Fairfax 2008 Year-end Results (February 19, 2008)

[Guest ericopoly]

Sounds reasonable Mungerville. 

[SharperDingaan]

 

Re the UW; you might want to normalize the last 3-5 yrs of CR against a broader view.

 

The income side has been artifically low for an extended period, as the assets were invested to maximize the compound vs cash (bond int/pref divs) return. Investment results have proven that this was the right strategy (CDS's, heavy cash weightings, etc.). But in reporting terms it moved some of CR return out to the day that the underlying investments were realized. Example: Holding a bond with a 3% coupon & a 20% YTM; will contribute only 3% cash to the CR today - but 20% on that future date when it matures. IE: YTM maximization does not translate into CR maximization. Going forward we should see mich higher income generation (convertibles at 10%+) which should push CR >100; & well > 100 if there is also a concurrent hard market.

 

Consider that if your people/approach didn't change, how did you suddenly became good at UW when you were supposedly useless at it before ? Weren't you allready good at it, but it just wasn't showing ? IE: measurement bias. Depending on the normalization assumptions everyone will get different results.

 

Normalized results certainly look like they are top quartile, & are consistent with what we'd expect from their approach. 

 

SD

[Guest misterstockwell]

Huh?

 

Interest income doesn't have anything to do with combined ratio

[FlyingArrow]

 

 

I'm still trying to wrap my head around this. We've seen the US/CAD dollar swing wildly over the past year and I don't ever recall seeing any discussion of combined ratio points swing associated with currency movements (either way) in previous quarterly or annual reports. I hope they make a point of discussing this on the call tomorrow.

 

Can anyone give me the "idiots guide to combined ratio impact due to prior years adverse reserve impact associated with US dollar strengthening" ???

 

Thanks Prem and team. It seems I'm not the only one confused. The first question was related to this and both Prem and Greg did a great job clarifying. Pretty straight forward.

 

Great call overall. I actually didn't realize how big Ike was (3rd biggest cat ever). While the massive gains this year on CDS and hedges won't repeat next year the combination of the increased income returns on the muni's, the reduction in minority interest due to NB purchase and ORH increased ownership, the upside associated with the common stock purchases (particularly since we took a nice OTTI) position us very well.

 

Man it's great to be a FFH shareholder!

 

Congrats everyone and great job Prem and Team!!

[tooskinneejs]

June 19, 2006:  FFH stocks sells for $88

February 20, 2009:  FFH earns $80/share.

 

Amazing.

[UhuruPeak]

I think I finally understand why they insist on giving us the CR "exclusive of cat", Greg alluded to it during his part: it gives us a way to compare year-over-year CR exclusive of irregular catastrophes.  I still think it would be best if they explained it in so many words, with a separate table showing us all what this adjusted CR looks like over a period of a few years, along with their estimate of the typical cat cost over time, to give us an idea of where they think a normalized CR should be.

 

 

Thoughts?

[FlyingArrow]

 

But seriously Eric, you've got to stop pumping this stock. I want to accumulate more before we get to 1.3x BV!!  ;D

 

Judging by Mister Market's response so far today it looks like I'll have no trouble accumulating all I want at or below book value!

 

Mister Market never ceases to amaze me. Just wish I had more powder!

 

Al, you might be scraping some more to pick up a few more leaps.

[Mungerville]

Ericopoly,

 

I think with that perspective, given lower stock market exposure, one can get comfortable with the downside in ORH pretty quickly.

 

I would think management would look at their downside potential in mark-to-market (not necessarily long-term value but mark-to-market value) book value in the same manner as I described above.

[Guest ericopoly]

The conference call indicated that they see a lot of margin of safety in muni spreads and corporate spreads.

 

1)  Assume spreads don't widen, and Treasury yields don't climb

2)  Assume 30% tax rate

3)  Assume 6.5% after tax yield

 

Given that 6.5% after-tax equates to 9.28%, and there's $2 bonds for every $1 equities, then a single year of bond interest income affords full protection against a further 18.56% drop in their equities portfolio.

 

This of course assumes no mark-to-market loss on their bonds.  The CDS is probably the hedge on widening spreads there.

 

I haven't included dividends on their equities and not talking about any money they make on their other $6b or so of cash & short term investments, CDS, etc...  You probably have at least full 20% equity drop protection per annum if you count in that stuff.

 

35% drop in equities then would result in a 12% hit to book value after adding in 12 months of interest income.

 

That's my view of the risk to book value from Mr. Market.

 

 

 

 

 

[SFValue]

irrelvant title  / good article

 

http://www.reuters.com/article/marketsNews/idCAN2026106920090220?rpc=44

 

 

 

 

[Parsad]

They still did not underwrite profitably, even excluding the currency issue. I'd like 5-10% underwriting profits to add to the stellar investment results. I just want to make the comparison to those who underwrite well--Fairfax's insurance companies definitely do not underwrite as well as their quality peers. That's my point, and one that Fairfax's peers have noted to me in conversations. It will be something to watch during the development of this hard market--how much will they increase premiums written and how profitable will it be?

 

 

 

That's rubbish!  I'm not sure what those "peers" have told you, but I'm guessing alot of it has to do with C&F and TIG's impact over the last few years.  Northbridge and Odyssey have outstanding underwriting standards and history.  As does Fairfax Asia.  The biggest problems were with Fairfax's U.S. insurance business and that was almost entirely attributable to C&F and TIG. 

 

It is also highly unlikely you will ever see a large property-casualty insurer get you underwriting profits of 5-10%.  That just doesn't happen.  Even Berkshire's historical underwriting profit has been only about 3.5-4%.  And I don't think that can be sustained either, because as soon as one big earthquake hits the West Coast, National Indemnity is going to take a significant loss.  Alot of people like to throw Markel's name out there, but much of their business is in specialty lines.  In general, a property casualty underwriters long-term goal is to have break-even underwriting, with gains from invested float accounting for profit.  The business is just far too competitive on pricing to allow any sustained underwriting profit for insurers.  Thus the short, swift cycles we see all the time.  Cheers! 

[oldye]

Getting 3-4% to invest 59 billion ain't so bad?

 

 

[valuecfa]

"In general, a property casualty underwriters long-term goal is to have break-even underwriting..."

 

 

That would be great!!

 

 

Underwriting will sometimes get lumpy, and the team at Fairfax deserve our thanks for an excellent year. If the market turns hard (with no catastrophes) , CR will improve in the future.

 

Those darn tail risks!

[Mungerville]

Ericopoly,

 

That's right.  Plus at that stage the market is hard as a rock for P&C insurance as half the industry would not be able to write as much business.  I would take a 12% hit to book for that opportunity. 

 

35% is one hell of a margin of safety.

[Guest ericopoly]

An interesting thing will be mean reverting convergence between munis and Treasuries.  That provides a margin of safety against rising interest rates.

 

[dual_bid]

Any idea what insured munis he's invested in? or what brk-sub insures?

[oldye]

Nope, we know that they are 7-10 munis 87% insured by Berkshire.  the Q4 numbers reflect a 5% increase in value, but like Eric points there is still room for further convergence (as we know yield of a risk free muni should be (treasury rate*1-tax rate)... I figure there is still room for 20-25% in mark ups

[watsa_is_a_randian_hero]

You can search municipal debt insured by Berkshire in Bloomberg.  It doesn't look like its a whole lot that they insure; just a handful of issues.

[StubbleJumper]

Wow!  FFH closed at US$257 today!  By my reckoning, the market is valuing it at about 85% of book, once you take into account the concealed value of ICICI Lombard.

 

After the past couple of years, this is truly astounding.  What does Prem have to do to get some respect? ??? ??? ??? ??? ???

 

SJ

[FlyingArrow]

 

But seriously Eric, you've got to stop pumping this stock. I want to accumulate more before we get to 1.3x BV!!  ;D

 

Judging by Mister Market's response so far today it looks like I'll have no trouble accumulating all I want at or below book value!

 

Mister Market never ceases to amaze me. Just wish I had more powder!

 

Al, you might be scraping some more to pick up a few more leaps.

 

Wow, I guess I really didn't need to worry about having time to accumulate at less than 1.3x BV!!

 

Very interesting times indeed. The leaps may prove once again an opportunity to enhance ones wealth when everyone is running for the exits.

[Guest ericopoly]

Ericopoly,

 

That's right.  Plus at that stage the market is hard as a rock for P&C insurance as half the industry would not be able to write as much business.  I would take a 12% hit to book for that opportunity. 

 

35% is one hell of a margin of safety.

 

 

Actually, I messed up the computation.  It's much better than I thought.

 

I forgot to add back in the deferred tax asset that would come from such a decline mark-to-market.

 

Assume 35% decline and 33% tax rate:

 

.65*.33*$4000m = $858m

 

Add back in $520m for after-tax bond income

 

That brings the loss back down to $338m. 

 

That's only a 6.76% hit to book value.

 

Then you have $1b invested in preferred, you have dividends on the common stocks, you have another $4b in short term investments, and you have (hopefully) underwriting profit.

 

Including those extras, you might whittle it down to break-even book value if CR were 97 (like last year without Ike).

 

 

 

 

[millsman]

Wow what a free-fall. Unfortunately Prem seem to have missed the top in gvnt bond and the bottom of this stock market. The damage are now huge on BV. Around 230 actually? But most important it's the big uw losses, again!. This year we can be without gains to offset operating losses. Maybe portfolio losses. We will see. They need to be perfect on uw side this year. After last couple of years claiming they will shrink to keep UW below 100, it's deceptive. We write in USA and yes we must expect some IKE. They don't shrink and priced right. I had faith in their discipline to keep uw below 100. It's why i'm loosing confidence. I'm a 10 years shareholders. Long term i know they will be right on investments side , but they need excellent UW to be alive long term.

[oec2000]

Millsman,

 

I wonder why you say that Prem has missed the bond mkt top and stock mkt bottom. They did sell their govt bonds at good levels and close out their equity hedges very close to the Nov mkt bottom.

 

I was not particularly bullish in guessing their BV prior to the results release but even accounting for the recent decline in stocks, I can't get to your $230 figure. It still seems to me that $260 is about the right level - before ICICI revaluation.

 

Their continued underwriting losses are more frustrating and I can see why you might be concerned. While it is true that their investment acumen has more than offset their 2-3% historical cost of float, the issue is why/how mgmt has not been able to meet their own target of 100% CR despite their repeated assertions that they will reject unprofitable business to do so.

 

If it is simply a mgmt issue, than I have confidence that this is solvable. However, if it is a structural competitive issue - i.e. they do not have a sufficiently strong competitive edge to maintain a reasonable level of business if they hold the line on premium rates - it might be a more difficult problem to solve. My inability to figure out what is the underlying cause is what bothers me.

 

The other thing that I cannot get my head around is the impact of USD strength on underwriting performance. Given that FFH reports in USD, I would have thought that non-USD liabilities would become smaller on translation into a stronger USD, not bigger. (I admit I have not read their results announcement in full yet so I might be missing something here.)

[millsman]

Don't really know about the bond, but they remove their hedge in november just before the december bond rally. With actual quarter another 500M would be good. For stock market bottom, when you look at 13F we lost 700M on stock since december 31. (WFC-GE)Common stocks cost 3964 and value at 3816 in last quarter. Roughly, and because they took big position, they probably are at 3100 on balance sheet. Yes, i know, we will see tax return on this. Maybe 250. But i prefer gains. Remove gains on last quarter results and they lose 206M on operation side. We don't know for Q1 2009 but why i would be optimist. They can lose 50M or 100M more. Some annonce an invisible hard market, i hope we will see real improvement and soon. Without the fall in stocks markets, nobody would be talking about hard market now. And this UW performance would be hard to swallow without these hedging gains. For the currency problem , it come from Advent and probably Northbridge. We can see advent showing an incredible 268%... but 42% before currency and hurricane!

 

Your comments on competitive edge seem the key to understand our UW performance. What's the price paid by our consumers vs competition offer would be interesting to know.

[T-bone1]

I hate to beat a dead horse, but with regard to many posters' comments/complaints about underwriting:

 

1) The portion of the combined ratio related to currency was directly hedged. This should not be thought of as part of combined ratio. They recieved an equivelent amount for their hedges. (I know it is a little confusing that they could have such a large move since they report in US$, but apparently a lot of non-US subs had dollar denominated liabilities). This portion of the combined ratio is simply irrelevent. It was a risk that was hedged out without counterparty risk (bought extra treasuries to hedge). This is not different than reinsuring a risk with Buffett . . . it should no longer count towards your performance.

 

2) The commutation of the reinsurance policy - to get the money now - hurt underwriting. This is a different issue, but again .. .  who cares? This has nothing to do with insurance: this was an investment decision they made that affected their combined ratio. It was a good decision based on the implied rate of return in the commutation an what they think they can make.  This is like the combined ratio being affected by the decision of whether or not to sell debt at the holdco level.

 

The CR for 2008 was 110.1

 

If you take out the commutation and the currency issues it was 104% . . . this isn't bad for a big catastrophe year.

 

They break out what it would have been without the catastrophe, 96.2% in 2008 and provide the 2007 CR also adjusted for the currency (benefit that year) for comparison. In 2007 it was 94.8% after removing the currency benefit.

 

I agree with many here that you should back out catastrophe's, but rather look at the average CR over time. However, if you figure the last two years where average (when in fact as a group of two years they were worse than average both for insurance rates and catastrophes) and you spread this year's cat losses (7.2%) over the last two years, then it would have been:

2007: 98.4%

2008: 99.8%

 

This looks pretty damn near the "zero cost float" everyone has been hoping for - And these were bad insurance years!

 

I don't mean to rant, as I know that everyone here is a fan of FFH management and that many who don't like the stock at these prices (or those of a few days ago) are past investors. But I must say . . . these guys are great investors on the long side, not the short side. Until last year, they had made almost all of their money on the long side (and preserved it by being more than prudent at very opportune times). I would posit that THIS MARKET we are in right now, not the overvalued market of 2007-2008 is the ideal time to be invested with Prem and his team.

 

I think that insurance results will be even better going forward, and they certainly have tailwinds to help this, but I think investment results will be stellar too. Everything in this company and management teams' philosophy and past performance suggests the best is yet to come. The notion that suddenly we can't afford to pay a few points for insurance float (not that I think we will) is a little silly in my opinion. If anything, we can afford to pay more for float now.

 

I would ask the question to those who are not interested in FFH at current prices (or roughly at book value): At what point in FFH's past has the outlook ever been brighter (balance sheet strength, investment opportunities, insurance market hardening)?

 

again, sorry for the rant. I obviously am emotionally attached to the company, but rationally, I can't figure out why now isn't the best time to buy FFH (other than saying there is "much cheaper stuff elsewhere"). If someone can explain to me why the outlook isn't as good as I think, please let me know. If someone sees a safe multi-billion dollar company that is a better buy right now, please also let me know why. If someone thinks my analysis is innacurate, offbase, or poorly spelled, those comments are welcome too.