Arch Capital Group Q1 2024 Earnings Call Transcript

Quartr
Provided by Quartr
April 30, 2024

There are 12 speakers on the call.

Operator

Good day, ladies and gentlemen, and welcome to the Q1 2024 Arch Capital Earnings Conference Call. At this time, all participants are in a listen only mode. Later, we will conduct a question and answer session and instructions will follow at that time. As a reminder, this conference call is being recorded. Before the company gets started with its update, management wants to first remind everyone that certain statements in today's press release and discussed on this call may constitute forward looking statements under federal securities laws.

Operator

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.

Operator

Management will also make reference to certain non GAAP measures of financial performance. The reconciliations to GAAP for each non GAAP financial measure can be found in the company's current report on Form 8 ks furnished to the SEC yesterday, which contains the company's earnings press release and is available on the company's website at www.archgroup.com and on the SEC's website at www.sec.gov. I would now like to introduce your host for today's conference, Mr. Mark Grandison and Mr. Francois Morin.

Operator

Sirs, you may begin.

Speaker 1

Thank you, Gigi. Good morning, and welcome to Arch's Q1 earnings call. We are pleased to report a terrific start to the year. In the Q1, we posted $736,000,000 in underwriting income and a 5.2% increase in book value per share as we realized the benefits from several years of strong and profitable premium growth. Underwriters in our P and C units continued to lean into hard market conditions, writing $5,600,000,000 of gross premium in the quarter, a 26% increase from the same quarter last year.

Speaker 1

Overall, rate changes are exceeding loss trends and absolute returns remain above our long term targets, positive indicators in our continued efforts to deliver superior results to our shareholders. Broadly, we are seeing incremental signs of increased underwriting appetite in the market, but this is not surprising given the favorable conditions that exist. It is still an underwriters market where Arch can thrive. At the beginning of this hard market, as other providers pulled back, Art sought to establish itself as a key trading partner, aiming to solidify relationships and remain top of mind when it comes to addressing our clients' increased needs. Our success in establishing deeper client connections continues to pay dividends in this extended yet increasingly competitive hard market.

Speaker 1

The Q1 served as a reminder of our risky world when an active catastrophe quarter concluded with a major industry loss as the Dally cargo ship collided with the Francis Scott Key Bridge in Baltimore. Although we recognized a loss related to this event, the virtue of having multiple lines of business with improved and positive expected margins made this event manageable for Arch. Incidents like this reinforce the importance of our core tenets. 1, we practice disciplined underwriting that builds a meaningful margin of safety into our pricing. 2, we take a long term view of risk in a conservative approach to reserving.

Speaker 1

And 3, we operate a diversified global business that we believe maximizes our total return by mitigating volatility in any one line of business. Capital Management has been a key differentiator for Arch and is integral to how we operate our company. Effective capital management requires that we allocate resources to the most profitable underwriting opportunities while retaining the flexibility to invest in our platform when we find attractive opportunities. One of those prospects came to fruition earlier this month when we announced our intent to acquire Allianz's U. S.

Speaker 1

Miller Market and Entertainment Businesses. We see this as a unique opportunity to quickly build scale in the $100,000,000,000 plus U. S. Middle market, a long time strategic area of underwriting interest for us. Increasing our Miller Market presence will further diversify our North American insurance platform by adding stable businesses with recurring premiums that can generate attractive returns over the cycle.

Speaker 1

As a cycle manager, we like having many ponds to fish in and this acquisition will significantly expand our opportunities in the Miller Market pond for years to come. I'll now share a few highlights from our segments. As you know, the property and casualty market cycle is evolving, but still offers attractive growth opportunities at good returns, particularly for our skilled specialty underwriters who can use their expertise and experience to differentiate Arch. The Q1 results from our Reinsurance segment were outstanding. Underwriting income for the segment was $379,000,000 while gross premium written grew by 41% over the same quarter last year.

Speaker 1

While there is some developing competition, we're observing an increased flight to quality and fully expect to capitalize on that trend as the cycle ages. Our Reinsurance segment is in an enviable position. The in force book constructed over the last several years is strong and allows us to exercise our underwriting acumen. When opportunities emerge, whether from dislocation in the casualty market or by offering value that others cannot, Arch is there to provide solutions and financial strength to its clients. In our Insurance segment, growth tapered from the highs of the past few years as rate increases slowed and some of the dislocations were met by additional capacity.

Speaker 1

Overall, conditions remain strong and the market is behaving rationally, 2 important factors that continue to support growth and strong profit. In the Q1, we found growth opportunities in several lines, including property and casualty E and S and other specialty lines. Across most of our specialty lines, pricing remains very healthy and we are able to deploy capital in order to deliver attractive returns above our long term target of 15%. Like Reinsurance, our Insurance segment has made strong efforts to establish itself as a first choice provider for its clients and that manifests in seeing more opportunities. In life, you have to play to win and in Insurance, if you don't see the business, you can't ride it.

Speaker 1

And now let's pivot from P and C to mortgage, which to borrow from a famous ad campaign just keeps on going and going and going. Our mortgage segment continues to generate solid underwriting income and risk adjusted returns from its high quality portfolio. While mortgage originations remain tempered by high mortgage interest rates, the persistency of our in force book remains a healthy 83.6%, while the delinquency rate is near all time lows. New insurance written is in line with our appetite given market conditions. When the mortgage market picks up again, we're prepared to increase our production.

Speaker 1

However, if the status quo persists, we're content with our current situation that has extended the duration over which we earn mortgage insurance premium. Competition within the MI industry remains disciplined, which means we are in a good place. Finally, our investments portfolio grew to generating $327,000,000 of net investment income in the quarter. The extraordinary premium growth from our P and C segments continues to increase our float, which provides a significant tailwind to our overall earnings through the next several quarters. In the U.

Speaker 1

S, the NFL conducted its annual draft this past weekend. Traditionally, the team that finished last season with a worst record gets the 1st pick, a chance to select the best college player, while the champions pick last. The players selected with the top picks are expected to be immediate difference makers, even though they are typically selected by a team with multiple deficiencies, making success far from guaranteed. If your talented quarterback has nobody to throw the ball to, it can ruin the players confidence and the pressure can quickly sabotage a career. Compare this with teams drafting at the end of the round coming off successful seasons with talented rosters in place.

Speaker 1

They often have the luxury of selecting an excellent player who doesn't need to contribute right away. Instead, these teams select players who can fill a specific short term role and be given time to grow into a difference maker. Our acquisition of the Allianz MidCorp business is like adding a solid player to a winning team. We already have established all stars, a winning talent dense culture and a favorable schedule in the years ahead. Adding the MidCorp team to our diversified franchise makes us better today and tomorrow, and that's a winning proposition.

Speaker 1

I'll now turn it over to Francois to provide some more color on our financial results from the quarter, and then we'll return to take

Speaker 2

your questions. Francois? Thank you, Mark, and good morning to all. As you will have seen, we started out 2024 on a very strong note with after tax operating income of $2.45 per share for the quarter for an annualized operating return on average common equity of 20.7%. Book value per share was $49.36 as of March 31, up 5.2% for the quarter.

Speaker 2

Our excellent performance was again the result of outstanding results across our 3 business segments, highlighted by $736,000,000 in underwriting income. We delivered exceptional net premium written growth across our Reinsurance segment, a 31% increase over the Q1 of 2023, driven by strong business flow in all our lines of business. Growth was also solid for our insurance segment, 12% after adjusting for the impact of a large non recurring transaction we underwrote in the Q1 last year in our warranty and lenders business unit. Overall, the combined ratio from the group came in at an excellent 78.8 percent. Our underwriting income reflected $126,000,000 of favorable prior year development on a pre tax basis or 3.7 points on the combined ratio across our 3 segments.

Speaker 2

We observed favorable development across many units, but primarily in short day lines in our Property and Casualty segments and in mortgage due to strong cure activity. The collapse of the Francis Scott Key Bridge in Baltimore last month has the potential to become the largest insured marine event in history. Both our insurance and reinsurance segments were exposed to this disaster and our current estimates represent an impact of 2.1 and 3.0 points respectively on the combined ratio in these segments results this quarter. We note that the losses for this event were reported as non catastrophe in our ratios. Catastrophe loss activity was relatively subdued and below our expectations across our portfolio with a series of smaller events generating current accident year catastrophe losses of $58,000,000 for the group in the quarter.

Speaker 2

Overall, our underlying ex cat combined ratio remained excellent with the increase this quarter relative to the last few quarters mostly due to the Baltimore bridge collapse. Despite the impact of this event, our current quarter ex cat combined ratio still improved by 1.4 points from a year ago as a result of earned rate changes above our loss trend in our P and C businesses and lower expense ratios mostly from the growth in our premium base. These benefits were slightly offset by investments we continue to make in people, data and analytics and technology to improve the quality and resilience of our platform going forward. From a modeling perspective, I'd also like to remind everyone that our operating expense ratios are typically at their highest in the Q1 of the year due to seasonality in compensation expenses, including equity based grants for retirement eligible employees that were made in March. As of April 1, our peak zone natural cat PML for a single event, 1 in 2.50 year return level on a net basis remained basically flat from January 1, but declined relative to our capital to 9.0 percent of tangible shareholders' equity well below our internal limits.

Speaker 2

On the investment front, we earned a combined $426,000,000 pretax from net investment income and income from funds accounted using the equity method or $0.0112 per share $1.12 per share. Total return for the portfolio came in at 0.8% for the quarter, reflecting the unrealized losses on the company's fixed income securities driven by higher interest rates. Our growing investment portfolio keeps providing meaningful tailwinds to our bottom line and remains of high quality and short duration. We have grown our investable asset base significantly over the last few years, primarily to significant cash flow from operations. This positive result combined with new money rates near 5% should support further growth in our investment income for the foreseeable future.

Speaker 2

Income from operating affiliates was strong at 55,000,000 dollars Of note, approximately $14,000,000 of this quarter's income is attributable to the true up of the deferred tax asset at our operating affiliate Summers in connection with the Bermuda corporate income tax, a non recurring item. Our effective tax rate on pre tax operating income was an expense of 8.5% for the 2024 Q1, slightly below our current expected range of 9% to 11% for the full year, mostly as a result of the timing of tax benefits related to equity based compensation. As regards our announcement to acquire the U. S. Midcorp and Entertainment Insurance Businesses from Allianz, We are making progress in obtaining the necessary regulatory approvals and are targeting a 3rd quarter close for the transaction.

Speaker 2

At a high level, the agreement is structured around 2 related contracts, a loss portfolio transfer of loss reserves for years 2016 to 2023 and a new business agreement for business written in 2024 and after. Overall, we expect to deploy approximately $1,400,000,000 in internal capital resources to support both contracts in addition to the cash consideration of $450,000,000 The overall transaction is expected to be moderately accretive to earnings per share and return on equity starting in 2025. It is important to note that even when reflecting the capital to be deployed for this transaction, our capital base remains strong with a long with a leverage ratio in the mid teen range. We maintain ample financial resources and remain committed in allocating our capital in the most optimal way for the long term benefit of our shareholders. With these introductory comments, we are now prepared to take your questions.

Operator

Thank Our first question comes from the line of Elyse Greenspan from Wells Fargo.

Speaker 3

Hi, thanks. Good morning. My first question is on the reinsurance market. Mark, I think in your opening comments, you mentioned something about potential dislocation in the casualty market. Are you starting to see market just opportunities emerge there?

Speaker 3

I know you've highlighted this, I think starting in Q3 of last year or is this something that you still think might take a couple of quarters to kind of fully present an opportunity to Arch?

Speaker 1

Yes. The casualty market is going through, I wouldn't say repricing, but not re underwriting as thorough because it has been already getting was hard getting harder for the last several years. We may had some respite in terms of price increase middle of last year, but I think that the development of the prior year as we all know has created a little bit more uncertainties and inflation is not ebbing. So right now what we're seeing is people still being very, very careful and disciplined into and how they underwrite the business, which leads us Arch, gives us opportunity to lean into this even more so. We have grown our casualty book of business on the insurance side quite a bit.

Speaker 1

Our casualty book is E and S as we all know and very specialized in specialty. But sorry, I thought there was some technical difficulties here. Elise, are you still there? I just want to make sure you can hear me.

Speaker 3

Yes, we can hear you.

Speaker 1

Okay. Thank you. Thank you, Elyse. You're a trooper. So the casualty market on the insurance side, we're growing.

Speaker 1

But I think now we're having more opportunities to grow. I think that there's some kind of not repricing, but definitely a focus on that line of business on the insurance side. On the reinsurance side, I think we're starting to see some of the renewals that came through and when anecdotally it's creating a little bit more friction in terms of renewal of the casualty quarter share for instance. So what we expect right now is the early stages. We don't know how long it's going to last and where it's going to go, but there's clearly a psychological belief within the human system and the human interactions and the casualty that people need and know that we need to get more rate to make up for all the risks and potentially some of the misses that we had in the past.

Speaker 3

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

Speaker 1

Yes. We have a long list of things we'd like to acquire or have part of our arsenal. We talk about Allianz as an acquisition and that's an important one and significant one and very good one for us. Us. We're very pleased with that one.

Speaker 1

But what we also would want to tell our shareholders is, as you know, Elyse, is we've also added teams along the way. So acquisition is a pure acquisition of a company is not the only thing that we're able to do. We've acquired some teams to do contingencies, some more terror and everything in between. So we're always on the lookout. Again, as a cycle manager at least, what you want is as many areas to deploy your capital depending on the market conditions, creates a much more stable enterprise, much less volatility to bottom line.

Speaker 1

And again, the more the market cycles are not monolithic. They're multi they come in multi phases and multi places. So we also have, as a little bit of an insight baseball, we our executive team is always always every other month, we have a list, a wish list that I will not share with you on this call, but it's a wish list of things that we know for a fact would be accretive and additive to our diversification of our portfolio and we're always on the lookout for those. Mid market was on the list and this is what so opportunities met the willingness to do it and this is where we are.

Speaker 3

Okay. Thank you.

Speaker 1

Thanks, Elyse.

Operator

Thank you. One moment for our next question. Our next question comes from the line of Jimmy Bhullar from JPMorgan Securities LLC.

Speaker 4

Hi, good morning. So just

Speaker 5

a question on the Baltimore bridge loss that you reported in insurance and reinsurance and I recognize your results were pretty strong overall. But the number seems fairly high that you reported relative to what some of your peers have talked about and also what the industry losses seem to be. So I'm just wondering, I'm assuming most of this is IBNR, but just wondering sort of is this because of how much conservatism there was baked into the number or maybe the market's underestimating what the losses from the event are eventually going to end up being?

Speaker 1

Well, Jimmy, just at a high level, right, I'll let Francois talk about the reserving level. But we have been a participant in marine liability for quite a while. I used to underwrite the IGA, the Reinsurance Group way back in 2002, 2003. This is nothing new to us. We also acquired Norbarkin in 2019.

Speaker 1

So we have and we have a stronger presence than we ever had in the London market, which again is another marine market positioning. So we do also we do insurance, reinsurance and some retro actually. So it's nothing new to us. We like that business quite a bit, mid money over the years. The rates and the returns are at were and are still acceptable.

Speaker 1

I mean, but sometimes a loss occurs. I'm not sure about what the other ones are thinking about, but we definitely think that this is pretty much in line with what we would have expected the market share to be or what we think that our presence in the marketplace would be. I'll let Francois talk about.

Speaker 2

Yes. I mean, again, we can't speculate or comment on how others are maybe or may not be reserving for this event. For us, it's not unusual. And I'd say that we've taken a very conservative view of the loss and still a lot to be determined obviously in terms of who's going to end up paying for it. But and to the last point you asked, last question is, yes, for us right now, it's all it's IBNR.

Speaker 2

I mean, we don't really have all the specifics to establish case reserves. So we booked it as IBNR and we'll see how things develop.

Speaker 5

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

Speaker 2

Well, part 1 of your question, there was really no material development on long tail casualty lines of business across all years. So both pre the 2015 to 2019 years and 2021 to 2023. So we're very comfortable with that. I think our reserves are holding up nicely. And I know there's been some concerns around the more recent years where there's been some signs of adverse in the industry.

Speaker 2

We're not seeing that actually or metrics or actuaries are commenting that our actual development is coming in more favorable than expected. Again, very early to declare victory, but that's certainly for us a positive sign and we'll keep monitoring and see how things develop for the rest of the year.

Speaker 6

Thank you.

Speaker 2

You're welcome.

Operator

Thank you. One moment for our next question. Our next question comes from the line of Andrew Kligerman from TD Cowen.

Speaker 6

Hey, thank you and good morning. Ralph, you mentioned that the MI market is going and going and going. How do you think about the favorable prior year developments? I mean, last year in the Q1, it was 25 points. This year in the Q1, it's another 25 points.

Speaker 6

I mean, does that still continue going forward as well?

Speaker 1

Well, I don't have a crystal ball for the future, but we're like everybody else, we're just on the receiving end of a market that's curing better. The borrower is in good conditions. There are programs on the GSEs that help the borrowers staying in their homes. Most of those that even would have a delinquency as we speak would have a much lower mortgage rate. So they have a lot of incentive to stay in the home and not having to do anything with it.

Speaker 1

Plus, there's a lot of equity being built up in the home. So people have are sitting on because as you know, there's been a significant increase in property valuation over the 3 to 4 years. So everything is really indicating that we have a lot of alignment between starting from the borrower all the way through the mortgage insurer and the mortgage origination of the mortgage companies to make sure that the borrowers can make the payment, you can refinance, delay or attach it

Speaker 7

to the intent. There's a

Speaker 1

lot of things, a lot of tools in toolbox that weren't there frankly in 2,007, 2,008 when the crisis happened. So but what does that mean in terms of development? We'll have to see what happens. But again, it's been more favorable than we would have said probably 2, 3 years ago. And we're just when we see the data, we just react to it.

Speaker 6

Pretty amazing stuff. And then my follow-up question is around the Allianz acquisition. And I love your analogy about the NFL draft and picking the high quality players. Some have criticized Allianz as maybe not maybe I'll say they weren't a 1st round draft choice. So with that, what will Arch be able to do to kind of turn them into a first round type player?

Speaker 6

I mean, I know I've heard about data and analytics, but can that help overnight? So I'd like to know what you're going to do there to really enhance that operation?

Speaker 1

Well, there's a lot of things going on. There's a thorough and very complete plan by our unit to first integrate them, make them part of our company and our culture. And we'll have to look at everything that we can do to help them out or there is an okay business, very decent business, but we'll have to make it more of an arch business. But recognizing some of the cultural differences and the distribution, it's a little bit of a different business. Data analytics is certainly one of them.

Speaker 1

We also bring to bear, we believe Allianz is a big company and they did a lot of work on this. We have a strong presence in the U. S. As well. We also already do some middle market business.

Speaker 1

So we already have experience in that space. And so we have a couple of things and a couple of tricks up our sleeves, if you will, to make it better. I won't go into all the details, obviously, but I think we're pretty excited about what we can do with the asset. And I think, like I said all the time, if there and this is not a comparison with Allianz or us, but truthfully, I'd say the same thing to the mortgage, the UG, they're relatively a bigger piece of our overall enterprise and perhaps they would be at some other company. So that makes it for a little bit more excitement, a bit more and a willingness from our part obviously to invest, right.

Speaker 1

I'll remind everyone that some of the earnings that we make it, we put aside to invest for the future. So we have a lot of things going on and we're pretty excited.

Speaker 6

Thanks a lot.

Operator

Thank you. One moment for our next question. Our next question comes from the line of Michael Zaremski from BMO.

Speaker 4

Hey, thanks. Good morning. On the Insurance segment, the underlying loss ratio of 57.5%. I know I'm probably just nitpicking, but I hear the commentary about the impact from the Baltimore Bridge. But just curious, you've grown into property, which has a lower loss ratio, attritional loss ratio, I believe.

Speaker 4

So is there anything going on there, mix that maybe you're putting into more conservatism on the casualty growth or anything we should be thinking about there?

Speaker 2

Well, Mike, I'd say it's just the nature of the business we're in. I think there's going to be some ebbs and flows. There's going to be some I wouldn't call them unusual or unexpected developments. There could be 1 or 2 claims that surfaced in the quarter. We book them.

Speaker 2

We recognize adverse or bad news early on and see how things play out. So there's really nothing to say that we want that needs to be highlighted. It's really par for the course. And yes, absolutely this quarter turns out that the ex GAAP kind of underlying loss ratio was up, I'd say 30 bps. And that's just the reality of the world we're in and we think it's still an excellent result.

Speaker 4

Okay, got it. Second question is probably a quick one, but you all are kind enough to give us guidance on the cat load in the last quarter. I think you said it was in the 6% to 7% range for I believe it's just the premiums ex the mortgage segment. Is that expected to change or maybe be towards the end of that range on a base case scenario as you kind of continue to lean into the hard market conditions as we think about 2024?

Speaker 2

Well, the comment I made last quarter was, yes, for the full year on the overall ACGL premium 6% to 8%. We don't see that changing at this point. I think that was based on our view of how the year had a chance to play out. That's why we gave you a range. We were very happy with the oneone renewals.

Speaker 2

4ones went pretty much as expected. And 6 ones so far are holding up nicely.

Speaker 1

I mean, still a

Speaker 2

little bit of time to go before that gets finalized. But big picture, again, that's the 6% to 8% range for the year in terms of cat load is holding up nicely.

Speaker 4

Francois, sorry, is that 6% to 8% on all insurance premiums ex mortgage or just with or with our total company with mortgage? Total companywide, ACGL total. Thank you.

Operator

Thank you. One moment for our next question. Our next question comes from the line of Den Dean Cicelytello from KBW.

Speaker 7

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

Speaker 1

No, I think if you look at the it's a good question. If you look at

Speaker 2

the last 4 or 5 years in

Speaker 1

the Q1, you'll see that our net to growth ratio hovers between 65% to 70%. Last quarter last year was 70% because we had a larger transaction that came through that was not ceded. So it's really just a comparison that's not one just one period comparison is not reflective of what's going on. If you look at a longer term, you look at the 6570, so nothing changed there. Okay.

Speaker 7

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

Speaker 1

Yes. So the it's the thing our professional liability has many things to it. It's got large company, large public company in D and O. It's got some smaller private, also has cyber in it and some professional liability like agents and stuff like this that's more E and O based. I think that the growth is largely attributed to cyber.

Speaker 1

Our teams are leaning a little bit more into it and we've also acquired a couple more team or developing a team in Europe. There's a big need for what we realize as a need for cyber in Europe and that's something that we're starting to grow and see more of. And the reason it's grown in cyber is because even though some of the rates as we all heard went down slightly, it's still a very, very favorable we believe very favorable proposition for us to underwrite. Also helps us doing other lines of business because it creates value for our clients. It's still a little bit harder to get in terms of coverage.

Speaker 1

On the D and O, we would have decreases and increases depending on whether rates are or where we see the relative high the relative valuation or profitability of a portfolio. On that note, the rate the rates in D and O went down about 8% in this quarter, not as bad as it was year, year and a half ago. You heard the comments that the SCAs are down. So there's still we believe there's still a lot of favorable opportunities in that segment as well. We just have to be a little bit more circumspect when we do this.

Speaker 7

Thank you. Sure.

Operator

Thank you. One moment for our next question. Our next question comes from the line of David Motamedian from Evercore ISI.

Speaker 8

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

Speaker 1

Yes. I think right now what we're seeing is more higher appetite for cyber is one of them, that's for sure. Insurance and reinsurance, I would also I mean, can run the gamut as many of them. Typically, right now, where we are the lines that are more short tail in nature, you can see a little bit more willingness to take some more risk from the competition. And how we react to it is, we have many things we do.

Speaker 1

We typically will tend to first look at the overall risk. No. If the rates go down or if rates stay as is within new conditions, you actually price the business as if it's a new piece of business and what kind of return, it will get you. And if it's a little bit not as much or not as or too close to for comfort, we might just decrease our participation. And we also might just stay on the clients that we believe have a better chance to really maneuver through that little bit sideways market, if you will.

Speaker 1

It's really an underwriters market at this time.

Speaker 8

Got it. Thanks. And just within reinsurance, the underlying margins there were strong and even better if I exclude the bridge loss. Can you talk about if there is anything in there that would flatter the results? Or is it more just sort of the earn in at the property, more short tail lines and these results are fairly sustainable.

Speaker 8

I guess, how should I think about the sustainability of the results on the reinsurance side?

Speaker 2

Yes. I mean, it's a great market, right? And we've been saying that for a few quarters. I think and we said it before, I think we encourage you all to look at results on the trailing 12 month basis. I think it's a bit more reliable, I think less prone to volatility that is sometimes hard to predict.

Speaker 2

But yes, I mean, we and Mark said it, I think the quality of the book that's in force right now is excellent. And we're going to earn that in. But whether how was this quarter a little bit better than maybe the long term run rate maybe, we don't know. But again, as you try to look ahead, I'd say more of a trailing 12 month again view is probably a bit more reliable.

Speaker 8

Understood. Thank you.

Speaker 1

You're welcome.

Operator

Thank you. One moment for our next question. Our next question comes from the line of Josh Shanker from Bank of America.

Speaker 9

Yes. Thank you very much for taking my question. On the other income, which doesn't get enough attention, that's Summers and Kofas. It was a weak quarter for Kofas' stock return in 4Q 2023, yet the other was quite strong. And maybe I'm misunderstanding how to model this, but I bring this up because CoBot had an excellent quarter this past 1Q 2024 and I'm wondering if that presages a very, very strong other income return for the company as we head into 2Q 2024?

Speaker 2

Yes. So just to be, make sure we're on the same page, there's a lag, right? So Colfas is booked on a 1 lag, 1 quarter lag basis. So what they just reported for Q1 will show up in their Q2 numbers. Summers is on a real time basis.

Speaker 2

And as we know, right, Summers should follow relatively closely the performance of our reinsurance book because it's effectively a sidecar. There's some nuances to it, but big picture that is booked on a real time basis and should mirror fairly closely our reinsurance book. But to your point, yes, I mean if Colfax reported a strong Q1, you should see the benefits of that flow through in our Q2.

Speaker 9

And in theory, there should be, I guess, as you're saying, some correlation between reinsurance segment underwriting income and Summers, which appears in that other mine?

Speaker 2

Correct. Yes. It's not perfectly correlated because it's not the whole segment. It's mostly the Bermuda Reinsurance unit that we that they follow, not the entire business, but big picture still, I mean, if the market conditions are good and reinsurance, the summers will benefit from that on a similar basis.

Speaker 9

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

Speaker 2

Yes, I mean, that's always an evolving topic, right? I think we are always focused on putting the capital to work in the business where we can. I think we've done a fair amount of that obviously this quarter with the reinsurance growth that we saw. The $1,800,000,000 that will support the Allianz transaction is another example. We will see how the year plays out.

Speaker 2

No question that we are generating significant earnings, so that goes to the bottom line. And we'll be patient with it until we can't really find other ways to deploy it. But for the time being, it's we're in a really good place in terms of capital and gives us a lot of flexibility.

Speaker 9

Thank you very much.

Speaker 1

Thanks. You're welcome.

Operator

Thank you. One moment for our next question. Our next question comes from the line of Brian Meredith from UBS.

Speaker 10

Yes, thanks. A couple of quick numbers and one big picture question for you all. The first one just quickly on the Allianz deal, is it possible to give us how much cash you're expecting to come in from the, I guess, the UEP and the reserve assumption, kind of net cash position you're expecting? And then obviously

Speaker 2

Yes, big picture, it's a $2,000,000,000 LPT and with dollar for dollar, right? So we get $2,000,000,000 cash and we were spending $450,000,000 that goes out back to them for the cash consideration. So net net, it's $1,500,000,000 of incremental cash that we will get. And the rest on the new business, then it's call it, it's the premium flow with as we write that business, that's the overall over time that will be the incremental investment income or invested assets that we will get.

Speaker 10

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

Speaker 10

Where does that come?

Speaker 2

Well, a lot of it is 3rd party capital, right? We last year was a very light or good year for the performance of that book. So some of those agreements, many of them actually pay us a commission that is there's a base and then there's a variable aspect to it. And that was kind of a lot a large part of that. So that's effectively performance based commissions on property cat or property business.

Speaker 10

Makes sense. And then one bigger picture question here. I'm just curious on your reinsurance business. Obviously, during the Q1, you're getting a lot of border rose coming in from clients. What are you seeing with respect to reserve development at your clients, right?

Speaker 10

And how you kind of protected against that and not potentially seeing some of that adverse development that your clients are seeing on your kind of casualty quota share business?

Speaker 1

Yes. So I think the Francois mentioned the actuals is expected, which is sort of consistent in both insurance and reinsurance on the more recent policy or accident year, which having a right starting point means that you don't really have to correct as frequently. So I would say that we're not surprised on the reinsurance about what we see. But as I said earlier, I think there is anecdotally and some heavy a lot of more friction, I would say, between insurance and reinsurance companies to make sure that people get an agreement as to what the ultimate is going to be. So we're hearing this going in the marketplace.

Speaker 1

Of course, we participate in that, but we're not seeing this as being a big issue for us. And the other years that would have been pre-twenty 20 21, I want to remind everyone that we were very defensive. We do not have a whole lot of those premium and those harder in developing areas that people are talking about. So I will say that we see opportunities to write more of those and we expect to see more opportunities to write more of these those types of deals this year. But I wouldn't say that we are the most present in that in those worst years, if you will.

Speaker 10

Great. Thank you. Sure.

Operator

Thank you. One moment for our next question. Our next question comes from the line of K. V. Montazeri from Deutsche Bank.

Speaker 7

Good morning. I only have one question today on the Florida market. The tort reform implemented

Speaker 1

over a year ago seems to

Speaker 7

have had some positive impact on the primary carriers and reinsurance capital seems to be coming back. This is a market that you guys know very well. Do you have any color you can share with us on the state of the market in Florida?

Speaker 1

No, I think it's to your point, some of the adjustments are coming through, but inflation is also picking up and there's also as we all hear, there's potentially more activity in the Southeast of the U. S. In terms of activities and storms. So I think that people are trying to sort out what they will do at this point in time. I think we have already existing relationships that we think will get us a little bit ahead of the game in terms of participating and getting a participation in the marketplace.

Speaker 1

But bottom line is we expect the Florida market to be well priced and very good on a from a risk adjusted basis. Nothing indicates anything else other than that. Even of course, the everything that's been done to take care of the AOB and whatever else in between, I think it's helpful. But it's still the largest property cat exposure for everybody around the world. So even if you make some corrections and they have made some corrections, I think we still have a couple of years before we start thinking about having a heavy softening in the market.

Speaker 1

There might be some here and there, but we still believe the market will be healthy as a reinsurer. Thank you. Thanks.

Operator

Thank you. One moment for our next question. Our next question comes from the line of Bob Kwan from Morgan Stanley.

Speaker 11

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

Speaker 1

No, it doesn't change. I mean, cycle management is a core principle of ours. And if anything, we'd like to be able to do, it's going to be a matter of degree perhaps, some lines of business have more acute cycle management need because it's probably more heavily commoditized. I would expect the cycle management to be much softer in the Allianz and the U. S.

Speaker 1

Mid Corp business and that's also what's attractive about it, right, because it creates more stability for the portfolio.

Speaker 11

Got it. No, that's very helpful. Thank you.

Speaker 7

Thanks.

Speaker 11

And then in that case, when we think about M and A or future M and A, is it the first preference to use the excess capital or excess cash you're generating from the business to do the M and A deals? Or is it more preferable to use some of the stocks given where the valuation is and things of that nature?

Speaker 2

I mean, there's no one answer to that. I think as always, I mean, and we talk about M and A, but M and A doesn't happen that often. So right, so there's size that matters, how much could we need would we need to raise in terms of using our own stock? Certainly, in terms of dilution, it's always we think better to kind of use your cash. But there's many considerations we look at, trying to optimize as best we can all the options.

Speaker 2

We've got plenty of capacity in raising debt too if need be. So, it's very much a function of each specific circumstance, each specific

Speaker 11

opportunity, we look at

Speaker 2

it on its own and go from there.

Speaker 11

Sorry, if I can just have a little bit of clarification. Is it fair to say that in that case, cash and debt is more preferable and then equity maybe a little bit less or am I being too sumptuous there? So sorry, just maybe a little bit clarification on that.

Speaker 2

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

Speaker 11

Okay. Thank you very much.

Operator

Yes. Thank you. One moment for our next question. Our next question comes from the line of Michael Zaremski from BMO.

Speaker 4

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

Speaker 2

I mean, it's grown over the years for sure. I think that the difficulty or the reality we face is some of these Cs are somewhat the expense the revenue we get that has some expenses to go with it and those are kind of co mingled with our own internal expenses. So isolating, call it the margin on those contracts is a little bit kind of cloudy. But yes, it's grown. It's part of what we do.

Speaker 2

It's part of the leveraging our platform, leveraging our underwriting capabilities in all our segments, right? All three segments have some fee income that comes into there. Obviously, summers is part of that as well. But yes, it's become a bit more sizable for us.

Speaker 4

Okay. I tried. Thank you.

Speaker 1

Yes.

Operator

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

Speaker 1

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

Operator

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

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Key Takeaways

  • Arch delivered $736 million in underwriting income in Q1, drove a 5.2% increase in book value per share and achieved a 20.7% annualized operating return on average common equity.
  • P&C underwriters wrote $5.6 billion of gross premiums (up 26% year-over-year), with rate increases outpacing loss trends in a still-hard market environment.
  • The Reinsurance segment posted $379 million of underwriting income on 41% premium growth, while the Insurance segment saw 12% adjusted net premium growth and the group’s combined ratio came in at a robust 78.8%.
  • Arch announced a deal to acquire Allianz’s U.S. Miller Market and Entertainment businesses for $450 million in cash plus ~$1.4 billion of capital deployment, bolstering its middle-market presence and recurring premium base.
  • A major Q1 catastrophe—the Baltimore Francis Scott Key Bridge collapse—added 2.1 and 3.0 points to the Insurance and Reinsurance combined ratios respectively, yet remained manageable thanks to diversified lines, disciplined underwriting and conservative reserving.
AI Generated. May Contain Errors.
Earnings Conference Call
Arch Capital Group Q1 2024
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