Prepared remarks
Good day, ladies and gentlemen and welcome to the First Quarter 2025 Arch Capital Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, this conference call is being recorded. Before the company gets started with its update, management wants to first remind everyone that certain statements in yesterday'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, including our annual report on Form 10-K for the 2024 fiscal year.
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 certain non-GAAP measures of financial performance. The reconciliations to GAAP for each non-GAAP financial measure 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 at www.archgroup.com and on the SEC's website at www.sec.gov. I would now like to introduce your host for today's conference, Mr. Nicolas Papadopoulo and Mr. François Morin. Sir, you may begin.
Good morning and welcome to Arch's first quarter earnings call. I'm pleased to report solid results for the quarter with $587 million of after-tax operating income, $1.54 in operating earnings per share and an annualized operating return on equity of 11.5%. These results were achieved despite $547 million of catastrophe losses affecting our Property and Casualty segment primarily from the California wildfire. The P&C market has become increasingly competitive. However, we remain optimistic about our prospects as we continue to achieve broadly attractive rates across the sectors where we compete. At Arch, we believe that prioritizing expected profitability of our market share by allocating capital to lines of business with attractive risk-adjusted returns gives us the best opportunity to outperform for the cycle. This is what we mean by cycle management and we stand by the historical results of this approach.
While the market may be more competitive, ample growth opportunities remain. This is true despite emerging macroeconomic concerns, including the potential impact of tariffs that increased uncertainty for many of our insured across the globe and raised inflationary risks for some of our businesses. During times such as these, risk selection is critical as a growing number of our previously attractive accounts no longer meet our return criteria. We believe the acumen of our underwriting teams, breadth of our platform, investment in data and analytics and depth of our financial resources have Arch well positioned to navigate the P&C cycle. Now we'll turn to our segments, starting with Reinsurance. Reinsurance results were solid despite substantial catastrophe losses in the quarter and a 91.8 combined ratio, inclusive of 18 points of catastrophe losses demonstrates the strong underlying profitability of our diversified reinsurance portfolio.
Growth in net premium written in the quarter was modest due to an increased level of competition, more risk retention by ceding companies and reducing our participation for treaties where margin no longer meets our hurdles. In the first quarter, the reinsurance group deployed additional capacity into property catastrophe lines where opportunities remain attractive, particularly in loss-impacted accounts. Specialty premium rising declined primarily due to non-renewing a large structure transaction. Weaker margins in cyber and part of our international treaty business also led to reduced premium linings. Treaty casualty lines experienced growth in the quarter as Arch recapitalized on a handful of select opportunities. We are hopeful these lines will continue to achieve rate, and the treaty casualty market terms and conditions will continue to improve. As we look towards major renewals, particularly wind coverage in Florida and the Gulf, we expect additional demand from existing and new clients.
On the supply side, it is worth noting that for many reinsurers and ALS funds, this zone represents peak exposure. As a result, significant additional capacity may be harder to come by — even if the market is more competitive on the margin. Moving to our insurance segment, where the California wildfires led to a small underwriting loss for the quarter due in part to commercial risk from the recently acquired middle market commercial and entertainment businesses. The additional premium generated from those businesses contributed to the insurance group, $1.9 billion of net premium return in the quarter, a 25% increase from the first quarter of 2024. The integration of the middle market business is progressing well, and we remain excited about the increased capabilities this team brings to the Arch Insurance platform. As we've said before, there isn't one underwriting cycle, but many. In today's market, it's possible to deliver double-digit growth in some lines, while experiencing similar declines in others.
In the first quarter, we generated meaningful growth in casualty-led sectors, including construction, national account and international casualty. At the same time, we experienced premium reduction in other lines of business due to rate decreases and our desire to maintain margin in lines such as E&S property and professional lines, including cyber. We have seen competition increasing in the London market specialty lines which has made profitable growth difficult. Looking ahead, we expect continued growth in casualty lines as well as the U.S. middle market where opportunities remain for both rate and premium growth. We are well positioned across the insurance group because of our market-leading capabilities and relevance with distribution partners that gives us first look at many opportunities. The Mortgage segment continued to provide a steady earnings stream contributing $252 million of underwriting income in the first quarter.
Economic uncertainty, limited housing supply and high relative mortgage rates continue to create headwinds for new mortgage origination which resulted in modest new insurance returns in our U.S. and international Mortgage businesses. For U.S. MI, high mortgage interest rates and on price appreciation have kept persistency around 82% and insurance in force relatively stable. The delinquency rate of our in-force portfolio remains low ending the quarter below 2%. Our near-term outlook for the Mortgage industry is unlikely to change significantly. While recessionary trends resulting from tariffs and other economic policy could create headwinds, we still expect the Mortgage segment to continue generating attractive underwriting income given the high credit quality and embedded equity of our in-force portfolio. Turning to our Investment group, where invested assets increased by 4% from year-end to $43.1 billion, providing a large sustainable contributor to group earnings.
Investment market volatility increased broadly leading us to reposition our portfolio to a more market-neutral position. To manage the cycle, it's important to understand that you cannot control the market, but you can control how your underwriting teams respond to it. At Arch, we manage a different cycle across our many lines with the ability of our underwriters to assess, analyze and ultimately select risk. Over time, our underwriting teams have built strong relationships with our distribution partners which gives us an access advantage as they look to place risk with fewer, more relevant carriers, including Arch. Risk analysis combines experience, expertise and deep analytical insight to understand and assess the underlying risk and match it with a technical price that reflects an adequate premium for that risk. Ultimately, risk selection is what separates the winners from the losers.
If the return doesn't adequately account for the risk, you must be willing to let others take the business. The P&C market in transition is one where Arch can and has previously demonstrated its ability to find success. While premium growth may be more challenging than in recent years, plenty of profitable opportunities remain. For a company with a strong underwriting culture like Arch, this is a market where we can stand out and continue to maximize returns for our shareholders.
Thank you, Nicolas, and good morning to everyone. Last night, we announced our first quarter results, reporting an after-tax operating income of $1.54 per share, which translates to an annualized operating return on average common equity of 11.5% and a 3.8% increase in book value per share for the quarter. Overall, our three business segments performed exceptionally well, achieving an accident year combined ratio of 81%, with each segment showing improvement compared to the same quarter last year. Our underwriting income included $167 million in favorable prior year development on a pre-tax basis, which contributed 4 points to the overall combined ratio. We experienced favorable development across all three segments and many lines of business, particularly in short tail lines in our Reinsurance segment and in Mortgage due to strong cure activity. The acquisitions of the MidCorp and Entertainment Insurance Businesses have positively impacted our financial metrics within the Insurance segment.
This quarter, the net premiums written from the acquired businesses totaled $373 million, which contributed 24.2 points to the year-over-year premium growth for the segment, remaining consistent with last quarter. Additionally, the inclusion of the acquired businesses lowered the current accident year combined ratio by 1.1 points, which can be detailed as a current quarter acquisition expense ratio that decreased by 0.9 points due to the write-off of deferred acquisition costs upon closing under purchase GAAP, as well as a reduction in the other operating expense ratio by 0.9 points and an accident year loss ratio that was 0.7 points higher, reflecting the acquired business results. The reinsurance segment's net premiums written showed a quarter-over-quarter growth of 2.2%, impacted by several factors. Notably, this quarter's net premiums written included around $70 million of reinstatement premiums mainly related to the California wildfires.
Conversely, the non-renewal of sizable structured transactions in the specialty line reduced our top line by $147 million in the quarter, alongside some timing differences in the recognition of certain treaty renewals that led to approximately $103 million less in net premiums written for the quarter. Our mortgage segment achieved another strong quarter with underwriting income of $252 million. Despite a challenging origination environment, the underlying business fundamentals remain excellent, as indicated by key metrics including a very low delinquency rate for our U.S. MI business, currently at 1.96%. On the investment side, we earned a total of $431 million pre-tax from net investment income and income from funds accounting using the equity method, or $1.13 per share pre-tax. The decline in net investment income compared to last quarter is due to several factors, including the $1.9 billion special dividend paid in December, timing of incentive compensation expenses, slightly lower interest rates this quarter, and our portfolio's repositioning to a lower-risk posture amid ongoing macroeconomic uncertainty.
Income from operating affiliates decreased this quarter, primarily due to lower affiliate income at Somers Re, partly because of the California wildfires. Our cash flow from operations remained robust at approximately $1.5 billion for the quarter. Our effective tax rate on pre-tax operating income was 11.7% for the quarter, reflecting a one-time discrete benefit of 4.6% from differences in how noncash compensation is expensed. Additionally, we began amortizing the deferred tax asset established at the end of 2023 regarding the Bermuda corporate income tax; however, this benefit does not affect our operating or net income effective tax rates for the period but will reduce our taxable payments going forward. As of January 1, our peak zone natural cap probable maximum loss for a single event at a one in 250-year return level increased slightly to 9% of tangible shareholders' equity, which remains well below our internal limits.
In terms of capital management, we repurchased $196 million of our common shares in the first quarter and an additional $100 million in April, reflecting our disciplined approach to capital management aimed at enhancing shareholder returns. In conclusion, our balance sheet is extremely strong, with common shareholders' equity at $20.7 billion and a low debt plus preferred to capital ratio of 14.7%. With these introductory remarks, we are now ready to take your questions.
Questions and answers
The first question comes from Mike Zaremski at BMO.
Thank you for your insightful comments on the market. Regarding the Reinsurance group adding more capacity in catastrophe lines, you mentioned that accounts impacted by losses are particularly attractive. Should we consider how we might adjust our loss ratio if you plan to continue this approach? Do you have any updates to your catastrophe load guide? Last time it was 7 to 8 points; should we expect that number to increase?
I don't think so. I believe the number should remain relatively stable for the full year catastrophe load, although there is some seasonality involved. Considering market conditions, we anticipated that after the California wildfires, there might be some stabilization in that market, and we expect that to occur. However, Florida is a distinct market, and it is still a bit early for us to determine how Florida will ultimately perform or what opportunities will arise. Overall, I think the trends we observed at the beginning of the year are continuing to hold up well.
I agree. The outlook for Florida, as I mentioned, appears to be quite flat. We appreciate the business and believe our teams may uncover growth opportunities as we anticipate increased demand in the market for various reasons. The FHCF is increasing retention by $1.5 billion, and more cedents are looking to raise their limits, which hasn't been possible in recent years due to capacity constraints. Therefore, we see a potential opportunity for growth if rates remain stable.
Got it. Okay. Switching to market competition outside of Reinsurance. A common theme in recent quarters is that large account property is well priced, and we are observing significant downward pressure. You mentioned the London specialty market as well. Could you explain what you mean by the London specialty market and which lines in particular are not aligned with your growth objectives?
In London, the situation is twofold. First, after several years of strong performance, there is a growing willingness among businesses to expand in areas like terrorism, marine, and energy, which have traditionally excelled in Lloyd's. Additionally, London functions as the excess and surplus market for the global landscape. As companies in their local markets gain confidence in managing their risks, their willingness to take on more increases. Consequently, there is a decrease in business from regions like Australia and Asia, where companies traditionally relied on Lloyd's as their local risk appetite diminishes. We are observing this combination of factors. There are positive trends for us and a few other markets due to the consolidation around leading firms, and we believe we will excel in many of our business lines. It's challenging to forecast precisely, but we are optimistic about our ability to leverage our position in that market.
The next question comes from Cave Montazeri at Deutsche Bank.
My first question is about net premium growth in Reinsurance. It's evident that the era of over 30% growth in NPW is behind us as you become more selective. I believe that 2.2% growth might be a bit too low to expect moving forward. Could you elaborate on some of the main factors causing the deceleration you experienced this quarter? Additionally, please provide more details on the impact of structured yields to help us understand how we should consider premium growth in Reinsurance going forward.
Yes, I mentioned this earlier. There are a couple of factors to consider. If you take into account what we've discussed, we're not adjusting for every detail, but even with those two factors, you still arrive at a growth rate of about 6% to 7%, which might be more in line with what we expect in the near future. Beyond that, there's a noticeable difference; we experienced good growth in property outside of property catastrophe and property capital, whereas we saw declines in the specialty lines, particularly outside of structured products and due to changes in accruals on written premiums. This decline is influenced by some of the smaller specialty lines we are involved in, which have faced increased competition. A key example of this is the cyber sector, where rates have decreased slightly and some of our ceding companies are retaining more risk. So, while you're correct that the days of 30% growth are likely over for us in the midterm, we hope that these points help clarify the transition from 2.2% to a growth rate you might consider more realistic for the remainder of the year.
Yes. I think in the specialty book, you have a mix of lines of business. I mean it goes from credit to a cyber to agriculture and a few others. So our team are really scouting the world to find opportunities. We had a great opportunity in Brazil last year on the agriculture side. And this year, the cedent is winning more of the business. So, I think you have to be opportunistic in those lines of business to make money. So yes, if we have a big book, the ups and downs offset each other. In the last few years it grew together because it was what the hard market does. I think we should be prepared to see more ups and down quarter-by-quarter going forward in that particular book. That's what we want them to do.
My second question is on casualty. Last year, a big theme was just the strengthening in the casualty reserves at the industry level. We haven't seen much of that so far in 2025. I think some people are thinking maybe we might be past the point of maximum fear with regard to social inflation. Just wondering like what your thoughts are? Do you agree with that? What do you think we're just in the eye of the storm and there's more pain to come in the second half of 2025?
My prediction is that while I don't know when the pain will arrive, I believe it is inevitable. There will be additional challenges ahead. We think the issue of social inflation in the casualty sector has not yet fully unfolded. That's our perspective. We are consistently seeing rates above the trend on our casualty line, and where we are comfortable with the exposure, jurisdiction, and terms and conditions, we are willing to engage further. However, I don't believe we are in a market where we can confidently capture market share while ensuring an adequate return. So, I think there is more to anticipate. This reflects our overall underwriting perspective.
The next question comes from Elyse Greenspan at Wells Fargo.
My first one, I think, is a quick one. François, the 7% adjusted growth in Reinsurance that you were talking about, in the quarter. Is that excluding reinstatements and the structured deals? I just want to make sure I understand what you're backing out.
No, I'm just putting back in the two items I mentioned. That's all. I'm not backing out the reinstatements, I'm just handing back the non-renewed deals and the timing of the accruals on some business.
Okay. Got it. My second question is about the commentary regarding midyear. It seems like you might anticipate some opportunities on the demand side. What about pricing? Are you expecting prices to decline but still see some growth opportunities driven by demand? Can you clarify those two aspects for me?
It is clear that as of April 1, most areas are seeing a single-digit decline, which is more pronounced in Japan due to a reduction in purchases by one of the players affecting the market. However, Florida's situation is somewhat different since it serves as a major area for both markets. People tend to prefer the top players, but there are only a few top players available, and there is little interest in the lower end of the program. Past observations, which are still relevant today, indicate that the lower-tier programs have been affected by last year's hurricane, and we anticipate some price increases there. Whether this will be offset by price decreases at the higher end of the market is uncertain. Therefore, our expectation for Florida is a relatively flat performance, and we believe that given our positioning, we should be able to maintain our market share among the programs that are experiencing increased demand, potentially allowing us to invest more capital.
Okay. And then one last one. In insurance, if I kind of ex out MidCorp, is that I think, around like a 56.7% underlying loss ratio that was slightly below the Q4. Is that about like run rate-ish, I guess, on core Arch, right? And then we think about bringing in MidCorp on top? Or anything else we need to think about just with pricing and loss trend and dynamics on the margin as we go through the year.
Yes. Regarding the legacy Arch book, our margins are stabilizing, with rates trending steady. However, you need to consider that the mix is evolving as we shift more towards casualty. This could lead to a slight increase in the underlying loss ratio due to heightened competition in the property sector. A significant portion of our growth has come from casualty-focused lines of business, which may be a factor. Nonetheless, we believe that the loss ratio from this quarter can continue to maintain at its current level.
The next question comes from Andrew Kligerman at TD Securities.
First question is around the reserving. It looked like you had some nice favorable developments, particularly in Reinsurance. But could you call out anything around commercial auto and other liability, net plus or minus in both Insurance and Reinsurance, how did that perform? And how do you feel about the reserving in those lines going forward?
Great question. We review our reserves every quarter, and the actual versus expected that we are closely monitoring looks positive. However, it's still a bit early to declare success. We're keeping a close eye on everything, noting the ups and downs. There are some areas where we've experienced slight adverse outcomes, but these have been balanced out by other areas where we've seen favorable developments. Overall, I'd say we're relatively stable. In terms of the casualty long-tail side, particularly with auto and some of the more challenging lines like umbrella, we feel comfortable with the reserve indications.
It's great to hear that. I have a two-part question for you. As a recognized expert in cycle management, could you provide some insight into the casualty and property cycles? Specifically, how do you see these cycles evolving now? How much longer do you anticipate property pricing will decline, and how long can casualty pricing remain stable? I understand this is a tough inquiry, but I'd be very interested in your thoughts. Additionally, what is your perspective on managing general agents today? Are they still on the rise and competitive? I'll pause there, as that was quite a few questions. Apologies for that.
The two aspects are difficult to distinguish. I'll begin with the property side and then address the Reinsurance side. I believe the market is more disciplined now. We've observed rate decreases from the market's peak, but overall, the market remains appealing. There hasn’t been irrational behavior from major players. New entrants are appearing, although they are relatively small. Consequently, we maintain a very positive outlook on property catastrophe insurance and how the industry is responding overall. Looking specifically at the catastrophe property market, especially in excess and surplus lines and North American properties, we are witnessing two distinct markets. The middle market, which includes more admitted retail, is facing pressure from convective storms and recent catastrophes, including wildfires. Companies are under pressure to increase rates to manage the rising catastrophe load observed in recent years.
On the other hand, the E&S catastrophe market, particularly coastal and earthquake-related risks, sees managing general agents playing a larger role. Surprisingly, the market has quickly moved away from double-digit rate increases we previously experienced. Companies did not favor high limits due to significant losses, leading to a more disciplined market in 2023. As capacity has withdrawn, we've seen rates increase, resulting in a notable upswing in re-underwriting alongside changes in terms and conditions. About a year or 1.5 years later, MGAs whose capacity was restricted have begun returning with larger limits. For a typical risk valued at $200 million, requiring around 20 markets for coverage, we might see a company like Arch taking the first $100 million, while the MGA steps in with $40 million. This scenario creates a rush to place remaining risk in the market, putting considerable pressure on rates. The capacity available from MGAs has increased this year, and I believe they play a significant role in making the market more competitive. That's the current situation.
And same thing on casualty?
On the casualty side, there are fewer MGAs. In terms of casualty, what we've observed is that while we have increased capacity, it hasn't been by a huge margin; for instance, we might go from 10 to 15 but not from 10 to 40. On the casualty side, whether it's E&S or other areas, you've noted a similar trend. The typical response to losses has been a reduction in limits. It's important to apply prices to various risk types to achieve diversification, which works better with a lower number of risks. Consequently, the reduction in capacity and limits from 50s to 25s and then to 15s has created an opportunity for rates to increase, particularly on the excess side. We haven't observed a significant number of participants entering the market; in fact, we're still witnessing people reducing limits. This suggests to me that it will take longer to reach a more competitive marketplace.
The next question comes from David Motemaden at Evercore ISI.
Good morning. I had a question on the $147 million of structured deals that were non-renewed. Just so I'm thinking about it correctly. Were there any other chunkier quarters in 2024 that we should think about where like there were chunky structured deals that might not renew as we go through the rest of 2025?
There are often significant deals that we complete throughout the year. However, it's uncertain whether these will recur or if they'll renew at the same scale and structure for another year, which makes it difficult to predict their impact for the remainder of the year. We're trying to provide some clarity on the premium variations and their causes. Sometimes, we benefit from securing substantial new deals that boost growth or reported growth, but in this case, it was different. These deals are typically on the larger side and it's not common for us to have so many with a high premium associated with them.
And then on the insurance underlying loss ratio, I think last quarter, you spoke about it running at around the 58% level going forward. It obviously came in nicely below that this quarter. I'm wondering was there anything that drove that? It sounded like you split it out between the legacy Arch and MCE was there more improvement on the MCE side? Is that something we can expect to continue? So maybe some color around that would be helpful.
Yes, it's difficult to say. The quarterly numbers are important, but we don't place too much emphasis on them. We prefer to focus on the long-term view of the underlying profitability of the book. Therefore, I do not anticipate any significant fluctuations in either the MCE or the legacy business. As you know, last year, the Baltimore Bridge increased the loss ratio, but we did not have that this quarter. There will always be some randomness due to a few large clients that can influence the quarterly loss ratio. Overall, we consider it a relatively stable environment, though we do expect some volatility from quarter to quarter based on various factors.
The next question comes from Alex Scott at Barclays.
I thought I'd see if you could provide a little more commentary on what you're seeing in the property cat reinsurance market I guess, specifically, what's your view of the impact of ILS? Is the pricing pressure more at the top of the tower? Any commentary on sort of the way it's affecting these towers and where you play in them?
Yes. What we are observing is consistent with your description, with increased pressure at the top of the market. The cat bond market is being repriced to lower margins, which also affects the layer underneath it. Although we have not experienced losses in those lower layers, we have seen losses due to factors like the California wildfires, some nationwide accounts, and various storms. The primary focus of the price decrease appears to be at the top of the program. In Florida, the situation is expected to be more complicated due to limited supply in the marketplace, making it likely that it won't be as robust as in the Northeast region, where there have not been any losses among the top players for an extended period. Therefore, I believe that, if an event occurs, we are likely to see increased pressure at the top of the program and possibly moderate pressure at the bottom.
Got it. That's helpful. Next one on capital management. I mean, you had very strong capitalization and growth slowing a little bit, just given the environment. How do you think about priorities there? And how quickly do I ramp up capital return if you don't get the opportunity to grow in the midyear?
Yes, we are constantly evaluating this as part of our ongoing strategy. We expect that as growth begins to moderate, which it is, we will continue to see strong earnings. This may lead us to accumulate more excess capital, which we would likely return to our shareholders. While there may be some minor mergers and acquisitions or other opportunities, overall, it's reasonable to anticipate a significant capital return as we progress. We had a special dividend late last year and we are very favorable towards share buybacks. If the conditions align with our pricing and metrics, we are open to pursuing that option.
The next question comes from Wes Carmichael at Autonomous Research.
In Reinsurance, I think you mentioned a couple of times of primary companies retaining more risk. Just hoping you could provide a little more color on what you're seeing from primaries and maybe where that's most pronounced?
I believe this trend is most noticeable in other property lines, such as energy, where the results have been positive, and companies are more confident in their performance. It's common to see people retaining more risk as they navigate the market. Companies previously sought reinsurance to manage volatility or uncertainty in their performance, and as they re-evaluate their portfolios, their comfort with the risk tends to increase. At Arch Insurance, for instance, we have become more comfortable with our risk profile and are purchasing more insurance. This shift has led us to favor excess of loss reinsurance, allowing us to keep a larger portion of the premium. While we haven't observed a lot of quota share arrangements currently, we are seeing companies retain more risk as their confidence in their financial position grows. Additionally, structured deals, which typically provide capital relief, will continue as long as companies require surplus relief. Once they no longer need that support, those deals may cease.
That's helpful. And I think in mortgage, prepared remarks touched on headwinds of origination. Can you maybe just talk about what behavior you're seeing in that business? And are you seeing any potential leading indicators of recessionary activity at this point?
It’s quite early to draw conclusions. We can certainly speculate and have our opinions. If there were a severe recession that affected unemployment and caused a slight decline in home prices, it could impact our performance. However, we continually focus on the strong fundamentals and the high credit quality of our borrowers. Homeowners have built up significant equity, making this situation quite different from what we experienced in 2008. We acknowledge the potential concerns, but we feel much more secure in our position now. For a stressful scenario to significantly impact Arch, it would need to be extremely severe. Currently, we believe we are in a very good position.
The next question comes from Josh Shanker of Bank of America.
Good morning, everybody. Back in the fourth quarter, you paid a big special dividend, you bought back a little stock. You bought back more stock this quarter. I tend to find it difficult to parse paying special dividends and buy back stock at the same time, either the return on the stock is attractive or you need to give money back to shareholders promptly because it's not so attractive. A couple of things there. One, can you talk about, a little about your philosophy, which is about 3-year ahead book value. But I've done a little bit of the math. And if the 3-year ahead book value rule of thumb applies, the market is very much underestimating your earnings power for the next couple of years. Can you talk about the philosophy of buybacks versus dividends and what that means for this year and what you think about the attractiveness of the stock at this point?
We definitely like the stock, but the main challenge, Josh, is really about how quickly we can execute share buybacks. There are limits on daily trading volume and similar factors. Even if the price is appealing for buying back shares, dividends allow for a much quicker return of capital. For us to buy back $1.9 billion of stock at the pace we can due to our restrictions would take a significant amount of time, and we'd likely end up with more excess capital that we wouldn't be able to utilize effectively. It's important to understand that there’s a limit to what we can achieve with share buybacks. Regarding the 3-year payback, we find that metric useful. Our perspective on book value over the next three years may differ from yours, but we continuously assess our business. We're still aiming for that roughly three-year payback period and believe we still have plenty of opportunity to grow our book value significantly in the near future. This gives us confidence that buying back stock at the current price is a solid method of returning capital to our shareholders.
If you started now, do you think you could execute $2 billion in buybacks before year-end and preclude the need for a special dividend?
It would be challenging to commit to a specific program. We prefer to maintain our flexibility and optionality, so we avoid publicly announcing a definite buyback amount at a set price. We aim to be opportunistic and continuously assess our options to optimize our strategies as effectively as possible.
The next question comes from Andrew Anderson at Jefferies.
Just on the income from operating affiliates, I think it was $17 million in the quarter. It was down a bit year-over-year. I think that Somers is in Coface. Can you maybe just talk about the moving pieces there and perhaps how you're thinking about full year?
Coface has performed very well for us, and we are extremely pleased with it. There might be some pressure on trade credit moving forward, but we are monitoring the situation. We don’t have complete visibility or clarity on it. The decline in income from operating affiliates was primarily due to Somers, which is essentially a sidecar to Arch Re. This quarter, we faced challenges from wildfires that affected both us and Somers. Additionally, there was a one-time impact from a Bermuda tax reflected in Somers' financials for the first quarter of 2024, which may have made the decline appear more significant than expected. Looking at the overall run rate, this quarter is somewhat lower than we would typically anticipate for our operating affiliates. Regarding our returns, we generally expect to earn around the 10% range on these investments, if not more, given that we manage over $1 billion in assets.
That's helpful. And then just insurance expense ratio and there was improvement in OpEx but is full year '24 still a good way to think about the rest of the year for the OpEx? Or is there still some headcount costs coming on?
It's a good situation. As we consider our growth and manage our expenses, we are being very careful about whether we need to replace employees who leave or retire. We believe the MCE acquisition will provide benefits, as it allows for better scalability. However, we are still looking to hire on the MCE side, particularly for data scientists and a few more actuaries. Overall, we are monitoring our expenses closely, which will continue to be a priority as we move ahead.
The next question comes from Meyer Shields at KBW.
I think I have the same question in two contexts. I think Nicolas started for comments talking about the preference of brokers to work with fewer bigger insurers. And I'm wondering if you could talk about the volume versus profitability implications of that to companies like Arch?
I don't believe the two are necessarily connected. In my opinion, a good place to address this is probably the London market. In London, the brokers, due to business requirements, hold significant control over access to the business we engage in. It's about supporting them where needed and aligning with their strategies. Considering how they structure the market, including their own facilities, it's clear that leadership is essential; without leaders, operations falter. They also have secondary facilities, along with an open market that continues to exist. You must find your niche; focusing solely on one aspect won't suffice. It’s essential to develop a robust distribution strategy as it is crucial for our future success. We have dedicated considerable time to identifying how we can better align with our distributors and add value. This differs for larger distributors, where our approach might be one thing, and smaller or mid-market distributors, which may rely more on our expertise—with varying needs.
To succeed moving forward, it’s vital to evaluate the value we contribute to each transaction; we can't rely solely on underwriting. Thus, you need to approach the underwriting cycle thoughtfully while also understanding your position in the hierarchy and the value you offer. We've put in a lot of effort and continue to rethink our approach, emphasizing that it’s ultimately about the customers. Without customers, we do not exist, so we must deliver value to them. This dynamic is present in London and North America. You cannot merely wait for business to come to you by operating from a desk in Lloyd’s; you can't be certain that the business you will get is desirable. If five people in front of you are selecting the best business, you'll be left with secondary options. Thus, exerting effort is crucial, along with the significance of size and relationships, enabling you to target the right business effectively. That’s where a well-planned distribution strategy becomes vital.
Okay, perfect. That's very helpful. Secondly, regarding reinsurance, when cedents retain more business, how do you manage the risk of adverse selection when a more knowledgeable cedent decides what to keep and what to reinsure?
A significant aspect of our business revolves around adverse selection. The key question is whether we have the insight necessary to understand why customers are making their purchases and if their needs align with what we are willing to insure or reinsure. We dedicate a considerable amount of effort to gaining insights into their requirements, and there are certain areas where we choose not to engage due to the associated risks. We aim to identify opportunities where the potential benefits outweigh the risks, as we typically avoid scenarios that only present downsides. Adverse selection is a persistent challenge in this dynamic market, and it is crucial to incorporate this factor into our risk selection process. Our approach involves ensuring that we understand the risks adequately, as advice from underwriters can sometimes resemble unfounded optimism. Success in underwriting requires the ability to ask the right questions and form strong relationships with clients so they approach us with genuine concerns where we can offer real value through insurance or reinsurance solutions.
On the insurance side, we encourage our team to make sound decisions. If a risk appears favorable, we advise them to hold onto it and have confidence in their assessment. Initially, if there is uncertainty, they may opt for reinsurance on a quota share basis. As they gain confidence that their underwriting guidelines and pricing are effective, they can choose to retain the risk directly. There is nothing wrong with that approach, and it reflects the important role that reinsurance plays in our overall strategy.
I'm not showing any further questions. Would you like to proceed with any further remarks?
No, thank you. I believe it was a good quarter for us even in a more difficult and competitive market, and we remain optimistic about the future. I look forward to seeing you all in the next quarter.
Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may all disconnect.