ERICOPOLY

I guess Goldman Sachs doesn't care, they upgraded Citi: http://wallstreet.blogs.fortune.cnn.com/2010/05/24/citi-rallies-on-upgrade/?source=yahoo_quote

Consider that it wasn't too long ago where for every put you sold at-the-money in SHLD you collected enough premium to purchase two calls at-the-money. This gave you 100% upside while only taking risk of 50% downside. Moral of the story: never dismiss an asset class.

It's fairly arbitrary isn't it.

The past few weeks I've watched my YTD gains go from +27% to +9.8% for the year. If only I'd locked in that 27% I would be a good deal better off. However if I were bearish enough to do that I doubt I would have racked up the 27% gain in the first place. So it's difficult to say if I cost myself anything.

Obviously he didn't intend for the stock price to fall after putting out the compensation proposal, but usually the parasite class-action guys will try and say he did. It might be true that he didn't intend for the stock price to fall, but I have trouble believing that he did not expect it to fall. I expected it to fall. Who here didn't expect the share price to fall? His compensation proposal destroys intrinsic value per share... there is only one way you can expect a stock to react to that kind of news.

Warren Buffett offered his strongest defense yet of Goldman Sachs, saying he doesn't believe the investment bank acted improperly in a sale of subprime-related securities at the heart of a Securities and Exchange Commission fraud case. http://money.cnn.com/2010/05/01/news/companies/buffett_goldman.fortune/index.htm

Today I listened to the replay of the conference call. Very interesting tidbit from Brad Martin: On an accident year basis they wrote a CR of 95% if you exclude ALL cat losses. This compares favorably to q1 2009 where they wrote 96.1% on an accident year basis, excluding all cat losses. Translation: They improved the CR by 1.1 points, exclusive of that which is beyond their control. They are hitting the ball better, fielding it better. Underwriting improved. Lumpiness in cat losses hides this underlying trend. They also said that they have $2.3b at holdco right now and will still have $1b after buying ZeniTh. Prem said high CRs at Zenith due to extremely soft workers comp market in California. Zenith wrote $1b a few years ago and now writes $400 -- so CR crushed by expense ratio.

If they have pricing power then inflation may help them up until the point it is time for them to refinance their debt. Then inflation will kill them. Inflation of course is good for high debt companies (with appreciable assets) over the near term as their assets grow in value (while their liabilities in the form of debt stay fixed), yet it is terrible for high debt companies when it comes time to roll over that debt. I think many forget to factor in refinance rates in high inflationary environments. One of the nuances I'm thinking of is that they already pay extremely high rates on their debt, much higher than average corporate debt costs -- my preliminary thinking is that this is partly based upon a thin margin between their total debt levels and what their assets would conservatively sell for at auction. Inflation widens that gap between liquidation and total debt. So if interest rates on corporate debt were to rise 700 bps, theirs might not rise as much. Or maybe their debt would go up just as much -- perhaps what's recoverable at liquidation matters less to investors than I suspect. Or maybe inflation would cause the opposite effect -- put such a squeeze on what corporations could afford to pay that instead of getting increasingly more money for sale of assets at auction, the bidders would simply be getting an increasingly terrific deal in real terms?

All right, so what you are saying is that you want lower CRs as a measure of margin of safety. Currently, at about 5% yield the insurance operations break even around CR of 115%. But they've been writing 105 CR despite some very nasty cat years. I imagine to hit the break even point of 115%, you could rewrite history of the past decade to include a disaster nearly as large as the Chilean quake EVERY SINGLE QUARTER. Fortunately, that 5% yield is just a conservative number and their actual returns were far in excess of that -- so they still made money on their insurance ops despite a Chile sized loss EVERY quarter. It looks to me like their insurance business isn't really that bad, and that there is a fairly large safety margin before taking losses.

It feels like LVLT would benefit enormously from inflation. Do I understand it correctly that the maintenance costs are low, that replacement costs and barriers to entry are extremely high? Further, long term demand is dependable and growing? Isn't their asset a real one and aren't they levered a very high amount against that asset? Would rising demand long term bring about pricing power to help them increase revenue at least in line with inflation? Would a high interest/inflation environment make it tricky for competition to find the money to lay new fiber? Or perhaps I'm ignoring a core reason why inflation would serve to hurt them instead? Thoughts?

Well, let's go back to the beginning of time (when they started Fairfax) and let's ask whether shareholders would have been better off in a hedge fund run by Prem. A couple of things go through my head. 1) book value per share for Fairfax has compounded far in excess of the pre-tax returns on their stock picking 2) the hedge fund therefore needs to use leverage to beat the book value growth rate Now, let's discuss these 105 CR's that you seem to think are worthless today... On $4b of underwriting this costs them 200m a year. But they have roughly 12b a year in float. For their hedge fund to invest 12b in bonds and have it only cost them 200m a year, they will need to borrow money at 1.67% per year. Where are they going to find money at 1.67% per annum interest cost? I won't wait for the answer, it's a rhetorical question. And suppose somebody did offer them some crazy low rate like that... is it callable? As in, a margin call? Who borrows money at 1.67%? Name a single hedge fund.

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 105 CR on 4b -- that 200m that I'm talking about is pre-tax. You seem to think it's after-tax... Do I have it wrong? I believe the hurdle on the incremental 3b of float is only 6.67% pre-tax. Not 10% pre-tax. When I worked at Microsoft, it amazed me that they launched product lines that never made money. I could suggest to Mr. Ballmer that we should just stop doing this... I mean, why launch products that won't make money? My point is that... nobody really belives that Fairfax intentionally writes an extra $3b of business on purpose where they need to make more than 6.67% investment performance to make it pay off. I'm sure anyone admitting to doing this would already have been dealt with by Prem. If they aren't doing it on purpose, then it's not going to be easy to identify exactly which policies to cut. One year it's a quake in Chile, the next year a windstorm in Europe, another year it's 9/11 and another year it's Katrina. Which lines do you cut... all of them? They each contribute equally. Next year it will be a hurricane in Hawaii or a quake in California. Maybe it will come again this quarter. I think it's whack a mole, where they can't just run in there and surgically cut out 3b of the most costly policies.

When you have CR of 105 on 4b written, you lose 200m to underwriting. But when you also are making 5% yield on 12b float, you wind up with 600m income. This nets out to 400m a year in profit from insurance operations. Some people think they are losing money from their insurance operations but I'm not in your club.

Cardboard, Regarding that pond... I found some facts on C&F's product mix. They have a much lighter mix of the business where Chubb has it's best CRs (Property & Multi-peril) In 2009 gross premiums written at C&F were $863.8m. $87.4m was in property and $81.5m was in multi-peril. So that represents only 19.5% of their business. Chub wrote $1,121m in Multiple Peril (85.8% CR) and $1,264 in Property and Marine (83.3% CR). That's 51.18% of their total $4,660m commercial business! Remember what I posted before about Chubb (look at where their sub-90 CRs come from): Chubb's 4 commercial classes of business: Multiple peril (85.8% combined ratio) Casualty (96.7% combined ratio) Workers' comp (92.7% combined ratio) Property and marine (83.3% combined ratio) Total commercial (89.9%) Also, I discovered that 23% of Chubb's market is "international" (South America, Australia, Asia). Don't know whether the pricing is better in those markets, but it looks pretty good in Asia judging by what Fairfax Asia produces.

You are correct, Chubb has been shrinking their net premiums. Their commercial lines declined just 2% in 2008 and a further 7% in 2009. But as Chubb states in their 10-k, some of that is due to foreign currency changes. Crum shrank by 16% in 2008 and a further 22% in 2009! I doubt it was foreign currency either.

Chubb is a big cookie. Cardboard has been putting up their numbers for the entity as a whole, but here are the results for their commercial lines in 2009: Chubb's 4 commercial classes of business (42% of Chubb's premiums written in 2009) Multiple peril (85.8% combined ratio) Casualty (96.7% combined ratio) Workers' comp (92.7% combined ratio) Property and marine (83.3% combined ratio) Total commercial (89.9%) Chubb's casualty business (it's worst measured by combined ratio) in 2008 and 2007 had combined ratios of 95% and 98.6%. The pond analogy might stick, or at least it might explain a lot of it -- for example, why is Chubb's casualty combined ratio so much worse than their Property&Marine? Further, if their overall commercial ratio is 89.9%, which is 6.8% better than their casualty combined ratio, are they doing most of their business in multiple peril and property and marine? And how does that compare to Crum&Forster? Is it the same pond? Does Crum&Forster write a heavy amount of multiple peril and property and marine? Or is C&F more weighted towards Casualty? Then, another topic is to notice that C&F's expense ratio was 4.3% higher than Chubb's during 2009. Unfortunately, the Chubb annual report does not mention what the expense ratio was for it's commercial lines, but rather merely states it for the company as a whole. Now, C&F had a combined ratio of 102.2% in 2009. If you strip off that 4.3% from it's higher expense ratio you get a CR of 97.9% for all of C&F compared to Chubb's 89.9% for it's commercial lines. But are the ponds the same? I think the choice of not discounting the reserves is making at least a 1% impact on CR, and that further knocks C&F down to 96.9% compared to Chubb's 89.9%. That's a difference of 7% overall, but again how much business does Crum write in the areas of Property and Marine and Multiple Peril (Chubb's best lines). Crum's adjusted CR is not that much higher than Crum's CR in it's Casualty line (2/10 of a percent difference), and it's 4.2% higher than Chubb's workers' comp number. Unfortunately, I can't find a breakdown of the CR's for C&F's different business classes.

Cardboard, If they are competing head to head with Chubb then the issue at hand is not one of underwriting discipline -- it would be either reputational or for some reason Chubb' clients have special loyalty. Chubb is much larger than Crum and Crum's volume is plummeting. There is some reason why Crum is losing business despite offering policies at lower prices. Call it the same pond if you wish, but there is something going on in the marketplace other than simply price. Does it make sense to explain the divergence as mere pricing discipline at Crum when Crum's volumes are dropping through the floor at a faster rate than that of the larger Chubb?

The numbers vary so much. Fairfax Asia always has tremendous underwriting, whereas C&F is high CR. Asia keeps growing whereas the falling volumes and high expense ratio at C&F is killing them. In the very long term, Asia will overshadow C&F. Don't fault Prem. C&F seems to be what it is -- not the same pond as Asia. I would bet that if you hired the Chubb underwriters to run Crum you likely would get the same CRs. I think it is a Carp pond where you catch carp, not trout. Now, if you double volume in a hard market you'll get underwriting profits at Crum high enough to fill in the holes you see today. I'm using Crum as a metaphore for all of their operations that earn high CRs. Not just picking on them. Generaly, their underwriting is far better than what existed prior to acquisition. So they have discipline, but I think they bought carp ponds and they won't produce trout.

Personally, I make use of the "except for" number to see whether the underlying trend of underwriting is getting better or worse. That's why it is valuable to me and I believe that is why it is valuable to Prem. You are misunderstanding his motives I think. Stated differently, Prem turns to his presidents and says, "Stop bullshitting me gentleman. I'm tired of you guys always obscuring your overall performance behind a big cat loss. You can't be a major league player unless you can consistently field and hit well. So you'll tell me how bad things are even without this big loss."

Imagine a world where they only provided the one large CR number... Can you guess what the first question on the conference call would be? My guess: "How big of an impact did you suffer from the Chile quake?"

Buybacks given out to officers for retention/awards do not help us out though. They buy shares every year for that reason. Not sure if they bought them for that reason this time, but at that pace it's probabably safe to say that they will give award at least that many shares in any given year.

Every time we have a big cat loss, somebody always grumbles that Fairfax states what the combined ratio would have been were it not for the big event. This quarter will not let you down, as there was the Chile quake and they state: The combined ratio of the company's insurance and reinsurance operationswas 111.5% on a consolidated basis, producing an underwriting loss of$122.6 million Prior to giving effect to theimpact of the Chilean earthquake losses, the company generated acombined ratio of 98.7% and an underwriting profit of $14.2 million. Okay, so it's time for somebody to step up and grumble about this again :)

6.4% gain in book value adjusted for the dividend (28.1% annualized).

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

Okay, I actually did some research (hurray!) First, turn to page 33 of 2009 annual report: The cost of reinsurance purchased by the company (premiums ceded) is included in recoverable from reinsurers and is amortized over the contract period in proportion to the amount of insurance protection provided. Next, turn to page 52 of 2009 annual report: Here on page 52 we find the effects of discounting: insurance and reinsurance liabilities overstated by $539.5m ceded reinsurance contracts overstated by $284 million The last thing we need to do is to subtract the overstated reinsurance recoverable assets from the overstated liabilities, and I get $255.5m total overstatement. That's before tax of course. Shareholders' equity is understated by $255.5m (pre-tax) due to their decision to not discount their liabilities and ceded reinsurance contracts.