Arch Capital Group's CEO Discusses Q1 2014 Results - Earnings Call Transcript

May. 2.14 | About: Arch Capital (ACGL)

Arch Capital Group Ltd. (NASDAQ:ACGL)

Q1 2014 Results Earnings Conference Call

May 02, 2014 11:00 AM ET

Executives

Dinos Iordanou - Chairman, President and CEO

Mark Lyons - Executive Vice President and CFO

Analysts

Amit Kumar - Macquarie Research Equities

John Hall - Wells Fargo

Michael Nannizzi - Goldman Sachs

Vinay Misquith - Evercore Partners

Kai Pan - Morgan Stanley

Ryan Byrnes - Janney Capital

Meyer Shields - Keefe, Bruyette

Jay Cohen - Bank of America Merrill Lynch

Brian Meredith - UBS

Ian Gutterman - BAM

Operator

Good day, ladies and gentlemen. Before the company gets started with its update, management wants to first remind everyone that certain statement 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 assessment 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 statement 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 turn the presentation over to your host for today Mr. Dinos Iordanou and Mr. Mark Lyons. Please proceed

Dinos Iordanou

Well, thanks Glenn. Good morning everyone and thank you for joining us today. We had an excellent first quarter from an underwriting perspective and we were also successfully launching two strategic initiatives this past quarter, we entered the U.S. direct mortgage insurance market place and also became a reinsurance manager for our pool of Watford Re. I will comment further on this initiative shortly, but first let me share a few observations on the quarter.

Earnings were solid and were driven by excellent reported underwriting results aided by low catastrophe activity. On a consolidated basis, our premium revenue grew by approximately 11% on a gross written basis and nearly 12% on a net written basis. Although we were -- a few noteworthy items which I will get to in a minute.

On an operating basis, we earned $1.20 per share for the quarter, which produce an annualized return on equity of 12.1% for the first quarter of 2014 compared to 12.9% for the same quarter in 2013. On a net income basis earned a $30 per share this quarter which corresponds to an annual rate of 13% return on equity.

Our reported underwriting results in the first quarter were excellent as reflected by a combined ratio of 84.7% and were aided by low level of capacity losses and favorable loss reserve development. We also benefited from improved accident year performance in our U.S. reinsurance group, which was more than offset or by an increased in the accident year combined ratio in the reinsurance group.

It is worth noting that there were three components to the increase in reinsurance groups accident year combined ratio. In the first place the mix of business changed, with the group writing less property cat business, which has the lower expected loss ratio. And secondly our reinsurance grew over the past 12 months found more casualty and professional liability business both in the U.S. and internationally, which met our return threshold.

And third because some of this casualty business we underwrote has a longer duration, which should produce excellent economic returns, we follow our historical practice of reserving very long-tail business at a more conservative level. The longer the tail, the more conservative is a loss pay and historically this approach has worked very well for us.

So, no need for us to change that methodology and we chose not to. Net investment income per share on a sequential basis was flat in the quarter at $0.49 per share. Our operating cash flow for the quarter was approximately $200 million a bit less than the $205 million from the same period last year.

The total return on the investment portfolio was 100 basis points for the quarter inclusive of fluctuation in foreign exchange rates. Our book value per common share at March 31, 2014, rose to $41.53 increasing by 4.3% sequentially and 10.3% relative to first quarter of a year ago.

Now, let me return to the strategic initiatives I mentioned earlier. As you know, we along with Highbridge Principal Strategies a subsidiary of JPMorgan Chase & Company launch a newly form multi-line reinsure what we in late March with $1.1 billion of initial capital. Arch invested approximately 11% of the common equity and we’ll serve as the Watford Re reinsurance manager. Mark will go into more detail on the accounting and for Watford, when he gets to his prepared remarks. Despite the late start in the first quarter, Watford Re was only formed in the last few days of the quarter, Arch seeded $32.2 million of premiums to Watford Re. We believe that this new venture will benefit shareholders of both Arch and Watford Re.

our mortgage segment includes primarily mortgage insurance, we sell through Arch mine in the U.S. and internationally the reinsurance treaties covering mortgage risk which is written globally as well as other risk bearing and structural mortgage business.

Our mortgage business in the U.S. serves two major markets, credit unions and banks and other mortgage lenders.

Arch U.S. MI represents about 40% of their $43.3 million of net written premium in the first quarter of 2014, most of which is attributed to the credit union sector. As we have discussed on prior calls in the banking sector, we continue to build our client base. As of last week, we have had received over a 100 master policy applications from banks of which 98 have been approved, 13 of these approvals represented national accounts and the rest are regional or local banks.

The number of master policies is increasing each month with March approvals doubled February’s rate and April running at 2.5 times the March rate. Of course, approvals on the first step in this process, it takes time to integrate systems and then get into the banks with patience in order to receive new mortgage insurance policies. Our sales force is working hard on this and they are intended to achieve their sales targets all the time.

In the primary markets, in which our insurance group participates we continue to obtain rate increases above most trends slightly above the levels that we observed last quarter. In our U.S. insurance operations we achieved rate increases in the quarter that provided the 120 basis points of expected margin improvement which was better than the last quarter.

We continue to see a best opportunities in some sectors of the E&S market and binding authority and program businesses. In these areas, we’ve been steady, we have seen steady improvements in pricing and steady gain in exposure units which contributed to our solid growth in the first quarter although we did observe the large account casualty and professional liability guarantee course segments coming under more pricing pressure in the first quarter of 2014.

We currently remain a minor player in these sectors. On the reinsurance side of the business, we have seen a continuation of softening in terms and conditions that we noted in our prior quarter’s remarks. As you’ve heard on other calls the property cat area remains under pressure primarily due to the alternative capacity that has entered the market. For the first quarter we experienced approximately a 15% reduction in property cat rates on a gross basis. Also as we reported on the last quarter’s call, cedents are aggressively requesting additional ceding commission on quota share contracts of between 2% and 4% and reinsurance buyers continue to shift business to excess of loss treaties.

Let me remind you again, since we fall within insurance and reinsurance enterprise, should we experience pain in our insurance segment, we tend to benefit from the improvement in terms of on our insurance operations as we are significant buyers of reinsurance.

From a production point of view, gross return premium in the reinsurance segment grew by 14.8% over the same period last year to two significant treaties returned in 2013 on a risk attaching basis as well as some new international casualty treaties. Net written premium increased just 5% over the same period due to additional retro-purchases and our sessions to Watford Re.

The insurance segment grew premium by 6% on a gross basis and 8% on a net basis. Most of our growth is coming from no limit accounts and our loss sensitive business which is national accounts and constructions, mostly return on large deductible loss-sensitive basis.

Group wide on an expected basis, we continue to believe the ROE in the business we underwrote this quarter will produce an underwriting year ROE in the range of 11% to 13% with ROE improvements in the insurance group results offset by deterioration in the reinsurance group primarily due to lower cat rates. The higher reserving rates for the casualty business in the current accident year will not affect the underwriting ROE at ultimate in our reinsurance business.

Before I turn it over to Mark, I would like to discuss our PMLs. As usual, I would like to point out that our cat PML aggregates reflect business balance 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 purchases and retro sessions.

As of April 1, 2014 our 250 year PMLs for a single event decreased to $705 million in the Northeast for 11% of common shareholders equity. This is the lowest level I think I believe in our history while Gulf PMLs also decreased to $624 million. Our Florida Tri-County PML now stands at $488 million.

We know that these reductions reflect a change in catastrophe models from RMS version 11 to version 13 as well as opportunistic retro session purchases that we chose to buy.

I will now it over to Mark to comment further on our financial returns and results. And after his prepared comments we will entertain your questions. Mark?

Mark Lyons

Great. Thank you, Dinos and good morning. As you’ve noticed by now, we have made some changes to our reporting format. We added two new segments in addition to our prior insurance and reinsurance segment as well as modified some line of business definitions.

The new segments are mortgage business and the colorfully named other segment. The mortgage business segment in composes both insurance and reinsurance across U.S. and international operations and additionally any risk-sharing transactions with the GSEs or banks will be contained here.

Previously mortgage insurance, reinsurance and risk-sharing transaction results were reported within the reinsurance segment, but that is no longer the case and we’ve provided apples-to-apples comparatives so you can profitably reference prior period.

The second new segment called other, currently reflects the Watford Re results, which is a new Bermudian Class 4 reinsurer with an A minus A.M. Best rating and as Dinos said, 1.13 billion in total capital. Arch acts as Watford’s underwriting manager, while Highbridge is a subsidiary of JP Morgan, manages Watford’s investments.

Even though Arch only holds an 11% minority interest in the common shares of Watford Re along with some warrants, we have consolidated 100% of their results in Arch’s financial statement with a requisite offset reported as non- controlling interest.

We’ve consolidated Watford not due to our percentage ownership, but due to the accounting rules of variable interest entities or VIE. Therefore Arch’s consolidated statements not reflect Watford’s assets, liabilities, cash flows, revenues and other income statement items at a gross 100% level with a corresponding approximate 89% non-controlling interest removed as a single line offset where appropriate.

Unlike other segments, Watford has its own operations and accordingly has its own assets, investment strategy and management. We will present Watford results inclusive of its investment performance.

The other change we made within our financial presentation is our definition of grouping of products within the insurance segment. Some lines are broken out more finely than before whereas others are combined with previously provided lines. In both cases, groupings were made with an eye towards our line of management accountability in conjunction with materiality levels.

Now, I’ll proceed the report on our financial results for the quarter. At this point, the financial results of ACGL, with or without Watford Re are not materially different from each other since Watford only had 2.2 million of net earned premium. Over time however as Watford Re grows, they will become more significant and I will make some comments that include or exclude their results as appropriate in the future quarters.

The only comment of significance this quarter is to point out that ACGL’s cash increased approximately $1.1 billion. This is predominantly due to the capital rates for Watford Re in late March and that Arch is consolidating Watford.

For this quarter, I will make financial comments that include Watford, since they don’t move the needle at this time. The consolidated combined ratio for this quarter was 84.7%, with six-tenths of a point of current accident year cat events, net of reinsurance and reinstatement premiums, compared to the 2013 first quarter combined ratio of 84.6%, which reflected 1.5% of cat-related events.

Cat losses occurring in the 2014 first quarter represented $5.5 million net of reinsurance of recoverable and reinstatement premiums, emanating from various events.

The 2014 first quarter consolidated combined ratio also reflected 9.5 points of prior year net favorable development, compared to 7.1 points of prior period favorable development in the 2013 first quarter. 86% of this net favorable development was from the reinsurance segment, with nearly 75% of that due to net favorable development on short-tailed lines, primarily stated with the more recent underwriting years.

Approximately 20% of the reinsurance segment’s favorable development was attributable to longer-tailed lines, mostly emanating from the older 2003 to 2005 underwriting years. The remaining 5% of the Reinsurance segment’s net favorable development was attributable to medium-tailed lines throughout many underwriting years. The Insurance Group accounted for 14% of the aggregate net favorable development, which was almost entirely driven by short-tailed lines in recent accident years.

Similar to prior periods, approximately 68% of our total net reserves for loss and loss adjustment expenses, a $7.2 billion are IBNR or additional case reserves, which is fairly consistent ratio across both the Reinsurance and Insurance segments over time.

Therefore the current accident quarter consolidated combined ratio excluding cats for the first quarter was 93.6% compared to 90.2% accident quarter combined ratio in the first quarter 2003. In the Reinsurance segment as Dinos has already commented on the 2014 accident quarter combined ratio excluding cats was 92.6% compared to 79.7% in the corresponding quarter in 2013, and 85% in the 2013 fourth quarter serially.

The Reinsurance segment’s result this quarter reflected reduction in property cat writings on a gross basis with additional record sectional support as well along with an increase of casualty business driven by a large U.S. professional liability treaty as an European excess of loss contracts.

In the insurance segment the 2014 accident quarter combined ratio excluding cats improved to 94.8% compared to 97.9% a year ago, showing continued improvement in margin expansion that has been aided by the lesser valuable smaller accounts strategy implemented over the last half years. Also on a consolidated basis, the ratio of net premium to gross premium in the quarter was 82.2% versus 81.9 a year ago.

In the Reinsurance segment the net to gross ratio is 85.9% in this quarter compared to 93.8% a year ago primarily due to the changing mix of business on a written basis, and the increased use of the large professional covers as previously mentioned. The insurance segment had a 74.7% net to growth ratio compared to 73.2% a year ago, as a function of the lesser volatility businesses as they continue to expand upon.

The consolidated expense ratio of 34.0% this quarter is 2.5 points higher than the 31.5 expense ratio reported in the first quarter of 2013. This is largely driven by increase in acquisition expenses in the Reinsurance segment along with the operating expenses related to our U.S. primary mortgage insurance operation.

The insurance segment expense ratio was flat with the first quarter of 2013. As we expect pricing levels the U.S. insurance operation as Dinos mentioned, achieved a net 120 basis point margin expansion in the quarter, or a corresponding quarter of 2013, larger expansion to as a reminder, as we reported represents the excess of written effective rate increases over estimated loss trends, margin expansion continues in our program casualty and construction and national accounts business while contracting slightly in healthcare and property.

We are continuing to see a lower level of loss cost inflation, but are approaching lease trends cautiously. Our new mortgages business segments posted an 81.3% calendar combined ratio for the quarter, expenses ratio was 59.4% as largely driven by front ended operating expenses assumed during the CMG, PMI acquisition such as staff and infrastructure to support the acquisition of premium for the bank channel of our new U.S. primary mortgage operation.

The increase in net written premium is $17.5 million this quarter is driven by premium gains from our new U.S. primary operation, mostly via the credit union side as Dinos mentioned and by assume premium emanating from 100% reported share of PMI’s 2009 to 2011 underwriting years as part of the aggregate acquisition of those platforms.

Although reinsurance business added $25 million of net written premium offset by approximately $11 million reduction from one reinsurance stream. At March 31, 2014 we held $5.3 billion of risk in-force from our primary U.S. operations and additional $5.5 billion to our mortgage reinsurance and risk-sharing operations.

Risk in-force is a standard measure of exposure in the mortgage insurance industry, that generally represents approximately 25% of the total aggregate loan values. It is this risk in-force figure and forms the bases for capital ratios leads by the GSE’s regulators and rating agencies.

This segment also experienced $1.2 million of net favorable development this quarter which represents approximately three combined ratio points. This net favorable development mostly emanated from order of report years that had better than expected emergence.

The other segment currently contains the results of Watford Re. As I discussed previously Watford Re was consolidated into Arch’s financial statements at 100% level, therefore the $32.2 million of net written premium, written by Watford this quarter represents 100% of all the business they assumed and not just Arch’s 11% current share interest.

Adjustments for the non-controlling interest are made in the single adjustment line to net income rather than each line on the income statement balance sheet or cash flow statement. Watford Re reported a 151.8% calendar combined ratio on a small net premium basis $2.2 million certain startup expenses associated with the formation of Watford were also reflected and these should be reviewed as non-recurring.

Reported net investment income in the quarter was $0.49 per share substantially unchanged from the 2013 first quarter of $0.48 a share. Our embedded free tax put yield before expenses was 2.27% as of March 31st, compared to 2.38% at prior year-end.

The duration of the portfolio increased this quarter to 3.24 years from 2.62 years as of year-end. The total return on the portfolio was 100 basis points in the quarter with non-investment grade, fixed income, equities and alternatives augmenting returns on our core investment grade income portfolio. Excluding foreign exchange total return was marginally different at 102 basis points in the quarter.

The effective tax rate on pre-tax operating income for the first quarter of 2014 was an expense of 1.7% versus an identical expense of 1.7% in the first quarter of 2013. As always fluctuation in the effective tax rate, that result from variability in relative mix of income or loss reported like jurisdiction.

Arch’s total capital was $6.8 billion at the end of this quarter, compared to $5.7 billion at the end of 2013 first quarter and $6.5 billion at year-end 2013. The $1.1 billion increased in total capital from a year ago is primarily driven by the $500 million debt raised in December 2013 plus approximately $600 million of retain earnings over the last four quarters. Our capital structure now at March 31st is comprised the 13.2% debt, 4.8% preferred and 82% even of common equity.

At the end of this quarter, we continue to estimate having capital in excess of our targeted capital position. And Dinos has just mentioned book value per share as a reminder increased 4.3% in the first quarter up to $41.53, which is also 10% -- 10.3% higher than a year ago. The growth in book value this quarter is driven by the company’s continued strong underwriting results.

With these introductory comments, we’re now pleased to take your questions.

Dinos Iordanou

So Glen, we’re ready for the questions.

Question-and-Answer Session

Operator

(Operator Instructions). And our first question comes the line of Amit Kumar, Macquarie. Please proceed.

Amit Kumar - Macquarie Research Equities

Thanks and good morning, and congrats on another strong quarter.

Dinos Iordanou

Thanks Amit and good morning to you and everybody else by the way.

Amit Kumar - Macquarie Research Equities

Just two quick questions. The first question is, goes back to your comment on capital and I guess declining PMLs and your two new initiatives. I was just wondering, how should we, maybe can you update your views on potential acquisition opportunities in the marketplace versus what you are building out right now.

Does your view change if something presents itself? Or are you more focused on MI and Watford Re right now?

Dinos Iordanou

Multiple questions. Let me start with, we’re always focused intensely on everything that we want. I don’t care, if it’s insurance or reinsurance, the MI or Watford. So, that focus is always going to be there, but it doesn’t preclude us from also looking forward on other opportunities.

Your question about M&A activity, yes we are willing to look at opportunities presented in the marketplace. But still I prefer way is to build versus buy, we find that from a lot of different perspectives to be more attractive. Culturally, we better selection or at least the selection of people that we believe culturally fit with us et cetera.

So and there are some of those opportunities that we are pursuing now globally that will fit into the category. And of course we will not say no to a potential acquisition if it fits our characteristics. It is specialty business that does it fit with our D&A is the underwriting pasture past and going forward a good fit with us because maybe I am very bias to culture within a company. And one thing that I am extremely careful is not to change the culture that we have within Arch. I am not saying it is better or worse than anybody else, but it is what it is and it seems we have had very good performance over 12 years following that philosophy I am kind of the guardian on it. So with more of a difficult company to come to an agreement on an M&A opportunity because of all these issues.

Amit Kumar - Macquarie Research Equities

Got it. That’s actually very helpful. The only other question I have is on your MI platform. First of all and may be this is the numbers question, but some other MI players and again I am new to this give sales metrics in terms of new insurance written et cetera, would that be in the Q or how should we sort of think about the sales metrics?

Dinos Iordanou

Well we’re going to be reporting that in our Q and eventually don’t forget this is our first attempt on MI disclosure. And as I said in last quarter we’re looking also from input as to what is going to help you as I know is viewing our business. So any suggestions you have or what kind of information that will be helpful to you to see, get with Don Watson, which is the head of our Investor Relations. And then if we find it appropriate, we’ll improve disclosure in our press releases and supplemental data.

Mark Lyons

But the overall approach of that is that we’ll provide by at least as much as what’s standard in the industry.

Amit Kumar - Macquarie Research Equities

Got it that’s very helpful. And I guess related to that and this is my final question. Any update on your views on the MI market? I guess my understanding that there have been some players who have attributed a slowdown, I guess to the cold weather in Q1 and there is some discussion I guess in that market place regarding the housing recovery, any update would be helpful on the marketplace? Thanks.

Dinos Iordanou

Well, first a little bit of a shameful plug on our people. If you go on our website, we bought mortgage insurance, published as a quarterly newsletter which gets into a lot of these macro issues. And I will encourage you instead of taking everybody’s time, to get on the website, go to Arch MI and look at the quarterly views that we have on the macro issues within the Mortgage Insurance page.

It is clear that in the first quarter refis have been reduced significantly, on the basis that interest rates, mortgage interest rates have gone up and I believe if you look at it from inside mortgage finance I think the reduction in refis would like 63% in the first quarter. Having said that, the persistency there is no refis goes up on the existing business. So because a mortgage that gets refilled, you are losing the premium if you was already at cover mortgage to a new one that we are going to get under the refi.

We are not projecting at least in the data that we have a significant change in volume on our credit union business, but we expect some slowdown over the year because new originations are down and refis that a way down.

Now the more difficult question for us, once that what is going to take three, four quarters for you guys to get a flavor of, it’s our penetration in the bank channel because we are early on in the process, we are signing these master agreement, we are starting to receive business but it’s a lengthy process; you’ve got to go through the process of filing and getting approvals on the master agreement then the systems linkage has to be there and then you are starting to get on there with patience to start receiving that business. Mark anything else?

Mark Lyons

Yes. I would just add, Dinos really has just outlined kind of the staggered approval process and I think that supplement that has affected the industry is dominated by monthly not single premiums. So even when you get the approval to business flow takes a while to build because of the monthly nature of the premium lenders.

Amit Kumar - Macquarie Research Equities

All right. Thanks for those answers.

Operator

And your next question comes from the line of John Hall with Wells Fargo. Please proceed.

John Hall - Wells Fargo

Good morning, Dinos, Mark and the rest of the Arch team.

Mark Lyons

Good morning.

Dinos Iordanou

Hi, John.

John Hall - Wells Fargo

Hi, there. I’ve got questions related to I guess the shifting business mix in the combined ratio in the reinsurance segment?

Dinos Iordanou

Right.

John Hall - Wells Fargo

Have we sort of reached a steady state, where by the mix shift has occurred and the migration up in the combined ratio is (inaudible) expenses aside. We’ve sort of hit where we’re going to be on a going forward basis?

Dinos Iordanou

I’d say that’s a tough question, because I got to understand, the mix that we’re going to have going forward. I would say probably because of a bit of conservatism we took on some of the business we will that had very long duration. And I’m not talking about four, five year duration, this is business that it will have maybe 7, 10 and some of it even beyond that duration.

We’re always very cautious when we price that business and also when we reserve that business. Because you confirm yourself early on and we try not to. If you saw where our reserve releases came from casualty in the reinsurance sector, they came from the ‘03, ‘04, ‘05 year. So that tells you, it was a same philosophy we had then that he, let’s not celebrate early on very long term duration business. So, not knowing, what kind of contracts, I’m going to see in the future, I would tell you that, we have reached that, if the mix is exactly the same next quarter. In all probability that would be probably down 5 or 6 loss ratio points, if we go back to more of a normal mix that we had in prior quarters.

So, it’s a very difficult question to answer, unless you have a scenario as to what we’re going to write and what type of business going forward. But, Mark, do you want to add a few points on that spend more time on that analyzing and …?

Mark Lyons

Yes, I’d be happy to do. So, I think first thing I got two points to make, I think the first one is that, you really got to look not as much quarter to quarter, but perhaps what year-to-year would be like. I mean the first quarter big as 79.7% last year, that was really an 82% for the year and fourth quarter and this is like 84% or so something. So, it’s a little bit of an artificial movement.

But I think what’s more important and I think it’s telling that since I changed job from the insurance group over and had a chance to really dig into the reinsurance group in this position. If you look backwards either, this is emanating out of the U.S. or from reinsurance operations, not only was it an outstanding job of underwriting. It was an outstanding job of reserving.

And if you look now versus then, it’s the same chief actuaries, it’s the same management of the segment, it’s virtually the same, as a holding company, which is what we’re talking about here.

So, it’s one thing for a company to say, we haven’t changed anything on the reserve methodology, it’s different to say that compoundably so it’s the same individuals involved with regards to consistency. And I think that’s an important point.

Dinos Iordanou

And John, accident year in one quarter especially the most recent quarter is a self grading exam. Self grading exams to something that it has more than let’s say five year duration is in full paradise. At the end of the day, look at me five years from today and you see how well we’ve done on that business. Now, it makes it difficult for you guys to estimate and I understand. But I think the historical performance which is where Mark is pointing you, might give you an indication of the culture and also the methodologies that we go through in making these long-term reserve decisions that we have to make.

John Hall - Wells Fargo

I appreciate that. Thank you, Dinos. And I guess the profit characteristics, can you talk about the target ROE and ROE you’re achieving here, I guess there is a greater portion of the most recent quarter’s business attributable to investment earnings?

Dinos Iordanou

That’s correct. When you write a very long tail line of business, there is a few of these, we have treaties that we have booked at 110 combined, we have treaties that we booked 115 combined depending on very long duration of liabilities. And you are going to earn the adequate return because the investment income is going to come over many years. So, when you take those cash flow metrics and value them back and then you look at it from that perspective, and that’s why I made that comment the 11 to 13 on an underwriting year basis, because that’s the [states] that usually make all of our decisions.

When we bring all the cash flows, we want something, it’s going to be revenues and expenses going out and claims going out over a long period of time, we bring it all back to that underwriting year and then we make that determination, what is the expected return, and that’s what guides us. I mean that’s been the methodology, not only from a pricing point of view but also from a reserving point of view. So, and usually we’ll start reflecting some of that depending on the longevity of the business, maybe four, five years out, we take another look at, we’re not going touch it for four, five years, because it’s too early. You’ve got to allow that data to come in, you get more confidence and you say, hi maybe my reserves are little higher than they should have been. And the beauty of our reserves, nobody has fixed their hands in your pocket and takes some money out.

It’s in our bank accounts, the running interest and dividends on our behalf. And at the end of the day when you recognize them in your financial statements, it becomes data driven, but data driven from our perspective needs some conservatism here.

Mark Lyons

And John, one of the key principles in any part of the market cycles that we’ve operated on is that we’re driven by the economics of the dealer transaction, not the accounting of it. And I think the best example of that would excess workers’ compensation which is more, the green light decision, I’ll add more than function of the interest rates, more than they [underwrite] pricing in some cases, because it’s 16 to 18 year duration business.

So it’s super sensitive to changes in interest rates and is dominated by the investment return. So and that will book [clearly] that might be booking at 120 or 130 even in the good market, but it will be a killer on a return basis.

John Hall - Wells Fargo

I appreciate that. I just have one point clarification, in your prepared comments Dinos, you mentioned that rate in primary market was above loss trend, but you didn’t mention what that number was, I was wondering if you could share that.

Dinos Iordanou

Well, we said a 120 bps you know in improvement; in the last quarter, we said it was 80 bps. I think the rate increase on average I think in the last quarter was 3.8%; this quarter, I think it was 4.0%, so 20 bps came just from that. And there is a little bit of a trend improvement. But when it comes to trend improvements, we are very, very, very hot bunch of guys to convince. We are always -- we look at it, we look at the improvement but we don’t factor it a lot on our published numbers until work from Missouri, it quadruple itself, but I can tell you, I look at a lot of these indications I think we actually see, they see a lot of mayhem there. I don’t know they like it or hate but I am the only actuary in the room usually and they are all around me.

But a lot of our indications the positive, the trend indications better than expected and more importantly, we do an analysis on actual versus expected, we got these curves and then we try to see what expected most as we expect from more the underwriting years for the quarter and how much has come in and those have been extremely good, especially this quarter. But one quarter can always fool you, but we have consistency in looking at actual versus expected and being very, very positive.

John Hall - Wells Fargo

Great. Thank you very much, Dinos.

Dinos Iordanou

You’re welcome.

Operator

Your next question comes from the line of Michael Nannizzi, Goldman Sachs. Please proceed.

Michael Nannizzi - Goldman Sachs

Thank you. Let me just ask if I can just on the reinsurance, was there anything unusual, I mean in this quarter about the profitability of that book or I realized the year-over-year is different because of mix, but just standalone this quarter, anything unusual about where the profitability came in?

Dinos Iordanou

Yes. The only thing unusual is that we expect less to hit from the property cat from two points of you. One is less volume, because -- and second probably a little less I will read, because of the rate reduction, we’re not happy about it. But there is -- even the best management teams can fight Mr. market, Mr. market is going against that in that particular segment.

So that’s the only thing unusual. Everything else is as normal as anything. We look at transactions, we look at potential profitability long-term, we don’t [clear] it is short tail, medium tail, very long tail, as long as you make the return characteristics, we do it. And as Mark said we don’t really pay too much attention on the accounting.

Michael Nannizzi - Goldman Sachs

Got it

Mark Lyons

Just to add one thing there. I think there is one that [attends] your question. No, there was no underlying influx of paid claims, reported incurred claims, frequency or severity that would have caused this and cause to move that but no, there was nothing of that kind.

Michael Nannizzi - Goldman Sachs

Great, thank. And I guess, I mean if we were to isolate the cat reinsurance book, what impact would the pricing that we have seen have on the attrition loss ratio? And, all else equal, would you expect that the attritional loss ratio in that book, given pricing is now higher?

Dinos Iordanou

Well, listen putting volume a side, because the recent reduction in volume, because it force us to buy more retro, we felt it was advantageous for us to buy retro. The cost of capital of some of our retro providers is lower than ours. So, essence, they allowed us to buy that and what we think on an expected basis, a good price. So putting aside volume, we also believe that based on our old calculations, the ROE projections, expectation on our cat book has gone down by 2 to 3 points.

So, if we brought on a net basis, we had let’s say 15% to 16% ROE last year, this year it will be more like 12% to 13% ROE.

Michael Nannizzi - Goldman Sachs

Got it. So, just overall, I mean your book aside, I mean it’s probably why you are shrinking and then the expectation would be as if pricing continues to recede in property cat business, but margins should fall, attritional loss ratios should rise. That would be the logical outcome.

Dinos Iordanou

Well, in the cat business is, it’s based upon you don’t have the event

Michael Nannizzi - Goldman Sachs

Right.

Dinos Iordanou

It’s not going to show up. Let me remind you guys, we had very little exposure in Japan. We saw Japanese rates that were ridiculously low, we didn’t participate. Our P&L in Japan before the quake was $75 million and it was from international programs that we couldn’t even avoid, we didn’t have much of Japanese only quake, but that was extremely well when that event happen because at the end of the day even will look foolish for 10 years there is no quake there is no losses so any premium you wrote became profit. We were proven right 10 years later. So I have a lot of confidence in our cat teams. I think we have great analytical team there and great underwriting team and I don’t want, one area that I don’t put my two sense in and I usually I like two in a lot of areas in the cat area because I think those guys are better than me, I wish I can get as good as they are.

Michael Nannizzi - Goldman Sachs

Great, thanks. And then metrics on the MI book, risk to cap, maybe different from other carriers just given the way you run that business, a breakout of primary to risk-sharing and reinsurance that -- and then some demographic data on the profile of the book. Vintage, for example, would be helpful. And then, just last one on -- a numbers question. What were the startup costs in the quarter, just so we can try to think about what the business should run at, excluding those costs that hit the first quarter? Thanks.

Dinos Iordanou

Yes, I think it was roughly $2.6 million plus there was some unusual ones and you can see in our presentation and we have like other expense. I am sorry that was… you’re talking… well I am sorry, I am sorry, MI start up cost.

Michael Nannizzi - Goldman Sachs

VMI, yes sorry about that yes.

Dinos Iordanou

Well what we have VMI start up cost and we have a sales force that came on board ahead of that transaction and we’ve been experiencing that. So and we have a lot of expenses in the first quarter from the sales force which had no corresponding revenue attributed to it, because don’t forget, we got two sales forces, one which is the existing business, which is (inaudible) employees working on our behalf that they distribute to the credit union channel and then our own sales force who is trying to penetrate the bank channel and other mortgage originators. And so all that and we can get you a number, I haven’t added it all up, but I’ll get Mark Lyons and then we’ll try to figure that number out, we haven’t…

Mark Lyons

So one thing you need to understand about the totality of how is work is that there is a like a shared services agreement, that goes on that verify quarter on what services, what performed, so we had everybody on the old PMI onto our payrolls system now if there was offset associated with various classes of work, accounting work, IT work, claims handling work and so forth that is measured in those metrics is becoming what that percentage allocation is. So overtime there will be a shift, where it’s going to be more resident in Arch, right now, a lot of that is still pushed off as a credit, against it, but it really varies by quarter.

So understandably it’s going to be little hard for you to see through that that’s a little (inaudible) but that’s the dominant driver of the OpEx from quarter-to-quarter.

Dinos Iordanou

But the one area you can focus that eventually is, I think we got about 40 people in the sales force all that is going to be of course, I mean we are not going to share that because we are building right, we are building, we have the sales force, the sales force is our expense. We don’t -- we are expensing it, as we go with salaries and benefit et cetera and the revenue is going to come down the line.

There is no early insignificant amount of revenue coming from the bank channel in the first quarter, it will be starting to show up in the second, third and fourth quarter I don’t know to what magnitude it depends how effective we are, but we want to build out those stage.

Michael Nannizzi - Goldman Sachs

Got it. Maybe a better way to ask it is, once you reach scale and once you kind of reach critical mass, where do you think the acquisition and/or operating expenses should run into? -- run to?

Mark Lyons

Again it’s hard to ask, hard to answer, but it’s three years or more out, now for the entire segment now, it should be in the 20 area, that doesn’t mean every unit within the mortgage business run through that.

Michael Nannizzi - Goldman Sachs

I understand, okay, thank you.

Operator

Your next question comes from the line of Vinay Misquith, Evercore. Please proceed.

Vinay Misquith - Evercore Partners

Hi, good afternoon.

Dinos Iordanou

Hi, Vinay.

Vinay Misquith - Evercore Partners

Well, the first question, just wanted to clarify on the reinsurance operations. So about a 93 accident year ex-cat, that is the normalized -- I mean, that is the new norm, correct? Is that the way that we should think about that?

Dinos Iordanou

No, that’s not the new norm. I said it might be 5 or 6 points up.

Vinay Misquith - Evercore Partners

So this quarter was 5 or 6 points higher than the normally you’re saying?

Dinos Iordanou

Assuming no change, so I guess that you heard my comments, right. Assuming no change in the mix. If I right a lot of very long tail business, because I continue to find opportunities there and buying those contracts it might still be another quarter 92, 93. But if I go back to more of a traditional mix, you will probably be at least 5 or 6 points lower than that. And Mark just went through the evolution of this, it didn’t come overnight.

In the past, we were below 80, there has been some deterioration to that, we will always reflect, because of additional costs exceeding commissions and then there is some deterioration to that, because of change of mix less short tail, as a percentage of the total that has low accident year loss ratio on an expected basis. So I would say mid-80s is more of a number. But let me caution everybody, it will depend on our mix.

Vinay Misquith - Evercore Partners

Sure. Okay. That’s helpful. The second question was on the MI business. I thought that -- I mean, you said that it would take about maybe two or three years to really gather steam and contribute to the bottom line. It seems that, even the new acquisition, that is actually having a small positive impact on the bottom line this quarter. Just curious as to whether you think that impact is going to increase even in the near term.

Dinos Iordanou

Again, it will depend as we start getting more business, how do we do with this book, target transactions. So, it’s hard to predict right? But don’t forget, even though it’s positive, and it’s good news, I think it’s positive faster than we thought right? We didn’t expect to have a positive earnings, especially with front loaded expenses on this first quarter.

The ROE associated with it is not yet acceptable to us, long-term it’s going to be much better. But a lot of the other indicators, we’re very, very pleased with, especially on the existing on the book that we have for credit union business. First quarter numbers was the delinquency rates are coming down and they are coming down significantly. And new delinquency rates in the quarter, they were down by 24.7%, that’s a significant number.

The average cost per claim in one quarter was down by almost 20% from an average of 48,000 at year end to 38,000 at March end. So, there is a lot of positive, on the existing and this is I’m only talking about U.S. MI and I’m only talking about what we do with the credit union business.

So, there is a lot of positive indications, because that is an existing book, we have it, we own the old and we own the current and we’re going to own the future. So, those indications (inaudible). It is a good segment to be and with very acceptable profitability.

Mark Lyons

And [Vinay] I would suggest simply just think of it like this, the U.S. MI operations versus I’ll say everything else, reinsurance operations and everything else has comparably outstanding loss ratios. The primary business has the drag of expense that we just talked about because the (inaudible) where the reinsurance transactions being up.

Vinay Misquith - Evercore Partners

Right, right. Okay, that’s helpful. And the $6.7 million from the 100% quarter share from BMI so will that record every quarter or is that still one-time to you?

Dinos Iordanou

No, it’s quarter or year over quarter. That’s the business that’s really on the books and usual this business takes I don’t know 6, 7 years to run-off right. So this is business they wrote in right before they went into receive a shift that would be ‘09 to ‘11. So I mean it’s going to there is declining revenue coming overtime because some of the -- the mortgages are big air off of that is those are they achieved more than 78% loan to value and the mortgagee decides to interrupt insurance refi that they drop off otherwise sale when the mortgage gets satisfied, but usually a tail on these about 6, 7 years so it would go out until ‘16, ‘17 a take in tenants as the midpoint of this.

Vinay Misquith - Evercore Partners

Okay. That’s helpful. Thank you.

Dinos Iordanou

You’re welcome.

Operator

And your next question comes from the line of Kai Pan with Morgan Stanley. Please proceed.

Kai Pan - Morgan Stanley

So first on the investment side the duration is standing from 2.6 to 3.2 is that related to now that sort of you have longer duration liability basically on the reinsurance side?

Dinos Iordanou

Yes, a little bit of that a combination also where we believe with at least our investment people believe where interest rates with a new Fed Chairman might or might not go. Duration for us usually gets conservative, we think that there is eminent rise of interest rates, we don’t see that yet, at least for the next year or so based on statements they made, so make that adjustment and also we always match duration of reserve liabilities with assets covering those.

Kai Pan - Morgan Stanley

And so would we expect with the higher duration than at the higher like you mentioned yields?

Mark Lyons

Could you ask that again?

Kai Pan - Morgan Stanley

We see longer duration of your investment book, is that the average…?

Mark Lyons

See I don’t think it’s going to move the needle, we have got $14 plus billion of investible assets, a few 100 million won’t move the needle that much. So…

Dinos Iordanou

And it’s also what’s the -- the U curve going to be quarter-over-quarter flattened out in the quarter just passed maybe a little more and different to where you were.

Kai Pan - Morgan Stanley

Okay, then second question on Watford Re, besides sort of your minority interest in the operations and what other economic benefits for Arch in term of receiving commission or the others?

Dinos Iordanou

It is what we put in our -- we get paid for that activity upfront as managers of reinsurance and then we have a performance suite that we get at the end on underwriting performance, (inaudible) program. So that’s the benefit that we get is an organization for that business that goes there.

Kai Pan - Morgan Stanley

In terms of accounting where are those sort of booked in your income statement?

Mark Lyons

Yes, acquisition.

Kai Pan - Morgan Stanley

Okay, okay. Lastly it is on the capital management, now you have the MI and Watford Re behind you and the stock is trading 1.4 times booked probably a little bit past your threshold. And at the same time you still have access capital. So what is your prefer way to deploy that access capital and have you considered like a dividend?

Dinos Iordanou

Our preferred way is to deploy it in our business. And there is a few opportunities that we are still looking at. So that hasn’t changed. I haven’t given it a lot of floor that we are going to do a dividend or share repurchases because right now we are focused on the opportunities rather than, how to return capital to investors. And let’s say they are paying us to find the opportunities, and I am spending a lot of time and all of our people are looking at new opportunities and there is quite a few out there in the market.

Kai Pan - Morgan Stanley

Thank you so much for the answers.

Dinos Iordanou

You quite welcome.

Operator

Your next question comes from the line of Ryan Byrnes, Janney Capital. Please proceed.

Ryan Byrnes - Janney Capital

Great, thanks for taking my questions guys. Quickly on the Watford segment. How long should that take to get to scale, because again thinking from a reinsurance standpoint, you think it should be able to get an underwriting premium dollars in a fairly quick manner?

Dinos Iordanou

I would say maybe three years or so. It’s going to take at least two maybe three is to get the scale. I mean it depends on a lot of things market conditions et cetera what the opportunities. But we don’t force things, we’re going to go. Our obligation to them is to be prudent underwriting managers, that’s what we got higher to be use that techniques that we have been using for Arch and look for the opportunities for them. And if it take two years, fine; if it takes three years, it’s fine.

And as Highbridge is going to focus on the investment returns, so I think they have the same approach, they have a long-term approach.

Mark Lyons

Remember, this year is already just a nine month here.

Ryan Byrnes - Janney Capital

I’m sorry, just because that it was closed in…

Dinos Iordanou

(Inaudible).

Ryan Byrnes - Janney Capital

Yes, sure. Thanks very much. And then this is my last question on the increased retro purchases for the procat book. It clearly had looks like it had an impact on your one and two 50 PMLs. But just wanted to see where in the risk curve, you’re trying to, you’re seeking this efficiency, it certainly seems like, is there 1 to 2, 50 levels. But you want to see how far lower that dose?

Dinos Iordanou

Well, I’ll give you the 40,000 foot view to this, because it’s a little more complicated than that. But we try to maintain the customer relationships that we have. There is more tendency, because capacity is plentiful and available for a lot of the buyers who want you to play across the placement.

So, they don’t want you to pick and chose layers et cetera. As usually, we don’t like to be down on the frequency area, we believe that this is a high rate on line areas that also have a lot more exposure from a frequency expectation. So that’s where we buy most of our overall retro.

So, on the front end of the curve, we buy more retro. We don’t like to be at the tail end of the curve. So even on a direct basis, we don’t bring in that business, we’d not pay to put a lot of PMLs or a lot of capacity on 2% or 3% rate on line business. We try to avoid that. Yes.

So that’s a general principle of our thought process. And with that, that’s where cat teams go and buy the retro sessions.

Ryan Byrnes - Janney Capital

Okay, great. Thanks for the answers.

Operator

Your next question comes from the line of Meyer Shields, KBW. Please proceed.

Meyer Shields - Keefe, Bruyette

Hi, everyone, thanks for sticking around for the late questions. Two quick one if I can. One, when we look at the other segment, I guess I would have expected the income available to Arch to be about 11% of total but coming a little bit less, I am wondering what I am missing here.

Mark Lyons

Well it’s not exactly 11%, it’s within spitting distance of 11%. So I am not sure exactly what you’re looking at because it’s there.

Meyer Shields - Keefe, Bruyette

I guess what I am thinking and maybe this is [recounting] of it, but since you’ve got 11% annual collecting fees, the net impact should translate into higher percentage?

Mark Lyons

Right. And part of it is geography because this is Watford Re, the fees that we earned don’t go to Watford Re, they go to Arch.

Meyer Shields - Keefe, Bruyette

Okay, got it. That makes sense.

Dinos Iordanou

So it’s going to be in our numbers, right?

Meyer Shields - Keefe, Bruyette

Right. But maybe in the other segment showing above?

Dinos Iordanou

Well, the other segment is only going to be the investment and that will be pari passu with any other investor in Watford Re. Fees and/or profit commission because of our performances, underwriting managers or Highbridge, investor managers and all that is not going to be on this line.

Meyer Shields - Keefe, Bruyette

Okay. That’s in the acquisition…

Mark Lyons

So, we did set the price, because you’re looking at the 100% numbers and you’ve got the niche line of account at a 100% and then there is one line that’s amalgamation of all the impact that 89% subtraction. So, we don’t make the rules, we got to follow them.

Meyer Shields - Keefe, Bruyette

Yes, absolutely understood. With regard to, just a follow-up on (inaudible) question before, I understand that the flatter yield curve limits the benefits of the increasing duration, but then why increase duration in the quarter?

Dinos Iordanou

It’s for our belief as to where the yield curve is and is going. We didn’t -- we elongated by almost half year in duration. Our approach to duration is that we match liabilities on the reserves, this way we don’t take any risk there. When we borrow funds, right, we try to have the cost of those funds on the spread. So in that sense (inaudible) borrowing 500 million that pushes us to increase duration a bit and then we use the shareholders capital to very duration up and down depending on how we view where the prospects and where the yield curve going to go.

That’s the combination of all three principles in one. And like I said before, that’s what pushed us, our investment people to move duration to the level that we have.

Meyer Shields - Keefe, Bruyette

Okay. Thank you very much.

Dinos Iordanou

You are welcome.

Operator

Your next question comes from the line of Jay Cohen with Bank of America Merrill Lynch. Please proceed.

Jay Cohen - Bank of America Merrill Lynch

Yes. Thank you. I guess a question on Watford. the premiums that you seeded Watford, is that basically a mirror image of your whole book, or were they around the particular lines that were seeded?

Dinos Iordanou

No, it’s -- to simplify, it was a few transaction, some of it mirrors what we have, some of it doesn’t, but don’t forget Watford was in business. And some of it -- think of it as at least for the first quarter we [warehouse] something that they might have written direct themselves. And then we seeded it back to them, we are the underwriting managers so we said this will take Watford, we didn’t want to lose time and wait for them until they were in business, so we might have bound a piece of business put it on Arch and then we see it to them, when they were up and running.

Jay Cohen - Bank of America Merrill Lynch

That’s helpful and then….

Dinos Iordanou

You are not going to see a 100% sessions from Arch to Watford in future quarters, what you are going to see is, it’s going to be some sessions from Arch because we still receiving to a lot of reinsurance Watford being one of them, and also you want to see a lot of deals that Watford will write direct. And also…

Mark Lyons

Back to the whole underlying theory area it, although this property cat that maybe there as a piece of the overall portfolio and all likely there is always going to be a lesser percentage then what Arch would have and they are for a longer duration on the liability stream of Watford versus the average of Arch.

Jay Cohen - Bank of America Merrill Lynch

And in the casualty business, you will see -- or I should say, they will write at the end of the day, do you think that will be a lot different than the casualty business that you have or -- they seem to have some similarities to it.

Dinos Iordanou

They are going to have, it’s the same underwriting standards right, we view their advantage is I think we can assume a bit of higher investment year, and so that will always and I don’t know transaction-by-transaction, but it might push you to maybe little longer duration in liabilities type of business because that’s where their advantage becomes greater, but only time will tell as we see the transactions either for us and the Watford come in and then our underwriting people apply our standards to come up to expected ROE and see where it fit.

Jay Cohen - Bank of America Merrill Lynch

Yeah, that makes sense. Thanks a lot.

Dinos Iordanou

You’re welcome.

Operator

Your next question comes from the line of Brian Meredith with UBS. Please proceed.

Brian Meredith - UBS

Thanks. Two questions here for you. First, in the mortgage insurance operations, where do you guys stand in getting on the platforms of large national banks?

Dinos Iordanou

We’ve got 13 already out of the top 40.

Brian Meredith - UBS

But what about the big three a lot that comes from?

Dinos Iordanou

Well, we’re selling the process, I don’t know exactly where we are and I don’t know with the top three in your mind are. But we’re not going to comment on specific relationships that we have. But believe me, our goal is to be in all top 40 all the time and we’re working hard to get approval from all over.

Brian Meredith - UBS

Okay. Great. And I guess my second question for you, Dinos, is I am just curious -- so increasing in casualty reinsurance business, although you listed the people in the market and they are talking about higher ceding commissions and a lot of capacity there, I am just trying to understand why is all of a sudden the casualty reinsurance business that much more attractive? Is it because interest rates are up, call it, 100 basis points.

Dinos Iordanou

No, listen you got to look at it transaction-by-transaction, there is always displacement in places. Four years ago, five years ago, it was the more mortal XoL in France because everybody was with growing et cetera. So, we look at these opportunities, we don’t like to talk much about it, as to where, because if I found a little vein, with a little bowl in it and I’m digging into it to, I don’t want every competitor to know what it is and then they go and they mess up the market.

So, you guys trust, we got the underwriting skills to do that or you don’t. And I trust our people and when they find the opportunities and we look at economics, if it fits we do it. And we don’t really but as Mark said, we don’t really care that much about the calendar year accounting issues, because you can’t make a decision to buy your reinsurance underwriter on calendar year numbers.

You got to understand policy year and you got to understand that their underwriting your performance and do you trust that, they will do a job in making those determinations.

Mark. Lyons

Hey, Brian, I think you should think of it as a collection of well sought out transactions, rather than sector bets.

Dinos Iordanou

Well said Mark. You see, you’re much smarter than I am.

Brian Meredith - UBS

Thanks.

Operator

And your next question comes from the line of Ian Gutterman, BAM. Please proceed.

Ian Gutterman - BAM

Hi, good afternoon.

Dinos Iordanou

Hey, Ian you are between me and my (inaudible) sandwich

Ian Gutterman - BAM

I know it’s getting cold. So, you know, I am not as smart as Mark either, so I am still confused on the reinsurance. I guess I don’t understand why it should be so variable quarter to quarter. If we are looking at written ratios, I can get that. But the earned should be a reflection of what you have written over the last year or so. And I would think that is reasonably baked in for the next couple of quarters of what this mix change is, given casualties have been growing a lot the past few quarters and cat has been shrinking, I particular want to know for the next couple of quarters what it should be so why it might be supposed locked Q2 versus Q1?

Dinos Iordanou

Well don’t forget you had Q1 versus Q1 of a year ago as Mark said that thing was inching up alone as we worked those transactions, and some of these transactions we wrote in the third and fourth quarter so they’re inching up if the earnings are coming through. So your statement is absolutely correct, but also you’ve got to go back and see the sequential movement that we have done.

The only change to that is what we’ve done in the first quarter and mostly in our European business which was not as part of what it was coming from the third and fourth quarter last year. And don’t forget if you go and look at our statements and what we have reported we talked about some of these transactions, they had a higher combined ratio on an expected basis, but very good return characteristics over time.

Ian Gutterman - BAM

Okay. So if the written patterns stay consistent with the last few quarters, then if I am understanding right, we will see the exit years increased year-over-year but not as much as the first quarter but sequentially be reasonably similar to this quarter and did the rest of it comes through from higher investment income because you’re going to longer tail is that fair?

Mark Lyons

That’s correct.

Dinos Iordanou

And you might reverse itself and go the other way depending if those transactions get renew or not as when you get to the expiration.

Mark Lyons

I think one thing we probably do and that is we try to take maximum awareness of what the market gives us and it changes from quarter-to-quarter, what it allows and what it gives us.

Ian Gutterman - BAM

No, I agree to that, I get that underwritten I just want to make sure what’s the most (inaudible) thing they earned.

Dinos Iordanou

No, no, no you are absolutely, you are right on to it, but that’s why the comparison year-over-year sometimes Scott will be supplemented by also the sequential change quarter-over-quarter.

Ian Gutterman - BAM

Exactly, got it.

Dinos Iordanou

Quarter-after-quarter, right.

Ian Gutterman - BAM

Got it and then on the mortgage insurance business, I guess two questions there. One from just the publicly available rate filings everyone has, it looks like you guys are priced lower than the market, a is that accurate and b, sort of what’s the thought behind that, does that just need your way to get to established or something else?

Dinos Iordanou

The statement you made is incorrect.

Ian Gutterman - BAM

Okay.

Dinos Iordanou

I have the table with our competitors and we are right on, there is not even a (inaudible) out of a table that is, it has one, two, three, four, five, six, seven, eight, 16 cells, right. We are slightly lower in only one and not with all, right. And in everything else, I think we’re right in line with everybody else.

Ian Gutterman - BAM

Got it. I’ve to take another look at that. I am still learning this stuff.

Dinos Iordanou

It’s, I have Arch compared to (inaudible) General, SN and NMI. And we have the grade, I mean the grade I was recurring to is the right cohort and when you look at the right cohort there is one, only one cell that we slightly cheap, every of the cell is exactly the same as everybody else.

Ian Gutterman - BAM

Got it, Okay.

Mark Lyons

Supplier pay cell as opposed to the lender pace.

Dinos Iordanou

Right.

Ian Gutterman - BAM

Okay, got it, and then just my last one, the stackers that you have written through, how does that show up, was that it was not in the commentary of the premium dues, that was in the premium this quarter does that show up somewhere else because it’s derivatives for or how does that work?

Mark Lyons

Ian it doesn’t, we have gained it because of the way the loss side works. The loss severity is referential to the tables, has nothing to do within those characteristics of declined itself. So we viewed it as the derivative. So you are not going to see it anywhere in premium. Instead it’s closer to market-to-market impact each quarter and it finds itself into, okay, yes, it’s an acquisition expense.

Ian Gutterman - BAM

Okay, so where do we see that, so is that kind of an operating income, I am just trying to figure out how to think about where that will show up in my model base with an operating income line or is it just..?

Mark Lyons

It’s an acquisitions stand, so it’s in underwriting.

Dinos Iordanou

It will affect the underwriting combined ratio but it’s in the acquisitions of expense.

Ian Gutterman - BAM

Okay, okay. But it is in that mortgage insurance…..go ahead.

Dinos Iordanou

It is a derivative. So at the end of the day it’s going to be income, you know.

Ian Gutterman - BAM

Got it, okay. And is that because of the derivatives, might be volatile based on what’s going on with industry as such or is that reasonably [compatible]?

Dinos Iordanou

No, it’s a derivative because if you look at these transactions a portion of the static transactions is done the cash market, that sold as bonds, right and those trades on a daily basis and then you’ve got a market to that. So depends what that happens right, how those bonds will trade, it will tell you, you can write a (inaudible) transaction that over the long period of time we’ll give you positive returns, but maybe in the first or second or third quarter depending where the cash transaction trades, you might take a loss in the first year.

Ian Gutterman - BAM

I’m sorry, terrific. Okay, got it. Okay so as that becomes material on this call that out of if you have any of that one?

Dinos Iordanou

Right. We expect that to be positive, we expect it to be. But and don’t forget it is going to come over six or seven years, so you (inaudible).

Ian Gutterman - BAM

Got it. Okay, thank you enjoy your lunch.

Dinos Iordanou

You want to pay for it.

Ian Gutterman - BAM

We’ll see maybe next time.

Dinos Iordanou

Okay. Thanks Ian.

Operator

At this time, we have no further questions. I will now turn the call over to. Mr. Iordanou and Mr. Lyons for closing remarks.

Dinos Iordanou

All right. Thanks Glen. Thank you, everybody for attending, we are looking forward to speaking to you on our next quarter. Have a wonderful day.

Operator

Ladies and gentlemen, that concludes today’s conference. Thank you for your participation. You may now disconnect and have a great weekend.

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