Viking

Bond yields moving up dramatically are going to result in a hit to year end book values for insurers (offset by gains in equities). Treasuries Dec 8 Sept 30 June 30 5 year 1.88 1.27 1.79 10 year 3.27 2.53 2.97 It looks to me that muni yields are also up about 75 basis points since Sept 30. There are so many puts and takes (particularly for insurers like FFH who also have hedges in place) that it will be very difficult to forecast Q4 results and YE book value. The good news from the rise in bond yields is insurers will be able to reinvest at higher rates which will help future earnings. Bottom line is the well run companies looks to me to be crazy cheap.

I believe FFH stated 15% increase per year in mark to market BV.

Here is a nice summary from WSJ: "Low Interest Rates Hurt Insurers' Bottom Line" online.wsj.com/article/SB10001424052748704405704575596932278239578.html With 10 year US Treasuries yielding 2.5% and 10 year corporates yielding 3.5% book values at insurance companies are high; the offset is operating income has been shrinking. When interest rates turn the opposite will happen with BV getting pressured (at first) but over time operating income will improve. It will be interesting to see what happens the next couple of years in this space. We have had two very slow years on the cat side of things so companies have been able to rebuild their balance sheets (and BV is high). Should we get above normal catastrophes (on a full year basis) things will really get interesting (only a matter of time).

Myth, I would argue that a compelling reason to buy now is because they are cheap. 1.) earnings are depressed. Underwriting profits are shrinking and bond yields are very low. 2.) they are out of favour and many well run companies are trading right around book value. The key point here, though, is the well run insurers are still VERY profitable (meaning you get paid to wait via dividends and growth in BV). When the hard market comes, earnings will improve and they will be back in favour. I have been very fortunate over the past few years of being able to time the market. I am in the process of trying to unlearn that (somewhat). When I find great opportunities (likely with a three to five year holding period) I am starting to establish a position (not too aggressive). Should a sell off happen then I will buy more. The risk I am finding in trying to get too cute with timing is great ideas can move up faster than you can pull the trigger and once you miss the initial move it is hard to get in (too tempting to wait for it to fall back) and as it keeps moving up you miss the initial 20% to 30% move. PRE is a great example (for me). I bought it in the spring and then sold it going into hurricane season (this was supposed to be a bad one) thinking I could buy it cheaper. And then got busy with life. Their business chugged along and the hurricane season was a non event. Stock was trading at $72; now it is trading at $82 and it is STILL dirt cheap. My learning is I got too cute (it is easy to identify the risks but not so easy to identify the positive catalysts). And, yes, I have reestablished a position.

I recently posted my thoughts on FFH Q3 results. Lots of things going on with insurers. I thought I would ask what board members were thinking right now. 1.) Does anyone like insurers at current price levels? 2.) If yes, is it a sector play? Re-insurers? Others? 3.) Or are there companies out there that people feel are dirt cheap? At current price levels, I like the re-insurer space and PRE (there are a bunch of cheap ones). And I also like WRB (as I have previously posted). My challenge with FFH is underwriting results will likely continue to be poor and I cannot estimate investment gains over the next 12 months (and I have been conditioned that positive moves in financial markets will not be reflected in the stock price in a timely way so I will likely have time to buy later should investments do well). So I will take a pass at current valuation.

I do find it fascinating to see how various companies are managing their business and capital during the current soft market. The re-insurers impress me the most as they remain disciplined on pricing (posting solid CR's) so when you fold in low interest and div income and decent investment gains you get decent overall results. and what are they doing with earnings? Buying back huge amounts of stock (given that most are trading at or below BV). FFH has been aggressive consolidators. Last year it was NB and ORH. This year it was Zenith. And they have made a bunch of smaller moves that I am having trouble following (shotgun approach versus rifle???); I am not sure how they can be sure they are getting best of class companies when they are making so many moves; perhaps they don't care given the small size (so I would ask who do it? Roll it all together and FFH has a bit of a conglomorate look to it... WR Berkley is growing organically (a while ago pulled in some teams from AIG I believe) and is using quaretly earnings to aggressively buy back shares (closer to re-insurers than FFH). It is easier to understand what the re-insurers and WRB are doing than FFH. But you have to love FFH track record the past 3 years.

I finally had a chance to gert through the quarterly report (needed a couple of drinks so if I make no sense I appologize). Here are my key takeaways: 1.) at 57 pages, not a light read (I noticed BRK's quarterly reports are also getting longer) 2.) ex ORH looks to me that FFH is writing at a CR of 110 (which is what WRB says 'industry' in US is currently writing at - but not reporting... perhaps they are on to something!) 3.) ORH had a phenominal Q3 4.) Goodwill and intangible assets = $943 million = $46/share 5.) net gains on investments = $68 million but the swings were wicked: bonds were up $422 million (looks to me that Zenith had lots of US treasuries); common stocks were down $388 million and equity derivatives lost $23 million. Not sure where the hedge fits in??? When I weave it all together and look out into the future I see a company: Underwriting (incl runoff) = -$200 Interest & Div = $600 Op Inc = $400 Int Exp = -$200 Corp = -$60 Total before investment gains = $160 million (= small potatoes) Until pricing improves (so CR improves) the company remains (perhaps similar to a few short years ago) a play of how you think they will do with their investments. If they continue to make shrewd investments then BV will grow.

Key Takeaway: "the supply of reinsurance capital continues to grow at a faster rate than insurers’ demand for capacity" = continued pressure on pricing come Jan 1, 2011 renewals. Drip, drip, drip... [ftp=ftp://http://www.aon.com/attachments/reinsurance/201009_ab_reinsurance_market_outlook_sept_2010.pdf]http://www.aon.com/attachments/reinsurance/201009_ab_reinsurance_market_outlook_sept_2010.pdf[/ftp]

Bottom line is the hedge funds felt that they could make money with FFH. - FFH had issues (two large aquisitions had reserving issues that FFH did not fully understand until after aquisition). - Stock had just started trading on NYSE. - Stock was thinly traded. - Confidence (banks, investors) was key to company remaining going concern. Having lived through the dark days, my takeaway is the hedge funds felt they could drive the share price lower through a short and distort campaign. Given the incredible volatility we saw in FFH shares my guess is they made money on the downside and also on the upside. What likely stopped FFH from going to zero was the strength of their management team and the relationships they had with the investment community that allowed them to get more capital despite the misinformation campaign being waged by the hedgies. In the dark days they were able to get money from Templeton, Markel and Southwestern. Times kind of felt like the wild West!

Why I love FFH: 1.) trust management (years ago I placed a very large bet back when the stock fell to $70 and it was based on this) 2.) investment returns (they are as bright as any group I know) Jury is out: 1.) how good they are at underwriting (need to see how they exit this soft market)

It looks that we have a partial answer as to what insurers will be doing with all the excess capital that is out there... share buybacks. Interesting to note that it is expected that re-insurer rates will be falling 2% to 5 % for January renewals. Swiss Re is targeting 12% ROE. When you look at low bond yields and falling pricing one has to wonder how long ROE's can stay at double digit levels. My guess is things may go sideways until reserve releases slow or natural catastrophes get back to more normal levels. [ftp=ftp://http://www.bloomberg.com/news/2010-09-13/swiss-re-to-spend-up-to-3-5-billion-on-buybacks-dividends.html]http://www.bloomberg.com/news/2010-09-13/swiss-re-to-spend-up-to-3-5-billion-on-buybacks-dividends.html[/ftp]

This is also something I am starting to think about for my kids (doing something at their school) although my oldest is only in grade 5. What about having 'the club' run some fundraising type activity, such as the school concession? Or they could run a fundraiser with the proceeds going to the school (and they need to research what kind of fundraiser, build a business plan and budget, manage people, execute, finish and then do a post mortem, including final financials). For older kids, I had a family friend run a Student Painter program one summer and he learned a ton (although he was third year university).

Just finished listening to the presentation and Q&A. For those interested in learning more about insurance, the future and WRB I highly recommend you listen to this. My key takeaways: Industry current year underwriting continues to be poor. As bond yields fall, interest and dividend income will continue to shrink. It looks to me that all that is saving the industry are reserve releases (likely being fueled by lower than expected inflation). Clearly not a sustainable situation. Perhaps all that is needed to drive in a hard market is a couple of large catastrophes. Regardless, once reserve releases are burnt through the day of reconing will arrive and select companies (WRB, BRK, FFH) will do very well. In the presentation Bill reviewed their minimal exposure to catastrophes so I will spend some time thinking about when I want to re-establish a position in the stock...

stahleyp, I am also optomistic that the US will get through this. I remember in the late 1980's at university being taught how the US (and their system) was doomed and how the Japanese (and their system) was the future.

Loved the article. Thanks for posting. Great sketch of one country and the issues it is dealing with. My guess is many counties are dealing with serious issues (that are all similar and not). Hard to see how the worst is behind us...

Munger, thanks for getting this thread going. I must admit that I am a history buff. I find I am spending lots of time these days thinking about the past, present and future. I am having a very hard time reconciling much. The Nikkei was 40,000 in 1989 and today it is trading at 8,870 (20 years later). I do not think this fall in value was due solely (or even primarily) to the Bank of Japan making policy mistakes. The 30's were a terrible time for many; my grandmother carried the lessons from that time to her grave (frugality; risk aversion etc). I also think that many things go in long cycles (i.e. bull markets & bear markets). To me China does look like the real deal; perhaps they will continue to develop and be a catalyst of growth. I also think John Mauldin is on to something when he says the US will rebound as some engine of growth will emerge (it always does, like WWII, computers, the internet etc); we just can't see it today (hence, why we tend to be pessimistic). If I was in my 20's or early 30's perhaps I would think about this stuff less and just invest and dollar cost average. Given that I am in my mid 40's and taking some time off, capital preservation is top priority for me (I am now 96% cash). I am more than happy to simply wait for a GREAT pitch from Mr. Market. My experience tells me to be patient and I will once again be rewarded in the next year or two (perhaps much sooner). Am I a market timer? Sure looks like it. But I don't care what it looks like as this approach has served me very well over the years and lets me sleep very well at night. Prem also is being very cautious right now; 12 months ago he was loading up with equities... FFH certainly makes massive changes to their portfolio over a 12 month period. Looks to me that they pay attention to the macro and also are students of history...

Sanj, I love your optomism! Yes, history teaches (and Buffett too) that the US grinds its way through these hard times and we, in short order, see economic growth again (and stocks do well). At least when looking at things post WWII. If we go back further, I think history teaches us something else: at certain times, things get really ugly for many year because (you can fill in the blank). I wonder if we are not in the midst of something a little uglier that what we have seen post WWII. If so, I would expect to see the economic situation get ugly and for financial markets to also reflect this reality. The economic situation looks to be playing out (looks ugly). The government bond market is playing ball (ugly). Common stocks... recovery just around the corner??? I think we may be at another inflection point. Maybe not. Upside potential is not worth the downside risk... for me. For others, fill your boots and best of luck!!!

Hawks, here is a summary from Calculated Risk of what he sees coming the next little while (and he simply calls things the way he sees them... i.e. he is no doom and gloom guy although he certainly sounds like it in this post). What makes me nervous regarding the market in general is it is priced currently for good things to happen although it looks more likely that things are flat to getting worse. If things are flat then my read is the stock averages retreat. If things get worse (good chance) then the sell off gets worse. What causes revolution is not poverty or treating people poorly; what causes revolutions are unmet expectations - when people expect something and they don't get it. My guess is this is also part of what causes the market averages to fall... when the economic news is worse than what people are expecting. http://www.calculatedriskblog.com/2010/08/more-negative-news-flow-coming.html But as many have said... if you find something in your sweet spot then back up the truck!

I love the discussion. As per usual, I have a few thoughts: 1.) to state the obvious, we all have a different intellect, psychological makeup and personal situations. We need to remember this when filtering what others post. For a little more insight, my personal situation is most of my investments are held in RRSP so I have no tax considerations when deciding what to buy and when to sell. As well, my account is of sufficient size that I simply pay a (reasonable) quarterly fee and pay nothing to buy and sell individual positions. Capital preservation is paramount to me as I almost have enough (although I did quit my day job 5 years ago). 2.) most of my friends are fully invested and have no idea what they are invested in or why. Complacency is my read of where 'the market' is today. Yes, everyone is very nervous. I do not see blood in the streets. My friends were freaking out in March 2009. 3.) Regarding current markets, the Guru I would probably put at the top of list (FFH) has been reducing their equity exposure the past 6 months and in the past three months began reducing their corporate bond exposure and just increased their equity hedges to 90%. FFH obviously does not like what they see right now. I also enjoy reading John Hussman and he lays out very well why he feels stocks (in general) are not cheap. I would feel a little better about the economic situation if the number of unemployed in the US was doing better than it is (and, yes, I know it is a lagging indicator). 4.) Bottom line, based on our personal situation and risk tolerances we have to do what we think is the right thing because we think it is the right thing (and not because we think that is what Buffett or Watsa or Templeton would do in the same situation).

87% cash; 13% equities (ABT, BAX & GVC).

the fact this was Buffett's only large recent purchase tells me all I need to know about current valuation (as I have said in the past holding this co is perhaps a better option than holding bonds). The fact that it is a large FFH holding further confirms to me that it is a solid long term bet. Having said all this my current favourite big pharma play is ABT. They are similar to J&J, but they are smaller and look to have a much higher growth rate (looking out 3 to 5 years). My guess is J&J will grow earnings 7-8% and ABT will grow earnings 10-12%. Both are trading today at similar PE's (around 12).

myth465, your Buffett quote below rattles around in my head quite a bit. Lynch has some great ones as well about the foolishness of trying to time the markets (I like to re-read One Up On Wall Street about every second year because I like Lynch's stuff so much). What gives me pause is the chance we are entering a 'US in the 30's' or 'Japan in the 90's' type slowdown (not necessarily another great depression; perhaps just a decade long absence of growth that rewards bonds and punishes equities as earnings shrink). I do not want to end up like Ben Graham in the early 30's; I want to keep what I got (as I almost got enough)! If I was younger, with a small base and adding to my capital every year in a big way then I likely would be more fully invested. Today I am 13% equities and 87% cash (having recently sold a chunk of equities); about 25% of my portfolio is US$; 75% is CAN$.

Insurers are currrently reporting pretty decent earnings. Underwriting income is decent (driven by reserve releases) and investment income is decent (driven by interest income and realized gains). Bottom line is capital in insurance is at a very high level. Having said all this, we can all see the storm clouds: 1.) accident year underwriting appears to be over 100; reserve releases should continue to trend lower 2.) interest income continues to fall as bond yields fall 3.) realized gains will likely diminish (given current bond and equity valuations) We look to be in the slow drip phase. My guess is until a meaningful amount of capital disappears the slow drip will continue. Berkley feels we will see a turn the end of this year. He's a pretty smart guy...

alwaysinvert, I agree that holding mostly cash is not ideal. I also am not trying to closely imitate Buffett or the other gods of value investing. I am going with a strategy that works for me (I sleep at night and my long term return has been more than acceptable). I have benefitted a great deal over the past 10 years by being very, very cautious. It's funny because my friends and family think I am an optomist; most on this board likely see me through my comments as being quite a pessimist. Past experience has taught me that there are times to be fully invested and other times when cash is a beautiful thing. Currently, my preferred asset class is cash and I have no problem holding a chunk for a year or two. Yes, stocks are not overvalued like they were in 2000. However, I do not think they are screaming buys like they were in the late 1980's. And it looks to me that a slowing of the economy is the most probable outcome over the next 12 months and stocks are not priced for this scenario; the risk of capital loss is too high and the reward is too low. If I am right I will do well; if I am wrong I forgo some return and I am OK with that.

It certainly looks to me that we are beginning to slip into what appears to be a multi-year deflation. My guess is the government is largely powerless to stop it, although they likely can make things worse with inappropriate policy decisions. The fact that we have not seen something like this in 80 years means most people do not get it (they only get and view as possible stuff they have experienced, and the more recent the better). The fact that Japan has been living it the past 20 years should provide valuable insights and more than a few lessons. I do not expect our current situation to mirror Japan but it perhaps will rhyme. At the end of the day, no one really knows. However, the risks appear to me to be rising to the extent that a possible deflationary period should be entering into rational investors thought process. If Ben Graham understood better the risks that were brewing in the late 1920's what would he have recommended an intelligent investor to do? Would he have said 'do not try and predict what the economy might do'? The first rule is capital preservation. If we have a situation where the probability of a deflationary depression is the highest it has been in 80 years (perhaps still only 20% chance of actually happening) my guess is he would recommend extreme caution. The reward is not worth the risk.