Welcome back to the Bank of America Securities 2021 Virtual Insurance Conference. If you're joining now, it means you're joining the Arch Capital presentation Q&A, and we're happy to have you. On your apps, there's the Veracast app. You can send a question to me, and I will ask it. Please don't be shy. We would love your questions. Just know queuing up, the next session is going to be Hanover, so you can also queue that one up as well. I'm really pleased to welcome Marc Grandisson, with a C, by the way, which is very modern, CEO of Arch Capital Group, and François Morin, the CFO. Really pleased to join us from Bermuda. I have lots of questions. Obviously, a lot is going on in the world. You're not one business, you're a bunch of businesses, and that's kind of where I want to start. If I think about maybe a year ago, maybe 2 years ago, I don't know when, you said multiple times, I believe, that the mortgage insurance business was a mid-teens ROE business, is something that you said in the past. In the third quarter conference call, you said that right now, among your businesses, the mortgage insurance business is your third-best use of capital after insurance and reinsurance. My question is, has the ROE for mortgage insurance come down? Maybe interest rates have done that a little bit. Two, what does that mean for the ROE on the P&C businesses if mortgage insurance is now the third-best use of capital? Josh, nice seeing you. We missed you yesterday on our call, your typical questions. I'm sure we're going to get more of those today, which is good. Which is a good place to be. Yeah. On the ROEs, I think that it's true that our mortgage We had changed our expectation of long-term loss ratio and loss rate on the portfolio in the second and third quarter. We were a bit more careful with the long-term expected. I think that what's happened over the last 4 or 5 months has sort of brought us back into more of a longer trend that is more probably pre-COVID level. We've talked about having a 2018 sort of level of profitability. I would say right now that mortgage has actually crept back up again, among the top, if not the top provider of return on capital. I think the other 2 businesses are certainly still in the mix of being really good returns. I think that we are getting better rate increases. I think right now the three lines are competing for a good return. I don't think that on the insurance and reinsurance we're quite back in the mid-teens quite yet. I do believe that low teens for both and maybe reinsurance a bit better because of the speed by which it takes advantage of the market opportunities and the ability it has to deploy capital a bit more quickly, I think could be probably between the insurance and the reinsurance. All the three of them are giving us double digit plus returns as we see in the fourth quarter and also as we got into 1/1, 2021. In a way, Josh, it's a great place to be for us. It creates more opportunities and more opportunity set, a wider opportunity set for us at Arch, which we were thinking was going to be much more focused on the P&C as we were heading into 2021. It turns out MI is also really favorable right now at this point in time, which is good. I'll add a couple complexities into the picture. You historically have said, and it's not a rule, but it's a spoken sort of guideline that you would be happy to repurchase your own stock at a price below three-year ahead book value. Right now, I think the stock is trading about three-quarter ahead book value, if I'm calculating correctly. Yeah. You're going to be buying in Watford about 81% of book. You also, earlier in the year, made a deal to buy one-third of Coface. Those two things are growth, I guess, to some extent, buying back shares isn't growth. Obviously, growth is attractive, but if you were buying in shares five years ago at three years ahead book value when the ROEs were, I don't know, still probably low double digits, I don't know where you want to say it. Where does repurchase, acquisition, where does that fit into the frame of best use of capital? Let me take that. I'll start by saying the one thing that matters to us, and I think rightly so, is visibility. I think the forward-looking view of capital and book value, yes, there's a baseline on where we think the book value is growing. What you saw from us in 2020 was really a bit of uncertainty, and rightly so, with COVID and mortgage and housing and even the P&C lines not knowing, having uncertainty around the claim environment and everything that comes with it, and then cats on top of that. We took a pause in 2020, as we entered 2021, we knew that our forecasts were a bit more solid, a bit more predictable as we look forward. Certainly, you saw us buy back some $80-plus million of shares since the start of the year. I think it answers, hopefully, your question that buybacks are in the mix. Growth is in the mix. We'd like to think that we can do both. We can grow, we can find attractive opportunities to deploy the capital. The fact that the returns are good and we think will remain good for the foreseeable future, that those retained earnings, the way we generate earnings, and we can deploy that in the business, gives us the ability to return a bit of excess capital to shareholders and improve our overall numbers. I guess the sum of all. It's hard to say one's better than the other. Look, you said that maybe low teens- Yep for P&C, mid-teens for mortgage, also repurchase is very forecastable, it might be a lower returning use, you know the answer already. I guess Coface, can we just talk a little bit about where that is in terms of ROI? Has the ROI changed in the past 12 months on that transaction? No, it hasn't. I think that we got into this with our eyes open. We had a lot of things that we knew they had in place to protect themselves against the downturn, and the government interventions, Josh, definitely helped. No doubt about this, the ultimate result that they produced for the year, which was very favorable, very positive given all the things that are surrounding their environment. We're buying it below book value, right, Josh? From that perspective, they're about a 6% or 7% ROE this year. We're buying 0.8 times book, 0.85 times book, so we are sprucing our returns right now. This is more immediately, it's going to be an accretive transaction as low as would be from the headline perspective. Having said this, Coface is really meant to be a strategic investment, right? I think it's one of the lines of business that has a sizable or very interesting moat, very much the same way the MI would have. You need to have the expertise, the pipe, the relationship, and the expertise to do this. The relationship with all these clients. Almost 100,000 clients in 150 countries, very intimate knowledge of all their affairs, right? Because they're a trade credit provider, they do have a really good insight into the credit worthiness and stability of their clients and the buyers that these clients are facing. It is also, to be fair, somewhat of a work in progress, right? We know Xavier Durand was brought in from GE. We knew this for a fact. He's a really good operator, and really is on the way to transform that business, make it more data analytics driven, a bit more digital driven. A lot of improvements are definitely, we can see on the horizon. It's a good story from Coface and having access to and being partnered with a business that's diversifying further away from most of other lines of business, is something that we want to, right? Being a cycle manager, and certainly that I would expect that over time we'll rub off a little bit of our own DNA, if you will, onto Coface as it goes. I think Coface is strategically another pond to fish from, right? As a cycle manager writ large, if you take a step back, Josh, the more you have various pond to fish from, the more you're able to flex in and out of different markets as you cycle through different markets, right? Because as we all know, the market cycles are not monolithic. It's not in one hard market getting across the board. We understand that sometimes trade credit can be hard when workers' comp is soft or D&O is softer. For us, it's part of the, within the insurance industry framework, having been exposed to this, I've been underwriting this business for 26 years. We understand it very well at Arch. We know there's really long-term value in this. If we apply a bit more of the little rubbing of DNA of Arch on towards Coface, I think the returns are going to be there. The expectation of return for Coface, for all the shareholders out there and those who are thinking about us, we're still in the teens, and we're going to hold up all these investments at the same level of return or threshold and target. The only thing with Coface is it's more of a work in progress. It's going to take a little while to get there, but we're in for the long haul. It's an investment for the future, and we're very excited about it, actually. Okay. Let's move to mortgage a little bit since it's a hot topic. One of my personal hobby horses. In the third quarter, you guys experienced a net favorable cures of about 5,000 homes. In the fourth quarter, the cure to delinquency trend was also net favorable by 6,000 homes. You took up reserves about $140 million in the third quarter, $80 million in the fourth quarter. The homes have been appreciating through the pandemic. I'm thinking that if delinquencies are curing, we should start seeing favorable development. I'm not seeing it in the text and seeing that your lessons are, you know what? For the remaining delinquencies and forbearances we have, we need to be putting up more reserves. Can you square the circle and tell me where my math is wrong? Your math is not wrong, Josh. It's only math. I think what we superimpose on top of math is a bit of judgment. I think the reality is, yes, it's a great story that we're seeing all these cures, that the inventory of delinquencies is coming down at a good clip. The delinquency rate went down 50 basis points in the quarter, that's good. Trends are suggesting that we should see more favorable reductions in the delinquency rate in 2021 for sure. What we don't know yet is the remaining delinquencies, how they're going to behave. That's where, yes, we have historical data to tell us how a delinquency that's 12 months old or 12 months delinquent or two years delinquent, so many missed payments. There's data to help us guide us. This is a different environment. Consistent with the way we think, we'd rather be a bit conservative, be more prudent around how these people are going to come out of delinquencies. Yes, there's excellent data saying that house prices are strong. If people need to sell their house because they're truly in a situation where there's a claim and we need to settle the affairs of the delinquent borrower, that the things should resolve themselves. That said, it'll take a bit of time for us to know more. I'd like to think that first half of this year will give us more data. Maybe later on this year, if things keep progressing in a way that tells us that our reserves are maybe a bit on the high side, we'll adjust at that time. For now, what we got in front of us is a bit of uncertainty, and we'd rather be a bit prudent at this time. I don't know if yesterday, did you give investors any information about January numbers? We did not. Did not. Okay. We did not give, no. Of new notices that you're getting, are these forbearing notices still people who didn't elect to forbear immediately, but six months into the CARES Act they're electing now, or are these delinquencies just by characterization? They're mostly forbearances, still. New forbearance coming through, right? It's now delinquencies has moved a little bit in true delinquencies. Again, this is what's interesting. I think you hit the heart of the matter, Josh, and François alluded to that, is that there's a lot to unfold, right, between the time now and the forbearance program expire, whether they expire in three more months or six more months. We'll see what the FHFA provides to the marketplace. The problem with the marketplace, I think the forbearance that we had in the CAT events, CAT areas, it was a bit quicker in term resolution. I think that the forbearance right now are not necessarily delinquent to the way that you and us would hear or would understand historically. It's still very hard. It's more opaque in terms of information and knowledge, right? Once it seems like the market has said, "Well, it's going to forbearance," that's good enough for now. We don't have as much granular data. The industry does not have as much granularity as we would want to really go into this and deeply evaluate. There's a lot of reasons why people go to forbearance, Josh, right? It may not be necessarily because they lost their jobs. It could be for various reasons out of being more security or being more careful or try to see what happens at the end of the forbearance program. I think it's too uncertain, and I don't think we've ever seen anything like this. That's also something that we are reminding ourselves every day, is that we've never been through that kind of event. We're trying to take a lot more conservative approach to what would be a traditional forbearance program impact, say, on the CAT losses that we saw historically. I think it's appropriate right now, Josh. I think there's a lot of uncertainty still. We tend to think that we're on the prudent side of things. I got two quickies. With the FHFA news yesterday, the day before, about extending out forbearance, do you expect there to be any extension of the CARES Act for private mortgage insurance to also extend out, or too early to say, or probably not? This is a really helpful program for all of us, including the PMI. Obviously, we're private MIs, such as ourselves. Yeah, I think we're playing ball, if you will, with the FHFA and the GSEs, right? Which is the right thing to do, because I think they're providing a lot of support in helping us and helping the homeowners first in staying in their homes. We want to encourage that and be participant in helping them in that fashion. We've been playing ball with them, as we should because they're doing the right thing for us and for the homeowners. Well, here's a related investor question, and maybe because it's going to be off in the distance. The question is: When forbearance runs out, do you expect a big spike in cures suddenly? Well, it depends on all the mitigating things that have been put in place, right? One of them is, I think there is a lot of tools in the toolbox for all these mortgage originators to extend, refinance. Many things they could do to make the loan be more acceptable and favorable and actually digestible by the homeowners, provided they went back to work. I would expect this to happen to some extent if the forbearance programs play the way they should be playing out, and then we fully expect them to do as the GSE. Yeah, we should see a fair amount of cures going through if that works the way that is described here, right? Which is working the way it should be working. In addition, I think that what is comforting, and you touched upon this, Josh, in your comment, is that the house prices have increased over the last year and a half, and they continue to increase as we speak. There is a lot of pent-up demand in housing. There is only about 2 months worth of inventory available for people to purchase homes. I think you need about 5 or 6 months to make it like a regular market. We are really on the short end of the supply for the housing. Which means that if somebody were to not be able to get that out of forbearance into a new refinancing and a better situation to be able to cure its default or delinquency, or bring back to To be current, there is always the option of selling the home, right? You could probably sell the home now at a better price even than you could have done it last year. That also helps in terms of ultimate claims for us. I think there is a lot of mechanisms, mitigation factors as we go towards working through those forbearance out into more being current. Even if that were not to happen, we are encouraged that the housing prices will help mitigate largely whatever cannot be resolved after that. It is all pretty positive. All right. Let's switch. François, you want to say anything, or should we go to insurance? Let's go to insurance. This number hasn't quite been updated to the end of the fourth quarter because you reported just a day ago, but it is going to be basically the same. I calculate from inception through 3Q 2020, the combined ratio in aggregate for the insurance business was a 99.2%, 19 years into the company. Obviously, it is much better right now. Certainly, the fourth quarter it did very well on the insurance combined ratio. Why should we expect over the next 5 to 10 years, the current pricing market aside, that this is a much better than break even underwriting business? What was inhibiting a better underwriting margin the previous 19 years, and what is different for the next 5 years or 10 years? That's a really good question, Josh. I think it's a combination of things, market choices, market conditions, ability to deploy capital in the marketplace, maybe making a few choices differently than should have been made with not full information. What I want to tell you, and this is really the right question, is what has changed. I think that there's a lot that's changed over the last two, three years. As I said yesterday on the call, I'm very, very pleased. We're very pleased collectively as the executive level and the board as to what happened in the insurance group. I think they've been tremendous in improving the IT, improving the data analytics, improving the processes, the claims, the way they approach claims, and their ability and their willingness to be more urgent in seizing opportunities in the hardening areas. Frankly, the other thing that also really helped us this year, it was a bit of timing, a bit of good luck, as I would say to you, Josh, is that we're able to expand our footprint in London through the Barbican acquisition, which has been a very, very positive place to be. We had a couple of things to fix in London, and we've largely fixed them. It's becoming now a huge and a very sizable contributor to what we do on a quarterly basis. To top it all off, we have all these good momentum building in the company last two years. You can talk to anybody on the insurance group, and they will tell you that we did a lot of things to really improve the platform and improve the way we look at things and analyze the risk. Now we have a hard market. Really good timing to bank on this. The insurance group's, the way it's structured, the way it thinks right now is different than it did historically. I think I will describe it in no insignificant part to Nicolas, who is, as you guys know, on the reinsurance side, who's now got promoted to President this year. Nicolas brought a little bit of this reinsurance feel of things and focusing on things for the insurance group, and I think it helped them a tremendous amount. I think we have a really solid story on the insurance side. I think that the improvement is real. We can see it culturally as well as financially. We had a video spread around the network yesterday, and I was able to watch all the insurance guys talking, and you could see the enthusiasm and the willingness to flex into this market and understanding that we have all made all these good investments, sorry, and to take advantage of them. I think it is real. I'm encouraged. I think that we've done a lot of good work, and I'm excited. I think the insurance group is in a really, really good position. If I look at the 2020 loss picks, I have to make some assumptions, but I estimate, even excluding the COVID reserves, that paid to incurred ratio in the P&C businesses is sub 50% for 2020. Maybe you're going to say that's not the case. I get about 40%. Has something changed in the tail length of the average type of business that you're writing, or is it conservative picks? Am I in the right ballpark about how low the paid to incurred ratios are? What's going on right now? Nothing's changed in a dramatic way. I think, certainly, if you're looking on a policy year basis, the numbers should remain pretty consistent in what you've seen in the past. If you look at the aggregate of the portfolio when you're growing, I think some of the numbers that you're quoting are just going to start maybe a bit distorted, right? I think there's a little bit going on when paid to incurred on an aggregate basis in a growth mode, I think should come down, and that's what we're seeing. In terms of loss picks more, yes, there's a lot of good positive signs around terms and conditions improving slightly and rates moving up above, greater than loss trends. As we keep reminding everyone, it's going to take a bit of time for those to truly earn in. For those reasons, I think we like to think that it's better to start with maybe loss picks that are maybe on the high side, and who knows how it plays out. At least we don't have to fill up the void or close the gap if it doesn't work or it doesn't materialize in the way that we think it can or should. Okay. Two questions on compensation, one from me, one from an investor. If you asked me 10 years ago to explain why Arch was successful, I'd always pointed to what I would call a bespoke compensation model, where everybody's compensation is tied to the long-term performance. In 2003, Arch had about 1,000 employees. No, I should say 600 employees. Now you guys are up like 4,500 employees or something to this extent. It's much easier to design a bespoke compensation model in a smaller organization. As the markets change right now, can Arch continue to apply the lessons of its initial compensation model to a much bigger workforce? Are people going to be tied in for decades going forward today? Can you make more money working at Arch than working at one of your competitors? Okay, there's a lot of quick questions out there. I think it's the best place to work. I've been here for 20 years. I love this place, so I'm not going anywhere. Neither is François. I think in terms of compensation, Josh, the interesting thing in all of this is we haven't changed our compensation plan. It's been running for 20 years, and it still continues. This is still what our employees are compensated on. They understand it. I think the only thing that would've been different is possibly in the beginning, you had more people making decisions, in that we hired earlier on. Probably those people were more likely to be on a compensation on the performance bonus plan, like this traditional 10 year that we talked about, Josh, four-year payout and based on ROE with a cap at two and all these beautiful things. I think in terms of percentage, we have more people in the plans, but less of a percentage, because there's a lot less people that we believe are intimately involved in the underwriting. We have the infrastructure, too, that we've built over time, so not everybody has to be in that plan. Although these individuals who are not necessarily on the underwriting function also have a performance-related bonus paid on a yearly basis. We've established this. It's been explained to them on a yearly basis as to why they're getting that multiple. I think the other thing that we would have as well, part of our compensation, Josh, that you won't be surprised has been a really good retaining mechanism, is our stock price, right? Our stock price has done very well. Maybe not so good over the last year and a half, but over the last 15, 20 years, it's done extremely well. That's a really strong retention mechanism. When you look at people, say, comparing themselves with other people who are doing on a dollar basis, but then when you add, some of our competitors did not do as well on the stock price. When you start accumulating all the stock and stock options that some of our employees have received, I think that they are in a really good position, much better position than they would be if they weren't into the other competitors, presumably that would pay more on a cash basis. I think the story is twofold, right? We still have underwriting first. It's still on that basis. We pay less amount of percentage of our employees, but still a very large amount of our underwriting team, most of them are on this performance plan. This pays out every year. I just think that in addition to this, we have the stock price that's been a really good story, and that really helps solidify wanting to be here. Josh, the one last thing I will tell you that has also been more and more clear to me as I got into this, for 20 years I've been here, is that once you've been at Arch and you've worked through a cycle management philosophy of not running a business when it's bad and really focusing on rate, it's really difficult to transfer into some other place. It's difficult for you to unsee cycle management. I think the true Archies, the true Arch bleeding blue, if you will, find this as a place that's more economically rational than another place would be. That sort of helps us to keep those who are really believing in the story. That's really an important part of our story as well, as you know. It goes beyond just that short-term bonus payout. It also is interwoven with that increase in stock price because people do believe in that story. Long story, this is an important discussion that we have all the time, and I think it's worked out pretty well over time. For those that it doesn't work for, you won't be surprised to see that oftentimes we don't mind if they go somewhere else because they're probably not wholeheartedly buying into that story. Along with the question of stock price, I have here a question from an investor who notes that the management comp plan is highly aligned with book value per share growth. Yeah Arch pivoted into some more cyclical and volatile earning streams, in the investor's word, over the past let's call it half decade, which the market might be viewing as lower multiple businesses. The investor wants to know if that's caused a disalignment between management compensation and investor performance, and if management compensation should be more aligned with stock price appreciation than book value per share growth. I'll talk to it, François will correct me if I'm wrong, but I won't get the numbers exactly right, Josh, our long-term plan on the stock is, yes, you're right, has a variability around the book value growth, which we still believe to this day is what's going to make a difference over time. It could be, as we all hear about in the short term, it's a voting machine, the stock market. In the long term, it's a weighing machine. We still believe in that principle. That's the core principle of what we're built on, is to grow book value, presumably consistently above the cost of capital. I think we've achieved that almost without fault throughout our history. We still believe this is the way to generate shareholder value and sustainable shareholder value. In addition to this, the executive team, there is a modifier for stock price. There is a modifier that comes in at the end just to make sure and to echo the question or to follow on a question that was asked, there is an adjustment that has been made for stock price appreciation, outperformance versus the peer group. It is there. There is something in there to make sure that everything is kept in check. Frankly, I want everybody to understand this. It's very important. The plan is as such, the comp committee can decide to change it. It's still under the purview of the compensation committee to make that decision whether it is appropriate in that year to follow what has been filed in terms of this is a guidelines under which we are operating. I think the comp committee, as you guys know, and if you guys know us at any length, our board of director is really keen on performance and really in tune into what's happening in the stock price, and also because they also are shareholders themselves, and also on our performance. It's a lot of checks and balances going at Arch. It's not a one size fits all, everything is made to be within certain guardrails as to what we should expect, there's always a healthy amount of pragmatism around it and ability to weigh in from the comp committee. I think everything is pretty much aligned there. One question a little bit out there, I guess. About 18 months ago, you guys acquired Barbican. I think that's part of the idea was that Arch would become a major player or at least a competitive player in the third-party capital business for people who want to participate in insurance markets. This year, maybe you didn't control the timing particularly, but you bought in Watford a third-party business. Is Arch going to be a major player in the third-party capital market? What are you doing to affect those changes, especially in a period of time where maybe you want to cook your own eating or eat your own cooking, I should say, because pricing is so good? I think that the Watford and whatever else we do with Barbican, that we don't advertise, but I think if you look at the capital we have under management, it's north of $1 billion when you collect everything all together. We are still very much in the fray. We just don't talk about it because it's not our style to just talk about it. We understand that this is also in building mode. We actually grew fund assets under management on the cat side this year. We were actually on the receiving end this 2020 and 2021, actually, because we were on the receiving end of new capital and existing partners who wanted to flex more into their cat market than other kinds of markets. Watford was certainly third-party capital coming in to give it to us and say that you can manage it in a different way to Watford. Let's team up. As you guys know, we teamed up with two other private equity firm to bring more stability to this. If anything, I think this sort of solidifies because Watford was a bit left out there in the public domain. I think there's a misunderstanding and misappreciation, frankly, for what that platform could create. We said, "Let's not lose sight of what it is and what it could create for us for not only shareholders of Arch but also for our clients." We were very cognizant of that. We said, let's bring it home and really solidify the capital base and make sure we can still provide good underwriting expertise for that platform the same way we're doing for the other property cat. If anything, I think you're going to see us grow slowly over time as we have over time. We just don't advertise it a whole lot. I think third-party capital is a really important piece of what we do. Barbican was actually a great place for us to grow into London, which was something we were looking to do anyway. It's been a really good thing. I think more to come for us is what I would say to everyone. Well, I have a lot more questions, but unfortunately not a lot more time. That's the way the cookie crumbles. I appreciate you both, and I know investors appreciate your time. It's going to be an interesting year. As I say on most end of these calls, please do what you can. I realize we're all limited. Try and inoculate your employees as soon as possible so you guys can get back to work in a normal sort of way. I'll wait in line, and we'll see what happens, and I guess that's what we'll all do. It seems in Bermuda, I suppose for you guys, it's a little bit easier than some places so- Yeah. It is stay safe regardless. We'll talk soon. Thank you. Great. Thank you, Josh. Thanks, everyone. Take care. Bye-bye. Hanover next, everybody