Constantine Iordanou - Chairman and Chief Executive Officer Marc Grandisson - President and Chief Operating Officer Mark Lyons - EVP and CFO.

Elyse Greenspan - Wells Fargo Josh Shanker - Deutsche Bank Amit Kumar - Buckingham Research Brian Meredith - UBS Jay Cohen - Bank of America Meyer Shields - KBW Kai Pan - Morgan Stanley Ian Gutterman – Balyasny.

Good day, ladies and gentlemen, and welcome to the Q3 2017 Arch Capital Group Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct the question-and-answer session and instructions will follow at that time. [Operator Instructions] 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 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 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 introduce your hosts for today's conference, Mr. Dinos Iordanou, Mr. Marc Grandisson and Mr. Mark Lyons. You may begin..

Thank you, Crystal. Good morning, everyone, and thank you for joining us today. This past quarter, natural catastrophe significantly impacted the industry with three major hurricanes, large earthquakes in Mexico, and other ongoing events that are likely to make 2017 one of the costliest, if not the costliest for the insurers in history.

Although we were impacted by these losses, our diversified platform and good investment performance made this quarter an earnings event for us and I'm pleased to note that our book value per share increased by a $0.01 in the quarter to $59.61.

Based on expected industry catastrophe losses in the range of $80 billion to $100 billion, our guesstimates after-tax net losses of $320 million from all events in the third quarter. We have arrived at this estimate through a combination of top-down model industry loss estimates and a bottom-up review of reported losses from our insurers.

I'm sure many of you are puzzled as I am that by aggregating all the reported losses so far and adding an estimate for those companies and markets that have not yet reported, we cannot get anywhere close to the bottom-end of the model range.

While those losses are significant, this quarter again demonstrated core principle of large risk management philosophy. As expected, returns from property and property cat risk have declined over the past several years, our underwriters were focused on risk adjusted returns, and accordingly, significantly reduced their writings.

Implementing this approach is not easy, as competitors in both the traditional and alternative markets have accepted business at margins we deem inadequate. However, the weakness of these margins are only exposed in a volatile catastrophe year, like 2017.

As a result of these catastrophe losses in the third quarter, we're reporting a net loss of $52 million, or $0.39 per share, and on an operating basis, a net loss of $107 million, or $0.79 per share.

Arch remains in positive territory for the nine months, with net income of $363 million and operating income of $260 million for the nine months ending September 30, 2017. And we expect a positive year by year-end. Now turning to third quarter results, our reported combined ratio was 110% in the quarter on a core basis.

Mark Lyons usually defines that, and in a moment, he will give you the definition, and includes 30.7 points of catastrophe losses, partially offset by 5 points of favorable prior year development from all three segments in the quarter. Catastrophe losses pushed our reinsurance segment combined ratio to 127.4% combined ratio in the third quarter.

Although excluding catastrophe activity and prior year development, the combined ratio improved to 96.9% sequentially in the third quarter of 2017, as large attritional loss activity in a property fac unit moderated. Catastrophe losses also increased our insurance group's combined ratio in the quarter, which rose to a 138.7% combined ratio.

Excluding catastrophes and prior year development, the combined ratio was 98.9% in the third quarter, compared to 99.4% in the second quarter of 2017.

This quarter's catastrophe events also demonstrates one benefit of a diversification into a mortgage insurance business, with earnings from mortgage substantially offsetting losses in our other two segments.

While we expect a temporary increase in delinquency notices to occur from this natural catastrophes, we believe the language of master policies generally preclude liability for the mortgage insurer when a home has suffered extensive physical damage, and historically, actual losses from catastrophic events, such as Hurricane Katrina, have had minor effect in the MI industry.

Our mortgage segment, excluding prior year development, improved its combined ratio slightly to 42.2% from last quarter. The integration of the U.S. primary mortgage operations continue to progress very well and it remains on or slightly ahead of our target. Marc Grandisson and Lyons will give you more flavor on that.

Net investment income for the third quarter of 2017 was $94.1 million, or $0.70 a share, and increased marginally from the second quarter. As you know, we manage our investment portfolio on a total return basis, which, on a U.S. dollar basis, was a positive 160 basis points for the quarter and 126 basis points on a local currency basis.

Our equity and alternative portfolios were the principal drivers of the quarter's returns. Before I turn the call over to Marc Grandisson, I would like to discuss our PMLs.

As we mentioned last quarter, we are also reporting to you our exposure to mortgage risk from a systemic stress event, or what we call a realistic disaster scenario, or RDS, which at the end of the quarter is stood at 15.7% of tangible common equity.

We have begun using tangible rather than stated equity as a result of the United Guaranty Corporation acquisition as we believe that this is a more prudent risk management base.

Our property cat exposures are substantially the same as last quarter with our 1-in-250 year peak zone, which continues to be the Northeast PML, which is at 6.6% of tangible common equity. You will see additional PML numbers in our 10-K, which is being filed.

I will now turn over the call to Marc Grandisson to comment on our operating units and market conditions before we go to Mark Lyons for financial reporting, and then, we'll take your questions.

Marc?.

Thank you, Dinos, and good morning to you all. This was an eventful quarter for the millions of people directly affected by catastrophes as well as the insurance industry and for those of us at Arch. Before discussing the events of the quarter, it's worth commenting on some of the recent management changes that have occurred here.

One of our senior executives and an important member of our management team, David McElroy decided to retire. Fortunately, our deep bench included our highly regarded colleague, Nicolas Papadopoulo, who agreed to take on the insurance leaders role. In turn, this allowed Maamoun Rajeh to step up to lead the reinsurance group.

Both have been with us since 2001 and are terrific executives with a proven track record. We thank Dave for his leadership and are pleased that he has agreed to continue making his contributions to Arch as a respected senior advisor to the company. I'm also looking forward to Nicolas and Maamoun flourishing in their new roles.

Turning now to the third quarter cat events, I would like to add my thanks to our underwriting teams, who have demonstrated discipline as reflected by the decrease in our property writings over the last five years in response to declining premium rates.

In cat exposed business lines on a gross basis, Arch wrote over $800 million of property and marine premiums in 2017, and at the right risk-adjusted price, we have available capacity for additional property risk.

To put again our capacity in perspective, our 1-in-250 single event PML is still very low at 6.6% of tangible common equity, which allows us to increase property writings should pricing improve materially. We believe that the third quarter cat events will prove difficult to assess, especially on the insurance side.

The potential issues with flood and business interruption coverages as well as the assignment of benefit issue in Florida creates uncertainty in the estimation process. As a result, we estimate a greater share of our aggregate loss will come from the insurance group.

Turning to current property market conditions, we are still evaluating our tactics as the market remains in flux. If 2005 is any guide, and we have some reason to believe that it could be, it will take several months for the market to find an equilibrium.

However, for cat exposed business, we believe that substantial rate increases are required to achieve an acceptable risk-adjusted return. Focusing on the P&C insurance market conditions, they remain challenging, although we have seen some rates stabilized towards the end of the third quarter, particularly in the property sector.

Most other areas had continuing adequacy erosion. After factoring in rate changes of a positive 190 basis points and an overall loss trend year-on-year of approximately 200 basis points, we had small margin erosion of 10 basis points for all lines in the third quarter in our U.S. P&C insurance operations.

Our low volatility businesses continue to achieve rate increases, while the more complex, high capacity, more commodity driven lines of business continue to see rate decreases.

Our third quarter view consistent with the last several quarters was that most areas of the P&C insurance had expected returns that are below our threshold to grow our writings in these lines. Turning now to reinsurance, we continue to focus on the opportunities that have relative rates strength.

We are hopeful that more favorable returns will be available in property, but, as always, we will have to see how the January 1st renewal settle before we have a clearer view of the opportunity.

Our reinsurance net written premium increased by 35%, largely due to a specific loss portfolio transfer transaction as well as some reinstatement premiums from the cat events. Excluding the effect of these distortions, our growth was more modest at 8%. This growth is due to our seizing niche opportunities, such as motor and some specialty reinsurance.

Our property writings decreased due to market conditions as our reinsurance group continued to focus on margins. Now switching gears to mortgage insurance, or MI, as stated in prior quarters, the earnings contribution from our MI segment is again proving to be a diversifying offset to difficult conditions in our P&C operations.

Our MI segment expense ratio improved to 20.6% at the end of the third quarter, while our new insurance written, or NIW, in the U.S. was $17.7 billion for the third quarter, a slight increase of 2% over the second quarter, largely due to our targeted decrease in single premium business.

Although not all MI companies have reported yet, we estimate that Arch U.S. MI's market share may have dipped slightly below 24% in the third quarter of 2017. This is consistent with our expectations as we focus on improving the risk adjusted returns of our mortgage portfolio. In the third quarter, 80% of our U.S.

NIW came through our risk-based pricing platform, which, as of last week, is fully integrated into a single RateStar module. We are writing primary U.S. MI business, with an expected ROE still above our long-term target of 15%. The overall quality of the risks written remain very strong and we continue to experience favorable developments in our U.S.

MI reserves consistent with what you may have heard from others. Arch wrote five new U.S. GSE credit risk sharing transactions, or CRTs, bringing our total risk in-force from them to approximately $2.5 billion at the end of the third quarter of 2017. Average yield in the CRTs remain healthy and ROEs are above our long-term targets.

However, competition in this space is heating up and this could affect our risk appetite for new writings in coming quarters. We executed our first mortgage capital markets transaction this week, Bellemeade Re, which is the risk management tool and helping manage our capital.

We view the market's growing acceptance of these securities as confirmation that the mortgage market is originating products of very high credit quality with low risk of default. In summary, we will be preparing for opportunities that the market allows, but, as always, we will be disciplined and opportunistic.

Now, here is Mark with the more detailed financial analysis.

Mark?.

insurance, reinsurance and mortgage. As stated earlier, when discussing the earnings per share accretion, the relative underwriting income is distorted by the catastrophic events this quarter.

So if you adjust for long-term cat load as well as allocating intangible asset accretion and debt servicing costs and dividends and so forth by unit, on a year-to-date basis, the mortgage segment accounted for 60% of pre-tax operating income and the balance being 40% split with the reinsurance segment being 23% and insurance segment 17%.

Management, however, continues to evaluate performance for the operating segments primarily by underwriting income and views and manages the investment function at a total return basis across all three segments. This alternative view that we just provided may provide you additional insight into our sources of overall profitability.

It should also be stated that the increased additional profit streams provided by the mortgage segment permitted our after-tax catastrophe losses to only represent less than two quarters of operating earnings using the previous four quarters as the reference baseline.

On a GAAP basis, at September 30 versus year end 2016, our debt to total cap ratio was 19.3% and total debt plus preferred to total capital ratio is 26.3%, down 240 basis points from year end 2016.

This leverage reduction was due to a combination of paying down $100 million of our revolver facility debt this quarter and the growing common equity over the last nine months driven by retained earnings. During the third quarter, we partially redeemed $230 million of our Series C preferred shares.

These shares carried a dividend rate of 6.75% and were replaced with a new Series F that achieved 5.45% annual dividend. This amounts to a $3 million annual savings.

There was an associated charge of $6.7 million to net income, not to operating income or book value, to recognize the original costs associated with the Series C issuance as a result of the redemption.

Core operating cash flows were $440 million, up $90 million relative to the third quarter of 2016, and this increase was primarily driven by growth in net premiums collected, primarily in the mortgage segment, partially offset by higher level of net paid losses in the P&C operations.

Book value per share increased that mighty $0.01 per share and tangible book value increased as 0.4% sequentially this quarter. Tangible book value growth outstripped book value per share growth due primarily to intangible asset amortization. So with these introductory comments, we're now prepared to take your questions..

[Operator Instructions] Our first question comes from Elyse Greenspan from Wells Fargo. Your line is open..

Hi, good morning..

Good morning..

Hi..

My first question, just going back to some of your initial commentary on the conference – on the market outlook. Dinos in the past and Marc as well, you guys have mentioned you kind of told your underwriters, put your pens down, let's wait for the market to turn.

Are you thinking about telling them to get more excited and get ready to write more business at January 1? And then, I guess, or is it your expectation if rates are more and I guess this is more a reinsurance question, more in the impacted lines? Would that be something that we wouldn't really get more firmer pricing until some of the U.S.

renewals later on in the year?.

Well, it's a good question, but it's a complicated question. Let me say this. We look for moments like this as a company. By being patient in the years that pricing is not good, we get excited when prices might get much better. We don't know yet as to where this thing is going to go. Let me share some facts with you.

If you add the reported losses so far is $31 billion, plus a number of major facilities haven't reported, meaning the retro or alternative market, Liberty Mutual, Berkshire Hathaway, State Farm, et cetera.

Even if you come up with some good estimates for those losses, we might get to $45 billion, maybe we get to $50 billion, it's a long way from $80 billion to $100 billion.

So I believe that either the models, they are predicting much bigger losses, which nobody seems to have the point of view because everybody is agreeing that this is an $80 billion to $100 billion aggregate event for the industry or maybe even more. So, stay tuned in further development.

If we go back and we look at historically, Wilma developed by 68%, Sandy developed by 70% for the industry, and Katrina, we got it almost right, it only developed by about 20%. So I anticipate upward development to happen.

I believe that we were very prudent in establishing our numbers, because you have to do bottom-up and a top-down approach and we actually waited more the top-down approach, which is how big is this, what is our market share, where do we have exposure.

And as Marc said, we were cautious with our insurance group and we put what we believe is reasonable numbers for us. But depending what happens in the next quarter and depending what happens to pricing, I think we'd be ready to do quite a bit more, if the returns that would be acceptable to us.

So with that, I'm going to turn it over to Marc because he works with the units more day-to-day and he will give his comments too..

Yes. I think to more practically, what's happening right now is, we're in the planning process, right. We have a portfolio, which I mentioned, a substantial portfolio of property, that's going to be renewed over the next 12 months, hopefully renew over the next 12 months.

And right now, both our insurance teams and our reinsurance teams are actually going through the portfolio and assessing which one we need to get the rate, further rate increase or higher rate increase and so we're planning ahead as to how we're going to react.

The problem that we're seeing right now is there aren't that many renewals as you pointed out for the reinsurance up until the 1st of January. So, we have a lot of time and have a lot of discussion and as you can appreciate, there is a lot of positioning by the various players in that market.

So, we'll probably not know realistically how the reinsurance market plays out until very late in December. But we're going to have all the things laid on in front of us, knowing exactly how to react.

On the insurance side, we've seen a couple of things emerge, couple of rate changes, we've seen, the first thing we started hearing is there is no more rate decrease which is a good place to be. But the rate increases are sedate for now.

They are a little bit – they are coming up single to double-digit, but it's very sparse, there aren't that many things renewing right now. Again, we're very much on the reactive mode right now, evaluating on a weekly basis, I know Nicolas and Maamoun and their respective teams are talking constantly as to what's going to happen..

Yeah. One more comment about the available capacity in the marketplace is very, very hard to be estimated, because some players, they have significant capacity only because they believe that they have good support from the alternative markets and direct from market.

So, the underpinning of their capacity on a gross basis is because that market was significant and it was at reasonable pricing. As a matter of fact, we were buyers in that market.

We have no view yet, that's what is still in our minds, we have no view as to what's going to happen to the market, and then what will be the reaction of companies that they said, hey, I can do more on a gross basis because I got all these protection behind me.

So, I can be a little more aggressive in the marketplace and maintain customer relationships, et cetera. So, it's all inter-related and as Marc said, our teams are there, we're willing and able, we have capacity, but it will depend all on expected returns based on pricing..

Okay, great. I appreciate all the color. A couple of other numbers question.

In terms of the tax rate, I guess, should we just expect to go back to around 14% in the fourth quarter and onward?.

Well, think of it this way Elyse, the 19% contemplates a full year view. So as if the fourth quarter is more average with a normal cat load than we talked a little bit about California wildfires, the 19% should hold..

Okay.

And then in terms of the mortgage segment, can you tell us just kind of what the delta in terms of some of your additional severance cost? What expenses we could expect to come out in the fourth quarter versus the third quarter in terms of your operating expenses?.

Well, in terms of – I quoted salary expenses to you, so that's run rate of 8.3% per quarter. To the extent that there is any other actions contemplated there, we only talk about that once they happen for a lot of employee morale and other aspects or reasons.

There are associated additional costs with other kinds of compensation, employee benefits and so forth. But we really don't comment on that. But there is a lot of ongoing work with IT down over the next couple of years when redundant systems start to be peeled away, although savings and associated license costs will come to fruition..

And then in terms of the acquisition cost ratio itself also came down in the quarter, how should we think about that in terms of the mortgage business going forward?.

Well, first off, you should think about them in total between DAC and OpEx because there's always – you may think back to what we did at the end of the year, last year, because there's some – it's not like a direct sales force, so some of that goes into acquisition. And remember, say, as a result of the purchase, all the DAC got really written off.

So, it's really buried within the intangible assets. So as one more and then subsequent, as we write more business, that's on a single basis, it creates a UPR, that PR grows, DAC grows and that has to be created over time. So, you should be seeing an increase in the acquisition ratio..

Okay, that's great. Thank you very much..

You're welcome..

Thank you. Our next question comes from Josh Shanker from Deutsche Bank. Your line is open..

Yes. Thank you. I was wondering if you guys could help me out a little bit and think about the move to getting less exposed to property cat over the last, call it, five years, even longer maybe.

How much of that is relying on the retro markets to be affordable? And how much of that is in the gross premiums of the company?.

Well, I'll give you my comments and Marc might add to it. Listen, independent of the retro market, we always look what is the pricing and what is the market accepting as a expected return on that business. When that business starting going to single-digits expected returns, we are starting to lose a lot of interest.

And having said that, we do have a customer base that we want to maintain and continue to service. So then, that's when you look around and you say, maybe I combine more protection if that protection is available, and you will allow us to maintain relationship.

But the reduction, clearly the reduction in our writings, it was driven by our view that the pricing of that business was not adequate for us.

And for that reason, you can't go to zero and as a matter of fact, it's more difficult on the insurance side to cut as much back than on the reinsurance side, because you got brokers, agents, relationships or customers. So in essence, you know sometimes you do hedge your bet by buying more protection. And we've done all of those things.

If the market improves significantly, you might see a different approach, we might keep a lot more net and we have capacity to do it. And also, you may see us expanding our exposure base because we like the pricing.

Don't forget, we'll understand, we're in the business to deploy capital and make money for shareholders and we're not unwilling to take risk, we're just – we're not unwilling to take risk at inadequate price..

Josh, the way we look at the reinsurance purchasing, specific on the reinsurance side, they're still partners of ours and we fully expect them to be there if no going forward next year and a year after, if the market were to present itself.

But I would say that, it's certainly helped us managing the net exposure because the market was indeed getting softer for last five years, as you know. We actually – I would say that between our gross – our appetite to the market and relying on our partners, I mean, probably a 50-50 split between our management of the exposure.

So, that's probably allowed us to stay a bit longer, while not the overly reliant if you will on the retro placement. So because at the end, they were nice to have. I think that our partners will still be there for the long haul, but we're not relying on this to write the business going forward..

Well, thank you very much. And one other unrelated question. In terms of the amount of earnings being suppressed in the UGC transaction due to your reinsurance relationships, sort of two questions.

One, I think at the Investor Day, you spoke about the potential that you might think about doing that for a longer period in terms of reinsurance relationship with AIG. I just want to hear an update about that? And two, AIG provides data about how much that relationship is helping their P&L, but it seems to jump around a lot.

Is that revenue steadier in your books or can we use AIG's numbers about UGC to understand the degree to which Arch's currently under earnings potential?.

Good questions. I think I'm going to turn it around a little because I think you actually – your statement actually answered your question. Now, they don't have exact mirror accounting to us, they come up with their own views and estimates.

But I think from an EP or earned premium, net earned premiums, ceded earned premiums to them assumed earned premium, I think that's a reasonable way to look at it. But clearly, when it's starting the downside of the effect of the AIG for this year diminishing each quarter..

And whether you would renew it or is there any talk about doing that?.

No, there is not a renewing of that. That was 2014 through 2016....

You wouldn't do anything on the 2018 here with AIG or anything like that..

Well, if we did it, it wouldn't bound yet and I wouldn't be speaking about it..

Of course..

Everything is possible, Josh..

Thank you very much..

Okay..

Thank you. Our next question comes from Amit Kumar from Buckingham Research. Your line is open..

Thanks, and good morning, and thanks for taking my questions..

Speak up..

Amit, speak up, because we can barely hear you..

Is this better now?.

Yes..

Well, thank you. So two quick follow-up questions. Number one is just going back to the discussion on industry losses, and I want to be clear that I understand this.

Do you feel based on your statements that the industry loss will eventually get to the model's numbers we are hearing about? Or do you have a feeling that these models, and there was a lot of divergence between the numbers, overestimated the numbers.

I guess I want to understand if we are overestimating it, then clearly the market does not turn, any optimism is a bit overdone..

Yeah. First and foremost, all I am saying is that everybody seems to congregate against the $80 billion to $100 billion. Both the modeling agencies, if you take their average or point estimates for reach of the storms and also a lot of competitors including us, so I think the models, probably they're projecting the right number.

Now, I don't know every company's book, I am just making aggregate comments. But something doesn't add up, either that number is going to come down and your hypothesis is correct, if it comes down, people, they are not going to feel it is much on their P&L. So in essence, they might not, the market correction might be toned down.

On the other hand, if you go to historical performance, model has never overestimated losses in the past and usually, our early estimates as an industry, they were below what they ended up. So, I will leave you the judge of where do you think is going to happen.

I think we are going to have an effect that is not going to be felt totally for another two or three quarters before we know where these things are going to end up..

Moving away from modeling for one second, Amit, I think if you move – if you park aside Maria, because this one has probably the most uncertainty in terms of modeling an alternative protection, it's really hard for us internally based on the modeling and based on what we know in terms of damage what happened is very hard to even consider that both Harvey and Irma are less than $25 billion each.

So, that already takes us to the $50 billion. So before even considering Maria and the other event that happened, so that's why we are sort of building from there to – it's not a far reach to get to $70 billion, $80 billion, $90 billion, but I guess only time will tell.

But I think it's very hard in isolation to just look at these two losses and think that they are going to like $15 billion each. It's very difficult for us, and that the implications of the industry losses that we have seen reported so far that these two losses would be a lot less than they seem at this point..

Got it. That's actually helpful. The only other question I had was I guess going back to what Elyse and maybe Josh were asking, if you look at the subsegments in the reinsurance segment, they interplay between different segments.

Even based on the market opportunities, should we be rethinking about, I guess, the total top-line and the returns differently, is that premature or how should we think about I guess the capital allocation between the different segments at this juncture?.

It's very difficult because I can't answer you, because I don't know myself. What guide us is market pricing. At the end of the day, if you tell me what is going to be in January 1, maybe I can give you some projection.

But not knowing that, I really don't know what we gear our people to do is to look for every opportunity available, we'll evaluate it and if we needed to be very agile and move capacity to one area versus another, we are there to do it.

And if this is, we get another big event in fourth quarter with another catastrophe and the whole world take upside down for January 1, I can tell you there is a lot of actions we are going to take, including looking for additional capital and be in the business for our shareholders. That's what we get paid to do and we are willing to do it.

Marc, right now, we are evaluating exactly this because back in 2005, it was pretty clear that the rewards – risk rewards was much more advantageous to the reinsurance team. We, at that time, allocated 80% of the cat capacity to the reinsurance team, and 20% therefore for the insurance group.

This time around, it's different, right, because again, we don't know where the reinsurance market is going to go, a lot of these loses are retained within the company, so there may be a different outcome on the insurance side.

So, right now as we speak, the two guys leading our reinsurance and insurance are going through it to see what kind of return they will be expecting next year, and therefore, giving us a plan of action as to what they are going to do. But they still have to collect information as we speak.

The big question mark here, especially on the insurance side, is how much capacity has existed through these MGA facilities, that is somebody having the plan for somebody else and at the end of the day, their compensation is I got to write more, I got to write more, I got to write more, because they are commission-based compensation.

And will these facilities survive the event and get renewed, and that capacity is available, or they go by their wayside, or they get terms that they move the market upwards. So we don't know that, because some of these facilities as is toning down what's happening in the market, they haven't expired, or they might require a six-month notice.

So they're going to be used until they can be used. And if they are in place now and you don't think is going to be renewed, you're going to use it up to the last minute. So we don't know, there is a lot of things up in the air, we have our heads to the ground and we're looking at all these opportunities. But, it's not a clear picture yet..

Okay. I got it. I'll stop here. Thanks for the answers, and good luck for the future..

Thank you..

Thank you. And our next question comes from Brian Meredith from UBS. Your line is open..

Yes, thanks. A couple of questions for you all. The first one, just curious and maybe I missed it.

Did the RDS, which you provided in the mortgage, include the recent Bellemeade transaction or not, and if not, what that looks like with the recent Bellemeade transaction?.

It does include it, what will be the number without it? Do you have the number, Mark?.

Well, it's – did you quote what it was percentage?.

15.7%..

15.7%, it's not much of a movement on it. The benefit from that is a couple hundred..

It's $200 million..

Yeah..

Okay, great. And then I'm just curious, you guys have Watford Re out there which is more kind of a liability facility.

Are there any thoughts of creating facility that's more dedicated to severity or cat, if indeed the market doesn't rise enough to maybe be acceptable to you on a kind of a net basis putting a lot more cat risk on your balance sheet? Are there opportunities potentially to do something more from a gross perspective or in case fee income?.

Well, we have two considerations there. One is, if the market improved significantly, we'll use a lot of our own capacity, but also we'll be very much interested in managing third-party capital, because we don't want to change our risk profile. We've done that after Katrina with Flatiron.

On the other hand, if the market doesn't move, and there is people that they will be willing to get our underwriting skills and they're willing to accept may be a little less return than we will, we're not opposed to managing money in that fashion either. But that's not our preferred outcome.

We like the market to get hard, so we can write more on our balance sheet and maybe write for our partners also..

And Brian, I mean, I just appreciate you allow me to put the plug out there in the marketplace, if anybody's looking to deploy capital in this space, we'd love to talk to them. Yeah. Thank you for that..

Okay.

And then just question, I guess you kind of alluded, kind of I was asking, maybe you can put specifics on, how much more rate do you kind of need in property cat to kind of take more on a net basis, do you think?.

Well, if the rates – right now the returns in the space are in the mid-to-high single-digits. So, it's not expected return and not extraordinary..

Right..

So we've actually asked our team is what we are going through right now. We think that to get to a 15-plus return, we would need roughly 30% to 35% rate increase. So, we need a substantial increase in rate.

What people forget is we have to be careful with looking at a rate that changed in isolation, I think it's been mentioned on other calls is that we are at a pretty low level compared to history for the last five or six years.

So this is why – in 2005, when rates went up 10%, 15%, 20% we were in a very different market, pricing was a lot better, where it comes from, now it's not as good by any stretch of the imagination.

So, we will need substantial rate increase to really fully deploy it and even then, Brian, as you know, we are very careful with our capital management, we will have to see it and have a good clarity of it before we commit fully to this.

And I think it's going to take a gradual price increase and will take time, it's going to be a dynamic process for us to evaluate as we go forward. But, if you close your eyes and you roll the tape and you see the rates have gone up 50%, 60%, then I think we would have a lot more appetite to take on a net basis.

But we will sort of have to work our way towards this, as we see if the market allows us..

And Brian that would be a composite because you have to take into account the underlying ceding company rate changes as well as what it might be on the cat rate itself..

Yeah, sure..

Right, right. And I guess adding on to that, I mean what do you think the possibility of something like that happening given it doesn't seem like there has been a change in the perception of risk with these events? I mean, the last time we had that type of rate increase, you had massive changes in the models..

Well, I won't be too quick to make that judgment, yeah, if there is. I think smart people, they are going to step back and look at the events, and say, should we change our mind about how risky this business is and what kind of returns we should expect..

I think there is a recognition right now, Brian, as we speak when we hear from our producers and from even the buyers of insurance or reinsurance for that matter, and the recognition that rates need to go up. So I think this consensus is building slowly but surely. But the question is how much if it does go up.

I think to answer your question, we need to know will there be some creep, some increase in loss reserve – in loss estimation in a few players, will there be some change to rating agency perception of risk, will there some change to the modeling, there are a lot of things unfortunately, Brian, that need to happens for everything to converge to one area which was more the case in 2005 if you remember.

We had a two or three things converging at the same time, which really helped it. And also frankly, we might be sitting in the next call, talking to you guys about this and still not know fully where it's going.

In 2005, it took another four, it took really between June – May or June, March to June of 2006 to really see the market take hold and really find its footing, so it takes a little while longer than we would expect unfortunately..

Right, right. Yeah, yeah.

There is also the release that the new, the models came out right around that time, right?.

You got it. You got it..

Yeah. Great, thanks..

Sure..

Thank you. Our next question comes from Jay Cohen from Bank of America. Your line is open..

Yeah. Most of my questions are answered. Just I guess one follow-up. On the Bellemeade transaction, do you see this as the first of others given that this is a unique thing and you got it through. The next one might be a little easier..

Yeah, Jay. It's a good question. We do see that as an ongoing piece of our repertoire to manage risk management in the balance sheet, so yes..

And it's not the first one, it's the third one. Because United Guaranty, they too before us and then we've done the third one. And we're going to use that as a risk management tool, as we might use also a traditional reinsurance as a risk management tool..

Got it. Thanks..

You're welcome..

Welcome, Jay..

Thank you. Our next question comes from Meyer Shields from KBW. Your line is open..

Thanks. Two questions on Bellemeade, is the ceded written premium a one quarter event or is that going to play out over the....

Meyer, we can't hear you..

Hey, Meyer, could you please speak up?.

Sorry..

You're not coming through. Go ahead..

Is it better?.

Yeah. Much better, much better, yes..

Okay, great. Sorry about that.

I wanted to know whether the ceded written premium for Bellemeade is going to just impact, I guess, the fourth quarter or will it endure over the life of the contract?.

No. That goes over time. You are going to see sessions associated with that every quarter..

Every quarter. The first year is the $11 million....

Yeah. That's right..

And then, it cascades down as....

Correct, which will be the case on every, think of it as a laddering. We do another Bellemeade, its first payment will be higher and decremented. And then if we do another one in 2018, there'll be a first payment that's higher and it will decrement..

Yeah, Meyer, the way it works is that you have the – it's on a – if you look at quarterly, the amortization of the limit is amortized overtime. It's a 5% of risk-in-force and if there's persistency of 80% per year, you would expect 80% of premium to be paid the next year and then a, 64% or the $11 million in the third year and so on and so forth.

That's how the bond works, the $368 million, you know, will amortize over time..

Okay, perfect. That's very helpful.

And then just going to retroactive reinsurance transaction that's a second in two quarters, is there a – like a building market for that, that would align with broadly trading reserve redundancies across the industry?.

You're talking about the – talking about the -.

Meyer?.

No, no. He is talking about the reinsurance transaction, Marc. The retroactive reinsurance – yeah..

Oh, the loss portfolio transfer..

Yes..

We're seeing that market getting very active. And then we're very happy, very pleased with premium. Premium is a way ahead of its initial plan. And that's testament to our team's efforts in working very diligently.

I think that there's a – like we said before I mean there's a lot of books of business specifically on the liability – this is a liability transaction, that's why it's booked in the casualty unit.

There's a lot of books of business who have issues and worked, and people are trying to and I can't blame them, trying to find a new home for it to just move away from it and just put it behind them. This one is really meant to bring finality to that client.

So I think we're going to see more of these, I think in terms of – sense of capital management and earnings management, you can expect more companies to look at it. There's a very, very healthy flow of offers in the book for our premium folks..

Okay. That's perfect. Thanks so much..

Thank you..

Thank you. Our next question comes from Kai Pan from Morgan Stanley. Your line is open..

Thank you and good afternoon now. And so my first question is on the casualty line. I just wonder, do you think these increasing the property lines would spread out to the casualty lines.

And do you see any sort of changing term underlying loss cost trends?.

You've got multiple questions. First, we hope, but we don't see it. Second, it's needed, but we don't see it. And your third question, yes, loss cost, even though we're getting slight rate increases on average, we're having difficulty in – including us – we're sure pretty conservative in our underwriting, maintaining the same level of profitability.

As a matter of fact, we lost another 20 bps of margin between what we believe the loss cost escalation was versus what kind of rate increases we got on average. Marc, you want to -.

No, we're not seeing it right now. We think it should happen, but actually it might actually be – have a perverse reaction as a result of property lines having losses, people might look at casualty and professional lines.

For us casualty got to be clear, encompasses more – especially on the reinsurance, more than just GL, it also encompasses professional lines, it could have a perverse reaction that people use it as an excuse to get price decreases for accounts that haven't had a casualty loss in a while because – while look at the property accounts.

They're giving you losses, we're not giving you account. So everybody will, I shouldn't probably be using these arguments on a call to give it to our clients. But I'm sure they'll be using them so..

All right. And second question on capital management and you've paused buyback for the UGC transaction.

And like, do you think you will return to buyback in 2018 in light of potential of the market pricing environment to get maybe better, you may find other place to deploy your capital?.

I think, if I could just start. I think Kai, it's completely derivative to the other discussions we're having on property cat and the opportunity. The opportunity is strong then there was clearly a decreased likelihood of doing that on a return.

So they're totally in balance with each other, we need to see where the market is, before we can really answer that..

Kai, if I have to guess, I think they're going to be the price movements that it will cause us to have more opportunities in the market. So but we don't know, stay tuned, ask same question in the fourth quarter..

I will, thank you..

Yeah, thank you..

Nice shot..

Thank you. And our next question comes from Ian Gutterman from Balyasny. Your line is open..

We're not telling you what's for lunch yet..

That's okay. I actually really had a question for you.

Are you familiar with the game Where's Waldo? Dinos?.

No, no, no. My kids are certainly..

Okay, that's okay. So we'll go with that. So what I found out, I know where the missing losses are..

Yeah..

Waldo took your profits from selling all his book and he you wrote a bunch of reinsurance. So when you find Waldo, you're going to find $50 billion..

Okay..

But it could be in London, it could be in Bermuda, it could be in Germany, Waldo likes to hide in lots of places, so..

Yeah..

If you keep an eye out for Waldo, and you'll find the losses..

So when you find it, just call us, because then we might – help us with our strategy going forward..

Yeah, you can look too, he could be anywhere so..

Oh, we're looking..

He might be delivering lunch today you never know. So my first question is, what – I'm sure you listen to some of these calls, and everyone is strident that they've learned from 2011, they've learned from 2005 and they're not going to late report this time.

Where do you think the issues are? I mean a lot of the primary companies are even saying, we've closed most of our claims already like it's so obvious, we know what our inventory is, there's nothing that can surprise us.

You mentioned program, outside of that are there other reasons we should see late reporting on what the primary companies are calling simple storms, at least outside Maria..

Listen, there is – I can go into a lot of directions. Flood always has been a big problem. Look at Sandy and how long did it take et cetera. Second, if you go to Florida there's a lot of snowbirds that haven't even gone down yet to start looking repairing their homes.

And this assignment of benefits issue in Florida, it's going to have escalation of losses. So if they know they're closing and all that is news to me. At the end of the day, I'm only going by history and history has told us, there has always been an underestimation and we have more positive escalations than negative.

People instead of taking reserves down they add it to overtime. So listen, if it's less it's less, and then maybe my number is too high.

But how do I know?.

Ian, I think that the other thing you have to keep in mind, Ian, is if you have a portfolio of homeowners, very straightforward plain vanilla, and you had a lesser amount of risk, it's probably more likely that you'll be to close that file a bit quicker.

The area where we think there's a lot more variability is on the E&S and on unoccupied buildings and the sort and that's going to take a while for everybody to really figure out what the coverages are going to be. And you have insurers who are – possibly been more sophisticated than a bit more better equipped to fight with the insurance companies.

And surely we're seeing it as with the AOB phenomenon in Florida that surely doesn't help the matter. So I guess you have to put things in perspective and it depends who you talk about.

But I would echo what Dinos just said, a lot of the insured population will not probably have anything settled or finalized in terms of loss estimation and indemnity paid for another six to nine months. It takes a while..

You're going to see real losses. A restaurant who had no real damage to the restaurant, but the parking lot was flooded and as customers couldn't have access to the parking lot. And he was going to claim business interruption because of the flooding.

It's – and he was in a Zone 5 which is not considered a flood zone, so he had no exclusion on the policy and his deductable was pretty low. All these things are going to take a long time to get resolved and like I said, it's our view and usually not a lot of people agree with our views but more often than not, we are right..

I agree with you, Dinos. I think we're in the minority but I agree with you. So related to that the one that surprises me the most so far is that most people have Maria as their lowest loss storm and that's the one where I would think the greatest risk is of BI because in Houston, like you said, there were some issues with getting back on your feet.

It's not that hard, right? In Puerto Rico, I mean who knows how long, right? Why isn't every BI limit on the island for loss?.

Yes. This is very uncertain. I've asked our underwriters that right in the area this week actually, and again it's still extremely opaque, there's still a lot of – no information, lot of areas don't have power yet and things are not just back into an order and it's going to be a long time before, we figure out.

So this is where a cat – even a cat event, Ian, could be in long-tail event, a long-tail phenomenon, which is again, things that we forget as an industry sometimes..

Fair enough. And so the other comment you made earlier, Dinos, about the gross – first net line underwriting the companies who were relying on retro. So they didn't have to shrink their gross.

Again, I don't know how many calls you've listen to this week, but pretty much everyone who's been doing that has said on their calls, I'm simplifying here, we're going to keep our net lines, where we are. We're going to look for grow our gross.

So it feels like people want to double down on that strategy, which – if that's the case a, I'm not sure where they think they are getting all this extra incremental capacity.

But if so doesn't that suggest it's harder to get pricing, if – and so to Brian's question right, where's the pain no one wants to shrink?.

Well. But it's on the premise that – the net to gross can work, meaning that there is a robust retro market or quota share market, that is going to reduce their net exposure. We haven't heard from that market yet. We knew it was in that $20 billion range and some people that might be estimating maybe 50% or even maybe 75% of it might be gone..

And Ian, I think you're exactly right. I think not only on the loss estimates from the size, what the ultimate loss is going to be at the industry. But to add matter – to add even more complexity then you're quite right, and we talk about all the time, this alternative capital, it's a relatively newer phenomenon to our segment.

And it brings a little bit more – quite a bit more actually uncertainty, as to what's going to happen. And would add that it might increase the volatility of what could happen, which could be good for us in a way as well. So it's remains to be seen..

Absolutely, yep..

Yep..

Absolutely. All right. So couple of Arch-specific things.

First, the retroactive contract should I guess that that was you took a share of the deal Premia wrote?.

Yeah, 25% of it, yep..

Okay. Got it. Looking at your recoverable on the balance sheet, should I assume most of that growth was from the hurricane. So that your gross was about twice your net..

Bingo..

Yes..

Okay, good..

You do your homework, good..

It's pretty good, Ian, yeah..

I try, so it was a late night, last night. But I try..

Hey, Ian, for the record, I'll state, you weren't one of the guys that went to the 111.8% combined ratio so..

Exactly. And then what was I going to say was the – so one part that's surprising on your losses, was just the composition and I think I know why, but I just wanted to hear to make sure.

I am surprised that the amount of the insurance, just, you know, like a simple thing I looked at right, is your insurance loss from these events were basically equal to your 2011 plus Sandy.

Right, so it seems that I don't know, is that just because of the geography of things, is because you're in certain businesses that have more property now than you did then. Does that – I guess I was just surprised, the reinsurance isn't surprising at all.

But the insurance is a little higher than I thought?.

We're an E&S writer. And we believe the flat losses, they're going to have all these questions that I have raised. The business interruption et cetera, so we being cautious of estimating a loss. And same thing in Florida, we believe that this assignment of benefits is going to have an escalation of maybe up to 30% on the cost of repair.

So we factor all that in and that's why you see more on the our reinsurance book..

And Ian just to add further. So if we go through the losses that are reported and we look on the reinsurance side right. You see even if there was some creep up or some factoring, the AOB, the flood or the business interruption, it's hard to see a lot more creeping up into the reinsurance layers.

But it's a more, it's a provider effect on the reinsurance side. So we had to do a more prudent selecting the losses reflecting those uncertainty between the insurance and the reinsurance. I think it's a lot more uncertainty on the insurance side at this point of time..

And Ian, just to marry Marc's comments with some of the ones earlier on that proportional aspect, to the extent that the market losses, the industry losses start to decrease because of the proportionality on the insurance side that will be shared.

Whereas some programs on reinsurance or retro markets and some companies might be – think of it as event aggregate excesses. And you're really saving for the reinsurer more than just saving for your net..

Yep, that makes sense. Okay, got it. Very good, thank you, enjoy lunch..

Thank you..

Thanks and take care..

Thank you and I'm showing no further questions from our phone lines. I would now like to turn the conference back over to Dinos Iordanou for closing remarks..

Well. Thank you all and looking forward to talking to you next quarter. Have a wonderful day..

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may all disconnect and have a wonderful day..