the cat losses that were booked this quarter were Russia-related, and I'm assuming most of those are IBNR. But if you could give some color on that? And then relatedly you've in the past indicated what you had in terms of COVID reserves, and I think most of those were IBNR as well. But if you can talk about what you would need to see to be able to start releasing some of those reserves related to COVID?

Yes. I'll begin with Ukraine. I believe we are still early in understanding the situation. It reminds me of COVID two years ago, as it continues to unfold. We've taken a cautious approach based on our current knowledge. We anticipate some losses, but they are all IBNR. The key point is that we don't yet have any confirmed claims or the need to establish case reserves. At this stage, our assessment of the overall exposure is still very preliminary. We feel we are in a stable position currently, but we will need to keep an eye on developments in the upcoming quarters.

And I believe our COVID losses, we're about 70% IBNR at this point in time. So it's still not finalized by any means.

And what's the magnitude?

Well. Our numbers haven't changed, so total reserves, right? So total reserves for COVID is about $160 million and 70% of that is COVID. Sorry, not COVID.

IBNR.

IBNR.

Thank you.

You’re welcome.

Our next question comes from Tracy Benguigui with Barclays.

Hello, everyone. I recognize that the 10-year anniversary for mortgage insurers setting up their contingency reserves is approaching where these reserves will be released on a first-in first-out basis into unassigned statutory funds. And I believe Arch has about $3.1 billion of such contingency MI reserves. I'm just wondering, if this anniversary is of any significance for Arch, like does this orderly reserve relief improve your ordinary statutory dividend capacity or improve your view of capital allocation in any way?

First of all, the contingency reserves are a statutory requirement and part of our overall operations. However, they haven't really constrained our capital deployment or our ability to navigate the market. We monitor them closely, but they haven't posed a significant issue for us so far. You're right that the 10-year mark is approaching, which will enable us to start releasing those contingency reserves. This transition will allow us to reallocate funds from the reserves and enhance our capacity to declare dividends from the mortgage insurance companies. We are continuously exploring opportunities to access some of those funds earlier through regulatory exceptions, and we have presented plans to facilitate that process.

Got it. I'd also like to touch on the negative marks in your investment portfolio. So I noticed in your proxy, your key KPIs like growth in book value per share or ROE, these are metrics that Arch doesn't adjust for unrealized gains or losses while from your peers do. So my question basically is do these negative marks change your view on deployable capital in any way?

No, not really. I think that the operating income, the way we look at the operating return on equity, is more of a run rate for how our business is performing. We fully recognize that many of the mark-to-markets will eventually recover, so this is the approach we've taken historically to better reflect how we're performing from a core business perspective, allowing the larger market volatility to resolve itself over time. This is our way of being more forward-thinking in how we present our returns and performance.

Got it. Thank you.

Thanks.

Welcome.

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

Yes. Thank you. If I go back in time about nine months ago, when I asked you about opportunities you have to deploy capital, we look at it as mortgage insurance, reinsurance, share buybacks, acquisitions. The mortgage issuing pace was hot, and reinsurance is attractive. It still is, but ceding commissions are up now, and maybe with where rates are going, mortgage issuance is going to be declining? Does that make insurance and buybacks more attractive on the relative slate of things you can do right now? And what's changed about the ROI in mortgage and reinsurance over the last six months?

Yes. I think over the last year, Josh, good question. In terms of the rank ordering our opportunities right now, I think the growth in premium speaks for itself. It's really an indication of where we think the value proposition is for our shareholders. I think that clearly, reinsurance and insurance are close to one another. Our reinsurance team would argue that they have a better return perspective. We'd like to have these discussions internally, but certainly, the P&C has moved up in the rank in terms of top return. I think MI is a close second and as you saw on the share repurchase, I mean, it's clearly another way for us to deploy capital that's very attractive for our shareholders. So we have a lot of levers that we can deploy at that point in time. But having said this, our focus right now is really to grow the business, because we have so many good opportunities ahead of us.

And the Ukraine crisis has caused skepticism about the value of trade credit, which has hurt the valuation of Coface in terms of your view of the attractiveness of that asset post-Ukraine and whether the diminished pricing opportunity. Do you have any thoughts there?

Well, I think first, the Ukraine and Russia area is not a big portion of what companies such as Coface would be playing into. So that certainly is a smaller footprint. And a lot of the losses that could have emerged or are emerging, they'll be short-tail by and large, right? It’s definitely a shorter term, even though we're not out of the woods yet in terms of developing losses broadly. I think on trade credit, I'm confident that our Coface team has a good handle as to what their exposure is. And I think if I take COVID as an example for how resilient they are, even absence on the government scheme, I think that we like the resilience and the diversification even within Coface themselves, what they provided to the shareholders. So let's just say we're not overly concerned. I mean, I think the numbers are going to come today or very recently. I think they'll have way more and more insight into this. But at this point in time, our expectation is that it will have an impact on their result, but not to the extent that, as always, it seems that the market expects way more downside than actually meets the eye. Because it's a line of business that I believe is largely misunderstood. And the way that Xavier and his team has developed and deployed risk management is underappreciated. I think Coface, they do a very, very good job in risk managing the portfolio.

And if I can sneak one more in. You said that 75% of COVID reserves are still in IBNR. Is COVID a long tail or a short tail risk? And what would you be waiting for to get better comfort on the use or lack of the IBNR reserves?

I believe it's both a short and long tail situation. There's a lot happening, and we've experienced some of the BI losses last year and even earlier in 2020. Many of those issues are currently being addressed. We recognize that this is a significant event, and as people adapt to the new market and environment, there are added challenges like inflation and further dislocation. It's possible that we will see developments on the liability side eventually, but it's difficult to predict exactly what that will entail. Clearly, we are facing unprecedented challenges, which is why we tend to adopt a more cautious approach at Arch. There is significantly more uncertainty than what we've encountered in our history.

And even the short tail that you would think a short tail coverage’s are going to be litigated, then that will take time to resolve itself. So I mean, we're keeping an eye on it, but we think it's going to be with us for quite a bit longer.

Thank you for all the answers.

Thanks, Josh.

Our next question comes from Ryan Tunis with Autonomous.

Hey, thanks. Good afternoon.

Ryan. Are you still there, Ryan? We can't hear you.

Ryan, you may be on mute.

Yes. Yes, I think Ryan just came out somehow.

Can you hear me?

Ryan?

Yes. Yes guys got me?

Yes, we got you now. Great, we got to you, we got you and we got you.

I'm sorry about that. I had a question regarding the MI reserves. It's not as extensive as the last one, but I was wondering how the year 2020 has evolved. I noticed you released a lot of reserves from that year this quarter, and I could possibly calculate it myself. However, I would like to know the total number of reserve releases for the year 2020 since it was initially booked.

I don't have that number available at the moment. Most of it will come from the delinquencies, particularly from the largest group in April and May of 2020's second quarter. Those are the delinquencies that are now being resolved, so the majority is from the 2020 year.

Do you have a sense, Marc, of how the current ultimate compares to the years leading up to 2020? Are we reaching a point where, on a fully developed basis, that year resembles some of the past years? I'm trying to understand how much more reserve potential might exist.

Yes. Well, I have to be careful the way I answer it. I think I would say to you that 2020 and 2021 may turn out to be more like an average year. There's a good possibility for that to happen. It's still uncertain, because we're still going through the forbearance exiting as we speak. It's accelerating really as we speak literally. So I think 2020 and 2021 will turn out to be much more of average years than we had maybe feared when we talked about it in the second quarter of 2020.

Got it. And then on the P&C side, I guess, I might be wrong on this. But I don't remember there being quite this much volatility with the acquisition cost. It just seems like something that is kind of ramping, like as you said in the past two, three quarters. Could you just give us like maybe a little bit of a better understanding of why are we seeing more of that now? Is it because of the amount of loss ratio improvement that's going through the business? Is it the way you've structured reinsurance? I'm just kind of trying to understand what might have changed.

That's a great question. I would like to introduce you to Arch's approach to cycle management, which involves adapting to emerging opportunities. It may surprise you, but both Francois and I can't predict the acquisition expenses for any given quarter, as our team makes evaluations based on what's ahead. Regarding reinsurance, we previously noted that focusing on quota shares will eventually lead to an increased acquisition expense ratio. On the insurance side, travel premiums significantly decreased in 2020 but are now recovering, and historically, they carry a high expense ratio. We are also exploring new programs in insurance that will likely incur higher acquisition costs. The market is very dynamic now in a way we haven't seen before, allowing us to make more flexible capital allocation decisions. In the past, we maintained a stable market for about five or six years and were more defensive, with no significant need to shift strategies. Currently, though, the dynamics have changed, prompting this shift. Regarding the loss ratio, it will adjust naturally, whether we opt for quota share or excess of loss. Consequently, a higher expense ratio will generally lead to a lower loss ratio, as it is essentially a part of the combined ratio. I recognize that it's not easy to define precisely, but it's influenced by our cycle management strategy and the current market conditions.

Understood, that makes sense. Thanks guys.

Thanks.

Our next question comes from Meyer Shields with KBW.

Thanks. I want to start with one underwriting question, and maybe it pertains to what you were just talking about, Marc. We've seen year-over-year written premiums and programs actually go down after some very solid growth in the first three quarters of 2021. And I was hoping you could talk us through what's going on there?

Yes, there's some noise. I think it's really related to the timing of a program renewal and when we onboard one. So I wouldn't read too much into that, Meyer. I believe it's a one-off.

I think the earned premium is a better indicator of the trajectory of where we're going here.

Okay, perfect. That's very helpful. The second question, I'm sorry.

Go ahead, Meyer.

Okay, so you talked a lot and very helpful in terms of the guidance for corporate expenses. Is there the same sort of accrual trend in the individual segments, because I'm asking because of the year-over-year growth in other operating expenses?

The timing remains consistent. In the corporate segment, corporate expenses have some additional non-cash compensation, primarily affecting the first quarter. For the most part, this involves compensation and benefits compared to operational expenses within the segments, which include various systems and IT elements, leading to less volatility. The accounting rules apply consistently; when employees become eligible for retirement, it results in different accounting treatment for non-cash compensation. The growth in operational expenses is evident. We aim for the premium growth to outpace these expenses. As you noted, insurance arrangements have decreased in all segments. The key takeaway is that we are performing well and need to compensate our workforce appropriately since retaining talent is crucial, which was reflected in our incentive compensation decisions made in the first quarter.

Meyer, I want to emphasize that you can view that line item as either an expense or an investment. From our perspective, we are also investing in our people, as Francois mentioned. Additionally, we're investing in other areas that will enhance our results over time. This is an opportune moment to invest. We are experiencing growth and revenue is coming in, making it a suitable time for investment. Consequently, we are also allocating funds to make the platform more sustainable.

Okay, perfect. Thank you so much.

Welcome.

Our next question comes from Mark Dwelle with RBC Capital Markets.

Hey, good morning. Just a couple of questions, you've already covered a lot of ground. On the Russia-Ukraine losses, what lines of business or products were impacted there? Was it your own trade credit or war or marine whatever?

Yes. It's the traditional lines you would expect. I think that most of our losses come from our exposure at Lloyd's, either through from the insurance platform, the reinsurance platform. And that's what you would expect, right, because this is where the specialty lines have been underwritten. So either through the Lloyd's of the London really operations. So this is where we're expecting it from. One of the trade credit is part of the considerations. Again, like I said, so it's also part of that as well. So we look across our lines of business. But I would think London, Lloyd's, aviation, marine war, the classic Lloyd's exposure.

Okay. I'm just trying to ensure I understand this correctly. If Coface incurs losses, you will effectively report those on a one-quarter lag. This means you will receive your proportional share of the losses in the second quarter and so forth going forward, right?

100% correct, yes.

Okay. And then the last question, I just wanted to clarify, you made a number of comments related to the investment portfolio. Am I understanding correctly, so you're both extending the duration and getting a higher new money yield on both the reinvestment, as well as, I guess, any new money that you're generating?

Yes, there is an increase in yield without a doubt. I mentioned the 145 basis points, which compares the embedded book yield on the portfolio at the end of the quarter to current market conditions. Extending the duration is more of a strategic decision. We were somewhat short compared to our benchmark, and we have moved a bit closer to it as a defensive strategy. Our goal is to ensure we remain aligned with our target.

In terms of moving forward, the higher new money rate is likely to have a greater impact on increasing investment income than the duration extension.

Certainly. We are unsure how quickly the portfolio will turn over. However, as Marc indicated, the incoming free cash flow and the rate at which the portfolio matures or trades certain securities will enable us to reinvest that cash. It will take a few quarters, but we expect to start seeing some benefits next quarter, and by the end of the year, these benefits should be somewhat measurable and meaningful.

Our next question comes from Yaron Kinar with Jefferies.

Hey, good morning everybody. My first question, and maybe it's more of just me rephrasing and making sure I'm thinking about it correctly. Am I to understand that really your focus or your myopic focus is on getting the loss ratio better, and you're kind of agnostic as to whether the expense ratio goes up or down as long as the combined ratio comes down because the loss ratio improves more?

Yes, I think you're right. I think the combined ratio, which leads to return on equity is what we're focusing on. Yes.

Okay. I should be careful with how I phrase this regarding the industry. At some point in the cycle, you anticipate some negative reserve development that will likely be followed by positive development. Where do you see the industry right now? Also, when do you expect to see the reported combined ratio improve, and to what extent will it result from favorable development instead of improvements in the accident year loss ratio?

I can't really comment on the industry's reserve levels. It's subjective, similar to the saying that beauty is in the eye of the beholder. It's challenging for me to provide an opinion on this. Historically, I've noticed that the pricing cycle peaks first, followed by the earnings cycle peaking about two to three years later. If pricing does peak, I would anticipate earnings to continue to improve for a couple more years afterward. Currently, we are still seeing margin improvement in the market. It's a complex question to address regarding the source of improvement, whether it comes from prior development or current accident years, and this may vary by company.

Fair. I'd be happy for you to opine on Arch specifically, if you want.

We're doing pretty good.

Okay. If I could sneak one last one in. So two-thirds of cat losses are related to Russia. Is that true for both the insurance and reinsurance segments?

It's a good question. Directionally, it's about that. Yes, we might have had a bit more; the non-Ukraine cat losses were mostly reinsurance, so we picked up a bit more from the reinsurance side due to the Australian floods. But directionally, it's about the same, not a big difference.

Got it. Thanks so much.

Thanks.

Our next question comes from Brian Meredith with UBS.

Hey, thanks. A couple of one’s here for you. First, Marc, can you talk a little bit about what you think about the opportunities maybe in Florida with the renewal season, a lot of turmoil and stuff going on down there.

Yes, I can share what we've gathered from our team. Feedback from our colleagues, brokers, and other industry contacts indicates that the upcoming renewal will be challenging. There are many uncertainties and decisions pending. It's too early to determine the specifics, but there's a general expectation of a tough renewal, as you may have heard in previous calls. There are issues to address related to ongoing litigation that hasn't progressed as much as desired, and some companies are facing significant survival challenges, including getting paid for reinstatements. Additionally, the state is looking for solutions, and a discussion from the Department of Insurance regarding their plans in Florida seems imminent. So, like you, we're waiting to see how this unfolds. One important point for our shareholders is that if the right opportunities arise, we have capital ready to invest, and we remain optimistic.

That's what I wanted to know. So you've got the company. And then, Marc, another one, so a couple of stories out last night and this morning about companies looking potentially to sell themselves. I'm just curious what your thoughts are on M&A, kind of Arch's view with respect to the M&A environment? Is the organic growth opportunity just too good right now to distract yourself from potential M&A opportunities?

Listen, we're a broadly equal opportunity kind of company, right? We'll look at what can be done and what should be done and what makes sense for the shareholders. We're not looking for transactions necessarily. But our history shows that when a transaction come that's accretive to our shareholders, we'll entertain and look at it. We certainly have looked at what's out there, what has been discussed, as you would expect, Brian. So I think we have probably the best position possible, which is we don't have to do anything. We have plenty of opportunity. And we are in a seat where we can just like wait for the pitch to come to us. So I feel very, very fortunate to be where we are at Arch Capital Group. So we'll look at it. We'll look at it, pitch, if we like it, we'll swing, if not we'll just go back.

Great, thank you.

Yes, sure.

Our next question comes from Elyse Greenspan with Wells Fargo.

Hi, thanks. My first question, if I look at your insurance segment, it's been six quarters in a row where you guys have grown by more than 20%. It seems from your comments you guys are still pretty bullish about opportunities there, even with perhaps a little bit less price. So Marc, does this feel like an environment where you can continue to see pretty robust levels of growth within your insurance segment for this year and beyond?

The answer is yes, Elyse. I wonder where you were for the call. The answer is yes. Broadly, it was probably more of a broad market opportunity probably two years ago. Now it's refining itself and turn more certain lines of business. As we mentioned before, some of the programs, we're seeing a better pickup in pricing and property as we speak right now, it's getting hard again on the heels of failing to get the value right as an industry. So listen, I think that it's a bit more of an opportunistic. I think we still have the ability and the willingness to lean in hard if we see opportunities, and we are seeing opportunities, so yes. It's just not as broadly based perhaps as it would have been two years ago.

And then as we think about some stuff that's come up throughout the call, right, we're dealing with higher inflation, also higher interest rates that you guys mentioned could be a tailwind on the investment income side. So where would you put the ROE within the P&C business? Where do you think that's running at today when you think about how 2022 could come in? I know you've talked about, right, kind of targeting the double-digits in the past. Where do you think things are now?

I believe we can discuss our business performance. We anticipate our return on equity for the current policy year to be around the mid-teens. We've been making progress towards this goal, possibly improving each quarter since the end of 2019. So, this is our current outlook, Elyse. Is there another aspect of your question you would like me to address?

No. That was the event. There was another question regarding buybacks, which relates to the earlier discussion about ROEs. In the past, we've followed some guidelines related to book value. It appears that you bought back your stock, approximately at one-fourth of book value in Q1. I understand the shares are a bit higher today, partly due to the mark-to-market in the quarter. So, I assume buybacks would depend on growth opportunities, but it looks like you would still be inclined to buy back your stock considering the current valuation?

I think that's fair. Again, the multiple isn't something we focus on. However, based on Marc's earlier response, we are optimistic about our prospects. The forward-looking ROEs we see are very appealing, and we believe the stock is reasonably priced. Depending on the opportunities that arise and how we can deploy capital, share buybacks will always be a part of our capital deployment strategy.

Thanks for the color.

Thanks.

Our next question comes from Tracy Benguigui with Barclays.

Thank you for the opportunity to speak again. I noticed that you increased your reinsurance property catastrophe writings by 10% this quarter, and I see that you are underweight on probable maximum losses compared to your peers. Can you explain how significant this growth is and whether it is primarily driven by increases in exposure or rate increases? Additionally, could you provide some insights on your overall risk appetite regarding property catastrophe risk, particularly in terms of balancing pricing inflation with exposure management?

Yes. We have maintained a relatively neutral stance over the last few quarters and haven't seen growth. The recent increase in premium is somewhat of an anomaly due to the timing of a renewal, as we have a 14-month premium cycle that affects different quarters. Therefore, I wouldn't place too much emphasis on this quarter's growth figures. However, we remain active in the market and believe we need to increase our efforts to make significant progress. We'll see how things develop from here.

Yes. Regarding cat exposure, we consider how we deploy it. We can do this through cat Excel, quota shares, or marine coverage, and it's sourced from various lines of business. Over the past 18 to 24 months, due to significant changes and improvements in the property market, our capital deployment from the cat perspective has largely favored quota share reinsurance. Meanwhile, cat Excel has lagged in pricing, which we've mentioned before. The earned premium is likely a better measure of our relative growth or stagnation in the property cat sector.

Okay, great. And just one real quick follow-up on actually Elyse's question. I felt like last quarter, you kind of alluded that you could buybacks talk above the 1.3 times, just given your view of intrinsic value of your MI business. I don't know if those comments were fully appreciated. I don't know if it's possible, you could flesh out your view of what you think the intrinsic value of your MI book is and how that plays in.

It's part of the forward-looking return on equity. There is significant embedded value in the mortgage insurance book, and we have good visibility on that. We are very optimistic about it, which gives us more confidence that there is considerable value in the stock. When we consider share buybacks, it's clear that we have fully accounted for it on our end.

Thank you.

Thanks Tracy.

Our next question comes from Michael Phillips with Morgan Stanley.

Thank you. I have a follow-up question regarding MI. I want to connect your earlier comments about the order of capital allocation, where you placed MI second after P&C, which makes sense considering the current fundamentals in the P&C book. However, I am trying to reconcile this with your earlier positive remarks about the MI space. Can you provide any insights on how to assess growth for the MI business, particularly looking at the growth we've observed this quarter and what to expect over the next year?

I think it's challenging to gauge from our reporting, but we do have significant growth through the credit risk transfer program. Additionally, we have a robust credit risk transfer program from the government-sponsored enterprises. We've also acquired the mortgage company previously owned by Westpac in Australia, which is contributing to our growth. In the U.S., we need to keep in mind that production reached record levels in 2020 and 2021, making it difficult to achieve substantial growth from that starting point. The market might be contracting slightly, and we will see how it develops. Refinancing activity is largely behind us due to increased mortgage rates over the last six months. I wouldn't say new production is rising significantly because the U.S. mortgage insurance market is contracting somewhat from a refinancing standpoint. However, with the rise in mortgage rates, the premiums written may become more stable and potentially increase due to decreased refinancing activity. This means the insurance in force will rise, positively impacting our ongoing written premium. While we may not see the same level of production from new insurance written, I anticipate that the written premiums will increase on a gross basis, likely starting in the second half of the year.

Okay, well thank you, Marc. Thanks for the color.

Thank, Mike.

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

Yes, thanks everyone for being here today. Great questions and we look forward to see and talk to you again in July. Thank you.

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