Innovation and diversification

22-07-2016

Innovation and diversification

Africa Studio

Arch Capital’s diversification and subsequent performance is the envy of some of its peers from the Class of 2001. Much of this can be attributed to chairman and CEO Constantine ‘Dinos’ Iordanou, whose deft touch has helped him steer the firm through some choppy waters. He spoke to Bermuda:Re+ILS.

Although formed in 2001 along with a number of other re/insurers in the aftermath of the 9/11 terrorist attacks in New York, Arch Capital has always been different and stood apart from its peers.

Arch’s biggest differentiator has been its diversification. Unlike some of its rivals that subsequently suffered from too narrow a focus on catastrophe reinsurance, it opted to write both primary business and reinsurance from the outset.

As it has subsequently grown and developed, many attribute its advantages to the leadership and vision of Constantine ‘Dinos’ Iordanou, its chairman (since 2009) and chief executive since 2003, who has been instrumental in the company and its strategic direction since its inception.

“We are more competitive and more appealing now as a career option, and that makes for a bright future for the industry.”

As a pupil of Warren Buffett and Hank Greenberg during his formative years as an insurance executive, Iordanou has a remarkably adroit touch that has helped him lead Arch Capital through some difficult waters.

At the heart of that, he has always championed the importance of talent and innovation within the company and this philosophy has paid off.

“We do like to promote from within,” he says. “We have a leadership group of talented individuals who we try to identify at an early stage. We give them exposure to different areas of the business and we look to them as the managers of the future. We also have close links with St. John’s University’s School of Risk Management.”

The company takes up to 15 graduates a year on to an internship programme. Iordanou says Arch looks for individuals who, in addition to having the drive to succeed, are team players and flexible. He stresses that Arch is a much smaller company than those where he cut his teeth and was given the opportunities to prove himself.

 

Inspiring mentors

At AIG, his first job in insurance, Iordanou started at the bottom but worked hard and was quickly given exposure to many parts of that business. His peers at the time included the likes of Kevin Kelley, the future head of Lexington and later Ironshore; Brian Duperreault, the former boss of ACE, now CEO of Hamilton Insurance Group; Evan Greenberg, ACE’s current CEO; and Joe Taranto, the retired chairman of Everest Re.

He also had direct exposure to Hank Greenberg, the chairman and CEO of AIG, who is regarded as one of the industry’s great visionaries. He describes Greenberg as being very demanding and driven as well as being very detail-orientated.

His opportunity to prove himself to Greenberg came when he was given the responsibility of creating an environmental liability group at AIG in the late 1970s.

After successfully launching this new unit, he progressed quickly through the AIG ranks until he was in charge of all casualty at AIG subsidiary American Home, overseeing a division with $1.7 billion in revenue.

At this point, in 1987, he was lured away to work for another industry great, Warren Buffett, the chairman of Berkshire Hathaway, where he was made responsible for all casualty business. He describes Buffett as being different from Greenberg as a leader—more considered and thoughtful yet no less driven.

“Hank and Warren were both excellent learning experiences for me. They were very different but brilliant in different ways. Hank was more aggressive in his style of management and more demanding. I am not saying that Warren was not demanding, but he was less intense than Hank. He was more thoughtful.

“I learned a huge amount from both. The biggest thing I learned from Hank was the importance of understanding the detail of the business. He was always very involved in the detail. That was his style.

“In contrast, Warren taught me to step back and see the bigger picture. I also learned from him always to consider both the upside and the downside of decisions you make. If you protect the downside, the upside will take care of itself.”

While he learned from both mentors, Iordanou believes that he cannot be compared with either character. He has his own unique style, which has come to the fore especially since he took the reins at Arch Capital.

After a five-year spell at Berkshire Hathaway, he left to take on a variety of roles at Zurich North America. Then, following the 2001 terrorist attacks, a new class of start-ups were formed on Bermuda, including Allied World, Endurance and Montpelier Re. Iordanou was hired to launch Arch’s US insurance operations. From the start, Arch set out to build a diversified company, which has allowed it to steer clear of the consolidation frenzy enveloping its peers right now.

From 2003, at the helm, Iordanou was able to execute his own vision of how to build a re/insurance company as well as how to nurture young talent and encourage innovation. He believes the industry benefited from the 2008 financial crisis which badly damaged the banking sector in that it is now getting a better flow of talent than previously.

“There is enough talent in the industry and things have certainly improved in the seven or eight years since the financial crisis,” he says. “That triggered a big change in the number of young people entering the investment banking sector and commercial banks and that has benefited the risk transfer sector. We are more competitive and more appealing now as a career option, and that makes for a bright future for the industry.”

There is more the industry could do to promote itself and garner a better reputation, however, he says. He also believes that the so-called convergence between the capital markets and the risk transfer industry offers a new appeal to young people that the industry must capitalise on.

“We have stood up very well to the challenges of the financial crisis but we have not always done a great job of promoting ourselves to young professionals,” he says. “That is changing slowly and with alternative capital playing a bigger role in the industry and more hedge funds, private equity funds and pension funds committing capital to the industry you create a greater variety of roles and the industry offers more career options as a result.”

 

Innovation in talent

Translating this talent into innovation is not a linear process to Iordanou. He believes that innovation should occur in the business in many different ways all the time. It could represent a small tweak that makes an existing product better or come in the form of a strategic move such as the company’s entrance into mortgage insurance.

This more recent move was made in early 2014 when it moved into the mortgage insurance business by acquiring the assets of the bankrupt Private Mortgage Insurance company (PMI), for approximately $300 million.

Iordanou sees this foothold in the mortgage business as offering the company a third leg of diversified income that doesn’t correlate with its primary and reinsurance businesses. And that diversification has allowed it to enjoy continued growth and solid results at a time when others in the industry have floundered.

“I suppose some might call it innovative, but it is not a new product line for the market, of course, but it was for us and it does offer a separate earnings stream. It was a decision to enter a new sector of the insurance business that we felt was appropriate at the time and which offered opportunities based on economic conditions and macroeconomic factors,” Iordanou says.

Even within this space, Arch is not content merely to build a primary mortgage business. The company has again embraced innovation—it is one of just two companies that have introduced a risk-based pricing product into the market.

“We are trying to assess the risk in a different way than the industry has traditionally,” Iordanou says. “We do view that as innovation. We are trying to develop a more appropriate product for the customer that is based on the true characteristics of the risk.”

The move into the mortgage insurance business is a part of the reason Arch’s destiny is in its own hands, protecting it from the flurry of consolidations taking place elsewhere in the insurance industry. Iordanou says this is a good position to be in for a company amid turmoil and change elsewhere in the industry.

“We have our own path and we will try to grow in a different fashion,” he says. “Five years ago we did not have the mortgage operations, yet now that adds significantly to our business and it will accelerate in the future. We did not make a traditional acquisition yet it allowed us to expand capacity into that sector.”

 

Using new capital

Arch has also been at the cutting edge of innovation when it comes to leveraging some of the new forms of capital that has entered the industry in recent years.

It founded one of the first sizable property-catastrophe sidecars in the form of Flatiron Re in 2006 while Watford Re, which it launched in 2014, was one of the first ventures of this type also to offer investors exposure to casualty risks.

Iordanou is proud of Arch’s track record in this space.

“We were one of the first companies to create a big property sidecar after KRW (the 2005 storms of Katrina, Rita and Wilma). We ran it for three years until we determined the need was not there for it.

Watford represented a different way of introducing liability covers to a specific set of investors willing to take risks on both the asset and the liability side.

“That structure is very innovative. While currently privately held by investors, one day Watford may represent an industry standard for risk transfer and investors will trade its shares in the same way Arch allowed its private equity backers to exit via an IPO.”

He is underwhelmed, however, by the idea that this form of capital represents a radical change for the industry. He stresses that capital is fungible.

“The risk transfer business requires capital and if investors believe they can get a good return they will invest in our industry in whatever way they see fit. They commit capital, assume risk and seek a return.

How well that return pans out compared with their expectations will determine how much more they commit in the future,” he says.

He agrees that the industry is grappling with the challenge of overcapacity at the moment, which is a bigger problem at a point when demand growth is weak. But he stresses that some of this will disappear as investors either decide the returns are not good enough and/or find better investment options elsewhere.

“Whatever the challenges our industry is facing, it still produces reasonable returns, which are attractive compared with what is available elsewhere,” he says. “The problem is that everything else is unattractive. As investment opportunities improve elsewhere, capital will leave the industry.”

This strategy along with its mortgage insurance unit and primary operations gives Arch a nimbleness that is now the envy of many of its peers. Iordanou is clear that this diversity gives the company the luxury of flexibility and choice in tough market conditions.

“We try to navigate the market’s sometimes turbulent waters and adjust based on what parts of the business are profitable. The market is not completely efficient so it is not black and white. There will be pockets of profitable business even in sectors under great pressure from overcapacity.

“But that diversity and nimbleness has been part of our strategy since 2002 and our desire to maintain that flexibility is one of the main reasons we got into the mortgage insurance business as that is a very different business from re/insurance.”

While there seems no end in sight for either the soft market or the abundance of capital keen to participate in the risk transfer space, Arch Capital looks better placed than many companies to deal with that challenge in the long term. And with a mixture of industry legends Buffett and Greenberg in his DNA as an executive, Iordanou looks well placed to navigate even the choppiest waters.

 

Arch Capital, London, UK, AIG, Warren Buffet, Hank Greenberg, Constantine Iordanou, Insurance, Reinsurance, Innovation, Risk management, Property, Casualty

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