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Fairfax Financial Holdings Limited: Second Quarter Financial Results


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Fairfax Financial Holdings Limited (TSX:FFH)(TSX:FFH.U) announces net earnings of $238.7 million in the second quarter of 2016 ($9.58 net earnings per diluted share after payment of preferred share dividends) compared to a net loss of $185.7 million in the second quarter of 2015 ($8.87 net loss per diluted share after payment of preferred share dividends), reflecting a net gain on investments, partially offset by a provision for (rather than a recovery of) income taxes, a lower share of profit of associates and a lower underwriting profit primarily as a result of catastrophe losses. Book value per basic share at June 30, 2016 was $406.07 compared to $403.01 at December 31, 2015 (an increase of 3.2% adjusted for the $10 per common share dividend paid in the first quarter of 2016).

 

"Our insurance companies continued to have excellent underwriting performance in the second quarter and the first half of 2016 in spite of the Fort McMurray losses, with a consolidated combined ratio of 95.7% and 94.5% respectively. All of our major insurance companies again had combined ratios less than 100%, with Fairfax Asia at 83.3%, Zenith National at 83.9% and OdysseyRe at 94.4%. Net gains on investments of $229 million included $640 million of bond gains, partially offset by the impact of stock price fluctuations. Our operating income was strong at $209 million," said Prem Watsa, Chairman and Chief Executive Officer of Fairfax. "We are maintaining our defensive equity hedges and deflation protection as we remain concerned about the financial markets and the economic outlook in this global deflationary environment. We continue to be soundly financed, with quarter-end cash and marketable securities in the holding company over $1.5 billion."

 

The table below shows the sources of the company's net earnings, set out in a format which the company has consistently used as it believes it assists in understanding Fairfax:

 

Second quarter First six months

2016 2015 2016 2015

Gross premiums written 2,620.2 2,052.6 4,964.2 4,116.8

Net premiums written 2,138.2 1,754.3 4,168.5 3,586.4

Underwriting profit 82.3 136.1 204.0 262.9

Interest and dividends - insurance and reinsurance 127.0 188.4 252.0 297.7

Operating income 209.3 324.5 456.0 560.6

Run-off (excluding net gains (losses) on investments) (1.1 ) 25.4 (16.1 ) 12.3

Non-insurance operations 41.9 38.6 54.2 57.3

Corporate overhead, interest expense and other (75.3 ) (100.2 ) (155.6 ) (187.5 )

Net gains (losses) on investments 229.2 (661.2 ) 69.6 (484.7 )

Pre-tax income (loss) 404.0 (372.9 ) 408.1 (42.0 )

Income taxes and non-controlling interests (165.3 ) 187.2 (220.4 ) 81.5

Net earnings (loss) attributable to shareholders of Fairfax 238.7 (185.7 ) 187.7 39.5

Highlights in the second quarter of 2016 (with comparisons to the second quarter of 2015 except as otherwise noted) included the following:

 

The combined ratio of the insurance and reinsurance operations was 95.7% on a consolidated basis, producing an underwriting profit of $82.3 million, compared to a combined ratio and underwriting profit of 91.9% and $136.1 million respectively in 2015. The combined ratio included 3.2 combined ratio points related to the Fort McMurray wildfires (a loss of $62.6 million net of reinstatement premiums), which principally affected the underwriting results of Brit, Northbridge and OdysseyRe.

Net premiums written by the insurance and reinsurance operations increased by 17.7% to $2,067.5 million, primarily reflecting the consolidation of Brit for the full second quarter of 2016 (net premiums written increased by 6.8% excluding Brit).

The insurance and reinsurance operations produced operating income (excluding net gains or losses on investments) of $209.3 million, compared to $324.5 million in 2015, primarily as a result of higher current period catastrophe losses and a lower share of profit of associates, partially offset by increased net favourable prior year reserve development. Share of profit of associates of $15.2 million decreased from $116.9 million in 2015, primarily as the result of the realization in 2015 of a $78.0 million gain on a sale of properties by certain Kennedy Wilson entities in which the company is a limited partner.

Interest and dividend income of $161.2 million increased from $147.1 million in 2015, principally due to increased holdings of higher-yielding government bonds and the impact of consolidating Brit's portfolio investments. As at June 30, 2016, subsidiary cash and short term investments accounted for 19.0% of the company's portfolio investments. Interest income as reported is unadjusted for the positive tax effect of the company's significant holdings of tax-advantaged debt securities (holdings of $3,828.0 million at June 30, 2016 and $5,017.7 million at June 30, 2015).

Net investment gains of $229.2 million in 2016 (net investment losses of $661.2 million in 2015) consisted of the following:

Second quarter of 2016

($ millions)

Realized

gains

(losses) Unrealized

gains

(losses) Net

gains

(losses)

Net gains (losses) on:

Equity and equity-related investments 23.9 (232.2 ) (208.3 )

Equity hedges (41.8 ) (163.1 ) (204.9 )

Equity and equity-related investments after equity hedges (17.9 ) (395.3 ) (413.2 )

Bonds 303.0 336.9 639.9

CPI-linked derivatives - (2.1 ) (2.1 )

Other (principally foreign currency) (11.5 ) 16.1 4.6

273.6 (44.4 ) 229.2

First six months of 2016

($ millions)

Realized

gains

(losses) Unrealized

gains

(losses) Net

gains

(losses)

Net gains (losses) on:

Equity and equity-related investments (41.8 ) (502.1 ) (543.9 )

Equity hedges (10.0 ) (303.3 ) (313.3 )

Equity and equity-related investments after equity hedges (51.8 ) (805.4 ) (857.2 )

Bonds 314.2 758.4 1,072.6

CPI-linked derivatives - (56.7 ) (56.7 )

Other (principally foreign currency) (123.2 ) 34.1 (89.1 )

139.2 (69.6 ) 69.6

As previously announced, on December 22, 2015 the company agreed to acquire an 80% interest in Eurolife ERB Insurance Group Holdings S.A. ("Eurolife"), the third largest insurer in Greece, subject to governmental and regulatory approvals and customary closing conditions. Closing is now expected to occur in the third quarter of 2016.

On June 27, 2016 the company, through its wholly-owned subsidiary Fairfax Asia Limited, agreed to acquire an 80% interest in PT Asuransi Multi Artha Guna Tbk, an Indonesian insurer. The transaction is subject to customary closing conditions, including various regulatory approvals, and is expected to close by the end of the fourth quarter of 2016.

On July 6, 2016 the company agreed to acquire a 100% interest in Zurich Insurance Company South Africa Limited, a South Africa and Botswana insurer. The transaction is subject to customary closing conditions, including various regulatory approvals, and is expected to close by the end of the fourth quarter of 2016.

The company held $1,523.1 million of cash, short term investments and marketable securities at the holding company level ($1,478.2 million net of short sale and derivative obligations) at June 30, 2016, compared to $1,276.5 million ($1,275.9 million net of short sale and derivative obligations) at December 31, 2015.

The company's total debt to total capital ratio increased from 21.8% at December 31, 2015 to 23.2% at June 30, 2016.

At June 30, 2016 the company owned $112.4 billion notional amount of CPI-linked derivative contracts with an original cost of $668.2 million, a market value of $227.3 million, and a remaining weighted average life of 6.1 years. The majority of the contracts are based on the underlying United States CPI index (52.8%) or the European Union CPI index (40.2%).

($ in millions)

Underlying CPI Index Floor

Rate (1) Average

Life

(in years) Notional

Amount Cost Cost (2)

(in bps) Market

Value Market

Value (2)

(in bps) Unrealized

Gain

(Loss)

United States 0.0% 6.2 $46,725.0 $287.2 61.5 $80.5 17.2 $(206.7 )

United States 0.5% 8.3 12,600.0 39.7 31.5 82.6 65.6 42.9

European Union 0.0% 5.4 45,187.9 297.4 65.8 56.3 12.5 (241.1 )

United Kingdom 0.0% 6.4 4,411.4 23.2 52.6 1.8 4.1 (21.4 )

France 0.0% 6.6 3,499.5 20.7 59.2 6.1 17.4 (14.6 )

6.1 $112,423.8 $668.2 $227.3 $(440.9 )

(1) Contracts with a floor rate of 0.0% provide a payout at maturity if there is cumulative deflation over the life of the contract. Contracts with a floor rate of 0.5% provide a payout at maturity if cumulative inflation averages less than 0.5% per year over the life of the contract.

(2) Expressed as a percentage of the notional amount.

At June 30, 2016 common shareholders' equity was $9,419.1 million, or $406.07 per basic share, compared to $8,952.5 million, or $403.01 per basic share, at December 31, 2015.

Fairfax holds significant investments in equity and equity-related securities. In response to the significant appreciation in equity market valuations and uncertainty in the economy, the company has hedged its equity investment exposure. At June 30, 2016 equity hedges represented 115.3% of the company's equity and equity-related holdings. The increase in the equity hedge ratio from 88.1% at December 31, 2015 primarily reflected additional short positions in equity and equity index total return swaps and unrealized depreciation of equity and equity-related holdings. The market value and the liquidity of these hedges are volatile and may vary dramatically either up or down in short periods, and their ultimate value will therefore only be known over the long term.

 

There were 23.2 million and 22.3 million weighted average shares outstanding during the second quarters of 2016 and 2015 respectively. At June 30, 2016 there were 23,195,480 common shares effectively outstanding.

 

Unaudited consolidated balance sheet, earnings and comprehensive income information, along with segmented premium and combined ratio information, follow and form part of this news release. Fairfax's detailed second quarter report can be accessed at its website www.fairfax.ca.

 

As previously announced, Fairfax will hold a conference call to discuss its second quarter 2016 results at 8:30 a.m. Eastern time on Friday, July 29, 2016. The call, consisting of a presentation by the company followed by a question period, may be accessed at 1 (800) 857-9641 (Canada or U.S.) or 1 (517) 308-9408 (International) with the passcode "Fairfax". A replay of the call will be available from shortly after the termination of the call until 5:00 p.m. Eastern time on Friday, August 12, 2016. The replay may be accessed at 1 (800) 879-1871 (Canada or U.S.) or 1 (402) 220-4708 (International).

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Fairfax is looking pretty attractive right around $500 IMO. Especially the way insurance has been going - I'm estimating something like $500M in gains simply from bonds/coupons in Q2. No idea what insurance and total equity exposure will do (too lazy to calculate the individual names at the moment), but inflation breakevens are lower across the curve this quarter boding well for their deflation derivatives too. A $500+M quarter wouldn't be too shabby for an $12B company.

 

Well, I wasn't that far off with my $500M for fixed income/interest as bonds provided $303M and net interest income was $160M, but expenses and underwriting results were a bit worse than expected. Not a bad quarter all around though, just not the $500M I had been hoping for with the rally in bonds.

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Hi guys,

 

Can somebody help me out with a dumb question:

 

Are loss ratios reported by FFH (or any other insurer) the cash cost of claims paid out in the period, the estimated cost of premiums sold in the period or something else?

 

Also, what is the relationship between reserves (and redundancies/deficiencies) on the loss ratios if any... Or put it another way, where are redundancies recorded on the income statement?

 

TIA

 

 

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Loss ratios reported are "incurred losses" vs earned premiums. Incurred losses are a combination of paid claims and loss reserves. Loss reserves come in two flavors. Case reserves which are established case by case by the claim department are an estimate of the ultimate value of an individual claim. IBNR (incurred but not reported) reserves are established by the actuarial department on a book of business basis. They reflect the company's experience that at any point in time for a group of polices there are claims that have occurred but have not yet been reported to the insurance company (when the are the claims department establishes case reserves and IBNR reserves diminish). Reserve deficiencies or redundancies occur over time, as a given policy year matures, the company finds out if all these estimates they've had to make are too low or too high.

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