Arch Capital Group Ltd (ACGLO) 2011 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the first-quarter 2011 Arch Capital Group Limited earnings call.

(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 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 or 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. 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 conference over to your hosts for today, Mr. Dinos Iordanou and Mr. John Hele.

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

The first quarter catastrophic events were yet another clear reminder that we are in the risk business. Considering the magnitude and number of these events, our performance was acceptable in absolute terms and superior relative to peers that are similarly engaged, as we are, in underwriting catastrophe business. I continue to be pleased with the discipline exhibited by our insurance and reinsurance underwriting teams in executing our overall underwriting strategy.

Our strategy has been to stay within our risk managed tolerances, and only accept and underwrite risks that are priced appropriately, on a risk-adjusted basis, in order for us to achieve the required returns relative to the risk assumed. Our performance in the first quarter emphasizes the good execution of that strategy.

Our total catastrophe losses for the quarter were $178.7 million, with the Japanese quake contributing $79 million, the New Zealand quake adding $65 million, and in the balance coming from the first quarter Australian floods and Cyclone Yasi. Our annualized return on average common equity was 0.8% on a reported basis, which was negatively affected by the above-mentioned cat losses, which exceeded our quarterly cat load by a significant amount.

By our own estimation, we continue to believe that in the current underwriting and investment environment we operate in, on a normalized basis, we are still able to achieve approximately 9% ROE on an underwriting year basis. This is essentially the same model we achieved for the 2010 underwriting year.

Our investment performance for the quarter was good, with a total return of a 1.5% achieved for the quarter. And despite a slight upward movement in Treasury rates, we were able to achieve these very good result. As a result of this good performance, despite the cat losses, we were able to increase our book value per share to $91.02, which is an increase of 18.3% from a year ago and 1.2% sequentially.

From an underwriting point of view, we achieved 110 combined ratio for the calendar quarter, which we believe is approximately 13 loss ratio points worse than our normalized accident quarter combined ratio. Cash flow from operations remains good at $225 million.

The broad market environment continues to be competitive, with most long-tail product lines having plenty of capacity available in which we continued to experience slight price declines. In the property and property cat areas, the environment is improving, with the greatest improvements today reflected in international cat exposed businesses.

From a premium production point of view, our gross written premiums for the quarter were up 1% and our net written premiums were basically flat. Our reinsurance operations were up 2% on a gross written premium basis, and flat on a net written premium and our insurance operations were flat on gross written, and down approximately 1% on a net written basis.

During the quarter, in our April 1 renewals, we saw no significant change in market conditions in most of our reinsurance business, with what I mentioned before, property cat area being the only exception. We continue to see pressure from cedents to increase ceding commissions and, in general, we saw a reduction in primary rates, which affect all of our pro rata businesses, of approximately 4%. We also noted that the clients are continuing to look for opportunities to switch from pro rata contracts to excess of loss, in order to maintain a larger amount of net premiums on their books.

In our cat business, we saw increased submission activity as a result of clients seeking to move to more secure capacity and brokers anticipating an increase in demand, due to the implementation of RMS 11. The implementation of RMS 11 has not yet been adopted by the broad market, as the vendor continues to field test and make modifications. We expect this process to be finalized in the next few months and by mid-year.

Across our business segments, even in the most difficult markets, we always look for opportunities to find acceptable books of business to underwrite without sacrificing expected returns. We are starting to see some of these opportunities, both in our existing product offerings as well as on our new product initiatives, which have helped us to stabilize premium production. Our Insurance Group continues to emphasize and move their books of business to smaller accounts, and to less volatile lines, with an emphasis on reducing their exposure to US casualty business.

Two areas with significant volume reductions in the first quarter were Executive Assurance and Aviation. We continue to see the market granting rate declines in segments of the D&O product line that we cannot support and, of course, as we have stated in prior calls, we have exited the Commercial Aviation business. Our exit from the Aviation business happened in the second quarter of 2010, so the second quarter of this year will be the last one that will materially affect year-to-year premium comparisons.

We saw increased activity and opportunities across our business segments and resulted in premium increases in International Professional Liability, International Casualty, including Motor business, National Accounts and Lenders products. We continue to monitor the primary casualty in that sector in the US, as we continue to see price increases in isolated areas, but we are not yet at a point to switch from defense to offense, as we still believe that the improvement today will not produce adequate returns.

During the first quarter, our Board increased our share purchase authorization by $1 billion, and extended the time horizon in which to execute the authorization to the end of 2012. In the first quarter, we repurchased 2.7 million shares for an aggregate value of $237 million, which represents an average price of $88.25 per share. So far in the second quarter, we have not repurchased any shares. With these repurchases, our remaining available authorization stands at $992 million.

I would like to reiterate that our capital management philosophy has not changed. We will continue to return excess capital to our shareholders until such time that we can profitably deploy it in our business.

Before I turn it over to John for more commentary on our financial results, let me update you on our Catastrophe PML aggregates. As of April 1, under RMS 10, our one in 250 PML from a single event was $726 million, or 18.1% of common equity. This represents roughly the same exposure amount as of a quarter ago, and a slight increase as a percent of common equity, due to the reduction of our common equity from our share repurchases.

Under RMS 11, based on the current iteration of the model, our preliminary estimates of PML for one in 250 year event will increase approximately 32% in the Northeast zone, 22% in Florida Tri-County zone, and by 29% in the Gulf. Under this scenario, our largest PML will be the Northeast zone, with $955 million, or 24% of common equity, which remains within our risk-management limits.

With that, I'm going to turn it over to John for his comments, and after John we will take your questions. John?

Thank you, Dinos. Good morning. I will now cover some of the financial highlights of this interesting quarter.

For the 2011 first quarter, property and other short-tail lines represented approximately 47% of our net premium volume, compared to 50% in the 2010 first quarter . However, on a trailing 12-month basis, the ratio is about the same at 45% to 46%. On a consolidated basis, the ratio of net to gross was 79%, roughly the same as a year ago.

Our overall operating results for the quarter reflected a combined ratio of 110%, compared to 96.4% for the same period in 2010. The 2011 first quarter loss ratio included $179 million, or 28.2 points, of current accident year cat activity, compared to $58 million, or 8.7 points, in the 2010 first quarter.

The Australian floods and Cyclone Yasi had a gross impact of $44 million, net impact of $33 million, which came in at the low end of our previously announced estimate, indicated range of $30 million to $60 million. The New Zealand earthquake was booked at $86 million gross, $65 million net, which came in at the higher end of the range of $35 million to $70 million.

While Japan property losses were booked at $86 million gross, $63 million in net, which compares to our previously announced one in 100 PML for Japan of approximately $60 million. Japanese marine and personal accident losses were $16 million net, and were not included in the PML calculations. The cat losses in the 2010 first quarter were primarily related to the Chilean earthquake.

The 2011 first-quarter combined ratio reflected 9.2 points, or $58 million, of estimated favorable prior-year reserve development, net of related adjustments, compared to 4.4 points, or $30 million, in the 2010 first quarter. The prior-year development in the first quarter of 2011 reflected net favorable development, primarily in property and other short- and medium-tail lines, as well as in the reinsurance segment casualty business from the 2002 to 2005 underwriting years. In particular, the favorable development included $15 million related to reductions for prior year named cat events.

Overall, our reserve position continues to be reasonable to slightly conservative. The 2011 first-quarter current accident year combined ratio, excluding large cat events and net favorable development, was 99.9% in the insurance segment and 75% in the reinsurance segment, both consistent with results of a year ago.

The 2011 first-quarter expense ratio of 32.1% was 0.4 points lower than the 2010 first quarter, benefiting from a lower level of contingent commission expense and certain costs which were incurred in the 2010 first quarter that did not reoccur. The impact of these items that were partially offset by the impact of a lower level of premiums earned in the 2011 first quarter.

On a per share basis, pre-tax net investment income rose to $1.89 in the 2011 first quarter, compared to a $1.67 for the same period a year ago, and $1.81 in the fourth quarter of 2010. Income for the 2011 first quarter included $0.08, or $4 million, of expected non-recurring dividend income. Our embedded pre-tax book yield before expenses was 3.36% in the 2011 first quarter, down from 3.52% at year end, which reflects lower reinvestment rates and a shorter duration.

Total return of the investment portfolio was 150 basis points in the 2011 first quarter, compared to a loss of seven basis points in the 2010 fourth quarter. Excluding foreign exchange, it was 114 basis points in the quarter. The total return in the first quarter benefited from good returns on our equities and other alternative assets, partially offset by a slight increase in interest rates during the period.

We recorded net foreign exchange losses of $37 million, which results from revaluing our net insurance liabilities required to be settled in foreign currencies, and resulted from the weakening US dollar in the quarter. However, this is should be compared to the 36 basis points contribution to total return from foreign exchange in our investment portfolio, which offsets this income statement loss in the equity section of the balance sheet.

Throughout the past few quarters, Arch continued to allocate more assets to equities and alternative investments. Our allocation to equities was approximately 3.5% of our investable assets at quarter end, while alternative investments in equity method investments were 6.6% of our investable assets. We continue to maintain the vast majority of our investable assets in a very high-quality fixed-income investment portfolio with an average credit rating of AA plus. The duration of our investment portfolio decreased to 2.73, down from 2.83 at year end.

For the 2011 first quarter, our effective tax rate on pre-tax operating income was 2% and minus1.5% of pre-tax net income. Our expected range for 2011 for pre-tax operating income is 1% to 3%, but certain factors can always cause the tax rate to fall outside this range.

Our balance sheet continues to be conservatively positioned with total capital at $4.7 billion at March 31, 2011, down from $4.9 billion at year end, reflecting the share repurchase activity during the quarter. In the quarter, we repurchased 2.7 million shares for $237 million, at an average price per share of $88.25, which added $0.16 to our 2011 first quarter ending book value per share. Our debt plus hybrids represents approximately 15% of our total capital, well below any rating agency limit for our targeted rating.

Our book value per share ended up the quarter at $91.02, up 1.2% from year-end, and 18.3% from a year ago. Our excess capital position, which we define as the rating agency actual capital in excess of the required capital for an A plus rating, plus a buffer, was estimated to be at least $600 million at the end of last year under RMS 10 and including AOCI. The reduction in capital, mainly due to share repurchases in the quarter, brought this down by approximately $200 million to $400 million . The final implementation of RMS 11 and the rating agencies' reaction to this one model may also have an impact on our excess capital position, but it is too early to estimate this impact.

With these comments, we are pleased to

(Operator Instructions) Your first question today comes from the line of Jay Gelb with Barclays Capital. Please proceed, sir.

Thanks. Good morning. Two issues I would like to cover, if I could. First, in terms of the pace of share buybacks, you mentioned that Arch did not repurchase any stock in the second quarter yet. I'm trying to figure out if that is a signal that you think you will have the ability to write more business, or if it's driven more by the implementation of RMS. So that's the first one, in terms of the outlook for share buyback.

And the second one is, can you talk about more broadly in terms of the expectations for the June and July reinsurance renewals for the US, in terms of what your expectations are there? Thanks.

On the first one, usually when we are in the closed window we put a 10B5 plan, and the parameters we put in didn't allow us to purchase any shares. It doesn't mean that we're not going continue to look for opportunities to return excess capital to shareholders. Our usual pattern, though, is that we do more in the first and fourth quarters, and we do less in the second and almost none on the third. On the basis that the hurricane season is in the third quarter and we want to make sure that we know the outcome of the season before we go back and accelerate the share repurchases. So, no real change in strategy.

Too early to tell if RMS 11 will have a significant impact or a slight impact. We are in discussions with them and also with the rating agencies. We will know that and we will factor it into our calculations to derive as to how much excess capital. We still have excess capital on the books, even though there were not a lot of earnings in the first quarter and we did repurchase quite a bit in the first quarter. So no change in strategy on that.

Your second point, you are focusing mostly on the cat business, and all I can tell you is that the environment is better today, both significantly better on the international property cat area and better for domestic, especially Florida and Northeast. And as I said in my prepared remarks, I think there are two factors by our own estimation that is causing that. There is more need for more secure capacity, so some buyers, they would rather do business with the A-plus companies than the A or A-minus companies, if they can get more capacity out of them.

And, two, they are anticipating demand, because the PMLs will escalate with RMS 11, will increase. We have not seen that effect, as of yet, in the marketplace because everybody is dragging their feet in implementing RMS 11 and there is kind of a delay effect to it. But, it is already affecting the market because, the ask, even on great programs is slight negative or flat by the brokers. On not so great programs you're getting rate increases even for US. Too early to tell, but June, July -- by the next call I think we will have more clarity on that issue.

John, you want to add anything to that?

Just to follow-up on that, quickly. Sorry, John. Some of the brokers have come out and said slightly negative to flat for the June, July reinsurance renewals. Do you think that's a reasonable expectation? We've been hearing elsewhere of much higher expectations for rates.

You're asking me to guess. I don't know how the market will react. If I have to bet, I'm not a betting man, I like my dollars in my pockets, so I don't bet. I would say probably it will be flat to up as an outcome, not negative to flat.

We're still at the bid-ask spread of the process here, so I think it takes a little more time before you get some clarity where the market will settle.

The retro market is very hard right now. Not a lot of capacity in the retro market. Some participants, their capacity is driven or derived because they can buy retrocession protection. Absent of that, you might have some players that might not have enough capacity to deploy, so your supply/demand balance changes, especially with RMS11 pushing PMLs up, so in essence pushing demand up. Now, the buyers, they are resisting accepting it, and they are trying to rope-a-dope, delay and hopefully it will go away. I don't think it's going to go away. It will get readjusted, but it will have an effect in the market and the effect will be positive .

Very thorough. Thank you.

Your next question comes from the line of Dan Farrell with Sterne Agee. Please proceed.

Thank you. Good morning. Just a quick follow-up on the models and the PML numbers that you gave. To what extent do those PMLs also factor in the other modeling companies and your own internal assumptions? And when you went through the exercise, how do you decide how to weight each model in your own internal views when you come up with your own results?

We underwrite on a combination of models and adjustments we make to the models, and that has been our history. We don't take any one model and derive all of our decisions out of it. For consistency in reporting to you the PMLs, so you can have a point of reference that is consistent on a quarter-to-quarter, year-over-year basis, we always use RMS in its purest form, without any modifications. Our cat teams they will do, by using either AIR or our own internal modification that we do.

So, two different things. I report to you purely on RMS and those escalations is using our datasets running it at RMS 10 and RMS 11 and getting the numbers. You have seen that it is around the high 20s, low 30s, the escalation. From one to the other .

These are still preliminary, though. They are still underway, our teams are still in discussions with RMS on all of this. But we thought it would be good to at least share with you where we are at, at this moment.

Right. But it doesn't mean that's what we use to underwrite. Our underwriting process is much more complicated than that, and we don't talk too much about that. We like to enjoy the results we have been enjoying. We've been underwriting cat business for ten years, so we try to be as secretive as we can.

That's helpful. And even if they're preliminary, those numbers are certainly helpful to provide. So, thank you. An then, just one other follow-up. Can you talk about your purchases of any retro cover yourselves in the first quarter?

We have purchased retro cover that gave us, as you can see, there is a gross and net outcome, and I think we put it on the press release . The likelihood of us renewing that, depending on what prices are, is small right now. Because we would rather be a seller than a buyer right now, based on where the

Okay. Thank you very much.

You are welcome.

Your next question comes from the line of Dean Evans with KBW. Please proceed.

Yes, thanks. I was first wondering if you could just sort of touch on the three losses a bit. What could cause them to drift upwards or could cause us to see increased loss numbers there ? And I guess if you would be willing to comment, what percentage of contracts for each of them are booked at the full limits? Just any color you could give on those angles

You have the spreadsheet in front of you, John, I don't know if we do. Let me give you the first broad question. I don't think the losses, at least for the reinsurance world, might have significant escalation. The one event that has the most potential (for development) is the Japanese quake and the contingent business interruption. It's an area that it might shrink, but it's not going to be a significant number in the scheme of things.

If you believe the industry loss is somewhere between $25 billion to $35 billion, the insurer industry loss being between $25 billion to $35 billion, with heavy business -- contingent business interruption losses, you might be on the upper end of that scale. And you might be on the lower end, if it is, that is not a significant factor. So I don't think it's going to change things significantly. Now, on the contracts we have, yes, some contracts we have booked if we believe that the limit is gone, we booked the full limit, and some of them we have not. It was a process that we went through identifying all the contracts we had, information that we had from brokers and cedents, and also using our methodologies like market share based on industry loss and then from all that, putting it together we came up with our booked estimate.

Okay. That helps a bit on that.

Second question, shifting gears, if I could. Looking at the reserve development, even stripping out the $15 million from the named cat events, it does seem a little bit higher than maybe the historical run rate the past year or so. Can you give a little additional detail ? You touched on it a bit in prepared comments, but maybe just a little additional detail on where the reserve development coming (inaudible)and some of the specific

Before I turn it over, let me give you a general comment, and then I will turn it over to John and he can give you maybe a little more detail. The cat events came from both Chile, I think, and Australia flood. In the Australia floods, it was -- you remember, we had two events. We had a December event and then we had a January event. When we were booking the losses for closing the fourth quarter of a year ago, we put quite a bit more than we needed on the December event, and then upon reflection, we had to release that. It was more losses coming from the January event, not the December event. The Chile was an overestimation by us and the losses did not develop. So, put that aside. That's one-off. It happens. You try to be conservative in setting up your estimate. And let's face it, quakes are very hard to estimate until you get all the information.

Now, the 2002 and 2005 years in casualty reinsurance, they're really performing extremely well for us. It seems there has been at least six years, and maybe up to eight or nine years on the earlier years, we have more certainty. And as those diagonals on the triangles are getting developed, I think you might be getting outside the point estimate range that you are allowed. And then for that reason, we had to release the rest of it . With that, I will turn it over to John to give you a little more color on the specifics you

Certainly, Arch takes its time, when looking at casualty. I think history has shown that you can be a little too optimistic on these lines sometimes. So we tend to wait some time for it. But these 2002 to 2005 years in reinsurance, really, we do our audits, we look at what's happening and developing, and we thought it was appropriate to release these years from 2002 to 2005. We also had property -- cat had prior year favorable development, both in Chile and also in Australia floods. But also, just general, other than the large named cats, we have a cat load just for smaller cats and those just released and really came through, on a flow through basis. Those were the largest points, and the property happened, both in reinsurance and also on the insurance side.

Other than the 15 that was specific to the two events, we had more property releases, both on insurance and also on the reinsurance sector.

Okay. That's very helpful. Thinking about the casualty reserves a bit, when do you start to get comfortable about some of the more recent accident years there, like the 2006, 2007, or 2008. As of right now, are you seeing the same types of favorable trends that you've seen from the 2005 and earlier, from those years?

No, you're getting into years that we have concerns, not comfort. When you get into the 2008, 2009, 2010 years we have concern. Not with us, but in looking at the aggregate accident year numbers that the industry has booked, and all that. I -- if I have to guess, probably if you see any development in those years, it won't be positive, it will be negative development. Meaning, have to add, not release from it.

And we're in that peculiar period of time in our business that the rate reductions now, that have been almost five years or so, there have been rate reductions coming, going back to 2005, 2006. And at some point in time, you know, rate reductions have a way of eroding margins. Even if you have thick margins, they become thinner. And at some point in time, they get to be negative, and people don't always recognize that. And at the same time, you have the old years, the 2002, 2003, 2004, 2005 years, that they're getting more mature. Cases get closed. You don't have that many open cases. You're carrying a lot of IBNR. The actuaries are looking at it. The accountants are looking at it, and says, what are you doing (inaudible). If there is no claims, there is no claims.

So we're in that peculiar period of time that you're going to see releases coming from the good underwriting years, especially for those who haven't released them yet. And at the same time, you're going to see current accident years maybe not being booked exactly where they need to be. And that's what makes cycles. And at some point in time is when that pain comes in, with the current accident years being unacceptable, that you're going to see the broader market to turn.

The market is trying to get this uplift. The rate reductions, they have been small. There is a lot of pockets that you're getting increases. You've got to look hard for them, to find them. But it's not a broad market. It's basically, I would call it more of a bottoming, and an indication that things have to improve, otherwise, there is going to be blood on the street. And that's our point of view about the market, where it is.

You know, you remember that you can have casualty lines, you can have some fun things pop up seven years from the year. So, to answer your question, our 2010, well, we'll know in 2017. We will be cautious and wait to let those years fully mature.

Okay. That is borne out by your history and we appreciate that. Thank you for the thoughtful responses.

Your next question comes from the line of Brian Meredith with UBS. Please proceed.

Good morning. Dinos, there's a couple of questions. Most of the growth this quarter, a lot of it was coming from casualty lines, and as you pointed out, a lot of that's on the international side. Just wondering what's the difference in the market dynamics over there and why are you seeing better pricing in some of the other casualty lines?

Don't translate that as optimism; it was opportunistic. Most of the casualty increases came from energy casualty related business, and marine liabilities and it was more of the aftermath of Deepwater Horizon. To get specific, there were programs coming up and most of it was rate increases. In essence, my guys they told me three times yesterday when I was preparing for this call, keep telling them it's a one-off, because don't let them think that it will repeat itself, quarter after quarter. So that's that part.

How about personal liability?

The personal liability. It's a team of underwriters we have -- if you've been watching us closely we hired about, I would say, a year ago, five quarters ago, they came from Lloyds. They underwrite professional liability for small and medium-size enterprises. They have a traffic track record with extreme profitability through the years. It took them some time to get accustomed to us and our systems and get traction, and that's where that business is coming from. That is more, I would say, has more potential to have more growth, depending on where the market goes, but we're pleased with both areas. But this is not a broad movement on the casualty lines in the international arena that we think the environment will get much better, but when we find certain opportunities because of one event and we can take advantage of it, it is in our nature to do that.

They're already in this professional liability, mainly in continental Europe, for their SME-type businesses.

Okay. And the next question, just quickly on the capital management and your excess capital, and you talked about it being in excess of kind of where the S&P levels are. I'm curious, when you talk about excess capital or you talk about debt, are you factoring in the ability to take, call it a one in 100 year PML loss, and still be able to write business without raising equity capital? How should we think about that?

It's the same formula we had in the past. We take the rating agencies required capital at our rating. We look at how much capital we have, and then we add to that capital what one year's earnings would be. Then we subtract from it the one in a 250 year event, and that gives us the cushion that I can begin and end my year with a one in 250 event with my required capital. The rest of it I consider excess.

Excellent.

You have estimate earnings that you're comfortable with. You know, you're going to eat up the earnings for the year if we have an event. I need to have a little extra above it, because the event might be, I don't know, twice our earning potential whatever it is, so I account for that. And then basically, that gives me the rest as excess capital.

Brian, that's what I referred to as our targeted rating plus a buffer.

Got you. That's great. Thank you.

Your next question comes from the line of Mark Dwelle with RBC Capital Markets. Please proceed.

Hello. Brian actually took one of my questions. But the other question that I had is, within the investment portfolio, the cash and short-term investment component continues to rise fairly sharply. Obviously, we've had a little bit of a reversal in short and medium term rates. Is there any plan to deploy any of that on a little longer-term basis? You commented in terms of adding to the equity exposures, but it seems like the liquidity end of it, you're still keeping an extremely short duration there.

I don't think our outlook is changing. We want to be short in the current environment. We are in the camp. We don't know if we are right or wrong, but at least we tell you how we think. We are in the camp that we are afraid interest rates will go up, not down, and that will have, if you're long in duration, it has a devastating effect on your portfolio. What we are doing that is -- it's also difficult for you as analysts to go quarter to quarter and see what investment income is.

Not only are we putting some more into equities, but also we are putting more money into sometimes segregated funds that we are forced to account on the equity method. Even though some of the investments in those funds might be fixed income type of investments. So if we own them outright ourselves that would probably account as investment income, but because of the structure of the transaction we have to account for them on an equity method. We focus more on our total return and how well we do quarter after quarter, not the accounting. Because every time that we get with accountants, it's a three Advil discussion with me, because they have so many rules . I'm a reasonably smart guy, reasonably, take that with a grain of salt. But, I get confused with all the accounting rules. They got so many, it's beyond my

Well, Mark, Arch always believes in running a conservative investment portfolio, but it's a fascinating time when a conservative portfolio may not mean investing in long-term Treasuries. It's sort of the opposite way. So, we think being short, shorter is that correct approach today for the risks that are out there, and we will have to wait and see if we are proven right or not. Going long right now just doesn't appear to be a good risk return trade off.

Okay. Thanks for the clarification. Thanks.

Your next question comes from the line of Jay Cohen with Bank of America Merrill Lynch. Please proceed.

Thank you. Good morning.

Hello, Jay, how are you?

I'm great. The continued healthy level of favorable reserve development, even excluding some of the named cat favorable development you talked about, I guess suggests that the claims environment has not changed all that much. I'm wondering if you could talk about that, what you're seeing from a claims frequency standpoint in newly arising claims?

Don't forget, a lot of our favorable reserve development is coming from the years that both the frequency and severity, they were very favorable. The frequency trend is still positive, meaning that we don't see an uptick in frequency. But we are starting to see a little bit of an uptick in severity. And of course, what you need to worry about is not only what we see, but how you project into the future. Because it is not CPI that causes us problems, it's wage inflation that will cause problems, it's medical inflation that we already have in the numbers that causes problems, and most importantly, is socio-economic inflation, when you put 12 jurors in a box. They are going to determine if half a million or $1 million is a little bit or a lot of money, when they have to determine pain and suffering, or any of the other theories that the plaintiffs bring forward.

And I think that period of time that we had low frequency and low severity, it will reverse itself. And especially-- when people feel more wealthy, I think the numbers all of a sudden, even when they have to calculate pain and suffering, go up . We call that socio-economic inflation. Very, very hard to predict, but you've got to have your eyes open. That's why in maintaining our claim process true to what is going on in the environment. Every single open case we have has to get reviewed at least once a quarter and get readjusted to all the new information we have, independent if it's changing case law and/or new reality. In order for us to be able to derive our needed pricing going into the future, on an as needed basis. So, it's not an easy process. That's what makes this business more interesting.

And you've got to have-- not having the right reserves is it not just embarrassing when you have to make a reserve addition. It's problematic, because it might be guiding you're underwriting to be pricing the business at not adequate rates, because you didn't get your reserves right. And that's why we looked at not only our own data, but we looked at a lot of industry data in order for us to have a point of view on pricing that allows us to feel comfortable for the business we put on

That's helpful. I guess just to follow-up on that, on the property side, we certainly read a lot about commodity price inflation and building materials, whether it's steel, or lumber, roofing shingles. Has that's shown up at all in property claims?

No, because labor cost, which is a big component, is so much down. There's more unemployed construction workers. I think the construction industry is the hardest hit industry and -- listen, I'm in the midst of building a house, this project is -- I gave my wife and unlimited budget and she is exceeding it. I can tell you, when I negotiate with these guys, we get prices that even my GC says they are unbelievable today.

So, I know firsthand that it's a good buying opportunity. If someone wants to build a new factory, this is the time to do it. And if someone wants to renovate a home, this is the right time to do it, in my view. But that can change quickly. You get unemployment, you get new construction permits, if we are going to start getting into street and road work -- and you will see that escalate very, very quickly.

Great . Thanks for

You are welcome.

Your next question comes from the line of Matthew Heimermann with JPMorgan. Please proceed.

Hello. Good morning, everybody.

Hello, Matt. How are you?

I'm well. Thank you. Hopefully, these will be quick. And I will give them to your first. A lot of other commentators or managers of companies have suggested that they've made tweaks to the models over the years and therefore that's going to mitigate the impact that RMS 11 might have on the spokes. I would just be curious if that is something you did internally. Based on the numbers that you gave, it didn't necessarily sound like it was dramatic, if that was the case. And then, how believable some of the other commentary we may have heard is.

And then just quickly, remind us what alternative markets business is. And also just the national accounts, following up on Brian's question, that's another area that popped after several quarters of pretty significant reduction. So just some context there.

Okay, three questions. Let me start with the first one. The first one, the numbers we gave you is purely running the model at its purest form. So that's the comparison. Usually, I think the statement others made, and also what we do within our shop is correct. Very few shops that will run the model and underwrite without any modifications. We always had all modifications, especially in Florida, our cat teams had a different point of view about damagability in inland areas versus the models. So, it's the underwriting posture in a different direction than others. I can't tell you as to what other modifications others make, but I know our guys that were modifying their approach to underwriting, especially in Florida.

And some of that comes from the experience we have with different storms. If I take you back to 2004, Charlie entered from the Gulf and exited into the Atlantic, and I can tell you, it did more damage exiting than entering Florida. If you go back and see what happened, and people are going to tell you it was a narrow storm, the width of the eye was not that wide, et cetera. What difference does it make? Here's a storm that was doing a lot of damage in the middle of the state that it was doing on either one of the costs. Our guys, in their thinking and modifying things, they changed their underwriting approach. And it wasn't just that storm. They do a lot of analysis. The statement that others make that they do modify their models is correct. We do it, and I'm sure others are doing it as well.

Alternative markets is predominantly self-insured programs that buy rented captives. We have captive capability in Bermuda. And this might be a collection of clients that they want to self-insure most of their primary risk. Most of their primary risk is GL, auto liability, and worker's comp. They might be taking maybe the first $250,000 or maybe $0.5 million of each and every loss, and then they will buy a bit of the excess and maybe some aggregate protection to protect the rented captive. And we are in that business because we have the capabilities of managing all that.

In national accounts, it's a similar business, exactly that . GL, auto, workers comp, but written for a single entity, a very large corporation, that they want to self-insure quite a bit of their primary risk. A lot of them, they will take $250,000 on each and every loss or $0.5 million. When I say primary, the first $1 million of risk on the GL and auto, and then the statutory, of course, on the workers comp. That's what we do on those two areas.

A lot of this business has some underwriting risk, but it is more limited. You are underwriting the buffer, and in some cases, you are underwriting the aggregate stop that you might put. To be successful in this business, you have to be very good in service, because it is a service intensive business. And I think we are small in the sector. We are not as big as the Zurich or the Travelers, or the Hartford or Ace, et cetera. But for the clients that we attract, we give very good service and our retention percentages are very

Just following up on the -- Thanks for that, Dinos. Just following up on the first question of the PML. Is it fair to say then that, I forget exactly what the number was, but relative to Northeast PML-- it was 24% of capital, the $955 million

We take it at it's face value there.

Yes, so realistically, we are probably splitting the difference there somewhere?

It could be. And don't forget, it is only for our Northeast zone. It's not -- A lot of zones around the world we don't have that much exposure. The zones that it will affect us a bit is the Northeast, and maybe a little bit in Florida. We still have quite a bit more capacity in Florida. The changes on the quake was-- they were minimal.

And, Matt, it's John. This is still under review. We are in discussions with RMS to truly understand all the various components of this. We still stress preliminary, but thought we would just give you an indication .

Okay. Much appreciated. Thanks.

Your next question comes from line of Greg Locraft with Morgan Stanley. Please proceed.

Yes. Hello. Thanks, guys. Just again on this RMS model, if I seem to recall, I think you all had excess capital a couple quarters ago in the $600 million range, at the mid-point .

Correct.

Okay. If I now run it forward, we've had a heck of a quarter in terms of the storms. You guys were very aggressive, and continue to be aggressive, in buying back capital. And the PMLs went up. It is not a stretch to say your excess capital is less than 600, right?

What we said already is 400. And it might go even below, that depending on the RMS 11 implementation.

Okay, so that 400 -- I apologize then, I missed that number -- so that 400 is without RMS or is with RMS?

It is based on the old RMS model.

Right, on RMS 10.

Okay. And then RMS, you take the PML from a $726 million to a $955 million. Why wouldn't I just assume that 400 goes down by another $225?

Well, because that's a simple mathematical approach to it. It depends on what the rating agencies are going to do with the new PML. Is that going to require additional capital or not? Because the rating agencies in their capital model, they are not looking at just one event. They are looking at the aggregation, or the aggregate exposure you have, over multiple events within the same year. It is not as simplistic as doing that calculation.

There are also multiple models in which the rate agencies are still learning about all this, as we are with RMS 11, so we need some time to sort all of us out.

Right. And don't forget, that's my own calculation as to how I determine the cushion. It is not what the rating agencies want, right? I go far beyond the rating agencies' requirements. If I don't believe the 955 is the right number, and I'm going to modify my internal models, and let's say that number is 800, that's what I'm going to use. So, there is still a question as to how much safety we need to have in the way I calculate excess capital.

I totally appreciate that. You guys have always had tremendous levels of excess capital. I guess I'm sort of surprised at the rate of decline in six months in your levels of excess capital. And I sort of wonder, in a world without retro, how do your peers and how do people manage going forward?

It depends how they count and also--. Don't forget, I bought aggressively in the first quarter, because I bought shares back, because I thought it was the right thing to do for shareholders. When I can buy my shares at pretty attractive prices, and I knew based on the events that our earnings are going to be skimpy or nonexistent, right? As it really happened. When you get three major events in one quarter, we are lucky to be in the plus, right?

So, at the end of the day you've got to know your book of business. You have to understand your capital position, and manage accordingly. We will never run this Company thin on capital. We will always have the cushion that we like to have to handle, in our view, a one in 250 event, and begin the year and end of the year with the required capital the rating agencies want for our rating. The whole principle around that methodology is that I want to be on the dance floor when-- if you have a one in 250 event, which in our estimation, depends on which part of the world. If it happens in Florida, it's an $80 billion to $100 billion event. I can tell you, you have a totally different market and I want to be one of the companies participating on the aftermath of that.

That's why we are conservative with that. And that's why we are conservative also in our capital structure, by only having about 15% of our capital in hybrid securities, debt and hybrids, which allows me to quickly access the debt markets, if I need to. The opportunity to expand dramatically is there.

Okay. Thank you very much.

Your next question comes from the line of Matt Carletti with JMP Securities. Please proceed.

Hello. Thanks for taking my question. Real quick, just wanted to circle back to the share repurchase discussion. I know you talked about how maybe changes in the RMS model play into that, as well as capital levels. How much has the recent expansion of valuation in the shares temper your appetite at all for repurchase going forward?

Matt, we have a formula that we use all the time. It's a grid that looks at what ROE I produce by writing business, and what is the price to book value that I can buy my shares. Of course, when it is less than 1.0, it is really a very easy decision. When it is more than 1.0, you have to go through the calculation. And as long as our recovery is three years or less, we still believe that the share repurchase is the right way to return excess capital.

Of course, you have to look also what the outlook is for the business. What you expect for things happen in the future, et cetera, as part of that calculation. But on a pure price, at 112, we are trading at about 112, 113 times book, it's still attractive for us to buy shares back.

Okay. Thanks.

Your next question comes from the line of Ian Gutterman with a Adage Capital. Please proceed.

I guess it's good afternoon, now.

Well, you are always in the back of the room so--

Dinos, I feel like I have to clean up some of the questions.

Okay.

The PML thing, I'll ask -- I think people are beating around the bush. So if I can ask a bit more directly.

Go ahead.

I think we take at face value that 955 RMS, and noting historically your PML tends to go up into wind season a little bit. Maybe that goes over $1 billion and you're over 25%, on paper anyway. So, I guess the real question that people are trying to ask at is, if cat rates really up 10% or more at midyear, do you have the ability to grow exposure or are you just looking to maintain exposure and take the price increase?

No, don't forget, the one thing you missed and usually you are a careful listener. I said Northeast.

Understood .

The Northeast does not go up for us in June and July. Florida has the propensity to go up, or the Southeast. So, there is still quite a bit of capacity for us to use depending on pricing. And there is no limitations, other than are we getting the right rate on international cat, where we see a lot of opportunities, or in quake zones anywhere in the world, which also we believe we have significant additional capacity.

I guess I'm looking traditionally, though, Dinos. It seems the past few years Q1 the peak PML has been Northeast, and then when it becomes Q2 and Q3 and it becomes Florida, that number's been larger than the Northeast number, so I would expect that 955 to go up, traditionally.

Well, the 955 is the Northeast. And the Northeast usually doesn't go that much up in the middle of the year . So, what we have is what

I just meant that Florida tends to surpass the Northeast.

Yes, Florida might go to, if we add up-- don't forget, the percentage in Florida was less than Northeast. Northeast, if you recall, it was 32%, while Florida was 28%. So, even with that, we have capacity to go to $1 billion. So there is plenty of capacity there. I wouldn't worry about that.

So you feel you can grow exposure if the opportunity is there?

You tell me the prices, I can tell you how much I can do.

Got it. And just to clarify Matt's last question on the repurchase, I think last call you said 115 to 120% of book was the governor, and as you mentioned, you're pretty close to that. Is that grid based on with stated book or ex the unrealized gains? Because ex unrealized gains are obviously over your grid.

Stated book.

It is stated, okay. Do you worry, though, the fact unrealized gains are a meaningful component, and you know, if we saw a little rise in Treasuries, all of a sudden year-over-year your target price there?

Economically, you wouldn't get back.

Unrealized gains -- it's your entire portfolio you have to worry about. Not just unrealized gains. What difference does it make if they're unrealized or realized? At the end of the day, your bond portfolio is exposed to that reality and you have to calculate. As a matter of fact, when we do our scenarios, you guys, meaning the analysts, have a tendency to worry only about the cat events. But I worry about a 200 basis points movement on interest rates. A parallel movement, that it can happen within five or six months. And we might have an event like that. To me that's a cat event. What it does to your balance sheet.

Which is why we run with a buffer as well. The buffer could be for a big hurricane or a massive spike in interest rates.

That's what I was wondering, if that would make you slow the repurchase, because if we did see that move interest rates, you would have, in hindsight, bought it back too high.

Well, don't forget, I am still within all the cushions that I talked about. Because even a 200 bp parallel move on our bond portfolio for us costs us approximately $700-some million, which we will recover on the 2.7 years of duration we have. But still, if it happens rapidly, I have a lot of competitors that are a lot more wounded than I am, and also their recovery period is a lot longer than mine. The magnitude is going to be greater and the recovery period is going to be longer. So, I think I am in great shape.

Okay. Fair enough. And then, just some quick numbers, hopefully. Reinstatement in the quarter, what were they and what segment were they in?

Re-- ?

I think in the press release it mentioned there was some reinstatement premium?

For our retro purchases, we have to pay, you know--.

How much was that, I guess, is what I'm wondering?

We got -- it's--

I think it was less than $4 million. It was about $3.5 million.

Yes.

Yes.

And that was received, or paid?

Well paid if you-- an then in some cases--

That was received in reinsurance.

In reinsurance on some contracts, but also we had some that we paid. That was the net net.

Got it. And then were there any losses any of those large property losses like Gryphon or any other things like that, in the quarter?

Nothing material.

No. Nothing material.

It's all included.

If it was material, we would have highlighted it.

That's right, but I just wanted to double check. And your remaining cat cover for international events for the year, where are you on that? I don't know if you renew that on January 1 or July 1, but given we've had so many significant events, do you have enough cover for the remainder of the year or do you have to look to buy more?

No, we have plenty for the remainder of the year. As a matter of fact, our insurance group , there is not an event that would even come close to touching their cat cover. With one of the companies, we just gave them premium, we are not going to give them any

Perfect.

Well, it's not perfect. When you pay for something, you want to get something in return.

Understood, but it's better than the other way. All right, that's all I had. Thank you guys.

Your next question comes from the line of Josh Shanker with Deutsche Bank. Please proceed.

Thank you. Sorry it's running late, gentlemen.

Not a problem. You got in the back of the line again.

They get me sometimes.

We saved the best for last.

In terms of the aviation business, I think you guys started to shrink that business a while back and it's coming into premium now. How long should we expect the premium to shrink for in that line of business, as you move away?

I don't think-- With the aviation, I think the last year in the second quarter, we had a maybe $13 million, $14 million gross, and about $4 million or $5 million net. Don't hold me to the decimal point. I'm going by memory. That will be the last component that you would have something that is not renewing coming up, because we are out of that business.

For commercial and general aviation.

Right.

So we think about the property, energy, marine and aviation line, that should stabilize going forward?

Yes. After the next quarter.

By the amounts we just talked about.

Right.

Then, executive insurance versus professional liability. While they are not the same customers, they are often the same underwriters who are participating in those lines. Why -- can you--?

No, not in our shop.

Go ahead. Please explain.

They are two different units. Our professional liability underwriters are a different set of underwriters from D&O underwriters.

No, not at Arch. I'm talking about your competitors. You're competing with the same competitors in both those businesses.

That's correct .

So in terms of the market trend, are competitors getting more aggressive in executive assurance and they are lighting up? Why is this there bifurcation happening?

Well, if you are pricing the business on experience, you can justify being more aggressive in this market . If you are pricing the business on exposure, I think you ought to be more cautious. And that is our point of view. Our underwriters' point of view.

Listen, I'm not saying we are right and they are wrong or vice versa, it's a difference of opinion. I have faith in our underwriting teams that they are calling it with caution and we're giving up some volume. And at the end of the day, believe me, I want to grow this business, but I want to grow it in the appropriate market. And right now, both on financial institutions and in some commercial segments, what we see is it not acceptable to us. So, that's the reason we chose to

And Josh, you are seeing a shift between regions, because we are decreasing executive assurance in the US, but you're seeing what Dinos spoke about, the professional liability is SME and growing in Europe.

Very good. And finally, on the Aeolus loss expected for the next quarter, will you get an opportunity to reinvest for potentially higher rates there? Is there an opportunity as well as a loss there?

Well, no. Listen, we are participating in this investment, and I don't have a preview of their underwriting. But I can tell you, their underwriters that they write a lot of-- all of their business is in the cat business, and the cat business is improving. At the end of the day, we go with basically whatever activity they decide to do.

Okay. Thank you very much.

You are welcome.

Our final question today comes from the line of Vinay Misquith from Credit Suisse. Please proceed.

Hello. Miscue, that's interesting. Two questions. First is on retro. You seem to have bought more retro this quarter. Was that just reinstatement premiums? And when do your retro purchases expire, and would your PMLs go up because of that?

The PML we don't calculate on the basis of retro purchasers. At the end of the day, we want to eat our own cooking. At the end of the day, we go with the capacity, because there is no certainty that always you're going to be having the ability to buy retro and you don't know at what price. So from the PML perspective, it will have no effect on us. As a matter of fact, like I said, we don't anticipate that the pricing will be attractive for us to purchase. So, the likelihood is that for next year, we won't have retro protection.

Sure. Fair enough. And did you buy more in the first quarter?

No, it's whatever we bought -- it was a program that we renew year after year.

Great. And the second question is on share repurchases. Is some of the decision not to buy shares in the second quarter because of maybe waiting for higher pricing later on, or is it just purely an evaluation on the stock?

No. As I said, when the window is closed, we put a plan, a 10B5 plan, and then you have to set your parameters. Then the stock price moved, and when it went beyond the agent couldn't purchase anything, because it was outside the parameters . Now, after the earnings release, I think the window opens in two days, tomorrow, then we can resume, depending where our share price is, to repurchase shares. So, the fact that -- don't read into the fact that we didn't by any in the close window, that our desire or our strategy has changed on share repurchases. It's just that it happened as such, because of the 10B5 parameters that

Sure. And the fact that you are willing to buy back stock, would that mean that you think that the cycle down is further away?

Well, no, I still have the excess capital, right? At some point in time I have to account for it, if it is excess. Unlike the first quarter, we have no earnings. We were anticipating that we would have earnings in the second quarter. Third quarter and fourth quarter, I am hoping in your model you have us earning some money. That is what we are here for. So at the end of the day, we should be building additional excess capital through earnings . And then you need to do something with it. So, it's not an indication, as of yet, as to where the market is.

What I said we still believe. It is not a broad market turn. I think there is, this expression we are starting to see some green shoots in some of the casualty lines, but they are isolated and this is specific . And the property and property cat, especially international property cat, is improving. Florida, you heard the prior commentary. We are going to wait, but there is more positive movement even for the cat business in the Southeast. So, we are optimistic that it's going to be a better environment. Is that an environment that allows us to deploy oodles of money? I don't know as of yet.

But share repurchases, the beauty of it is you can turn the faucet on and off and it is at your own volition. So at the end of the day, we can monitor where the market goes, react to it and we can continue purchasing at the same level or stop, if we think that there is really tremendous opportunities for us to deploy the

Okay. Thank you very much for your answers.

You are welcome.

Ladies and gentlemen this concludes today's question-and-answer session. I would now like to turn the call back over to Mr. Iordanou for closing remarks.

Thank you for listening to us and enjoy your lunch, everybody.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.