Good day, ladies and gentlemen, and welcome to the Arch Capital Group first quarter 2016 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 operator assistance during the conference, please press star and then zero on your touch-tone telephone. As a reminder, this conference 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 the periodic reports that are filed by the company with the SEC from time to time. Additionally, certain statements contained in the call 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 will also make reference to some non-GAAP measures of the 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. Mr. Dinos Iordanou, you may begin.
Thank you, Abigail. Good morning, everyone, and thank you for joining us today for our first quarter earnings call. We're starting the year on a good note. Our first quarter, it was terrific from virtually all perspectives. Our reported combined ratio was excellent at 87.1, which was aided by low level of catastrophe losses and continued favorable loss reserve development in each of our segments. Investment returns were also very good as our fixed income portfolio benefited from the interest rate declines we saw in the first quarter. There are no significant changes in the Property and Casualty operating environment from last quarter, although there are some signs that reinsurance terms, especially ceding commissions, may be bottoming out. Within the insurance sector, we saw slight deterioration in terms and conditions, while the Mortgage Insurance industry remains quite healthy.
We're in a market where the importance of cycle management, not only in preserving capital, but also maintaining balance sheet integrity, is paramount. Navigating through this phase of the cycle requires that our underwriters remain disciplined, opportunistic, and laser focused in execution. Within the reinsurance segment, we are focusing more on special situations that utilize our underwriting expertise and capital strength and our ability to respond quickly. In our insurance segment, we continue to focus on less volatile, smaller accounts, both in term of limits, but also account size, and with reinsurance purchases helping us to reduce the volatility on large accounts and our high capacity business. The operating environment in the mortgage insurance space remains healthy, and we are generating excellent returns and continue to make significant progress in this segment. Marc Grandisson will give you more details in all of our segments in a few minutes.
On an operating basis, Arch earned $145.7 million or $1.17 per share for the first quarter of 2016, which produced an annualized return on equity of 9.7%. On a net income basis, we earn $149 million or $1.20 per share for the 2016 quarter, which results in a return of equity of 6.4% on a trailing 12-month basis. Remember that net income movements can be more volatile on a quarterly basis as these earnings are influenced by changes in foreign exchange rates and realized gains and losses in our investment portfolio. Group wide, our gross written premium increased by 6% to $1.39 billion in the first quarter over the same period in 2015, while net written premium rose 3.7% to $977 million, driven primarily by growth in our mortgage segment, along with modest growth in our construction and alternative market business within the insurance segment.
Our investment results were excellent on a relative basis and acceptable on an absolute basis given financial market conditions. Net investment income per share for the quarter was $0.57 per share, ups $0.04 sequentially from the fourth quarter of 2015. Despite volatility in the investment and foreign exchange markets in the first quarter of 2016, on a local currency basis, total return on our investment portfolio was a positive 1.48% as returns on our fixed income investments were partially offset by declines in our alternative investment portfolio. Including the effects of foreign exchange, the total return was 1.82% in the quarter, a healthy result. Our operating cash flow was $257 million in the first quarter as compared to $16 million in the first quarter of 2015. Mark Lyons will discuss the cash flows in more detail in a few minutes.
Our book value per common share at March 31, 2016, was $49.87 per share, a 40% increase sequentially from the fourth quarter of 2015. While some segments of our business have become more competitive, we believe that Group wide and on an expected basis, due to our mix, the present value ROE on the business written in the 2016 underwriting year should produce ROEs in the range of 10%-12% on allocated capital. Before I turn the call over to Marc Grandisson, I would like to discuss our PMLs, which remain essentially unchanged from January 1. As usual, I would like to remind and point to everybody that our cat PML aggregates reflect business bound through April 1st, while the premium numbers included in our financial statements are through March 31st, and that the PMLs are reflected net of reinsurance and all retrocessions.
As of April 1, 2016, our largest 250-year PML for a single event remains the Northeast at $494 million, or about 8% of common shareholders' equity. Our Gulf of Mexico PML decreased slightly to $438 million, and our Florida Tri-County PML increased slightly to $385 million. I will now turn it over to Marc Grandisson for comments on market conditions before Mark Lyons discusses our financial results. After their comments, we will take your questions. With that, Marc?
Thank you, Dinos. Good morning to all. We continue to face the challenges of softer pricing as the property casualty industry continues to report favorable prior year loss development and benefiting from below average cat losses, which obscures, we believe, the adequacy of risk-adjusted rates in the property market. However, in every market, there are some dislocations present, and we remain vigilant in our efforts to seize those opportunities that become available. On the positive side, as Dinos mentioned, recent actions by a few large participants in the marketplace may help to usher in a more disciplined environment in the casualty area in the near future. P&C rates are declining in the mid to low single-digit range, but there are pockets of rate strengthening. Our challenge is to be confident that current rate levels are sufficient on an absolute basis.
On the other hand, in mortgage insurance, which I will refer to as MI from here on, rates remain very healthy despite indications that they appear to be declining in light of the new rate cards filed by some of our competitors. Despite the headlines, we believe that on a risk-adjusted basis, the aggregate effective rate levels of MI providers are actually higher due to a shift in the quality of the risks assumed. Staying with our MI segment, which as you may recall, includes primary operations in the U.S. and mortgage reinsurance globally, as well as a GSE risk-sharing transactions portfolio. We estimate that the market's MI new insurance written or NIW was down about 10% in the first quarter of 2016 versus the fourth quarter of 2015. In spite of this, Arch continues to increase its presence in the sector.
Overall, our Arch MI segment grew its gross written premium this quarter by 21% over the fourth quarter of 2015 and 84% over the same quarter last year. The growth came primarily from new GSE risk-sharing transactions, as well as from a reinsurance contract with one of the major Australian lenders that we discussed last quarter. Our U.S. MI unit continues to increase its share of the market. Excluding the GSE transactions, we estimate that we continue to gain market share at a pace of approximately two percentage points per year since our acquisition of the U.S. MI platform. At March 31, 2016, our total MI segment risks in force was $12.8 billion, which includes $7.2 billion from our U.S. MI operation, $4 billion from worldwide reinsurance operations, and approximately $1.6 billion from the GSE risk-sharing transactions we wrote.
Our primary U.S. MI operation increased its NIW $2.9 billion during the first quarter of 2016, of which approximately 69% came through the bank channel and 31% via our credit union clients. Seasonally, the first quarter 2016 for credit union production typically runs lower than the other three calendar quarters. The amount of NIW from credit union this quarter is consistent with what we recorded in the first quarter of 2015. RateStar is a primary driver of this growth. We introduced RateStar less than five months ago, and to date, we have rate filings approved in all but three states. Through March 31st, 2016, 1,142 customers have elected to use RateStar. Over 50% of our commitments in the first quarter were obtained through RateStar.
We have seen many positive signs since its launch. The increase in our application volume is very encouraging and points to our clients seeing value in our differentiated pricing framework. RateStar is proving to be an effective tool in differentiating Arch relative to its competition while maintaining or exceeding our targeted average return of 15% ROE. We believe that our combination of high ratings, superior customer service, and product innovation will allow us to continue growing. I will turn now to our primary P&C insurance operations in the United States, which currently represent approximately 80% of our global insurance operations. We saw a more stable rate level change at 10 basis points effective rate increase this quarter versus the 140 basis points decrease last quarter, excluding the effect of ceded reinsurance.
That 10 basis points increase is somewhat misleading since it is skewed by one large professional liability program that renewed at a +7% rate increase in the quarter. Without the benefit of this program, our overall rate change would be a rate decrease of 80 basis points. We believe that we were able to recapture some of that rate erosion once we consider the purchase of our reinsurance coverages. Our insurance operations in the U.K., which represents around 17% of the insurance segment, is still pressured from a rate perspective. Rate decreases across all our product lines were 4.6% this quarter. We continue to actively manage this portfolio towards the more attractively priced lines. On a group-wide basis, our insurance unit premium written increased 4% in the 2016 first quarter versus 2015 on a growth basis, while they increased 1% on a net basis.
We continue to adjust our mix of business and are generally able to buy reinsurance on more favorable terms. Ceded premium increased 11% in our insurance group this quarter over the same period last year. Mark Lyons will provide more perspective on this in his commentary. Areas of opportunity for growth in the insurance sector in the first quarter were in our, as Dinos mentioned, construction, national accounts, travel, and alternative market lines. The vast majority of our growth came as a result of our ability to take advantage of the current dislocation in those areas where some major players are being challenged. In contrast, our executive assurance, property, and programs businesses are areas where rate levels lead us to a more defensive strategy. Let's turn to our reinsurance group. Our teams are being reactive and selective, consistent with our long-stated strategy of cycle management.
Most lines of business, especially the ones with good results, continue to see rate decreases in the 5%-10% range. There are, however, several lines that are experiencing some level of rate increases. A recurring question our team faces when looking at such areas is whether that positive rate change is enough to allow us to achieve an adequate return. As an example of this, we continue to struggle with large U.S. casualty placements. There is increased demand by buyers in the market for quarter shares, but we have been unable to write a significant new transaction at an appropriate return. Our reinsurance gross premium written declined by 1% for the first quarter of 2016 versus 2015, while on a net basis, we were down 8%.
Great. Thank you, Mark, and good morning to all. Our property cat gross written premium for the 2016 first quarter was down over 10% as we continue to exercise underwriting discipline and benefit from improved terms on retrocessional treaties. Most of our efforts in underwriting areas are currently directed to UK Motor, specialty liability products, and niche areas such as professional lines, excess motor, and facultatives. With that, I'll hand this over to Mark to cover the detailed financial results. Mark?
Great. Thank you, Mark, and good morning to all. As was true on previous calls, my comments that follow will be on a pure Arch basis, which excludes the other segment, that being Watford Re. I'll continue to use the term core to denote results without Watford Re and consolidated when referring to results including Watford Re. This quarter, our core business mix based on net written premium changed as follows relative to the first quarter of 2015. The insurance segment reduced from 58%-56% of the total. The reinsurance segment shrunk from 37%-33%, and the mortgage segment grew from 5%-11% of the total. This shift in mix continues to reflect our view of the market and the relative return expectation each segment provides.
As for a longer-term view of our mix changes, I would point out that four years ago, in the first quarter of 2012, within the reinsurance segment, the property cat line represented 26% of net earned premiums, whereas this quarter, it is down to only 6.9% of earned premiums. This was accomplished through a 71% reduction in net earned premiums over the four-year period. Yes, 71%. The insurance segment similarly has reduced its property and marine net earned premiums by 38% over that same time period. Both actions reflect our view of severe margin compression in the property cat space. Moving on to this quarter's financial results. The core combined ratio for the quarter was 87.1%, with a half a point of current accident year cat-related events, compared to last quarter in 2015 of an 87.5% combined ratio, which reflected six tenths of a point of cat-related events.
Losses recorded in the first quarter in 2016 from cat events totaled only $4.2 million, stemming mostly from within our reinsurance operations. The 2016 first quarter core combined ratio reflected 6.4 points of prior year net favorable development, which is net of reinsurance and related acquisition expenses, compared to 7.8 points of prior period favorable development on the same basis in the 2015 first quarter. This results in a 93% even current core accident quarter combined ratio excluding cats for the first quarter of 2016, compared to 94.7% in the comparable quarter last year. In the insurance segment, the 2016 accident quarter combined ratio excluding cats was 95% even, essentially unchanged from the accident quarter combined ratio of 95.1% a year ago. The reinsurance segment 2016 accident quarter ex cats was 94.3%, similarly comparable to the 94% even ratio in the 2015 first quarter.
Moving over to mortgage, their accident core combined ratio was 71.9% in the quarter compared to 94.1% in the first quarter of last year. As I've said in the prior calls, it's important to remember though, that the concept of accident year is more of a P&C concept and not a mortgage insurance concept due to their accounting conventions. As previously stated, the ACGL core accident quarter combined ratio dropped 170 basis points quarter-over-quarter, yet insurance and reinsurance segment ratios were virtually flat with last year's respective quarter. This is driven by the mortgage segment, as its inherent strong level of profitability is becoming a higher proportional contributor to our overall results.
The insurance segment accounted for roughly 11% of the total net favorable development in the quarter, net of associated acquisition expenses, this was primarily driven by shorter-tailed lines from the 2012-2014 accident years, and longer-tailed lines from the 2003, 2004, 2008, and 2012 accident years. The reinsurance segment accounted for 84% of the total net favorable development in the quarter, with approximately three-quarters of that due to net favorable development on short-tailed lines concentrated in the more recent underwriting years, and the remaining portion due to net favorable development on longer-tailed lines, primarily from the 2003-2011 underwriting years.
The mortgage segment accounted for approximately 5% of the favorable development, which translates to a 4.4% beneficial impact on their loss ratio this quarter, resulting primarily from continued lower claim rates from the CMG business we acquired in 2014 and from the PMI quota share we assumed within that transaction covering the 2009-2011 book years. As was the case last quarter, some of this favorable development benefit is offset by the contingent consideration earn-out mechanism negotiated within the purchase agreement. As a reminder, this contingent consideration impact is reflected in realized gains and losses and not within underwriting income. The core 34% even expense ratio for the first quarter of this year was 50 basis points lower than last year's comparative quarter of 34.5%.
Overall, the expense ratio, though, was aided this quarter by roughly 75 basis points through the release of an overestimated year-end 2015 bonus accrual. The insurance segment expense ratio improved 90 basis points for the first quarter of 2016, reflecting both a lower net acquisition and operating expense ratio. When one adjusts, however, for the aforementioned bonus accrual benefit, the expense ratio would be nearly 50 basis points higher, however, still an improvement over last year's comparative quarter. We, as managers, continue to focus on the total expense ratio, though, as mentioned previously, since the slotting of costs and benefits within net acquisition and operating expense ratios can be somewhat artificial since ceding commissions are recorded in the net acquisition line and not allocated to every operating expense category that they represent.
The reinsurance segment expense ratio increased 120 basis points this quarter, primarily reflecting a 6.6% lower net earned premium base. I will note, though, that the reinsurance segment's expense ratio this quarter was 100 basis points lower than sequentially in the fourth quarter of 2015. The ratio of net premium to gross premium for our core operations in the quarter was 70.2%, which is a decline from the 71.8% a year ago. The insurance segment had a lower 68.8% ratio compared to 70.7% a year ago, driven mostly, as was the case last quarter, by increased cessions on a larger alternative markets book, increased cessions on capacity-driven product lines, as Dinos mentioned, and a reduction in our P&C program business, which had been kept overwhelmingly net and still is kept overwhelmingly net. The associated average ceding commission ratio on quota share treaties improved another 200 basis points in the U.S.
In fact, quota share treaty c commissions have improved from 2012 to now by over 500 basis points in total, and the improvement ranges from +600 to +1,000 basis points for some product lines. Some of this net acquisition improvement, however, is masked by the growth of businesses using captive reinsurance arrangements. Many of these carry no or marginal front-end commissions, so the associated ceding commissions are lower since there are generally no front-end commissions to be reimbursed. Moving to the reinsurance segment, the net to gross ratio was 66.6% in the quarter, compared to approximately 72% a year ago, primarily reflecting cessions to Watford Re and other third-party retroc essions.
The mortgage segment, in addition to premium growth that Mark mentioned earlier, had approximately $4 million of other underwriting income in the quarter from risk-sharing transactions receiving derivative accounting treatment, and $7 million of underwriting profit associated with risk-sharing transactions receiving insurance accounting treatment. Over time, it is expected that more income will continue to emanate from transactions receiving insurance accounting treatment. The total return on our investment portfolio on a local currency basis was a reported positive 148 basis points in the quarter, reflecting positive returns in fixed income investments, both investment and non-investment grade, partially offset by negative returns in the equity and alternative investment portfolios. On a U.S. dollar basis, total return was a positive 182 basis points in the quarter. Over 80% of the portfolio was comprised of fixed income investments.
The embedded pre-tax book yield before expenses was 2.07% as of the end of the quarter. Duration remained fairly consistent at 3.56 years versus 3.35 years at the end of 2015 first quarter. Dinos already mentioned reported investment income per share. I won't go into that other than as a reminder that we evaluate investment performance on a total return basis and not merely by the geography of net investment income. Core cash flow from operations was $257 million in the quarter versus approximately $16 million in the first quarter of 2015. Last quarter, as you may recall, had cash flow from operations being affected by a reduction in gross premiums collected, timing shifts of reinsurance premiums cessions, and paid and deductible recoveries. Core interest expense for the quarter was $12.6 million, which is consistent with our longer-term run rate.
Our effective tax rate on pre-tax operating income available to Arch shareholders for the first quarter was an expense of 6.6% compared to an expense of 3.9% in the first quarter of 2015. This quarter's 6.6% effective tax rate has approximately 100 basis points of a non-recurrent discrete item out of our European operations. Fluctuations in the effective tax rate can result from variability in the relative mix of income or loss reported by jurisdiction. Our total capital was $7.3 billion at the end of this quarter, up 2.9% relative to December 31st of 2015. Our debt-to-capital ratio this quarter remains low at 12.2%. Debt plus hybrids represents only 16.7% of our total capital, which continues to give us significant financial flexibility. We also continue to estimate having capital in excess of our targeted position.
Book value per share was $49.87, which is 4% increase over year-end and 4.3% relative to one year ago. This change in book value per share primarily reflects the company's continued strong underwriting performance from all segments and improved investment returns. With these introductory comments, we are now pleased to take your questions.
Thank you. Ladies and gentlemen, if you have a question at this time, please press star and then one on your touchtone telephone. If your question has been answered or you'd like to remove yourself from the queue, please press the pound key. Our first question comes from Vinay Misquith with Sterne Agee. Your line is open.
Hi, good morning. Congratulations on beating numbers, one of the few companies to do so.
Thank you.
The first question is on the new opportunities because of market dislocation. If you could discuss that'd be helpful. Thanks.
Well, Marc talked about some unusual transactions that we see on the reinsurance side. Doesn't mean we're going to do any, but we see more requests. That means there is clients out there that they have special needs. On the insurance side, we continue to focus on small, medium-sized accounts. I believe we have built the infrastructure around the country. Recently, in our finding authority business, we also opened another new office in Scottsdale, Arizona. We're putting a lot of focus in trying to find these profitable segments for us. Let me reemphasize, we always look for bottom-line results first, and we look at premium growth second. At the end of the day, you can't focus just on premium growth. Of course, that's not the case with our mortgage business. That business we like a lot, and we try to grow it as fast as we can.
Mark, you want to add to it?
Yeah, absolutely. On the insurance side, I believe that we've seen an increase in submissions over the last quarter or so because some of our competitors have decided to exit some lines of business. There's been some mergers and acquisitions. We are seeing some movement. This is not widespread, but it is certainly starting to occur, and we're seizing the opportunity whenever we can and whenever we think it's appropriate.
Yeah. One area we're not participating, it seems that the flavor of the month now, or the year is broker line slips here and there, they can have control of the pen, et cetera. That doesn't fit well with us. We have not participated in any of these, because at the end of the day, you can't have the title underwriter and give it to somebody else. Either you're going to underwrite or you're not.
Right.
With our troops, I want us to have the ability to underwrite ourselves.
Okay. That's fair. That's helpful. The second question on mortgage insurance. If you could give us some metrics about how well RateStar is doing. I think you said 50% of the submissions were coming through RateStar. Do you think it's actually driving more submissions to Arch because of that? Any anecdotal evidence would be great.
Yeah. If you look at it from a submission point of view, let me give you. At first quarter, it was 50/50. If I look at April, it is up to 68/32. It's been trending like this. RateStar has only been out there for five months. I don't know where it's going to go, but it's more significant when I look at our submission activity from the bank channel. The bank channel is predominantly RateStar now, maybe eight out of 10 submissions in April that was coming from that. On the credit union channel is still in the 50/50 range. That's where the trajectory is going. The NIW, it was 44%, 45%, I think, in the first quarter out of RateStar priced business. In April, it was 61%.
That tells you that more and more of that business is moving to the place that we want it to move because we have a lot of faith in the way we price the business. Mark.
Yeah, Vinay, essentially, there's a huge increase in submission. We believe it's in the order of 50%, 60%, if you look last quarter of 2015 versus this first quarter. The vast majority of that pickup was through the bank channel. Just to give you an overall sense in the quarter.
Oh, yeah. That's helpful. Mark, if you could also clarify about rates. I think you mentioned that the risk-adjusted rates are actually higher now for this rather than lower.
Yes, because of cost.
Well, the return-
Yeah
the expected ROE on the business is higher than our rate card.
Okay. Even from a competitive standpoint, you've not seen the competitors sort of step in and do something similar?
No. Right now, the rate card seems to have stabilized. There are rumors. The only thing I can comment to you, Vinay, is there are rumors that some people will be extending the rate card or doing the risk-based pricing approach like we have. We have no way of knowing what's going to happen right now.
Right.
Right now, it seems that the rate card has been stabilized where it is right now.
Right.
Our future, Vinay, it's going to be RateStar. We like risk-based approach to it, looking at the many characteristics of a particular mortgage and trying to get the right price for the exposure that you have. We continue to refine our approach with that. I have a lot of resources committed to that effort, which is no different than what we do on the P&C side to begin with.
Good. Okay. Thank you.
You're welcome.
Thank you. Our next question comes from Amit Kumar with Macquarie. Your line is open.
Thanks, and good morning, and congrats on the results.
Thanks, Amit.
Two quick questions on MI, thanks for being patient with us and explaining the finer nuances of the MI market. The first question probably ties back to Vinay's question on the broader space. Recently, the National Association of Realtors wrote a letter to FHA asking them to cut their premiums. If FHA cuts their premiums, does that change the entire sort of the private MI market? It's obviously a different risk, so it does not impact you that much?
Well, it depends what sectors. You're correct. A lot of what they write is the private MI companies do not. They write the low credit score, high LTV type of business. Depending what they do, it might or might not affect the broader market. It's tough when you have the government competing with you at entirely, totally different capital requirements. None of us or our competitors in the space would be allowed to operate with the capital ratios that they have. I don't know. It depends what they do, and then we'll see the effect that it will have on the marketplace. By the way, thank you for the compliment that being patient. My guys here, they say otherwise.
The other question I have was in regards to the excess capital that you mentioned. There has been chatter in the marketplace, obviously, regarding the disposition of a large MI asset through one of the largest companies. At this stage of the cycle, Dinos, how do you look at growing organically, and I'm talking about MIPs versus looking at this obviously very large and game-changing property out there?
All I can say is we will look at all avenues. Right now our focus has been to grow organically. Given other opportunities, we will evaluate them. If they get presented to us, we will evaluate them. At the end of the day, we get paid to put capital to work at effective returns, and that's where our entire team is focused on. It's no secret that we do want to grow the exposure we have in the MI business.
Got it. Fair enough. That's all I have for now. Thanks for the answers and good luck for the future.
Thank you.
Thank you. Our next question comes from Jay Gelb with Barclays. Your line is open.
Thank you. On the core reinsurance segment, I was somewhat surprised to see that the gross written premiums were essentially flat. You mentioned some specialty opportunities. I was hoping to get a better perspective on whether you think that overall business might be flat from a premium volume perspective or maybe even grow this year.
I don't know. You want to take that?
I don't know about the rest of the year. It depends what we're going to be offered with. The first quarter certainly seized opportunity in the few larger transactions that Dinos alluded to at the beginning, and also a couple of opportunities which I highlighted in my comments, which are the UK Motor and some specialty liability, although not being very big, but with more niche-y, more specialty in nature. I would just say it's a reflection of in UK Motor, for instance, if you do a large quarter share, you will have a lot more throughput in a quarter. That's a great example as to why premium would actually be stable year-over-year.
That makes sense, Marc. The other point I wanted to touch base on in reinsurance is the high level of persistent reserve releases. Can you give us some perspective on what continues to drive that favorable result?
Well, let me give it an attempt, and then I'll give it. I'm being surrounded by actuaries here. Mark and Mark, they're both actuaries. We have a methodology. We haven't changed our methodology for the 14 years. To simplify, we try to pack the accident year based on what we believe we price the business at. The other thing we do is on long tail lines, if we see unfavorable, we recognize that early on, any unusual event where we ignore favorable at least for three or four years. That has been our methodology. Recognize bad news early. Don't celebrate too early on your wins. We follow the data. Whatever the data tells us quarter after quarter, that's what we report.
Now, that was a guy who doesn't have an actuarial degree, so I'll turn it over to Mark or Mark Lyons to give you the more scientific answer.
Good. My scientific answer as a reformed actuary is I have nothing more to add.
Thanks, Mark. The final question I had was on mortgage reinsurance. Clearly, there was a big benefit in 1Q from the Australian deal. I'm trying to think about on an organic, I guess organic is not the right word, but on a normalized basis, what do you think the growth rate could be in mortgage insurance? I mean, could this be a $500 million gross written premium business within a year or so?
We don't know. Australia is a market that's dominated by two or three players or four banks. We have a major relationship with one of the top four. It's kind of hard to see where if any, if we're able to grow relationships in other banks. Currently right now, we have a stable, very strong relationship there. What you're seeing right now is a production. Even though we call it reinsurance, it's really a flow of business that we assume on a 100% basis. So it's really like insurance, if you will. For the rest of the world- We're exploring all other geographical areas. Dinos and I are spending a lot of time trying to figure out what we could do in Europe, what we could do- We already are in Europe, Canada, and other countries.
This is sort of an ongoing, try to grow and use and take advantage of our expertise and strong knowledge and deep knowledge in the MI space to do more of it. It's really hard to see what it would be in two, three years' time. For the Australian business, I think you get pretty much a good picture of our quality production.
Hey, Jay, it's Mark Lyons here. Let me just add the difference between binding the business and expanding it versus the accounting recognition of it.
The Australian market is a single premium market. You got to really contrast that with the U.S., which is dominantly monthly, so it builds up and is recognized slowly. By single, it's not like it's a single program writing a big bullet single. It's not the case. The underlying business, the business that it's reinsuring, is a series of every homeowner having a single premium-
Right
that they put into play. The recognition will be accelerated relative to the U.S. You can't extrapolate that into something that may appear ultimately to be larger.
That's helpful. Thank you.
Thank you. All right, next question comes from Michael Nannizzi with Goldman Sachs. Your line is open.
Thanks so much. Just a couple here. I think most of mine have been answered. The ceded level that we saw in the first quarter, that lifted from the first quarter last year. I mean, do you guys expect to be ceding back to Watford or whoever in that sort of 30% range from here? Was there anything unusual in the quarter?
Okay. Oh, you're saying the 30 because the 70%, that's a gross.
Mm-hmm. Yeah.
Well, remember, those cessions are dominated by the insurance group ceding overwhelmingly to third-party, unrelated third parties. You have increased retrocession on the-
Right
property and marine that the reinsurance group will do. You have minor bits in the mortgage sector-
really as a function of the deal that was cut on, originally on the transaction. The movement, yes, there's Watford cessions, but the level of Watford cession is fairly consistent over the last couple of quarters. The biggest lever is what the insurance group does, and as Dinos pointed out, they were just shy of 70% this quarter. The growth in low volatility businesses are kept overwhelmingly net, and the high capacity business that Dinos talked about, and by high capacity, we mean $25 million limits, things like that.
Those are going to be reinsured more because we can get more favorable terms. We cut the aggregate net volatility of the total book as a result. Just keep in mind, Michael, it's the insurance group that drives that ratio.
Okay. Got it. Then the other income primarily in reinsurance, but I guess a little bit in insurance as well, that stepped down in the quarter. Did those dollars just move to a different line item, maybe somewhere else as geography, or was there a change in the-
No. No, no. It's a great question. Think of it this way. Quarter to quarter, that other underwriting income in reinsurance was virtually flat. It's coming from the GSE transactions mostly. Last year, there was what we called catch-up premium on the difference between when the capital markets piece went out, that's done earlier, and then the insurance/reinsurance segment was done later and had to catch up because of the time gap between them. That was roughly $3.5 million of catch-up. Yeah.
Okay. Good.
That's the first thing. The second thing would be occasionally, we call it periodically, we reevaluate that Ethniki lost portfolio transfer.
In that year's quarter, there was an adjustment, whereas this year's quarter, there was not.
I see. Okay. Now that we're all caught up, we should be reverting back to the pattern that we were experiencing previously. Is that?
For the derivative-oriented transactions for the GSEs in the reinsurance, in the mortgage, the answer would be yes.
Okay.
Ethniki , it depends when we deem a change is needed.
Sure. No, I understand. Yeah.
The derivative accounting for those transactions will be deescalating and going to zero over seven years.
Right.
Right? Every quarter, it's going to be slightly, a little less, a little less until it gets extinguished seven years out or so.
Got it. Main point being that other than this timing change you mentioned in the first quarter, nothing's really changed as far as that's concerned.
No. No, that's correct.
Okay.
Yeah.
All right. In reinsurance, the expense dollars and other operating expense declined in the quarter sequentially. I was just curious if the transaction or the item that you mentioned in insurance was relevant in reinsurance as well, Mark, or was there something else there?
I'm sorry, was that an operating expense question or an acquisition expense question?
Operating.
Oh, operating.
Yeah.
I think.
Other operating, yeah.
I think the quarter, and within the segments as well as in total was kind of affected by the bonus accrual takedown that I mentioned.
Okay.
I would expect the run rate to be a little marginally higher on a ratio basis.
Okay. Is the order of magnitude similar to what you mentioned on the insurance side in terms of what?
Within spitting distance, yeah.
Okay. That's fair enough. Okay, great. Thank you so much.
Which is as good as I get.
As a reformed actuary.
Yeah. Thank you.
Okay. Got it. Thank you.
Thanks, Mike.
Thank you. Our next question comes from Kai Pan with Morgan Stanley. Your line is open.
Thank you. Good morning.
Good morning.
First quick one, do you see any potential impact for the second quarter cats?
Second quarter.
The second quarter cats. Yeah, we have some reported losses. I don't know how big the impact is going to be. Mark, you have more of a feel for that.
The U.S. report.
Right. As you know, a lot of this stuff is pretty fresh. It just happened. It's a series of events. It's not a single event. You can appreciate that we're still accumulating some of that. I think from a 10,000-foot view down, it's more likely that there's insurance exposure than reinsurance exposure out of our U.K. operations, I would think. Our view at this point, Kai, is that across all of those aggregated together, it will still be contained within our cat load. We don't view anything unusual in that regard emanating from it.
Okay. What's your cat load assumptions?
Our cat load will be just shy of 40.
$40 a quarter.
A quarter.
$40 million a quarter.
Okay, that's great. Stepping back on the mortgage insurance. A couple of years ago, Dinos, you mentioned that this could become the third leg of the stool, but looking back at the premium, it's only less than 10% of your overall premium. If you look at the underwriting results, it's more than 20% now, so it's very meaningful. I just wonder, will the growth in this market faster than your other two segments will even sort of exaggerate or basically both your underlying margin as well as ROE will be growing faster than it has been?
You got to look at it from a lot of different perspectives. Premium is not the right measure for mortgage insurance because the accounting model is totally different. The way the business comes in is totally different, right? I write a mortgage today, and I'm going to be receiving premium over the duration of that mortgage, which is usually seven years or so. You got to look at it from a capital consumption, and you got to also look at it from the return point of view. Yes, I think we're on pace based on what we wanted to create a third revenue stream for the company and a third earnings stream for us. I wouldn't be surprised that depending what happens on the P&C world, the insurance, reinsurance, that from an earnings point of view, they might be even more than one-third.
They might go to 40%, 45%. On the other hand, P&C can turn in a couple of years, and it will be. We do look at it from a risk management point of view as to how much exposure we have in each one of the sectors, and do we feel comfortable with that vis-à-vis our balance sheet, or do we need to buy reinsurance behind it or bring other capital providers into it? We know we're close to any of those decisions. We believe that we still have a lot of room to grow on the mortgage business. Mark, you want to add something?
The only thing I would say in terms of creating a third leg in the sense of very sustainable and profitable on a return basis, I think we have accomplished that, and we're really looking forward to do more of that in the future. From that perspective, we're not really getting into the discussion as to how much it could be, would be. In the end, we're writing and looking at what we see every day, and we're very pleased right now. I think we've achieved at least establishing a stake in the ground and creating that third flow, diversifying flow, I would add, to our core P&C reinsurance and insurance. We're pleased with that.
Yeah. Look, I think Mark went on to how little cat we write today versus what we wrote four or five years ago. Things might change, but we always have that. Sometimes we shrink in areas that I don't like to shrink, but if there is no return, why be in it? Other times, you got to limit what you write because you're exceeding your tolerance from a risk management point of view. I can tell you right now, I'm way under leverage on the cat business. I wish the market was better for us to write a lot more in the cat area, and maybe one day will be again, and we'll be up utilizing quite a bit of capacity in that area. That's the kind of thinking that goes through our heads.
First, if it's profitable, let's write more until we got a guy called Chief Risk Officer. He's another actuary, François, who rings the bell sometimes. He says, "Yeah." He's nowhere ringing any bells yet because our risk tolerance in every sector is well within what we like to have. Kai, I'd just like to tie together that commentary with on managing the cycle and exposure with the fact we had $4 million of cats in the first quarter. If we hadn't reduced our volume 71% since 2012, we probably would not be able to report $4 million. It's got income statement aspects, price return aspects, and balance sheet risk management.
Just follow up on the risk management. This might be a high-class problem for you guys. If the mortgage become a meaningful portion of your overall profit pool because of different accounting, like treatment, basically you cannot smooth it out, for example, booking reserves. Do you worry about sort of volatility to the earnings?
No. Listen, there is two things that bring volatility to any book of business, including mortgage. One is what I will call micro decisions, that's the underwriting decisions. That we control, is within our hands. Then, the other volatility is macroeconomic changes, very high unemployment, which we monitor and see which direction. I would assign two-thirds on the micro and one-third on the macro. At the end of the day, in our quarterly risk management evaluations on everything we do, we'll look at those parameters to make sure that our compass is pointing us in the right direction.
Kai, lastly, because I want to make sure, given the way you phrased the question. The accounting model, as much as we criticize it, has nothing to do with our risk management evaluation. We project that to ultimate like we do our P&C line.
Right.
We make persistency assumptions, claims emanating from possible future delinquencies that are performing loans now, and so forth. Just because it's the accounting model's flaws doesn't mean we follow that in our risk management evaluation.
Yeah, we have a stressed test model that we run assuming certain economic conditions, where the housing market might go, where unemployment might go, et cetera, and where interest rates are going to go. Based on that, we see where we are with our book and where our book is growing to be.
Right.
That's great. Lastly, on the buybacks now trading at, you bought back around 1.3 times for the first quarter of book value, now trading at more than 1.4 times. Is that out of your comfort zone?
Well, if you ask me if I'm trading well, which is your assumption, no. I still think I'm cheap. That's a CEO talking his own account. Having said that, we're very disciplined into when we put capital to work, independent if we're going to buy our own shares or if we're going to buy something else. It's got to be within that three years, sort of told us that we got to recover anything we pay above book value. That's what's been guiding us both in if we try to invest in third parties or if we're trying to invest our own stock. That's basically where we are.
Kai, I applaud your five-part question.
Yeah.
Thank you so much.
Thank you. Our next question comes from Jay Cohen with Bank of America Merrill Lynch. Your line is open.
Thank you. Just a couple of questions. The first is, Marc, maybe just to make our lives a little bit easier, the reversal of these bonus accruals, can you actually give us the dollar number and where the location is?
It was roughly six and change, distributed all over, actually.
It was all 3 units and corporate, but call it $7 million.
Okay. Next question, I guess I'm looking for a little bit of guidance or help here. There's some line items within the mortgage insurance-
We don't give guidance.
Well, I'll call it help then, not guidance.
Okay. All right.
Assistance. For a non-actuary, not even reformed, how's that?
I love it.
Certain line items within mortgage insurance will jump around pretty dramatically quarter-to-quarter. You're looking specifically at the acquisition expense ratio. It's ranged from 33%-13% just in the last six quarters. Any sort of range that you could put that in that we should be thinking about?
On the traditional mortgage insurance, what we do in R2I in Walnut Creek is steady. It's your sales force every quarter, et cetera. What those numbers fluctuate on reinsurance transactions and on risk-sharings transactions. The cost with risk-sharing it's very, very small because we have a small unit, a couple of people that they review those transactions in the home office, and then Mark and I, and Andrew Rippert, who got to approve all those, we don't allocate our stuff into it. It's at a corporate level.
Jay, the early business we had in mortgage were largely mortgage reinsurance contracts and transactions. We migrated towards more of a mortgage insurance profile. That explains the ceding commission on reinsurance treaties right now on mortgage space are in the 28%-35% range. We're not doing many of those, or any, or at least not new as we speak.
Right.
Got it. In quarters where you have a big reinsurance transaction, the acquisition expense ratio will look a little lower?
You go the other way.
This is assumed, not ceded.
Right. Assumed. Correct. Yeah. Assumed. Yeah.
I'm just looking at this quarter, the acquisition expense ratio within mortgage insurance, within the mortgage segment was quite low, and you did a large deal. Maybe I'll take it offline with Don after.
No, we didn't have a big reinsurance deal.
No, exactly, Jay. I'm not sure which deal you're talking about.
I thought you guys did a sizable deal in Australia. I mean, for the mortgage reinsurance.
That's not a reinsurance transaction. Like Marc said, it's a reinsurance in the legal sense of the term, but we're doing 100% of really flow business. As Marc alluded to, that premium is earned over a very long period of time, and the earned premium is actually very small as we speak. Even though the acquisition there would be high, it doesn't really flow through the balance sheet or the income statement as we speak. It will take time to get there.
Right.
Got it. Okay.
Right. Okay.
Those are my two questions. Thanks for the information.
Okay. You bet, Jay.
Thank you. Our next question comes from Charles Sebaski with BMO Capital Markets. Your line is open.
Good afternoon. Thanks for getting me in. Just one follow-up on that Australian transaction. You say it's going to earn in over a long period of time. Despite the $43 million, we shouldn't see much effect on earned premium from that going forward for the next four or five, six quarters?
Yes, exactly right. Just picture, just to make things simplistic. Picture every month being a million-dollar single, and then those singles, each of those million dollars has to be earned over-
Six, seven
It's not linear, but six, seven years.
Right. Yep.
The written recognition is going to be a lot faster than the earned recognition.
Okay. Also on mortgage, has there been any activity on GSE risk sharing over the quarter? Is there a pipeline or anything, or is it kind of stagnant until something pops? Just curious what the outlook looks like for that.
No. There is activity, and there's a list of transactions that are coming down the pipe. Mark, do you have the detail on that or?
I look at the sheet right here. In the quarter, there were, I believe-
Three
three transactions, I believe.
Yes.
Yes, there were three transactions in the quarter, and there's actually a calendar, Charles, that There's a projection for the year that the GSE has shared with us. I'm not sure we are supposed to say anything, but you could track that they're on a pace to do, from our perspective right now, two to three a quarter for the next remainder of the year. We've done three this first quarter, and are working on some as we speak as well. Yeah.
Excellent. Finally on reinsurance, would appreciate your guys take. Some commentary in the market that the changing landscape in reinsurers means that smaller panels of reinsurers mean you have to stay at the table, maintain business. You guys have been contracting here. Do you believe that there's risk that over time you need to maintain some particular level of profile with cedents, or can you keep contracting and still get back in opportunistically?
Well, listen. It's a great question. At the end of the day, we have good ratings, good paper. We can be good partners, but I'm not there to do it on a just relationship basis and not have a return. My responsibility is to have returns from my shareholders. I'm not going to put that capital to work at a disadvantage on the hope that some future I'm going to make some money. If the deals make sense for us and our cedents, we'll do them. If they don't, we don't, and we look for something else. This is a big market, and we're still riding over $1 billion worth of reinsurance. Maybe not all of it is what I would call the traditional quota shares for large clients, et cetera, but we find little things here and there, niche things here and there, and we do it.
Our people, believe me, they're working harder today than in a good market because to find these small little nuggets, they got to process a lot of work. They're shoveling a lot. At the end of the day, that's our approach. We don't believe that we ought to give a pen away through just purely we ought to be making relationship-only decisions. Yeah, relationships are very important. We try to be as service-oriented as anybody else with our clients, give them our perspective about the market and pricing. We do underwriting audits, et cetera. We share all that information. We got to do a transaction that it has adequate return for us. Otherwise, we won't do it.
I appreciate the answer.
Mark. Yeah, I mean, you're on the reinsurance, I shouldn't be speaking on your behalf.
The one thing I will tell you about our reinsurance portfolio is that it's not really the same, as Mark alluded to, the same portfolio that we had when we started. I think that a lot of what we've been able to create on the reinsurance side, which sort of mirrors what has been done on the insurance side, is we try to get as, not controllable, but as somewhat protected or a line of business that has a little bit of more stickiness to it because it needs more knowledge or more expertise. Property facultative is a great example of that. In that segment, I think we are still very active, finding ways to grow and actually do more and be more relevant for our clients. We're not beholden to the large placements, as Dinos mentioned, which is a good place to be.
Thank you much, guys. Have a great afternoon.
Thank you.
Thank you. Our next question comes from Meyer Shields with KBW. Your line is open.
Thanks. Good afternoon, everyone. Really quickly, the mortgage insurance operating expense number went up sequentially. I wasn't expecting that. Everything else was phenomenal. Is that the new run rate?
No. As Dinos mentioned, it's a segment. The segment's made up of pretty disparate operating expense contributors. Clearly, until we hit scale on the USMI acquired piece, that's putting pressure on it. The mixture of that with GSEs, where the OpEx is marginal at best. The reinsurance, again, depending on the structure of it really comes down to mix. I would not read in anything to an incremental change quarter-over-quarter.
No.
Okay. Are you discussing the dollar amount or the percentage?
Well, technically both, but mostly the ratio.
Okay. Thanks. That helps. Then on the insurance segment, I guess you've talked a lot about a shift towards smaller account and low volatility. Is that going to have an observable impact on either the acquisition expense ratio or the loss ratio as that mix shifts?
Well, this shift has been happening now for five, six years. We didn't pivot to that. The largest initiative we have is about $160 million worth of business is our binding authority business. That has a little higher expense component. It comes from binding authority wholesale agents, and in essence, they do a lot of the work. It's all electronic. They use our systems, they price our pricing algorithms, et cetera, but they do all the input, and they issue the policies. Our system is so good that you can bind and issue a policy within 24 hours in the agent's office. It has a little bit of a higher expense.
Yeah. I would also say, you actually have seen some marginal improvement. Just in the past quarter, that's 30 basis points down on the net acquisition ratio. Just remember, premium taxes are in there, too. When you go from a harder to a softer market, it tends to become more admitted than not admitted, you get a little bump there on everything else being constant. The biggest thing you should keep in your mind is as we move to lower and have moved to lower volatility businesses, they come with a higher acquisition cost and a lower loss ratio.
The fact that we have a higher proportion of higher commission-oriented businesses, yet the net act is continuing to go down, shows you the leverage power of our reinsurance cessions with increased ceding commissions. It's offsetting and sometimes more than offsetting that mix shift towards higher act businesses.
Okay. The lower
Make sense?
I'm sorry?
Does that make sense?
It does. I'm not contesting it. I'm just interested, a lot of competitors have talked about lower volatility business having a higher loss ratio.
Well, remember, we're after volatility containment. You can cede a lot depending what's left, especially if it's a quota share, is still highly volatile on its own. You're getting ceding commission overrides, so you're putting gain into your income statement right away. What you still have left is volatile.
Okay. That makes sense.
We've moved more towards, as Dinos says, smaller accounts and small policy limits associated with those.
That we keep 100% net.
Yeah.
Okay. No, that helps. Are the ceding commissions that you're seeing in reinsurance the same as you're benefiting from on the insurance side?
Yes. The answer is yes.
Yes. Pain on one side, there is gain on the other side.
The other one. The market's phenomenon.
Yeah.
Good. Okay, perfect. Thanks so much.
Thank you.
Thank you. Our next question comes from Ian Gutterman with Balyasny. Your line is open.
Hi. Thank you. I guess first, Marc, you talked earlier about growth in UK Motor, and I think a number of others just talked about that. Can you just talk a little bit more about sort of what exactly that business is and what's appealing about it? I guess I have ancient bad memories of that causing trouble for people from time to time.
Oh, yes. You're quite right. It is very interesting and very volatile if you're not careful. We have a good relationship with one big originator in the U.K., and they've been a partner of ours for a little while, and we've been able to maneuver through the cycle alongside with them. We are seeing rate increases over the last three or four quarters, I would say. We were able to seize on the opportunity and give them what we think are appropriate reinsurance terms to be partners with them on a going forward basis. In addition to this, the excess of loss in the U.K. has also gone through a tough time in terms of a lot of changes in the rate level, and we were also able to take advantage of that.
It really is a reaction, to echo what you just mentioned, to the fact that rates have been increasing and improving, and as I said in my comment, and they've increased enough so that we believe that the returns are there for now for us to take advantage of it.
Got it. You're doing XL then?
As well as
We're doing both.
As well as quota share.
Doing both.
Yeah.
Got it. Are there loss caps on those to protect you, or is it just?
Well, there is terms.
Secrets of the trade that you're asking me, and I'm not sure I'm comfortable sharing that with you.
That's fair. Okay. I guess maybe what I was getting at is, I always figure that being a long-tail business and just, are there ways if you see it deteriorating, is it just you won't renew it the next year, or are there other things you can do to protect yourself if five years down the road it goes bad?
You're talking about the model.
Quota share?
or the XL loss?
I guess that's probably more on the quota, right? I guess it could be either.
Well, no.
Quota share.
The quota share you can adjust.
Okay
very quickly based on your underwriting audits and how you're monitoring rates. Don't forget, we do a lot of underwriting audits, and we continue to watch the pricing on a quarterly basis. The biggest bet is the excess of loss bet, because you get that wrong and it's not as easy to correct. You can get out later on, sometimes it might take you a couple of years or three years before you recognize that you didn't get the pricing right. That's not, from a premium revenue point of view, is not as big as the quota share.
Got it
We watch both, believe me.
Okay. Understood. I was just curious because I've seen a lot of people adding to it. On the MI, I guess a couple things on rates. One is, now that everyone has lowered their rate cards for your non-RateStar business, your existing rate card, I think in certain cells looks off-market. Do you feel you need to adjust your rate card to sort of match everybody or for those customers you want to keep that business?
We actually just, Ian, we just issued a new rate card on April 7th.
Okay
We're not matching everyone. There's no plan right now to do anything else.
Got it. Okay, I missed that. Then on the RateStar business, my sense is, and again, obviously, I don't know exactly what your rates are, it feels like conceptually, a lot of what the competitors did to change their rate cards felt like it was trying to get closer to where you and UGC are. Is that fair that maybe the Advantage rate card a little bit diminished?
I don't know what drove the actions, because you're mixing apples and oranges here, right? At the end of the day, if you have a pool of risks that on average gives you a good return ROE, now through a selection process, maybe one or two competitors, they might be taking out of the pool certain mortgages for a slightly less price but a much better risk characteristics. That means the remaining part of the pool needs to be priced a little higher than the past, not a little lower.
Right.
Adjusting the rate cards are not going to look at exactly what adjustments they make. You might be getting into adverse selection, so to speak. At the end of the day, the problem with the rate card is a simplistic way to price. Just credit score and LTV alone is not the only thing that is going to tell you as to how that mortgage is going to behave. There is other parameters around, and I think that's where our advantage is. Our advantage is we introduce other factors to allow us to more appropriately price that business.
Clearly, Ian, to your question a bit more directly, I believe that going to a more refined rate card is sort of a one step for most of them to get to that direction. There's recognition, to Dinos' point, that the rate card has been historically too generic in nature.
Yes.
Right.
Okay. That's what I was looking for.
It might die within a year or two, and it might get into more as to what we do in all of our other business on the P&C. I don't care if it's auto or homeowners or lawyers and accountants and all, et cetera. We don't have one or two rating parameters. We have multiples. Then you look at it from many different perspectives to put a price. I think the mortgage insurance business is moving in the right direction in our view.
For sure. Just last one on that topic is, if you were to look at a sizable acquisition in that space that would take you over the one-third mix, can you just talk about sort of how you evaluate metrics? Meaning, obviously, we can all look at EPS accretion, but what are the different things you look at in addition to just EPS and, is it ROE? Is it your PE? I think one of the concerns some people might have is those companies trade at lower multiples, so if it becomes too big a part of your mix, it might hurt your valuation. Just how do you think about sort of the combination of accretion versus-
Well, listen
valuation versus returns?
You know that old saying that says, in the short term, the equity market is a beauty contest, and in the long term, it's a weighing machine. That's Buffett's analogy. As long as I'm producing good profits and I'm keep adding, I don't worry about what the street valuations might be. How do you explain
One competitor we have, who is trading at 1.7x book, in MI space, versus another competitor we have who is trading at 1.1x. Maybe one has legacy business and the other one doesn't, et cetera. I'm not worried about that because the mortgage insurance business produces very good ROEs to demand a higher multiple than the P&C world right now. We only have one marker out of the seven who has that purity in only having post-crisis business, and the market is rewarding them with the 1.7x multiple. I don't know. Our actions is not as to about the market multiples. Our actions is, are we producing a good return for the capital that we're committing to a particular sector, and is the ROE acceptable? That's what drives us. That's the key driver in what we do.
Okay. That's the reason I asked. Yeah.
Ian, for an insightful guy like you and the others, it would wind up being that ACGL would bring up the mortgage multiple rather than the mortgage multiple bring down ACGL.
The reason I ask is because if it's something big, I assume you'd have to use some stock, so that was sort of the context I was thinking about it. Maybe a better way to say it is, historically you haven't done anything that's required an issuance in stock. What are the things you evaluate in deciding whether stock makes sense in a merger?
Well, let me just start on that one. I mean, we've talked about this before on tangible book value hits. That's not new as to how or when we repurchase our shares, there's that hit. What's the recovery period? That is still an in-force principle that we would look at. That's one of the criteria, not the only criteria. That's certainly one of them. Don't lose sight of the prior discussion, which is on the risk management side. EPS is a no-brainer. That's so tactical. We don't want to impair the balance sheet, number one, what's the recovery of it, and the risk management aspect. We wouldn't go into it if there weren't high ROEs to begin with. Defensively, we don't want to put any dents in the balance sheet.
That makes sense. What's for lunch today, Dinos?
That's your best question.
Today we have Keftedes.
Okay.
That's the Greek meatballs.
Oh, okay. I remember those.
I can give you the recipe when I see you.
All right. Sounds good.
They're phenomenal.
I remember those from last summer. Thank you.
Yeah. You're welcome.
Thank you. Our next question comes from Mark Dwelle with RBC Capital Markets. Your line is open.
Hello, thanks. Just one follow-up question. Something that was discussed on the Australian mortgage transaction that what you said kind of confused me. Is this a recurring revenue transaction, which is to say we'll see another one of $40 million or whatever the number will be next quarter, and then continuing thereafter? Is this a one-off, one-shot deal?
Like I said, and we're sorry for it, I just want to make sure it's clear to everyone. This is really like business that was produced in that quarter. That relationship is still existing. It's been around since last year. Yes, I would expect, depending on the level of production that our partner will do in Australia, we could be around that same level if they continue producing at the same level. If they originate the same level of mortgages-
Flow through
they will flow through with us, and it continues. It will continue as such until they cancel us or-
We terminate the relationship.
There is a termination by either party on the relationship.
Correct.
This puts in place really a fairly, I'm going to use the word permanent, or at least hopefully long-term kind of floor flow of premiums that should last for at least on an earned basis, for quite a long time.
Yes. That is correct.
Yes.
Yes.
Okay. That's what I thought, and that's my only question. Thank you.
Thanks, Mark.
Thanks, Mark.
Thank you. Our next question comes from Michael Nannizzi with Goldman Sachs. Your line is open.
Sorry for the follow-up. Just one last one here. Back to the MI, and Mark, maybe your comments on the expenses. I'm looking at premiums doubled year-over-year. Acquisition ratio is in half. Dollars are down notionally. Other operating expense, the ratio is flat. I understand there was a reinsurance transaction that may be obscuring some of that trend, but I would generally think that the ratio of dollars, it would seem to be more fixed in nature, the operating expenses. That ratio would improve, and that the acquisition ratio would remain relatively flat again, absent some adjustments. I'm just trying to get some understanding of what that should look I understand there are like three different businesses. They all operate differently. The stackers expenses are low and things of that.
With a line that's growing this quickly, I feel like I'm just missing the mark on how to think about it. Should we be looking at expense $ relative to written premium $ as opposed to earned during this growth phase? Just any guidance or help, not guidance, but any help in how to think about it would be great.
Well, I think written is a better way. It's more of a statutory view, but I still makes more sense. We talked about hitting critical mass and steady state at some point. Also, Michael, think about how market share is measured. It's measured on NIW, which is effectively-
Sure
new premium. That's new exposure. The premium comes in at a slow build-up rate over time. If we get to a reasonably larger market share in two, three years, that doesn't mean that overnight the whole in-force book is where it needs to be. That means the marginal amounts in 2017 that we hit market share of X is additive to the portfolio. In P&C world, we have new business and renewal business.
Sure.
Here, you don't have renewal business. You have new business and in-force.
All you're doing is adding onto the heap with the new NIW that you're getting. This is a long-winded answer to say you got to be patient. The OpEx dollars are really not going to grow as much. You got to wait for the revenue to catch up with that, and it will.
Okay. OpEx doesn't grow as much. The acquisition expense, I'm guessing that was then impacted somewhat by this Australia transaction and the lack of the reinsurance transaction you mentioned that you had in the prior year. Is this sort of teens level of acquisition expense? Given the mix of business you have, is there anything in there that we need to peel out in order to think about the forward?
No, I think it is the mix. The mix will change by quarter. By the way, changes in the reinsurance segment, changes in the insurance segment by mix, that changes the reported acquisition expense. The questions you ask are applicable to any of our business segments, but acquisition can fluctuate as a function of the business we write. I'd say no, it's a mix thing quarter by quarter.
Got it. Okay. Thank you so much.
Thanks, Mike.
Thank you. I'm showing no further questions. I'd like to turn the call back to Mr. Dinos Iordanou for closing remarks.
Well, thank you all. A little late lunch today, but I'm going to enjoy the keftedes along with the team. We're looking forward to seeing you next quarter.
Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect. Everyone, have a great day.