vinod1

You are right. From Page 48 of AR "At the inception of the short positions, the resulting equity hedge ($1.5 billion notional amount at an average S&P 500 index value of 1,062.52) represented approximately one-quarter of the company’s equity and equity-related holdings ($6,517.9). At December 31, 2009, as a result of decreased equity and equity-related holdings of $6,156.5 and increased short positions, the equity hedges had increased to approximately 30%." Vinod

1. I take "ignore macro" guidance as essentially not trying to use macro factors (interest rates, growth rates, currency changes, etc) to form specific opinions on the direction of the stock market. I do not think "ignore macro" ever meant ignoring macro variables in valuing and evaluating securities (can the business survive high inflation, can be business prosper if there is a sharp drop in economy, can the business earn decent return on invested capital due to the likley foreign competition, etc). 2. This also resonates with what Grantham is saying recently about value investors. Many value investors, including people like Pabrai are essentially investing in stocks ignoring the risks on far left tail. They just seem to assume that things would not really get too bad. Most of the time they seem to assume that things would not get too bad. So their investment strategies would most likely get good returns as long as we do not have a Great Depression type scenario or something close to that. But if such a scenario does occur, they would suffer very large permanent loss of capital. Many of the smallest stocks with high debt loads or highly cyclical businesses would not survive a 1 in 50 year event. Yet this is precisely the area where several deep value investors seem to invest a large portion of their portfolios. This seems to me to be quite different from the types of securities that Graham (via requring very very stringent criteria as evidenced by his emphasis on earnings/survivability "under depression conditions") and Buffett have invested in (See's, GEICO, Coke, Washington Post, Gillette preferred, Amex, Wells Fargo, General Dynamics, Boeing, etc). I respect Pabrai and posters on this board a lot but just could not reconcile this seeming obliviousness to far left tail risks. Thanks Vinod

I gave a conceptual example in the report that should better explain how to value float. Vinod

Thanks for sharing. Vinod

You are correct. It should all be pre-tax. So the hurdle rate is only 6.7%. I might be wrong in this, but drawing a line in the sand on pricing so that you are only writing business that have an expectation of profit and let the float fall to whatever level it may be. Doing something like this should be possible - basically underwriting discipline. Overall the float does add value, I do not disagree with that. Paying 1.67% on float seems nice, but we know there are going to be surprises and they are only going to be negative surprises so there is always the possibility of much much higher costs than anticipated. This is basically what Buffett has emphasized so much in his annual letters: We have no interest in writing insurance that carries a mathematical expectation of loss; we experience enough disappointments doing transactions we believe to carry an expectation of profit. I guess this boils down to one of risk tolerance thing. Prem seems to be saying, let float cost a little bit more, we know we are going to do much much better investing on the float, so let us not reduce float all that much. Vinod

Three conditions that prevail in insurance, but not in most businesses, allow us our flexibility. First, market share is not an important determinant of profitability: In this business, in contrast to the newspaper or grocery businesses, the economic rule is not survival of the fattest. Second, in many sectors of insurance, including most of those in which we operate, distribution channels are not proprietary and can be easily entered: Small volume this year does not preclude huge volume next year. Third, idle capacity - which in this industry largely means people - does not result in intolerable costs. In a way that industries such as printing or steel cannot, we can operate at quarter-speed much of the time and still enjoy long-term prosperity. - Buffett in one of his annual letters

You need to look at the benefit of incremental float. I am not saying float has no benefit for fairfax. Say Fairfax is able to choke the 4b written at 105 CR by 25% so that you are writing only 3b at 100 CR. If they exhibit this level of discipline the float would be about 9b instead of 12b. (Calculating a crude average float tail of 3 years - 12b float/4b written). By giving up 3b float fairfax is able to save 200m. So the cost of incremental float is 6.7% after tax (200/3000) - so we need 10% pre-tax returns on the incremental float that need to be generated from the bond portfolio. Is this worth the cost and risk?0 Vinod

Instead of thinking in terms of absolute reduction in volumes, maybe, Prem is thinking more in terms of overall insurance leverage. There has been a pretty dramatic reduction in leverage to the point it is same as Markel. So viewing it this way, Fairfax has dramatically reduced its business compared to available capacity when compared to Markel and probably other insurers. Loss Reserves/Equity Loss Reserves/Equity (2000-2006 avg) YE 2009 Fairfax 7.5 1.9 Markel 3.2 1.9 Premium Earned/Equity Premium Earned/Equity (2000-2006 avg) YE 2009 Fairfax 2.0 0.6 Markel 1.1 0.6 Vinod

Thanks! I think you might have misunderstood, but the point I am making is that using that formula one can get any value one wants. Hence I am using the formula to make a point that it is better not to use it to value float. Vinod

“If you could see our float for the next 20 years and you could make an estimate as to the amount and the cost of it, and you took the difference between its cost and the returns available on governments, you could discount it back to a net present value.” —Warren Buffett, 1992 Annual Shareholders’ Meeting, as quoted in Outstanding Investor Digest. “[if] I were offered $7 billion for [$7 billion of] float and did not have to pay tax on the gain, but would thereafter have to stay out of the insurance business forever—a perpetual noncompete in any kind of insurance—would I accept that? The answer is no. That’s not because I’d rather have $7 billion of float than have $7 billion of free money. It’s because I expect the $7 billion to grow.” —Warren Buffett, 1996 Annual Shareholders’ Meeting, as quoted in Outstanding Investor Digest.

The bottom of page 33 (2009 AR) outlines how much this reinsurance program costs them each year. pre-tax net impact of ceded reinsurance transactions 2009: $337.5m loss 2008: $144.3m loss 2007: $388m loss I interpreted this slightly differently. I am not sure if the losses are calculated on a policy year basis. In the table on page 55 (Printed page #53) the losses reported are "Claims incurred ceded to reinsurers", seems to imply it does include IBNR which would be reported in the following years. So the loss of $337.5 reported in 2009 is not the full cost to reinsurer's or to Fairfax if it has not bought reinsurance. Thanks Vinod

The only bright spot in this picture is that virtually all of the underreserving revealed in 1984 occurred in the reinsurance area - and there, in very large part, in a few contracts that were discontinued several years ago. This explanation, however, recalls all too well a story told me many years ago by the then Chairman of General Reinsurance Company. He said that every year his managers told him that “except for the Florida hurricane” or “except for Midwestern tornadoes”, they would have had a terrific year. Finally he called the group together and suggested that they form a new operation - the Except-For Insurance Company - in which they would henceforth place all of the business that they later wouldn’t want to count. In any business, insurance or otherwise, “except for” should be excised from the lexicon. If you are going to play the game, you must count the runs scored against you in all nine innings. Any manager who consistently says “except for” and then reports on the lessons he has learned from his mistakes may be missing the only important lesson - namely, that the real mistake is not the act, but the actor. Inevitably, of course, business errors will occur and the wise manager will try to find the proper lessons in them. But the trick is to learn most lessons from the experiences of others. Managers who have learned much from personal experience in the past usually are destined to learn much from personal experience in the future. - Buffett, 1984 or 1985 Annual Letter

I do not think there is any issue with providing the additional information. The problem is how it is presented and seemed to be viewed by management as in: "We are pleased with the way our company has performed so far in 2010," said Prem Watsa, Chairman and Chief Executive Officer of Fairfax. "With a 98.7% combined ratio, excluding the impact of the Chilean earthquake, our insurance and reinsurance operations are off to a promising start, despite challenging industry conditions and the soft economy." Until Prem acknowledges and thinks of this as an issue, we would continue to have these kinds of underwriting results. Imagine, Oakmark Select's Bill Nygren saying to investors, excluding the effect of Washington Mutual, we have handily outperformed the market. We are proud of this performance and.... If Prem really thinks that it is better to have a little higher CR's since there are better investment opportunities available or for whatever other reason, I do not have any issue. He definitely has earned my confidence and would give him the benefit of the doubt if he comes out and says it. Thanks Vinod

Thanks! Fairfax has a 4% headwind compared to Berkshire in the cost of float. Investors accessing float via Fairfax also are paying this ~4% (2.6% cost of float + 1% tax drag). I do not think we can put a cap on the cost with any degree of confidence in Fairfax case. It requires super-human skill to overcome this when you are pretty much forced to do it with a predominantly bond portfolio (for the float portion). So float would not be worth as much as in Berkshire's case. Vinod Vinod

mpauls - Thanks! Schroeder's report went through the framework for valuing float in great detail and we have Buffett himself weighing on exactly how to value float as quoted in OID. The main point of contention between investors seem to be in how to value the growth in float on a conservative basis. Any thoughts/pointers would be most helpful. Vinod

I have put together some notes on Berkshire valuation using a couple of different methods. http://vinodp.com/documents/investing/BerkshireHathaway.pdf Vinod

I/EE bonds should be a no-brainer at the very least. They should yield about 3 to 4% over the long term and tax deferred. You can invest only about $20K per person per year (5K I bond electronic, 5K I bond paper, 5K EE bond electronic, 5K EE bond paper). There is a lock up period for 1 year. Vinod

here is the article http://news.morningstar.com/articlenet/printArticle.htm

The dividend income is estimated based on the article by Robert Miles that Buffett's personal portfolio is worth $1.8 billion. I had a read a post on this board or on fool that Miles incorrectly calculated Buffett's personal portfolio and that it is only $500 million based on Buffett's own comments in the last couple of years. Vinod

Bargainman, The three public subs are consolidated on the parents balance sheet i.e. assets/liabilities of subs are added up onto the parent's BS. Thus MV of subs does not enter into the accounting book value of L. Vinod

GMO has a new article on bubble developing in China. One tidbit - only two countries previously had as much in foreign currency reserves as a percent of GDP as China has now, US in 1929 and Japan in 1989. https://www.gmo.com/America/CMSAttachmentDownload.aspx?target=JUBRxi51IICi3XDk3kgShyaxnDe%2ft3GtNdfbW3V%2bu5X9OpjBFxQN1nv8Ys%2bCNCqeh9QLxflkBbA2yu17szUivY6GTiSswW%2bdKMPr52uvAJo%3d Vinod

Myth465 - Thanks! I am going to dig a bit deeper into L.

Myth465 I am unable to understand your enthusiasm for CNA. 1. In the last 10 years they managed to decrease per share book value at 3.5% (From $53 to $37). Since 1992, if you ignore the 50% jump in book value in 1995 they have not created any value. 2. Their combined ratio’s are horrible over the last 12 years, although they have improved over the last couple of years This abdominal performance seem to be vindicated by the market prices of its stock which is trading at a large discount to book every year since 1993 with exception of 2007. 3. Their assets have been larger than current year right from 1998 onwards but it did not seem to have done any good. The only investment thesis I can see is that the new CEO would transform CNA into a disciplined underwriter. What am I missing here? I am tempted to invest in L but cant seem to get past CNA. Thanks Vinod

Rabbitisrich, My understanding is that Policy year data would really be the ideal way to evaluate underwriting as it is the most accurate way to match premium received on a policy to the losses paid. The next most accurate way is Accident year development followed by Calendar year. Most companies seem to report only by Calendar year and just wanted to see if it would be possible to get by Accident year. Vinod

Hi Kiltacular, Thanks a lot. Exactly what I was looking for. Vinod