Arch Capital Group Ltd (ACGLO) 2009 Q1 法說會逐字稿

Good day ladies and gentlemen and welcome to the first-quarter 2009 Arch Capital Group earnings conference call. My name is Francine and I will be your coordinator for today.

At this time, all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (Operator Instructions)

Before the Company gets started with its update, management wants to first remind everyone that certain statements in today's press release and discussed on this call may constitute forward-looking statements under federal securities laws. 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 at the SEC from time to time.

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

Management will also make reference to some non-GAAP measures of financial performance. The 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 presentation over to your hosts for today's conference, Mr. Dinos Iordanou and Mr. John Hele. Please proceed.

Thank you Francine. Good morning everyone and thank you for joining us today.

I'm very happy to first welcome and then introduce John Hele who joined Arch on April 1 as Executive Vice President and Chief Financial Officer. This is his first call with all of you.

Some of you know him from his prior engagements and he is looking forward to talking to you in the quarters ahead. We are really delighted he has joined our group and I'm looking forward in working with him for many years to come.

However, I have to admit that the leaders of both our insurance and reinsurance business, being actuaries, and now with our new CFO being also an actuary, I'm starting to develop a complex. So I talked to my wife and she suggested that I stood should start taking some of the exams towards getting an accreditation to the Actuarial Society.

She mentioned that I was pretty good in math when I was in college. But then I looked at my age I figure I'm too old for that.

Now on a more serious note, after a challenging 2008, it is really gratifying to start 2009 with a good quarter and an improving insurance marketplace.

On an operating basis, we had a good quarter from both an underwriting perspective and also an investment perspective. Our combined ratio of 86.7 was satisfactory in the current environment aided by light cat activity.

Our total return on the investment portfolio was 123 basis points for the quarter in local currencies and 109 basis points after factoring in the FX movements. We continue to be cautious in our investment strategy as we believe that government responses and stimulus packages across the globe will eventually create significant inflationary pressures.

We also remain cautious of the effects of the global recession on credit worthiness. As a result, we have shortened the duration of the portfolio to approximately three years and continue to be very conservative on the credit quality of new money invested. John will give you more details on our investment portfolio and performance in a few moments.

Our annualized return on common equity was 21.1% and our book value per share grew by $3.25 to $4.61, a 6.3% increase from the end of the fourth quarter of 2008. Our cash flow from operations continues to be very strong at $295 million for the quarter.

Now let me comment a bit on the performance of our operating units. Our gross written premium and net written premiums for the quarter were essentially flat at $1.25 billion and $823 million respectively.

Our insurance group experienced growth of approximately 2% on gross and 10% on net. The increase in the net writings was attributable to the change in mix of business and adjustments to the structures of certain reinsurance placements.

Our reinsurance group gross written premium were down 10% and while their net volume was down only 7%. Their reduction in both gross and net written was attributable to the movement of a January 1 contract to December 31, 2008 which we discussed in our last call, on the fourth quarter call; as well as to the non-renewal due toan unattractive rate environment on a substandard auto treaty we had on the books for the past six years.

The environment for our reinsurance business was actually better than we had anticipated, with opportunities to grow in quite a few segments although this is not obvious from our reported numbers because of the two issues I have mentioned just a minute ago. The pricing environment continues to improve in the reinsurance sector and became more stable in the insurance sector.

In the quarter, our reinsurance operations continued to decrease their exposure to casualty and nonstandard auto. Let me remind you that in our reinsurance group financials, we include all of the D&O and professional lines in the casualty sector.

Conversely, our volume in property, property cat and marine is growing. This growth is coming from both our treaty and our facultative books of business. Our outlook with regard to price levels, profitability and growth continues to be positive for those lines of business.

Our insurance group recorded growth in E&S property, the program business, executive assurance and national accounts. The property and D&O growth is primarily rate related while programs and national accounts business is growing because of new opportunities.

The increase in program volume is due to the new programs bound in early 2008 and are now coming online and building momentum in the marketplace. The increase in national accounts premium primarily is from the movement of business from carriers having financial difficulties.

We continue to be cautious on primary E&S and excess casualty and healthcare because of our view of the absolute rate levels that we see in the marketplace. We remain in a defensive mode on surety because of the economic environment.

We are continuing to substantially reduce our aviation and onshore energy exposures because of rate. Let me now give you a bit of a flavor on what we see on the rate environment.

We remain of the view that the best opportunities are in the cat segment, specifically US wind and quake with rate increases ranging from 15 to 25%. Even though we don't have significant exposure to European wind and flood and Japanese wind and quake, we have seen rate improvements in those two territories.

For us though, at least for now, it is not yet enough to increase our PML aggregate in those two zones. Rates in offshore energy for Gulf of Mexico exposures have grown significantly, triple digits in many cases, which allows us to continue to commit PMLs to that zone.

On the insurance side, the rate stabilization and improvements we saw in the fourth quarter of '08 continued in the first quarter of '09. This trend is spreading to more lines of business. However, with the effect of the credit crisis on claims inflation and the impact of available risk-free investment rates, additional rate improvement is required in some lines of business to achieve adequate returns.

Despite the improvement in the rate environment, current economic conditions will also have a negative effect on our customers. Rate improvements, while they will produce better risk adjusted returns will not necessarily translate into more premium revenue as exposure bases are negatively affected by reduced payroll sales and insure values. We have begun to see this manifest itself as certain insurers are purchasing less limits and retaining more risk themselves.

Before I turn it over to John for more commentary on our financials, let me update you on our PML aggregates. As of April 1, 2009 our one in 250 year PML from a single event expressed as a percentage of common equity was 23%, slightly below December 31 levels and our 25% common equity self-imposed limitation.

The reduction was more attributable to our increase in shareholders equity, not a reduction in the overall aggregate PML. Our capital position remains excellent under various measures and we remain well positioned to benefit from opportunities we see in either the insurance or reinsurance market.

With that, let me turn it over to John for a more detailed financial discussion on our results. And then after John, we will come back and take your questions. John?

Thank you Dinos. It is a great pleasure for me to be here on my first Arch Capital earnings call especially with the good results of the first quarter of 2009.

Before I start though, I would like to recognize the excellent financial organization and company that my predecessor, John Vollaro, built with Dinos. It is a great benefit to have John continue on as a senior advisor to the Company and it makes for a smooth transition.

I will briefly cover the financials and provide some insight into some key items that may be of interest to you. Dinos has already covered the trends and solid results of our premiums and overall business.

I might add that the mix between the shorter tail lines and the longer lines remain constant at approximately 50-50 in both quarters. The net to gross ratio was 80% in the first quarter of 2009 compared to 77% in 2008 primarily due to changes in insurance mix of business and reinsurance usage along with the reduction in the ceded business to Flatiron Re, the sidecar treaty that expired in December 31, 2007.

Now let me give you a little color on the ratios. The loss ratio reflects 7.3% or $51 million, a favorable development in first quarter of 2009 compared to 8% or $57 million of favorable development in the first quarter of 2008.

Approximately 70% of this development came from medium and long-tail lines and primarily resulted from better-than-expected claims emergent in older, underwriting years. The first quarter of 2009 reflects 1.1% or $8 million of losses related to current year catastrophic events, while the first quarter of 2008 reflected 3.7% or $26 million of cat activity which primarily related to Australian floods.

In current losses related to the major 2008 cat events, Hurricanes Ike and Gustav, were relatively unchanged from the 2008 fourth-quarter estimates. 71% of the Company's net reserves of $6 billion were incurred but not reported which was substantially unchanged from year-end.

On the 1.8% increase in the acquisition expense ratio, two-thirds related to lower commission income from the Flatiron treaty, 1.2 points, with the remainder resulting from favorable prior-year reserve development. The 1.4% decrease in other operating expense ratio was primarily driven by the insurance segment due to non-recurring adjustments in incentive compensation and the benefits of the insurance segment's expense management plan implemented in 2008.

The largest change this quarter compared to a year ago was in the net investment income, with decreases of $96 million or $1.53 per share compared to $112 million or $1.79 per share in the 2008 fourth quarter and $122 million or $1.80 per share in the 2008 first quarter. The pre-tax investment yield was 3.82% for the 2009 quarter compared to 4.5% last quarter and 4.88% in the first quarter of 2008.

The 4.88% excludes $3.4 million of arbitration proceeds. Before I delve into the details in net investment income, it is important to put the net investment income into perspective as the total return of Arch's $10.3 billion investment portfolio had a positive total return of 1.23% in original currency in the quarter, 1.09% taking into account currency fluctuations.

Arch manages its investment portfolio on a total return basis, as this is a core element to increase book value per share. In these volatile markets, we have found opportunities during the quarter that created some interesting and noteworthy results in the net investment income line, but still delivered a positive total return.

In comparing net investment income from the fourth quarter of 2008 to this quarter, the decline in the embedded book yield of 38 basis points from 4.55% at year-end to 4.17% at the end of March was the largest contributor as the Company lowered the average effective duration from 3.6 years to three years and maintained the portfolio's AA+ credit quality. As an example of noteworthy result in net investment income, we had an investment in TIPS which are actually an interesting anomaly from the credit crisis.

TIPS are inflation-adjusted treasury notes where the principle adjusts to inflation, up when there is inflation and down when there is deflation. The investment income under the accounting rules includes interest plus the amortization of the principle adjustment.

Now there's a quarter lag in the adjustment of the TIPS. In the fourth quarter of last year, we experienced deflation and that created negative investment income in the first quarter of this year.

One would think that the total return of the security then would also decrease over the quarter. But no, we bought TIPS in the fourth quarter of '08 at a discount to par and experienced a gain during the quarter as they are trading above par at the end of March 2009.

This was, we believe, due to the dislocated markets in the fourth quarter of last year which improved in the first quarter as well as the fact that there was a small inflation in the first quarter of 2009 that will positively adjust TIPS in the second quarter. So the TIPS had a positive total return and we have now sold most of the exposure in the first quarter.

As I mentioned earlier, Arch manages on a total return basis and this is just one of the examples where the accounting on a book value basis did not match the actual results on a market value basis. The net investment income for TIPS was a negative 12 basis points over the quarter and this is not expected to continue in the same magnitude in future quarters.

The remainder of the net investment income change can be explained by two less days in the first quarter which is about 10 basis points, less income on securities lending due to lower interest rates which is another 10 basis points and lower yields on cash and higher investment expenses which is 5 basis points. Therefore summarizing the return of the investment portfolio, it performed quite well in the first quarter.

The dominance of treasuries, muni's, agency-backed mortgage-backed securities and older year CMBS's and an increasing percentage of government-backed corporates provided stability and an increase in market values in the quarter. Our bank loan funds totaled $331 million in market value at the end of the quarter of which $211 million is held under the equity method through P&L and $121 million held as available for sale, where the changes in market value flow through equity.

The total bank loan portfolio experienced a 3% decline in market values of $10 million, substantially all of which was directly reflected in the P&L. We have provided further details on this portfolio in the press release and supplement, including sector allocations and the overall credit quality (inaudible).

Now last quarter, John Vollaro spoke about the accounting rules and how they were punitive for securities that were determined to be other than temporarily impaired as the full difference in market value and amortized cost was slowed through realized losses in the P&L even though one may expect to have an ultimate credit loss far less than this amount. The FASB must've been listening and the new standard FAS115-2 corrects this issue.

Arch has adopted both FAS115-2 and FAS157-4 as of January 1, 2009 which is the early adoption date. These standards will become mandatory as of April 1, 2009.

FAS157-4, which is the fair value standard, has had no impact on our fair values. But FAS115-2 has had an impact on both our balance sheet and the income statement in the first quarter of 2009.

To adopt the standard, we had to first reclassify all old OTTI provisions taken on the securities still in our portfolio as of January 1, 2009 into two components -- a credit loss component that stays in retained earnings and an other factor component that reflects interest rates, market conditions, etc. that is reclassified into accumulated other comprehensive income (AOCI) from retained earnings.

Of the $171 million of OTTI subject to review on 1 January, $109 million was deemed to be credit related and $62 million was related to all other factors, which increased the amortized cost of impaired securities by $62 million. We recorded a cumulative effect reclassification net of tax from retained earnings to AOCI in shareholders equity.

It is quite important to note that there is no restatement of prior year earnings under this standard even though in theory one would think you might do so. And equally as important, there is no impact on book value per share as a result of this adjustment.

In the first quarter, applying the same credit process, now an up-to-date assumptions and credit reports, we booked $36 million of credit related impairments which are reflected in the P&L and $57 million of all of the factors which were reflected in other comprehensive income. The first-quarter impairments were related to deterioration of recovery values in mortgage-backed securities as well as the winding down of a euro denominated bank fund during the period.

Our financial condition became even stronger in the quarter with $3.6 billion of shareholders equity, up 5.8% from 3.4% at the end of last year which we believe is well above rating agency requirements. Total capital, including our perpetual preferred securities and debt, totaled $4 billion at the end of March with the revolving credit facility of $100 million maturing in August 2011 and the long-term debt of $300 million maturing in 2034. Portfolio liquidity has remained very healthy with cash, short-term investments and treasuries and agencies representing 25% of our investable assets.

Finally, the two most important measures for Arch are operating ROE which came in at 21.1% on an annualized basis and the increase in book value per share which was up 6.3% to $54.61 which demonstrates the discipline and shareholder focus of the entire organization in what have been challenging insurance and financial markets. That concludes our prepared remarks and we're pleased to take questions.

Francine, we're ready for questions.

(Operator Instructions) Matthew Heimermann, JPMorgan.

A couple questions. One was, Dinos, could you talk a little bit about with some of the changes in the different lines of business in the reinsurance segment kind of how growth looks like -- what year-to-date growth looks like on a treaty year basis?

Yes, let me give you a little flavor. If you exclude that one single transaction which was the substandard auto facility we didn't renew, actually our reinsurance group would have had a slight growth even in the first quarter.

This is a much improved picture from my commentary in the fourth and third quarter when I was projecting that probably our reinsurance business will be shrinking at somewhere between 10, 20%. So that's an indication that we have seen more opportunities and we have enough aggregate capacity and PML capacity for those areas where we believe the pricing is strong - which is the cat area and we believe our prospects today on the reinsurance side of our business are better than what we saw maybe two quarters ago or even last quarter.

So that gives you a little flavor. At the end of the day though, the insurance markets have an ability to change quickly. Right now I think, I called it as a stealth recovery last quarter, that things are moving both on insurance and reinsurance in a positive direction and I am more optimistic than I was one quarter ago.

And then with respect to just how you're using your cat aggregate right now, in the quarter catastrophe was down, property (inaudible) catastrophe rates were up. I don't know if there was some FX in those numbers. But does that reflect you are holding that capacity for later in the year? Does it reflect the fact that the (inaudible) guys may be using a little bit more capacity than they have in the past? Is it some combination of the two or some other factor?

Well it's two factors. One, you remember we talked about a transaction. When you compare year-over-year, you have a little bit of dislocation because one customer we moved from January 1 to December 31. So in essence, it makes the comparison of year-over-year a little bit confusing because that contract was booked in the fourth quarter of 2008. And in essence, when you look at the 2009 numbers, you are missing that component.

If you adjust for that, basically we are using approximately the same PML capacity. And as our balance sheet is growing, I said we are at 23% of common equity right now as of April 1. We have still got a little more room and whatever opportunities we see in June and July, we will take advantage of up to the risk management level that we have set ourselves. We don't want to go beyond that 25% because it doesn't -- it's not prudent from a risk management point of view independent of how good the rates are.

Vinay Misquith, Credit Suisse.

Just to follow up on Matt's question, I remember last quarter you had a large contract that renewed. My understanding was that some of that aggregate would run off by the middle of the year so that you could drive more cat premiums. Is that true and would you be able to actually write more premiums in the middle of the year on the cat because of that contract?

Some of it will run. It is -- that contract is -- you know, it's a quota share contract. So you are running over the year, so some policies come off and some come on. But I think more capacity is going to come because our capital is growing and I will attribute more to that in our ability to write more in June and July.

Josh Shanker, Citigroup.

A couple of housekeeping questions and then a meaty one. What is the IBNR and ACR numbers for the quarter?

The ratio I think between IBNR, ACR together is 71%. I think the ACR is 2% and the IBNR is 69%, I believe. I can get you the specific total but that sounds right to me. I do the closing [a week] and I'm getting older, so I don't remember exactly the decimals. But it's -- 71 I know is the actual number for the combination of the two.

Very good. Two, what is the average liability duration of the reserves?

The duration of our reserves, they are about 3.3 to 3.5 (years). Don't forget, we have shifted the book a little bit to more property and moved a little bit of the duration closer. But that's where we are.

So you know, as you can see, we are moving the investment portfolio lower than that. So that tells you that the capital account is going to have a much shorter duration than the liability.

Assets that we are holding for our reserves, we usually match to the duration of those liabilities and we move depending on how we view the investment environment, the shareholders equity to -- from zero duration all the way up to five year duration. So right now we are getting closer to the zero than to the five. John, do you want to add something to that?

I think that it all depends upon the outlook as to what -- think what's going to happen. As Dinos mentioned, we do expect some (inaudible) inflation coming, so you don't want to be too long because it's -- you need to readjust your portfolio as inflation pulls in. It's very hard to predict when that may be.

But also, we're not out of the woods yet probably in terms of the global economic downturn and you've got to be cautious from a credit point of view. So we are doing both shortening generally overall as well as continuing to be very cautious on the credit side.

Ian Gutterman, Adage Capital Management.

Two questions. First is on the insurance side, it looks like you took up your retentions. Can you just talk about was that just a mix in the quarter or is that a conscious strategy that you want to retain more right now?

Well it -- actually it's neither. I think we have less quota share and more excess of loss. So we found a little bit of a change in how we bought reinsurance rather than the increasing our per risk net retentions. So we moved [through] a little more XOL. We found that to be more attractive purchases than quota share.

And that was a pricing decision or was that a view of concern about loss costs in the future?

It was a pricing decision.

Okay, great. And then my other question is on the impairments. I just want to make sure I'm understanding the FASB changes accurately, John.

So basically out of -- you classified $62 million from prior to this year as non-credit out of the 171, so about one-third of it roughly. And then this quarter you classified 57 out of 93 which is like 70% of it. So why was there so much more non-credit Q1 than what you have had cumulatively up until now?

We go through security by security and analyze the credit piece of it and in the older book or the starting book, we had things like Lehman in there and some things that are obviously credit related. But in the new quarter, we saw both some -- the prices on some of the mortgage-backs continue to be challenged in the quarter which we believe is still quite a bit due to supply and we do extensive analysis with our investment advisors as well as us in analyzing how much of that ultimate loss we expect to be credit. And that's how we come about the split.

And again, we have not changed the process. Our evaluation in the third quarter, fourth quarter, first quarter has been the same.

We use the same methodology, etc. Now under the new rule which we have to adopt either in the first quarter or mandatory in the second quarter, you bifurcate your decision. But the process has been exactly the same.

And as John said; we are very, very detailed. We go security by security. We have a committee and part of it, John Vollaro in his part-time assignment, he is part of that committee; John Hele. We have a whole bunch of us looking at that and we go security by security every single quarter.

So we have to repeat this. With the latest credit analysis at the end of the quarter, each and every quarter. So we will go through the whole -- everything has been impaired and redo this calculation each and every quarter.

So some of that $57 million from this quarter could move into the credit bucket next quarter if you see the environment getting worse?

Yes or some of the credit could come back again as (multiple speakers)

Exactly (multiple speakers) and then I think Dinos said it but just to make sure. It doesn't sound like then you had a migration to level three?

No, as we said, we haven't had any migration to level three. The level three we have didn't change by adopting 157-4.

Perfect, thanks so much.

One more point. You've got to understand that even with this change, it doesn't affect book value per share. We mark everything to market and it doesn't -- it's just -- you are rebucketing some of these to two buckets instead of one. At the end of the day, a balance sheet is marked to market from book value per share basis when you look at it and that's the true picture as to what we believe the healthiness of the Company is.

I agree. I agree with the FASB decision. Just as an analyst, it makes it a little harder to keep track of unrealized versus realized. You just had to -- just had to add an extra line to the model; no big deal.

I'm sorry. We'll try to be clear on this for each quarter so that you can (multiple speakers)

Exactly, as long as I can track it, that's fine.

(Operator Instructions) Josh Shanker, Citigroup.

Of course you guys have seen that I'm somewhat skeptical of all this hard market chatter out there and maybe I'm the only one. But is this really that much different from where we were in 2006 this time of year? Can you guys compare and contrast 2009 and 2006?

Well, I don't know -- if you're talking the absolute environment today or the trajectory where we are going, I can tell you 2006, it was a better year than 2009 is going to be. You don't have to think very, very hard.

On the other hand, you know that we do extensive monitoring of rates. You know, everything is improving even -- and let me go over quickly to give you some of the movements. This way you can -- this is on our book of business and I'm talking about effective rate change. That includes everything in the effective rate change.

In our E&S casualty and liability umbrella, we went from a minus 4.7% in the fourth quarter of 2008 to a plus 1.4%. That is a movement and it's a positive movement.

Our executive assurance which is the D&O has 7.9% positive in the quarter. Healthcare -- and you saw my prepared remarks. It is still negative at minus 8% and about the same that we saw in the fourth quarter of '08 but better than the third and second quarter of 2008. So a slight improvement but not where we -- trajectory, I'm talking about.

Property business is up. It went from negative in the fourth quarter of 6.8% to positive 5.4%. Professional liability is flat. Construction, we had minus 5% in the fourth quarter. It became minus 0.4 or four-tenths of one percent in the first quarter. In our special risk, it went to plus 9.2%.

So everywhere I look, I see either rate reductions easing, meaning the reduction is less than the quarter, and more and more lines getting into positive territory. Now some lines we feel very good about because we are seeing on an absolute basis they give us north of 15% ROE. Some of the lines are improving but still they're not giving us the double-digit ROE. So we're a lot more cautious.

But we made those judgments through our profit centers, both on insurance and reinsurance, on a quarterly basis. One thing that I love about Arch, we are small and nimble. So the message is from me and John and our senior team to our operating units, they are easily understood and implemented and also they have feedback back to us as to what's happening in the marketplace; is pretty instantaneous.

So that allows us the ability to shift focus where we believe we can find the best returns. But you know, I am not going to pound on our chest and say this is a terrific market like 2006. But the trajectory, where we are going, if it continues, we like.

It's improving and it's improving -- it's a slight improvement. And you know, there's many reasons for it. You've got companies that they have financial difficulty, they are starting to lose some business. New money invested and people when they price their business -- and we price all of our business assuming risk-free rate of return -- is nothing to write home about.

Even when we find something to invest in - very secure things like government guarantee, issuance, sometimes we can get under 150, 170 bps above treasuries, it still gets us in the 3 to 3.5%. Maybe we get lucky, 3.7% for the kind of durations that the business you're underwriting. So underwriting profits have to increase and you're not going to increase the component of your returns coming from underwriting profit unless rates go up. We see that in the marketplace. So we are cautiously optimistic.

Okay, just aviation, you surprised me. You said aviation was down. I thought aviation would start to work back in November.

We don't like the absolute rate levels yes. Aviation is part of our special risk and I said we are plus 9.2%. But from an absolute rate point of view, two classes we don't like, I don't think you're getting the adequate returns -- it's aviation and we're cutting back quite a bit on that and onshore energy.

Both of them have positive rate movement. But don't confuse positive rate movement and profitability. It's moving in the right direction but it hasn't got to the point yet that gets us excited.

Thank you for all the color.

Jay Gelb, Barclays Capital.

Dinos, it's just one analyst's opinion, but I don't think you're too old to learn the actuarial material.

Jay, I'm 59. Next birthday, I'll be 60. So even my young daughter who is 14 says 60 is old, dad. It's all relative. When I talk to Vollaro, I talk to him, he's says 60 is very young. So it's all relative.

I did want to ask you about Arch's ability to take market share from some of the stressed competitors out there. How is it going versus your expectations?

Where we have seen -- we have seen some movement on credit-related business, more people calling us for surety and more people calling us for D&O. I think we are responding to D&O, E&O. We're cautious on surety because of the general economic environment and we are getting a lot more opportunities, what I would call the loss-sensitive plans, the national accounts, that in essence -- the predominance of the risk is taken by the insured and you are managing of course their claims, their money and they are getting credit sensitive.

So we have seen some of the business come away. We are not a huge player in national accounts yet but you have seen we had a significant first-quarter growth and it's all related to what's happening to some of our competitors and how the market views the strength of the Arch balance sheet.

That's the only two areas we have tangible evidence that there is movement from -- the rest of it is competitive. You've got to compete for it, even in the lines that you're getting better rates. You're still competitive. But some of this I think you are seeing some shift.

And then separately on the reinsurance segment, I just want to make sure I understand. Are you saying now that Arch can generate positive gross written premium growth in the reinsurance segment over the remainder of 2009?

What I'm saying is we don't give guidance on -- because I don't know where the market is going to go. It might get competitive overnight. I've been in this business long enough to know that it behaves schizophrenically sometimes. So I don't know.

What I'm saying is that if you would've asked me that question one quarter or two ago, I would have said highly unlikely. But now I don't rule it out of the question.

Based on what we saw in the first quarter, the activity, the opportunities we see, the more -- like I said, if we would have renewed one big contract, you would have seen positive in the first quarter. It might or might not continue.

So I know you guys have got to build models and you've got to have projections. I don't worry about that. I let you guys worry about that. All I worry is our guys are pricing the business for a return and they're having margins in the business.

If we see a lot of business with margins, I will assure you we're not going to fall asleep. We are going to write it.

If we don't, we also have the ability, the willingness and the desire to cut the book back if the pricing is not there. You have seen that behavior with us. The last two years, we were reducing topline because we weren't finding the opportunities. But when we find the opportunities as we did in 2002, 2003, 2004; we were writing a lot of business and I think we know how to do that.

Michael Paisan, Stiefel Nicolaus.

Just a quick question and kind of asked a different way from some of the others. You mentioned that you're seeing more opportunities on the reinsurance side and I was wondering if you could just kind of drill down a little bit and explain where those opportunities are coming from, whether it's just strictly just from the weaker competitors or have the buying patterns changed from your customers or is it just simply that pricing is better today versus what you saw a quarter ago? It seems like a pretty quick fast change in judgment on that business from last quarter to this quarter.

Without mentioning names, I will give you an example. This is an example that you can see -- the reinsurance business is a lumpy business. We had a client that is a very good client of ours that -- we've been on their program for five years and we started with a 10% participation on that program.

And we were coming down and we were down to 6% and probably would have went down to 3% participation because we didn't like the trajectory where the business was going based on our underwriting audits. And we always have very good dialogue with our customers and this customer.

When we went for the renewal of this piece of business in the reinsurance sector, to our pleasant surprise we found out that they have instituted significant, not only rate increases, but underwriting guidelines changes that we like. So instead of budgeting that we're going to go from a 6% participation down to 3%, we went the other way and we have a 10% with a client that we like and we have been with.

And things in reinsurance can change on a dime. That's why it's very hard to predict how much revenue you're going to get. It's treaty by treaty. If we thought substandard auto rates, they were going up and we can have results, that transaction is $60 million for us.

So the other opportunities we see, it's related to balance sheet pressures that some have and their willingness to reinsure more of what otherwise they would have retained on their books of business. And we have seen some of that also. So it's a combination of the two.

Some cases, the underlying business, the rate environment is improving and we are increasing our share on programs that we might otherwise would have decreased our share and new opportunities because people they want to buy more because their balance sheet might not allow them to retain all the business that they would otherwise retain. But in a business that's very lumpy, you write one treaty or you don't. It can change your quarter from plus 10 to minus 10. It's hard to predict where premium goes. Hopefully we can predict where profits go and that's more important to us.

Okay, that's great. I have one more follow-up that's unrelated to that.

I'm just wondering if you could talk a little bit about what your assumptions are for inflation as it applies to your loss picks on your reserves? I think John had mentioned that there certainly is some inflation that's probably coming down the pike at some point. I think most people agree with that and I was just wondering if you changed your loss pick assumptions accordingly and if so, what kind of inflationary measure are you using?

Don't forget, trend in both insurance and reinsurance is slightly different than inflation. Inflation is only one component of what the trend is. And I can tell you we do that study and we do a trend study by our actuarial department. Let me run some numbers and tell you where we think they are.

For casualty lines, we're using about 5.5%. For D&O, we're using about 8%. For healthcare, we're using a little over 6%. For property, about 2.5%; for construction, about 2%; for professional liability, about 6%.

So it goes by line of business and as the socioeconomic inflation that comes with looking at a lot of data and where it's going, how big is the medical component as part of your loss and where labor cost is going, where material goes etc. So it's not a very simple calculation.

Our comments -- it was more relating to our asset base and how getting a little bit more conservative both on credit and duration. Because even though we cannot predict when inflation is going to come, we believe that with the budget deficits we're going to have, the stimulus -- and it's not just in the US but globally.

Eventually we're going to invite inflation and we might be the exception of the rule here. But we felt for our investment portfolio, we need to be a bit more conservative than go the other way around.

Okay, that's great. Thanks for the detailed answers.

Vinay Misquith, Credit Suisse.

Just a numbers question. In terms of the yield, 12 basis points of that was related to TIPS which will not recur in the next few quarters. Do you think that you would increase your investments in riskier assets or do you think yield ex the TIPS number will stay flattish for the next few quarters?

Let me just clarify something first that the reduction net investment income was 12 basis points due to the TIPS but the yield is a moment in time calculation on the date of March 31 and we have sold some of the TIPS since then. So the yield is less impacted by -- the yield on the portfolio with net investment income has other impacts on it.

So there's little difference there. No, I think we're trying to be clear here but our investment outlook -- we just don't think at this moment in time is the right time to be increasing risk or increasing duration until we see how things proceed through the course of this year and maybe even early next year. We will have to wait and see.

Our embedded yield now is what -- 4.17 (multiple speakers) that might move a little bit but I don't think you're going to see the same movement you saw from the fourth quarter to the first quarter that we gave up about 40 basis points. You might see a few basis points.

We're finding some good opportunities to invest in government guaranteed securities at somewhere between 150 and 170 basis points above treasuries. That gets us into the 3.5% yield.

And don't forget, not the entire portfolio is turning over. So the movement downwards, it's going to be slow.

And if we find opportunities that we believe fits our credit profile -- for example if we find CMBS's of the (inaudible) that we have, unfortunately we can't find them; that they yield 8, 9, 10%, we will buy them. But we are not finding those kind of securities that give us the credit comfort that comes with the yield.

That's great. The second point was on the expense ratio and the link -- in the primary insurance segment, sorry. That was down this quarter because of some one-time issues. Do you think that the operating expenses will stay in the $70 million range for the rest of the year within that segment?

Well expense ratio is a function of activity. If we're steady as we go; yes, that's a good assumption. The reduction in expense ratio was -- most of it was because of permanent restructuring.

Don't forget, we made a move from downtown Manhattan to Jersey City. 2008 you didn't get a lot of that benefit because you unwind some of the furniture but eventually that is starting to -- it's coming. The rent cost is going down.

And second, we are readjusting our incentive compenstion a bit because as you know, we pay for performance at Arch. And at the end of the day, the 2006, 2005, 2004 underwriting years -- and we have a time delay as to when we pay -- they will be better years from an incentive compensation than the '07 and '08.

So those adjustments get made as we accrue for all these things into our balance sheet. So if volume doesn't grow, I don't think expenses will grow. And if volume shrinks, we will probably have to be cutting expenses. But usually you don't cut expenses as quickly as volume shrinks. Right now I'm pretty comfortable where we are.

Ladies and gentlemen, that concludes the Q&A portion of the presentation. I would now like to turn the call back over to Mr. Dinos Iordanou.

Thank you all for joining us. John, again welcome to Arch. It's a pleasure to have you here and we're looking forward to talking to you next quarter. Have a good day.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a good day.