Arch Capital Group - Earnings Call - Q2 2020

Transcript

Operator (participant)

Good day, ladies and gentlemen, and welcome to The Second Quarter 2020 Arch Capital Group earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. If anyone should require assistance during the conference, please press star, then zero on your touch-tone telephone. As a reminder, this conference is being recorded. Before the company gets started with its update, management wants to first remind everyone that certain statements in today's press release and discussed on this call may constitute forward-looking statements under the federal securities laws. These statements are based upon management's current assessments and assumptions and are subject to a number of risks and uncertainties. Consequently, actual results may differ materially from those expressed or implied.

For more information on the risks and other factors that may affect future performance, investors should review periodic reports that are filed by the company with the SEC from time to time. Additionally, certain statements contained in the call that are not based on historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The company intends the forward-looking statements in the call to be subject to the safe harbor created thereby. Management also will make reference to some non-GAAP measures of financial performance. The reconciliation to GAAP and definition of operating income can be found in the company's current report on Form 8K, furnished to the SEC yesterday, which contains the company's earnings press release and is available on the company's website. I would now like to introduce your hosts for today's conference, Mr. Marc Grandisson and Mr. François Morin.

Sir, you may begin.

Marc Grandisson (CEO)

Thanks, Liz. Good morning and welcome to our second quarter earnings call. On a reported basis, Arch had an acceptable quarter despite COVID-19-related economic disruptions. Our operating results were good from the underlying accident year ex-cat combined ratio perspective, as each segment benefited from the recent rate improvements. All three segments are poised to seize the opportunities to grow based on the underwriting returns outlook. Consequently, this quarter, rate improvements continue to enable us to expand our writings in our property casualty units as we increasingly achieve acceptable risk-adjusted returns. We know from experience that this environment is an appropriate time to raise additional capital so that we can more significantly take advantage of this hardening P&C market.

As we have discussed in previous earnings calls, we continuously rank order our capital allocation opportunities among and within the units, and today, P&C insurance and reinsurance prospects have moved up the scale, even as MI returns improved at the same time. To be sure, we are experiencing unprecedented times across our world and the insurance industry. There is still much uncertainty from the pandemic and its ultimate impact. The P&C industry faces emerging claims trends, the possibility of long-lasting lower investment returns, and a strain from unmodeled cat losses and chronic underpricing from the soft market years. This new reality points to the need for further premium rate increases for the foreseeable future. While not all lines are fully attractive on an absolute basis, the positive momentum is evident and has accelerated through the second quarter.

Turning to our operating segments, I'd like to begin with the mortgage insurance segment. Reported delinquencies were 5.1% at June 30th, 2020, and came in better than our expectation last quarter, which was at the early onset of the COVID-19 pandemic. As you may recall from our call last quarter, given the uncertainty surrounding COVID-19, we were forecasting more pressure on the housing market and a more pessimistic view of the economy than is indicated by the latest delinquency data. As we stand today, we believe that the U.S. MI industry has been benefiting from a combination of solid credit quality of the post-2008 crisis originations, two, favorable supply and demand imbalance in housing inventory, as well as three, strong and swift government intervention to help homeowners.

As a result, we're seeing better than expected delinquency rates emerging this quarter, even as rates are at elevated levels reflecting the recessionary environment. Our current and cure loss view equates to a claim rate slightly above 5% on newly reported delinquencies. While this claim rate is significantly higher than what we have seen from claim rates on the previous hurricane forbearance program, it is also significantly lower than what the industry experienced in the GFC and reflects the better underlying conditions I mentioned earlier. Because of the current economic conditions, the credit quality of our new insurance written business, as measured by average FICO scores and loan to value, is stronger than a year ago. Mortgage lenders have tightened underwriting standards, and the higher quality of loans originated is a direct benefit to us.

We saw record mortgage originations fueled by the historically low mortgage rate, and that has created surges in both refinancing and purchase activity. This favorable financing environment is supporting home prices. We see prices rising around 5% on an annual basis across the U.S. Despite the weakened economy, we estimate that the market-to-market homeowners' equity in the vast majority of our policies is in excess of 10%. The level of equity, as a reminder, has proven to be a strong indicator of a borrower's propensity to default, i.e., the higher the equity, the less likely a default will happen and turn into a claim. Turning now to our P&C businesses. First, let's talk about COVID-19, which is affecting many lines at the same time and developing much more slowly than a natural catastrophe. Adding to the uncertainty is the fact that many coverage issues have yet to be resolved.

All of this informed how we approached our reserving for COVID-19 within our P&C segments based on a bottom-up approach to develop our view of ultimate losses. François will cover this in more detail in a few minutes. Moving on to the P&C business environment, starting with insurance. We see a growing number of opportunities as net premium written grew 7% in the quarter for the unit, despite the fact that our travel premiums decreased materially due to the pandemic. Excluding travel, our insurance and PW growth would have been approximately 17%. Most of our growth was generated in the E&S casualty, E&S property, professional lines, and the specialty lines written out of London. About two-thirds of that increase came from exposure growth and the balance from rate. Our overall insurance renewal rate change was plus 8.5%, up significantly from plus 5.5% in the first quarter.

Earned premium that we wrote at higher rate levels over the last several quarters helped lower our quarterly accident year combined ratio ex cat to 96.1% from 99.4% for the same quarter in 2019. In summary, our insurance group's main mission right now is to grow in those lines where conditions improve enough to allow for an appropriate risk-adjusted return, and the market is allowing this evermore. Over to the reinsurance segment now. We had very strong premiums growth at 50%, reflecting ongoing dislocations and improvements in the marketplace. Growth opportunities presented themselves across the vast majority of our business lines. Property cat and P&C was up 153%. Other properties was up 70%, and casualty was up 35%. Partially upsetting this growth were declines in our mortgage quota-share net premium written due to the impacts of COVID-19 exposure decreases.

Generally, our reinsurance segment is able to seize on opportunities earlier than our insurance segment. We're also incrementally increasing our capital allocation to our property cat sector. However, our PML usage is still substantially below what we could deploy if return expectations were to get to the levels we saw in 2006. Our reinsurance accident quarter combined ratio ex cat improved to 87.5% from 92.2% over the same period in 2019. This partly reflects our opportunistic underwriting strategy and capital allocation over the last two years, but also is a reflection of the benign attritional loss experience relative to the prior year's quarter. To summarize for our P&C operations, after several years of cycle managing our portfolio, we are well-positioned to deploy more capital at attractive returns.

As we expect our investment returns, our outlook remains cautious as we believe the economic recovery could be slow and take several quarters to develop. Accordingly, underwriting performance should be the driver of earnings for the industry in the near term, which we believe should help to sustain the momentum of increasing premium rates. From a capital standpoint, we are in a strong position, and we have room to grow with our clients after many years of playing defense. In other words, our core principle, again, of active cycle management exercised by our team has positioned us to move much more aggressively into a growing number of improving lines.

Last but not least, we want our shareholders to know that our employees' hard work and our clients' strong relationships over the last three months were critical in getting us through these tough times, and for that, a huge thanks to all of them. With that, François will take you through the financials.

François Morin (CFO)

We at Arch hope that you are in good health. On to the second quarter results. As a reminder, and consistent with prior practice, the following comments are on a core basis which corresponds to Arch's financial results, excluding the other segment, i.e., the operations of Watford Holdings Limited. In our filings, the term consolidated includes Watford. After-tax operating income for the quarter was $16.6 million, which translates to an annualized 0.6% operating return on average common equity and $0.04 per share. Book value per share increased to $27.62 at June 30th, up 5.8% from last quarter and 12.1% from one year ago. The increase in the quarter was fueled by the strong recovery in the capital markets. Outside of the losses related to the COVID-19 pandemic, our underwriting groups continued on their path of solid growth and improving results as we benefited from the generally improving property casualty markets.

Losses from 2020 catastrophic events in the quarter, including COVID-19, net of reinsurance recoverables and reinstatement premiums, stood at $207.2 million or 13.5 combined ratio points compared to 0.5 combined ratio points in the second quarter of 2019. The losses impacted both our insurance and reinsurance segments and include $173.1 million from the COVID-19 pandemic, as well as $34.1 million for other catastrophic events, including losses related to civil unrest claims across the U.S. The losses we recorded in the quarter for COVID-19 across our P&C operations were split 45% insurance and 55% reinsurance. These loss estimates incorporate additional information that became available during the quarter and represent our current assessment and best estimate of the ultimate losses for occurrences through June 30, based on policy terms and conditions, including limits, sublimits, and deductibles.

We are confident that the approach we took to develop these estimates is conservative and are comfortable with our estimates as they currently stand, but needless to say, we continue to monitor the pandemic and its effects as they play out, and we will adjust our estimates as necessary in the coming quarters. As of June 30th, the vast majority of our COVID-19 claims are yet to be settled or paid, as approximately 90% of the incurred loss amount has been recorded as IBNR, incurred but not reported reserves, or as additional case reserves within our insurance and reinsurance segments. In the insurance segment, the loss reserves we recorded this quarter for the pandemic were primarily attributable to exposures in our North American unit across the national accounts, programs, and travel lines of business.

In the reinsurance segment, the majority of the losses came from the property catastrophe, accident and health, and trade credit lines of business. As regards the potential impact of COVID-19 on our mortgage segment, it is important to mention that our estimates for our U.S. primary mortgage insurance book are based only on reported delinquencies as of June 30, 2020, as mandated by GAAP. As we discussed on the last call, our expectation at the end of the first quarter was for the delinquency rate to progressively increase throughout the remainder of the year, with a resulting expectation that underwriting income for the overall segment would be minimal for the remainder of 2020.

While we did see such an increase in reported delinquencies in the second quarter, the current delinquency rate of 5.14% is approximately 30%-40% lower than what we expected it would be when we developed our forecast at the end of the first quarter. While that is a positive sign for the ultimate performance of the book, we are also aware that many uncertainties remain, including the rate of conversion from delinquency to cure or claim, which we expect to be different than under more normal conditions. In addition, it is extremely difficult to predict how reported delinquencies and forbearance, which represent approximately two-thirds of total current delinquencies, will behave over time, given the lack of historical data that is directly applicable to the current economic reality, which includes elevated unemployment rates, historically low interest rates, solid home price levels, and unprecedented government intervention.

As we look towards the remainder of 2020 for our USMI business, in light of the developments we have observed during the second quarter, our current expectation is that pre-tax underwriting income for the remainder of 2020 for the entire mortgage segment will remain positive, with a combined ratio in the 70%-80% range, slightly better than the result we reported this quarter. In summary, while we are still faced with significant economic uncertainty, our expectations for the mortgage segment are definitely more positive than what we thought only a few weeks back. In the insurance segment, net written premium grew 7.1% over the same quarter one year ago, a strong result given the material impact COVID-19 has had on some of our businesses, such as our travel and accident unit.

As Mark said, if we exclude this line, the year-over-year growth in net written premium would have been 16.9%. The insurance segment's accident quarter combined ratio, excluding cats, was 96.1%, lower by 330 basis points from the same period one year ago. Approximately 90 basis points of the difference is due to our lower expense ratio, primarily from the growth in the premium base from one year ago and reduced levels of travel and entertainment expenses this quarter. The lower ex cap accident quarter loss ratio primarily reflects the benefits of rate increases achieved over the last 12 months. Prior period net loss reserve development, net of related adjustments, was favorable at $2.1 million, generally consistent with the level recorded in the second quarter of 2019.

As for our reinsurance operations, we had strong growth of 50.3% in net written premiums on a year-over-year basis, which was observed across most of our lines and includes a combination of new business opportunities, rate increases, and the integration of the Barbican and reinsurance business. The segment's accident year combined ratio, excluding caps, stood at 87.5% compared to 92.2% on the same basis one year ago, a 470 basis point reduction. The year-over-year movement is primarily driven by a more normal level of large attritional losses compared to a year ago, which explains approximately 330 basis points of the difference and the impact of the non-renewal of a large transaction from a year ago, which contributed approximately 50 basis points. Most of the remaining difference is explained by operating expense ratio improvements resulting from the growth in earned premium.

Favorable prior period net loss reserve development, net of related adjustments, was strong at $28.9 million or 6 combined ratio points compared to 3.1 combined ratio points in the second quarter of 2019. The benefit was mostly in short tail lines. The mortgage segment's combined ratio was 80.9%, reflecting the increased level of reported delinquencies in the quarter, as mentioned earlier. The loss ratio in the quarter is based on an assumed claim rate on newly reported delinquencies for our USMI book of slightly above 5%, combined with an average expected future claim value or severity that is approximately 50% higher than claims we settled and paid in the quarter.

This difference is explained by the fact that the distribution of the newly reported delinquencies carries a higher average outstanding loan balance, as a higher proportion is for mortgages from the more recent origination years and from states that have higher loan values, such as California, Florida, and New York. The expense ratio was lower by 100 basis points over the same quarter one year ago, reflecting lower operating costs, including reduced levels of travel and entertainment expenses. Prior period net loss reserve development was minimal this quarter, at $0.2 million favorable. Total investment return for the quarter was positive 372 basis points on a U.S. dollar basis, as the strong recovery in the capital markets produced healthy returns across our entire portfolio. The duration of our investment portfolio remained basically unchanged from the prior quarter at 3.18 years.

The effective tax rate on pre-tax operating income resulted in a benefit of 0.9% in the quarter, reflecting a change in the full-year estimated tax rate, the geographic mix of our pre-tax income, and 110 basis points expense from discrete tax items in the quarter. As always, the effective tax rate could vary depending on the level and location of income or loss and varying tax rates in each jurisdiction. We currently estimate the full-year tax rate to be in the 9%-12% range for 2020. Turning briefly to risk management, our natural cat PML on a net basis increased to $832 million as of July 1, which, at approximately 8% of tangible common equity, remains well below our internal limits at the single event, one in 250-year return level.

The growth in the PML this quarter is attributable to both E&S property within our insurance segment and property lines within our reinsurance segment, reflecting our ability to deploy more capacity to opportunities that safely exceeded our return thresholds, some of which were slightly tempered by additional reinsurance purchases. As you know, we issued $1 billion of 30-year senior notes at the end of the second quarter, enhancing our capital base and furthering our objective of maintaining a strong and liquid balance sheet. Our debt plus preferred leverage ratio of 23.8% remains within a reasonable range. As discussed on the prior call, we paused our share repurchase activity since the start of the pandemic, and we do not expect to repurchase shares for the remainder of 2020.

At USMI, our capital position remains strong with our PMIERs sufficiency ratio at 161% at the end of June, which reflects the coverage afforded by our Bellemeade Mortgage Insurance Link notes. In late June, we were able to obtain $528 million of coverage on our in-force book for the second half of 2019. Our ability to execute this transaction highlights the credit quality of our in-force book and further protects our balance sheet should an extreme tail event materialize. The Bellemeade structures provide approximately $3.1 billion of aggregate reinsurance coverage at June 30, 2020. With these introductory comments, we are now prepared to take your questions.

Operator (participant)

Thank you. If you have a question at this time, please press the star, then the one key on your touch-tone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. If you're using a speakerphone, please lift the handset. Our first question comes from Elyse Greenspan with Wells Fargo.

Elyse Greenspan (Managing Director Equity Research Analyst)

Hi, thanks. Good morning. My first question on the property casualty side, you guys seem pretty optimistic and started to see a continuation of pretty good growth in the quarter, and so you guys don't disclose the capital supporting your property casualty versus the mortgage business, but if we're sitting outside the company and we just want to get a sense of the opportunity at hand and the capital that you have, given the recent debt raise, could you potentially, if there really is a strong market, double the size of your insurance book of business on your current capital base?

François Morin (CFO)

I think it's a fair assessment. I think in general, you could think of capital allocation on premium from the P&C as a one-to-one that sort of gives you a range for capital usage. But certainly, the ability is there. And I would say that it's also informed by how you develop it, right? At least if you property cat is a different capital requirements than other lines of business, such as quota share, let's say, on the reinsurance side on liability. So there's plenty of room for us to grow.

Elyse Greenspan (Managing Director Equity Research Analyst)

Great. And then on the mortgage side of things, you guys see some pretty helpful color that the current delinquency rate is about 30%-40% lower than where you thought it would have been. So as you set the new guide for the outlook for the positive underwriting mortgage income for the rest of the year and that 70%-80% combined ratio, can you give us a sense of where you expect delinquency rates to trend in the third and the fourth quarter?

François Morin (CFO)

The quarterly movements are a bit harder to predict, but I mean, we had forecasted last quarter somewhere around a 10% or so delinquency rate by the end of the year. We think right now we're thinking it'll be more like around 8%. Obviously, we're monitoring weekly and we get data that comes in from all our servicers, etc. That's kind of where we're at, is about 8% delinquency rate by the end of the year.

Marc Grandisson (CEO)

Yeah. I think to add to this, Elyse, I would say that this is. It's a one-quarter data point, so it will take us. We still take a longer-term view and are not fully reflecting the decrease or the lesser delinquency that we had. You had reported versus what we expected, right? You had 30-40, and then François told you a 20% decrease. That tells you sort of a level. So we're thoughtful and measured in the way we want to recognize any immediate improvement.

Elyse Greenspan (Managing Director Equity Research Analyst)

That's helpful. And then my last question, you guys had pointed to the severity per claim. I believe you said was about 50% higher than some of the claims you settled in the quarter, just given the higher housing values, I believe. If I look in your supplement on the mortgage page, the average case reserve per default went down to $6,900 in the quarter, and it had been $14,400. Why would that number have gone down if you're actually setting up more for the current claims? I'm just trying to reconcile those numbers.

François Morin (CFO)

Yeah. The average is very much a function of the percentage of the delinquencies that are effectively in early stages of delinquency, so if you think of all these newly reported delinquencies in the quarter, they carry, again, effectively a 5% or so claim rate versus the older stage delinquencies, and the percentages go up as the more mature, the later stage delinquencies we have, so it's really. There's no changes in assumptions. I'd say it's really just the way the mix of the portfolio or the mix of the delinquencies that we currently have changes over time, and this was really, as you know, the first quarter where we had a large surge of delinquencies coming from the pandemic.

Elyse Greenspan (Managing Director Equity Research Analyst)

Okay. Thanks. I appreciate all the color.

François Morin (CFO)

You're welcome.

Marc Grandisson (CEO)

Thank you, Elyse.

Operator (participant)

Our next question comes from Mike Zaremski with Credit Suisse.

Mike Zaremski (Senior Equity Research Analyst)

Hey, good morning. I guess sticking with MI, so clearly there feels like there's some conservatism kind of built in that you expect delinquency rate to continue moving north. Is the government stimulus kind of a big X factor in terms of how the $600 weekly unemployment insurance subsidy, whether that continues or not? Just trying to think about, or I mean, should we just broadly be looking at unemployment levels as well? Just trying to think about how to gauge because clearly results have been good so far, much better than expected, which is great.

Marc Grandisson (CEO)

So, Mike, I think the easy question is unemployment matters. It is a contributing factor that would precipitate, if you will, delinquency in the claims ultimately. The number one, the leading indicator, as I said in my notes, that will tell you whether there's a heightened increased risk of delinquencies is really the house price index. So to the extent that the house prices are stable or keep on going up, or that there's, which is another way to say, as long as there's a reasonable amount of equity in the house, we have found that borrowers do not tend to walk away from their obligation on the mortgages. So if you saw the Great Financial Crisis, what happened is we had a combination of house price decreases and unemployment.

So it sort of contributed to the acceleration and more of an acute delinquency rate that we saw in the Great Financial Crisis, which we are not seeing right now. So what we're focusing on, of course, we look at what the government is doing. That's going to be helpful. And I think we'll see more of this impact at the end of the forbearance period. But for now, the house price index is extremely encouraging to us and really is a leading indicator on the propensity for homeowners to default.

Mike Zaremski (Senior Equity Research Analyst)

Okay. That makes sense, and that's helpful. Then in terms of we'll get a number of questions about the court cases in the United Kingdom. The FCA has kind of been writing about that. Is that contemplated in your COVID IBNR, whether those court cases go for or against the industry?

François Morin (CFO)

Yeah. We've taken a conservative approach, and we actually had reserved for it at the end of March. So we have reserved for it appropriately with a fairly good level of reinsurance against it. So we're pretty much reserved there. If things, it could presumably be good news going forward for us there.

Mike Zaremski (Senior Equity Research Analyst)

Okay. Just lastly, quickly, I'm sure other people will ask about kind of the segments. Any thoughts on new capital entering the broader insurance and reinsurance marketplaces? Do you feel that capital will continue to enter, or is it having an impact on your ability to play offense at this point, or is it still just a drop in the bucket? Any color would be helpful. Thanks.

Marc Grandisson (CEO)

So Mike, it's a little bit of everything you mentioned. I would say that the capital needs that are out there that we see in terms of clients, finding solutions, and towers of coverages needing a place, a new place, a new home. We would need a significant amount of capital to neutralize that impact, if you will. So we're seeing actually acceleration, even though there's more capital being raised and new entrants as we speak, thinking about coming in. We're not seeing any adding of the rate pressure that we see right now. And I think the demand for capital is pretty high. There's a couple of large players that were really providing a lot of capacity, acute capacity in very, very high capacity mongers in the industry have pulled out significantly.

So that means that there's a lot of other capital that needs to find its way around to support it. So I would say that we are not seeing. We hear what's out there, what's happening. We're encouraged by we raise some more capital and other folks, such as ourselves, who have access to the business, access to the client and relationships. We're able to raise capital. It bodes well for the health of those companies. But any new entrants, it will take them a while to get ramped up. I'm not saying it's impossible. I think it's totally doable, but it's certainly not something that we're losing sleep over.

Elyse Greenspan (Managing Director Equity Research Analyst)

Thank you.

Operator (participant)

Our next question comes from Yaron Kinar with Goldman Sachs.

Yaron Kinar (Equity Research Analyst)

Hi. Good morning, everybody.

Marc Grandisson (CEO)

Hi, Yoran.

Yaron Kinar (Equity Research Analyst)

First question. Hi. First question on MI and then a couple on the COVID losses. So at MI, I haven't really seen any significant pullback from that market. So I guess should I take that to mean that even with all the COVID and economic uncertainty, you still view it as a pretty attractive business?

Marc Grandisson (CEO)

Yeah. It is still very attractive. I would even argue, Yoran, that the production in the second quarter and as we speak, it's actually better than it was six months or a year ago. The rate pressures and also quality of underwriting, quality of the originations is a lot better than it was even a year ago. So yes, there is a lot more activity. And the activity, Yoran, to be fair, is also driven by the refinancing market, right, which was not there. And then by dropping the mortgage rate below 3%, that does create more business back into the market. As a result of that, there's a lot of prepay, right? There's a higher level of the lower level of persistency, which means that there's more churn, if you will, in the portfolio of business.

So, I think it's just a reflection of people coming out of their current. They're coming out of their higher mortgage rate, and it's just refinancing at a lower level, which totally makes economic sense that we're on the receiving end to grow. That's why we have such, we believe, much higher NIW than otherwise would have been in a more stable marketplace.

Yaron Kinar (Equity Research Analyst)

Got it. That's helpful. And then with regards to the COVID losses, maybe a couple of questions there. One, when you talk about IBNR, do you include only events or losses from events that have already occurred, or do you also include events in the future that are very probable to occur?

Marc Grandisson (CEO)

I mean, that's a good question, which I do know people are, I think, companies are maybe answering that. I don't want to say differently, but I think the words we have to be careful with how we use the words, right? So I'd say no question that we can only reserve for incidents or occurrences that have happened before June 30th. I mean, that's under GAAP. And anybody that tells you they're reserving for occurrences that are going to happen in the third or fourth quarter, I just don't know how you can do that. What we have done is set, again, a high level, I think a prudent level of IBNR on both insurance and reinsurance on things that we know have happened or think have happened, right? I mean, the whole concept of IBNR. So we have certain claims that have been reported.

We don't know. And certainly when you get into structures or when you're in an excess position, you're somewhat making a judgment on whether the claim will attach in your layer, etc. And that's where there's a bit of art that goes on and not necessarily tons of data or science around it. So I think the answer to us is we've reserved for everything through June 30, and we would say at ultimate, right, so truly our best estimate of what we think the exposure is. And that's where we are. I mean, we can't really do more than that at this point, given the accounting rules and guidelines.

Yaron Kinar (Equity Research Analyst)

Got it. And then final question also with regards to COVID. Between first quarter and second quarter, the increase in loss and COVID losses. Is some of that coming from IBNRs that you had already set up in Q1, but then took a second look and realized they need to be higher? Or is that from really new lines of business and new areas that had not been previously reserved for?

Marc Grandisson (CEO)

Well, I'd say it's a bit of both. I mean, I would say on the insurance side, for example, at Q1, we had reserved primarily in net IBNR primarily in our international book because, again, back to the, in the U.K. in particular, property book, regional property book there, we were of the opinion that there was exposure there, and we took action, and we booked IBNR on that. I'd say in the second quarter, for example, we booked, and I mentioned it on national accounts, that's where we have workers' comp exposure. Again, if you want to be very technical, at one point, I mean, the deaths or the occurrences hadn't happened at the end of March. They started to take place, especially with healthcare workers as an example, in April and May. So that's when we, that's what we reserved for in the second quarter.

I'd say on the reinsurance side, it's a bit murkier. It's not that we're somewhat at the mercy or have to have discussions with our reinsurers. And on the property cat book, for example, we had booked a little bit of IBNR at the end of Q1, but through additional discussions and investigations and file reviews in the second quarter, we booked a bit more on that front. And the same is true in trade credit. So hopefully that answers it, but it's a bit of both, I'd say.

Yaron Kinar (Equity Research Analyst)

That is helpful. Maybe one other one, if I could sneak it in. On the BI front, in reinsurance, the increases in COVID losses that you're reserving for today, are those coming more from international accounts or more from the U.S.?

Marc Grandisson (CEO)

Correct. More international. Absolutely. As you know, we have exposure. I mean, continental Europe in particular, there's France. There's certain countries where the BI coverage is more implicit and provided by the primary policies. So those are some of the examples of our policies or treaties that we're reserving for at this point.

Yaron Kinar (Equity Research Analyst)

Thank you very much.

Marc Grandisson (CEO)

Yep.

Operator (participant)

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

Josh Shanker (Managing Director)

Can we talk a little bit about July and how it compared with notices in for mortgage defaults?

Marc Grandisson (CEO)

Could you repeat the question, please, Josh?

Josh Shanker (Managing Director)

Yeah. Can we talk about comparing May, June, July as the time of you receiving notices for forbearance and defaults?

Marc Grandisson (CEO)

Yeah. I think no. I think the one place, the one thing that we could say, I mean, it's the data is probably lagging a little bit from our perspective, but the good one to look at is the information Black Knight, I think, and the MBA's providing information as to what is their estimate, surveying the market and their clients as to what's the forbearance percentage. I think it was pretty much plateauing as we got into towards the end of May into June and through the first or second week of July, and it's come down since then. So we're about 6.1% based on that metric in percent of forbearance from the GSC portfolio from the industry data. And now it's at 5.49% as of July 13th, I believe it's last week.

So we've seen a decrease right now, Josh, whether it continues that way or goes back up again. As you know, a lot of people pay on the first of the month, so we'll probably have more information and a better clear picture as to what July looks like in the middle of August.

Josh Shanker (Managing Director)

Okay. Thank you. And do you have any evidence one way or the other whether RateStar has had any discernible difference in claim behavior or I shouldn't say claim noticing behavior compared to how a lot of your competitors were pricing risk prior to adopting your methods?

Marc Grandisson (CEO)

Yeah. I think it does. It has had an impact. I think when we talk about cycle management, we also were doing it possibly a little bit more under the radar screen on MI. I think that our RateStar approach with all the parameters actually took us away from a higher 95 LTV, higher DTIs in certain geographical areas. So yes, we do believe if we adjust for all the variation, I mean, it's not a huge differential, but there is a slight improvement or a slight difference going to our advantage in terms of our delinquencies based on our portfolio and the risk that we underwrote for the last four or five years.

Josh Shanker (Managing Director)

All right. And one last one. I think you mentioned the change in PML. I don't think you mentioned the RDS change, or maybe I missed it. Where's RDS as a % of your equity as of the end of the quarter?

François Morin (CFO)

Still right at 8%, pretty flat. We did a couple of movements across the contributions, but yeah, 8% of tangible book.

Josh Shanker (Managing Director)

Thank you for all the answers.

François Morin (CFO)

You're welcome.

Marc Grandisson (CEO)

Thanks, Josh.

Operator (participant)

Our next question comes from Ryan Tunis with Autonomous Research.

Ryan Tunis (Senior Research Analyst)

Hey, thanks. Appreciate the MI guidance. I realize all of this is literally impossible to nail down, but I'll go ahead and I'll push on it a little bit more because it is interesting. So when you think about the full year delinquency rate, in your mind, what are you thinking the percentage of forbearances are going to be of, I think you said, what was it, 8%? How much of that is forbearance versus what you think of as a real delinquency?

Marc Grandisson (CEO)

The forbearance that we will declare, that we'll report, that we're reporting to you are delinquencies by definition, right? It's very hard to see, I know what you're asking. I think the one thing that we will tell you about projecting forbearance rates and delinquency rates in this forbearance world is that data is really hard to get, and it's lagging a fair amount. Very difficult for us to tell you.

Ryan Tunis (Senior Research Analyst)

And I just want to follow up too: how are you planning on treating these delinquencies as they age? So you're obviously using a pretty conservative incidence rate of 5%. And as those age to six months or whatever, are you going to keep it at 5%, or are you going to assume something bigger than that?

Marc Grandisson (CEO)

I think there are two moving parts of that 5%, Ryan. One is the it comes up really as our pre-COVID NODs to ultimate, which was 7.9%, and we gave a discount of about 33% haircut by virtue of being a forbearance. So as we move forward, that 7.9%, which is a claim that's aged three months versus a claim that's aged two years or nine months, even though it's a forbearance, we might have to increase those rates. But at the same time, if the forbearance programs are getting better, we might give a bit more discount or less discount. So it's a really, really and you're right. You just pointed at the beginning of your comment. I think I should have probably let you answer your own question, which is it's pretty much impossible to answer at this point in time, but right?

And all we have is a 7.9 pre-COVID ultimate NODs that we sort of starting point, getting some discount, recognizing that the regular forbearance program on hurricanes, which it is not right now, is as low as 2%. So we're trying to find our way around that environment, also recognizing that the delinquencies out of this crisis, this COVID-19, will be longer to resolve because the forbearance program, as we all know, lasts for 12 months. So it's going to take us a while to really understand the underlying fundamental characteristics of those risks. And to add all this to all of this, if that wasn't enough, we'll have remediation programs put in place by the GSEs, which presumably should help a tremendous amount. But again, it remains very early to see, to say.

Ryan Tunis (Senior Research Analyst)

Understood. And then lastly, Marc, this is purely hypothetical, but if you had $1 of capital for the next year or two years and you could only allocate it to reinsurance or primary insurance, is there a clear preference for which one you'd allocate it to?

Marc Grandisson (CEO)

How many years?

Ryan Tunis (Senior Research Analyst)

Two years.

Marc Grandisson (CEO)

Now, say to me, you're asking me to choose among my kids. I got three kids I love dearly. I would split it in three ways or I would like to make it. I mean, to me, it's not an all or nothing, but I do believe right now at this point in time, which is I think what you're getting into, which I've mentioned in my comments, the returns on the reinsurance are quicker to a higher level, quicker. But in terms of value creation over a longer time, insurance will get there and get traction. It just takes a longer time to accumulate business at a higher level. But the problem with the reinsurance, it's great for a couple of years, but then you might lose that business. So it's not an all or nothing kind of situation.

I wouldn't want to go, let's say, all in reinsurance, even though they have higher ROEs sooner at the cost of losing long-term value creation from the insurance unit.

Ryan Tunis (Senior Research Analyst)

Thanks for the thoughts. Appreciate it.

Operator (participant)

Our next question comes from Meyer Shields with KBW.

Meyer Shields (Managing Director)

Thank you. I wanted to follow up on that question, but in a different direction. You talked about reinsurance maybe recovering faster than insurance. How is the current hardening cycle playing out in terms of speed relative to past cycles? Is there any observable difference?

Marc Grandisson (CEO)

Not really. I would say that we may have had the discussion before. A hard market never happens overnight. It takes two, three quarters. Losses have to develop. Management team have to figure out what they want to do and put pressure on their underwriting team, so it's not unlike others that we've seen before. I would say that we were going to a strengthening of the market conditions even before COVID-19. I think that COVID is probably accelerating the reaction and the willingness and the boldness that we see in the underwriting teams around the industry, but there are still pockets, I'm aware, people seem to be a little bit aloof in what's going around, and these are the areas we're not going as much as we should, but I know every cycle turn is different, but I'm not seeing significant difference.

It does take a, and well, one last thing I will tell you. The one thing about this one that we have yet to see is the one-month renewal in reinsurance is a really important renewal date, so we'll have a lot more sense as to how quickly and how reactive the market will be as we head into this one.

Meyer Shields (Managing Director)

Okay. No, that's very helpful. Thank you. In the past, we've been, I guess, targeting improvements within insurance that would get to a 95% combined, and when we look through the lens of current pricing, is there an update in terms of what that 95 can become?

Marc Grandisson (CEO)

I hope it's lower. But all kidding aside, Meyer, I think that the 95 was put in place as an aspirational number two, three years ago, now, two years ago now, in an interest environment that was different. So I think right now what we're parsing it through, this was sort of an aspirational as a guiding sort of target for our insurance group. I think right now what we're seeing is we're going through every different line of business and business unit and attributing capital and return on investment, and we're pitching everything to get to the right level. So 95 is an oversimplistic way of looking at this. But all things being equal, I think I would expect it to be lower, right, for the industry. And that's also why you'll probably see a bit more pressure on the pricing around us in the industry.

Meyer Shields (Managing Director)

Okay. Perfect. And then final question, if I can, just in terms of whether you've had to take into account whether it's COVID or something like that that's still remote or other pressures, whether you've dialed up your overall loss trend numbers in insurance or reinsurance?

Marc Grandisson (CEO)

Not in a meaningful way. I think, I mean, we've been pretty cautious, and I think I've been, I'd say, realistic about what the loss trends have been and what we expect them to be going forward. As you know, we haven't relied exclusively on kind of the last five or 10 years of data. We've superimposed our own views on what a more normalized view of loss trends is or should be. And I think we're still very comfortable with where we were at and recognizing that, yeah, COVID is a bit of an outlier, but at this point, haven't really factored in any material changes in our loss trends and how we price the business.

Meyer Shields (Managing Director)

Okay. Fantastic. Thank you so much.

Marc Grandisson (CEO)

You're welcome.

Operator (participant)

Our next question comes from Brian Meredith with UBS.

Brian Meredith (Managing Director)

Yeah. Thanks. A couple here for you. First one, I don't think you mentioned it, but was there any benefit at all in the quarter from this lower frequency of economic activity kind of from a claims perspective in any line of business?

Marc Grandisson (CEO)

I mean, there's some indications that in some places, yes, there's lower economic activity, which will translate to lower losses or claims. We really haven't reflected that yet. I mean, we want to take a cautious approach on that. So I'd like to think that maybe there's some to come down the road, but for now, we haven't factored that in anywhere in our numbers.

Brian Meredith (Managing Director)

Great. And then second question, I'm just curious, Marc, as you look at, I guess, the HEALS Act here, there's a component into it of kind of a liability called indemnification. As you think about it, if that doesn't go through, is that a potential issue here for you and the insurance industry? And how do you kind of think about it from an underwriting perspective here going forward?

Marc Grandisson (CEO)

I missed a word you said, Brian. Could you repeat that early part of your question?

Brian Meredith (Managing Director)

Basically, I'm curious about protection or what you think about as far as the economy reopening here and potential liability associated with kind of COVID-19. The current, I think it's called the HEALS Act or the CARES Act, has got some language in there trying to grant businesses some immunity for it, right? I'm just curious of your thoughts around that.

Marc Grandisson (CEO)

It's not good for insurance. If they're going to allocate more liability to us or presumption to us, it's not good. But I think in this sense, these laws are always there. There's always things that are happening. We're going to have to react to what we see when we see it. That's all I can tell you, Brian. It's very hard to sit here and go through what impact it is. If we were to react and do this full drill about everything that goes in a bill that's proposed, it would take a lot of our time. So we'll react to it when we react to it, right?

Brian Meredith (Managing Director)

Yeah, Mark. I think you had it wrong. I think I misstated my question. My question more is, from your insurance policy's perspective, as you look going forward, as the economy reopens up, there's clearly EPL exposures, there's GL exposures, all sorts of exposures that potentially present themselves as a benefit. How are you thinking about that from an underwriting perspective?

Marc Grandisson (CEO)

We have written policies that have EPL exposure. We have GL exposures, but we are not a large risk writer. We don't write the large insured. So that's certainly something that would be helpful to us. We would argue that a lot of the larger claims, a lot of the focus from the lawyers' plaintiff bar would be focused on the larger, deep-pocket insured. So that's one thing we have for us. We also have a fairly good, healthy amount of reinsurance. So we're not overly concerned with the sideways change.

Brian Meredith (Managing Director)

Gotcha. Okay. And then another just quick one here, your travel insurance. I'm just curious, how big of a book is that? And obviously, we're probably going to see some continued pressures there for the rest of the year.

Marc Grandisson (CEO)

Yeah. It was around about $200 million of premium, and now it's down. I mean, you could see the numbers. You can multiply by four. I don't need to $250 million, actually, for the year. So it's taken a big dent, and that also explains why the growth was more tested this quarter than otherwise could have been.

Brian Meredith (Managing Director)

Great. And then one other just quick one here for you. I know you guys launched a sidecar, I guess, was in the first quarter. Any thoughts about additional kind of alternative capacity here to potentially capture some of the attractive opportunities in reinsurance?

Marc Grandisson (CEO)

It's a good question, Brian. You're trying to get us to say something we don't want to say or we can't say or we won't say. I think we don't mention about we certainly are always on the lookout to raise capital to deploy with third party. A lot of discussions are happening all over. We'll have probably more update as we see it happen, and we'll be communicating to you to the extent it's appropriate. But I'm not sure if this is clear.

Brian Meredith (Managing Director)

Great. Great, and last one, just quickly, any updates on Coface?

Marc Grandisson (CEO)

Coface, strategically, still something we really very much think is valuable for the shareholders. There's a lot going on. We're still going through the approval process, and we're keeping a keen eye on what's happening. I think they reported results yesterday, which were better than the street expected. So we'll see how that goes. It's also there as well, a developing situation with them, so.

Brian Meredith (Managing Director)

Great. Thank you.

Operator (participant)

Our next question comes from Phil Stefano with Deutsche Bank.

Phil Stefano (Research Analyst)

Yeah. Thanks. Just a quick one on the Bellamy transaction and thinking about the potential for these moving forward. I guess it feels like the Bellamy deal that was done in the past quarter, just given its attachment, was probably more for S&P Capital Credit than PMIRS. And we saw an MI PurePlay come out with their own ILN transaction, which is, in my mind, more of a traditional attachment point in the low single digits. But the spreads on that and the pricing was significantly higher. How are you thinking about the managing of tail risk that Bellamy provides versus just the capital credit that could be from playing, I would think, something that could be considered well above the working layers for the MI reinsurance coverage and the capital relief that something like that might provide?

Marc Grandisson (CEO)

Yeah. That's a good question. I think it's always something we evaluate when and if we place or look at options that are in front of us. You're correct. The last one attaches above the PMIERs credit, but we're still very much in that we have a healthy PMIERs ratio, so that didn't really concern us too much at this point. Not to say that next time or down the road, we may not go back to a lower attachment point. But yeah, the focus was really, yes, it's an available source of capital. From a rating agency point of view, S&P, you're correct. It covers that. It provides us coverage there.

And also, we felt, as being the first one out of the gate, even before the GSEs, to go back and access the capital markets was, we thought, a very strong message. It demonstrated, again, I touched on it, the quality of the book, and the investor base is still very much has a lot of interest and appetite for the product. So I think we were happy with the placement. No question, it's always too expensive. We'd like to see the prices come down. We hope they do down the road. But for the time being, given the economics in front of us, we were. I think it was a good move on our part.

Phil Stefano (Research Analyst)

Got it. Thanks, and to the extent that you guys have a disclosure wish list that you keep in the background, I think it might be helpful to see the USMI disaggregated from the international and the mortgage reinsurance books, just given the significant differences in how those businesses are reserved for, but thanks. Appreciate it. Congratulations.

Feedback.

Marc Grandisson (CEO)

Thank you.

Operator (participant)

Our next question comes from Jeffrey Dunn with Dowling & Partners.

Jeffrey Dunn (Research Analyst)

Thanks. Good morning. I guess first, just a quick number question. Can you quantify the impact of the accelerated singles in the quarter?

Marc Grandisson (CEO)

Did we do this? I think it's about $50 million.

Jeffrey Dunn (Research Analyst)

$50 million. Okay.

And then let's think forward past the end of new forbearance, so early next year. So given what you know about the economy now, obviously very different from a couple of months ago, how would you think about claim rates on new notices without forbearance? Because again, you pointed out it's very different with home prices. It remains to be seen if we're going into a recession or not. And I think, Marc, last quarter, you suggested we might be looking at 13%-14%, given what you knew then. So what do you think about that type of number as you get into early 2021 based on what you know today?

François Morin (CFO)

I think the 5% is probably this is on NODs, or you're talking about ultimate claims rates for the portfolio?

Jeffrey Dunn (Research Analyst)

On NODs, so new notices coming in before forbearance goes away.

François Morin (CFO)

Yeah. Right. I think we were at 7.9% pre-COVID. I think that the forbearance should be pretty helpful, and to bring it up, not bring it up to the 13%-14% you just mentioned. I mentioned the first quarter. My gut would tell me a slight increase for a little while until we see things shake out and things getting back to more normalcy, and I think reverting back to some kind of level. I think if the forbearance program were to play out the way it should play out, it's still very uncertain, as you know, Jeff. I think that we should get back to it. It might stay elevated for a while, maybe 12%-13% for a little while, but it should go back down at some point for the next year, I would say.

Jeffrey Dunn (Research Analyst)

Okay. All right. So you do think, given what you know about the economy and built-up equity, that you could still see 12% type of incidence assumption?

François Morin (CFO)

Yeah. Yeah. On NODs, right? On new NODs for regular DQ, not for the forbearance piece. The forbearance piece, we did give a discount, right?

Jeffrey Dunn (Research Analyst)

Right.

François Morin (CFO)

There was a discount to that. So yeah, then discounted from there. Right. Exactly. Yes.

Jeffrey Dunn (Research Analyst)

All right. Thank you.

Marc Grandisson (CEO)

Thanks, Jeff.

François Morin (CFO)

I mean, before you go on to the next one, Jeff, quick update for you. The actual impact of the singles was $27 million in the quarter. Just correction to Mark, it's $50 million.

Jeffrey Dunn (Research Analyst)

Thanks again.

François Morin (CFO)

Okay. That was 51.

Marc Grandisson (CEO)

You're welcome.

Operator (participant)

Our next question comes from Jimmy Bhullar with JPMorgan.

Jimmy Bhullar (Equity Research Analyst)

Hi. I just had a question on pricing and just how you think about the interplay between decline and exposures if the economy remains weak and how that could affect demand and pricing? And relatedly, what else is out there that you think could potentially derail the momentum that you've seen in pricing, both in insurance and reinsurance?

Marc Grandisson (CEO)

I mean, it's hard to predict the future, as you know. Oh my God. I think if everything resolved, I mean, even if things resolved for the better, I think the momentum that we'd seen in the first quarter, late 2019, early 2020, I think we would still see some momentum. I think it would be just a matter of degree, how much higher the rates could go, but I do believe the momentum was there for a turn of the market way before COVID-19. COVID-19, like I said before, exacerbated the need for rate and accelerated the need for rate.

Jimmy Bhullar (Equity Research Analyst)

And then there's been a lot of talk about sort of ILS and trapped capacity. And what do you think about when either some of the capacity gets relieved or potentially gets absorbed? And once there's clarity on that, do you think by this time next year, a lot of the trapped capital would actually be out?

Marc Grandisson (CEO)

It's a possibility. I mean, that's also assuming there's no more cap occurring this year, but this is a long-lasting cat event, so it's not as clear as having a quake, let's say, in March, and I guess in a year out, it's still developing, but you have a better sense for wanting to or would be willing to release capital. This one will take a bit longer to process through, right? For instance, you could have arguments in courts and new ways and new pushback on the insurance industry to pay claims on property damage, and that could take another year and a half to two years to resolve, so there's a lot more uncertainty in terms of timing, finding resolution of the ultimate losses, so it's a lot less certain that it will take only a year to get through it.

Jimmy Bhullar (Equity Research Analyst)

Thank you.

Marc Grandisson (CEO)

Sure.

Operator (participant)

Our next question comes from Jimmy Nielson with Wells Fargo.

James Nelson (Investment Manager)

Hi. Good afternoon. I wanted to follow up on the conversation we've been having about forbearance programs and to what extent delinquencies get cured, get claims, turn into a claim sort of, etc., and I appreciate that we don't know what's going to happen going forward, but I wonder if you could speak to what you learned in previous forbearance programs and how that affects your thinking about your current book, and what you learned in there, did you learn anything about LTVs, geographies, sort of, etc., and how does that apply to your existing book today?

Marc Grandisson (CEO)

I think we have done reserving in the past, considering all the dimensions you just talked about. I think that we had the beautiful thing about the prior hurricane or the beautiful thing in a way is that we had prior hurricanes and prior events that we can go back to and look at the experience. It does definitely help us put, I guess, boundaries around what could happen. But this one is very unusual in the length of the forbearance program and the breadth and how widely spread it is. And I think we also have to throw in there the $600 per week unemployment benefits and the distribution that we talked about. Some regions are more heavily affected than others. So I think everything gets in the mix, Jamie. It's not just one dimension.

I think what we've learned is that we sort of can use the historical forbearance experience as sort of a range of possible outcomes. We actually are digging heavily, heavily into developing a much more refined view of a forbearance-specific program such as the one we're facing right now. We may never use it again, but at least we're in the process of readjusting our development claims model called ARM that we have internally. We're still very much developing, and we're learning on the fly.

James Nelson (Investment Manager)

Yeah.

François Morin (CFO)

Two things I'll add quickly to that. As Mark mentioned, historically, forbearance delinquencies, most of them cure. I mean, and we made comment that the 2% kind of claim rate. So that's obviously a very positive sign, but that's, again, more localized, and it's a short-term issue. So I mean, understandable that these delinquencies, most of them would cure. So that would be, on one extreme, that'd be a very good result in this situation. Maybe a little counter to that, as you may know, many of the claims or the mortgages or loans in forbearance, up to 40%, were actually still current up until recently. So in the early days of the second quarter, many loans that had access to forbearance programs but remained current and made their mortgage payments, the data now suggests that that percentage has come down.

The reality is now we got a few more loans that have turned delinquent that were historically current or had been current in forbearance but now turned delinquent. That's a bit of a data point that we're monitoring, but that kind of gives us a bit of not necessarily concern, but we have to understand better so that we can refine our estimates as we move forward because the 2% ultimate claim rate may not be achievable or probably won't be what we end up with in this current situation.

James Nelson (Investment Manager)

Okay. All right. Great. Appreciate it. Good luck in the future.

Marc Grandisson (CEO)

Thank you.

François Morin (CFO)

Thanks, James.

Operator (participant)

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

Marc Grandisson (CEO)

Thanks for joining us this quarter. Please stay safe. Have a nice rest of the summer, and we'll talk to you in the fall again. Thank you.

Operator (participant)

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