Arch Capital Group Ltd. (ACGL) Earnings Call Transcript & Summary

Awesome. So good morning, everyone. It's a pleasure to have Executive Vice President and CFO, Francois Morin, on the line. I just want to notify everybody, following this discussion, we're going to host an open group meeting where you can join to ask questions. You can also shoot questions to me now via chat. And to access the meeting afterwards, just click the link within our MeetMax conference website. And then once you join, please click panelists, if you'd like to be able to speak and ask a question. So I just want to make sure everybody was clear on that.

Francois, it's great to have you here. And I think I'll just kick off with a question around share repurchases. Management said that buybacks remain a big topic of debate internally. Maybe you could tell us a little bit about that debate? And if Arch did not repurchase shares in '23, why does it sound like the second half of '24 might be a good time to do that?

Yes, sure. And again, thanks for having me here. Happy to participate in the conference. Yes, I mean, share buybacks to us is just, again, one of the tools that we have available in terms of capital management and being good stewards of capital as we think we've demonstrated over the years, I think it's something that we use in the past. You're correct in '23, we were -- stayed on the sidelines. It's been a terrific market for us. We had the opportunity to -- we're able to deploy the capital we had in the business, and that certainly comes first. So I think we put this capital to work both in insurance and reinsurance. But we're certainly aware that the market is still very, very healthy. But the opportunities for organic growth may not be as plentiful going forward. And we are also -- we've been able to accumulate the capital and grow the capital base. So when we think about do we have excess capital? And if so, what do we do with it? Again, share buybacks are part of that discussion and maybe dividends or regular or special, those are all the traditional tools that we have access to. But for the time being, we're still enjoying this very good market, and we're putting that capital to work. Will things change, could they change? They could, certainly, later this year, maybe next year. But again, I'd say nothing new in terms of how we think about the options and it's really very much a function of kind of what kind of market we have in front of us and what the opportunities are.

Got it. And just quick to clarify the comment about dividend, that would mean a onetime dividend, not a steady dividend, correct?

Everything is on the table. So we have those discussions with the Board. There's -- we discuss all the pros and cons of all kind of forms of returning capital to shareholders. And again, we'll definitely try to make the best decision for the shareholders when the time comes.

Interesting because that one seems like it was always off the table, but it's interesting. So Francois, how come the decision to buy Allianz's U.S. middle market and entertainment business? And what other areas might you still be looking at for M&A given your capital position?

Yes, for sure. Well, you know us, right, what we've been historically, primarily on the insurance side, focused on specialty lines with some large commercial products or lines of business. And as we look at our footprint and our operations, middle market business was an area that were just dabbling in, really didn't have a meaningful presence. We have some offerings in some lines of business, but it wasn't really a big part of what Arch insurance does. So middle market had always been -- or for the last little while at least have been identified as an area where that would be a nice addition to the Arch product offering and distribution network. So we were exploring ways to get into that space, whether -- and then you get into the discussion between buy and build and what makes sense. And there's a reason why some of the larger market players established a presence, and it takes time to build. It can be expensive. There's no guarantee that it's going to be a success. So we thought about it. But when this asset became available, we thought that we'd just accelerate our entry into that space, right? We're talking about $1.5 billion-or-so, just maybe a bit less of premium in that space for us. We're talking a $100 billion-plus market space. So it's a large market that we would have a very tiny market share in at this point. And then it's on us once we post to shape the portfolio in a way that we think we can be successful and look for opportunities to make it even better and maybe slightly bigger as well. So lot of work to be done, but it's certainly part of our strategic thinking for -- in this phase of our evolution, and we're happy we are kind of getting close to owning the asset.

Yes. And it seemed -- maybe just shifting gears a little bit, it seemed like investors were very jittery last quarter about casualty reserves across the whole sector. And Arch reported a favorable $126 million reserve development that included $7 million in insurance, $21 million in reinsurance and $107 million in mortgage with no material adverse development in the long-term casualty lines where everybody seems to be quite nervous. So Francois, maybe you could share your thoughts on the sufficiency of reserves at Arch for the 2016 through 2019 accident years? And then separately, how about the more recent years, 2020 to present, industry-wide versus Arch?

Yes. Well, on the earlier years, right, the '15 to '19 kind of years, how we play, how we do business, right, is very much around cycle management. That's one of our key principles where we need to be very thoughtful and careful when we see market conditions that are most likely not going to be in our favor. So the '15 to '19 years on the casualty side, in particular, were we thought could be problematic. We thought could -- there's definitely pressure on the rates. And the loss costs -- the assumptions you make around loss costs are always an estimate, but we've been all through our history, I think, very careful not to be overly optimistic on those. We take a long-term view of loss cost trends. And it certainly has -- trends have picked up a little bit in the last couple of years. But when we were writing the business for us in those years, we were very much playing a lot of defense. We were pulling back in a lot of areas. So we were effectively underweight and kind of we think avoided most of the trouble areas that were out there. So when we talk about reserve adequacy for those years, and we say it all the time, we're not perfect. I mean, we do see the same kind of industry issues that most people or a lot of people talk about, but for us, I think it's been very much being underweight has made it less of an issue. And we've been prudent along the way in terms of how we think we're booking, we think at those time -- at that time, kind of more conservative loss ratio picks, and we've taken a long-term view on it to see how those are going to develop. And so far, it's been -- it hasn't been all good. We've had some adverse in some pockets. But in totality, as we look at the overall book at Arch, both in insurance and reinsurance, it hasn't been a major issue for us. And then when we switch over to the more recent years where, yes, the market was certainly better. So we were -- we grew a little bit more in those years in the, call it, the casualty lines, and that -- as we all know, it's a pretty wide range of exposures from D&O to umbrella to all types of general liability business. So we thought it was a good time to grow that -- our presence because conditions were much better. But in terms of reserve adequacy, then it's really more the debate over what's your initial loss pick? And traditionally, we and others make the -- pick the loss ratios on a relative basis to the prior years. And so I think the key item here is more what's your starting point? And while we saw improving market conditions in the last couple of years, there's potentially some companies that may have been a little bit aggressive in their initial loss picks even for the '21, '22 and even '23 years. And with some of the trends that we've seen in the last couple of years, maybe those initial loss picks are just not holding up. For us, that hasn't been an issue. Again, there's some small pockets that we're watching carefully. But in aggregate, we're very comfortable with how our -- what our reserves look like at this point.

Awesome. Maybe moving over, Francois, to the excellent 1Q -- the first quarter you posted really hard to [indiscernible], But I guess if we were to, we would say net written premium in insurance rose 7.3%, which isn't as robust as maybe you've seen in recent years. So what should we expect going forward on net written premium for insurance?

Yes. I mean, the point on the call, I mean, we had a onetime transaction, a large transaction a year ago that impacted the relative, the growth, right? So if we excluded that transaction growth would have been slightly north of 10%, which maybe is a little bit more in line with expectations. Yes, no question that I think that the market has been -- we've been in the hard market for, call it, almost 5 years now since the fourth quarter of 2019. And we know it's not going to be there forever in terms of the opportunities, the dislocation, which is really how we've been able to grow so much faster, I'd say, than the average than the overall industry, I think, is in specifically maybe less so in the last, call it, 6 to 12 months. But from '19 to certainly end of '22, early '23, there was a lot of dislocation in a lot of areas and different points in time, again, D&O and other property. And so there's a lot of lines of business that went through significant dislocation, participants pulling back, cutting limits, et cetera. So that gave us an opportunity, with our strong balance sheet and really, really good underwriting, to step in and kind of grab market share on some of those lines of business that we thought were extremely well priced, and it's proven out to be the case. So we just see less of that type of dislocation in this environment. I think companies have stabilized their portfolios. There's less people pulling back, not necessarily or very little, I'd say, significant competition from new entrants. It's more the established market participants that we know and compete with. People are a little bit more willing and given the market conditions, very much a function of understanding the exposure and are seeing the risk and seeing the pricing that comes with that, there's -- it's just -- I call it a very healthy level of competition. So the growth opportunities coming from dislocation are just fewer. What is that -- what does it look like for us for the rest of '24 as we think about 25? We'll still -- we expect to still see growth. I think it's still there. There's still very healthy margins, very healthy pricing, but it most likely will not be in the, call it, 20% range or even higher than that, some of the quarters we've had. I think it's tempering or tapering off a little bit, but we saw in the first quarter for us was, I'd say, within expectations. Our teams are working hard, and we're chasing and trying to get the business that we think will produce very good returns for us, but it's still very much a function of the market and what opportunities are out there.

That was super helpful. And then maybe turning to the loss ratio in the Insurance segment. It's still outstanding. You had an underlying of 92.7; all in, it was 94.1. But it was off about 2-ish-or-so points versus what you -- at least on the underlying versus what you saw in the prior year quarter. So I mean, is what we saw in 1Q kind of a good indicator going forward? Where do you see the things going?

Yes, I'd say, well, a, there's a little bit of noise from the Baltimore Bridge, the Dali. So that we -- for us was not a cap. Others, I think, recognize it a bit differently. But for us, we -- it's just a large claim that's the business we're in. We're in the risk business, and these things happen. And we honor our commitments. So that was reflected in the first quarter. And going forward, I'd say we are cautious. I'd say we are -- we think the results that we are able to produce given our view of the market, the pricing, the loss trends, the levels of combined ratios, and there's going to -- always going to be a little bit of volatility quarter-to-quarter, that's just the business we're in, but the combined ratios that we had in Q1 was very much kind of what we think was in the range of expectations. What does Q2 look like? I don't know. And there's always a function of claims happening here and there, and there's developments on prior accident years, et cetera, positive, negative. So that's all part of the picture. But given what we -- we're still maintaining our margins, expanding margins in a few areas. So I think what we saw in Q1 is, again, very much within the range of expectations that we're comfortable with.

That's good. Yes, to your point, Q1 had 2.1 points of Baltimore Bridge in there. So maybe from an analytical -- from where I sit, maybe I throw that out because it was just very unusual, but...

Yes. I mean that's -- yes, it's -- but something else could happen this quarter, too. So it's -- that's okay. That's the business we're in.

Right. That's why you're there. And then shifting over to reinsurance. I mean that was blowout quarter. I mean, you came in at an underlying of 78.1. The overall combined was 77.4. I mean just so exceptional. So what's the sustainability there? I can't imagine you can keep that one...

Well, we'd like to, but we're also realistic that it's a market, there's cycles, and we'll see what comes next. It's a very, very healthy reinsurance market. Property cat gets a lot of attention, gets a lot of press, and that's understood. But it's a much, much bigger story for us than just property cat. And we keep saying it property cat is -- I forget the last number, but it's 10% of our reinsurance premium or it's not the driver. It certainly feeds into the overall results, but it's -- we're much more than just a property cat story. There's so many areas that are -- where the market is very, very strong. I mean property facultative, for example, a lot of just non-cat or less cat-exposed properties is very, very strong. There's many lines of business in the specialty side, whether it's -- it could be anything from A&H to agriculture, to trade credit, to -- the list goes on. I mean, we do a lot of that -- those types of businesses, specialty lines and market conditions have just been terrific. So combine that with really good growth the last few years in reinsurance, and we were able to produce just $380 million-or-so of underwriting income from reinsurance in the first quarter. It's just been a terrific story for us that we've been able to enjoy the market conditions and position ourselves in a way that gives us a good shot at getting the business and setting our terms and generating excellent returns.

So where are we in the -- and clearly, Arch has done an excellent job of cycle management. Where are we in this? Are we -- I think are we around 11:30, where are we in the cycle?

Well, we're certainly not at midnight. That's for sure. There's -- and with the caveat that it's not just 1 cycle, right? There's many sub-cycles as part of the market. People do point out D&O, large commercial D&O, specifically on an excess basis, that's been a bit more challenging for most everyone here in the market, lasting a little while the last 12 months, if not a bit longer. But -- and others are still -- we think of casualty in the U.S., we think has room to improve further. It's not at peak for sure. So yes, I mean, in total, like in the 11:00-or-so range we've been on the [indiscernible] clock is a reasonable way to think about it, but I'll just caution people to -- there's nuance around it because, again, different lines of business kind of peak at different times, and we're seeing it even though, as an example, cyber pricing has come down a little bit, but on a relative basis, may not be the best story. But on an absolute basis, we are still very much thinking that cyber is a good opportunity for us. It's not growing as much as it was a certain -- a few years back, but we still like the returns that it produces, and we are selective in how we do the -- who we underwrite and where we participate, but that's an example where a line of business, certainly on a relative -- on an absolute basis, sorry, we think can generate very good returns.

And then you have, relative to peers, quite a unique compensation structure in that it's based on the prior 10 underwriting years. So Francois, what could you share with us about how that compensation structure works? And then how does that affect your recruiting when you're looking for talent? Is this something that's tough for them to stomach or do they like that?

That's a great question. I mean I'd say that the highlights of the comp structure for -- and it's not everybody at Arch. I mean, it's very much that the plan that we talk about here, what we call our formula plan, is designed and really focused on our most senior underwriters and there's a few people around it, but the people that really are on the front lines making the underwriting decisions on what to write, when to write it, et cetera. The key takeaway, which I think makes us unique is nobody at Arch has any incentive to focus or there's no incentives that [indiscernible] people for premium for top line. So everything is bottom line focused, everything is ROE based and the structure here is, yes, as you know, business, the insurance that we write, the reinsurance that we write, we have a view when we write it, what we think it will generate, but it takes some time for the results to come in and for the business to season. So that's why we call it -- yes, it's paid over 10 years, it's more, call it, a deferred comp plan a little bit because we think it's just better to not have to argue over what's the ultimate loss pick for 2024 business, might as well just let it season out, and we'll know a lot more about it in a few years' time. And so there's incremental payments that underwriters get than they get payments across 10 underwriting years. So that's how we manage it. In terms of recruitment, I'd say it's -- Arch is not for everyone, no question. We strongly believe in our culture. We think it's a key reason why we've been successful and how we've been able to navigate the markets and the cycles. For those underwriters that have been part of Arch for a long time, they believe in the culture, they believe in the comp plan, and it's been -- it's worked out very well for them. For new underwriters, we do recruit, and we like to add to our team in areas where we think we can get better and find the right people. But certainly, it's not for everybody. So there are some people that buy into the story, buy into the opportunity and are willing to -- and we work with them, and there's ways that we can construct comp or rewards that will still be -- where we'll still be able to attract new employees, new underwriters. But some people just don't believe in the same key themes that we do, and we decide to go somewhere else. So it's a great retention tool. I mean, no question that the people have been with us for a long time. We have just terrific kind of tenure and people have stayed with us for a long time and that -- we think that's what makes us better and different.

You mentioned, Francois, that you like the cyber market. We were at the Berkshire shareholder meeting about a month ago and Ajit Jain expressed some concerns. Why do you feel like Arch has a handle on it? How do you analyze the PMLs? What gives you confidence that some nasty event can't really do some damage?

Well, there's no guarantees in what we do. That's for sure. There's -- and it's -- cyber is 1 of them, but everything we do has downside, I mean, and that's the reality of the business we're in. We like to think that we can -- if we do the work, we spend the time, we can come up with a very honest assessment of the downside. And when you deal with an exposure like cyber that is relatively new and has not really been, I'd say, tested in a material way. For us, it's very much around risk selection, it's around limits management, it's about offloading, buying reinsurance or seeding to partners to make sure that we can manage our downside. And given our balance sheet, we think we're not betting the balance sheet nowhere near, but we are willing to take a bit of risk. We think the rewards, we think the risk-return proposition is a good one for us at this point. And we keep improving our tools. There's a lot of work that's being done. But fundamentally, like in anything we do, we are very thoughtful and careful about not overexposing ourselves to in terms of limit size and industry concentration, we want to be diversified. We want to be dealing with multiple types of insurers and different -- that don't all have the same characteristics, which is -- can be a source of a concentration and could be problematic if something were to happen. So we're watching it carefully. We get better every day at it. But there's a lot of -- and the thing that we like about it is the insurers are very much vested in improving their position, right? The way they manage their exposure to cyber risk, nobody wants to be on the front page of a newspaper kind of being unable to do business for 2 weeks because they've been hacked. So there's an alignment of interest where we can actually contribute to the -- as part of the underwriting, we can ask the right questions and the buyers, the insurers are very much vested in doing what's right for them as well.

I see we've got about 2 minutes remaining on the clock. So I'll ask you 1 to answer in like a minute and 30 seconds, Francois, and then everybody please join the group meeting afterwards, where you can ask questions as well. So catastrophe losses, I think Colorado state university researchers assume a very active season here, they're forecasting 23 named storms, 11 hurricanes, 5 major hurricanes of Category 3. Anyway, this is a big number. Should we be concerned and how will that affect Arch?

Should we be concerned? I mean, people hopefully understand the business we're in. So there's risk in what we do. We like to think and we'll work very hard to make sure that we price for the risk that we see in front of us. We reprice every year, right? So that's at least a good thing about our business. But there's a random part of what we do that we just can't control. So if there could be a lot of hurricanes and none of them make landfall, there could be fewer than 23 and 1 big one hits, could happen. But I will say that we are prepared for that. We are, again, -- they're very -- demonstrated that we are good risk managers. We are not overly exposed in any 1 area. We take it very seriously. And if some of it happens, we'll react to it, we think appropriately and be around to -- for tomorrow, I'd say.

Francois, awesome insights. Really enjoyed hearing about Arch. And we're going to stay on and look forward to the group session, it's going to start exactly now.