Earlier this week, in an abrupt turn of events, Arch Capital announced the retirement of its former CEO and chairman, Marc Grandisson, and the elevation of Nicolas Papadopoulo, chairman and CEO of Arch Worldwide Insurance Group and CUO for P&C operations, in his place.
The reasons behind this are unclear, although the timing could have been better. The announcement fell on the date of the “Celebration of Life for Dinos Iordanou” gathering in Midtown, NYC.
The memorial event was attended by a “who’s who” of the insurance industry, with many current and former CEOs as well as founders in attendance, eulogizing Iordanou’s work ethic and his impact in shaping the culture of the company.
Under Iordanou’s tenure (2002-2017), Arch went from strength to strength and was consistently a top value creator with a 15% total value creation CAGR. Grandisson followed suit with a 13% CAGR.
For his efforts, Grandisson will walk away with a $428mn potential long-term payout - including 1.7mn of unexercised stock options and awards, which will become exercisable over several years from now, current ownership of 2.2 million in shares, which include triggered options and awards, and a potential partial bonus. See the appendix for additional details.
Grandisson’s untimely departure could have a ripple effect on long-term CEO planning. It comes at a time when the company and the broader industry are in a pivotal place in both insurance and reinsurance. Further complicating the issue is the high stock price and multiples of the company, with investors looking for stability in the near term.
The company is slated to hold its investor day on November 14, 2024, after a period of four years, which has been a pivotal time for the (re)insurance sector. Instead of presenting a refreshed story, Papadopoulo is likely going to end up playing defense on how the company will operate without Grandisson.
We discuss these in detail below:
A botched transition at a company with a deep bench creates departure risk
Typically, most larger companies follow a well-crafted succession plan so as not to upset the short and long-term rhythm of the business operations. These plans are triggered in the course of time or, as and when, any event occurs that necessitates a change.
For Arch, Grandisson’s role was well-telegraphed during Iordanou’s tenure, with the company's reins handed on in an orderly manner.
The same cannot be said of the new CEO, Papadopolou, who has had a limited visible presence.
The speed at which events transpired likely upset the plan to have an orderly handover since the last handover nearly took two years (2016-2018).
Unplanned successions can sometimes have a ripple effect on senior management, but Arch has a deep bench, as shown in the table below.
On the plus side, the team is well-steeped in the Arch culture. On the minus side, every organization needs fresh ideas and fresh direction, which can sometimes come externally.
An unplanned departure at a company with a deep bench can also create a flight risk for leaders or business heads.
Looking at Arch’s team, one could make the case that both Maamoun Rajeh (chairman and CEO, Arch Worldwide Reinsurance Group) and David Gansberg (CEO, Global Mortgage Group) could also be worthy contenders for the CEO position in the group down the road. As the following segment shows, mortgage insurance has been the most significant value creator over time. The reinsurance segment has also delivered value opportunistically, while the insurance segment, apart from the underwriting income, would also generate the larger part of the investment income.
However, there could be a clash between personal ambitions and which business segments contribute the most and least to value creation, coupled with whose age allows the ability to execute as a CEO for a ten-plus-year period or longer.
All these factors have the potential to come into play over the next few years and create a distraction.
Business mix has evolved, but mortgage is the star performer
Earlier this year, Arch announced a deal to acquire Firemen’s Fund’s middle market business. At that time, we noted that the deal was well-shopped, and Arch would have to do significant cleanup of the book. It will then have to eventually make a successful, competitive case against well-established middle market franchises such as Travelers, Chubb, or The Hartford.
The table below shows Arch’s evolution from a (re)insurer to a carrier which has the three legs of insurance/reinsurance and mortgage insurance.
Clearly, even when factoring in the investment income on the P&C side, mortgage insurance is the most significant piece, as seen in the underwriting income comparison.
The comparison between the segments is even more visible when comparing the segmental results against many big-ticket carriers.
The charts below compare the combined ratios of Arch’s insurance and reinsurance businesses against the median of a group of its peers.
Over the longer term, Arch’s insurance combined ratios have run hotter than the peer group while in contrast reinsurance has outperformed during the same period.
A detailed company-by-company analysis is included in the appendix.
With mortgage returns likely peaking and a middling insurance performance, there is an increased risk of whether it will struggle to deliver continued outperformance.
Returns and stock multiples are at peak levels, creating downside risk
Our past analysis has shown a close relationship between value creation and stock performance.
The chart below graphs value creation on the vertical axis vs volatility of return. The best place to be is on the top left of the quadrants shown below, since that translates into a high-value creation and low volatility, which is rewarded with a high stock multiple.
Arch Capital rightly lies close to other well-known value creators such as Kinsale, Progressive, and RLI Corp, to name a few.
This has translated into a higher stock return, as shown below, with Arch being the leader in its cohort. Only Kinsale, which is 100% E&S, outperformed it during the period, riding on the recent golden age of surplus lines.
Arch’s stock has been trading at a near-all-time high of $109.00/share, which equates to an all-time high price to tangible book value (Q2) multiple of 2.1x. Although that multiple is lower than Chubb at 3.4x, WR Berkley at 2.9x, or Travelers at 2.7x, it is materially higher than its perceived cohort of Renaissance Re, Axis, and Everest Group.
This creates a downside risk if there are any stumbles in the future execution at Arch Capital, and investors might look to rotate out of a priced-for-perfection story.
In summary, Grandisson’s untimely departure, which comes when the company and the broader industry are in a pivotal place in both insurance and reinsurance, could have a ripple effect on long-term CEO planning. Further complicating the issue is the high stock price and multiples of the company, with investors looking for stability in the near term.
Appendix
