In the last year, Arch Capital Group has sold some of its investments and all its reinsurance business and moved to Bermuda. It has repurchased 25 percent of its shares from its once largest shareholder, and bought a merchant bank specialising in the insurance industry. Arch Capital has also purchased a small, insurance-focused and under-capitalised–but otherwise successful–regional specialty insurer, and has announced the acquisition of a company in the alternative risk transfer business. Something else, big, seems to be in the air. All this, and Arch Capital is still at the preparatory phase of its new life, just warming up before the kick-off. What’s going on?
At the helm of Arch Capital is Peter Appel, a Harvard man with a taste and a talent for insurance and high finance. The company converged the insurance and banking worlds about five years ago, to form a merchant bank of sorts for insurance companies, when the rest of us were wondering if convergence was real or not. Oh, and the chairman of the group is Robert Clements, named the world’s insurance leader of the year 2000. Clements is one of the great figures of modern insurance. Bermudians know him as the man who, figuratively and this year literally, built his own wing on Hamilton’s international insurance structure.
At its founding in September, 1995, Arch Capital, then known as Risk Capital Holdings, was a one-stop capital shop for anyone in the insurance industry with brains and a good idea.
Geographically, we are, in a way, in the Valhalla of alternative risk transfer. Greenwich lies half an hour’s drive north of New York City, and is a bucolic hamlet that, like Hamilton, lies at the heart of a fabulous accumulation of insurance capital, both financial and intellectual. Among its treasures, Greenwich has a Starbucks and a town hall and a building on Horseneck Lane, with glass doors bearing the legend 20:20. It’s a fair summary of Clements’ career. Inside the doors are the US offices of the Arch Capital Group.
It is tempting to assume that when Appel and Clements renamed Risk Capital Holdings as the Arch Capital Group, they had in mind an arch between New York and Bermuda, or at the very least an arch between insurance and banking. Approaching the group’s offices on Horseneck Lane, however, one has to turn off Arch Street and that’s all there is to that.
The real story of Arch Capital isn’t Clements. It’s about the changing needs of capital; it’s about shaking off, finally, one or two of the strait-jackets the larger global economies have worn since the Depression; it’s about creative ideas; and in good measure, it’s about the very real insurance market that Bermuda has become. Arch Capital would not have happened under US regulations. Of course, it hasn’t really happened anywhere yet. Arch Capital is merely dusting off its quiver, and yet it may well become the insurance story of the year.
Listening to Appel and Clements share their vision, it is hard not to notice the subtext. Clements is the man with the past, and what a past it is (see sidebar p.54). Appel, then, is the man with the future, the 21st century insurance man, the brain now arriving on platform one. Both men are casually dressed, Appel in an open-necked shirt and chinos and Clements in a fleece, as if he were at a ski lodge, as relaxed in his skin as any man has the right to be.
Clements is living what might be described as an alt.corporate existence, able at his level to focus entirely on the things he enjoys and not bother much with what he calls “the ritual” of corporate life. His office at Arch Capital is anything but your classic rectangle with rosewood furniture, a couch and a chair. It has odd corners, a conference table, some lounge furniture, an action desk with neatly organised papers, chairs and, if necessary, room for impromptu dancing, although nothing of the kind was ever mentioned. Its walls are hung with his wife Marilyn’s art, bold statements in bold colours, which give the room a feel of theatre.
Appel’s office downstairs is more traditional, although it has the most excellent glass doors and a fine bay window. His desk is neat, too. It’s just rented space, but being at Arch Capital is much more like being at home with friends than one imagines Eastern Seaboard high finance to be. The atmosphere is not so much collegiate as post-graduate.
Appel is honest enough to say that he is not entirely comfortable with the glare of publicity, but has gone along at Clements’ bidding. Now that the spotlight is on him, he’s almost enjoying it. This is a man who knows his stuff. “When we were looking for a general counsel five years ago, the role Peter originally filled with the company, we had someone else in mind, who, we were told, was pretty much the best there was,” Clements confides, off-camera. “He turned us down, but did me a huge favour: he recommended Peter, who turns out to be even better.”
It’s time for a few questions.
Bermudian Business: Arch Capital Group has sold its reinsurance business, sold its investments in Latin America Re and Annuity & Life, bought one of its own investors and a private bank and moved to Bermuda. What’s the story?
Peter Appel: We want to build a diversified financial services company, based in Bermuda and with an emphasis on insurance, that has the capability of growing its top and bottom lines with both fee-based income and risk-based income, and we want to participate in the insurance sector with businesses that can capture premium from multiple points in the insurance chain. We intend to own insurance companies as well as creators and distributors of insurance products. Some of the premium that is controlled by these creators and distributors will be placed with our insurance companies. In harder insurance markets, we would expect to increase our risk-based activities, while in softer markets we will focus on fee-based sources of revenue.
The businesses that we acquire must be ones that we are capable of understanding and of providing oversight to, and must be run by smart and dedicated people, because we do not have the resources at our holding company level to micro-manage. Most of these businesses will fit together in some way. For example, Hales, our merchant bank, can help source clients for Altus, our alternative risk transfer business. Some acquisitions, though, will be purely opportunistic.
Robert Clements: That rules out manufacturing businesses, commodity businesses, retail businesses, and anything to do with a technology business, unless it has a particular focus on something we know about. When you look at our strengths, they’re in insurance and financial services, and the background of our board is similar to the background of our management. We’re good at intangibles, money-related business.
PA: We also expect that Arch will become, to some degree, viewed as a business that can provide a full range of capital-related services to the insurance distribution world. For example, if you’re an owner of an MGA (managing general agent) and are faced with significant capital decisions, Arch Capital could provide any of a number of solutions. If it makes sense to buy other MGAs or sell, Hales provides investment banking services specifically to insurance distributors and carriers; if the MGA is seeking relatively passive capital, Distributions Partners, a private equity fund devoted to insurance distribution deals, of which Hales is the general partner, could make an investment. If the MGA controls a meaningful amount of quality premium or is consistently profitable and well-priced, it could be a candidate for acquisition by Arch Capital. If the owners of the MGA wish to participate in the underwriting results of their business or simply need a policy issuing carrier, our recently announced acquisition, Altus, and its fully-licensed, A-rated carrier, First American, can help.
BB: So Arch Capital is a merchant bank for reinsurance companies?
RC: If you think about a reinsurance transaction, at the one end you have a policyholder, not us, and at the other end you have the reinsurer usually taking a principal portion of the risk, probably not us, either. Our services and facilities would be available along the entire chain of distribution, including the playing of any direct participating roles along the way. You could call us risk transfer facilitators.
We’re not going to be much involved in reinsurance, at least in the foreseeable future, because the capital required is beyond our current capability. We are more comfortable where we are meaningful players.
BB: If you’re looking to invest in companies with smart management, why did you sell your shares in Latin America Re?
PA: XL, our largest shareholder at the time, had previously acquired a direct competitor of our recently-divested reinsurance company. We obviously needed to address the situation. We happened to be co-investors with XL in a couple of companies that fit XL’s strategic needs, one of which was LARe. We were able to buy back our shares from XL for $12.45 per share in exchange for these semi-liquid and illiquid investments, with no additional cash (actually, we received some cash in the exchange). At the time our book value was around $20 per share so it was too good a transaction not to do, and it resolved nicely for both companies a situation that needed resolution.
RC: The relationship with XL was always outstanding in every way. It was useful to us and, we think, to them. We made quite a number of investments together. At the time it made its own investment, XL’s strategy was to be a Bermuda company with strategic investments. That strategy changed with the Mid-Ocean acquisition. XL now has operations all over the world and wanted to own an American reinsurance business.
PA: Even after XL left, (XL nominee directors) Ian Heap and Michael Esposito were asked to stay on and serve on our board ...
RC: ... because we value their wisdom and judgement.
BB: RCH, now Arch Capital Group, relocated to Bermuda late last year. Why?
RC: For a number of reasons. The overriding one is the regulatory environment. In the US, the Supreme Court ruled over 50 years ago that insurance was interstate commerce, but Congress decided to circumvent the effect of the decision and passed a law that returned the business to state control. We moved back to the 19th century at a time when the business was national and on its way to becoming global. Today, it is not possible to be competitive in a global marketplace and have your primary operations be subject to US state regulation.
Also important, unless you’re in the personal lines business, is that it helps to be in a marketplace, because that’s where you pick up information, get new ideas. That’s where the talent is concentrated and more readily available. That’s where the brokers bring their business. So, arguably, the leading insurance marketplaces today are London and Bermuda. There is more insurance capital in Fairfield County (in Connecticut, where Arch Capital has its US offices) and in New York City and in Switzerland, than there is in Bermuda; but those places don’t have the feel of a marketplace. Insurance is not what people at the next table are talking about at dinner, as is the case in Bermuda and in London.
BB: What was the purpose of the Hales acquisition?
PA: There were two purposes to the Hales acquisition. First, we believe that Hales is a valuable franchise in insurance distribution, with solid growth potential. But Hales is a relatively small business, given the size of our balance sheet, so the primary reason for the acquisition was more strategic than financial–we now have available to us a group of professionals, paid for in a business that we think was priced fairly on a purely financial level, who can help us find acquisition candidates, evaluate them, conduct due diligence, and monitor them if they are ultimately acquired. Two people in particular made the Hales acquisition very attractive–Marty Becker, its chairman, and Jeff Cappel, its chief executive officer. Marty used to run Orion Capital and has a great deal of experience in the insurance business. As an advisor to Arch Capital, he will play a vital role in what we are doing.
RC: Marty led Orion Capital into a merger with Sun Alliance. We’re delighted he has joined the board (of Arch Capital). Jeff has a wide network of contacts. He spends time sourcing and developing opportunities for us. They are two very talented personages.
BB: So what comes next for Arch Capital?
PA: We are focused on improving and growing our existing operating companies, and are evaluating a number of opportunities relating to the development of our fee-based business, as well as our existing businesses. It took us a year to sell our reinsurance business and reorganise in Bermuda and to take care of other matters relating to the positioning of our company. Although we certainly worked on formulating our strategy during this time, we now feel that we are finally positioned to execute it.
BB: In light of continuing moves in the US to persuade Congress to tax Bermuda insurance companies, whose side would you be on?
RC: We would be on the side of free trade, without territorial preferences. It’s very hard to support an idea like that, applied to a single country and a single industry. I think one of the reasons it’s not going to gain any headway is the fear in other global industries of protectionist interests in individual companies targeting competitors with legal and natural advantages.
BB: Tell me about yourselves and each other.
RC: Peter is an attorney with a Harvard law degree. When we formed RCH in 1995, Peter was one of its first employees, from a Wall Street law firm, one of the youngest partners they ever had. He did a lot of M&A work, including deals for big, famous insurance companies. We were fortunate to attract him as general counsel of RCH. When we decided to go in a different direction, by far the principal asset of the company was Peter. He’s extraordinarily capable in business.
PA: I have a wife, Polly, and three young sons. I live in Bedford, New York.
RC: He loves sports and is a great athlete.
PA: Bob is also a sportsman. He loves to be outdoors.
RC: I get exercise. I hate to walk. Kayaking, canoeing, tennis, biking.
BB: What is it about Arch Capital that appeals to a man who’s done everything in the business, really, and who, besides, is past retirement age? Why not hang up the phone and go kayaking?
RC: It helps you stay alive. My wife is a painter. Most of our friends are in the world of the arts, as opposed to business, and I have noticed over a period of time that they don’t tend to retire. A painter, Marilyn, for example, would not ever announce that she would retire, never again to put brush to canvas. That’s also true of writers, composers, and, I suspect, most people who really enjoy their work.
I became aware a long time ago that if I wanted to retire on my 65th birthday, I’d have to do it alone. So I tried to construct a business life that consisted primarily of those elements of the business that I enjoyed. Eliminate the administrative responsibilities, avoid committee meetings, and remove myself from the ritual that is such a large part of the obligations of corporate executives. I have been fortunate enough to be able to achieve the business life I wanted.
PA: When the change in Arch Capital occurred, and Bob asked me to stay on, I made it clear to him that he had to commit. He is of enormous value to the stockholders and this would have been far less interesting to me without him.
It’s of great importance to Bob that this be successful. He cares a great deal about the shareholders who have bet on us. Who knows if this is his last act? If it is, he’ll want to go out like Ted Williams, who hit one out of the park in his last at bat.
BB: Did ACE and XL succeed faster than you had imagined they would?
RC: They were designed with 21st century technology and communications in mind, and a paucity of physical plant. No controlled distribution system, extremely high productivity. Revenue per employee, five years in, averaged 15 to 20 times what their competition was achieving. If you go back and look at the 1990 annual reports, add up the premium and investment income per employee, in the average company it might be $500,000 or $600,000. At ACE and XL, it was $10 million. That let you hire a quality of talent on a whole new level. They were designed to use their capital for taking risks. For a long time, they had the highest retention rates.
The answer to your question is: no, they have succeeded slower than we thought they would, for two reasons.
First, although we did not want to form a mutual, the idea was considered so radical that we could not raise money from anyone but the policyholders. So we went to them, but we didn’t have efficient business structures at the beginning. ACE started with 35 directors, XL with 69. Fortunately, we had great leadership from the very beginning at management level, but it took an extended period of time to move the governance of the company to a format that would allow the company to run in an entrepreneurial way.
Second, what retarded the realisation of expectations was a 13-year soft market, because the natural, intrinsic advantages–low expense ratio, favourable regulatory environment, benign taxation, high talent–win over the long term; but in a cyclical industry, those advantages can take time to prove their superiority. BB |
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Golden Arches
