Yahoo Finance Arch Capital Group Ltd. (NASDAQ:ACGL) Q1 2024 Earnings Call Transcript
Arch Capital Group Ltd. (NASDAQ:ACGL) Q1 2024 Earnings Call Transcript April 30, 2024
Arch Capital Group Ltd. isn't one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
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 the federal securities laws. These statements are based upon management's current assessments and assumptions and are subject to a number of risks and uncertainties. Consequently, actual results may differ materially from those expressed or implied.
For more information on the risks and other factors that may affect future performance, investors should review periodic reports that are filed by the company with the SEC from time to time. Additionally, certain statements contained in the call that are not based on historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The company intends the forward-looking statements in the call to be subject to the Safe Harbor created thereby. Management will also make reference to certain non-GAAP measures of financial performance. The reconciliations to GAAP for each non-GAAP financial measure can be found in the company's current report on Form 8-K, furnished to the SEC yesterday, which contains the company's earnings press release and is available on the company's website 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. Marc Grandisson and Mr. Francois Morin. Sirs, you may begin. Marc Grandisson Thank you. Good morning, and welcome to Arch's First Quarter Earnings Call. We are pleased to report a terrific start to the year. In the first quarter, we posted $736 million in underwriting income and a 5.2% increase in book value per share as we realized the benefits from several years of strong and profitable premium growth. Underwriters in our P&C units continued to lean into hard market conditions, writing $5.6 billion of gross premium in the quarter, a 26% increase from the same quarter last year. Overall, rate changes are exceeding loss trends, and absolute returns remain above our long-term targets, positive indicators in our continued efforts to deliver superior results to our shareholders.
Broadly, we are seeing incremental signs of increased underwriting appetite in the market, but this is not surprising, given the favorable conditions that exist. It is still an underwriter's market where Arch can thrive. At the beginning of this hard market, as other providers pull back, Arch sought to establish itself as a key trading partner, aiming to solidify relationships and remain top of mind when it comes to addressing our clients' increased needs. Our success in establishing deeper client connections continues to pay dividends in this extended, yet increasingly competitive hard market. The first quarter served as a reminder of our risky world when an active catastrophe quarter concluded with a major industry loss, as the Dali cargo ship collided with the Francis Scott Key Bridge in Baltimore.
Although we recognized a loss related to this event, the virtue of having multiple lines of business with improved and positive expected margins, made this event manageable for Arch. Incidents like this reinforce the importance of our core tenants. One, we practice disciplined underwriting that builds a meaningful margin of safety into our pricing. Two, we take a long-term view of risk and a conservative approach to reserving. And three, we operate a diversified global business that we believe maximizes our total return by mitigating volatility in any one line of business. Capital management has been a key differentiator for Arch and is integral to how we operate our company. Effective capital management requires that we allocate resources to the most profitable underwriting opportunities, while retaining the flexibility to invest in our platform when we find attractive opportunities.
One of those prospects came to fruition earlier this month, when we announced our intent to acquire Allianz's US. middle market and entertainment businesses. We see this as a unique opportunity to quickly build scale in the $100 billion-plus US. middle market, a long-term strategic area of underwriting interest for us. Increasing our middle market presence will further diversify our North American insurance platform by adding stable businesses with recurring premiums that can generate attractive returns over the cycle. As a cycle manager, we like having many ponds to fish in, and this acquisition will significantly expand our opportunities in the middle market pond for years to come. I'll now share a few highlights from our segments. As you know, The Property and Casualty market cycle is evolving, but still offers attractive growth opportunities at good returns, particularly for our skilled specialty underwriters, who can use their expertise and experience to differentiate Arch.
The first quarter results from our Reinsurance segment were outstanding. Underwriting income for the segment was $379 million, while gross premium written grew by 41% over the same quarter last year. While there is some developing competition, we're observing an increased flight to quality and fully expect to capitalize on that trend as the cycle ages. Our Reinsurance segment is in an enviable position. The in-force book constructed over the last several years is strong and allows us to exercise our underwriting acumen. When opportunities emerge, whether from dislocation in the casualty market or by offering value that others cannot, Arch is there to provide solutions and financial strength to its clients. In our Insurance segment, growth tapered from the highs of the past few years as rate increases slowed and some of the dislocations were met by additional capacity.
Overall, conditions remained strong and the market is behaving rationally, two important factors that continue to support growth and strong profit. In the first quarter, we fund growth opportunities in several lines, including Property and Casualty E&S and other specialty lines. Across most of our specialty lines, pricing remains very healthy, and we are able to deploy capital in order to deliver attractive returns above our long-term target of 15%. Like Reinsurance, our Insurance segment has made strong efforts to establish itself as a first-choice provider for its clients, and that manifests in seeing more opportunities. In life, you have to play to win, and in insurance, if you don't see the business, you can't write it. And now let's pivot from P&C to Mortgage, which to borrow from a famous ad campaign just keeps on going and going and going.
Our Mortgage segment continues to generate solid underwriting income and risk-adjusted returns from its high-quality portfolio. While Mortgage originations remain tempered by high mortgage interest rates, the persistency of our in-force book remains a healthy 83.6%, while the delinquency rate is near all-time lows. New insurance written is in line with our appetite given market conditions. When the mortgage market picks up again, we're prepared to increase our production. However, if the status quo persists, we're content with our current situation that has extended the duration over which we earn mortgage insurance premium. Competition within the MI industry remains disciplined, which means we are in a good place. Finally, our Investments portfolio grew to $35.9 billion, generating $327 million of net investment income in the quarter.
The extraordinary premium growth from our P&C segments continues to increase our float, which provides a significant tailwind to our overall earnings through the next several quarters. In the US, the NFL conducted its annual draft this past weekend. Traditionally, the team that finished last season with the worst record gets the first pick, a chance to select the best college player, while the champions pick last. The player selected with the top picks are expected to be immediate difference makers, even though they are typically selected by a team with multiple deficiencies, making success far from guaranteed. If you're a talented quarterback has nobody to throw the ball to, it can ruin the player's confidence, and the pressure can quickly sabotage a career.
Compare this with teams drafting at the end of the round coming off successful seasons with talented rosters in place. They often have the luxury of selecting an excellent player who doesn't need to contribute right away. Instead, these teams select players who can fill a specific short-term role and be given time to grow into a difference maker. Our acquisition of the Allianz MidCorp business is like adding a solid player to a winning team. We already have established all-stars, a winning talent-dense culture in a favorable schedule in the years ahead. Adding the MidCorp team to our diversified franchise makes us better today and tomorrow, and that's a winning proposition. I'll now turn it over to Francois to provide some more color on our financial results from the quarter, and then we'll return to take your questions.
Francois?
François Morin: Thank you, Marc, and good morning to all. As you will have seen, we started out 2024 on a very strong note, with after-tax operating income of $2.45 per share for the quarter for an annualized operating return on average common equity of 20.7%. Book value per share was $49.36 as of March 31, up 5.2% for the quarter. Our excellent performance was again the result of outstanding results across our three business segments, highlighted by $736 million in underwriting income. We delivered exceptional net premium written growth across our Reinsurance segment, a 31% increase over the first quarter of 2023, driven by strong business flow in all our lines of business. Growth was also solid for our Insurance segment, 12% after adjusting for the impact of a large nonrecurring transaction we underwrote in the first quarter last year in our warranty and lenders business unit.
Overall, the combined ratio from the group came in at an excellent 78.8%. Our underwriting income reflected $126 million of favorable prior year development on a pretax basis or 3.7 points on the combined ratio across our three segments. We observed favorable development across many units, but primarily in short-tail lines in our Property and Casualty segments and in Mortgage due to strong cure activity. The collapse of the Francis Scott Key Bridge in Baltimore last month, has the potential to become the largest insured marine event in history. Both our Insurance and Reinsurance segments were exposed to this disaster, and our current estimates represent an impact of 2.1 and 3.0 points, respectively, on the combined ratio in these segments results this quarter.
We note that the losses for this event were reported as non-catastrophe losses in our ratios. Catastrophe loss activity was relatively subdued and below our expectations across our portfolio, with a series of smaller events generating current accident year catastrophe losses of $58 million for the group in the quarter. Overall, our underlying ex cat combined ratio remained excellent with the increase this quarter relative to the last few quarters, mostly due to the Baltimore Bridge collapse. Despite the impact of this event, our current quarter ex cat combined ratio still improved by 1.4 points from a year ago, as a result of earned rate changes above our loss trend in our P&C businesses and lower expense ratios mostly from the growth in our premium base.
These benefits were slightly offset by investments we continue to make in people, data and analytics and technology to improve the quality and resilience of our platform going forward. From a modeling perspective, I'd also like to remind everyone that our operating expense ratios are typically at their highest in the first quarter of the year due to seasonality and compensation expenses, including equity-based grants for retirement eligible employees that were made in March. As of April 1, our peak zone natural cat PML for a single event, one in 250-year return level on a net basis remained basically flat from January 1, but declined relative to our capital to 9.0% of tangible shareholders' equity, well below our internal limits. On the Investment front, we earned a combined $426 million pretax from net Investment income and income from funds accounted using the equity method or $1.12 per share.
Total return for the portfolio came in at 0.8% for the quarter, reflecting the unrealized losses on the company's fixed income securities, driven by higher interest rates. Our growing Investment portfolio keeps providing meaningful tailwinds to our bottom line and remains of high quality and short duration. We have grown our investable asset base significantly over the last few years, primarily to significant cash flow from operations. This positive result, combined with new money rates near 5%, should support further growth in our Investment income for the foreseeable future. Income from operating affiliates was strong at $55 million. Of note, approximately $14 million of this quarter's income is attributable to the true-up of the deferred tax asset at our operating affiliate Somers in connection with the Bermuda corporate income tax, a nonrecurring item.
Our effective tax rate on pretax operating income was an expense of 8.5% for the 2024 first quarter, slightly below our current expected range of 9% to 11% for the full year, mostly as a result of the timing of tax benefits related to equity-based compensation. As regard to our announcement to acquire the US. MidCorp and Entertainment insurance businesses from Allianz, we are making progress in obtaining the necessary regulatory approvals and are targeting a third quarter close for the transaction. At a high level, the agreement is structured around two related contracts. A loss portfolio transfer of loss reserves for years 2016 to 2023 and a new business agreement for business written in 2024 and after. Overall, we expect to deploy approximately $1.4 billion in internal capital resources to support both contracts, in addition to the cash consideration of $450 million.
The overall transaction is expected to be moderately accretive to earnings per share and return on equity, starting in 2025. It is important to note that even when reflecting the capital to be deployed for this transaction, our capital base remains strong with a leverage ratio in the mid-teen range. We maintain ample financial resources and remain committed 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.
See also
30 Most Beautiful College Campuses in the US and
40 Best Business Schools in the World for 2024.
To continue reading the Q&A session, please click here.
