Fairfax 2023

[Munger_Disciple]

20 minutes ago, TwoCitiesCapital said:

 

I'm actually thinking the recessionary scenario is better for Fairfax than status quo now that they're locking in duration. 

 

Having $1B+ per year in stable interest income and/or billions on capital gains from Treasuries in a rate cur scenario gives them plenty to work with in the case of credit dislocation. This will be especially true if they start pairing down the TRS position prior to any recession taking away a potential liquidity drain from a dropping share price. 

 

Credit spreads haven't budged yet, but the pace of bankruptcies in the US is currently at levels that have previously seen 8-10% HY spreads (currently at ~5). If the Fed keeps hiking, I'd expect the pain will become more acute and we could see absolute mayhem in corporate spreads - IG and HY. That environment would give Fairfax the potential to reinvest gains/income at significantly higher rates than the 4-6% currently available to them

 

Yeah that's a good point. 

[jbwent63]

On 7/4/2023 at 5:46 PM, gfp said:

 

The way morningstar's chart works, they are telling you that Berkshire's A shares increased by that dollar amount during the period.  It isn't the closing price.

Thank you for the helpful response, unlike another just before yours....

[Intelligent_Investor]

Treasury yields are popping, 30 year bond now at a 4 handle, this could be very good for FFH

Edited July 6, 2023 by Intelligent_Investor

[gfp]

24 minutes ago, Intelligent_Investor said:

Treasury yields are popping, 30 year bond now at a 4 handle, this could be very good for FFH

 

Well they didn't bite the last four times it happened in the past 8 months.

[glider3834]

https://www.businesswire.com/news/home/20230706093283/en/AM-Best-Upgrades-Credit-Ratings-of-Odyssey-Group-Holdings-Inc.’s-Members

[nwoodman]

2 hours ago, glider3834 said:

https://www.businesswire.com/news/home/20230706093283/en/AM-Best-Upgrades-Credit-Ratings-of-Odyssey-Group-Holdings-Inc.’s-Members

Positively gushing, thanks for the link

 

“The rating upgrades recognize the removal of ratings drag from Odyssey Group’s parent company, Fairfax Financial Holdings Limited (Fairfax), which has demonstrated sustained improvement in its overall credit profile in recent years. Fairfax has reduced its debt leverage materially and improved its overall operating performance, while maintaining consistently sound balance sheet strength and financial flexibility. As a result, debt servicing metrics have improved sustainably, reducing the burden imposed on Fairfax subsidiaries and supporting the removal of ratings drag on Odyssey Group.”

 

Can take or leave ratings agencies a the best of times but this is well deserved .  Fairfax with a strong balance sheet who woulda thunk.

[Viking]

6 hours ago, glider3834 said:

https://www.businesswire.com/news/home/20230706093283/en/AM-Best-Upgrades-Credit-Ratings-of-Odyssey-Group-Holdings-Inc.’s-Members

@glider3834 thanks for sharing. Great to see the ratings agencies recognizing the significant improvements being made under the hood at Fairfax and its largest subsidiary. Its funny because it looks to me like AM Best might be further along in this regard than the equity analysts; probably because they are more specialized? 
 

Who is AM Best? 
 

AM Best is the largest credit agency in the world specializing in the insurance industry. It is the gold standard for insurance companies (please correct me if i am wrong).
 

What did we learn from this news release?

 

The financial strength rating of Odyssey has been upgraded to A+ (Superior). This is the same rating that AM Best currently has for both WR Berkley and Markel. As far as AM Best is concerned, Fairfax’s largest insurance subsidiary, Odyssey, belongs in that group.

 

Why the upgrade? 

• balance sheet strength, which AM Best assesses as strongest
• strong operating performance
• favorable business profile
• appropriate enterprise risk management

I am not an insurance expert. AM Best is. For those board members who are worried about ‘reserving’ or ‘risk management’, at least at Odyssey, things look very good. 

 

We also learn a little about Fairfax in the news release:
 

“The rating upgrades recognize the removal of ratings drag from Odyssey Group’s parent company, Fairfax Financial Holdings Limited (Fairfax), which has demonstrated sustained improvement in its overall credit profile in recent years. Fairfax has reduced its debt leverage materially and improved its overall operating performance, while maintaining consistently sound balance sheet strength and financial flexibility. As a result, debt servicing metrics have improved sustainably, reducing the burden imposed on Fairfax subsidiaries and supporting the removal of ratings drag on Odyssey Group.”

 

We also learn a little more about Odyssey in the news release:

Odyssey has been slowly building out is specialty insurance business (the business everyone is trying to grow because it is higher margin and has more of a moat) in the US and this positive development gets a shout-out from AM Best.

 

“Odyssey Group otherwise continues to produce consistently strong underwriting results, despite elevated global catastrophe losses and is well-positioned to take advantage of continued rate improvement in many of its key business lines. Odyssey Group’s risk-adjusted capitalization remains strongly supportive of its strongest overall balance sheet strength assessment, and the group continues to benefit from its position as a global reinsurer with a well-diversified portfolio that also includes a significant position in the specialty primary market in the United States.”

Edited July 7, 2023 by Viking

[Maverick47]

The balance sheet management for Fairfax has been impressive, compared to almost any other insurer not named Berkshire.  With interest rates rising, many other competitors saw the market value of their bond portfolios fall, in many cases reducing their policyholder surplus/shareholder equity year over year for 2022 over 2021, at the exact same time that inflation in loss costs was requiring dramatic rate increases.  
 

For competitors that were writing (in 2021) almost as much premium as their surplus could support, 2022 was a rude wake-up call.  All else being equal, to keep the same level of claims paying ability/AM Best rating in 2022 that they had in 2021 simply while writing the same customers (no growth in policy count) would require an increase in surplus roughly equivalent to the double digit rate increases many of them filed for in 2022.  

 

Since their surplus often dropped year over year at the exact time that they would have desired it to increase, they face some difficult management choices — they can limit their appetite for new business until surplus valuations recover, raise equity or debt, or watch their ratings possibly be put on watch with negative outlooks.  Fairfax is in exactly the opposite position (as is Berkshire, and, I believe, Markel).  

 

Reminds me of former Citigroup CEO chuck Prince’s famous quote before the 2008 mortgage disaster:  “As long as the music plays you have to keep on dancing.  We’re still dancing”.  With their refusal to reach for yield on their bonds, Fairfax is now reaping the benefits of taking the long term view for the health of their business over the long run.

 

 Now Fairfax can dance while most of their competitors have had to take a seat.

Edited July 7, 2023 by Maverick47
Readability and add name of Citigroup CEO.

[Haryana]

On 5/13/2023 at 10:29 PM, Viking said:

Fairfax Financial: 'The big fish that got away’

 

Investors have lots of regrets. Missed opportunities. 'The big fish that got away.' Like not buying Fairfax (or selling your position) at US$492 on Dec 31, 2021. On Friday, FFH shares closed at US$690. That is a 40% increase in 15.5 months. Fairfax also paid out two $10 dividends.

 

How has the S&P500 performed since December 31, 2021? It is down 13%. Yikes! That makes Fairfax’s performance even better!

 

But guess what? Fairfax is actually a better buy today (at US$690) than it was on Dec 31, 2021 (at $492). As we digest Q1 results, the big fish is back and once again taunting investors…

 

How can this be? It’s not that complicated if you believe the following: a stock is worth the present value of the cash flows that are expected to be generated in the future.

 

To prove our preposterous claim we need to answer three questions (we are going to keep things very top line… to make it as easy as possible to follow):

1.) what did investors expect future operating cash flows to be for Fairfax at Dec 31, 2021 when shares closed at $492?

2.) what actually happened with the business over the past 15.5 months?

3.) what do investors expect future operating cash flows to be for Fairfax at May 13, 2023 when shares closed at $690?

-----------

1.) what did investors expect future operating cash flows to be for Fairfax at Dec 31, 2021 when shares closed at $492?

• Fairfax earned $1.8 billion in operating income in 2021 (see table below) or $77/share pre-tax.
• investors expected this to increase to perhaps to $2 billion in 2022, with modest growth thereafter.
• that was the level of operating earnings that were built into Fairfax’s stock price of $490 at December 31, 2021.

2.) what actually happened with the business over the past 15.5 months? For this part, we are only going to look at three asset sales by Fairfax:

• in June 2022, Fairfax sold its pet insurance business for $992 million after-tax = $40/share
• in July 2022, Fairfax sold Resolute Forest Products at the top of the lumber cycle for $625 million plus $180 million CVR. Dec 31, 2021, Resolute had a carrying value of $276 million. With the sale, Fairfax crystallized $350 a million gain (plus $180 CVR). Let’s say this was a $10 after-tax gain (let's be conservative).
• in January 2023, Fairfax sold Ambridge Partners for $400 million plus $100 million performance incentive. Pre-tax gain will be $255 million (plus present value of performance incentive). The deal closed in May. Let’s say this is another $10/share after-tax gain.

These three transaction delivered an unexpected $60/share after-tax gain for Fairfax shareholders. This $60 was a one time gift for shareholders. Totally unexpected. Like finding a pile of gold in your back yard.

 

3.) what do investors expect future operating cash flows to be for Fairfax at May 13, 2023 when shares closed at $690?

• Fairfax earned $3.1 billion, or $132/share pre-tax, in operating income in 2022. This was much more than expected at the start of the year.
• Fairfax is poised to earn $3.8 billion in operating income in 2023, or $167/share pre-tax. Nobody thought this was remotely possible Dec 31, 2021.
• This is more than double what Fairfax earned in 2021, or an increase of $90/share pre-tax. Think about that. Double.
• And Fairfax is poised to earn $3.8 billion in operating income in 2024 and 2025. 

What happened?

• underwriting profit beat expectations: hard market is lasting longer than expected. In 2022, Fairfax grew net premiums written by 25% and delivered a better than expected CR of 94.7. 
• interest and dividend income: interest rates spike much higher than expected. And Fairfax just locked in higher rates moving from 1.2 year average duration Dec 31, 2021 to 2.5 years at March 31, 2023. 
• share of profit of associates: earnings from Fairfax’s collection of associate holdings increased much more than expected. This is expected to grow further in the coming years.
• all three 'buckets' are delivering much more earnings than expected - new records every year. Especially interest and dividends and share of profit of associates. 

Most importantly, 2023 operating earnings of $3.8 billion are expected to be the new baseline for Fairfax moving forward. 2024 and 2025 operating earnings should be able to grow from 2023 levels. In short, $3.8 billion in operating earnings will be D-U-R-A-B-L-E. This is the critical point that I think many investors are missing today.

 

So Fairfax’s stock price went up $200 over the past 15.5 months. Three unexpected asset sales delivered $60 after-tax to shareholders. That leaves us with $140. How much is an increase in operating earnings of $1.9 billion ($90/share pre-tax = $70/after-tax) worth to shareholders? Is it worth $140/share? It is worth much, much more than that. Because it is durable.

 

What is the better buy?

 

A.) Fairfax at $490/share at Dec 31, 2021 - knowing what was known then.

B.) Fairfax at $690/share at May 13, 2023 - knowing what we know now.

 

My choice is B. And it’s not even close.

 

Just like December 31, 2021, that big fish (called Fairfax) is once again staring investors right in the face. And guess what? It’s probably going to slip away from most investors for a second time. And in another couple of years they will think back to today and kick themselves. And the story of ‘the big fish that got away’ will get even bigger.

 

 

 

Maybe a good time to reread this post by Viking before the Q2 results.

 

[Thrifty3000]

23 hours ago, glider3834 said:

https://www.businesswire.com/news/home/20230706093283/en/AM-Best-Upgrades-Credit-Ratings-of-Odyssey-Group-Holdings-Inc.’s-Members

Great news.

 

My understanding is if a reinsurer fails to pay claims then the primary insurer is still on the hook for the liabilities. (That’s why insurers disclose gross premiums and net premiums.) 

Therefore the reinsured premiums involve a certain amount of credit/counterparty risk (which should correlate with the reinsurer’s credit ratings). That’s why higher credit ratings are an important competitive advantage for reinsurers. I’m sure the A+ rating increase will drive additional pricing power.

[Tommm50]

20 hours ago, Thrifty3000 said:

Great news.

 

My understanding is if a reinsurer fails to pay claims then the primary insurer is still on the hook for the liabilities. (That’s why insurers disclose gross premiums and net premiums.) 

Therefore the reinsured premiums involve a certain amount of credit/counterparty risk (which should correlate with the reinsurer’s credit ratings). That’s why higher credit ratings are an important competitive advantage for reinsurers. I’m sure the A+ rating increase will drive additional pricing power.

 

That's correct. The back end purchase of reinsurance does not alter the insurance company's obligation to the policy holder.

[racemize]

Saw this on twitter—any insurance insiders have any comments?

 

 

[Parsad]

1 hour ago, racemize said:

Saw this on twitter—any insurance insiders have any comments?

 

 

 

Dino has no idea what he's talking about.  Knows little actually about underwriting or what type of policies FFH is underwriting.  17 years of 100% or better CR isn't an indication if they are pricing premiums appropriately?! 

 

If FFH doesn't write good business, how did they know that other insurers were writing shit business on several occasions in the last 35 years?  You don't write crappy business while calling out your competitors underwriting.  They've also run surpluses on claims for a couple of decades...that isn't an indicator of appropriate pricing or risk management?

 

Go back and read the annual reports...which I bet Dino has not done!  Cheers!

[glider3834]

full disclosure guys thats me dino was replying to

cheers

 

[nwoodman]

Not an insurance insider, but the issue I have with this sort of "industry gossip" is that it is never specific. What long tail lines are they actually talking about?  Riverstone? Are they  pre/post Andy Barnard?   At least give us a hint or STFU.  If anything it sounds like a view that is about 13 years out of date.

 

When they picked up Allied World, Rivett actually named Med Mal as a potential issue but that those policies were all written prior to Fairfax's involvement

 

https://www.canadianunderwriter.ca/insurance/how-fairfaxs-allied-world-acquisition-is-working-out-1004163093/

 

If the perception that there is an insurance "sword of Damoclese" hanging over the company I hope it persists for  another few years and they retire 15-20% of shares outstanding in the meantime.

 

If they are talking about Riverstone then there may well be some skeletons but from my perspective the run-off business is idling

 

From the 2023 AR

"RiverStone, our run-off operation, ....... The industry continues to be challenging, especially in the United States with the plaintiff bar, armed with third-party litigation funding, continuing an aggressive push to create new mass torts. We continue to see development on asbestos claims as well as recent emerging claims such as molestation and opioids. Given

the nature of these claims, the results can be lumpy, with significant uncertainty around the eventual exposures and potential outcomes. RiverStone has been kept very busy focusing on our own latent claims and has not entered into any traditional third-party run-off acquisitions over the last number of years other than some small, very successful captive insurance deals. "

 

What is a runoff operation?

In insurance, a runoff operation refers to the process of managing a block of policies that a company has decided to stop writing or renewing. Essentially, the insurer continues to service the policies in the block (by paying claims, for example) until they expire, are cancelled, or all potential claim obligations have been settled.

During the runoff period, the insurer does not write new business or renew existing policies in that block. The decision to put a block of business into runoff might be due to various strategic reasons, such as a change in the company's risk appetite, a decision to exit a particular market, or a response to regulatory changes or shifts in the business environment.

 

[MMM20]

4 hours ago, nwoodman said:

If the perception that there is an insurance "sword of Damoclese" hanging over the company I hope it persists for  another few years and they retire 15-20% of shares outstanding in the meantime.

 

Exactly. And could be higher with the sorts of cash flows they've lined up and the auction buyback playbook.

[MMM20]

Value of BRK Float

By the way, a while back, my big thing was that Buffett and others kept saying their float is more like equity, and some even proposed to add float into the valuation of BRK stock. Like, literally, take book value of BRK, and then add to it the amount of float as if it were equity etc. I thought this was interesting, but sort of nuts. My argument then was that this “float” was actually never even invested in stocks or even their operating businesses as, up until that time, the amount of cash and fixed income on BRK’s balance sheet was always around what their float was, and never below it. This was true, by the way, only post Gen Re.

 

And with interest rates so low, I argued that the float is not worth all that much to BRK in that case. It adds some incremental income for sure, but nothing big enough to value all of float as equity. But now, with rates rising, the value of float is increasing.

 

Float at BRK as of the end of 1Q 2023 was around $164 billion, and cash / fixed income was around $150 billion, so it is still very close to the amount of float. But what has changed since my last post about all of this stuff is that interest rates are now in the 4-5% range. OK, so on the short end, let’s say it’s 5%. Assuming all of the cash / fixed income can earn 5%, that’s $8.2 billion in additional pretax income for BRK, or $6.5 billion after tax (assuming 21%). With $500 billion in shareholders equity, that adds 1.3% of incremental return on equity to BRK. If you value BRK at 20x P/E, this float earning 5% will add $130 billion to the value of BRK ($6.5 billion x 20). Well, this is kind of circular; assuming something earns 4% after tax, revaluing it back at 20x P/E etc… Anyway, $130 billion comes to 26% of BRK’s book value. That’s a nice bump compared to when interest rates were 0-1%.

 

https://brklyninvestor.com/2023/07/04/value-of-brk-float-buffett-market-view-etc/

 

 

 

Sorry about another float post…but the market is still way behind the curve on this for Fairfax. The impact of this alone is ~3-4x higher for FFH than for BRK — by my math something like +75-100% to fair value on book value. ~+$1-1.5B of net income = ~+$50 of EPS * low-to-mid teens fair multiple = +$600-800/share vs. prior fair value at 0% short term rates = ~US$2000 IVPS.
 

Maybe normalized short term rates are only 2-3%… but that’s still a few hundred dollars per share incremental to FFH fair value, and then they’re still getting zero credit for the many other recent positive developments. 

 

Edited July 9, 2023 by MMM20

[Luke]

Whats remarkable to me is the low volume of FFH shares, 31k of average volume, Berkshire would need to buy 60 days straight of all shares to get to a reasonable 1.3b USD position. If even possible, shooting up the price. Talking about available universe of stocks...

Edited July 9, 2023 by Luca

[SafetyinNumbers]

18 minutes ago, Luca said:

Whats remarkable to me is the low volume of FFH shares, 31k of average volume, Berkshire would need to buy 60 days straight of all shares to get to a reasonable 1.3b USD position. If even possible, shooting up the price. Talking about available universe of stocks...

It trades a bit more when including all the ATS besides just the TSX but your point is well taken. The link below lets one look at the last three months. 

 

https://www.stockwatch.com/Quote/Detail?C:FFH&snapshot=SX

[Thrifty3000]

12 hours ago, nwoodman said:

Not an insurance insider, but the issue I have with this sort of "industry gossip" is that it is never specific. What long tail lines are they actually talking about?  Riverstone? Are they  pre/post Andy Barnard?   At least give us a hint or STFU.  If anything it sounds like a view that is about 13 years out of date.

 

When they picked up Allied World, Rivett actually named Med Mal as a potential issue but that those policies were all written prior to Fairfax's involvement

 

https://www.canadianunderwriter.ca/insurance/how-fairfaxs-allied-world-acquisition-is-working-out-1004163093/

 

If the perception that there is an insurance "sword of Damoclese" hanging over the company I hope it persists for  another few years and they retire 15-20% of shares outstanding in the meantime.

 

If they are talking about Riverstone then there may well be some skeletons but from my perspective the run-off business is idling

 

From the 2023 AR

"RiverStone, our run-off operation, ....... The industry continues to be challenging, especially in the United States with the plaintiff bar, armed with third-party litigation funding, continuing an aggressive push to create new mass torts. We continue to see development on asbestos claims as well as recent emerging claims such as molestation and opioids. Given

the nature of these claims, the results can be lumpy, with significant uncertainty around the eventual exposures and potential outcomes. RiverStone has been kept very busy focusing on our own latent claims and has not entered into any traditional third-party run-off acquisitions over the last number of years other than some small, very successful captive insurance deals. "

 

What is a runoff operation?

In insurance, a runoff operation refers to the process of managing a block of policies that a company has decided to stop writing or renewing. Essentially, the insurer continues to service the policies in the block (by paying claims, for example) until they expire, are cancelled, or all potential claim obligations have been settled.

During the runoff period, the insurer does not write new business or renew existing policies in that block. The decision to put a block of business into runoff might be due to various strategic reasons, such as a change in the company's risk appetite, a decision to exit a particular market, or a response to regulatory changes or shifts in the business environment.

 

Something concerning related to this that I flagged in the annual report…

 

Asbestos provisions and amount paid:

 

2021 provision: $840 million

2021 paid: $150 million

 

2022 provision: $839 million (really?)

2022 paid: $132 million

 

2023 provision: $820 million!!

 

Anyone else see a problematic pattern there?!

[Thrifty3000]

7 hours ago, Luca said:

Whats remarkable to me is the low volume of FFH shares, 31k of average volume, Berkshire would need to buy 60 days straight of all shares to get to a reasonable 1.3b USD position. If even possible, shooting up the price. Talking about available universe of stocks...

Ha, what happens when the population of potential buyers of an asset consists only of value investors that will never pay full price?

[Viking]

56 minutes ago, Thrifty3000 said:

Something concerning related to this that I flagged in the annual report…

 

Asbestos provisions and amount paid:

 

2021 provision: $840 million

2021 paid: $150 million

 

2022 provision: $839 million (really?)

2022 paid: $132 million

 

2023 provision: $820 million!!

 

Anyone else see a problematic pattern there?!

@Thrifty3000 can you please tell me what the ‘problematic pattern’ is? We have know for years that runoff is a drag of $150 to $200 million per year. I don’t consider known events that are baked into historical results (and future estimates) to be ‘problems’. Is there something new here that is now emerging that is making this a bigger issue? Not speculation but something concrete?

 

With interest rates spiking, my guess is the runoff fixed income portfolio will be earning much higher interest income. This tells me runoff portfolio will likely be less of a drag on earnings for Fairfax in 2023 and future years than in recent years when interest rates were zero. But as i constantly say… i am not an insurance guy and so I remain open minded. 

Edited July 9, 2023 by Viking

[newtovalue]

@Viking - any estimate where you see Q2 2023 Book value standing when FFH reports later this month?

[SafetyinNumbers]

I’m going with $850

[Thrifty3000]

5 hours ago, Viking said:

@Thrifty3000 can you please tell me what the ‘problematic pattern’ is? We have know for years that runoff is a drag of $150 to $200 million per year. I don’t consider known events that are baked into historical results (and future estimates) to be ‘problems’. Is there something new here that is now emerging that is making this a bigger issue? Not speculation but something concrete?

 

With interest rates spiking, my guess is the runoff fixed income portfolio will be earning much higher interest income. This tells me runoff portfolio will likely be less of a drag on earnings for Fairfax in 2023 and future years than in recent years when interest rates were zero. But as i constantly say… i am not an insurance guy and so I remain open minded. 

I’m not suggesting this is a deal breaker concern. And, I don’t know whether FFH is handling it differently than other insurers.

 

But, back in 2015 FFH had reserved $896 million for asbestos. In my mind that suggests FFH expected to eventually pay $896 million. However, since 2015 they’ve actually paid something like $1.2 BILLION and they are still showing reserves of over $800 million.

 

If FFH has historically not discounted their reserves then it seems pretty clear to me they are intentionally under-reserving.

 

Let’s say in 2020 they had reported more realistic asbestos reserves - of maybe $1.5 or $2 billion - wouldn’t this have put even more pressure on their credit line covenants?

 

I’m trusting how they are handling asbestos reserves is above board with regulators, but there appears to be a strong incentive to under-reserve here, so I’ve flagged this as an area that I need to look into more.

Edited July 10, 2023 by Thrifty3000