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Arch Capital Group Ltd (NASDAQ:ACGL)
Q3 2020 Earnings Call
Oct 30, 2020, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, ladies and gentlemen, and welcome to the Third Quarter 2020 Arch Capital Group Earnings Call. [Operator Instructions]

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. Francois Morin. Sirs, you may begin.

Marc Grandisson -- President and Chief Executive Officer

Good morning, Liz, and welcome to our third quarter earnings call on Halloween Eve. You're in for a treat. In our results, you can see tangible evidence of the advantages of the Arch model. By protecting our capital during the soft market years, we are well positioned as each of our segments leans into improving market conditions. Our underwriters are making the most of the hardening property and casualty market, while our mortgage insurance segment is benefiting from record mortgage origination activity this quarter.

This year, for the first time in nearly a decade, we've been able to grow significantly and deploy more capital in our P&C businesses that provide acceptable expected returns. And due to our strong financial position, we have accomplished this while maintaining a strong presence in MI, which continues to deliver meaningful returns.

Our ability to continually rebalance capital among our diverse businesses enhances our total underwriting returns. It also should decrease earnings volatility over time. Since our inception, we have believed in cycle management, and this strategy brings an added margin of safety to our collective underwriting activity.

Allow me to elaborate on our third quarter results by touching on three key themes; one, growth; two, margin improvement; and three, capital allocation. First, let's talk about growth. In this quarter, net written premiums in our P&C units grew 25% in total, 17% in insurance and 38% in reinsurance over the same period a year ago. This growth was driven by rate improvements, but also reflects our ability to increase our participation where clients needed additional capacity. In the insurance segment, we continue to obtain strong rate increases in areas like property, D&O, and casualty. Groupwide, our rate increase for the third quarter averaged over 11%, and we believe this trend of increasing rates should continue through 2021.

At Arch, we have always followed the simple rule, our participation in the business should follow the direction of premium rates. As rates improve, we write more business. When rates decrease, as they did over the past several years, we write less. This strategy takes courage. You will often appear an outlier to the market. But being intellectually honest, disciplined, and applying our cycle management techniques is what we're all about at Arch.

Obviously, the P&C market is broad, and all opportunities are not created equal. There are areas such as workers' comp, where premium rates or conditions are not improving to the levels we believe are needed for an adequate return, and in those instances, we manage our appetite accordingly. Despite headwinds from the pandemic, our growth in insurance lines like E&S, property, casualty, and professional lines are great examples of our platform's ability to flex into improved underwriting conditions.

Our reinsurance unit has been able to lean into this hardening market both earlier and with more vigor than our primary operations. There are two main reasons for this. First, when a market transitions, needed rate increases compound up the insurance supply chain. Reinsurance is often a leading indicator of what's to come more broadly. Second, reinsurance can provide capacity quicker and in larger amounts, since it can put capital to work through clients' platforms. Of course, sheer growth is only one part of the equation of growing returns.

Let's turn now to margin improvement. We all know that, mathematically, rate increases in excess of loss trends lead to margin improvement. The marketplace seems to be supporting the momentum of continued rate increases. We are in the early stages of seeing the benefits of rate-on-rate increases in our operating results. Simply stated, adding the two parts, growth and margin, will lead to better returns.

Many factors are driving today's P&C markets. These include elevated natural cat loss activity in each of the past four years, weakened reserve positions from soft market years, lower investment yield, and a rise in claims inflation. Add in a global pandemic that is still ongoing, and it's not surprising that market conditions are changing.

Now pivoting to MI. Our $33 billion of NIW in the U.S. in the quarter was a record for Arch. Low interest rates are producing huge refinance activity and, unsurprisingly, some churn in our in-force business. However, MI premium rates remain above pre-COVID levels and the continued high credit quality of borrowers is generally better than it was pre-pandemic. We continue to face uncertainties such as the economy's health and how the pandemic may ultimately affect individual borrowers. However, we are optimistic that, among other positive factors, recent trends in the U.S. housing market will mitigate the effects of the pandemic.

Finally, Arch's ability and willingness to allocate and manage capital remains a key competitive advantage. We always think about balancing our capital deployment over five pillars, into the insurance, reinsurance, MI, into our investment portfolio, and lastly, into our stock repurchase. Our job is to optimize risk adjusted returns through capital allocation across these pillars. We see managing the five pillars being similar to coaching a basketball team. We're constantly looking at how we can distribute the ball, i.e., our capital, to the right players.

For the past several years, we've been able to feed the big 7'7" MI guy down low [Phonetic] and rely on him to get easy dunks. Now as the playing field, i.e., the market changes, we've adjusted our tactics slightly and are increasingly relying on our two hot shooters, reinsurance and insurance. MI will still score its fair share of points, but the P&C players are getting more open three-point looks and layups. In short, our game is becoming more complete and diversified. Our ability to adapt to the new conditions is what makes us stronger as a team.

The market dynamics take me back in time. We have talked about Paul Ingrey's underwriting clock that helps track and measure the phases of the insurance cycle. It's been central to our management philosophy since the beginning and is a helpful reference to understand the underwriting lifecycle and assist us in gouging our risk appetite. I recently asked our underwriting teams where we were on the Ingrey clock, and the most common response was around 8 o'clock. If you take a look at the clock in our most recent annual report, you will see that it's a very nice time to be at Arch. There's a buzz among our underwriters because we've become the first call for so many of our clients. They know that we have the capacity, the expertise and the desire to serve them.

Now, I'll turn the coach's whistle over to Francois as he goes into more detail on our quarterly results. And I look forward to responding to your questions afterwards. Francois?

Francois Morin -- Executive Vice President, Chief Financial Officer and Treasurer

Thank you, Marc. And good morning to all. We at Arch hope that you are in good health. On to the third quarter results. As a reminder and consistent with prior practice, the following comments are on a core basis, which corresponds to Arch's financial results, excluding the other segment, i.e., the operations of Watford Holdings Limited. In our filings, the term consolidated includes Watford.

After-tax operating income for the quarter was $120.3 million, which translates to an annualized 4.2% operating return on average common equity and $0.29 per share. Book value per share increased to $28.75 at September 30, up 4.1% from last quarter and 12.2% from one year ago. The increase in the quarter was fueled by the continued strong performance of our investment portfolio and good underwriting results, taking into consideration the elevated catastrophe activity in the quarter and the uncertainty surrounding the current pandemic.

Our property casualty teams continued on their path of solid growth and improved performance as we continue to see strong, positive pricing momentum in their markets.

Losses from 2020 catastrophic events in the quarter, including COVID-19, net of reinsurance recoverables and the reinstatement premiums stood at $203.3 million or 12.5 combined ratio points compared to 5.2 combined ratio points in the third quarter of 2019. The losses impacted both our insurance and reinsurance segments and include $191.4 million from a series of natural catastrophes in the quarter, including Hurricanes Isaias, Laura and Sally, the Midwestern Derecho, California wildfires, and other smaller events, as well as $11.9 million for losses related to the COVID-19 pandemic.

The COVID-19 losses we recorded in the quarter were small, reflecting additional information that became available during the quarter and represent our current assessment and best estimate of the ultimate losses for occurrences through September 30, based on policy terms and conditions including limits, sub-limits, and deductibles. As of September 30, the vast majority of our COVID-19 claims are yet to be settled or paid, with close to 80% of the inception-to-date incurred loss amount recorded as incurred but not reported, i.e., IBNR reserves or as additional case reserves within our insurance and reinsurance segments.

As regards the potential impact COVID-19 on our mortgage segment, we note that the delinquency rate at the end of the quarter was 4.69%, down from 5.14% at June 30. Our current expectation is that the delinquency rate should be in the 5% to 5.5% range at year-end 2020. While we have seen many positive signs over the last few months that point us to a more favorable view of the ultimate performance of the U.S. MI book, many of the uncertainties we identified on our last call remain. In particular, the potential impact from a second wave of infections, potential lockdowns, and the lack of an additional fiscal stimulus package or risk factors that we continue to monitor and evaluate on an ongoing basis. For these reasons and consistent with our corporate reserving philosophy, we believe it is prudent to take a cautious approach in setting loss reserves across our MI book.

In the insurance segment, net written premium grew 17.1% over the same quarter one year ago, a strong result demonstrating our ability to achieve profitable growth in this environment. Adjusting for the net written premium decrease observed in our travel, accident, and health unit, the year-over-year growth in net written premium would have been 26.5%. The insurance segment's accident quarter combined ratio, excluding CATs was 94.1%, lower by 620 basis points from the same period one year ago. Approximately 300 basis points of the difference is due to a lower expense ratio, primarily from the growth in the premium base from one year ago and reduced levels of travel and entertainment expenses this quarter.

The lower ex-CAT accident quarter loss ratio reflects mix change and the benefits of rate increases achieved over the last 12 months. Prior period net loss reserve development, net of related adjustments was favorable at $1.1 million, generally consistent with the level recorded in the third quarter of 2019.

As for our reinsurance operations, we had strong growth of 38.4% in net written premiums on a year-over-year basis, which was observed across most of our lines and includes a combination of new business opportunities, rate increases, and the integration of the Barbican Reinsurance business. The segment's accident quarter combined ratio, excluding CAT stood at 83.1% compared to 92.8% on the same basis one year ago. The year-over-year movement is primarily driven by a more normal level of large attritional losses compared to a year ago and rate change activity over the last 12 months. Most of the remaining difference is explained by operating expense ratio improvements, primarily resulting from the growth in earned premium.

Favorable prior period net loss reserve development, net of related adjustments, was $40.8 million or 7.4 combined ratio points compared to 4.0 combined ratio points in the third quarter of 2019. The development was mostly in short tail lines.

The mortgage industry had a record-breaking quarter in terms of NIW, and we certainly followed suit with this quarter's NIW of $32.8 billion, a full 30% higher than our prior high watermark. Offsetting this record level production was the high level of refinancing activity across our portfolio with the net result being a slight reduction in our insurance in-force. The combined ratio was 64.2%, reflecting the lower delinquency rate observed during the quarter. The trends we saw in this quarter were favorable relative to last quarter, but the game is far from over. The expense ratio was slightly lower over the same quarter one year ago and prior period net loss reserve development was favorable at $4.5 million this quarter.

Total investment return for the quarter was positive 230 basis points on a U.S. dollar basis as the strong recovery in the capital markets produced healthy returns across our entire portfolio. Returns on our equity and alternative investments contributed approximately 40% of the total return for the quarter. The duration of our investment portfolio remained basically unchanged from the prior quarter at 3.21 years.

The effective tax rate on pre-tax operating income was 4.8% in the quarter, reflecting a change in the full year estimated tax rate, the geographic mix of our pre-tax income, and a 10-basis point benefit from discrete tax items in the quarter. 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. We currently estimate the full year tax rate to be in the 8% to 10% range for 2020.

Turning briefly to risk management, our natural cat PML on a net basis increased to $918 million as of October 1, which, at approximately 8.4% of tangible common equity, remains well below our internal limits at the single event 1-in-250-year return level. The growth in the PML this quarter is attributable to our E&S property unit within the insurance segment, which increased its writings in an improving marketplace.

On the capital front, the increased interest expense this quarter was mainly the result of the issuance of the $1 billion senior notes we issued in June 2020. So far, we have been able to fund our recent growth with our existing capital base, and our balance sheet remains strong with a debt plus preferred leverage ratio of 23.1% that remains well within the reasonable range.

As for our U.S. MI operations, the mortgage insurance linked notes market has recovered to a great extent from the lows we saw at the onset of the pandemic. Earlier this week, we priced our third Bellemeade transaction of the year at terms that are getting closer to what we saw in 2019 both in structure and price. Our latest transaction will provide 6.5% of in coverage in excess of a 2.5% attachment point both expressed as a percentage of the risk in-force. Including this transaction, the Bellemeade structures currently provide approximately $3.9 billion of aggregate reinsurance coverage. The fact that this market has recovered as extensively as it has in just over six months with investors more and more comfortable with the exposure they are assuming is quite telling and provides support to our current assessment of the health of the U.S. housing market.

With these introductory comments, we are now prepared to take your questions.

Questions and Answers:

Operator

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

Elyse Greenspan -- Wells Fargo Securities -- Analyst

Hi, thank you. Good morning.

Marc Grandisson -- President and Chief Executive Officer

Good morning.

Francois Morin -- Executive Vice President, Chief Financial Officer and Treasurer

Good morning.

Elyse Greenspan -- Wells Fargo Securities -- Analyst

My first question is on the capital allocation. So, Marc, you laid out five pillars. I just want to confirm, I guess, based on how you were talking, it sounds like share repurchase is last kind of on the chain right now and I guess -- because it seems like you have such good growth opportunities that you could put your capital to use, just basically to incrementally add to your insurance and reinsurance writings. Am I understanding that correct?

Marc Grandisson -- President and Chief Executive Officer

So yeah. I didn't mean to put them in ranking order. I think that they are probably all fairly equally attractive at this point in time. I think that we are investigating, as you know, on a quarterly basis as to what the opportunities are in various lines of business. I didn't mean to name stock repurchase as the last one of the rank ordering mechanism. I think that is also part and parcel of the discussion. I think that, for the first time in a while, I would argue that the five players actually are, you know, actively making the point for receiving ball, the ball and play -- be part of the game. So I would definitely say that. And we're evaluating, but certainly, our game, number one -- focus number one is to allocate capital to the underwriting units if the returns are there. And that certainly is a -- relatively easier place to deploy, an easier way to see it at this point in time. But everything is up, every -- everybody's playing on the field, on the court, so.

Elyse Greenspan -- Wells Fargo Securities -- Analyst

Okay. That's helpful. And then my second question. Your insurance underlying margin 94% in the quarter. Arch had targeted to get to kind of a mid-90s, yet, you guys are kind of there, but there is more, you mentioned a lot of rate, I think, 11% that you're getting in your book of business, which you haven't earned that in yet. So as we think about the earning end the rate you're getting today, plus what seems like incremental rate you could get into 2021, do you have any target for that business? Or is there a way that we can think about the margin profile there, especially since you've kind of hit that target that you laid out?

Marc Grandisson -- President and Chief Executive Officer

Yeah, so let me go back to 95 combine, which I mentioned, I think, three years ago now. I think it was meant to be there as an aspirational target and to shoot for, at that point in time, based on the mix of business and the opportunities that we had in our marketplace. I think this has changed, right. I think now that we are obviously going in that direction very nicely and the market is certainly helping us, I think we still look very heavily into line by line and ROE by line of business. And I would argue, Elyse, that some lines of business would need less than a 95 combine and some might be still OK at above 95. But certainly, what I would tell you is, the combined ratio was aspirational. We have to keep in mind that there's still -- COVID-19 is still ongoing. And second, the interest rates have also been decreased -- have decreased significantly since three years ago. So rate increase might be needed beyond the combine ratio just to make the returns equivalent to what they should be or would have been at a 95 historically. So it's really an ongoing process of reflecting current investment yield. So there are no targets on the combined ratio. But certainly targets on a return basis. And I would argue with the 140 bps to 150 bps decrease in interest rate that the combined ratio would, presumably, mathematically need to go down to make an equivalent return.

Elyse Greenspan -- Wells Fargo Securities -- Analyst

Okay, that's helpful. And my last question, you mentioned taking a cautious approach to reserving within your mortgage book. And then I think you also laid out the default rate to get to 5% to 5.5% by the end of the year. And so I'm just trying to understand like, as the default rate, I guess recognition is -- it will go up a little bit from where it sits today. And I'm assuming that you'll continue with the same conservative approach that we saw in the third quarter. So how should we think about kind of the combined ratio, you've been giving some metrics for how that business could trend, and you've obviously come in better than expected in the second and the third quarter. Do you have an expectation for how that could ultimately trend into Q4? I'm not sure if you want to provide initial color on 2021.

Francois Morin -- Executive Vice President, Chief Financial Officer and Treasurer

Yeah, I'll take that, Elyse. I mean, just to be pretty clear, as you guys all know, I'll take the blame. I did a pretty poor job of forecasting combined ratios or delinquency rates over the last two calls. So I think we're trying to minimize those kind of bad forecasts. But listen, as we know, there is a lot of uncertainty out there. Yes, we're extremely pleased that the delinquency rates have come down, right. We had talked about even just last quarter, we had said like somewhere around 8% by the end of the year, it doesn't look like we're gonna -- it's going to be as bad as that based on what we know today. Still few months to go, but definitely saw some encouraging signs this quarter. So that's all well and good. Does it translate to -- what kind of combined ratio does it translate to, I mean, it's hard to know, because again, what we're facing is really we just don't know how long this pandemic is going to last. And, the fact that the forbearance programs are, at this point, scheduled to end, but who knows if they get extended or not and how do people convert from forbearance to a regular delinquency, there's a lot of unknowns at this point that we feel are extremely hard to predict and estimate. So listen, we're taking it one quarter at a time. We're happy with where things are at right now. Again, it's reassuring. But we're not -- as I said, the game's far from over. And who knows, maybe, hopefully, even my 5% to 5.5% forecast or expectation for delinquency ends up being a bit high. But we'll find out in a few months, and we'll reassess at that point.

Elyse Greenspan -- Wells Fargo Securities -- Analyst

Okay, thank you very much. I appreciate all the color.

Marc Grandisson -- President and Chief Executive Officer

Sure.

Operator

Our next question comes from Jimmy Bhullar with JPMorgan.

Jimmy Bhullar -- JPMorgan -- Analyst

Hi, good morning. First, I just had a question on how you're thinking about pricing, reinsurance pricing as a buyer of reinsurance and how should we think about sort of overall exposure, especially to CAT as you're entering 2021? Are you giving better pricing? Are you going to hold more exposure or may be should we assume that you'll keep your retention sort of similar and be a buyer of record regardless of prices?

Marc Grandisson -- President and Chief Executive Officer

The short answer is we don't know yet, right. I think we'll have to see what the 1-1 brings to our reinsurance folks on the inward side and certainly on our E&S property. We'll have to evaluate and assess what kind of exposure and what kind of margins we're getting there. And then look back and say, OK, now what is the, -- because buying reinsurance, as you know, is like raising -- it's like using capital, it's like we have to pay for that. So we're going to go through a very straightforward analysis of capital usage and what we pay for it. And we take a very, very, first economic view of the whole world and specifically as it relates to the insurance exposure we take on a property CAT exposure specifically, but I think, said all this, we are also -- balancing it or adding to that information process is that we also are careful and not overstretching the capital. So we'll always be buying reinsurance to some extent. The question is what level and how much and at what price. But clearly, we are -- we like stability, and we're always trading stability for sometimes lesser margin. And that's going to be part of the mix. But clearly, both markets, where we can be on the advantage -- we can gain both sides, can actually get rate increases on the insurance side, find a way to buy reinsurance in a good way. And on the assumed basis, we actually are benefiting from the improvement in the market there as well. So it's really a holistic view of the CAT exposure. Too early to tell what exactly is going to transpire, but everything is always up for discussion.

Jimmy Bhullar -- JPMorgan -- Analyst

And then on what Watford, you raised the price, there's pressure on you to raise it again. And at what point does the deal become sort of uneconomic and or are you already there? Or any comments on how you're thinking about that situation?

Marc Grandisson -- President and Chief Executive Officer

Well, I mean, we didn't raise our price. We did not raise the price, right. We have an agreement. We have a signed agreement with Watford that we're starting the process to get regulatory approvals, etc. But yeah, I mean there's another party that has come in that Watford feels they have to look into their potential offer and what it all means to them. But at this point, what's been announced is what is still valid. Depending on what they end up deciding, we may choose to do something different. But at this point, we can't really say much more than that.

Jimmy Bhullar -- JPMorgan -- Analyst

Okay, thank you.

Operator

Our next question comes from Mike Zaremski with Credit Suisse.

Michael Zaremski -- Credit Suisse -- Analyst

Hey, thanks. Good afternoon. Focusing on the reinsurance segment, robust growth. Thanks for the commentary, bullish commentary. If we look at the underlying accident year loss ratio, I mean actually expense ratio too, so just a lot of improvement. Anything we should be thinking about, anything you want to call out or, a lot of this is just market conditions and operating leverage that you're benefiting from.

Marc Grandisson -- President and Chief Executive Officer

Yeah, so the reinsurance group has grown tremendously to the expense ratio going down or what it did certainly is explained by that in large part. I think in terms of the loss ratio, what I would like -- and we said that in prior calls as well is we tend to look at reinsurance performance on a 12-month to 18-month basis. There's a lot more volatility in that segment, in that sector, there's also a lot of shift in the mix over time. Our reinsurance folks do not tend to have a -- they have stable relationships, obviously, but there's a lot of things moving on in terms of seizing the opportunities in the marketplace. So what I would look at the loss ratio is more like. this is -- some quarters is much better than others, and it's really due to the volatility in the reinsurance results, I would say.

Michael Zaremski -- Credit Suisse -- Analyst

Okay. Okay, got it. So the expense ratio, some of that's going to...

Marc Grandisson -- President and Chief Executive Officer

Grow.

Michael Zaremski -- Credit Suisse -- Analyst

Okay. Follow-up on the mortgage side. I think I heard you say earlier that ILN pricing kind of had improved a lot. I guess I'm looking at or trying to -- we've been trying to track overall ILN pricing and we kind of still see it as double what it was pre-pandemic. But maybe I'm just looking -- maybe Arch's pricing is better or maybe I'm just incorrect.

Marc Grandisson -- President and Chief Executive Officer

Yeah, I mean there's two parts to it, right. There's the structure meaning, in particular, attachment points and then the pricing, right. So this is our third one. Our first one of the year, really, we were the first ones out of the gate after the pandemic. The reality of that point is, appetite from the investors was not as good as it was in the past and our attachment point was much higher. Second one, attachment point came down with slightly better pricing. And with this new latest one, we're effectively back to the same -- the 2.5% attachment point that we had seen pre-COVID. So that's certainly a very good sign. Pricing, if you risk-adjust for everything, it's still up, no question. It's not at the same level that it was pre-COVID, but it's not double, for sure. So it's much better than that, much lower than that. And quality of the book is better, so how does that get factored in. And so there's a couple other things that it's hard to make it perfectly apples to apples, but directionally, on an absolute basis as well, we're very happy with where things are going.

Michael Zaremski -- Credit Suisse -- Analyst

Okay. Got it. That's helpful. I think you're describing it to be better than what we have thought. Okay. And lastly, sticking on mortgage, hopefully, you said you -- the delinquency rate doesn't tick up as much as you thought. But are you -- it's almost November now, are you -- have you seen over the last few weeks delinquency rate tick up?

Marc Grandisson -- President and Chief Executive Officer

So last few weeks has been -- it's been actually keeping in the same general direction that we saw in the third quarter. So it hasn't ticked up, flattish I'd call it. And we got a couple of months to go. We'll see how things play out, but that's kind of what we're seeing.

Michael Zaremski -- Credit Suisse -- Analyst

Understood. Thanks for the color.

Marc Grandisson -- President and Chief Executive Officer

Sure. Thank you.

Operator

Our next question comes from Josh Shanker with Bank of America.

Josh Shanker -- Bank of America -- Analyst

Yeah, thank you. Two questions. One just understand accounting and the other one is about Watford. On the accounting, you had a decline in delinquencies due to cures of 6,000 approximately. But you took up reserves. I know you can't really reserve for a loss that hasn't happened yet, but it looks like your reserving for these new claims at about $12,000, $13,000 per claim compared to a historical average of $4,000 to $5,000 per claim. Am I doing the math correctly? And can you explain sort of how you think about that in the books? I think, in the first quarter, you also took up reserves more than typical because you can only take them up when you have claims. Can you walk through that a little bit?

Marc Grandisson -- President and Chief Executive Officer

Yeah, no question that we bumped up reserves this quarter on effectively the delinquencies that we saw in the second quarter. So your math is correct. I mean the reserves per delinquency, you did the math right. But what you need to adjust for, I would say, is call it a reserve strengthening exercise that we went through just to reassess where we were, take a hard -- every quarter, we take a hard look, and our view is that might as well not -- be cautious knowing what we know and knowing what we don't know. So, think of about a $45 million adjustment on reserves in the third quarter for effectively Q2 delinquencies. So once you adjust for that, I think you get back to claim levels or severity that you would be more in line with what maybe you would have expected.

Josh Shanker -- Bank of America -- Analyst

So, along those lines, is there a reason to believe that the severity of the losses are going to be different than historical severities. I can understand, these are all frequencies and you can't really take frequencies, and so you get a claim. But is there a reason to be more cautious surrounding severity in this pandemic?

Marc Grandisson -- President and Chief Executive Officer

We don't see it. The only adjustment, obviously, that we're reporting in our supplement in terms of paid severities is lower than what we're seeing from the new delinquencies, right. New delinquencies, we mentioned it last quarter, at about a $65,000 or so per NOD. This quarter, it's right around $60,000. So I mean it's certainly higher because it's more recent -- more recent loans that are going delinquent versus the loans we paid on in the quarter. So that's the only adjustment. But in terms of percentage of the insured value or the insurance in force or the risk in force, we don't -- at this point, don't have a reason to think that it's going to be materially different than what it's in the past.

Josh Shanker -- Bank of America -- Analyst

Okay. And then on Watford, we don't know how it's going to turn out. But your own stock trade's around book value, the offers for Watford were around 0.8 times book. I'm not sure, maybe you've done some thoughts on whether Watford is a better investment at 0.8 times book than Arch's at one time book. But if you don't buy in Watford, it would suggest that you have a chunk of excess capital that you were already allocating toward financial uses. Can we expect that your interest in buying business you already know is attractive, even given the market opportunities here?

Marc Grandisson -- President and Chief Executive Officer

I think we made the point clear by putting our offer up there, and that's pretty much what we'll leave it as, Josh. I think we are -- we still think that Watford is a good platform, a valuable platform. We'll see how things shape out.

Josh Shanker -- Bank of America -- Analyst

But clearly, Arch is more valuable platform than Watford. If you're willing to buy in Watford stock, shouldn't you be willing to buy in Arch stock as well?

Marc Grandisson -- President and Chief Executive Officer

I think the answer is always yes. We're always looking at the possibility of buying our stock and certainly, like I said before, on the five players on the court, I think that the share repurchase is really -- is attractive. As you would expect me to say as the CEO of the Company.

Josh Shanker -- Bank of America -- Analyst

All right. We'll keep watching. Thank you.

Marc Grandisson -- President and Chief Executive Officer

Thank you.

Operator

Our next question comes from Yaron Kinar with Goldman Sachs.

Yaron Kinar -- Goldman Sachs -- Analyst

Hi, good morning. Thanks for taking my questions. I do want to start by thanking you for giving a basketball analogy. So I can actually understand what's going on. I was worried you'd give a hockey analogy. My first question goes to the slight increase in COVID losses in the quarter. Can you maybe talk about what drove that, specifically, I guess, specifically what I want to get at is, do we have anything to do with the FCA court case over in the U.K. and how you're thinking about your overseas business interruption exposures?

Marc Grandisson -- President and Chief Executive Officer

Yeah, I mean it's really in two parts. I think on the insurance side, it's very much -- it's all basically related to our travel book in the U.S. So no connection to the FCA ruling. And a little bit, we added in the reinsurance side is around property exposure is mostly out of Europe. So it's a little bit of a -- a little bit of a Bi angle to it. But that's pretty much it. I mean its, I call it a bit of new information coming in, nothing, -- no material new information that came through that would have caused us to revisit our picks. [Speech Overlap] And the FCA, as we said, we didn't change it. And the ruling, where it stands, we're still very much -- we had fully reserved for it, and there's, again the ruling doesn't change our position on that.

Yaron Kinar -- Goldman Sachs -- Analyst

Okay.

Francois Morin -- Executive Vice President, Chief Financial Officer and Treasurer

The rest of the portfolio, Yaron, for what it's worth, and we mentioned on a prior call is that we have the vast majority, almost the totality of our policies have the exclusions that would protect us somewhat a deviation. So this is nothing in there to really think about.

Yaron Kinar -- Goldman Sachs -- Analyst

Okay, that's very helpful. And then my second question. When you talked about the improvement in the accident loss ratio for insurance, you didn't talk about favorable frequency. So is it because you didn't see that or is it because you didn't book that?

Marc Grandisson -- President and Chief Executive Officer

It's a little bit of both actually. We saw some of it, some improvement on the frequency of claims possibly in the second quarter. There was definitely a difference. But if you neutralize for the obvious lines of business, where claims would actually naturally go down for such as travel for instance with a lot less exposure or go up. Then if you're neutralize all this, we didn't see a discernible change through the nine months of this year. It's hard to see what the natural rate would be. But we don't see a discernible change in the frequency to speak up. And really, we'd put our reserve back in a loss pick based on long-term trend, -- long-term averages. We're not looking at specifically one quarter at a time and one even actually year at a time, we do get in the mix of multiple years and project out much more on a longer-term expected. So we'll take a little while before we would recognize any significant improvement in frequency of claims if at all.

Yaron Kinar -- Goldman Sachs -- Analyst

Got it. And then maybe one final very quick one on Watford. If the deal does go through, I just want to confirm that the Company wouldn't lose the fee income, if Watford is consolidated, right?

Marc Grandisson -- President and Chief Executive Officer

Correct.

Yaron Kinar -- Goldman Sachs -- Analyst

Okay. Thank you.

Marc Grandisson -- President and Chief Executive Officer

Sure

Operator

Our next question comes from Ryan Tunis with Autonomous Research.

Ryan Tunis -- Autonomous Research -- Analyst

Hey, thanks. Good morning.

Marc Grandisson -- President and Chief Executive Officer

Good morning.

Ryan Tunis -- Autonomous Research -- Analyst

The only question I had was just on NII and thinking about low rate headwinds. Looks like you guys have almost 30% of your assets in -- essentially government bonds. Looks like your portfolio yield is sub-two. We just heard another Bermuda competitors today, say that their new money yield is 2%. It would seem to me given how you're allocated and given your current portfolio yield that there actually wouldn't be that much incremental yield headwind moving forward, actually, arguably, for you to move out of some of the govvies and take some credit risk will actually seem like maybe to expand your portfolio yield. It doesn't sound like that's right, given your commentary. I'm just kind of trying to understand, why is Arch continuing to be incrementally exposed to this low rate environment, given the fact that you guys really take it on the chin in terms of where your [Indecipherable]?

Marc Grandisson -- President and Chief Executive Officer

Yeah, I mean, we've -- no question, we've been defensive on credit. So yeah, we have a bit more on the treasury side that you're right. I mean, unless rates keep going down, but they seem to have stabilized, I guess, for the time being. Our play in the last few quarters has been trying to, as many others, I'm sure have done the same is try to find other opportunities that are more in the alternative space, that provide us still some level of investment income without taking on too much risk. So something we keep looking at, but it's a bit of a challenge. There's not a ton of opportunities out there. We're not -- we're worried a little bit. We're defensive on credit still, and that's something that we look at carefully. Don't want to over-source ourselves there either.

Ryan Tunis -- Autonomous Research -- Analyst

Do you do you guys have a new money investment yield you call out handy that you did in the third quarter?

Marc Grandisson -- President and Chief Executive Officer

Well, the last call, in the last month, what we've been -- where we've, -- call it, putting our money to work is just about 2%. So that's kind of where the latest information that we get -- that we got from our investment guys.

Ryan Tunis -- Autonomous Research -- Analyst

Got it. Thanks for the answer.

Marc Grandisson -- President and Chief Executive Officer

Thank you.

Francois Morin -- Executive Vice President, Chief Financial Officer and Treasurer

Sure.

Operator

Our next question comes from Geoff Dunn with Dowling & Partners.

Geoffrey Dunn -- Dowling & Partners -- Analyst

Thank you. Good morning.

Marc Grandisson -- President and Chief Executive Officer

Good morning.

Francois Morin -- Executive Vice President, Chief Financial Officer and Treasurer

Good morning.

Geoffrey Dunn -- Dowling & Partners -- Analyst

First question, and I appreciate the added color around the MI reserving. If we make the adjustment, is the math correct that you changed your incidence assumption up to about 9%?

Marc Grandisson -- President and Chief Executive Officer

Close enough, 8% to 9%. Yes. Yeah. And our view on that is that we feel like the more recent NODs are may be prone to a bit more stress. So the fact that these people took a bit longer to go into delinquency may tell us that there may be, again, subject to more stress. But again, time will tell.

Geoffrey Dunn -- Dowling & Partners -- Analyst

And is that 9%, is that just an overall number or is it a blend of just, as an example, 6% on forbearance, and 13% on non-forbearance notices? Can you delineate between the two or is it just more of a holistic approach?

Marc Grandisson -- President and Chief Executive Officer

It's more of an aggregate approach that we take. Yeah, we don't separate the two per -- as cleanly as you're suggesting. [Speech Overlap]

Francois Morin -- Executive Vice President, Chief Financial Officer and Treasurer

Geoff, I want to make sure you understand that. We also do look at prior events, prior CAT events, prior program of the sort, so, but its -- as you could appreciate, Geoff, it's probably art than science at this point in time.

Geoffrey Dunn -- Dowling & Partners -- Analyst

All right. With the new ILN, a little confusing in the documentation. It looks like it applies for policies after Jan '19. But it looks primarily more recent loans, over the last three, four months, what is it designed to do? Is it really for the last quarter or so? Or is it part of the design to come underneath 20-1?

Marc Grandisson -- President and Chief Executive Officer

No, it's -- the latest, the 20-3 is very much -- I mean, the vast majority is covering June, July, and August. So that's three months of production. There is a little bit of kind of spillage of the 20-2 that, and also some 2019 loans that had kind of been late being processed, whatever. It's just a little bit of a catch up on a few small things, but think of it as really June, July, August production.

Geoffrey Dunn -- Dowling & Partners -- Analyst

All right. Great, thank you.

Marc Grandisson -- President and Chief Executive Officer

Yeah, sure.

Operator

Our next question comes from Meyer Shields with KBW.

Meyer Shields -- Keefe, Bruyette & Woods -- Analyst

Thanks. Marc, I'm a little confused about something that you said. You were talking about the five capital deployment opportunities, and you said of the investment portfolio, and I guess I would have thought that if you're going to be writing more P&C or mortgage insurance, then the supporting capital will be in the investment portfolio anyway.

Marc Grandisson -- President and Chief Executive Officer

Yeah. So you're saying that we should -- just repeat the question, Meyer, please.

Meyer Shields -- Keefe, Bruyette & Woods -- Analyst

So I'm trying to figure out how capital deployment in the investment portfolio is distinct from capital deployment into either P&C or mortgage.

Marc Grandisson -- President and Chief Executive Officer

Yeah. Okay, now I see what you mean. So the way we look at the underwriting returns is we attribute to the units, the treasury return or the risk-free return. And we try and separate church and state, what we call it internally, we actually credit the float on the insurance on the underwriting pieces at the treasury rate level, and then we allocate the capital for the excess over that to the investment portfolio. So this is how we separate the capital usage between those -- between the underwriting units and the investment unit.

Meyer Shields -- Keefe, Bruyette & Woods -- Analyst

Okay, that makes sense. Got it. I'm trying to get a general sense of how you see either profitability in property catastrophe in retro or your view as to whether the vendor catastrophe models are conservative enough based on recent years CAT activity and the underlying trends.

Marc Grandisson -- President and Chief Executive Officer

Yeah, it's a good question, Meyer. I think that our position on this, we have no weather scientist upstairs. And we have a lot of the lengthy experience and information to look at. Listen, we actually augment and modify the vendor models as we see fit. So the vendor model represents to us a solid starting point from where we can -- this definitely has a lot of science into this one. So we've been historically using them as a starting point and augmenting it and modifying it with our own view of the world. But I would caution everyone by saying that, yeah, we do have a view of [Indecipherable] and various exposure around the world, and we also try to factor in shorter-term versus longer-term, possibly modification and what could happen out there. But, you know, it's hard to predict those things. So what we tend to do is to hold ourselves to a higher return for those risks that are inherent in the way we underwrite the business. That also helps explain why we've taken possibly somewhat of a more conservative approach to property CAT exposure over the last four, five years as you've seen in our numbers. So I think, it's a year-on-year analysis. But we would look at it and we'll evaluate. I think -- in some of our discussion, we had El Nino, El Nina and all these various discussions happening all the time. And we're not the largest writer of property CAT. But we do have a very solid team looking into this. But I think we make it up -- try to make it up with holding ourselves up to a higher level of returns.

Meyer Shields -- Keefe, Bruyette & Woods -- Analyst

Okay, that's very helpful. Thank you so much.

Marc Grandisson -- President and Chief Executive Officer

Sure.

Operator

Our next question comes from Phil Stefano with Deutsche Bank.

Phil Stefano -- Deutsche Bank Securities -- Analyst

Yeah. Good morning. Just one -- most have been asked and answered. One follow-up on the MI piece, and thinking about the increase in the default rate. I guess, in my mind, there are three mechanisms to get there. It's either new defaults are increasing, cures are slowing down, or the denominator policies in force is shrinking. I mean, I'm just curious how you're contemplating which of those levers is contributing to the increase in the default rate. I think it helps us think about. Does this come through as losses or premiums or maybe a development as the cures arrive?

Francois Morin -- Executive Vice President, Chief Financial Officer and Treasurer

Okay. So, Phil. Let me try and take this. There's a lot of questions -- it's a big question with a lot of parts. So first and foremost, the denominator is not changing a whole lot, right. It's about $1,250 billion [Phonetic], that's what it is in terms of policy. The DQ rate has decreased this quarter, right. Went from 5.1% to 4.7% this quarter. So this is like what's the number of policies, the numerator that are in default, and you divide by a similar number. So it did go down. I think what we're saying in terms of reserving, you reserve for the new notices that you received in the quarter, right. We received 58,000 in the second quarter, we received 20,000 this quarter. And what we're telling you is we take the book or these 20,000 new notices, the cures are the cure, they go away from the overall balance, if you will, that we just mentioned, which is at 4.7%. But the new notices, we reserve for those in the quarter. So we have to reserve, in the quarter, on those that were newly notified. This is what typically you would do in our reserving. What we did in addition to this is, we modified our view of what we should have booked for the second quarter for the new notices in that quarter. So I'm not sure -- I trying to help give you a picture, a bigger picture, hopefully, that helps you understand how the...

Phil Stefano -- Deutsche Bank Securities -- Analyst

That makes sense from the reserving side, but the default rate is loans in default, that population, over policies in force. And if the policies in force isn't changing and the default rate is going up, then presumably there is an expectation that new defaults is going to increase this quarter. And I guess I just wanted to make sure that I was thinking about it correctly, because to get from 4.7% to 5%, 5.5%, there must be an acceleration in new default or cures are slowing down. I don't know. That's kind of the question.

Francois Morin -- Executive Vice President, Chief Financial Officer and Treasurer

I mean, listen, it's a big, kind of top-down view. It's hard to know. We can't predict. You don't have the crystal ball on whether cures are going to accelerate or not or slow down and same thing with new notices. Again, we're trying to, I think just provide a bit of color that we think, obviously, knock on wood, we're not going to be at 8% delinquency rate by the end of the year. We're certainly well below 5%. Does it go back to above 5% by the end of the year, that's what we think could happen. But again, we don't know. So I think if everything stays the same, the odds are probably that it won't be at 5%. But we -- that'...

Marc Grandisson -- President and Chief Executive Officer

But Phil, you're right, you're right on your assessment, that if we go from 4.7% and we tell you it's going to be 5.5% at the end, that we will have to have an increase in NODs or less of cure. I'm not sure we have made enough assessment as to which is which. I would argue that we have tended to -- since May, we have tended to -- these last two quarters, we've overstated the amount, the number of new NODs that we received. And that probably is what will drive the potential. We just still don't know. Francois said that we haven't been as good as we would have liked to be in predicting. So I think the new NODs would be more of the place to look at. Having said this, Phil, you also know that we had two things going on, less new NODs and higher cure rate. So that both actually help to manage them, and they help accelerate and actually go -- help explain why we had a projection of about over 10% and earlier in the year too much less right now. They are two moving parts.

Phil Stefano -- Deutsche Bank Securities -- Analyst

Yeah, no, understood. I guess, in my mind, this default rate might continue to come down. But I guess that -- the crystal ball is very cloudy at this point. Thank you, guys.

Francois Morin -- Executive Vice President, Chief Financial Officer and Treasurer

Thank you.

Operator

Our next question comes from Brian Meredith with UBS.

Brian Meredith -- UBS -- Analyst

Thanks. Yeah, a couple of them for you, just quickly. I'm just curious, given that you're getting 2% new money yields and your book yield is below that. Should we just expect that your book yield on your investment portfolio fixed income is going to be stable here going forward?

Marc Grandisson -- President and Chief Executive Officer

I think, for the short-term, I think it's reasonable. Yeah.

Brian Meredith -- UBS -- Analyst

Okay, good. That's helpful. Second question. On the reinsurance space, I'm just curious, your property mix is definitely increasing as a percentage of your overall book. How much of the underlying combined ratio improvement that you're seeing there is actually driven by that mix shift versus just better loss picks?

Marc Grandisson -- President and Chief Executive Officer

Well-I don't think we parse out this way. It's still early in the game to see what is going to look like. I would say that, it's probably more mixed at this point in time, because our growth is largely in property other than CAT itself. So we have a lot of play in that sector right now. Just more and more mix, I would say, Brian. Yeah.

Brian Meredith -- UBS -- Analyst

Yeah. So it's not so much of the rate activity we're seeing, it's the mix shift that's driving it.

Marc Grandisson -- President and Chief Executive Officer

Well, the way we are, Brian, for all these years is we'll tend to go where the rates are the better ones, so we have a better increase in margin. So that sort of goes hand in hand.

Brian Meredith -- UBS -- Analyst

Got you. That makes sense. Another one, just quickly on Watford. I'm just curious, is it your guys' intentions to significantly increase your ownership in that ultimately? Are you going to buy the whole thing in, just because volatility of the investment portfolio, it's kind of just a different strategy?

Marc Grandisson -- President and Chief Executive Officer

Well, what we said publicly is that we are certainly talking to other parties to bring into the fold to support us in this vehicle if it moves forward, if we close on the acquisition. So the answer is, we would most likely increase our participation, but not to a 100% and be much less than that. So increase a little bit, but recognize that it's a different model that we -- others would want to participate on with us as well.

Brian Meredith -- UBS -- Analyst

Got you. So the net capital outlay for this transaction wouldn't be this big as it could. Okay, that makes sense.

Marc Grandisson -- President and Chief Executive Officer

Correct. Correct.

Brian Meredith -- UBS -- Analyst

Got you. And then last question, I am just curious, any updates with respect to the Coface investment, where that stands? The regulator is going to ultimately make a decision on this?

Marc Grandisson -- President and Chief Executive Officer

Yeah, I think it's in process. We are going through the regular process. It's on track. We're hopeful that we could get something done, potentially in the first quarter or second quarter of next year. It takes a while, as you know, in this COVID environment, government and regulators take a little while longer than otherwise. But yeah, it's on track, and they produce, as you know, the results, I believe, earlier this week, or early late last week. So, it's also looking much better for them, which is good for us.

Brian Meredith -- UBS -- Analyst

Yep. Great. Thank you.

Marc Grandisson -- President and Chief Executive Officer

Thanks, Brian.

Francois Morin -- Executive Vice President, Chief Financial Officer and Treasurer

Thank you.

Operator

Our next question comes from Jimmy Bhullar with JPMorgan.

Jimmy Bhullar -- JPMorgan -- Analyst

Hi, I just wanted to clarify your comment on not losing the fee income on Watford. Is that just because of the five years remaining on the contract? So there's a sort of a finite life to it? Or was there something else that was behind that comment?

Marc Grandisson -- President and Chief Executive Officer

Well, I mean, the question was asked if we buy the vehicle, do we still retain the fees. The answer is yes. I mean...

Jimmy Bhullar -- JPMorgan -- Analyst

Yeah, it's an internal validation, but in case it goes to somebody else, then that fee arrangement paid in fact through the length of the [Speech Overlap]

Marc Grandisson -- President and Chief Executive Officer

Yes, correct.

Jimmy Bhullar -- JPMorgan -- Analyst

Okay. And then, does your approach to underwriting overall and how much sort of capacity you have and take on a given change, if you own more of Watford versus maybe if it does end up being bought by a third party at a higher offer.

Marc Grandisson -- President and Chief Executive Officer

I think that in a third-party environment, Jim, I think it's pretty clear that we need to take care of our brethren as well as we could take of ourselves. So our view is always to do the similar underwriting. Watford had a different investment profile, which allowed us to do slightly different things. But at a high level, the underwriting is very, very similar. And then I would remind everyone that whatever we do on Watford, we take 15% of it on a quota share basis in the back. We also are participating on a capital -- we had like -- we're up to about 13%, I believe in our shareholding. So we collectively own 20% of the underwriting. So we do -- cooking there as well. It's really important to us.

Jimmy Bhullar -- JPMorgan -- Analyst

Okay.

Operator

I'm not showing any further questions. I would now like to turn the conference over to Mr. Marc Grandisson for closing remarks.

Marc Grandisson -- President and Chief Executive Officer

Thank you, everyone. Looking forward to the last remaining couple of months in the year. And I hope you have a good one.

Operator

[Operator Closing Remarks]

Duration: 61 minutes

Call participants:

Marc Grandisson -- President and Chief Executive Officer

Francois Morin -- Executive Vice President, Chief Financial Officer and Treasurer

Elyse Greenspan -- Wells Fargo Securities -- Analyst

Jimmy Bhullar -- JPMorgan -- Analyst

Michael Zaremski -- Credit Suisse -- Analyst

Josh Shanker -- Bank of America -- Analyst

Yaron Kinar -- Goldman Sachs -- Analyst

Ryan Tunis -- Autonomous Research -- Analyst

Geoffrey Dunn -- Dowling & Partners -- Analyst

Meyer Shields -- Keefe, Bruyette & Woods -- Analyst

Phil Stefano -- Deutsche Bank Securities -- Analyst

Brian Meredith -- UBS -- Analyst

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