LakesideB

Again .. they are not terrified of a 20% drop but of a massive 90% swing .. where they will effectively get wiped out. it's interesting they are worried about a global collapse but then they bought a serious chunk of bbry? doesn't make a lot of sense. BBry is about 3% or so of their portfolio so not that significant from their portfolio allocation prespective. Its a balance sheet play .. you could perhaps arrive at a liquidation value that is closer to $18 to $20. This ancors the downside. There is a transformation in the business happening where handset business will be less relevant as they become focused on deploying QNX as a security toll road for the enterprise and charge a recurring fee to get on this toll road. If they are successful this think could be worth substantially more. Whether the global crises happens or not in the long run enterprise need for security is not doing to go down.

Again .. they are not terrified of a 20% drop but of a massive 90% swing .. where they will effectively get wiped out.

They were worried about it going much much lower than 800. Prem has often mentioned the famous Ben Graham's saying about only 1 in 100 investors surviving 1929 if they weren't bearish in 1925. The Dow Jones went from 400 to 200 ... a 50% crash in the 1929 ... and if you weren't bearish u would seen the 200 level as a great opportunity to come right back in. The Dow reached 300 .. but what would have killed you is the the second leg of the crash which was a 90% drop !! It is precisely this severe second leg they are worried about. On a side note ... I have noted many think of FFH as someone who looks to profit from active macro bets. In my opinion this is completely false. Prem and his team are good in picking stocks and protecting their downside. The macro bets are there to protect their downside so that they can create value to do what they do best - pick great stocks. The cds bet was to protect them from recoverable from reinsurers, while the equity hedge is to protect against a massive drop in equity markets so that they can live to see another day. The former was an asymmetric bet, while the latter is a bet on their skills to deliver value well and beyond the market will do over the long term. Correct. But they have to do this because of the leverage. The 1 in 100 investor's not surviving "The Crash" is somewhat of a fallacy. That number would be 1 in 100 if the investor used leverage or were on margin. An investor who owned their stocks outright, or had the equivalent of a cash account, would have survived perfectly well as long as the underlying brokerage didn't go under because of fraudulent use of the investor's assets. The same would have been true in 2008/2009. Even when Buffett said that everything would have gone under, including Berkshire, but they would have been the last to fall, is because of the use of debt, leverage and especially counterparty risk. An investor who owned Coca-Cola outright would have no problem surviving a 1929 style crash. Leverage is great when things work, but it can kill you when things go wrong. Cheers! True Ofcourse. But here I think the concern is not of leverage killing them but MTM. P&C leverage has its advantages over traditional leverage. With equity mkt dropping however, their equity base will be marked to market and AMBest and rating agencies will essentially make it impossible from them to do normal business... possibly wiping them out should you have a cat event at the same time.

Hi Eric ... I am not sure how you could equate both to be the same .... If I loose 25% of my capital I need about 35% return to get back even... and if the loss is more than 25% the return required to break even gets exponentially higher. But surely you also know this .. so perhaps i am not getting what you meant to convey ..

They were worried about it going much much lower than 800. Prem has often mentioned the famous Ben Graham's saying about only 1 in 100 investors surviving 1929 if they weren't bearish in 1925. The Dow Jones went from 400 to 200 ... a 50% crash in the 1929 ... and if you weren't bearish u would seen the 200 level as a great opportunity to come right back in. The Dow reached 300 .. but what would have killed you is the the second leg of the crash which was a 90% drop !! It is precisely this severe second leg they are worried about. On a side note ... I have noted many think of FFH as someone who looks to profit from active macro bets. In my opinion this is completely false. Prem and his team are good in picking stocks and protecting their downside. The macro bets are there to protect their downside so that they can create value to do what they do best - pick great stocks. The cds bet was to protect them from recoverable from reinsurers, while the equity hedge is to protect against a massive drop in equity markets so that they can live to see another day. The former was an asymmetric bet, while the latter is a bet on their skills to deliver value well and beyond the market will do over the long term.

Its only "too hard" if you get too caught up in the weeds and miss the forest from the trees....

SD, I think P&C Insurance Not being an oligopoly is a very good thing. Alteast this allows guys like BRK, FFH, Greenlight, etc to come and set up a model where they can juice their returns even more provided they have adequate skills/temprament to do so. Imagine if the industry was one that was similar to industrial gas industry where there are only 5 players : 4 of which have been in existance for the last 100 years and the fifth one only entered the industry in 1980s. If you know the limitations of what you are doing, have the right mentality and the right structure, you should be able to get an underwriting profit regardless whether industry is able to collectively do this or not. For instance, in the last 35 years, the industry overall has only been profitable 3 times : 2004, 2006 and 2007. ROEs have rarely crossed over 10% ... but that doens't mean there aren't companies like Ace, Markel, etc who are able to consistently do much better than the industry. I agree both P&C and Airline aren't industries one would want to be in. But there is something very unique about the P&C industry. It has forbidden fruit of the 'free leverage' ... or the ability to have a big part of you asset base financed by a zero coupon perpetual bond . Many participants either become banckrupt in their pursuit of this in this comoditized industry... or if they manage to achieve it don't have the skills to utilize it to the max on the asset side of the eqation. BRK is that rare company that has been able to show skill on both sides of the balance sheet. FFH to me is well on its way to show its skill on the liability side. Ultimately, I feel its a business model that is not very well appreciated by investors and it completely baffles me as once you game this model, the power of this structure is tremendous. Mr. Watsa realizes that the value of this model is only harnessed by a relentless focus on the downside. The upside will take care of itself. Hence, the positioning. As he said in his annual report this year. 'The long term is where its at!'

Thanks ap1234. Excellent points. 1) Underwriting. I agree 96% accident yr number over the last 10 yr is probably not a good proxy for the future 10 years due to the massive hard markets of 2001. Although, I find that last hard market of 1984 - 1987 due to liability crisis resulted in even a bigger rate increases (closer to 50%) than the hard mkt following 9/11. Generally looking at the historical P/C cycles I find that hard markets in the last two decades have become shorter in duration and much further away from each other. This is obviously not a good trend for a P/C operator. The yield has allowed the weaker players to persist for much longer allowing for much longer soft cycles. Although in absence of yield, I don't know if weaker players have any place to hide. Something has to give and capital has to flow out of this industry if yields persist at these levels for much longer. As I said earlier, if you believe cat events are only increasing in frequency, this only means on a risk adjusted basis much of the capital is not earning any return so will flow out or risk becoming impaired. It bodes well for well capitalized P/C operators and especially ones which have a market neutral stance. But for my analysis I have assumed that the 96% calendar moves up to a 100% combined. So the 6.5% return is based on 100% combined. Anything below that should be a good positive. 2) I didn't say 7% to 9% on the full capital. The table I included was for their equity only performance including hedging. I was trying to point that given that chart ... wouldn't you take a 7% to 9% return over the long term on your equity portfolio while protecting your capital base? I recognize the equity portion is relatively small vs bonds and that they benefited from the massive tail wind their bond portfolio. But I offer two points: 1) Look at their bond performance relative to the benchmark 5Yr 10Yr 15Yr Taxable Bonds 14.0% 12.4% 10.8% Merrill Lynch US Corp 6.9% 5.7% 6.4% Diff 7% 6.7% 4.4% Presumably the benchmark has also benefited from the lower IR tail wind. In future this tail wind is no longer there ... so their outperformance can be viewed as an indication of what they will earn in absolute returns. Obviously they can play with duration and credit sprds to limit the destruction of rising rates... so their alpha is only a rough approximation of the absolute return they can achieve. 2) A rising rate environment should help them plenty on the yield side. Now regarding 30%+ cash: it can have two meanings. To a short term investor this is probably one of the biggest concerns. While a long term investor sees massive future optionality that exists in this positioning and a big reason to believe why they can do atleast a 6.5% return on their invested capital in the long run. Your suggestion to look at markel is great. I will pull up their numbers and that should help me get a handle on future combined ratio. For now I think assuming 100 is not too aggressive and a number which justifies why FFH's structure is massively better than an unlevered fund.

I agree with much of what giofranchi has said. I have only recently looked at the company so please take all this with a grain of salt. With respect to underwriting, I think looking at historic underwriting results is probably not that fruitful. Investors have to ask themselves two questions: 1) Why are the accident year and calendar year numbers so far off with each other:101.8% vs. 95.8% over the last 10 years 2) Is there a reasonable possibility that the two could converge in the near future? Calendar year numbers muddle things up for evaluating performance of an insurer. Much of the deterioration in the calendar yr numbers is due to bad/terrible business written prior to Mr. Watsa's leadership. Look at the accident year numbers - it shows that business written in the last decade, which captures the full insurance cycle, under Fairfax's stewardship was profitable. The answer to the second question is trickier and one that is contingent on you believing that when Prem says he is done buying distressed insurance operations he truly means it. The higher the business written under Fairfax's stewardship becomes as a % of the overall book of business the faster the convergence. This situation is somewhat similar to one of a rail investor in 2003. If one were to look at railroad’s decade long performance in 2003, you would have rightly summed up the business as terrible and one that hardly met its cost of capital. Hindsight is 20-20 but the genius was obviously in realizing the inadequacy of historical performance for railroads to predict the future. One truly had to focus on the transformation of the book of business in the railroad industry. A combined ratio of 100% meant an ROE of 16% in 1980s ... while right now its means an ROE of around 8% to 10%. The industry participants need to price properly or risk being eliminated. The increased cat occurrence means that they need to adjust their pricing to the new cat reality. In the current environment, in absence of yield to boost ROE, insurers are one cat event away from earning a negative ROE. So on the risk adjusted basis, the capital is earning low to negative returns. This is likely not going to last long. With respect to hedging……. the hedges are not to be confused with a short position on the index. The former is a market neutral strategy and the latter is one which has an unlimited downside. I am not sure I agree with the statement that hedging has neutralized their competitive advantage. Here is why. ... Take a look at these numbers: As at Dec 31, 2012 5 Yr 10 Yr 15 Yr Common Stocks (with equity hedging) 5.5% 14.5% 13.5% S&P500 1.7% 7.1% 4.5% Diff 3.8% 7.4% 9% If you truly believe in your competitive advantage of being able to pick stocks AND you are worried about the economy, then wouldn't you want to neutralize the lift you got from market returns in exchange for protecting your equity base against a massive crash? If you know you can achieve 7% to 9% returns with a market neutral strategy, while eliminating all the downside to your equity base, in the long run, wouldn't you take that bet? The above numbers actually understate the true outperformance as it includes the results on equity hedging. Their true unhedged stock performance is likely a lot more. That 7% to 9% market neutral unlevered return means wonders to FFH's shareholders in FFH's structure. This obviously means one has to take a long term view on FFH. Regarding comparison to an unlevered fund … having float finance a large portion of your capital is hugely advantageous if you can do a negative cost. It has value even if you have a positive cost but it has to be lower than the long term bond yield. If underwriting convergence happens, its possible that investors start to assume float as being a zero coupon perpetual bond similar to BRK. The bottom line I think is that FFH doesn’t need to do something massive to get to a 15% ROE. By my calcs it needs to deliver 6.5% on its $26b investment portfolio and with little help from convergence happening on the underwriting side, I think this should trade closer to 1.7 to 1.8 times book. I can see however, why its difficult to see how they are going to generate a 6.5% return in the short term given the massive cash and bond position.

Happy Birthday Sanjeev. What an amazing community you have managed to create. Bravo!

Any idea if Canadians can buy his funds? I have this impression in my mind that Canadians can't buy US mutual funds ... which really sucks if true as it precludes them from investing with some really great investors such as Berkowitz and Yatchman, etc.

Thanks gio for the wonderful quotes. Made my morning. Placed the order of the book this morning aswell.

Thank you racemize.

Appologies OP. I misunderstook and realize now that you want to be able to derive full accident year combined ratios for the subs. I wasn't careful enough to read your question carefully and thought you wanted to know the accident year development. However as racemize suggested, perhaps there is a way to get a reasonable approximation of what the accident year ratios would be. For instance, from the 2003 annual reports one could get the loss ratio, the cat loss ratio, calendar yr reserve development, commissions and expenses. Now loss ratio numbers would already have cat loss ratio and calendar yr reserve development embedded in it. If the cat loss number is not provided for that year in the AR, Prem has mentioned that typical cat loss ratio is roughly 6 combined points. The loss triangles will give the 2003 calendar year reserve development which you will subtract from loss ratio and apply the 2003 accident year reserve development instead. Add in the commish and expenses and you should be able to get a good enough estimate of what the accident yr combined would have been. Its a bit of work to do this for all the years as you would have to open individual annual reports to get the breakdown of combined ratios etc. racemize : would loveto get hold of your spreadsheet. Could you kindly attach it in your msg?? Also OP thanks for the info on Zenith. I have always wondered by Prem has always thought so highly of Stanley Zax .... especially when I see the combined ratios numbers since fairfax acquired them. I can finally realize what a terrific job they have done over the last three decades.

Hi Tom, Thats a phenominal set of slides and notes you have attached. Many thanks. As pertaining to loss ratios for Zenith. Here are the details I found from the annual report (pg 130) 2012 2011 Zenith loss ratio 77.9% 78% Commissions 9.8% 10.1% Und. Expense 28.2% 34.5% The loss ratios don't look that impressive to me. Especially when you contrast it with C&F at 73% and 72% as of 2012 and 2011 respectively. Perhaps that it not the right comparison as the former is doing workers comp and the latter commercial line insurance! It could be that he meant that among the group of worker comp insurers, Zenith has the best loss ratios, which may make sense as workers comp pricing is much harder to get right. Also the OP of this thread wants to know how to get the accident yr numbers for different subs. These are detailed quiet lucidly in the annual report for each sub. For instance, for northbridge accident yr loss triangle is on page 157. You can see from the loss triangle the development based on accident year which should reconsile with average numbers Prem gives out in his letter. Thanks

Thanks Uccmal.

Hi Guys, I recently read that 25Yr at Fairfax book. One thing that intrigued me was that Prem convinced the ICICI bank CEO to look at P&C Insurance instead of Life Insurance just as ICICI was about to enter the insurance business in India. I don't have the exact statement in front of me but from what I recall the reasoning was that with PC insurers all the value accrues to the shareholders and that was not the case with Life insurers. Could someone elaborate on how Prem reached this conclusion? Thanks

Thanks giofranchi. Do you have access to his prior letters? Would be great if you could post them here... Many thanks

I have access to some mkt data that probably isn't easily available right away to public .... as i work in the equity mkt industry .. I will leave it at that for now ...

Thats cause PD share supply is 1.47 ADV vs 15 ADV for fairfax

Expected indexer flows for Addition/Deletions to the MSCI Canada Index Ticker Name Weighting Change - bps Index Demand / (Supply) x/ADV Add / Delete DOL DOLLARAMA 36.38 1,724,000 4.77x ADDITION FFH FAIRFAX FINANCIAL HLDGS -59.80 (488,000) 15.13x DELETION PD PRECISION DRILLING -13.41 (5,765,000) 1.47x DELETION

Its beeing kicked out of MSCI Index .. as it failed liquidity test by a small amount (10bps or so )... there couldn't have been a better opportunity to buy at under book (which i estimate at 370 after brick etc) christmas gift coming early ...