Arch Capital Group Ltd (ACGL) 2014 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the quarter 4 2014 Arch Capital Group earnings conference call. My name is Laura and I will be your operator for today. At this time, all participants are in listen-only mode. We will conduct a question and answer session towards the end of this conference. (Operator Instructions). As a reminder, this call is being recorded for replay purposes.

Before the Company gets started with its update, management wants to first remind everyone that certain statements in today's press release and discussed on this call may constitute forward-looking statements under the federal securities laws. These statements are based upon management's current assessments and assumptions and are subject to a number of risks and uncertainties. Consequently, actual results may differ materially from those expressed or implied. For more information on the risks and other factors that may affect future performance, investors should review periodic reports that are filed by the Company with the SEC from time to time.

Additionally, certain statements contained in the call that are not based on historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The Company intends the forward-looking statements in the call to be subject to the safe harbor created thereby.

Management also will make reference to some non-GAAP measures of financial performance. Reconciliation to GAAP and definition of operating income 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. I would now like to turn the call over to Dinos Iordanou and Mark Lyons. Please proceed.

Thank you, Laura. Good morning, everyone, and thank you for joining us today. We had an excellent fourth quarter and closing a very, very good year. In our history over the last 12 years we had three years that we earned over $800 million of net income, and this is one of them.

Earnings were driven by excellent reported underwriting results and solid investment results. Net premium revenue grew by 7.5% as growth in our insurance and mortgage businesses more than offset a decline in reinsurance net writings.

As a reminder, our US direct mortgage business was acquired in the first quarter of 2014 and, therefore, the year-over-year comparison should be viewed in that light.

On an operating basis, we earned $1.15 per share for the quarter, which produced an annualized return on equity of 10.4% for the 2014 fourth quarter versus 11.7% return in the fourth quarter of 2013. On a net income basis, Arch earned $1.60 per share this quarter, which corresponds to an annualized 14.5% return on equity. As we discussed in prior calls, starting shortly after the financial crisis, we have allocated a greater portion of investable assets in alternative categories, which includes all of our equity investments.

Looking back over the past five years, from 2010 to 2014, operating return on average equity has averaged 10% annually, where our net income ROE has averaged 14%. This is a significant delta of 400 basis points [overage here], and roughly translates into an additional $190 million of annual income for each of the last five years. As I indicated earlier, our reported underwriting results in the fourth quarter were excellent as reflected by a combined ratio of 85.5%, and were aided by a low level of catastrophe losses and continued favorable loss reserve development.

Net investment income per share on a sequential basis increased for the quarter to $0.56 per share, up from $0.53 per share in the third quarter of 2014. Our operating cash flow for the quarter was essentially flat at $227 million compared to $224 million in the same period last year.

Despite headwinds from foreign exchange, the total return of the investment portfolio was 85 basis points for the quarter and 134 basis points if expressed in local currency. As you know, we maintain a natural hedge with our investments as we match our outstanding liabilities in the currency that they exist with investments in the same currency.

Our book value per common share at December 31, 2014, was $45.58 per share, an increase of 3.5% sequentially and 14% annualized, and 14.5% as it compares to the fourth quarter of 2013.

With respect to capital management, we continue to have capital in excess of our targeted levels. And in the fourth quarter 2014, we repurchased 3.6 million shares at an average price of $56.28 for a total cost of $202 million, and have purchased an additional [70 million] of our shares so far in the first quarter of 2015.

We have increased M&A activity in the sector. We continue to evaluate opportunities such as acquisitions of other business units, people, and renewal rights transactions. As you know, we prefer to deploy our excess capital back into our business, but today these opportunities have not met our criteria.

The insurance segment as written grew by 9.8% and net written premium by a similar 9.6%. The growth emanated from our professional lines, excess and surplus casualty business, including our contract binding units and alternative markets. And it was partially offset by decrease in construction and national accounts businesses. Mark will have more details on this later in the call.

Most of our organic growth is coming from small accounts with low limits, which should have lower volatility. On the other hand, competitive conditions in the property sector had negatively affected primary property rates and, accordingly, our US premium volume in those lines. In the primary markets in which our insurance group participates, despite an increased competitive marketplace, we continued to obtain rate increases in most lines of business at approximately the same level as we have observed last quarter.

On the reinsurance side of the business, as you might have heard on other calls from our competitors, we have seen a continuation of softening in pricing and broadening pressures on terms and conditions. From a premium production point of view, net written premium was down 6.5% in the quarter for the reinsurance group, where gross premiums rose by nearly 5%, with the growth in the segment primarily coming from businesses we produce on behalf of Watford Re.

Our mortgage segment includes primary mortgage insurance written through Arch MI in the US, and reinsurance treaties covering mortgage risk which is written globally, as well as other risk-sharing transactions. Net written premium in this segment declined sequentially in the fourth quarter of 2014 to $53 million from $58 million in the prior quarter.

As we discussed last quarter, some of our growth in the third quarter came from participation on single pay premium policies. These are loans where the mortgage insurance premium is paid up front.

In the fourth quarter, we have seen increased competition in the single pay premium policies and, as a result, we reduce our writings significantly. As in all of our units, underwriting discipline is the foundation that Arch was built on and we will continue to exercise that discipline in all of our segments.

What is important to note is that our sales force is now fully staffed and, as a result of their efforts, we continue to gain traction in the back channel. As of December 31, we have approved more than 481 master policy applications from banks, and more than 150 of these banks have already submitted loans for us for our approval. Of these master policies, 34 represent national accounts and the balance are regional banks. Of the top 25 mortgage originators for conforming mortgage sold to the GSEs with, of course, attached mortgage insurance, we now have approval on master policies with 19 of those 25 lenders.

We continue to see GSE sharing transactions increasing in 2015 with the GSE established goals for credit risk-sharing rising from $90 billion -- this is notional value of mortgage loans for each Fannie and Freddie in 2014 -- to $150 billion and $120 billion for Fannie and Freddie, respectively in 2015. That is a significant increase.

Today, on average, approximately 70% of the risk-sharing has been provided by the capital markets, although an increasing percentage of the risk pool has been allocated to the insurance and reinsurance markets in 2015. While [carrying] accounting treatment requires us to use derivative accounting for the GSE risk-sharing transactions, we expect these contracts to receive insurance accounting treatment on a prospective basis for all in force and any new transactions in the near future.

Group-wide, on an expected basis, we believe the ROE on the business we underwrote this past year will produce an underwriting year ROE in the range of 10% to 12% as on a percentage value basis improvement in the insurance group and the addition of the mortgage segment approximately offset lower expected returns in the reinsurance segment.

Before I turn it over to Mark, I would like also to give you our PMLs. As usual, I would like to point out that our CAT PML aggregates reflect business bound through January 1, while the premium numbers indicated in our financial statements are through December 31, and that the PMLs are reflected net of all reinsurance in retrocessions we purchased.

So January 1, 2015, our largest 250-year PMLs for a single event decreased significantly in the Northeast to $544 million or 9% of common shareholders' equity, while Gulf PMLs also decreased to $527 million and our Florida Tri-County PML now stands at $419 million. Last quarter, I said that was the lowest numbers as of that time. This quarter now brought us to even lower PML accumulation for the group.

I will now turn it over to Mark to comment further on our financials and then we will come back and take your questions. Mark?

Great. Thank you, Dinos, and good morning, everyone. As was true on last quarter's call, my comments to follow today are on a pure Arch basis, which excludes the other segment, that being Watford Re, unless otherwise noted. Furthermore, since the accounting definition of the word consolidated includes the results of Watford, I will not be using that term, and instead will be using the word core to refer to our combined segments of insurance, reinsurance, and mortgage. This permits an apples-to-apples comparison of Arch's current results with prior periods.

So moving on now, with that being defined, the combined ratio this quarter for our core businesses was 87.5% with 2.3 points of current accident year CAT-related events, net of reinsurance and reinstatement premiums, compared to the 2013 fourth quarter combined ratio of 85.4%, which reflected two points of CAT-related events. Losses recorded in the fourth quarter -- 2014 catastrophic events, net of reinsurance recoverables and reinstatement premiums, totaled $19.9 million, primarily emanating from our reinsurance operations, representing smaller events around the globe.

the 2014 fourth quarter core combined ratio reflected 8.3 points of prior year net favorable development, net of reinsurance and related acquisition expenses, compared to 7.9 points of prior-period favorable development on the same basis in the 2013 fourth quarter. This resulted in 93.5% current core accident quarter combined ratio, excluding CATs, for the fourth quarter of 2014, compared to 91.3% accident quarter combined ratio in the fourth quarter of 2013.

In the insurance segment, the 2014 accident quarter combined ratio excluding CATs was 96.4%, compared to an accident quarter combined ratio of 96.5% a year ago, and also represents a sequential improvement from the 98.0 accident quarter combined ratio last quarter. The reinsurance segment 2014 accident quarter combined ratio without CATs was 87.3% compared to 84.9% in the 2013 fourth quarter, but this also represents a sequential improvement from the 90.6% combined ratio last quarter.

As noted in prior quarters, the reinsurance segment's results reflect changes in the mix of premiums earned, including a lower contribution from property and catastrophe business. The mortgage segment 2014 accident quarter combined ratio was 98.9% compared to 62.1% for the fourth quarter of 2013. This increase is predominantly driven by the substantial change in mix resulting from the January 2014 acquisition of our US primary mortgage operations.

The full accident year 2014 core combined ratio without CATs was 94% even, versus 91.3% for the full 2013 accident year. By segment, the insurance group's full 2014 accident year was 96.3% versus 97.5% for the 2013 accident year, and the reinsurance group combined ratio for the full 2014 year was 90.7% versus 82.9% for the 2013 accident year.

The insurance segment accounts for roughly 16% of the total net favorable development in the 2014 fourth quarter, excluding the associated impact of acquisition expenses. And this was primarily driven by shorter tailed lines from the 2007 through 2013 accident years.

The reinsurance segment accounts for approximately 84% of the total net favorable development this quarter, with approximately half of that due to net favorable development on short tailed lines, concentrated in the more recent underwriting years, and about half due to net favorable development on longer tailed lines, primarily from the 2002 through 2006, and 2009 through 2011 underwriting years.

Our core operations across the full 2014 calendar year experienced $307 million of net favorable development, net of reinsurance, reinstatement premiums, and related acquisition expenses, which represents 8.8% combined ratio points versus $254 million of net favorable development last year for the 2013 calendar year, which represents 8.1 combined ratio points. This full 2014 calendar year net favorable development was approximately split 15% in the insurance group and 85% in the reinsurance segment.

Approximately 68% of our core $7.3 billion of total net reserves for loss and loss adjustment expenses, our IB&R and additional case reserves, which remains fairly consistent across both the reinsurance and the insurance segments.

The core expense ratio for the fourth quarter of 2014 was 34.7% versus the prior year's comparative quarter expense ratio of 33.7%, driven by an increase in the operating expense ratio, partially offset by a decrease in the acquisition expense ratio. The increase in the operating expense ratio component continues to reflect the addition of our US mortgage insurance operations, which is operating at a higher expense ratio until business hits a steady-state, as well as the effective incremental expenses due to certain platform expansions in both our reinsurance and insurance businesses.

The insurance segment improved to a 32.4% expense ratio for the quarter compared to 33.9% a year ago, primarily reflecting a lower net acquisition ratio, driven mostly by a change in the accounting treatment of New York workers' compensation surcharges and securing improved treaty ceding commissions on quota share contracts ceded. The reinsurance expense segment expense ratio can increased from 31.7% in the fourth quarter to 32 point -- in the fourth quarter of 2013 to 32.5% this quarter, primarily due to a higher level of operating expenses supporting selected platform expansions.

The ratio of net premium to gross premium of our core operations in the quarter was 75.2% versus 78.4% a year ago. The insurance segment had a virtually constant ratio of 69.1%. The reinsurance segment, net to gross ratio, was 85.5% this quarter compared to 96% a year ago, primarily reflecting cessions to Watford Re as a reinsurer.

Our US insurance operations achieved a plus-3.3% effective renewal rate increase this quarter net of reinsurance. As commented on last quarter, the pricing environment is quite different for short tailed lines versus long tailed lines. Short-tailed lines of business had an effective 2% renewal rate decrease for the quarter compared to a 4% effective renewal rate increase for the longer tailed lines, both on a net of reinsurance basis.

Rate increases on longer tailed lines continue to be above our view of weighted loss cost trends.

Looking more deeply, some lines incurred rate reductions, such as nearly 6% reduction in property and 3.5% reduction in our high-capacity D&O lines, while others enjoyed healthy increases such as a 9% effective rate increase in our lower capacity D&O lines, 10% increase in national account businesses, 6.5% rate increases in our contract binding book, 6% increases in our A&H or accident and health business, and 4.5% rate increases in programs.

Also, certain lines continue their achievement of strong cumulative rate increases. So for example, our lower capacity D&O lines have now achieved 14 consecutive quarters of rate increases and have, in fact, secured double-digit rate increases in 10 of those 14 consecutive quarters.

The mortgage segment posted a 100.6% combined ratio for the calendar quarter. The expense ratio is expected and, as mentioned, earlier, continues to be high as operating ratio related to our US primary operation will remain elevated until proper scale is achieved.

The net written premium of $52.7 million in the quarter is driven by the $25.3 million from our US primary operation and $27.4 million of net written premium from our reinsurance mortgage operations, including the 100% quota share of PMIs 2009 to 2011 underwriting years as part of the acquisition of the CMG companies in the PMI platform. This reflects a lower sequential level of written premium on competitively bid single premium US mortgage insurance, as Dinos has already noted, versus the 2014 serial quarter for the third quarter.

At December 31, 2014, our risk in force for our mortgage business equal to $10.1 billion, which includes $5.6 billion from our US mortgage insurance operations, $4.4 billion to our worldwide reinsurance operations, and $135 million through the risk-sharing transactions. Our primary US mortgage operation bound $1.4 billion of new insurance written during the quarter, which represents the aggregate of original principal balances of all those receiving new coverage during the quarter. The weighted average FICOs for the US primary portfolio remains strong at 733 and weighted average loan-to-value ratio held steady at 93.4%.

No state's risk in force represents more than 10% of the portfolio and our US primary mortgage insurance company is operating at an estimated 9.5 to 1 risk to capital ratio at year-end 2014.

The other segment, which is effectively Watford Re, reported a 101.6 combined ratio for the quarter on nearly $91 million of net written premiums and [$53.6 million] of net earned premiums. As a reminder, these premiums, as posted, reflect 100% of the businesses assumed, rather than simply Arch's approximate 11% common share interest.

Our joint venture, Gulf Re, produced a $5 million loss for the quarter due to an unusually high frequency of large technical risk losses stemming from the Middle East. This is reflected in the income statement within the other income line. Effective October 1, 2014, Arch agreed to acquire complete ownership of Gulf Re and has also instituted a loss portfolio transfer, including an unearned premium unearned reserve transfer, and established an ongoing 90% quota share agreement for new and renewal business. Final approval of the acquisition terms is pending with the Dubai Financial Services Authority.

The total return of our investment portfolio was a reported positive 85 bps in the 2014 fourth quarter, reflecting positive returns in our equity, alternative investment, and investment-grade fixed income sectors, partially offset by the impact of the strength in the US dollar on most of our foreign-denominated investments. Excluding foreign exchange, as Dinos has mentioned, total return was a positive 134 bps in the 2014 fourth quarter. And on a full 2014 calendar year basis, the total return was a positive 321 bps. And, excluding foreign-exchange, the return was a positive 426 bps, led by our alternative and equity sectors.

Our embedded pretax yield before expenses was 2.18% as of year-end, compared to 2.21% at September 30, while the duration of the portfolio lengthened slightly to 3.34 years from last quarter's 3.28 years. Fixed income duration fluctuates due to tactical investment decisions as opposed to long-term strategic shifts. The current duration continues to reflect our conservative position on interest rates in the current yield environment.

Reported net investment income for this quarter was $72.6 million or $0.56 per share versus $72.2 million in -- at the 2014 third quarter, or $0.53 per share, and versus $67.1 million or $0.49 per share in 2013 fourth quarter. As always, we evaluate investment performance on a total return basis and not merely by the geography of net investment income.

Interest expense of $12.7 million has returned to the quarterly run rate after last quarter's adjustment that we discussed for a certain loss portfolio transfer.

Our effective tax rate on pretax operating income available to our shareholders for the fourth quarter of 2014, was an expense of 1.7% compared to an expense of 8.3% in the fourth quarter of 2013. The full year of 2014 effective tax rate on pretax operating income was 2.4% versus 4.8% for calendar year 2013. Fluctuations in the effective tax rate can result from variability in the relative mix of income or loss reported by jurisdiction.

Our total capital was $7.03 billion at the end of this year, up [0.7%] relative to September 30, and up 7.4% relative to year-end 2013. During this quarter, as Dinos mentioned, we purchased nearly 3.6 million shares at an aggregate cost of approximately $202 million, bringing our full year repurchases to $454 million. These repurchases occurred during the third and fourth quarter since we repurchased no stock in the first half of 2014. Our repurchases during the year were accomplished at an approximate 1.25x multiple to average book value.

Furthermore, approximately $887 million remains under our existing buyback authorization at year-end 2014. These share repurchases in the quarter had the effect of reducing book value per share by $0.29 and $0.59 for the entire year.

Our debt to capital ratio remains low at 12.8% and debt plus hybrids represents only 17.4% of our total capital, which continues to give us significant financial flexibility. As Dinos has already said, we continue to estimate having capital in excess of our targeted position. Dinos has already commented on book value and changes in book value, so I see no need to repeat that.

So with these introductory comments, we are now pleased to take your questions.

(Operator Instructions) Sarah Dewitt, JPMorgan.

I wanted to get your view on the recent consolidation in the industry and what are your thoughts on the implications of that from a competitive standpoint? And do you feel the need at all to be bigger? Perhaps -- it sounds like $10 billion is the new minimum.

Well, first, the consolidation, I think, is positive for the business. You eliminate some competitors. You are creating larger enterprises, and, hopefully, more responsible enterprises from a pricing and risk-taking point of view. So all in all, I think -- I view that as positive. There will be less what I will call desperate competitors doing things that they can be extremely competitive in the market.

So, on the size question, I don't -- yes, if you are a tiny company, you might have disadvantages, but I don't know if $5 billion or $10 billion is the new norm. As far as we are concerned, it is quality that we are looking for, not size; quality underwriting talent and ability, and not size. We have enough size as a company.

Our market cap is approaching $8 billion. We have over $7 billion of net capital. And for that reason, we are more focused to do things that make sense for Arch and our shareholders rather than focusing what size our Company is.

Okay. Great. And then, on mortgage insurance, could you update us on our long-term outlook for that business? Is it still reasonable to think it could be 15% of your earnings in five years, particularly given some of your comments around some increased competition in particular lines?

Your first question, yes. I think it can be 15%, even maybe 20%. Don't forget, we have a global mortgage business. It is not just the US primary MI. There is that risk-sharing transaction that they are coming from the GSEs. And, as I mentioned in my prepared remarks, they're allocating a larger portion of that to the insurance reinsurance market instead of just the capital market. And, also, they are increasing their purchasing.

These are -- a lot of these transactions, they are protection that Fannie and Freddie buys for their 60 to 80 LTV loans who don't require, by law, to have mortgage insurance. In addition to that, our penetration with the bank channel, even though it has been extremely good, we have signed 19 out of the top 25. But it takes time to start receiving and underwriting and binding that insurance with these channels.

And we are more optimistic today than I was a year ago that not only the business is still very good, despite some competition in one tiny segment of the business, it's -- the upfront paid single premium is not a huge part of the business, a significant part. But if there is competition there, we don't need to underwrite business that doesn't fit our return characteristics. And we go to other places.

But, overall, I am very optimistic about what we have told our investors about the prospects of the mortgage business for Arch. It will be a significant part of our business even though it will take a few years to get to steady-state.

Michael Nannizzi, Goldman Sachs.

Just a couple more quick ones on the MI business. Can you tell us, what percentage or what is the breakdown of that US MI in terms of force that is either -- that is single premium versus the typical monthly business?

I don't have that number on top of my head, but, Mark, can you get the number and then we will give it to you. Our guys in Walnut Creek will know that in a second and a half. I just don't have it on top of my head.

That's fair, totally fair.

Yes. We don't have it right in front of us, but we can certainly get it.

Yes. And I guess when you think about the base for thinking about your growth in that franchise, I would imagine is more the monthly business. How should we be thinking about the potential growth of new insurance written from here on, I mean, given some of the master policy developments and some of the other items? Just because, aside from just the top line impact, that is obviously going to have an impact on the operating leverage in that segment.

Well, I will give you a macro answer to it. Everything points to what we originally said to you guys. We expect to be north of 10% market share. And it will take us at least three years to get there. And that has not changed, in our minds, based on what we see.

It took us about three quarters longer than I thought to close the transaction. So, in that sense, we lost at least six months, maybe nine months from our original -- I am an impatient guy, so I thought things closed a lot faster than they did. But, dealing with a lot of different entities and constituencies, it took us longer to close.

But I think we are catching up on it, because I have been more optimistic as we have built a sales force. We have about 60 people nationwide. And, also, the reception that we have received from the originators and us entering the segment. So 19 out of top 25 is a big accomplishment in almost five quarters since we will be in operations.

It will take time as those mortgages come, because when you underwrite a mortgage, you do it and then you wait for all the premiums to come. And it comes over the next six, seven years. And that is why you see there is a little pressure on us now on the expense ratio. But, at the end, all the business that we write is good business. We like the return characteristics of it, and we are patient with it because that is the nature of our business.

Got it. Great. Thanks.

I would just add to that, that outlook is dependent on the view and what emerges on the macroeconomic front on construction building and new housing starts and originations and where that trajectory goes. But you asked kind of a general question as well on macro, so about recent developments, one of which would be the FHA pricing, for example. And that may not be negative for the industry. I mean, that is overwhelmingly focused in a differential sense, really, in lower FICOs and higher LTV quadrants, if you will.

Right.

Which is more traditionally the FHA wheelhouse anyway.

Got it. Fair. Thank you. And then, when thinking about the insurance segment and the growth that we saw in 2014 is impacted -- I think it was impacted by the start of renewal (inaudible) in the second quarter, which is not attributable. How should we think about that? Should we be sort of peeling that out as we look forward? Or should we be assuming that continues to be part of the premium base in forward years? And on that same note, how should we think about premium trends excluding that transaction on a forward basis? Thank you.

On Sparta and those kind of deals, I think you should be viewing that as residents and, therefore, inclusive, on your view. On your relative comparisons, you have to control for it because it explains a lot of the differences. But, remember, there is not a lot of big nets on those deals because of the way they are structured, where you write it and you see the bottom rather than traditionally ceding the top on excess. You are ceding the bottom. So the premium, stick to the ribs, is 22%, 25%, 27%, things of that nature.

So the short answer is, you should continue to view that, I think, as resident within the book of business going forward. Your second point, refresh me.

Just -- so we back that out and we think about the remainder of the book, how should we think about -- are we thinking about an 8% to 10% sort of trajectory on the remaining business? Is that sustainable? I mean, are you seeing enough business where you can continue to run that?

Well, Michael, as you know, we never give forward guidance on these things. However, the part of a premium growth attributable to rate growth, as I commented on, third-party lines continue to still have traction there. It is challenging in property, which is why you see really across the enterprise property volume -- particularly property CAT volume dropping, really, on both sides of the coin. So it is going to be a function of what we can do on our mix. I think we have demonstrated we have done a pretty good job of shifting and managing it.

So, but in terms of what the markets give us, that is what we react to. So I really can't, and I don't think I am equipped to tell you whether it would be 8% or 7% going forward.

You know, our principle here is to underwrite business that meet return characteristics. And we don't spend a lot of time thinking about, oh, we have to grow by 5% or 10% or shrink by 5% or 10%. My old boss says, Mr. Market is Mr. Market, and it will tell us what it is. Hopefully, we will make good decisions in operating in that market.

So not knowing where rates are going to go, not knowing what the competition might heat up or ease, you have got all these transactions, the M&A activity usually, in our business, one plus one never equals two. There are going to be slices of bread and breadcrumbs falling off the table. We will be there to pick it up. We are not bashful. That is how I grew up. I was eating breadcrumbs when I grew up.

So at the end of the day, it is a hard question because we really don't focus on it. But, I can tell you, we still like the primary insurance business. Yes, the market is more competitive. I don't think we lost ground, as you saw, between the third and fourth quarter. Just a little bit on our first quarter, numbers are on in, but I get monthly reports and our first quarter was not as projected to be disappointing as some people were predicting. It just happened as we thought it was going to happen. So you can cook all that and then come up with your own projection.

And if you allow me, I have that number for you guys on the split between -- on the MI business. The single premium volume for the industry is about 13% of the total. So 87% is monthly and about 13% is upfront single premium.

And that is the industry or for your (multiple speakers)

For the industry. For the industry, yes. We do a little in the single premium sector. As I said, we reduced significantly in the fourth quarter because of the competitive pressures.

Got it, great. Thank you for the answer.

13% -- 13% of the business in general, right.

And, Michael, before we leave that point, one thing you can pretty much think about is that -- and we have been harping on this for a while -- back to your insurance group question, is that continued emphasis on mix towards smaller account, low limit business where you have more strength of price and strength of terms and conditions is likely to continue. And if the continued high capacity commodity business continues in its current pace, that will continue to shrink.

Vinay Misquith, Evercore.

Good afternoon, the first question (multiple speakers) I don't recall whether you mentioned about the January 1 renewals as to how you guys did.

No, I was making a comment a little bit, the January 1 renewals. We didn't see a significant change with the numbers we mentioned. Long tailed lines, rate increases in the 2% to 4% range, and property continue to be losing ground in the 5% to 10% rate. We reduced significantly on the reinsurance property, property CAT. You saw our PMLs go down significantly.

Volume wise, I think we did okay; loss on volume, here and there. We got some new business. But it is too early. It is only -- we are not -- because of our insurance group, and also our reinsurance group participating in a lot of these small enterprises, so to speak, looking to underwrite the same kind of business our insurance group underwrites. Our business is more spread throughout the year and is not heavy January 1. But I was not disappointed with January 1.

Sure. But, modestly down would be normal for us to expect, correct?

Yes.

Yes.

Okay. Second question is on the reinsurance margins. I mean, the accident year combines have been coming in very strong. So is that because of now business mix as the towers transaction and some of the higher loss transaction go away? And so should we be looking at the last two quarters average as the base for the future?

Well, the improvement, as you mentioned, in the fourth quarter is clearly a function of mix. We have a lot of transactions that can come through that can wait at one direction or the other. So it is kind of hard to say whether the average of the last two is representative, because that would excuse exclude 1/1 business because that is only the second half of last year. But it is going to fluctuate and it is going to be a function of mix.

What I can tell you is that the ultimate projection of the same line of business in those two quarters didn't really change. It is simply the mixture of them that changed to weight down -- fourth quarter to be lower than the prior quarter.

That is helpful. And the mortgage insurance business did pick up in the expense ratio. Do you expect the dollars worth of expenses to stay at these levels for next year -- [at least for 15]?

No. As a matter of fact, we expect expenses to be coming down as we are building the book. Also, we had an unusual expense for this quarter on one transaction. We had a reinsurance transaction in the mortgage space that we bound the cede and had an option to terminate and then we negotiated that option away. And it comes in as additional acquisition expense in that negotiation.

So it is business that we like. It is business that will be very profitable for us. But, in the quarter that you do the transaction, you take the hit on the expenses. So you are putting the expenses upfront and then you are going to earn the premiums over the next six, seven years.

So likely non-recurrent.

Okay. That's helpful. And just one sort of 50,000-foot question, Dinos, has been transaction that was announced recently, sort of take-under of a large reinsurer. Curious as to your thoughts as to why Arch would have not been involved in that transaction at a lower valuation.

Well, we don't usually sit there or worry about who is going to show us a transaction or not. That transaction, it was negotiated by two parties. We had no knowledge of it, for whatever reason. They didn't think we could be on an attractive partner. But, I think you ought to ask them as to why they didn't approach us. But all I can tell you, that we were not approached.

Ian Gutterman, Balyasny Asset Management.

Dinos, my first question --

You must have done well, Ian. You meet in the middle of the pack. Where does pack grow stuff (multiple speakers)

My New Year's resolution was to show up earlier, so I only was half successful with it. My first question is, I was surprised to hear the breadcrumbs comment. I thought you grew up on (technical difficulty)

Listen, I grew up as a very poor kid; six siblings and my father was a cop, so not a big salary. But we made it.

I think this is lucky; helps with the term lumpy.

So my first real question is, Mark, I thought I heard you say earlier -- I just want to make sure I heard it right, that you were able to get insurance to (technical difficulty) going forward on these GSE risk-sharing deals. Is that correct?

The feeling is that that is sooner than later. Still details and finality to be worked out, but all vibrating antenna tell us that that is probably going to be a 2015 event.

Okay. Got it.

Just 2015 and not end of 2015; probably this quarter, late second quarter. They are reworking the contracts to allow us to have insurance accounting on those contracts on a prospective basis.

Right. Right, on a prospective. So related to that, I guess I am trying to piece things together here. It looks like you started a new subsidiary, Arch Mortgage Guarantee. That seems like it is designed for these transactions. Is that correct? That is what the purpose is of that? And (multiple speakers)

Well, it is designed to have flexibility mostly to write mortgage insurance that -- they come from originators, banks and others that might not really require by law to have mortgage insurance attached to them. These might be jumbo loans. They might be other transactions. But the goal is to use that entity to provide more product and more flexibility in our toolkit for what we do for all those originators.

And some of the rationale that could be -- it sounds like it is packaged and sent on conforming loans to the GSE. This is stuff with the banks are having native capital requirements where we could provide some value.

Got it. Okay. I was wondering if there is a confluence of you feeling the need to set up this subsidiary was sort of an indicator of faster growth, potentially, in that area and maybe the accounting as well as an indicator that proxy is being made on doing more of these type of deals.

Well, these buyers are going to be more sophisticated. I think credit risk is an issue. That entity has the highest credit rating in the business. And when sophisticated buyers of the product, when they are buying protection for maybe their jumbo loans that they are not going to sell to the GSEs, et cetera, that will make a difference. So that is the avenue that we chose to go down to show the strength of the group in painting an entity that it has a high financial rating, that it will make a difference for sophisticated buyers of the product.

Got it, interesting. And then, my other question --

One other quick thing. I think one takeaway you should have with that whole insurance accounting thing is, I think it shows a level of desire and commitment on behalf of the GSE towards the insurance and reinsurance sector that they are willing to invest the time and effort to -- and have been listening to the preferences of the industry to have insurance accounting. I mean, they wouldn't go through all this effort and time commitment if they view us as a longer-term partner.

That is kind of what I was getting at. So that is good to hear. And then, just my other question, switching gears, reserve releases and reinsurance, obviously, I think you expressed a lot of comfort with reserves, but just it is interesting to me the last two years have been your highest years of reserve releases, at least dollar-wise, I think, in the history of the reinsurance company.

And I guess I found it a little surprising just because we think of the fat years being sort of the first five years of the Company's formation and the last five years maybe being still very good, but not as good. So is there any more color you can give us as far as (multiple speakers)?

Well, the only thing I can tell you, Ian, is we have not changed methodologies. And we feel as confident about our aggregate reserve position today as we felt a year ago, two years ago, three years ago. So we let the numbers speak for themselves.

I got a lot of quants in this Company. I think, pretty soon I will be worried that they are going to fire me because I am the only guy who doesn't have an actuarial degree in the senior management. [Gratis Papadopoulos], Mark Lyons -- oh, yes, Dave and I were the two orphans without the actuarial degrees. Everybody else has one.

Yes, but Dave doesn't have an aeronautical engineering degree.

I guess what I am wondering is, has there been a shift -- maybe if we went back a few years ago, it was mostly, say, 2002 to 2008 years, has shifted to where those have kind of run out of juice and now it is the 2008 to 2011? Or is that sort of classic hard markets to releasing a lot and just the more recent years on top of it are reaching new heights? Or -- I am just trying to get a sense of sort of the (multiple speakers)

Ian, I think it is a reinsurance question. I think -- we have commented on this on prior quarters. And you asked a full-year question. The complexion of the releases on both the US-based reinsurance operation and Bermuda-based reinsurance operation has been towards a looking hard at the longer tailed lines from the earlier years.

Going back to 2010, 2011, 2012, they were dominant by short tailed lines and medium tailed lines. It is longer tailed enough for an insurance carrier, let alone a reinsurance carrier with late reporting and excess loss contracts and things of that nature. You have got to wait longer. And now that we have waited longer, you are starting to see some of those come down because the evidence is much more clear-cut.

Kai Pan, Morgan Stanley.

I just met the queue behind Ian. So, Dinos, before I let you go for sort of lackey lunch, I have three questions. Number one is on capital management. So you said that there is less deals out there attractive and also your PML at a very low level; that your stock actually trading at upper end 1.3 times where you typically would like to buy below that. So how do you -- what do you see a process here in terms of return to shareholders?

Well, we will look for deals if they make sense for us. We will look -- we still believe that share buyback is an option. And we also have the ability to do an extraordinary dividend if we chose to release some of the excess capital.

To tell you the truth, right now, based on the -- I wouldn't call it turmoil, but based on the heat of activity, I will wait to see what -- I can't predict what might or might not come our way that makes sense for us. And patience is being a virtue in this Company, and we continue to have patience.

Believe me, we are cognizant that the money is not ours. It's the shareholder's. And we have got to find ways to get it back to them if we have excess. But, also, but we have got to be prudent. That is why we have a conservative balance sheet with plenty of financial flexibility.

We have excess capital. If the right deal comes along that is helpful to creating value for our shareholders, we will look at it. If not, we will look at share repurchases. And if we think that is expensive, then we look at extraordinary dividends.

Great. Second question, on the general renewals, some argue that if the larger reinsurer actually has favorable pricing and terms and conditions, do you see that in the transaction you see?

No. I think the larger reinsurers -- and it is not larger, it is also the financial strength rating -- will get a look at the business and maybe get better signed lines. Occasionally, there might be private transactions that they might get preferential terms. But, then, they are not preview to anybody.

Like when we do a private transaction, we don't go out and tell everybody what terms we got. And, likewise, when others do private transactions, they don't go advertising them. So -- but, I do believe those occasionally happen in the business. If you come with significant capacity, willingness to move quickly and do a large deal, you will do it.

That was the case with us with F. McGee, one big transaction we did. It was just us; nobody else. And I thought we got pretty good terms. So Berkshire does that. Swiss and Munich do that. And they have their private deals. But I am not privy to it, so I cannot comment.

Great. My last question, actually, circling back to the merger acquisition topic, you said strategically you have a size to compete in the marketplace. But, given where your stock is trading at versus some of your peers, would you be willing to consider, for financial reasons, to be accretive to shareholders, basically more on a financial basis?

We don't like to do just purely financial transactions because, in the long run, that doesn't create a lot of value. What creates a lot of value is -- what are you purchasing? How are you going to purchase the ability to deploy that talent, to write more business over the next 5 to 10 years? In my view, it is not just what investment banks -- they come with their little books and they say, oh, this is accretive and all that. To me, that is financial engineering and gobbledygook.

At the end of the day, what am I buying? Am I buying something that is -- am I buying something that is going to create value over the long run, or I am just going to get bogged down for two years in trying to get synergies and I try to do this and that, and then my business is -- and the profitability of that business goes south. It is a lot of characteristics you have got to look at. That is why, whom you buy, how you buy, beyond the financials, how are the two organizations -- can mesh together.

And, believe me, I am not a fool. I know any transaction, even if we do it or somebody else, you have got to be prepared to say one plus one is not going to be two. It is going to be something less than that, but potentially can be 2.5 and 3, five years from today. And if I can see that, that is a transaction I am going to do because, at the end of the day, that is transformative and it allows us to grow the business and create value for shareholders.

And you can't look at it just from the financial engineering point of view. But maybe I am naive, but that is the way my brain works. And at 65 I am not going to change it, right.

Josh Shanker, Deutsche Bank.

Both in 2005 and 2011, arguably, you earned your cost of equity capital in those years, whereas most companies in your peer group lost money. Given that in a year like 2014, you are running at an 11% ROE, what do you think Arch's results look like in a heavy, heavy catastrophe year? And what do you think happens to the peer group? Are your competitors taking risks right now that will make opportunities for Arch in the future?

Well, it is hard to talk about the competitors, because I don't know what they are doing with their portfolios. I mean, I can talk about mine. I can tell you that on a heavy CAT year, our losses are going to be much more manageable because our PMLs have come down.

I am not so sure all of my competitors, they haven't done similar things we have. I think some of them who have been in the business for a long time and they are good underwriters, they have utilized what is available in the marketplace because there is a new -- a lot of new capital that came in that particular sector, the property CAT sector. And there is purely an opinion.

If you think that you will be positively arbitraging and you are going to improve your book, you're going to buy protection because you think that the economics are favorable to you. But you have got to be cognizant. I mean, in years you buy protection, sometimes you look like a fool, too, because if there is no CATs, any price is a good price for those who sell it.

On the other hand, as Warren Buffett says, you don't really know who is naked until the tide goes out. And in our business, the tide goes out when you have a super CAT. And, let's face it, Florida has been quiet now since Wilma. Wilma was 2005. I would never have predicted that we would have had 10 years of no CAT activity in Florida.

But, the one thing you could say -- and it is not forward-looking, but it is looking backwards and making your judgments from there, your 2005, 2008, and 2011 years, because of the way CAT is underwritten here and managed here, they were partial earning events for us. There was never any capital impairment issues. That's the first thing.

Second thing, as you heard Dinos report, that in the current environment we have our all-time lowest PML relative to equity. So we are shrinking it. We have demonstrably shown it in tough CAT years, which is the heart of your question. If nothing really happens, we performed, I think, better than most peer groups because of that. But that is looking backwards, not forwards. But I think it is instructive.

Okay, well, good luck and we will talk to you again soon.

Hey, Josh. Are you still there?

Yes, I'm here.

Just one thing, because I want you to know, is we have a new exhibit in our financial supplement that we are calling the Shanker exhibit that deals with our effective tax rate, because you were one of the guys that drummed that up last quarter, given Watford. So if you go back and look at page 31 of the supplement, it uses all information on the segment of page 11 of the supplement where it starts with -- that is something you know, which is Arch's core operation. And rather than starting with consolidated with Watford in it, it starts with Arch's core operations and layers on top of that the Watford contribution. So you can see how the effective tax rate is calculated.

So Josh, we couldn't name a street after you. So we did the next best thing. We gave a page after you.

I always get nervous when people are naming things after me. It's usually not positive.

No, this is positive. This is positive.

Charles Sebaski, BMO Capital Markets.

I have a question about the one on the insurance business and the E&S line. Curious how much of the growth is due to the contract binding business, and what effect that business has on ROE versus combined ratio within the insurance segment.

Okay. Good question. First off, within the E&S casualty section, all of it is attributable to the contract binding operation. And when you compare 4Q to 4Q, that premium virtually doubled, just a little shy of doubling. So I think that gives you the magnitude and the contribution in that line.

This is stable book of business. It has got a high renewal rate or persistency attached to it. It is lesser volatility. Some of the growth, though, was due to some broadening. The limits may go up to $5 million where it may have been a lot of ones and threes. It has got some broadness. It has some non-CAT property in it, non-CAT property.

So it is a more rich, a fuller, offering and it is also reducing at the same time some of the contract exposure that they originally started with. So I think it helps the volatility. It accounts for virtually all the growth in the E&S line, and I think it will operate as a ballast or a dampening on the volatility of the other lines at the insurance group rates.

Does that run, though, at a higher steady-state combined ratio because that lack of volatility? I guess what I am trying to understand is, as that grows, the effect on the accident year combined ratios going forward should increase that at the same kind of ROE contribution?

Well, what normally happens in a business of that type, it usually gets a little more expensive to acquire it. So the ac is higher and the loss ratio is lower on average than similar businesses. Because it is new to us, we are a little more conservative so we are booking it at a level that time will tell what it is. So I think over time it will perform better than where it is booked at this time. But, as a general rule, it is a lower loss ratio at a higher acquisition ratio.

Okay. And then, on the reinsurance side the growth in Asia-Pacific in the quarter, I guess I am just curious about what is the business line writing there and is there any kind of change. Most of the PMLs on the US basis, if there is just any kind of PML pickup with Asia, Japan.

It is just a little bit of CAT business, but we don't have big operations in Asia-Pacific. It is miniscule of what we do.

Okay. I thought in the quarter on a premium written basis, that it has picked up here somewhat, to $70 million relative to $25 million last year. I'm just curious -- relative to what the quarter is, that seemed like a big piece of it.

That was the adjustment of us buying Gulf Re, 100%. So it is a onetime event and we bought the 50% we didn't own, and you going to the purchase accounting and that is what it is all about. It is no change in anything that we do. And because Gulf Re is in the Middle East, all that is in the Asia-Pacific region.

In rough terms, think of that as roughly $52 million of impact in the quarter on a net written basis. That was that influx that Dinos had talked about.

Meyer Shields, KBW.

Two really quick questions. One, in general, if the pricing level at Gulf Re comparable with legacy Arch?

Yes. I think our issue with Gulf Re is -- it was -- and that is the reason we bought 100% of it, is that it requires high limits to operate. They write a lot of tech risk accounts. And, for a small company who has $50 million, $60 million in revenue, the purchase of reinsurance, it was totally disadvantageous to us.

In essence, we paid a lot of money to reinsurance with zero recoveries over the years. And, finally, we convinced to restructure to our other partners, which we respect a lot, because then, now, we can use our purchasing within Arch from a much bigger block of business. So the reinsurance cost is going to be down significantly.

Gulf Re, when you look at our net results, they are not anything to write home about. But the gross results, they were not bad. So -- and I am not there to be producing for the reinsurance market. So, as a standalone, it didn't make sense. It didn't grow to a size that they can leverage the kind of capacity they need to have and buy cheaply. They were buying excess of loss and, believe me, we had tiny recoveries. And over the years we paid a lot a premium for that, and we have the ability to restructure.

Also, I think, they were trying to do more quota share contract where sometimes it makes sense to make excess of loss. But in a company that you are trying to build volume, you are looking for quota share. And then, even though the excess of loss might be a better structure and you can make more money, it doesn't show significant premium. So for that reason, we have made the changes.

We said, before we did the purchasing of 100% of the unit, we send our teams and we looked at every single account they underwrote, et cetera. And now they are coming under our underwriting authority and guidance with the same auditing teams that we have. So they become kind of a branch of ours in the Middle East. But the business we like, we have got to structure the reinsurance in a much better form than we used to.

Okay. That is very helpful. And then, very quickly, Mark, you mentioned that there was some investment in platforms in insurance and reinsurance. Is that spend going to continue in the near-term?

The ones that have been done on the A&H platforms and some expansion in other distribution in A&H and the contract binding and so forth, if we find opportunities analogous to what we did with contract binding, yes, that will happen whether it is in the US or in other parts of the world. It is hard to say. But we are always looking, and if we can find a pocket or some individuals with great market following, we are going to pursue those.

Yes. And you can see from the numbers, I think our life, accident, and help reinsurance health team now is -- I think it tripled in size and number of people. And these, to me, they are long-term investments in personnel and capabilities and the premium comes later. So I am not -- when we find the talent, we are going to hire it. And then we look for them to grow the book over time.

Okay. I mistook it as a technology expense. That's very helpful.

No, no, no. It wasn't -- there was some technology expense, but, no, this is -- maybe when you spoke, we can clean our language. It is mostly people.

People.

Brian Meredith, UBS.

I will just be quick here. So first, Mark, new money yields versus book yield on the investment portfolio, are we going to see some pressure here with where interest rates are?

I think we are close to rock-bottom at this point. By the way, I want to congratulate you for being the caboose on the call today.

I know. It is usually Ian, so I guess I get to replace him. All right. So that is near rock-bottom. And then the last question, just curious, when you are setting your reserves or your loss picks right now, what kind of lost trend are you kind of assuming? And has that changed much over the last, call it, year and then three years?

Yes. It has changed a little bit, I think. We still take a long-term view on trend. We don't just look at the last three or five years. We do a 10-year study and so forth.

And, let's face it, trends have been benign now for quite a long time. So that starts coming line by line into our thinking, but it is not something significant. It might be -- I don't know, I am guessing this because I haven't sat with the actuaries to do a real comparison what our long-term trend was by line of business five years ago versus now. But I think it should be down at least a point, maybe even a little more than that.

Great. Great. And then, I guess just on that, so near-term trend is obviously lower than what you are putting up with respect to your long-term trend, when you are setting loss picks.

Well, yes. When you look forward, you are making some level of assumption line by line on what loss cost trend, what effective rate changes you have achieved and what you think you might reasonably achieve.

Got you. Perfect. That's all I got.

The conservatism, Brian, that comes in the way we price business, et cetera, it comes from two places. It comes with your assumptions on trend. Are you truthful to it and not jump and say a trend is zero and negative, some people think it is in some lines or -- and the other thing is, what are you -- where your new money invested. Are you using the risk free rate and you are willing to price business with 1%, 1.5%, 2% -- the return on new money invested and then see what the projections tell you.

So that is where our conservatism comes. Other than that, like everybody else, we knock doors, we befriend the new brokers, we kiss them on both cheeks. We love to see more business and we try to write as much as we can.

And, Brian, to Dinos's point about line of business, I mean, just an example, some products you don't care where it is. Like product liability, we don't know where the claims are going to be brought versus where they were manufactured, let alone if it's durable goods. It can be anywhere. So a national view on that may make more sense.

Workers' compensation is the obvious local one. You've got to take local indemnity trends into account, local hospital costs, physician trends, and things of that nature. Plus, we're only talking about severity. There is frequency. There is really the pure premium that matters or the total loss cost trend.

Right.

And comp, historically, has been showing decreases in frequency. There was a blip in California, I think, for a year or two, but it is returned. And, generally, our actuaries within the loss rating models and pricing models assume the negatives to be flat. So, to Dinos's point, it kind of is a longer-term view, but it takes in slowly.

I would now like to turn the call over to Dinos Iordanou for closing remarks.

Well, thank you all for bearing with us. We went a little over time, but it is all right. We get overtime pay here, and looking forward to see you next quarter. Have a wonderful day.

Thank you for joining today's conference. This concludes the presentation and you may now disconnect. Good day.