Arch Capital Group - Q1 2023

Transcript

Operator (participant)

Good day, ladies and gentlemen, welcome to the Q1 2023 Arch Capital Group earnings conference call. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. Instructions will follow at that time. As a reminder, this call is being recorded. Before the company gets started with this update, management wants to first remind everyone that certain statements in today's press release and discussed on this call may constitute forward-looking statements under the federal securities laws. These statements are based upon management's current assessments and assumptions and are subject to a number of risks and uncertainties. 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 may 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 on the SEC yesterday, which contains the company's earnings press release and is available on the company's website and on the SEC's website.

I would now like to introduce your host for today's conference, Mr. Marc Grandisson and Mr. François Morin. Sirs, you may begin.

Marc Grandisson (CEO)

Thank you, Lisa. Good morning and welcome to Arch's earnings call for the first quarter of 2023. I'm pleased to report that as a direct result of our premium growth momentum from the past few hard market years, we reported an excellent start to the year. Financial highlights include book value per share growth of 8.4% in the quarter and an annualized operating ROE of 20.7%. Our P&C underwriting teams continued to lean into attractive market conditions where excellent risk-adjusted returns remain available, growing net premiums written by 35% over the same period last year. A key element of cycle management is to respond aggressively when you see conditions change. Since 2019, we have seen the market psychology pivot to underwriting discipline. Our underwriting teams were prepared to become a more willing provider of capacity.

The current property cat dislocation has resulted in us targeting growth in property lines, and this should further improve our returns as we continue to benefit from the cumulative effect of improved rates, terms, and conditions. The $327 million of underwriting income generated from our two P&C segments this quarter is a testament to our commitment in the improved market. Our mortgage segment operates on a different cycle than the P&C, but it remains a significant contributor to earnings, generating a healthy $243 million of underwriting income in the quarter as our high-quality insurance in-force portfolio remained stable at $513 billion. Amid our P&C growth, I want to emphasize that Arch is first and foremost an underwriting company.

Being an effective underwriting cycle manager means that our underwriters know that they have degrees of freedom in choosing to deploy capital across our diversified, specialty-focused platform. We have a wider range of choices to allocate underwriting capital at any time, we can generate more consistent and stable underwriting incomes over the long run. Our growth in this hard market would not exist without our unwavering underwriting integrity. Our focus on underwriting leads to profit stability and better reserving visibility. Over time, these more stable results lead to greater balance sheet strength, which in turn enables us to more aggressively deploy capital when we see market conditions change in our favor. At Arch, we're deeply committed to the art and science of underwriting because we know that underwriting integrity over time solidifies our conviction and agility to proactively respond to changing market conditions.

I'll now share a few highlights from our segment, first with P&C. Overall, the P&C environment continues to offer plenty of opportunities as evidenced by our growth. As you see in our premium numbers, the reinsurance market in particular is very attractive right now. Reinsurance typically reacts more quickly to the changing environment than primary insurance. We are witnessing this phenomenon in these early stages of improvement in the property market. In our insurance segment, we continue to take advantage of favorable market conditions. For the past few quarters, property has seen significant rate escalation, which supported our 37% net premium written growth in that line of business during the first quarter of 2023. The property market is still broadly dislocated. We believe it will take further rate improvement before it finds equilibrium.

Elsewhere, general liability rates have picked up again. Large account D&O is one of very few P&C lines that has decelerating rates. Overall, the market remains disciplined in its behavior. We continue to obtain rates above trend. On our last earnings call, we noted property cat reinsurance dislocation at the 1/1 renewals, which led to significant effective rate increases. For the first quarter, reinsurance cat net premiums written roughly doubled over the same period in 2022. From our perspective, the improved conditions at 1/1 are a positive leading indicator as we prepare for the mid-year renewals, where peak zone capacity remains tight. We are well-positioned to take advantage of this opportunity. Arch is an increasingly prominent provider of choice in the property and casualty space. This is to be expected over time because of our differentiated cycle management strategy.

To execute our strategy, we continuously invest in improving our capabilities. We hire and retain top-tier talent and teams, and we seek to enhance our tools and technology with the aim of becoming a more intelligent, stable, and able provider of insurance products for our clients. Finally, our compensation structure rewards underwriting performance first and foremost. This is a powerful glue that aligns strategy with execution. Let me move to mortgage. Our mortgage segment continues to generate solid underwriting income and risk-adjusted returns, largely because our portfolio was shaped with a focus on credit quality and data-driven risk selection. Credit quality in our mortgage portfolio is excellent, as demonstrated by our 1.65% delinquency rate, the lowest since March of 2020.

Our disciplined underwriting approach has produced a portfolio with a more favorable risk profile, including higher FICO scores and both lower loan-to-value and debt-to-income ratios than our peers in the sector. Typical seasonality and tempered demand for housing in the first quarter affected new insurance written. However, production was in line with our expectations given the housing market's conditions. We're seeing pricing discipline across the MI industry as rates have increased over the past year. The MI industry's underwriting discipline is encouraging and allows us to maintain our focus on risk selection to achieve adequate risk-adjusted returns. The MI industry is competitive, but faced with the current risk factors in the broader economy, is acting rationally. As a result, our MI team continues to have opportunities to deploy capital. It isn't football season yet, but with the NFL draft beginning tonight, football was on my mind.

Back in the 1960s, a football team from a small Wisconsin town dominated the sport, winning five championships in a decade. The team, as you all know, was the Green Bay Packers, and their coach was Vince Lombardi, widely regarded as one of the greatest coaches of all time in any sport. One thing that made Lombardi a great leader was his obsession with excellence and execution. During their dominance, a key part of their offense was a very simple play called the power sweep. The quarterback would hand the ball to the running back, who ran the ball to one side of the offensive line, and then the offensive line acted as blockers, allowing the running back to plow ahead. No frills, no surprises. Opponents knew what was coming, but because of management, nobody could stop it.

We talk a lot about cycle management and underwriting discipline on these calls, and for good reason. It's hardwired into how we operate the company. They are not novel concepts. They're actually quite simplistic. The key, like with Lombardi's Green Bay Packers, is conviction and execution excellence. day after day and year after year, we line up and essentially run the same play. Write a lot of business when rates are high and a lot less when rates are low. François?

François Morin (CFO and Treasurer)

Thank you, Marc. Good morning to all. Thanks for joining us today. As Marc highlighted, we kicked off 2023 with excellent underwriting results across all segments. Our investment income continued its upward path, benefiting from a higher interest rate environment and strong operating cash flows. For the quarter, we reported after-tax operating income of $1.73 per share for an annualized operating return on average common equity of 20.7%. Book value per share was up 8.4% in the quarter to $35.35, reflecting not only our strong results, but also the unwinding of approximately $350 million of unrealized losses on our fixed income portfolio, net of taxes. Turning to the operating segments.

Net premium written by our reinsurance segment remained on its strong trajectory and grew by 51.5% over the same quarter last year. This growth occurred across most of our lines of business, with a particular emphasis on property lines, marine and aviation, and other specialties. The overall bottom line of this segment was also very good, with a combined ratio of 84.3% and a relatively small impact of $59 million from current accident year catastrophe losses. It's worth mentioning that our top line reflects the impact of some larger transactions, which are not uncommon during periods of significant market dislocation. We cannot tell whether the frequency and size of these transactions will recur in future periods, but we are optimistic that market conditions will remain attractive for the foreseeable future.

The insurance segment also performed well with first quarter net premium written growth of 19.1% over the same quarter one year ago, and an accident quarter combined ratio excluding cats of 89.8%. There were a handful of items affecting our top line more significantly this quarter, such as a large transaction in the lenders and the warranty line of business, and very strong market conditions in the property, energy, and marine line of business, both which were partially offset by the headwinds of weaker foreign currencies against the US dollar compared to a year ago. We estimate that on a constant dollar basis, our net written premium growth would have been approximately 230 basis points higher than reported in our financials.

Most of our lines of business still benefit from excellent market conditions both in the U.S. and internationally. We remain positive about our ability to grow in the right business at expected returns that meet our ROE targets as we approach the second half of the year. Our mortgage segment had another excellent quarter with a combined ratio of 20% from strong performance across all our units. Net premiums earned were up slightly on a sequential basis, reflecting the increased persistency of our insurance in force during the quarter at USMI and good growth in our units outside of USMI. We recorded approximately $73 million of favorable prior year reserve development in the quarter, with approximately two-thirds coming from USMI and the rest spread across our other units.

Cure activity this quarter at USMI was particularly strong as we benefited from the highest first quarter cure rate we have seen in the past six years, excluding 2020. At the end of the quarter, over 80% of our net reserves at USMI are from post-COVID accident periods. Overall, our underwriting income reflected $126 million of favorable prior year reserve development on a pre-tax basis, or 4.3 points on the combined ratio, and was observed across all three segments. Quarterly income from operating affiliates stood at $39 million and was generated from good results at Coface, Somers, and Premia. As you may already know, Coface recently declared a dividend of EUR 1.52 per share, which should result in a EUR 68 million dividend to Arch in late May, subject to Coface shareholder approval.

Although this amount will not benefit our income statement next quarter, we believe it reflects very well on Coface's results and prospects for the periods ahead. Pre-tax net investment income was $0.53 per share, up 10% from the fourth quarter of 2022 as our pre-tax investment income yield exceeded 3% for the first quarter since 2011. With new money rates in our fixed income portfolio holding relatively flat in the 4.5%-5% range, we should see further improvement in our net investment income returns in the coming quarters. Total return for our investment portfolio was 2.54% on a US dollar basis for the quarter, with all our strategies delivering positive returns.

The contribution to the overall result was primarily led by our fixed income portfolio, which benefited from slight downward pressure on interest rates during the quarter. While fixed income market volatility was elevated intra-quarter because of the stress in the U.S. and Swiss banking systems and the implications for monetary policies at central banks, spreads at quarter end were generally consistent with those at year-end 2022. The overall position of our investment portfolio remains neutral relative to our target allocation. We are well positioned to capitalize should there be further dislocation in the capital markets. Of interest, our commercial real estate exposure is distributed across a variety of strategies, accounts for only 6% of Arch's investment portfolio, is highly rated as a low loan to value ratio and is more concentrated in multi-family housing investments with minimal positions in office properties.

On the cash side, positions are concentrated with large money center banks with no significant exposure to U.S. regional banks. Turning to risk management. Our natural cat PML on a net basis stood at $1.069 billion as of April 1 or 8.1% of tangible shareholders' equity. Again, well below our internal limits at the single event 1 in 250-year return level. Our peak zone PML is currently the U.S. Northeast and reflects some pockets of increased capacity we deployed at April 1 in response to good market opportunities ahead of the more active renewal periods at June 1 and July 1. In summary, we remain very positive on the current market and the opportunities ahead of us across all our segments.

At the current expected returns, we believe deploying meaningful capacity in our businesses currently represents our best option to maximize returns for the benefit of our shareholders. Our commitment to being active, yet disciplined capital allocators remains a core principle of ours that should lead to long-term value creation and success.

With these introductory comments, we are now prepared to take your questions.

Operator (participant)

Thank you. If you would like to ask a question, please press star one one on your telephone. If you would like to remove yourself from the queue, please press star one one again. One moment while we ask go to the first question. The first question comes from Elyse Greenspan of Wells Fargo. Your line is open.

Elyse Greenspan (Managing Director)

Hi. Thanks. Good morning. My first question, Marc, in your introductory comments, you said that, you know, we're in the early stages of improvement in the property market, right? We've seen, you know, strong rates at January 1 that have persisted into April 1, and my sense is could persist through the midyear. Could you just comment on what you mean by, you know, early stages and how you could see this playing out, you know, in during the rest of 2023 and into 2024?

Marc Grandisson (CEO)

Very good question, Elyse. Good morning. I think When we have a dislocation such as the one we sort of realized and experienced after Ian in the fourth quarter of last year, the renewals took place on the reinsurance place at much higher rates, right, 30%, 50%, 60% price and the rate increases, obviously. You've heard that on other calls. We had the same experience. The reinsurance is typically the first to move, reacting to deploying capacity, and they should because they have to commit the capital for a 12-month period. We have a lot of portfolio. I'm going to switch now to the insurance side.

This is where I think is going to be leading the market and continue to underscore and support the market, is the insurance portfolios, ours included at the insurance level, they're going through a re-optimization, you know, realigning of capacity, realigning of pricing, terms, and conditions. This is widely spread across the industry. An insurance product does not get all renewed at 1/1, right? The renewal takes place over a 12-month period. What we're seeing and hearing right now is the market psychology is spoiling the cat of getting improved terms and conditions on the primary side, which will then lead to, obviously, you know, further improvement from the distance of the reinsurer.

This will take 12 to 18 months to really take hold, and we believe, which is actually a little bit, you know, positive from our perspective, we should see that improvement carrying on and staying around for more than this year. We expect the underlying property improvements to be there for two, maybe two and a half, maybe three years, which is a great leading position to be from the insurance. First, the reinsurance react. The insurance is reacting. It takes a longer time to modify and correct itself. There's momentum being built in creating a better equilibrium on the insurance level. The reinsurance will get renewed again at 1/1/2024. We most likely have more, you know, more things to improve on our portfolio.

I think this is how the hard market takes place over time, how it develops and unfolds over time. That's what we mean. We think that we have a little bit, you know, quite a, you know, some nice runway ahead of us because of that reason.

Elyse Greenspan (Managing Director)

That's helpful. you know, could you give us a sense if, you know, the in your margins in both insurance and reinsurance, did, you know, social inflation or financial inflation, you know, did that impact, you know, how you booked, you know, the current accident year in both insurance and reinsurance?

Marc Grandisson (CEO)

Yeah. The way we operate and the way we put our reserving, our loss ratio, you won't be surprised to hear from us, is we tend to take a prudent stance. That's the first step that you need to understand, and we could all realize, and I know we saw that historically. This is one of the key things that we need to, that we work on. Our game plan is to look at a trend and look at the rate level on a quarterly basis, modify it if we have a good reason to modify it, and book it to a, shall we say, maybe a 60th percentile, you know, confidence interval, not playing too close to the average, because we want to have some protections, because who knows what the future will hold.

If you look at the reserving overall in our company, we look line by line, we look at inflation, be it financial or social, by layer, by attachment point, by region, and we, you know, we correspondingly take a loss ratio for the overall portfolio. What you see in our results, in our numbers, is the sum total of the aggregation of all these various decisions within our insurance or reinsurance units. I think that. At the end of the day, François and I look at it to make sure that we have, we feel, you know, more comfortable than possibly the average bear out there, and we make sure that it's on a trajectory that is responsible and prudent as well. Our tendency will not to take all the good news right away.

We will probably, you know, wait and see. We've grown as well, Elyse, as you know. It means that we have to be, you know, a little bit careful and thoughtful in the way and the pace at which we would recognize some of these improvements.

Elyse Greenspan (Managing Director)

Maybe just one more sticking there, Marc, right? In the reinsurance segment, right, the growth, you know, exceptional, really strong, but, you know, the underlying loss ratio, right, was, you know, did tick up, you know, from last year. I think part of that, there's always noise in each quarter, and it does take time to, you know, earn in this business written at January 1. Can you help us, you know, kind of put that all together and just give us a sense of the margin profile of the reinsurance business over the balance of the year?

François Morin (CFO and Treasurer)

Yeah. I'll take that one, Elyse. I think a lot of insurance people, you know, obviously, you know, look at the quarterly numbers. Our view is we look at it, but we don't lose sleep over it. I think we look at long-term trends. We look at the quality of the business and how it prices and what the expected returns are at and when we find the deals. Specific to this quarter, you know, as I mentioned, I didn't give you really a whole lot of specifics, but there was two transactions that really distorted a little bit our ratios with basically higher loss ratios and lower acquisition. Yes, you saw a little bit of movement on both the loss ratio and the combined ratio.

The impact on the ex-cat accident year loss ratio was 2.2 points. It's, you know, it's there. We know it's there. Again, it's, I wouldn't make it a trend. I mean, it's just the reality of the business we've had this quarter. That's why I mentioned that, A, we, you know, these are non-recurring items. In this market, who knows? There could be more in coming quarters. That's kinda how we, you know, that's the result of the business we had this quarter.

Elyse Greenspan (Managing Director)

Thank you.

Marc Grandisson (CEO)

You're welcome.

Operator (participant)

Thank you. One moment while we prepare for the next question. The next question is coming from Jimmy Bhullar of JPMorgan. Your line is open.

Jimmy Bhullar (Equity Research Analyst)

Thanks. Good morning. First had a question on your comments on pricing, obviously very positive both in reinsurance and insurance. Can you distinguish between pricing in both reinsurance and insurance on property and more of the cat exposed business versus the casualty lines?

Marc Grandisson (CEO)

Yeah. The last numbers we heard, it's a good question. The last numbers we heard on the primary side, we're looking at pricing depending on the zone. If you're cat exposed, obviously it's more acute. Rate increases, you know, 40% to, you know, 40%-50% plus, definitely. A little bit less if you're intercoastal. If you win inland, it might be 10-15% increase. It's clearly a push for rate increase. What's not really fully reflected, and you should hear, there are other things going on underneath the terms and conditions. Deductibles are going up. That's also a really important factor, also helps if you're a reinsurer of this portfolio.

There's a statement of value which pretty much states that any company now providing, providing coverage needs to have a up-to-date valuation of the property you're trying to insure. That is a big deal because the industry has been frankly lax in its updating these numbers. Once you have the right exposure, it actually makes the pricing that much more, you know, effective and accurate. This is the whole market is moving in that direction. Thirdly, I think that's also important, which creates more dislocation, is there's a shrinking of capacity at the individual players. So when people were putting $25 million-$30 million worth of capacity on even a cat exposed, these limits are going down $2.5 million, to $2.5 million, maybe $10 million on an exceptional basis.

I think that the insurance portfolio, the rates are going up for a lot of reflection. I go back to one of the questions about an inflation on the property side that is reflected in the statement of value. We're definitely clearing that one. You know, depending on where you are, you went from 15% lesser cat exposed to 40%, 50% if you're cat exposed. On the reinsurance side, it's a little bit similar, although it's a bit more of a monolithic marketplace. The rates are going in a much more narrow range. It's almost like more commoditized, if you will. It's a little bit between 30%-50% pretty much broadly across. Of course, there'll be differences. We'll see what the June 1 reserve for us.

The more acute the cat need, the more acute in the key zones of capacity demand, the higher the pricing is. As a general, the overall general pricing is in sync. The insurance one will be able to grab those increased rates and improve terms and condition over the next 12 months. The reinsurance work was able to get there quicker.

Jimmy Bhullar (Equity Research Analyst)

Just on the MI business, you had very high cures. I'm assuming most of these are just on reserves you put on around COVID when there were forbearance programs. If that is the case, how much more of these such reserves do you have that'll most likely, I'm assuming, will be released over the course of this year?

Marc Grandisson (CEO)

Well, we still have, we definitely do have still some delinquencies that are in forbearance programs. You know, I quoted 80% of our loss reserves are from post-COVID periods. You know, we don't have all the detail around, you know, how much are, you know, by year, etcetera. Just hopefully that gives you a flavor of like, what maybe, you know, could potentially be coming down the pike in terms of, you know, more releases if, you know, we're able to cure. I think, you know, the fact that unemployment, you know, levels are still performing very well, I think that that's a good sign, right? I mean, that's, you know, there's some pressure on home prices, etcetera.

For the in-force book, we think again, the credit quality's been excellent and we think there's, you know, performing well. You know, when we're able to cure those delinquencies over time, hopefully that should help the bottom line.

Jimmy Bhullar (Equity Research Analyst)

Okay. Thank you.

Marc Grandisson (CEO)

You're welcome.

Operator (participant)

Thank you. One moment while we prepare for the next question. The next question is coming from Tracy Dolin-Benguigui of Barclays. Your line is open.

Tracy Dolin-Benguigui (Director and Head of Insurance Equity Research)

Thank you. Hey, I'm trying to understand mechanically why an LPT type of transaction could add noise to your underlying loss ratio on the reinsurance side. Is it that you're not imposing a loss corridor and you're assuming losses would attach at inception? Or is it accounting on the premium recognition? If you could explain the mechanics, that would be helpful.

François Morin (CFO and Treasurer)

Sure. I mean, at a high level, what these transactions typically look like is, you know, they limited. In terms of, A, the acquisition expense is zero, if not, you know, very, very small. If you think in a, you know, traditional quota share deal where the, you know, assume the acquisition ratio could be 30%, well, that goes away. You're effectively just, you know, picking up losses. You know, the, you know, the investment income on the float is effectively part of the overall return of the transaction.

It changes the dynamic, and that's what we're, you know, trying to convey here, is that, you know, on the underwriting side, you know, it's usually booked closer to 100% combined, you know, within, you know, that kind of range. You know, the investment income that you pick up, is significant. That impacts the overall bottom line returns on the business.

Tracy Dolin-Benguigui (Director and Head of Insurance Equity Research)

Okay. Also, it may be a little bit early, but can you discuss how June 1 and July 1st renewals are shaping up at this point? Like, how would you compare pricing to what you saw in January?

Marc Grandisson (CEO)

We heard from our team, we've been talking to them quite a bit of late. I can't talk about all the specifics, but at high level, a continuation and, you know, of the hard market that we saw at one-one. We're seeing, you know, continuing hardening or on the same level as one-one. If not that, it's better. As I want to tell you, Tracy, six one and seven one are not done yet. Like, people are still very actively working on it. The momentum is there, clearly.

Tracy Dolin-Benguigui (Director and Head of Insurance Equity Research)

How would that compare when you say momentum? The same or better since January?

Marc Grandisson (CEO)

It's early. I think it's early right now. I don't want to venture because also, Tracy, what we all collectively have to keep in mind is 7/1 of 2022 was also pretty good renewal for the quarter, for instance, right? It may not need as much of a pricing because of we believe more specifically in Europe that we believe, you know, not as well priced as ought to be based on the risk that you're taking. It's still gonna be return wise, better, most likely better return than possibly most likely the 1/1 that we saw because it's a peak zone. It's everybody's, you know, source of capital or use of capital.

Tracy Dolin-Benguigui (Director and Head of Insurance Equity Research)

Thank you.

Marc Grandisson (CEO)

Thanks.

Operator (participant)

Thank you. One moment while we prepare for the next question. The next question is coming from Yaron Kinar of Jefferies. Your line is open.

Yaron Kinar (Equity Research Analyst, North America Non-Life Insurance and Insurtech)

Thank you. Good morning. I want to go back to the margins in reinsurance, the underlying margins. I think that even with the LPTs, the accident, your loss ratio, ex cats still deteriorated a bit. I just want to understand kind of the context or why that would be if we are seeing business mix shifting more to kind of inherently lower loss ratio lines on an underlying basis and with the rate environment?

François Morin (CFO and Treasurer)

Yeah. Three things I'd say. A is, I mean, we focus on returns. You know, while, you know, the, you know, obviously what's in front of you is just the underwriting part of it. We focus on, you know, overall returns, which is the first thing. Second thing I'd say is, you know, you got to give us a little bit of a chance to earn the premium. I mean, the market was solid in 2022. It got better at 1/1/2023. We're a quarter into the year. I think there's more benefits or more improvements to come, but it doesn't all show up at, you know, initially. You know, third thing, as Marc said earlier, I think we're being prudent.

I mean, the math may suggest that, A, you know, if you did this and that the combined ratio or loss ratio should be X. You know, we are prudent in how we look at things. You know, when the data tells us that, you know, the, you know, maybe we were a bit high, we'll be more than happy to release those reserves, but we're not gonna declare victory, quite yet.

Yaron Kinar (Equity Research Analyst, North America Non-Life Insurance and Insurtech)

Okay. A second question just on cats. Can you maybe offer some color on the distribution between the various sources, whether it's Turkey or New Zealand floods, the European storms and so on, in both reinsurance and insurance?

François Morin (CFO and Treasurer)

Yeah. I mean, it's small ticket items. I'd say the biggest one for us was we had, you know, $25 million loss in Turkey, which, you know, is kind of what we do. It's not, you know, a huge deal, but that was the biggest item. Yes, we had some kind of participations in New Zealand with the cyclone or and also some floods. In the U.S., you know, kind of the normal run-of-the-mill kind of tornadoes, convective storms that hit. You know, that was mostly insurance, but a little bit of noise there as well in reinsurance. It's, you know, call it a hodgepodge of small things, but the biggest one was for us this quarter was the Turkey earthquake.

Yaron Kinar (Equity Research Analyst, North America Non-Life Insurance and Insurtech)

Was Turkey and then New Zealand, were those mostly reinsurance?

François Morin (CFO and Treasurer)

Yeah. Yeah. Turkey was only reinsurance. Yes.

Yaron Kinar (Equity Research Analyst, North America Non-Life Insurance and Insurtech)

Okay.

François Morin (CFO and Treasurer)

Is Florida. I mean, both of them are only reinsurance.

Yaron Kinar (Equity Research Analyst, North America Non-Life Insurance and Insurtech)

Got it. Thanks so much.

Marc Grandisson (CEO)

Yep.

Operator (participant)

Thank you. One moment while we prepare for the next question. The next question will be coming from Josh Shanker of Bank of America. Your line is open.

Josh Shanker (Managing Director)

Yeah. Hi there, everybody. Good morning. I was looking at the investment return. I mean, there's a lot of ways to measure yield. I would just take the investment income divided by the float. I'm getting about 2.76% for the quarter, which makes Arch by a material amount, the lowest earner on its float in your peer group. I know you guys have a more conservative portfolio that's also allowed you to redeploy higher pretty quickly. With new money yields maybe in the 5% range, without taking any equity risk or whatnot, you have an opportunity to increase that yield. Are you still keeping some powder dry? Do you still think it's time to be fairly conservative in seeking yield at this point?

Marc Grandisson (CEO)

I mean, It's something we obviously realize that there's, you know, new money yields are higher, and for us it becomes a question of, like, crystallizing losses. There's implications around statutory versus GAAP accounting. You know, we have restrictions in some places. I think, you know, for us, you know, we do the analysis very carefully in trying to make sure that we're doing what's best for the, you know, ultimately the shareholder. Sometimes we're better off kinda holding some investments to maturity until, and not kinda taking on the, you know, the loss and reinvesting the money faster. In terms of opportunities, whether we see more or wanna take more, on more risk, it's something that we are thinking about.

You know, we have grown our presence in alternatives in the last few years, and that's something that. For us, alternatives is, you know, call it more right structured of investments, and that's where we see the better opportunities and we've been pretty aggressive in growing the money there. Obviously the returns there don't show up in investment income. They show up in equity method funds for the most part. You know, that's where we expect to see a little bit of pickup as well going forward.

Josh Shanker (Managing Director)

Right.

Marc Grandisson (CEO)

Also just thinking about the overall risk, right? Of the enterprise, right? We have a lot of underwriting, you know, push and grow. That's also factored in our risk. You know, not that we're concerned, but just, you know, it's one of the other part of the equation that we have to factor in as well.

Josh Shanker (Managing Director)

What's the new money yield right now for you?

Marc Grandisson (CEO)

We're 4.5-5.

Josh Shanker (Managing Director)

4.5-5. Okay. You know, look, I know that you do listen to your competitors' conference calls and think about what they're saying. Looks like the pricing environment's pretty attractive. I think that's universally viewed. A few of your competitors have said as much. When we look at their premium growth in the quarter, it's kind of tepid, especially on the insurance side. You guys are growing your net premium written about 20% right now. It's been going that way for a little while. Is business hard to capture? Hard to get the business you want and you've been really successful outmaneuvering your competitors? I guess there's two things.

One is why are you so successful growing when others have not been able to do so? Two, can you give comfort to the fact that maybe some question, maybe the market's not as good as we think it is, and maybe there should be more concern? I guess, I mean, how can you give us comfort with the rate adequacy, and why are you successful where others have failed?

Marc Grandisson (CEO)

From the rate adequacy perspective, I mean, this is sort of a, it's a system that's well established in our company. I don't know how many times we verify the assumptions and the projections, be it at the individual underwriter level, group level, in segment level, at corporate between, you know, the holding company, including the board. I mean, there's a lot of vetting going on and comparing notes and triangulating. We're pretty confident. We wouldn't be growing that level if we didn't think that the returns were in our favor. Does that mean that we're gonna get all the returns that we expect precisely to the decimal? Most likely not, Josh. We're in an uncertain world, and we're making a bet on the longer term expected, and that's the best thing that we can do right now.

We're big fans of thinking about the rate as being by far the most important, you know, place to start to make sure that you have enough that you put the odds in your favor. The rate's going up, you know. A lot of lines, rates go up 60%, 80%, 70% even some of them 1x to 2x. Even if there's some of it, you know, decrease, it goes to 1.9x. We also look at the history of the industry, and the industry was sprinting five or six years ago, 60%-65% loss ratio.

Even if they were wrong on a reserving level and, you know, grows to 80 and you put all the factor in the trend and you put the cumulative rate impact, I think that there's no certainty but there's certainly a level of margin of safety that you've built within the price. That's what makes us feel that much more comfortable. Now, in terms of, you know, our production in the marketplace, how we're able to lean in and see that business. First, you know, we were early in the 2019 to really lean into it. A lot of people were pulling back, and that creates, you know, voids and vacuum for our clients. We were the ones, the beacon in the storm, if you will, able to give them capacity.

That goodwill, for lack of a better word, really builds upon itself. It really creates more relationship, builds relationship that frankly has been a little bit less strong because of our defensive mode, prior to 2019. We rebuilt it very, very nicely. We're always there, but we rebuild, we kindle them in a much major way. You can talk to our producers, they'll tell you that we're a great partner of theirs, and that makes a big difference. When the next piece of business comes in, you look at the people who could write that business, and we purchased from our insurance group. We can look at 10 markets. The market that wants the business right now was on it 4 years ago. They'll probably not have the first dip at it.

We'll probably have the first look at it because we were there for four or five years. I would add that we're an E&S player, and as you heard, the E&S market is growing. The market is also growing, you know, towards us. The tailwind going from our perspective on that note. We're pretty good security, Josh. We're a pretty good company. People want to deal with us. We're good for the money. We have a good expertise and good teams that really can advise a client. I think we spend a lot of time, not only providing coverage and policies, but advising clients and being a good market leader in right now. Certainly that growth over the last three, four years have created its own momentum and inertia.

The gravity, if you will, that it's been creating has been pretty nice. It helps. It helps grow further even in that marketplace. Even the market gets a bit more competitive, I would argue that we'll be able to hold on to a lot of good business that we've written over the last four or five years.

Josh Shanker (Managing Director)

Well, thank you for the fulsome answers, and congratulations to everyone on graduating from rounding to the nearest thousandth to rounding to the nearest millionth.

Marc Grandisson (CEO)

Thanks, Josh.

Josh Shanker (Managing Director)

Take care.

Marc Grandisson (CEO)

Thank you.

Operator (participant)

Thank you. One moment for the next question. Next question is coming from Brian Meredith of UBS. Your line is open.

Brian Meredith (Managing Director)

Thanks. A couple of them here for you. Just quickly, François, you gave us loss ratio impact of the LPT. Can you give us what the combined ratio, maybe the premium impact, just for modeling purposes?

Marc Grandisson (CEO)

Combined ratio is 1.1.

Brian Meredith (Managing Director)

Yes.

Marc Grandisson (CEO)

2.2 in the loss ratio. Again, all that stat and the premium was $118 million.

Brian Meredith (Managing Director)

Brilliant. Thanks. Second question. Marc, looking at the 6/1 renewals, Florida, I guess, one, what is the impact of the legislation that was, you know, recently enacted having you think on that marketplace? You know, will it have an impact on renewals, pricing, capacity coming into the market? How do you typically think about Florida from a reinsurance perspective? You know, is it a market you'd like to play cat? Do you like to play quota share? How do you kind of think about it when you look at the Florida market?

Marc Grandisson (CEO)

The second part, Brian, the second part of your question is easier. I think we're much more of a excess of loss writer in Florida. We believe this is a better play for us at this point in time. That seems to be sort of where also where the market is slowly migrating towards, at least from the first indication. The first part of your question, which is the most interesting one, is we're in Florida, but we sort of might as well be in Missouri, in the show me state, right? We need to show, we need to start to see and have evidence that those, you know, tort reform will take hold. It's going to take a while.

You know, as we all know, we've had a slew of claims that went in before the 1st of, 1st of April. The 1st of May, I can't remember which one, you know, a slew of claims to make sure that we, that they, you know, take advantage of the last, you know, remnants of the weaker, tort area there. You know, that's going to take a while to work through. It also might mean that some of the losses from prior years are developing adversely, which is not necessarily going to be useful and helpful for those who try to renew, for on an ongoing basis, right?

If you have more losses from that, from the prior years, the acceleration of losses, you may have to, you know, make up for a lot of that or some of that. It's not a lot of it if you're a buyer of reinsurance. I think overall, I think the market will take sort of a view that it's not there at 100%, and they'll probably sort of factor in who is more, you know, who is more or less, you know, exposed to those, probably give credit to those more or less exposed. You're not going to get, it's like everything else, you know, we'll need to see it through to get full credit. I think the market will give some credit, but not the full extent of it. There's no way, at least not in this time.

Maybe in two years or next year or two years time, but it's going to take a while because we need to show and see what's happening before.

Brian Meredith (Managing Director)

Great. Thank you.

Marc Grandisson (CEO)

Sure.

Operator (participant)

Thank you. One moment while we prepare for the next question. The next question comes from Meyer Shields of KBW. Your line is open.

Meyer Shields (Managing Director)

Thanks. I had one, I guess, technical question on the LPT side of things. Is it fair to assume that this is a 100% combined ratio business as you write it, or does the fact that it pertains to...? Well, let me stop there.

Marc Grandisson (CEO)

Well, that's typically where we book it. I mean, plus or minus those types of transactions, that's kind of where they, yeah, that's where the combined ratio is on those. Because the contribution to profit and margin is square a lot more on the investment income side than it is on the underwriting income, pure underwriting income side.

Meyer Shields (Managing Director)

Okay. Then speaking, I don't know if you want to talk about the transactions or the demand that you're seeing, and you talked about that, I guess understandably being a function of distress in the marketplace. Is this, is the market right now focusing on the, let's say, 2019 and earlier accident years where pricing was soft or I should say, and or is there interest in even more recent years because of loss trend?

Marc Grandisson (CEO)

Yeah, I think the market is focusing on it because I think that. Also if you add on top of it the reopening of the courts, post-COVID, there's a lot of uncertainty. We've heard about inflation, you know, financial inflation and social inflation. Yeah, there's a lot of scrutiny, and the rates were much lower back then. There is definitely less, you know, bank for those years to, you know, to get the right number, the right loss ratio pick. Yeah, definitely people are looking. As we are as well, and when we on the reinsurance side with your treaty, we can see, we, you know, without naming any names, you know, some companies have development that's adverse in those periods. Some of them don't.

Yeah, there's definitely a point of discussion, which I think, Meyer, helps explain why we continue to have the strike increase from the GL, for instance. I do believe that people are realizing it and understanding that they're recasting, right, the long-term trend, and long-term loss ratio projection on an all level basis. You know how that works. I do believe that people are reflecting, and that's also why we have this, you know, we don't have, you know, massive combined ratio above 100 across the industry. What we do have still a healthy level of price increase because of that phenomenon.

Meyer Shields (Managing Director)

Okay, that's helpful. If I can just pick up on that because in your prepared comments also, you talked about GL rate increases picking up a little bit.

Marc Grandisson (CEO)

Yep.

Meyer Shields (Managing Director)

Haven't heard a lot of that. We've heard a lot on the property side, so was hoping you'd get a little more color.

Marc Grandisson (CEO)

Yeah. The liability lines are, I mean, of course, a lot of it has been historically, you know, led by, it's auto specific on the umbrella. The GL is clearly picking up again, and it's of late, and it's also international. We have our Lloyd's book of business as well as our insurance portfolio in the U.S. I think that there's also a dislocation going on on the GL side. People are reevaluating the lines of business, the areas and the industry that they're providing GL coverage for. This is happening, probably a bit more. It sort of slowed down a bit towards the second half of 2022, and I think it's reoptimizing or re-underwriting or, you know, refocus on the underwriting and price for the GL.

It also led, as you can appreciate, Meyer, about some, you know, increase in trend, specifically if you're on the excess layers because it's levered. I think that's what we're seeing some of that prior year coming through and having to recast the pricing, which you wouldn't have had or wouldn't have seen necessarily in 2020, 2021 because those years, 16 to 19, were probably too young to really get the development coming out. You probably can see that the duration of development of GL coming through and people reacting to it.

Meyer Shields (Managing Director)

Okay. Fantastic. Thank you so much.

Operator (participant)

Thank you. One moment while we prepare for the next question. The next question comes from Mike Zaremski of BMO. Your line is open.

Mike Zaremski (Managing Director and Senior Equity Research Analyst)

Hey, thanks. Maybe a question or two on the catastrophe levels this quarter. I mean, Marc, you brought up terms and conditions changes. I think it probably blows certain people's minds that the valuations on property, you know, are just getting up to date and seems kind of antiquated, but that's just, I guess the way that the reinsurance maybe with them or, sorry, the overall marketplace works. Just curious though, the PCS cat loss levels for the industry in the U.S. were way above a normal 1Q. I know you guys aren't, right, that's not the best guide for Arch, but you know, looks like Arch's cat levels were normal-ish, but you can correct me if I'm wrong.

Any read-throughs on, you know, the terms and conditions changes that have taken place that are, you know? Is there any read-through there that there's some good things coming through?

Marc Grandisson (CEO)

I think on our results, I don't think you would describe the improvement in terms and conditions. I think it's probably just a function of how the book, where our exposures are, right? We didn't have as much exposure in the areas where the big losses occurred. I guess I would say it's a mix that could happen, you know, that happens sometimes. That's really all we can see right now. We haven't seen the impact of the things I mentioned already because they're starting to take hold anyway, so it's gonna take a while for them to see. That loss or these losses next year would presumably be because of all the conditions and terms, as I told you, are changing.

It would be reasonable to expect that the losses will be, you know, less than they are right now. We have yet to see whether the portfolios go through these changes. Nothing other than our exposure, you know, was not where the losses occurred.

Mike Zaremski (Managing Director and Senior Equity Research Analyst)

As a follow-up, where when we're hearing about, you know, the substantial rate increases, especially in property, does that take into account the terms and condition changes, or is that like, are these kind of risk adjusted rate increases that you're speaking to and some industry participants are speaking to?

Marc Grandisson (CEO)

No, they're not fully risk adjusted. It's a really good question because it's a factor of a harder market or a softer market that when you see a rate, the thing that you can measure, you will incorporate into your calculation. There are things that you cannot, you know, calculate for or, you know, specifically, isolate for and put in your formulas, right? Some, you know, there's some co-insurance clauses in there that are finally going to be put back in the marketplace that really prevents some of the collections and that could otherwise happen. That's not factored in the pricing. There's a, you know, having the venue for litigation of mitigation of the losses to be in a different environment, one that's for instance more litigious to one that's less litigious. You're unable to factor that in the pricing.

I would say to the extent that you factor in the deductibles, the sub-limiting, and you can run the cat losses based on the layers where you attach. If you attach higher, I think that is reflected in the pricing that we mentioned. The other things that are also going in the same direction, that's the trademark of a hard market that is not fully reflected. It's sort of the extra pickup, that extra gravy that we don't see, but that we know collectively is there. That also helps us, you know, feel a bit more, we have more conviction, you know, writing more of that business.

Mike Zaremski (Managing Director and Senior Equity Research Analyst)

Got it. Maybe lastly, switching gears a bit. I believe Arch writes a decent amount of professional lines. That's one marketplace that, you know, we've seen some stats pointing it to being, you know, more of a softer marketplace. Maybe you can comment if that's the case for Arch as well. I don't know if you gave commentary also just on overall kind of rate increases on your primary insurance book this quarter. Thanks.

Marc Grandisson (CEO)

No. Thank you. They're good questions. On the first part, for the D&O, our portfolio has been going down, you know, a bit further than the rate increase that we saw. The professional lines that we have on our financial supplement includes more than this, obviously. Suffice it to say that we're like everybody else, seeing a little bit more aggressiveness in that segment. The one thing that makes us being still wanna be in there, and not, you know, declare that this is over by any means, is that the trends have been favorable to the D&O. The AOB claims were down for the last two years.

A lot of clients got, you know, broad brushed rate increased, rate increase and presumably did not fully deserve it. There's a lot of pushback on this as we speak right now. Again, talk about underwriting and risk selection. There are ways and there are areas where you'll keep getting a 10% rate. There are other areas where you're not okay giving, getting a +5%. I think our, you know, our team is extremely experienced, have been doing this for almost 30 years. They're, they're pretty good at picking and choosing their spot in that basis. The overall rate change on that, we don't report it because the overall rate change, you know, is not a good indicator, especially when you have so many varied line of business going up and down.

I think that the delta between the rate and, but you heard what other people and also our book of business, the average is not really a good indicator. I think the pickup between the trend and the rate is anywhere between 2-500, you know, depending on the line of business. We're still getting some pickup. Those that we may not be getting, you know, pickup in margin, at least from the appearance, the jury is still out as to whether the losses, the loss trend is truly positive. It's still not certain where these lines will be, specifically D&O.

Mike Zaremski (Managing Director and Senior Equity Research Analyst)

Thank you.

Marc Grandisson (CEO)

You're welcome.

Operator (participant)

Thank you. One moment, we have a follow-up question from Jimmy.

Jimmy Bhullar (Equity Research Analyst)

On your PMLs, they've obviously gone up because you've written a lot more business and you're retaining a lot more. The 8.1% number that you mentioned, it's still lower than peers. Where would you feel comfortable taking it if the market environment remains favorable?

Marc Grandisson (CEO)

We think, yeah, just a quick reminder, I think, each zone for us, you know, right now we're kinda, you know, Northeast is our big zone, but we also have like Florida, Tri-County, which is kinda at the same level. The 1/1 renewals were more international, more national. National accounts, not really, Southeast specific, where, you know, we expect to see more, you know, more activity at 6/1 and 7/1. No question that, you know, we think it'll go up. I mean, if the market stays as it is right now, you know, could it go up to 10%-12%? We think so, and we think it's a reasonable scenario.

You know, obviously, we'll have to wait and see and figure out and see how the renewals, you know, how everything gets lined up. You know, that directionally, I think that's kinda where we think we might be heading at, you know, July one.

Jimmy Bhullar (Equity Research Analyst)

Okay. Thank you.

Marc Grandisson (CEO)

You're welcome.

Operator (participant)

Thank you. I'm not showing any further questions. Would you like to have further closing remarks?

Marc Grandisson (CEO)

Thank you everyone for listening to our story. It's a great one, and we are looking forward to get even more good news in the July call. Thank you for everything, guys.

Operator (participant)

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