Arch Capital Group Ltd ( ACGL)

Q3 2011 Earnings Call

October 26, 2011 12:30 am ET

Executives

Dinos Iordanou - Chairman, President & CEO

John Hele - EVP, CFO & Treasurer

Analysts

Jay Gelb - Barclays Capital

Mike Zaremski - Credit Suisse

Keith Walsh - Citi

Joshua Shanker - Deutsche Bank

Matthew Heimermann - JPMorgan

Dan Farrell - Sterne Agee

Doug Mewhirter - RBC Capital Markets

Court Dignan - Fidelity

Vinay Misquith - Evercore Partners

Ian Gutterman - Adage Capital

Ron Bobman - Capital Returns

Presentation

Operator

Good day, ladies and gentlemen, and welcome to the Third Quarter 2011 Arch Capital Group Limited Earnings Conference Call. My name is Fab and I will be your operator for today. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions) As a reminder, this call is being recorded for replay purposes.

Before the company gets started with its update, management wants to first remind everyone that certain statements in today’s press release and discussed on this call may constitute forward-looking statements under the Federal Securities laws. These statements are based upon management’s current assessments and assumptions and are subject to a number of risks and uncertainties. Consequently, actual results may differ materially from those expressed or implied.

For more information on the risks and other factors that may affect future performance, investors should review periodic reports that are filed by the Company with the SEC from time to time. Additionally, certain statements contained in the call that are not based on historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

The Company intends the forward-looking statements in the call to be subject to the Safe Harbor created thereby. Management also will make reference to some non-GAAP measures of financial performance. The reconciliation to GAAP and definition of operating income can be found on 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. Please proceed.

Dinos Iordanou

Good morning, everyone, and thank you for joining us today. Our third quarter result was satisfactory when we take into consideration the difficult market conditions that we operate in. Significant catastrophic activity continuing in the third quarter, however the level of this activity and resulting in trouble damages were only slightly above our average expected cat loads for the quarter.

As you may recall, the first two quarter experienced cat activity and resulting losses that were significantly above average. Our total net catastrophe losses for the quarter were about $60 million with $46 million coming from the current quarter events and $14 million related to net increases in loss estimates from the first and second quarter events.

Our underwriting teams continue to execute our soft market strategy by emphasizing small accounts for the large ones and focusing more on short tail businesses. The market is showing signs of slight improvement. However, we still see more opportunities for adequate profitability in the short and medium tail lines of business rather than the long tail business.

As more and more competitors are factoring into the pricing, the skimpy returns available for new money investments eventually pricing levels for long tail lines will improve; at least we hope so. In the mean time, we are continuing a defensive approach for these lines of business. As a result of these strategies, our mix of business continues to shift towards more short tail and medium tail while our long tail business on a trailing 12-month basis remains approximately 25% of our book.

Our annualized Return on Average Common Equity was 10.4% on a reported basis including a slightly negative effect of above-average cat activity and aided by prior year reserve releases.

We continue to believe that in the current market environment, we are earning high single-digit ROEs on an underwriting year basis. This is essentially the same level of ROE performance we estimated for the 2010 underwriting year with slightly less earnings from investment income offsetting by slightly better underwriting results generated by adjustments to our mix of business.

Our investment performance for the quarter including the effects of foreign exchange was a total return of negative 23 basis points as September was a difficult month in the financial markets. As a result, our book value per share for the quarter increased slightly from $31 per share to $31 20 per share, while book value per share from the year ago grew by 5%.

From an underwriting point of view, we record a 94.3 calendar quarter combined ratio, which is an excellent result for the prevailing market conditions. Cash flow from the quarter remained solid at $310 million as claim trends remain favorable. The broad market environment is showing slight improvement across the board.

From a rate stand point, most lines of business move into positive territory. The exception were in executive assurance and medical malpractice, where we’re still seeing rate reductions in the rate of 1.5% to 2% for malpractice business and approximately 7% for executive assurance.

Even with this slight improvement in the rate environment, significant more rate is needed in many lines in order to achieve adequate returns.

For us adequate returns is returns that produced 15% return on equity. In our view based in part on the level of interest rates currently available, the long tail lines need quite a bit more improvement in rate to become attractive.

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