2018 shareholders letter

[Cigarbutt]

There is no specific regulatory requirement, but Fairfax could never put so much in equities that a major drop (of 50% type magnitude or more) would impair their claims-paying ability or their solvency as an insurer. Rather than look at it as “does fixed income cover claims?”, you might want to see it in reverse “does my capital cover my equity portfolio?”

 

At the end of the day, the claims are a revolving door. In any one period, Fairfax does not need access to most of its investments. But it does need to be (comfortably) solvent at all times.

 

Even Berkshire, with all of its earnings sources, has rarely had its equity portfolio greater than its actual shareholders’ equity (in other words, a leveraged equity portfolio).

 

Imagine for a second that Fairfax put 150% of its capital in equities — so call it $16 billion — which then fell 50% in a market rout. With $3 billion of capital left, they would be in very, very dire straits as an insurance company - the regulators could force them to raise capital, stop underwriting, dilute, etc.

 

So there are limits - but not hard limits. This is my understanding.

They have described before a "doomsday" scenario stress test, periodically used against their portfolio which would still result in their continued ability to write insurance business: 50% drop in the stock market and a 20% drop in convertibles and preferreds. This issue was raised at a recent conference call but I felt the answer was less satisfying.

 

I guess it's about the dual definition of financial flexibility (protect the downside and take advantage of opportunities).

 

Looking back, interesting to remember two episodes.

 

1-In 1999, they reported a 1,24B unrealized loss on their bond portfolio (about 10% of their bond position and about a third of shareholders' equity). They noted then that the unrealized loss had no impact on regulatory capital although I guess they had to show or explain how they could hold the bonds to maturity. About 50% of the bonds had a put feature with the potential to lengthen duration and maximize gain in a decreasing interest rate environment. Not only did the unrealized loss disappear but realized gains became significant, contributing to the great bond record. Given what they had to deal with around that time, share price declined and they did buy about 8% of shares outstanding in 1999-2000 with an average price of 258.38, not a great deal from today's observation point.

 

2-In 1990, they reported a 34M unrealized loss (26M from common and preferred stocks) which was about a third of shareholders' equity. The unrealized losses reversed remarkably and, in passing and with their share price going down with the mood of the time, were able to spend 17,46M and buyback 1.8M of their shares (average price of 9$ and about 25% of SO) and I would say that was one of their best transactions.

 

What's the point?

 

FFH have financial flexibility but IMO downside protection is not fortress-like and, because of that, the hypothetical ability to benefit may be muted.

 

This post made me re-read part of the 2001 annual report and that makes it quite obvious how things have changed. The most frequent reason (re)insurers run into trouble is inadequate reserving but asset quality is also something to consider under various scenarios.

[Dazel]

 

I am not concerned with the drop in holdco cash vs debt....they bought back more of their subs and they had a miserable year investing not unlike everyone else this time. I have argued and continue to argue their massive cash position and treasury position puts them in position to outperform the Markel’s of the world who got caught in quarter four of 2018. This has allowed them to fund AGT, Seaspan, Greek eurobank-real Estate merger funding if needed and to give Blackberry the courage to make a game changing acquisition and most importantly to me...to give Brian Bradstreet the ability to print cash (I like the corporate bond position and hope that he went bigger in quarter one...it is likely up 10 to 15%=$700m to $1b from dec 31). Fairfax and Prem’s gift are operating companies not stock picking. They are vultures....it has cost them lately but that’s how they built Fairfax. Bradstreet and

the insurance companies give me enough confidence that they will create very solid operating earnings...the investing side needs to do very little to create big numbers from the 2018 low.

 

In quiet year this year...Fairfax should make $3b pretax.

 

 

$1.73b pretax in the first 6 months...I know....no one cares.

Cheers,

Dazel

[John Hjorth]

... In quiet year this year...Fairfax should make $3b pretax.

 

$1.73b pretax in the first 6 months...I know....no one cares.

Cheers,

Dazel

 

I do, & I hear you, Dazel! [ : - ) ]