Good day, ladies and gentlemen, and welcome to the Q3 2018 Arch Capital Group 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. If anyone should require assistance during the conference, please press star then zero on your touchtone telephone. 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. Marc Grandisson and Mr. François Morin.
Sirs, you may begin.
Thank you, operator. Good morning to you all. Happy Halloween to all and best wishes to your little ghosts, goblins, and princesses. While the stock market has been providing some scares this past week, here at Arch, we had another good quarter despite higher cat activity around the world as our operating strategy of diversification, cycle management, and focus on risk-adjusted returns produced an annualized operating return on equity of 11.4% and a 2.3% increase in book value per share at September 30th, 2018. Francois will provide more commentary on our financial results in a moment. It's worth noting that our modest exposure to property losses this quarter is not just a result of our good risk selection. It also reflects our ability to remain disciplined in a market where risk-adjusted returns do not meet our return hurdles.
The 2017 and 2018 catastrophes are a reminder that margins in cat-exposed property lines remain thin and in many cases are inadequate relative to the severity and frequency of catastrophe events. With respect to market conditions in our property casualty operations, outside of property, there are just a few specialty areas such as travel accident and European motor, where current market conditions provide opportunities to deploy additional capital. In most of our insurance lines, rate changes are positive and appear to be outpacing claim trends. As we have discussed in prior quarters, the spread between rate changes and loss trend, claims inflation if you will, is small, and we remain cautious in establishing our loss picks. In addition, specialty lines such as those that we write are volatile by their nature, and it is necessary to use a longer assessment period in order to evaluate the ultimate margins.
In summary, overall market conditions in our P&C businesses seem relatively unchanged from last quarter, and we continue to believe that additional rate increases are needed to provide a more adequate margin of safety and broader growth opportunities. Turning now to MI, where the operating environment remains attractive. I will focus my comments on our U.S. primary business, which represents over 80% of that segment. MI pricing appears to have stabilized in the third quarter after the rate changes announced in the first half of this year. The credit quality of loans insured remains strong, and our key risk barometers are still at benign levels relative to historical norms. If you have a chance, visit our Arch MI website for our full housing and mortgage market report, called the HAMMER report.
It will give you a good idea of why we remain confident of the health of the U.S. housing market. In short, due to the factors I just discussed, we like the visibility in the future performance of our U.S. mortgage insurance business. Our U.S. MI new insurance written or NIW was strong again at $21.4 billion, a 21% increase over the same quarter last year. In the third quarter, higher loan to value or LTV mortgages with greater than 95 LTVs grew slightly as a percentage of our NIW to about 15%. Credit quality, as indicated by FICO, remains high across our risk in force with an average score of 743. We remain underweight relative to the market in the greater than 95 LTV and the higher DTI products. Our single premium policies remain low at 7% of NIW this quarter versus the industry average of roughly 15%.
In the current rising interest rate environment, monthly premium products should continue to produce better risk-adjusted returns over time. The persistency of our monthly policies increased to 82% in the third quarter and supports the allocation of more capital to the monthly products. In addition to maintaining the credit quality of our in-force book, we increased our protection for mortgage tail risk by completing our second and third Bellemeade risk transfers to the capital market this year, where we have become a regular issuer. Insurance link notes enhance the level and the predictability of our expected returns. As far as the new MRT programs with the GSEs, the IMAGIN and EPMI facilities, they have begun to generate business. Momentum is building slowly as banks develop new systems to handle the programs. More on that later.
Now, briefly, with respect to our investment operations, higher yields available in the financial markets and growth in invested assets led to a 21% increase in net investment income in the third quarter. We remain underweight both credit and interest rate risk, given the rising rate environment. Finally, a few words on capital and risk management. Share repurchases by Arch are typically light in the third quarter, and this quarter was no different. While we repurchased some shares this past quarter, we have been working on a few opportunities to deploy our capital into our businesses, and we will let you know if and when these opportunities come to fruition. As to risk management, for the reasons I mentioned earlier, our property cat exposures remained at historically low levels with our one in 250-year peak zone at 5% of tangible common equity at the end of the third quarter.
For our mortgage segment, as of September 30th, our realistic disaster scenario declined as growth in the insurance in force was more than offset by the capital relief from the Bellemeade transactions and the continuing runoff of pre-2009 business. With regards to PMIERs, which applies to our primary U.S. mortgage insurance business as of September 30th, 2018, Arch MI was at 151% of the current GSE capital requirements. Arch required assets exceeds both the current sufficiency ratio known as PMIERs 1.0 and the revised GSE required assets as proposed under PMIERs 2.0, which is to be effective on March 31st, 2019. With that, I will turn it over to François.
Thank you, Marc, and good morning to all. Let me jump right in and give you all some comments and observations on our results for the third quarter. Consistent with prior practice, these comments are on a core basis which corresponds to Arch's financial results excluding the other segment, i.e., the operations of Watford Re. In our filings, the term consolidated includes Watford Re. After-tax operating earnings for the quarter were $242.3 million, which translates to an annualized 11.4% operating return on average common equity and $0.59 per share. On a year-to-date basis, our annualized operating ROE also stands at 11.4%, a solid result in light of challenging conditions in the P&C sector.
Book value per share was $21.15 at September 30th, a 2.3% increase from last quarter and a 6.4% increase from one year ago, despite the impact of higher interest rates on total returns for the quarter and on a year-to-date basis. Moving on to operations. Losses from 2018 catastrophic events, net of reinsurance recoverables and reinstatement premiums were $58.2 million or five combined ratio points. While these losses were predominantly the result of Hurricane Florence hitting the Carolinas, we were also impacted by other events across the globe, including Typhoon Jebi in Japan. As for Hurricane Michael, while we are still early in the process of assessing our exposure to this event, we believe the impact to our insurance and reinsurance operations will be in the range of $40 million-$60 million on a pre-tax basis, given the information available at this time.
As for prior period net losses of development, we recognized approximately $77.6 million of favorable development in the third quarter or 6.7 combined ratio points, compared to 5.1 combined ratio points in the third quarter of 2017. All segments were favorable, led by the mortgage segment with approximately $38 million favorable, the reinsurance segment at $33 million favorable, and the insurance segment contributing $7 million. This level is higher than in recent periods, primarily as a result of the significant favorable development observed in our first lien portfolio in the mortgage segment, where cure rates this year continue to be materially higher than long-term averages and expectations. The calendar quarter combined ratio on a core basis was 80.1%, while the core accident quarter combined ratio excluding CATs improved to 81.8%, down 260 basis points from last year's third quarter.
The insurance segment's accident quarter combined ratio excluding CATs was 100.2%, slightly higher than the comparable 2017 level as a result of elevated attritional claim activity across a small number of lines, slightly offset by lower operating expenses resulting primarily from lower compensation costs. In comparing the quarterly accident year results, it should be noted that the reported results can be subject to noise due to random occurrences that can take place in the lines of business we operate in. Just as we reported that our results last quarter were enhanced by the lower frequency of large non-CAT claims, the opposite result materialized this quarter. In order to detect trends in the performance of our units, we tend to focus on trailing 12-month analyses to remove some of the noise that we see from quarter to quarter.
The reinsurance segment accident quarter combined ratio, excluding CATs, stood at 92.5%, compared to 96.9% on the same basis one year ago. As we discussed in the prior call, the combined ratio in the quarter one year ago was impacted by a large retroactive reinsurance contract. Given the nature of our book and the impact certain large transactions may have, fluctuations of quarterly results are not unusual and should be expected. The expense ratio benefited from the reduction in federal excise taxes of $2.3 million, or 0.8 points, as a result of the cancellation of certain intercompany property casualty quota share agreements effective January 1st, as discussed in prior calls. This item will continue to impact comparisons of 2018 to 2017 results.
The mortgage segment's accident quarter combined ratio improved by 410 basis points from the third quarter of last year as a result of the continued strong underlying performance of the book, particularly within our U.S. primary MI operations. The calendar quarter loss ratio of 3.2% in the third quarter of 2018 compares favorably against the 12.8% in the same quarter of 2017 due to substantially lower delinquency rates. 570 basis points of the difference, or $17.1 million, is attributable to increased favorable prior development, while an additional 280 basis points of the difference, or $8.3 million, is attributable to favorable development on 2018 delinquencies due to very strong cure activity in the period. The expense ratio was at 21.4%, slightly higher than in the same period one year ago, as a result of a higher level of acquisition expenses due to increased amortization of deferred acquisition costs.
These figures highlight the contribution to our pre-tax underwriting income from the mortgage segment, which remained strong this quarter. After allocating corporate items such as investment income, interest expense, and income taxes to each segment, the mortgage segment's contribution to our 2018 year-to-date net income decreases to approximately 70% of the total after normalizing our results for catastrophic activity. Total investment return for the quarter was a positive 31 basis points on a U.S. dollar basis and a positive 37 basis points on a local currency basis. These returns were impacted by the effects of higher interest rates on investment-grade fixed income securities, with marginally higher returns on alternative investments and non-investment-grade fixed income. During the quarter, we continued to shift our allocations away from municipal bonds and into corporates due to relative valuations. The investment duration was substantially unchanged on a sequential basis at 2.94 years.
Operating cash flow on a core basis was a strong $543 million in the quarter, reflecting the solid performance of our units. Lower levels of claim payments and higher levels of investment income received explain most of the increase over the same quarter one year ago. The corporate effective tax rate in the quarter on pre-tax operating income was 11.8% and reflects the benefit of the lower U.S. tax rate, the geographic mix of our pre-tax income, and 190 basis point expense from discrete tax items in the quarter. As a result, the effective tax rate on pre-tax operating income, excluding discrete items, was 9.9% this quarter, slightly lower than the 10.4% rate last quarter. As we look ahead to year-end 2018, we currently believe it's reasonable to expect that the effective tax rate on operating income will be in the range of 9%-12%.
As always, the effective tax rate could vary depending on the level and location of income or loss and varying tax rates in each jurisdiction. With respect to capital management, our debt to total capital ratio was 16.6% at September 30th, and debt plus preferred to total capital ratio was 23.5%, down 290 basis points from year-end 2017 and 520 basis points from year-end 2016, when we closed the UGC acquisition. As for share repurchases, we repurchased 414,000 shares during the third quarter at an average price of $26.48 per share and an aggregate cost of $11 million under a Rule 10b5-1 plan we implemented during a closed window period. Since the start of the fourth quarter, we have purchased an incremental 575,000 shares at a cost of $15.3 million.
Our remaining authorization, which expires in December 2019, now stands at $247 million after consideration of the share repurchases made through October 30th. With these introductory comments, we are now prepared to take your questions.
Thank you. Question at this time, please press the star, then the number 1 key on your touch-tone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. For optimal sound quality, we do ask that if you are currently using a speakerphone, please lift the handset before asking your question. Again, ladies and gentlemen, that is star 1 to ask a question. Our first question comes from Geoffrey Dunn from Dowling & Partners. Your line is open.
Thank you. Good morning.
Hey, Jeff.
I guess first, could you update the RDS number for the MI business? Specifically, can you give us what the gross RDS is and then the net RDS after all the ILN benefits?
Well, we do the gross and cede, but we focus on the net because there's a lot of movements there, and there's a lot of reinsurance protection, as you know, that comes into play. The current number is just at about $1 billion, net of all the protections we have.
Yeah. It's higher 13%, Geoff.
Is there any way for us to try to back into that gross number?
Not really. From just talking to you, I guess at some point we might want to talk to it through it, but it's not very easily manageable, I guess, on a call like this.
Okay. With respect to managing capital in the MI platform, as you consider both regulatory limitations on dividends and just overall surplus until contingencies start releasing, is it possible to manage to an efficient cushion on a pro forma 2.0 basis as a recurring ILN issuer?
I just want to make sure. The question, in a sense, a cushion, yes. Just to be clear, we certainly want to have a cushion above PMIERs 1.0 or 2.0. We don't think it's prudent to run the business right at PMIERs, whatever that is. No question that yes, as you saw, the PMIERs ratio did go up this quarter, driven by the new Bellemeade transaction we closed on in the third quarter. We're in the middle of discussions and planning around how we can extract some of that excess capital from the regulated mortgage entities and see what we can do with that.
Two things to add to this, Jeff. I think that the Bellemeade transaction, as you know, are by and large so far have been backward-looking. You really only know after you've accomplished or you've realized them. Your question assumes that you're going to have the same level of execution in the market going forward on a guaranteed or semi-guaranteed basis, which we don't know if that's the case. Having said all this, you also have opportunities that may develop over time in the marketplace that might mean more need for capital, and that also will cause sometimes delay or it's not a very immediate release of capital. As you know, with the regulated entities in the U.S., we have to be careful, and it takes a little while to go through the capital management because of all the constituencies out there.
It sounds like maybe it's a little too early to ask the question.
Well, we're working on it. The answer is, it's a fact. We close on the transactions, as you know, it takes time to get approvals done, that's really the first thing we need to do. If and when we get those, we'll have more flexibility in what we can do with it.
Okay, thanks.
Yep.
Thank you. Our next question comes from Kai Pan from Morgan Stanley. Your line is open.
Thank you. My first question, just follow up with Geoffrey on the MI business. It looks like last two quarters, your underlying combined ratio running at the high 30s, given the strong credit environment, that's compared with last year, probably in the mid-40s. I just wonder if the credit environment remains stable, will that be a sort of reasonable run rate for that business? Other sort of like minus pluses could impact that core combined ratio going forward?
Kai, all moving parts that are there's a lot of things going on. If anything else change, you're quite right that we should expect to have a very similar combined ratio. That's just based on the credit quality of the borrowers. It's still extremely good out there. Yes, that we would expect that everything else being equal, which it never is, right? We still need house price to go up. We still unemployment remaining low and mortgage rates not increasing dramatically or in a significant way. There's a lot of things that need to happen for this to be conceivable. For the shorter term, yes, we would expect this to be a sustainable combined ratio.
Okay, that's great. Then switch to the reinsurance side. We have heard a lot of sort of new demand in the marketplace in the casualty re-, as well as this year's CAT activity is not quite. It's not like as large as last year, but we have some adverse development from last year's events as well. What's your outlook for January 1 renewals? If you can talk both on the property CAT side and as well as the ongoing sort of like pricing on the casualty side as well.
Let me take the property CAT. It's still early, right? We're a couple of months before the renewal of the January 1s. The market is still flush with capital, there's a couple of things going on there that brings a lot of dynamic as we get towards January 1. Based on the results of the losses that we've seen over the last two, three years, we would expect there should be at least some price increase to recognize the fact that the long-term average, the short-term average is probably not going in favor of the insurance companies and the reinsurance companies. We would expect that to have an influence on the renewals. However, capacity is plentiful, and there's a lot of alternative capital that could come in and change it. We'll have to wait and see what happens. It's not a clear-cut answer from that perspective.
On the casualty side, it's a very tough place to be. The results on the casualty, we're not a big casualty reinsurance player. What you see in our casualty segment is not at all the GL, general liability or the traditional casualty reinsurance. We still feel this is too competitive for our own taste. The fact that people want to buy more reinsurance might indicate to me that there's a willingness and a desire to share or at least to de-emphasize the risk that is inherent in their portfolio. We'll be very cautious in the way we are going about running that business. We're not as optimistic about the casualty market as people would be out there.
Okay. Last one you may on the primary insurance side. You mentioned attrition loss is higher. Could you quantify that for the quarter? Also you mentioned the business results have been close to breakeven, and you have mentioned about 95% long-term outlook and how quickly we can get there.
Not soon enough, right? That would be the right answer. I think that we've seen the trailing 12-month combined ratio hovering around 99% this quarter, yes, did have larger attritional losses. I think it's 2 to 2.5 points impact on the quarter, which would have put this quarter in line with the other ones. On trailing 12 months, we're pretty much at the 99%. This is the one that we tend to focus on. Any one quarter does not make a trend. As you'll remember, we had large losses on reinsurance last quarter. We did not have them this quarter. We had it in insurance. There's a lot of volatility going around those, given the specialty lines that we write.
I think that we also look at this in sense of the overall market being soft, terms and conditions not strengthening any better. We have some rate increase. It just makes us be that much more prudent. When there's a large loss that comes in, most of the time IBNR would be there to make up for that loss. We tend to take a more conservative approach to this and maybe not take a full impact on the IBNR and leave the IBNR at the same level and take the large loss as it comes, because we're not sure that the fundamentals are improving as much as we would hope they would be.
Okay. Thank you so much.
Thank you.
Thank you. Our next question comes from Michael Zaremski from Credit Suisse. Your line is open.
Thanks. Starting with mortgage insurance. In the prepared remarks you mentioned that momentum is building for, I think you said some of the bigger banks to handle some of the adjustable mortgage insurance pricing. Is that, you think, helping you maintain your market share position? Because I think your market share jumped up a lot in 2Q, and still stayed higher than expectations, which is a good thing this past quarter.
I'm not sure what part of my remarks you referred to, the thing about our ability to increase market share and being that relevant to our clients is most of the clients that have embraced risk-based pricing are actually the ones who are gaining market share in the industry. That's been a phenomenon that's been going on for several quarters. Yes, by virtue of us being, there's much more nimbleness, if you will, at the more the non-bank loan originators than there are the larger banks out there. I think that for the recent quarters, I think there's been a recognition that the larger banks might be losing market share to those non-bank loan originators. RateStar actually works much better for those loan originator and actually helps them win business.
That's actually helping us grow market share or maintain our market share at the very least.
Okay. That's a good nuance to know. Sticking with mortgage insurance. I know this is probably difficult, but is there any way that we could maybe try to size up how to measure how much could be left in terms of the pace of reserve releases if the cure rates continue to be significantly lower than historically? I guess, because I don't know if you're using a two-year average or a three-year or a 10-year historical average. I'm assuming you're not just assuming the rates that you've seen in 2017 and '18 overlay on the entire portfolio. Just curious if there's anything we can look at to better understand and size up how that could trend if things do stay good for the foreseeable future, as you mentioned in your prepared remarks in terms of your outlook for MI.
Yeah, I'll say a couple of things on that. First, yeah, delinquency rates are at very low levels, we don't think they're going to go much lower than that. The reality is the performance has been very, very good. As you know, the reserving methodology in the mortgage segment is very much a more of a mechanical prescribed exercise. There's a lot less flexibility in the mortgage segment that there might be on the P&C side. If the delinquencies are there, yes, we can put up reserves for it, and if they're no longer there, they cure, the reserves come down. There's no in-between. Is it delinquent? Is all delinquent? Yes or no? From there, the models we built produce the estimates we carry or the reserves we have on the books.
To answer your question, I think maybe there's a bit more to go. I think to be honest, the level that we saw in this quarter has been extremely high and probably higher than any of us here expected. If it happens again next quarter, say, well, I'd be surprised. I'm not saying it can't happen, it would be, again, a continuation of very favorable trends that the whole industry is seeing. We're not the only ones, as you know, that are seeing these trends. Again, I don't think they'll be there sustainable for an extended period.
Okay. Great. Lastly, just on capital, you mentioned that looking at some new opportunities, I know you guys are always opportunistic in looking at things. Just curious if you can give us a flavor, whether it's primary insurance or reinsurance or MI or all of the above that you're kind of looking at.
It's pretty much all of the above that are possibilities. We'll be communicating with the market as and when we find out, if they do find out they've come up to fruition. Yes, the answer is all of them.
Okay, thank you.
Thank you.
Yep.
Thank you. Our next question comes from Elyse Greenspan from Wells Fargo. Your line is open.
Hi, yes, good morning. My first question is going back to the discussion on your insurance business. Obviously the higher non-cat losses drove the increase in the quarter. I'm just trying, as we think about going forward and you guys getting to kind of that 95% target, can you just give us a little bit more color on what you're seeing with inflation? Anything that you guys are watching out for as you think about setting your picks and as we think about the margin outlook for the business for 2019?
The trend is a very interesting and important discussion. The problem is nobody will really know what it looks like until 5 or 6 years from now. Historically, trends in the insurance industry has been outspacing the core CPI increase, and we've seen the CPI at about 1.7%-1.8% over the last four or five years. Which would mean to me that a trend, and if you look at the spread over that historically, it was 100 basis points above that. The inflation on claims for insurance claims is always higher than CPI. I just want to make sure it's clear here. We've seen 250 basis points above this over the last four or five years. There's a lot of uncertainty on this. We're trying to do two things, right? One of them is portfolio construction.
We try to focus on more primary policies because we think that the excess portfolios will have a lot more uncertainty in terms if we turn out to be wrong on a trend on the pricing, the trend is going to impact the excess insurance market a lot more than the primary market. The second, we are pricing for those kinds of trend, or give us a range around those trend and putting a cushion so that we're not on the wrong side of the decimal when we actually produce the returns, the results. There's all sorts of other things, Elyse, that help us. We could buy reinsurance to help us shave around the expected at the margin.
By and large, it's a give and take and working through with the marketplace and really portfolio construction and also focusing on line of business where you heard us talk about travel and property, right? Those two lines of business would be lines where inflation is a lot less relevant because you're going to tend to find out what inflation truly is much quicker than, let's say, in E&S casualty or high excess workers' comp.
Okay, great. In terms of the tax rate, I know there's potential for some changes as we get closer to the end of this year. Do you still think your rate will kind of stay in that 9%-12% range as we think about 2019?
Too early to tell. We think it's not a bad place to start. We're in the middle of planning for 2019, all I can say is we'll give you more color with the year-end call. I'd say once we're into 2019, we'll have more visibility on how things are shaping up and the mix of business and what jurisdictions and how we think that'll play out.
Okay, great. One last question on mortgage. Your market share seems like it might have grown a little bit this quarter, could put you maybe slightly around 25% or a little bit higher. You had been taking that down after the deal, it started to come back up earlier this year. As you know, I thought you guys kind of got ahead with RateStar of some of the others in adjusting your pricing. Others probably kind of caught up this quarter. I just want to get a full sense of, do you see kind of that 25% or so as a share that you would expect to maintain? How should we think about that going forward?
First, we don't run the business, as you guys know, on a market share basis. We just provide our best foot forward with our rates and our approach to risk-based pricing and try to give good service to our clients and provide them with good products. At the end of the quarter, we count and we look at where the chips fell, and it is what it is. We have no design for market share. When we do UG acquisition, we had indicated we might be lower 20s, just by virtue, some of it was by virtue of the singles being less of a relevant product, and we have delivered on this. We like the monthlies. I guess there's no answer to this, Elyse. I don't know where we're going to be.
I just know that what we've done this quarter generated X market share, and we're happy with that. I don't know what the future holds there.
Okay. Thanks very much, Marc. I appreciate the color.
You're welcome. Thank you.
Thank you. Our next question comes from Joshua Shanker from Deutsche Bank. Your line is open.
Yeah. Hi there, everyone.
Good.
There was an earlier call from Genworth who said that they lost a major U.S. customer. I'm wondering how that shapes up in the market and whether you'll get the same share of a large customer that the rest of the group did, or is your market share in such a way that it's harder for you to take a big chunk out of that new opportunity, per se?
I think we're in the same market as Genworth from that perspective, right? That happens all the time, that might decide to reallocate between providers of mortgage insurance for various reasons. There's no grand design here. I think that it could happen to us. It's happened to them, we might be gaining what they lost, vice versa. There's nothing really magical there, Josh. I can't read much into it, much more in this.
Okay. I saw there was decent amount of growth in property, marine, aviation. That's a pretty big catchall for a lot of things.
Yeah.
Insurance. What's going on exactly?
It's really property. A lot of it came out of the mostly London cat exposed business that went through substantial rate changes, rate increases as a result of the 2017 cat event in the areas like Texas and the Caribbean. This is most of where the increase came from on the insurance side. On the reinsurance side, very similar story. You'll see that the property also grew dramatically. We have some growth in marine, but it's largely driven by property. For the record, it's not aviation. Just want to make sure everybody's clear. It's not aviation.
Does this business have a lower normalized combined ratio than the aggregate book? What I'm getting at is this going to cause one year from today, the combined ratio, all things being equal, to lower than it is now?
Everything else being equal, it should. I think that that property cat exposed insurance or reinsurance business will have a combined ratio of probably 60 or 70, 75, whereas a more or less cat exposed, this is absolutely cat, right? If there's a cat
Yep
Of course, it could be a lot worse, right? Yes, you're right. Well, it will depend on the cat activity in the year, but all things being equal, your assumption is right.
Okay, thank you. Good luck.
Thanks, Josh.
Thank you. Our next question comes from Meyer Shields from KBW. Your line is open.
Great. Thanks. François, you talked a little bit about lower other expenses. I guess we saw that in reinsurance, mortgage, and corporate. I was hoping you could provide a little bit more color, really, in terms of the sustainability of the third quarter versus prior 12 months run rate.
No question that we look at our expenses. It's something that we watch very closely, this quarter just turned out there's always going to be movements from quarter to quarter. On the corporate side, yes, a little bit lower, I wouldn't read too much into it. There's sometimes just timing of some cash payments or what have you, some expenses that we have throughout the year. I wouldn't read too much into that. The reality on the reinsurance side is there, yeah, lower compensation, which is a direct result of the performance of the units. No question that as we accrue bonuses throughout the year, they're based on an expected ROE, which this year turns out may not be as good as it has been in prior years, we're adjusting for that.
Certainly, you think that the operating expenses should adjust over time based on the profitability of the units. The reality is there's also a couple of miscellaneous payments here and there that will move the needle. Again, the message is, yes, we keep looking at it. We're trying to be as diligent and do as good a job making sure that we're spending the money in the right places and making the right investments in our people, in our technology, in our systems. There's no question there's going to be some movements from quarter to quarter.
Okay. Same with mortgage, I guess, where the underlying seems to be getting better.
Say it again, Meyer, please. I didn't catch this.
I'm sorry. The other expenses in mortgage insurance declined, I don't know if it's significantly, a lot by $7 million, $7.5 million from the second quarter to the third, and I would naively maybe expect the better cure rate to drive more incentive comp rather than less.
That was, second quarter, we have accrual for a lot of.
Yeah
based compensation. Go ahead.
Yeah. There's a timing of the second to third quarter. Second quarter is historically where we've done our equity grants, and that there's a spike there across the board for all units. There's also a depending on whether they're retirement age people or not, there's a different way of accounting for the grants, but that's really why comparing second quarter to third quarter is something that you got to be careful with. Just to give you a bit of a heads up as you plan ahead and maybe on the year overall 12-month period, it doesn't make a huge difference, but we're contemplating moving the equity-based awards from the second quarter to the first quarter next year. That might, again, we'll give you more color when and if we get there, but that's a possibility we're exploring right now to make those all in the first quarter.
Okay. No, that's very helpful. Then bigger picture question, I guess, for Marc. If you were to isolate insurance segment casualty pricing, I guess, what are you seeing in terms of rate increase accelerating, if at all?
Whether they do or not, yeah, most of the rate increases we've seen in casualty over the last two, three years were led by commercial auto. It's still very hard to get significant rate increases outside of that realm. I think, as you know, Meyer, that is slowing down. I'm not judging whether it should or not, but I think what we're seeing that the rate increases are slowing down. Because it went through two or three years of significant rate increase, we still are able to push rate increase on some of the E&S casualty that have some auto exposure. But if you don't have auto exposure, it's still not clear that you can get those rate change accelerate or getting higher. Again, I think the rate on the E&S casualty will react or will start to accelerate when and if we see losses emerging.
We believe we will, but we've been wrong before. Since the downside of being wrong is too painful, we'd rather take a pause and take a step back and just wait for the clarity.
Okay, thank you very much.
for us to start developing.
Yes.
Thank you. I am showing no further questions from our phone lines. I'd now like to turn the conference back over to Marc Grandisson for any closing remarks.
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