Arch Capital Group Ltd. (NASDAQ:ACGL) Q4 2023 Earnings Call Transcript
Arch Capital Group Ltd. (NASDAQ:ACGL) Q4 2023 Earnings Call Transcript February 15, 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 Q4 2023 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 this update, management wants to first remind everyone that certain statements in today's press release and discussed on this call may constitute forward-looking statements under the federal securities laws. These statements are based upon management's current assessments and assumptions and are subject to a number of risks and uncertainties. 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 filled 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. François Morin. Sirs, you may begin.
Marc Grandisson: Thank you, Gigi. Good morning and thank you for joining our earnings call. Our fourth quarter results conclude another record year as we continued to lean into broadly favorable underwriting conditions in the property and casualty sectors. Our full year financial performance was excellent with an annual operating return on average common equity of 21.6% and an exceptional 43.9% increase in book value per share, which remains an impressive 34.2% if we exclude the one-time benefit from the deferred tax asset we booked in the fourth quarter. The $3.2 billion of operating income reported in 2023 made it Arch's most profitable year-to-date. Growth was strong all year as we allocated capital to our property and casualty teams, we short over $17 billion of gross premium and over $12.4 billion of net premium.
And while most current growth opportunities are in the P&C sector, it's important to recognize the steady quality underwriting performance of our mortgage group. Although, mortgage market conditions meant fewer opportunities for top-line MI growth, the business unit continued to generate significant profits totaling nearly $1.1 billion of underwriting income for the year. As we have mentioned on previous calls, those earnings have helped fund growth opportunities in the segments with the best risk adjusted returns, demonstrating that the disciplined underwriting approach and active capital allocation are essential throughout the cycle. Our ability to deploy capital early in the hard market cycle is paying dividends as we own the renewals, a phrase I learned from Paul Ingrey, a personal mentor and foundational leader of Arch.
What Paul meant was quite simple. When markets turn hard, you should aggressively write business early in the cycle. This puts your underwriters in a strong position to fully capitalize on the market opportunity. By making decisive early moves, you won become an [indiscernible] then want to do more business with you. In some ways, the growth becomes self-sustaining, which explains part of our success throughout this hard market. At Arch, our primary focus has always been on rate adequacy, regardless of market conditions. Our underwriting culture dictates that we include a meaningful margin of safety in our pricing, especially in softer conditions. And we also take a longer view of inflation and rates. For these reasons, Arch was underweight in casualty premium from 2016 to 2019, when cumulative rates were cut by as much as 50%.
I thought I'd borrow a soccer analogy to help explain the current casualty market. In soccer, players who commit a deliberate foul are often given a yellow card. Two yellow cards mean the player is ejected from the remainder of the match and their team continues with a one player disadvantage. Today's casualty market feels as though some market participants took to the field with a yellow card from a prior game. They're playing in match but cautiously, not wanting to make an error that will put their entire team at a disadvantage. So whilst Arch sometimes plays aggressively, we've remained disciplined and avoided drawing a yellow card. At a high level, we must remember that casualty lines take longer to remediate than property. So if insurers are being cautious and adding to their margin of safety, we could experience profitable underwriting opportunities in an improving casualty market for the next several years.
Now, I'll provide some additional color about the performance of our operating units, starting with reinsurance. The performance of our reinsurance segment last year was nothing short of stellar. For the year, reinsurance net premium written were $6.6 billion, an increase of over $1.6 billion from 2022. Underwriting income of nearly $1.1 billion is a record for this segment and a significant improvement from the cat heavy 2022. Reinsurance underwriting results remain excellent as we ended the year with an 81.4% combined ratio overall in a 77.4% combined ratio ex-cat and prior year development both significant improvements over 2022. Turning now to our insurance segment, which continued its growth trajectory by writing nearly $5.9 billion of net premium in 2023, a 17% increase from the prior year.
While the business model for primary insurance means that shifts may not appear as dramatic as our reinsurance groups, a look at where we've allocated capital year-over-year provides meaningful insight into our view of the market opportunities. In 2023, the most notable gains came in from property, marine, construction, and national accounts. The $450 million of underwriting income generated by the insurance segment in 2023 doubled our 2022 output as we continue to earn in premium from our deliberate growth during the early years of this hard market. Underwriting results remained solid on the year as the insurance segment delivered a combined ratio of 91.7% and a healthy 89.6% excluding cat and prior year development. Now on to mortgage, our industry-leading mortgage segment continued to deliver profitable results, despite a significant industry-wide reduction in mortgage originations last year.
The high persistency of our insurance in-force portfolio, which carries its own unique version of owning the renewals, enables a segment to consistently serve as an earnings engine for our shareholders. The credit profile of our U.S. primary MI portfolio remains excellent and the overall MI market continues to be disciplined and returned focus. These conditions should help to ensure that our mortgage segment remains a valuable source of earnings diversification for Arch. Onto investments, net investment income grew to over $1 billion for the year due to rising interest rates that enhanced earnings from the float generated by our increasing cash flows from underwriting. The significant increases to our asset base provide a tailwind for our creative investment group to further increase its contributions to Arch's earnings.
Over the past several years, Arch has leaned into both the hard market and our role as a market leader in the specialty insurance space. We have successfully deployed capital into our diversified operating segments to fuel growth, while also making substantial operational enhancements to our platform, including entering new lines, expanding into new geographies and making investments into new underwriting teams, technology and data analytics. Finally, as we bid adieu to 2023, I want to take a moment to thank our more than 6,500 employees around the world who help deliver so much value to our customers and shareholders. Our people are our competitive advantage and without their creativity, dedication and integrity, none of this would be possible.
So thank you to team Arch. François?
François Morin: Thank you, Marc, and good morning to all. Thanks for joining us today. As Marc mentioned, we closed the year on a high note with after-tax operating income of $2.49 per share for the quarter for an annualized operating return on average common equity of 23.7%. Book value per share was $46.94 as of December 31, up 21.5% for the quarter and 43.9% for the year aided by the establishment of a net deferred tax asset related to the recently introduced Bermuda Corporate Income Tax, which I will expand on in a moment. Our excellent performance resulted from an outstanding quarter across our three business segments highlighted by $715 million in underwriting income. We delivered strong net premium written growth across our insurance and reinsurance segments, a 22% increase over the fourth quarter of 2022 after adjusting for large non-recurring reinsurance transactions we discussed last year, and an excellent combined ratio of 78.9% for the Group.
Our underwriting income reflected $135 million of favorable prior year development on a pretax basis or 4.1 points on the combined ratio across our three segments. 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. While there were no major catastrophe industry events this quarter, a series of smaller events that occurred across the globe throughout the year resulted in current accident year catastrophe losses of $137 million for the Group in the quarter. Overall, the catastrophe losses we recognize were below our expected catastrophe load. As of January 1, our peak zone natural cat PML for a single event, one in 250-year return level on a net basis increased 11% from October 1 but has declined relative to our capital and now stands at 9.2% of tangible shareholders equity, well below our internal limits.
On the investment front, we earned $415 million combined from net investment income and income from funds accounted using the equity method, up 27% from last quarter. This amount represents $1.09 per share. With an investable asset base approaching $35 billion, supported by a record $5.7 billion of cash flow from operating activities in 2023 and new money rates near 5%, we should see continued positive momentum in our investment returns. Our capital base grew to $21.1 billion with a low leverage ratio of 16.9%, represented as debt plus preferred shares to total capital. Overall, our balance sheet remains extremely strong and we retain significant financial flexibility to pursue any opportunities that arise. Moving to the recently introduced corporate -- Bermuda Corporate Income Tax.
As mentioned in our earnings release and in connection with the law change, we recognized a net deferred tax asset of $1.18 billion this quarter, which we have excluded from operating income due to its non-recurring nature. This asset will amortize mostly over a 10-year period in our financials, reducing our cash tax payments in those years. All things equal, we expect our effective tax rate to be in the 9% to 11% range for 2024, with a higher expected rate starting in 2025. As regards our income from operating affiliates, it's worth mentioning that approximately 40% of this quarter's income is attributable to non-recurring items such as Coface adoption of IFRS 17 and the establishment of a deferred tax asset at summers in connection with the Bermuda Corporate Income Tax.
With these introductory comments, we are now prepared to take your questions.
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