Arch Capital Group Ltd. Q1 FY2024 Earnings Call

Good day, ladies and gentlemen, and welcome to the Q1 2024 Arch Capital Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. As a reminder, this conference call is being recorded. Before the company gets started with its update, management wants to first remind everyone that certain statements in today's press release and discussed on this call may constitute forward-looking statements under the federal securities laws. These statements are based upon management's current assessments and assumptions and are subject to a number of risks and uncertainties. Consequently, actual results may differ materially from those expressed or implied. For more information on the 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 certain non-GAAP measures of financial performance. The reconciliations to GAAP for each non-GAAP financial measure can be found in the company's current report on Form 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. Good morning, and welcome to Arch's First Quarter Earnings Call. We are pleased to report a terrific start to the year. In the first quarter, we posted $736 million in underwriting income and a 5.2% increase in book value per share as we realized the benefits from several years of strong and profitable premium growth. Underwriters in our P&C units continued to lean into hard market conditions, writing $5.6 billion of gross premium in the quarter, a 26% increase from the same quarter last year. Overall, rate changes are exceeding loss trends, and absolute returns remain above our long-term targets, positive indicators in our continued efforts to deliver superior results to our shareholders. Broadly, we are seeing incremental signs of increased underwriting appetite in the market, but this is not surprising, given the favorable conditions that exist. It is still an underwriter's market where Arch can thrive. At the beginning of this hard market, as other providers pull back, Arch sought to establish itself as a key trading partner, aiming to solidify relationships and remain top of mind when it comes to addressing our clients' increased needs. Our success in establishing deeper client connections continues to pay dividends in this extended, yet increasingly competitive hard market. The first quarter served as a reminder of our risky world when an active catastrophe quarter concluded with a major industry loss, as the Dali cargo ship collided with the Francis Scott Key Bridge in Baltimore. Although we recognized a loss related to this event, the virtue of having multiple lines of business with improved and positive expected margins made this event manageable for Arch. Incidents like this reinforce the importance of our core tenets. One, we practice disciplined underwriting that builds a meaningful margin of safety into our pricing. Two, we take a long-term view of risk and a conservative approach to reserving. And three, we operate a diversified global business that we believe maximizes our total return by mitigating volatility in any one line of business. Capital management has been a key differentiator for Arch and is integral to how we operate our company. Effective capital management requires that we allocate resources to the most profitable underwriting opportunities while retaining the flexibility to invest in our platform when we find attractive opportunities. One of those prospects came to fruition earlier this month when we announced our intent to acquire Allianz's U.S. middle market and entertainment businesses. We see this as a unique opportunity to quickly build scale in the $100 billion-plus U.S. middle market, a long-term strategic area of underwriting interest for us. Increasing our middle market presence will further diversify our North American insurance platform by adding stable businesses with recurring premiums that can generate attractive returns over the cycle. As a cycle manager, we like having many ponds to fish in, and this acquisition will significantly expand our opportunities in the middle market pond for years to come. I'll now share a few highlights from our segments. As you know, the Property and Casualty market cycle is evolving, but still offers attractive growth opportunities at good returns, particularly for our skilled specialty underwriters, who can use their expertise and experience to differentiate Arch. The first quarter results from our Reinsurance segment were outstanding. Underwriting income for the segment was $379 million while gross premium written grew by 41% over the same quarter last year. While there is some developing competition, we're observing an increased flight to quality and fully expect to capitalize on that trend as the cycle ages. Our Reinsurance segment is in an enviable position. The in-force book constructed over the last several years is strong and allows us to exercise our underwriting acumen. When opportunities emerge, whether from dislocation in the casualty market or by offering value that others cannot, Arch is there to provide solutions and financial strength to its clients. In our Insurance segment, growth tapered from the highs of the past few years as rate increases slowed and some of the dislocations were met by additional capacity. Overall, conditions remained strong and the market is behaving rationally, two important factors that continue to support growth and strong profit. In the first quarter, we found growth opportunities in several lines, including Property and Casualty E&S and other specialty lines. Across most of our specialty lines, pricing remains very healthy, and we are able to deploy capital in order to deliver attractive returns above our long-term target of 15%. Like Reinsurance, our Insurance segment has made strong efforts to establish itself as a first-choice provider for its clients, and that manifests in seeing more opportunities. In life, you have to play to win, and in insurance, if you don't see the business, you can't write it. And now let's pivot from P&C to Mortgage, which, to borrow from a famous ad campaign, just keeps on going and going and going. Our Mortgage segment continues to generate solid underwriting income and risk-adjusted returns from its high-quality portfolio. While Mortgage originations remain tempered by high mortgage interest rates, the persistency of our in-force book remains a healthy 83.6%, while the delinquency rate is near all-time lows. New insurance written is in line with our appetite given market conditions. When the mortgage market picks up again, we're prepared to increase our production. However, if the status quo persists, we're content with our current situation that has extended the duration over which we earn mortgage insurance premium. Competition within the MI industry remains disciplined, which means we are in a good place. Finally, our Investments portfolio grew to $35.9 billion, generating $327 million of net investment income in the quarter. The extraordinary premium growth from our P&C segments continues to increase our float, which provides a significant tailwind to our overall earnings through the next several quarters. In the U.S., the NFL conducted its annual draft this past weekend. Traditionally, the team that finished last season with the worst record gets the first pick, a chance to select the best college player, while the champions pick last. The player selected with the top picks are expected to be immediate difference makers, even though they are typically selected by a team with multiple deficiencies, making success far from guaranteed. If a talented quarterback has nobody to throw the ball to, it can ruin the player's confidence, and the pressure can quickly sabotage a career. Compare this with teams drafting at the end of the round coming off successful seasons with talented rosters in place. They often have the luxury of selecting an excellent player who doesn't need to contribute right away. Instead, these teams select players who can fill a specific short-term role and be given time to grow into a difference maker. Our acquisition of the Allianz MidCorp business is like adding a solid player to a winning team. We already have established all-stars, a winning talent-dense culture, and a favorable schedule in the years ahead. Adding the MidCorp team to our diversified franchise makes us better today and tomorrow, and that's a winning proposition. I'll now turn it over to Francois to provide some more color on our financial results from the quarter, and then we'll return to take your questions.

Thank you, Marc, and good morning to all. As you will have seen, we started out 2024 on a very strong note, with after-tax operating income of $2.45 per share for the quarter for an annualized operating return on average common equity of 20.7%. Book value per share was $49.36 as of March 31, up 5.2% for the quarter. Our excellent performance was again the result of outstanding results across our three business segments, highlighted by $736 million in underwriting income. We delivered exceptional net premium written growth across our Reinsurance segment, a 31% increase over the first quarter of 2023, driven by strong business flow in all our lines of business. Growth was also solid for our Insurance segment, a 12% increase after adjusting for the impact of a large nonrecurring transaction we underwrote in the first quarter last year in our warranty and lenders business unit. Overall, the combined ratio from the group came in at an excellent 78.8%. Our underwriting income reflected $126 million of favorable prior year development on a pretax basis or 3.7 points on the combined ratio across our three segments. We observed favorable development across many units, but primarily in short-tail lines in our Property and Casualty segments and in Mortgage due to strong cure activity. The collapse of the Francis Scott Key Bridge in Baltimore last month has the potential to become the largest insured marine event in history. Both our Insurance and Reinsurance segments were exposed to this disaster, and our current estimates represent an impact of 2.1 and 3.0 points, respectively, on the combined ratio in these segments' results this quarter. We note that the losses for this event were reported as non-catastrophe losses in our ratios. Catastrophe loss activity was relatively subdued and below our expectations across our portfolio, with a series of smaller events generating current accident year catastrophe losses of $58 million for the group in the quarter. Overall, our underlying ex-cat combined ratio remained excellent with the increase this quarter relative to the last few quarters, mostly due to the Baltimore Bridge collapse. Despite the impact of this event, our current quarter ex-cat combined ratio still improved by 1.4 points from a year ago as a result of earned rate changes above our loss trend in our P&C businesses and lower expense ratios, mostly from the growth in our premium base. These benefits were slightly offset by investments we continue to make in people, data and analytics, and technology to improve the quality and resilience of our platform going forward. From a modeling perspective, I'd also like to remind everyone that our operating expense ratios are typically at their highest in the first quarter of the year due to seasonality and compensation expenses, including equity-based grants for retirement-eligible employees that were made in March. As of April 1, our peak zone natural cat PML for a single event, one in 250-year return level on a net basis remained basically flat from January 1 but declined relative to our capital to 9.0% of tangible shareholders' equity, well below our internal limits. On the Investment front, we earned a combined $426 million pretax from net investment income and income from funds accounted for using the equity method, or $1.12 per share. Total return for the portfolio came in at 0.8% for the quarter, reflecting the unrealized losses on the company's fixed income securities, driven by higher interest rates. Our growing investment portfolio keeps providing meaningful tailwinds to our bottom line and remains of high quality and short duration. We have grown our investable asset base significantly over the last few years, primarily due to significant cash flow from operations. This positive result, combined with new money rates near 5%, should support further growth in our investment income for the foreseeable future. Income from operating affiliates was strong at $55 million. Of note, approximately $14 million of this quarter's income is attributable to the true-up of the deferred tax asset at our operating affiliate Somers in connection with the Bermuda corporate income tax, a nonrecurring item. Our effective tax rate on pretax operating income was an expense of 8.5% for the 2024 first quarter, slightly below our current expected range of 9% to 11% for the full year, mostly as a result of the timing of tax benefits related to equity-based compensation. As regards to our announcement to acquire the U.S. MidCorp and Entertainment insurance businesses from Allianz, we are making progress in obtaining the necessary regulatory approvals and are targeting a third-quarter close for the transaction. At a high level, the agreement is structured around two related contracts: a loss portfolio transfer of loss reserves for years 2016 to 2023 and a new business agreement for business written in 2024 and after. Overall, we expect to deploy approximately $1.4 billion in internal capital resources to support both contracts, in addition to the cash consideration of $450 million. The overall transaction is expected to be moderately accretive to earnings per share and return on equity, starting in 2025. It is important to note that even when reflecting the capital to be deployed for this transaction, our capital base remains strong with a leverage ratio in the mid-teen range. We maintain ample financial resources and remain committed to allocating our capital in the most optimal way for the long-term benefit of our shareholders. With these introductory comments, we are now prepared to take your questions.

Our first question comes from Elyse Greenspan from Wells Fargo.

Hi, thanks. Good morning. My first question is on the reinsurance market. Marc, I think in your opening comments, you mentioned something about potential dislocation in the casualty market. Are you starting to see casualty market opportunities emerge there? I know you've highlighted this, I think, starting in the third quarter of last year. Or is this something that you still think might take a couple of quarters to kind of fully present an opportunity to Arch?

Yes. The casualty market is going through, I wouldn't say repricing, but not re-underwriting as thoroughly because it has been already getting harder for the last several years. We may have some respite in terms of price increase in the middle of last year. But I think that the development of the prior year, as we all know, has created a little bit more uncertainties, and inflation is not ebbing. So right now, what we're seeing is people still being very, very careful and disciplined in how they underwrite the business, which leads Arch and gives us the opportunity to lean into this even more so. We have grown our casualty book of business on the insurance side quite a bit. Our casualty book is E&S, as we all know, and is very specialized in specialty. But sorry, I thought there were some technical difficulties here. Elyse, are you still there? I just want to make sure you can hear me.

Yes, we can hear you.

Thank you for your patience. The casualty market in insurance is growing, and we're now seeing more opportunities for expansion. There's a noticeable emphasis on that sector in insurance, though it's not necessarily a repricing. On the reinsurance side, we're beginning to experience some friction with renewals, particularly with the casualty quota share. We are currently in the early phases of this situation, and it's uncertain how long it will continue or its future trajectory. However, there is a clear awareness within the industry that we need to increase rates to account for past risks and setbacks.

And then you guys mentioned the middle market opportunity you saw with this Allianz deal. After this transaction, are there other things on the list like when you think about Insurance, Reinsurance, now middle market and Mortgage? Are there other things that you guys think that maybe down the road, you would need or want to potentially add to the platform?

We have an extensive list of potential acquisitions and enhancements to our resources. The acquisition of Allianz is significant and beneficial for us, and we are very satisfied with it. However, it's important to note that we have also been expanding our teams. Acquiring a company isn't our only strategy; we've added teams for various purposes, including contingency and other areas. We're continually searching for opportunities. As a cycle manager, it’s vital to have multiple avenues for deploying capital, as varying market conditions can lead to a more stable enterprise with reduced volatility. Market cycles are complex and come in different phases. Additionally, our executive team regularly maintains a wish list of strategic opportunities that would enhance our portfolio's diversification. While I can’t disclose specifics during this call, we are actively seeking prospects that align with our goals. The middle market was one of our focus areas, leading to our current position.

Our next question comes from the line of Jimmy Bhullar from JPMorgan Securities, LLC.

Hi, good morning. I have a question about the Baltimore bridge loss you reported in Insurance and Reinsurance. I recognize that your overall results were strong, but the number you reported seems quite high compared to what some peers have mentioned and the industry losses. I’m assuming most of this is incurred but not reported, but I’m curious if this is due to conservatism in your estimate or if the market is underestimating the eventual losses from this event.

Well, Jimmy, I'll let Francois discuss the reserving level. We've been involved in marine liability for quite some time. I used to underwrite the IGA in the Reinsurance group back in '02 or '03. This is not new to us. We also acquired Barbican in 2019, enhancing our presence in the London market, which is another aspect of our marine market positioning. We engage in Insurance, Reinsurance, and some retro as well. This business is familiar to us and one we appreciate, having made profits over the years. The rates and returns have been acceptable, although losses can occasionally occur. I'm not certain what others are considering, but we believe our market share aligns with our expectations and presence in the market. I'll let Francois address...

Yes, we can't speculate or comment on how others may be reserving for this event. For us, it's not unusual. We've taken a very conservative view of the loss, and there is still a lot to be determined regarding who will ultimately pay for it. Regarding your last question, for us right now, it's all IBNR; we don't have all the specifics needed to establish case reserves, so we've booked it as IBNR and will see how things develop.

And then on casualty reserves, your overall development was favorable, but was there any pockets of unfavorable within the overall number? And then if you could talk specifically about how your casualty reserves trended for pre-COVID and post-COVID years?

Well, part one of your question, there was really no material development on long-tail casualty lines of business across all years. So both pre-2015 to '19 years and '21 to '23. So we're very comfortable with that. I think our reserves are holding up nicely. And I know there's been some concerns around the more recent years where there's been some signs of adverse in the industry. We're not seeing that. Actually, our metrics or our actuaries are commenting that our actual development is coming in more favorable than expected. Again, very early to declare victory, but that's certainly for us a positive sign, and we'll keep monitoring and see how things develop for the rest of the year.

Our next question comes from the line of Andrew Kligerman from TD Cowen.

Hey, thank you and good morning. Marc, you mentioned that the MI market is going and going and going. How do you think about the favorable prior year developments? I mean last year in the first quarter, it was 25 points this year. In the first quarter, it's another 25 points. I mean does that still continue going forward as well?

I can't predict the future, but like everyone else, we're currently experiencing a market that is improving. Borrowers are in a good position, thanks to programs from government-sponsored enterprises that assist them in staying in their homes. Most borrowers who might be delinquent right now have much lower mortgage rates, providing strong reasons for them to remain in their homes without taking any drastic actions. Additionally, there has been significant equity accumulation due to substantial increases in property values over the past three to four years. Everything suggests a strong alignment among borrowers, mortgage insurers, and mortgage origination companies to ensure that borrowers can meet their payments. There are various options available for refinancing and other tools that weren't accessible during the crisis in 2007 and 2008. However, regarding development going forward, we will have to observe how things unfold. Overall, the situation appears more favorable than we expected two or three years ago, and we respond to the data as we see it.

Pretty amazing stuff. And then my follow-up question is around the Allianz acquisition. And I love your analogy about the NFL draft and picking the high-quality players. Some have criticized Allianz as maybe I'll say they weren't a first-round draft choice. So with that, what will Arch be able to do to kind of turn them into a first-round type player? I mean, I know I've heard about data and analytics, but can that help overnight? So I'd like to know what you're going to do there to really enhance that operation?

There are many developments underway. Our unit has a comprehensive plan to integrate Allianz into our company and culture. We need to explore all possible ways to support them. While it's a decent business, we aim to align it more closely with Arch while acknowledging the cultural differences in distribution. Data analytics is definitely one area we plan to leverage. Allianz is a significant player, and they have established a strong presence in the U.S., which aligns with our existing experience in the middle market. We have some strategies to enhance their operations, and while I won’t disclose all the specifics, we’re optimistic about the potential of this asset. It's worth noting that this acquisition adds significant value to our overall business, more so than it might for other companies. We are committed to investing in this venture and will continue to allocate some of our earnings toward future growth. Overall, we have many initiatives in progress, and we are genuinely excited about them.

Our next question comes from the line of Michael Zaremski from BMO.

Hey, thanks. Good morning. On the Insurance segment, the underlying loss ratio of 57.5%, I know I'm probably just nitpicking. But I heard the commentary about the impact from the Baltimore bridge. But just curious, you've grown into property, which has a lower loss ratio, attritional loss ratio, I believe. So is there anything going on in the mix, that maybe you're putting in more conservatism on the casualty growth or anything we should be thinking about there?

Mike, it’s simply the nature of our business. There will be fluctuations, and while there might be a couple of claims that arise during the quarter, we have accounted for them and acknowledged any negative developments early on to see how things unfold. There isn’t anything particularly noteworthy that needs special attention; this is just par for the course. In fact, this quarter, the underlying loss ratio, excluding GAAP, increased by about 30 basis points. That’s just how the industry operates, and we still consider it a strong outcome.

Okay. Got it. The second question is likely a quick one, but I appreciate you providing guidance on the cat load in the last quarter. I believe you mentioned it was in the 6% to 7% range for the premiums excluding the Mortgage segment. Should we expect any changes, or could it potentially trend towards the higher end of that range in a base case scenario as you continue to navigate the hard market conditions looking ahead to 2024?

Well, the comment I made last quarter was that for the full year, overall ACGL premium is expected to be in the 6% to 8% range. We don't see that changing at this point. This expectation was based on our outlook for how the year could unfold. That's why we provided a range. We were very satisfied with the January 1 renewals. The renewals on 401s went largely as anticipated, and the June 1 renewals so far appear to be strong. There's still some time before those are finalized, but overall, we maintain that the 6% to 8% range for the year regarding cat load is holding steady.

Sorry, is that 6% to 8% on all insurance premiums ex mortgage or just with total company?

Total company-wide, ACGL total.

Our next question comes from the line of Dean Criscitiello from KBW.

My first question was on the net to gross ratio in reinsurance. I saw that it ticked down about 5 points year-over-year. I was wondering, is that a function of buying more reinsurance? Or is there anything else going on there?

No. It's a good question. If you look at the last four or five years in the first quarter, our net to gross ratio typically ranges from 65% to 70%. Last year in the same quarter, it was 70% because we had a larger transaction that was not seated. So, comparing just one period isn’t a true reflection of our performance. When looking at the longer term, it remains within the 65% to 70% range, so nothing has changed there.

Okay. And then the next thing, shifting back to the insurance business, I was a bit surprised to see solid growth within Professional lines given the rate environment there. So can you maybe talk about the market dynamics or the opportunities that you're seeing in that? And is that growth coming from D&O? Or is that within other professional lines?

Yes. Our professional liability encompasses various elements, including large public company D&O, smaller private sectors, and cyber insurance, along with professional liability related to agents and similar areas that focus on errors and omissions. We attribute much of the growth to cyber insurance, as our teams are increasingly focusing on it. Additionally, we have expanded our team in Europe due to the significant need for cyber insurance in that region. The growth in cyber continues despite a slight decrease in some rates, as we still find it to be a favorable proposition for underwriting. This segment also enhances our other business lines by providing added value to our clients, though obtaining coverage can be a bit challenging. As for D&O, we observe both decreases and increases based on current rates and the relative valuation and profitability of our portfolio. This quarter, D&O rates decreased by about 8%, which is an improvement compared to 1.5 years ago. Although the comments indicate that rates are down, we believe there are still considerable opportunities in that segment, but we need to approach it with more caution.

Our next question comes from the line of David Motemaden from Evercore ISI.

Marc, you mentioned in your prepared remarks that you're seeing increased underwriting appetite and developing competition, specifically within Reinsurance. Could you just talk about where you're seeing that, elaborate on that a little bit? And what specific lines you're seeing that in and how you guys are responding to that?

Yes. Currently, we are observing a greater willingness to take risks, particularly in cyber, insurance, and reinsurance. This spans a variety of lines, especially those that are more short-tail in nature. We notice that the competition is showing more readiness to accept additional risks. In our response, we typically begin by evaluating the overall situation to see if rates decrease or remain stable. When new conditions arise, we price the business as if it's new, considering the expected returns. If the returns do not meet our comfort level, we may reduce our participation. Additionally, we may choose to focus on clients who seem better equipped to navigate the current market dynamics. Overall, it is definitely an underwriters’ market at this time.

Got it. And just within Reinsurance, the underlying margins there were strong and even better if I exclude the bridge loss. Can you talk about if there is anything in there that would flatter the results? Or is it more just sort of the earn-in of the property, more short-tail lines and these results are fairly sustainable? I guess how should I think about the sustainability of the results on the Reinsurance side?

Yes, it's a strong market, and we've been highlighting this for several quarters. We recommend looking at results over a trailing 12-month period, as this provides a more dependable view and is less susceptible to unpredictable volatility. The quality of the current portfolio is excellent, and we are confident in realizing that value. As for this quarter, we can't say for sure if it outperformed the long-term average, but moving forward, focusing on a trailing 12-month perspective is likely the most reliable approach.

Our next question comes from the line of Josh Shanker from Bank of America.

On the other income which doesn't get enough attention, that's Somers and Coface. It was a weak quarter for Coface stock return in 4Q '23, yet the other was quite strong and maybe I'm misunderstanding how to model this, but I bring this up because Coface had an excellent quarter this past 1Q '24. And I'm wondering if that presages a very, very strong other income return for the company as we head into 2Q '24?

Yes. To clarify, there is a delay involved. Coface is accounted for on a one-quarter lag, meaning what they reported for Q1 will appear in our Q2 figures. Somers, on the other hand, is recorded in real-time. Somers should closely follow the performance of our Reinsurance book, although there are some nuances to consider. In general, it is tracked in real-time and should align fairly closely with our Reinsurance results. So, to your point, if Coface had a strong Q1, you can expect to see the benefits reflected in our second quarter.

In theory, there should be some correlation between Reinsurance segment underwriting income and Somers, which appears in that other line.

Correct. Yes. It's not perfectly correlated because it's not the whole segment. It's mostly the Bermuda Reinsurance unit that they follow. Not the entire business, but the big picture is still that if the market conditions are good in Reinsurance, Somers will benefit from that in a similar way.

And if one other numbers question post the S&P Model, the change from a few months ago, is there any way to think smartly about how much excess capital you think you're sitting on or the possibility if you find other interesting M&A items, the ability to quickly deploy?

Yes. I mean that's always an evolving topic, right? I think we are always focused on putting the capital to work in the business where we can. I think we've done a fair amount of that, obviously, this quarter with the Reinsurance growth that we saw. The $1.8 billion that will support the Allianz transaction is another example. We will see how the year plays out. No question that, we're generating significant earnings so that goes to the bottom line. And we'll be patient with it until we can't really find other ways to deploy it. But for the time being, we're in a really good place in terms of capital and gives us a lot of flexibility.

Our next question comes from the line of Brian Meredith from UBS.

I have a couple of quick numbers and a big-picture question for you. First, regarding the Allianz deal, can you provide an estimate of the cash you expect to receive from the net cash position?

Yes, in broad terms, it's a $2 billion deal with a one-to-one cash exchange. We receive $2 billion in cash and we will be paying out $450 million back to them as part of the cash consideration. So effectively, we will have $1.5 billion in additional cash. As for the new business, it will generate premium flow, and over time, this will lead to increased investment income or invested assets for us.

That's helpful. Second quick question here. You referenced in your commentary higher contingent commissions on ceded business in your Reinsurance. What exactly is that?

A significant portion of it comes from third-party capital. Last year was a relatively good year for the performance of that book. Many of those agreements pay us a commission that includes both a base and a variable component. Thus, a large part of our earnings comes from performance-based commissions related to property catastrophe or property business.

That makes sense. I have a broader question regarding your Reinsurance business. During the first quarter, you've been receiving significant input from clients. What are you observing in terms of reserve development at these clients? How are you managing the risk of potentially experiencing some of the negative developments that your clients are facing in relation to your portion of casualty quota share business?

Yes. I think Francois mentioned that the actual performance is meeting expectations, which is consistent across both insurance and reinsurance for the more recent policy or accident years. Having the right starting point means that frequent corrections aren't necessary. So, we're not surprised by what we observe in reinsurance. However, there seems to be significant friction between insurance and reinsurance companies as they strive to reach an agreement on what the ultimate figures will be. This is a topic we're encountering in the marketplace. While we engage in it, we don't see it as a major issue for us. Additionally, regarding the years before 2020 and 2021, I want to remind everyone that we took a defensive stance. We do not have a substantial amount of those premiums in the more challenging developing areas that are being discussed. Nonetheless, we see opportunities to underwrite more of those, and we anticipate more chances to pursue those types of deals this year, though I wouldn't say we are heavily involved in the toughest years.

Our next question comes from the line of Cave Montazeri from Deutsche Bank.

I only have one question today on the Florida market. The total reform implemented over a year ago seems to have had some positive impact on the primary carriers, and Reinsurance capital seems to be coming back. This is a market that you guys know very well. Do you have any color you can share with us on the state of the market in Florida?

Some adjustments are occurring, but inflation is also increasing. Additionally, there seems to be more activity and storms in the Southeast U.S. right now. People are trying to figure out their next steps. We have established relationships that should give us an advantage in participating in the market. Ultimately, we anticipate the Florida market will be well-priced and favorable from a risk-adjusted perspective. There are no signs indicating otherwise. The efforts made to address issues have been beneficial. However, it remains the largest property catastrophe exposure globally. Even with some corrections made, it may take a couple of years before we start seeing significant softening in the market. There may be minor fluctuations, but we believe the reinsurer market will remain healthy.

Our next question comes from the line of Bob Huang from Morgan Stanley.

Quick question on the M&A side. Obviously, you have historically generated very durable underwriting returns, mainly because of cycle management, in my view. Just curious as you move into M&A and diversify your business mix, does that impact your cycle management ability for retention levels when we think about M&A or potential M&A down the road?

No, it doesn't change. Cycle management is a core principle of ours. If anything, we'd like to be able to do it to some degree. Some lines of business require more intense cycle management because they tend to be more commoditized. I would expect cycle management to be much softer in the Allianz and the U.S. MidCorp business, which is also appealing because it provides more stability for the portfolio.

Got it. No, that's very helpful. And then in that case, when we think about M&A or future M&A, is it the first preference to use the excess capital or excess cash you're generating from this business to do the M&A deals? Or is it more preferable to use some of the stocks, given where the valuation is and things of that nature?

There isn't a single answer to that question. We often discuss M&A, but it doesn't occur very frequently. The size of the deal is important, particularly regarding how much we might need to raise by using our own stock. Generally, we believe it's better to utilize our cash when considering dilution. However, we take into account many factors as we aim to optimize our options. We also have ample capacity to raise debt if necessary. Ultimately, our approach depends on the specific circumstances and opportunities we face, and we evaluate each situation individually.

Could you please clarify that for me? Is it correct to assume that in this situation, cash and debt are more preferable, while equity might be less favorable? I apologize for needing a bit more clarification on that.

I mean that's been the preference historically. But I mean, again, it's hard to speculate on what could be the next thing. So yes, historically, but things change over time too.

Our next question comes from the line of Michael Zaremski from BMO.

Just a quick follow-up. You mentioned fee income earlier. Arch has a lot of diversified sources of income. Is there a way you can update us on kind of what percentage of your earnings maybe last year was derived from these kind of fee income type arrangements at a high level?

It's definitely grown over the years. The challenge we face is that some of these fees are associated with expenses linked to the revenue we generate, and these expenses are somewhat intertwined with our internal costs. Isolating the margin on those contracts can be a bit unclear. However, it has grown and is an integral part of our operations, utilizing our platform and underwriting capabilities across all three segments. Each segment generates some fee income, and Somers is included in that as well. Overall, it has become a more significant aspect for us.

Thank you. I would now like to turn the conference over to Mr. Marc Grandisson for closing remarks.

Thank you very much for hearing our earnings. Great start of the year. We look forward to seeing you all in July.

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