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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good day, ladies and gentlemen, and welcome to the Arch Capital Group Fourth Quarter 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. [Operator Instructions] As a reminder, this conference call is being recorded.
Before the Company gets started with its update, management wants to first remind everyone that certain statements in today's press release and discussed on this call may constitute forward-looking statements under the federal securities laws. These statements are based upon management's current assessments and assumptions and are subject to a number of risks and uncertainties.
Consequently, actual results may differ materially from those expressed or implied. For more information on the risks and other factors that may affect future performance, investors should review periodic reports that are filed by the Company with the SEC from time-to-time.
Additionally, certain statements contained in the call that are not based on historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The Company intends the forward-looking statements in the call to be subject to the Safe Harbor created thereby. Management also will make reference to some non-GAAP measures of financial performance.
The reconciliation to GAAP and definition of operating income can be found in the Company's Current Report on Form 8-K furnished to the SEC yesterday, which contains the Company's earnings press release and is available on the Company's website.
I would now like to introduce your host for today's conference, Mr. Marc Grandisson; and Mr. François Morin. Sirs, you may begin.
Thank you, Shannon, and good morning to you all. Once again, this quarter strong earnings from our Mortgage segment offset the effects of catastrophe losses in our Property Casualty segments, as Arch produced an annualized operating return on equity of 8.8% and 10.7% for the 2018 fourth quarter and full-year respectively.
Given the level of catastrophe losses across the globe in 2018, our results demonstrate again the value of our core principles of diversification, sound risk, selection, underwriting, discipline, and cycle management. François will provide more commentary on our financial results in a moment, but it's worth pausing for a minute to thank all employees at Arch who are committed to meeting the needs of our clients while producing superior returns.
Given the notable catastrophe events for the past two years, we will begin our discussion of market conditions with the January 1 renewal market and property cat reinsurance. As you may have heard on other earnings call this quarter, on average, property cat rate increases at Jan 1 are positive, but below expectations given the record level of insured cat losses that were reported in the past two years.
Across the industry, loss affected property accounts are rate increases of 10% or more, while some property accounts in Europe were flat to down 5%. Hidden within the underlying property cat industry average rate changes. There are some signs of tightening capacity within the retro and facultative markets, but in many case rate levels relative at to risk remain in adequate to deploy additional capital from our perspective.
At Arch, we believe that we enhance our odds of doing better than the industry average by allocating capital dynamically to areas where the better risk reward trade-off and that disciplined underwriting and risk selection will remain at the core of what makes us - it has made us successful.
There is reason to believe that some rate improvements may occur throughout the year as the market absorbs the recent history of large capital losses. However, uncertainty with respect to both the expected amount of capital and return on capital within the property cap markets make it difficult to predict where cat rates will be by year-end 2019.
In the interest of time, I'm not going to review market conditions line by line. As I'm sure you have already heard about that on the calls this quarter, but I will list and address the underwriting environment in general. In our P&C segments in some of our insurance lines rate increases appear to be outpacing claim trends.
But as we have discussed in prior quarters, we continue to believe that the risk of claim inflation rising above its long-term trend is high and we remain cautious in our allocation of capital and in setting our loss picks. The modest improvements in rates are concentrated primarily in the short tailed cat exposed business in the U.S. commercial auto and some areas of casualty. As always, we focus on the absolute level of risk adjusted returns, not just relative rate changes.
Turning now to our Mortgage segment. The underwriting environment remains very attractive with ongoing growth in our insurance in-force producing strong increases in earned premium and will contribute to a future stream of earnings that is both stable and predictable.
For the fourth quarter, our U.S. MI new insurance written or NIW was $16.7 billion, a 16% increase over the same quarter last year and the proportion of single premium business remain low at about 9% of NIW this quarter.
Within our U.S. primary business, the credit quality of loans insured remains excellent, and our key risk barometers are still at very healthy levels. To put this in historical context, our risk indices tell us that the current borrowers credit characteristics are still substantially higher, in fact, by roughly a factor of two relative to the borrowers of the late 90s and early 2000.
We have seen mortgages with greater than 95 loan-to-value grow slightly as a percentage of our NIW to about 16% in the fourth quarter. While credit quality as indicated by FICO scores, remained high across our in-force book with a weighted average score of 743.
As far as the new mortgage risk transfer programs with the GSE, so named IMAGIN and EPMI facilities, we believe that these programs will continue to grow within our expectations, roughly at a modest 2% of total NIW for the market on an annualized basis.
Briefly, with respect to our investment operations. Higher yields available in the financial markets and growth in invested assets, led to a 16% increase in net investment income in the fourth quarter over the same period a year ago. We remain underweight credit in interest-rate, reflecting our cautious outlook.
Moving to capital management. Despite our exposure to property cat in 2018, we were able to deploy some of our capital towards expanding our distribution capabilities, deleveraging our debt and repurchasing our shares. As you know, we recently closed on acquisitions in the U.S. and the UK that are expected to expand our distribution base.
Volatility in the equity markets also gave us opportunities to repurchase approximately $100 million of our common shares in the quarters at attractive prices. As in all of our capital allocation processes, we employ a rigorous and disciplined assessment of available opportunities to deploy capital in order to generate long-term returns for our shareholders across all phases of the cycle.
Turning now briefly to risk management. For the past few years and continuing into 2019, our property cat exposures remained at historically low levels with our 1-in-250 year peak zone at about 4.5% of tangible common equity at January 1. We have the ability and the capacity to deploy more capital to the sector if available returns improve to acceptable levels this year. For Arch clients and investors, our ability to increase our support in times of need is a significant benefit to the marketplace and a source, we believe, of long-term value creation for our shareholders.
In our Mortgage segment, our issuance of insurance linked notes, know as Bellemeade Securities have significantly reduced our shareholders' exposure to the tail effects on our business from economic recessions, and that paved the way for a significant reduction into our risk profile despite growth in our insurance in-force.
With regards to PMIERs, as of December 2018, Arch MI’s sufficiency ratio was 141% of the GSE capital requirements, known as PMIER, as I mentioned. It also exceeds the proposed GSE revisions under PMIERs 2.0, which is to be effective on March 31, 2019.
With that, I will turn it over to François. François?
Thank you, Marc, and good morning to all. I would like to give you some comments and observations on our results for the fourth quarter. Consistent with prior practice, these comments are on a core basis, which corresponds to Arch's financial results, excluding the other segment, i.e., the operations of Watford Re. In our filings, the term consolidated includes Watford Re.
After-tax operating income for the quarter was $189.2 million, which translates to an annualized 8.8% operating return on average common equity and $0.46 per share.
For the full-year, our operating ROE stands at 10.7%, a solid result in light of the elevated catastrophe activity in the second half of 2018, and a pricing environment in the P&C sector that remains competitive. Book value per share was $21.52 at December 31, a 1.7% increase from last quarter and a 6% increase from one-year ago, despite the impact of higher interest rates on total returns for the quarter and the year.
Moving on to underwriting results, losses from 2018 catastrophic events in the fourth quarter, net of reinsurance recoverables and reinstatement premiums were $118.2 million or 9.7 combined ratio points. These losses were predominantly the result of Hurricane Michael hitting the Florida Panhandle and the California wildfires, but we also felt the impact of other minor events across the globe.
As for prior period, net loss reserve development, we recognized approximately $74.4 million of favorable development in the fourth quarter, net of related adjustments or 6.1 combined ratio points compared to 4.6 combined ratio points in the fourth quarter of 2017.
All segments were favorable led by the Reinsurance segment with approximately $33 million favorable, the mortgage segment also at $33 million favorable and the Insurance segment contributing $8 million. This level is consistent with a third quarter 2018 results as we continue to benefit from significant favorable development in our first-lean portfolio in the mortgage segment where cure rates this year are continued to be materially higher than long-term averages and expectations.
The Insurance segments accident quarter combined ratio excluding cats was 98.3% slightly lower than for the same period one year-ago. Most of the improvement came from lower levels of attritional losses and acquisition expenses.
The Reinsurance segment accident quarter combined ratio excluding cats stood at 96.2% compared to 103.2% on the same basis one year-ago. As we mentioned on prior calls, we tend to look at trailing 12 month analyses in order to assess the ongoing performance of our segments, given the inherent volatility in the business that can emerge from quarter-to-quarter.
The year-over-year comparison for the Reinsurance segment is affected by a few notable items. First, as we mentioned on a previous call, our acquisition expense ratio last year, reflected the federal excise tax is associated with a large internal loss portfolio transfer.
Second, our loss experience this quarter was impacted by a large attritional casualty loss arising from the California wildfires and third, we had a noticeable amount of reinstatement premiums and premium adjustments this quarter that benefited our combined ratio.
Once we adjust for these variations, the underlying performance of our Reinsurance segment remains strong this quarter. The mortgage segment's accident quarter combined ratio improved by 1,410 basis points from the fourth quarter of last year as a result of the continued strong underlying performance of the book, particularly within our U.S. primary MI operations.
The calendar quarter loss ratio of 2.1% in the fourth quarter of 2018 compares favorably against the 17.8% in the same quarter of 2017 due to substantially lower delinquency rates. Part of the difference is attributable to increased favorable prior development, which was approximately 320 basis points higher than last year.
In addition, there was approximately $13 million or 410 basis points of favorable development on 2018 delinquencies due to very strong cure activity in the period. The expense ratio was 20.5% lower by 160 basis points than in the same period one year-ago as a result of expense savings achieved.
I'd like to remind everyone that due to the nuances of purchase accounting, the amortization of our debt asset should continue to increase in 2019 by an amount that is approximately $8 million higher on an annual basis than 2018 levels increasing acquisition expenses acquisition expenses. These results highlight the contribution to our pre-tax underwriting income from the mortgage segment, which remains strong this quarter.
After allocating corporate items such as investment income, interest expense and income taxes to each segment, the mortgage segment's contribution toward 2018 net income decreases to approximately 75% of the total after normalizing our results for catastrophic activity.
Total investment returns for the quarter was positive 51 basis points on a U.S. dollar basis and a positive 83 basis points on a local currency basis. These returns high light the defensive high-quality position of our fixed-income portfolio and solid result in our alternatives portfolio in light of a volatile quarter across global financial markets.
During the quarter, we continued to move away from municipal bonds and into corporate and government bonds due to relative valuations. The repositioning of our portfolio during 2018 combined with the reinvestment of shorter maturity bonds and other swab activity at higher yields generated higher investment income year-over-year. We extended the duration of our investment portfolio in the quarter to 3.38 years, up from 2.94 years on a sequential basis as global economies weekend.
Operating cash flow on a core basis was a strong $384 million in the quarter, reflecting the solid performance of our units. The corporate effective tax rate in the quarter on pretax operating income was 16.8%, and reflects the benefit of the lower U.S. tax rate, the geographic mix of our pretax income and a 210 basis point expense from discrete tax items in the quarter.
As a result, the effective tax rate on pretax operating income, excluding discrete items, was 14.7% this quarter, higher than the 9.9% late last quarter. The difference from this rate to the numbers noted in our recent prerelease is primarily attributable to discrete items in a higher level of U.S. based income, which triggered a true up of tax accruals for the first three quarters of the year.
As we look ahead to 2018, we currently believe it's reasonable to expect that the effective tax rate on operating income will be in the range of 11% to 14%. As always, the effective tax rate could vary, depending on the level and location of income or loss and varying tax rates in each jurisdiction.
With respect to capital management, we paid down the remaining $125 million of our revolving credit facility during the quarter and we also repurchase 3.6 million shares at an average price of $27.11 per share and an aggregate cost of $98.2 million under our Rule 10b-5 plan that we implemented during this quarter’s closed window period.
Our remaining authorization which expires in December 2019 stood at $164 million of December 31, 2018. Our debt to total capital ratio was stood at 15.5% at year-end and debt plus preferred to total capital ratio was 22.5% down 390 basis points from year-end 2017 and a full 620 basis points from year-end 2016 when we closed a UGC acquisition.
Finally, I would like to bring to your attention a change we are introducing in 2019 regarding or incentive compensation practices. As you know, equity grants made to employees had historically been awarded in May of each year. Starting this year, equity grants are expected to be awarded in the first quarter subject to Board approval.
As a result, we would expect a small distortion in the timing of our operating expenses. The impact of this change based on 2018 equity grants is an expected shift of approximately $11 million to $13 million in operating expenses from the second quarter to the first quarter of 2019. Two-thirds of that expense is expected to be reflected within or operating segments with the remainder in corporate expenses and investment expenses.
With these introductory comments, we are now prepared to take your questions.
Thank you. [Operator Instructions] Our first question comes from Kai Pan with Morgan Stanley.
Thank you. Good morning. MI segments continue to show very strong results, is the 16%, the underlying loss ratio, a good run rate going forward? Or you see continued improvements from there?
The loss ratio has been very good and actually, better than we had anticipated, probably a year, a year and a half ago. So we have ongoing improvement in notice of default and cure rates. So right now, everything we're pointing to is much less than the long-term average, which will be 20%, I would think, overall cycle. So yes, you could pick your number, Kai, it's very hard to predict the future, but certainly, we are in a very benign loss environment.
That’s great. If you take out, I mean, that large amount of reserve releases, the reported loss ratio below 10%. Had it been around 10% or less for the last several years, at what points the regulator, would you say, the results is too good? And would be more focused on either pricing or competition could start to come in?
Well, I think, I'm not sure whether regulars would do, but from our perspective, this is still a risky insurance product like everything else is out there, and what matters is, where are you about the return. And I would argue that even if you have a little bit higher than average return in the current environment, that’s probably more than makes up for some of the bad year that have occurred to the industry.
So we're not losing sleep over this. There was no commentary to the effect that the loss ratio is too high or too low. In fact, I would even argue that the new capital framework from the GSEs are leading us to a directive – in a direction of still appropriate level of capital and return in the industry to make sure it’s a solid framework for housing finance.
That’s great. Hopefully, the industry have a lot of memory. So on the reinsurance side, the topline growth is very strong even without the reinstatement premiums for the quarter. Could you talk a little bit about what do you see growth opportunity and what kind of return you're getting from those businesses? Are they higher than your existing business?
Yes. So the growth year-on-year is a little bit of the story. If you look at the last four quarters, it's more consistent. The growth that we've seen over the last 12 months is continues to be areas that we've talked about before, international motor quota share. Actually some commercial auto, we have some opportunities in there and some workers comp opportunities of all things. So there's a lot – and some property specific, property cat related exposure in the reinsurance group as well.
So the growth that we're seeing in reinsurance is consistent with our fishing and looking around in the world for good returns, better risk adjusted return if we can. No way from them, probably the more traditional commoditized reinsurance business. So it’s a little bit more bespoke than the rest of the things you would hear about in the marketplace.
Okay. Last one, if I may, on California, you have losses both from the property side as well as the liability side. So how do you think the market going forward, in terms of pricing, in terms of like any sort of like your risk appetite in the market on both the property side as well as the liability side for the utilities?
Yes. So on the liability side, it’s a little bit easier to answer it because these things almost – a lot of question mark in the industry as to whether these are insurable and at what level and at what price. And as you know, it's not a big market. And currently the player that's been tagged or had been identified as being liable for that loss is going through a lot of difficult times, but we'll see how that develops, which currently developing as we speak. This is still a very small market, right, in a broader scheme of things.
As far as the property is concerned, it's really uncertain. As I said in my opening remarks, the capital supply is still plentiful. There were talks at the beginning Kai, maybe that's what you alluded to the fact that there might be some changes to the modeling of California wildfires, but it's still very early. People are still trying to figure out what they have and what it means in their modeling.
And as you know, it's a little bit isolated in fact, right. It's isolated to one area of the country and people will have a way to manage a portfolio and deploy capital in other areas. So it's a very hard question to answer because we don't know what the supply of capital is going to be by midyear. But largely, it would dictate, it should go up to some extent, but we'll see what happens.
Great. Thank you so much and good luck.
Thanks Kai.
Thank you.
Our next question comes from Geoffrey Dunn with Dowling & Partners. Your line is open.
Thanks. Good morning.
Hey, Geoff.
I was hoping you could comment a little on the ILN market. Now that all the – just about all the MIs are using that market and indicating that they plan to use it on recurring basis, are you seeing any change in terms, conditions, appetite? Or is it as steady as it was over the last few years?
No, what we've seen that there's actually no indication that it's weakening. We see tremendous investor appetite for the product. As you know, that the GC's really started that we were in there as well as the soul MI that was accessing that market in the last year, most of the others have jumped into, I call it, the bandwagon. And it just makes it for, I mean, investors now have the ability that when they do their research, they do the analysis, they feel it's something that's repeatable.
They can access that type of product not only through us, but also through some of our competitors. So as far as we can tell, there's still tremendous appetite for the product and it's expanding a little bit, getting some of our instruments rated has also helped, but we see that as something that there's nothing on the horizon that suggests that we will be able to execute on it.
And to add to this, Geoff, I would also argue that the spreads are not widening, we don't see any indications of spreads widening. So this appears to be a stability of pricing expectations in the product as well.
Volatility here and there, but in the long-term, we said, yes. Spreads have been very stable. Yes.
It looks like you took another dividend this quarter, should we take that to assume that the regulators are also comfortable with this market and view it as true capital relief?
Absolutely.
Okay.
I mean, we argue, it's even better than traditional reinsurance because we have the cash on hand, so it's collateralized from that point of view, they…
If they were to accept it, they should be happier than just other forms of capital. I mean, aside from just the traditional equity.
Okay. And then a follow-up on new notice development, is the Company's book reaching at an inflection point where even though the new vantages are very high quality and outperforming, but book size is obviously, in the season is going to drive this new notice levels. Are the more recent vintage is now exiting the benefit of the runoff of the 2008 mean that we should see on average new notice growth going forward?
We I think we will at some point. I'm not sure that we've crossed it yet. It's very hard for us to see and put to predict that. But you're right, over time, we would expect at the 2009 in prior – the 2008 in prior, is it going up. Yes, we would expect that. I'm not sure that we are there yet.
Okay, great. Thank you.
Thanks, Geoff.
Our next question comes from Josh Shanker with Deutsche Bank.
Good morning, everybody.
Good morning.
So I was noticing the trend and it's not so surprising that the proportion of new policies being renewed on the mortgage segment that are coming from refi’s get smaller and smaller all the time, now down to 5%. Is there any difference ultimately you think, in the quality of a refi mortgage versus a new mortgage? I guess you know of the refi mortgages is better. At least the market knows them better? How should we think about that?
Yes, clearly, there tends to be at the margins, quality for the finest market. It's clearly not a target market for the MI market, right? So broadly you are right, but in terms of what pertained to the MI market, our penetration for origination of MI, of mortgages in the refinance is 5% to 6%, so it's very, very small. The market that we are targeting that is really our bread-and-butter, if you will is a purchase market, and that's still pretty healthy, and that's really what we've been focusing on.
So having said all this, if you look at it historically, the brand of the cycle with the brand of the DTI has been fairly consistent and I think that speaks to that there's not much of a difference between the credit requirements, whether you will be financed or whether you purchase.
And not too much on the refi but typically, if you are what your MI on the refi mortgage, were you the MI on the mortgage that's replacing?
Not necessarily because you be refinancing with a different financial institutions and at the end, that institution may have a different agreement with a different MI, not necessarily.
Okay. And switching gears, on the wildfire liability – look obviously that was a difficult loss two years in a row. But the pricing might have been adequate to take that. A lot of times though in certain markets, the market really isn't a big enough to give you a payback, no matter how good the pricing is. Do you think you'll get a chance to write wildfire liability this year, and as a market sizable and attractive enough to make it a worthwhile business to write on a multi-year basis?
Yes, the answer is yes to all of those. I think in general, we don't think of either being in the market or not, be based on size. I think what it means to us is we would put in Malaysian to the market size, our commitment to that marketplace. And you have to – the interesting in Reinsurance, Josh, is you have to forget last year and look forward, because if you look back to what the losses you had, you don't have to make the money that you’ve lost. That’s clearly one thing that we always live by everyday.
But certainly every time the proposition comes to us, provided we have the right information and the right perspective on the loss, if there's a profitable thing, we would do it regardless of the start of the market. Only thing that we would do is right size, our commitment to that specific market based on its size relative to the broad capital base of the company.
And is that a midyear renewal?
I believe so. Yes, everyone has multiyear, yes. Correct.
Okay, thank you.
Thanks Josh.
Our next question comes from Michael Zaremski with Credit Suisse. Your line is open.
Hi, good morning.
Good morning.
First off, François, in the prepared remarks, you made comments about actions you take on the expense side to improve the ratio and that the trend has been improvement over the last year or so. This quarter came in, I think better than expected is any one-time in there is that improvement? Somewhat sustainable.
Well are you referring specifically to mortgage?
Yes.
Yes. Well mortgage, right, we acknowledge internally that it's been two years since the acquisition and we're basically completed with the integration and we told hopefully we – you guys will remember that we told you it'd be a journey. We'll take a couple of years to fully integrate the two operations.
And we're at the stage now when you compare obviously, year-over-year Q4 2017 to Q4 2018, we just realize more savings and technology and people et cetera. So I think we're kind of there. There's also a bit of seasonality that comes into play, but that we're truly in a good spot in terms of where we want to, where we think our expense base and especially operating expenses will be going forward.
Okay. Got it. And sticking with the Mortgage segment. Marc, you made a interesting stat you made in the prepared remarks about mortgage credit quality being approximately, I think you said 2x better than prices levels. Maybe you can further elaborate on what's behind that viewpoint?
We have internal proprietary credit analysis evaluation and you could also look at some things that are published by outfits of [Fairview Urban Institute]. And you will look at the relative you credit quality, based on an index, looking at a 90s early 2000 factoring income, credit score and all these various aspects of a credit worthiness of the borrower. And when you, run it through the grinder if you will, and you've come up with a number at the end, that number is half of what – half of what it was back in the late 90s in 2000. So this may on a comparable basis long stay it to be as apples-to-apples that's can be,
Okay. It's interesting because we know qualitatively there's lot of reasons why credit qualities most likely better. So it's interesting that you're trying to quantify that’s helpful?
Yes. Very, very much off. Yes.
And so I just follow-up on that and maybe I am missing this from the supplement. I can get it offline, but at what percentage of the mortgage insurance portfolio has reinsurance protection and what's the average duration of that reinsurance protection?
That's a good question. I mean I don't have the numbers right in front of me, but it's…
A couple of things about 50% quarter share with AIG…
In years 2014 through 2016. Then you have Bellemeade. We have about $1.1 billion of outstanding limits. On the Bellemeade that covers about two-thirds. Two-thirds of our portfolio has reinsurance against it. Thank you.
Okay. And the duration of the Bellemeade transactions roughly?
Well, there are 10-year transactions, right? So they're all different, some have features where we try to have the coverage be enforced for a bit longer, but I would say, about five years is probably something where we – as we keep rolling off, we're adding new ones. So I think that should remain pretty stable as we move forward.
Okay. Thank you very much.
Thank you.
Our next comes from Elyse Greenspan with Wells Fargo Securities. Your line is open.
Hi, it's my first question. So you guys said, if you normalize for cats that you're seeing mortgage, I think you said about 75% of earnings, I guess, what do you view as your normal cat load since your P&Ls have come down, right. But we're coming off of two years of pretty high cat losses?
Well, the cat load roughly in is about 30 million a quarter, 30 million to 35 million a quarter that scan of where we've been – what we've been running at the last couple of years. And in these numbers that I quoted really all we do is replace effectively the actual cats with the expected or the cat load. So that's, hopefully that answers your question.
Okay. And then, so when you give us the tax rate guidance for the coming year. You're also assuming that cat's fall within that normal level, correct?
Correct. Yes. That's full-year forecast. Expect with an unexpected GAAP year, which as you know as usually not the case. It's either lower or higher, but yes.
Okay. And then on reinsurance, you guys seem to kind of be cautious and balanced in terms of what might happen at the midyear renewals. Marc how much would you say you need rates to go up for Arch to, one materially write more cat business, if you want to talk separately about what you might want to see at April 1 versus 6/1 and 7/1 in Florida?
I guess I could tell you a lot more, but that's not going to get you what you want. So I think if you go back at least to one of my comments about six quarters ago, looking back at the characteristic at the time the numbers were 35% to 40%, to really start getting us to the risk-adjusted return that we believe is appropriate. We've had since maybe 10% to 12% rate increase, so that tells you we’re probably 25% to 30% still short of rate change to really get there.
And again, I want to caution everyone that's listening to this saying that, that 20%, 25% is not going to come across the board all at once. There's some pockets that need a bit more than this, some that need a little bit less than this. But that gives you a flavor for how much more we believe we need to get us to start going the path of deploying more capital.
Okay. Thank you. That’s helpful. And then on the mortgage side, as some of your competitors have adopted risk-based pricing models as well, have you seen started to observe a broader impact on the market? Kind of anything changing there?
Nothing yet. It's still very, very early. So we'll have to wait and see how it's rolled out, how it's actually developing in the marketplace. And I would say that for everybody's benefit that our risk-based pricing was created back in 2011. This is our UG – well, now our U.S. MI operation, and there is a lot of things that need to happen to have the run rate. So we're going to have most likely some bumps along the way.
Our competitors are going to be trying things and figuring out things that work and don’t work out as well. So we're bracing for it. But the key thing from our perspective is we're keeping steady in our grid and our risk-based pricing and we're going to take, you know, whatever market, however they react, we'll be the beneficiary or we'll lose some business because it's mispriced based on our own. But it's too early to tell, Elyse. It's going to take a while.
Okay. Great. And then now there's some concerns on the outside in terms of recession and impact on credit and how that might play out, late this year, maybe into 2020, as you guys, obviously alluded to credit being really strong relative to past cycles, but what would you be paying attention to, to see the potential turn in the credit cycle?
Right now, I think if you look historically at what went wrong, it really did not – I mean, certainly the credit quality or the credit worthiness of the borrower is extremely important, right. But what happened historically that really created the issue is a product development. If the product I'll be – like low DAC, no DAC, I'll say all this stuff comes back to the market.
This is what would be worried about. Of course, the macro things that could impact everything is the housing price depreciation across the economy. The one thing that we're not worried about – the reason why we're not so worried about right now is because there is a shortfall on housing supply and has been there for quite a while. So everybody is predicting smaller price increase in house prices, but still positive for the next two or three years.
So recession could probably put a bump on this. So if you look at it historically on some recessions in the past, we had times when house price increased by 1%. The only time it went down guys for your benefit and that's actually very useful to know, is only in the 2007, 2008 crisis. For the last 45 years, it never – the house price index, despite having gone through five, I think, different recessions, only came down once. The price index came down once. So the product is really the problem, Elyse, and we don’t see anything yet.
Okay. Thank you very much. I appreciate all the color.
Thank you, Elyse.
Thank you. Our next question comes from Meyer Shields with KBW. Your line is open.
Great, thanks. Marc in your introductory comments, you noted not just that loss tends to get worse, but they could resume sort of above-average levels. So I was hoping you could sort of clarify why that is a concern right now?
Because we’re seeing some changes in some of our submissions and some of our data, it's still very early signs and it's really anecdotal, sometimes anecdotal, sometimes it’s actually real. So we're seeing loss trend picking up in certain areas and we believe it's only a matter of time before it starts spreading to other lines of business.
And Meyer, as you know, we're students as well of the industry, and the CPI is about 1.8%, 1.7%, as I've mentioned that in prior calls. The inflation – or the insurance inflation is typically running ahead of it by 1.50% to 2.50%. So I would expect the trend that could be recapturing, having a very vibrant economy exposure growth and more friction in the marketplace, we would expect those to generate more losses.
And the reason we're putting that out, Meyer, is because I want to put that into perspective of the price increase that we talk about on average, being 200 or 250 or 300 bps. It just doesn't make for a lot of margin of safety as you go about in analyzing how you allocate capital between lines of business. And as you know, more probably than I do is when you write a business in insurance policy, it takes years for you to really find out how bad or how good it's going to be. So we tend to take a more cautious approach to it.
Okay. That’s very helpful. Thank you. Quick modeling question, with the recent U.S. and UK acquisitions, are those going to produce any appreciable change in the expense ratio?
Well, I mean both acquisitions were in the mortgage segment. So I would say that the expense ratio, yes, no question that in one of our acquisition in the UK, maybe a bit of integration expenses that will have – that will be reflected. But all-in-all, that you've given that the U.S. one was something that we – it's a partner as a business that we've done business with many, many years. That should not really impact the expense ratio. And the final thing, which you'll see in the 10-K is that we'll certainly trigger a bit slightly higher intangible amortization expenses that start coming through in 2019.
Okay. And that’s segment or corporate?
Well the intangibles is all one number altogether. So – when we finish up our analysis and we published a 10-K in a couple weeks, you'll see that the slight changes in – from what we published year-ago which was primarily UGC related.
Okay, fantastic. Thank you.
Thank you.
Thank you. Our next question comes from Brian Meredith with UBS. Your line is open.
Hey, guys. Seth Rosenberg here for Brian, thanks for taking my questions, I’ve got one for you. So if you look at the Insurance segment, large losses improved versus last year, but if you look back at last year, I think you had called out 2.2 points, which was elevated at time. So if you kind of just take this quarter in a vacuum and not the comparison. Will you say that large losses were better or worse in line with expectations and as because so many companies are calling at a higher frequency and severity of large losses? So just trying to get a feel if there something in loss cost there that concerns you?
Right. So our insurance group had some lumpiness to it, right. Not as much as reinsurance for obvious reasons, but there's still some quarters that are above average or below average. This quarter was sort of an average quarter for us in terms of large risk loss or non-attritional loss, as they call it.
We have a hard time for everybody's benefit, slicing and dicing the losses in so many different sections. At the end of the day, we are providing insurance coverage for all kinds of losses. So this is what you're seeing right now is sort of what is a loss speaking to instead of all the things that could happen in our portfolio.
Got it. So nothing particular to construction cost or labor that really stuck out in terms of severity?
No. If anything would've happened there, it would be already factored in our loss ratio effect.
Got it, thank you. And then switching over to mortgage, last year the delinquency rate kind of spiked up due to the storms in the third quarter. No reason to believe that it would be a similar dynamic in the first quarter from Michael and the wildfires?
No. We looked at this and we also thought about the government shutdown, which was on the horizon, but there's certainly GSE rulings that prevent us from these potential delinquencies developing into claims. And going back to the hurricanes, 2017 was different in the sense that both – in particular Harvey, where flooding was persistent for a number of weeks and is more damaging than Michael that came in and through that really have an allocated timeframe to the event. So at this time, we don’t think there will be any spike in our delinquency just from the cats.
As far as the government shutdown, Trump signed up something at the end of January, so it's releasing that base. So that should be a long way to alleviate any of our concerns there.
Great. That makes lot of sense. Thanks guys.
Our next question comes from Amit Kumar with Buckingham Research. Your line is open.
Thanks and good morning. Just two quick follow-up if I may. The first question goes back to the discussion on wildfire casualty losses. I just wanted to understand a bit better, if the utilities numbers change or if there is any other development, does your current number remains static or how was that reserve, maybe just help me just explain that a bit more?
Well, from our point of view it was a – it's fully reserved. So there's no adverse development that we can see on this particular claim. Yes. It might with bankruptcy court and things could change, but if they change, we think they'll be in our favor. They'll reduce the number. But we’ve taken the most conservative view that we can think of at this point and we'll see how things play out.
And what is the size of this book for you in terms of percentages? Or any would sort of think about it?
Well, it's really a one-off, right? It’s not a book per se. We have a small unit that focuses on these kind of the bespoke transactions. Typically there's a lot of them that are property type deals. This one was a casualty deal as well. And as you know, these, these deals come to the market infrequently that you don't know when they're coming.
You look at the opportunity, you assessed the risk, you make a decision on the pricing and if the risk adjusted returns are there, we try to participate. So at this point, I mean it's really not – it's not really a book in itself. It's an emigrant, an amalgamation of policies that we write down in the ad-hoc basis.
And Amit, the one thing that's interesting with this one because it's such in a high price to get out of breath. You don't hear about the [98] others that are actually that worked out to our favor, but let’s leave it with that.
That's a very fair point. I guess the only other question I had was going back to the discussion on buyback. And I think in your opening remarks you talked about the volatility in the market is going to giving you an opportunity, the buyback, obviously, was higher than my numbers and discrete numbers. In the past, we used to talk about a matrix and in – there used to be a matrix on your website, which I was having trouble finding. Are we still utilizing that payback matrix? Or how should we think about future buybacks?
Well, yes. The matrix that you're referring to is still the starting point of our analysis. And the question that comes up often from many – many of you on the phone is, is with the growth in the mortgage segment. Does that matrix or that view change? And the answer is, is does, but it's not black and white. What we like and we told everyone before about the mortgage segment is that we liked the visibility and the predictability of the earning stream that it gives us.
So the three-year payback that we've targeted in the past, we have a view that yes, maybe we'd be willing to extend it to four years to five years, who knows. But that's always considering all the options that are available to us. We talk about acquisitions, we talk about reducing your leverage. So there's all these aspects of capital managers when they come into play and yes, I mean, so hopefully that answers your question. So that the grid is still there, but it had – we have some flexibility around it.
Got it. That's what I was looking for. That's all I have. Thanks for the answers and good luck for the future.
Thanks. Amit. Appreciate it. Thank you.
Our next question comes from Yaron Kinar with Goldman Sachs. Your line is open.
Hi, good morning. Just one quick one. Can you recap the cat losses by event?
Well, we typically haven't done that. So that's the number you have in front of you is both for wildfires and Michael Bright, predominantly with a few, a small others along as well.
Okay. And maybe one follow-up and as you look at the market into 2019? Would you expect opportunistically to grow the property cat book and the property cat exposure?
Like I said, if we get the rates that we think are warranting an increase, we will increase. And we have increased some property exposure in the last quarter. So there were some opportunities to do it. As we said, it's just not a broad-based market opportunity, but we always look out for specific transactions or relationships to really take advantage of that. So we have – we're present on front street, we're open for business as you know, and we will do it, if it's there.
Okay. Thank you very much.
Thanks Yaron.
I'm not showing any further questions. So I would now like to turn the conference over to Mr. Marc Grandisson for closing remarks.
Thank you very much, everyone. It was a good year. Appreciate your time, and happy Valentines to all of you guys.
Love you all.
Thank you.
Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may all disconnect.