Fairfax 2023

newtovalue · September 9, 2023

15 hours ago, Thrifty3000 said:

Interesting you point that out, as I actually made a mental note recently that I’ve been seeing a pattern of deals valued around 1x premiums. I believe FFH has had some in this neighborhood recently. But, I’ve been meaning to follow up to confirm that it’s not just my imagination. I have a hunch you’re probably right on the valuation front. It actually makes perfect sense to have a valuation around 1x premiums if you assume the insurance income, investment income and growth will provide a reasonable long term return.

Yes agreed! I may go back and try to see where past insurance deals got done (relative to float).

this is another useful metric to either prove or disprove the thesis that FFH is cheap!

SafetyinNumbers · September 9, 2023

Fairfax buybacks in August

Viking · September 9, 2023

23 minutes ago, SafetyinNumbers said:

Fairfax buybacks in August

@SafetyinNumbers thanks for posting. It is nice to see the backbacks happening again. I am hopeful Fairfax can keep taking out a minimum of 2% of effective shares outstanding each year - keeping the trend in recent years going. The buybacks also signal the company continues to see their shares as being undervalued. Obviously shares aren’t as cheap as prior years but the company’s earnings and prospects have improved greatly in recent years.

SafetyinNumbers · September 9, 2023

1 hour ago, Viking said:

@SafetyinNumbers thanks for posting. It is nice to see the backbacks happening again. I am hopeful Fairfax can keep taking out a minimum of 2% of effective shares outstanding each year - keeping the trend in recent years going. The buybacks also signal the company continues to see their shares as being undervalued. Obviously shares aren’t as cheap as prior years but the company’s earnings and prospects have improved greatly in recent years.

They are definitely not priced as low but arguably cheaper based on the outlook. Durability is arguably up a lot too which reduces risk and allows for a higher multiple.

I’m not saying I can win these arguments.

UK · September 10, 2023

https://www.theinsurer.com/reinsurancemonth/odysseyres-overy-further-corrections-are-needed-at-1-1/

returnonmycapital · September 11, 2023

On 1/20/2023 at 10:21 AM, gfp said:

I had missed these filings showing Brian Bradstreet gobbling up Fairfax preferred shares in December -

https://www.canadianinsider.com/company-insider-filings?ticker=FFH

I like the same variable rate preferreds (series D/F/H/J) that Mr. Bradstreet has been buying. Fairfax has announced their dividends for the 4th quarter and they show current yields of around 11% (annualized) across the different variable-rate series. The series D is redeemable at par at the end of 2024 (F in March 2025, with H/J following in Sep and Dec, respectively). Based on the current declared dividends, the variable rate prefs are quite expensive for Fairfax (between 7.32% and 8.31% at par) and yield as much as double their fixed-rate equivalents. Of course, interest rates could always decline between now and the end of 2024 but they would have to go done a good deal to bring them back into line with the fixed-rate series. They're not easy to trade but given their cost to Fairfax, my thinking is Mr. Bradstreet sees a probability of redemption and, if so, the annualized return on today's prices range from 28% to 42%.

SafetyinNumbers · September 12, 2023

Lauren Templeton just dropped a new podcast featuring Ben Watsa

https://podcasts.apple.com/ca/podcast/investing-the-templeton-way/id1604395168?i=1000627607421

It’s a terrific listen for long term Fairfax and Fairfax India shareholders. He makes a very good case why India is a tremendous investment opportunity and provides comfort that Fairfax will have controlling shareholders that keeps the culture that his father has fostered.

Edited September 12, 2023 by SafetyinNumbers

glider3834 · September 13, 2023

10 hours ago, SafetyinNumbers said:

Lauren Templeton just dropped a new podcast featuring Ben Watsa

https://podcasts.apple.com/ca/podcast/investing-the-templeton-way/id1604395168?i=1000627607421

It’s a terrific listen for long term Fairfax and Fairfax India shareholders. He makes a very good case why India is a tremendous investment opportunity and provides comfort that Fairfax will have controlling shareholders that keeps the culture that his father has fostered.

agree - great interview & thanks for posting

Grenville · September 13, 2023

Thank you for sharing the interview. Nice to get to know Ben Watsa better along with his background. Appreciate his perspective.

I did think he was a good salesman when he talked up family control but part of me thinks that should be earned(either through purchased ownership or at the time of founding) versus given. Shareholders should have the ability to choose because there are a lot of counter examples to family control not always being in the best interest of short or long term shareholders. Also who knows how great Ben will be when Prem retires or who will take Ben’s place when he retires. Cementing control prevents any future check both short or long term.

It was cool though to hear the anecdotes about Sir John and Tony

SafetyinNumbers · September 13, 2023

4 hours ago, Grenville said:

Thank you for sharing the interview. Nice to get to know Ben Watsa better along with his background. Appreciate his perspective.

I did think he was a good salesman when he talked up family control but part of me thinks that should be earned(either through purchased ownership or at the time of founding) versus given. Shareholders should have the ability to choose because there are a lot of counter examples to family control not always being in the best interest of short or long term shareholders. Also who knows how great Ben will be when Prem retires or who will take Ben’s place when he retires. Cementing control prevents any future check both short or long term.

It was cool though to hear the anecdotes about Sir John and Tony

I think his task as future Chairman will be to maintain Fairfax’s culture and having grown up in it, he’s probably best suited to do so. Hopefully Prem still has a long tenure and it’s not a role, Ben, will have to takeover any time soon giving him that much more experience when he does.

Xerxes · September 13, 2023

23 hours ago, SafetyinNumbers said:

Lauren Templeton just dropped a new podcast featuring Ben Watsa

https://podcasts.apple.com/ca/podcast/investing-the-templeton-way/id1604395168?i=1000627607421

It’s a terrific listen for long term Fairfax and Fairfax India shareholders. He makes a very good case why India is a tremendous investment opportunity and provides comfort that Fairfax will have controlling shareholders that keeps the culture that his father has fostered.

thanks the post.
good to hear from him. Kind of funny that his kids own the very same stock that the grand dad would be shorting

Thrifty3000 · September 13, 2023

13 hours ago, Grenville said:

Thank you for sharing the interview. Nice to get to know Ben Watsa better along with his background. Appreciate his perspective.

I did think he was a good salesman when he talked up family control but part of me thinks that should be earned(either through purchased ownership or at the time of founding) versus given. Shareholders should have the ability to choose because there are a lot of counter examples to family control not always being in the best interest of short or long term shareholders. Also who knows how great Ben will be when Prem retires or who will take Ben’s place when he retires. Cementing control prevents any future check both short or long term.

It was cool though to hear the anecdotes about Sir John and Tony

I'm pretty sure I heard Ben say the company would always be professionally managed. If memory serves, I believe Warren Buffett once wrote that one of the most effective, if not the most effective, form of corporate governance stems from a controlling owner (like a family) hiring/overseeing a professional manager. It makes sense to me. The controlling owner has plenty of incentive to have the most effective manager possible, and therefore can hold the manager accountable for performance. It's much better than the alternative situations:

- where the controlling shareholder runs the company personally and doesn't answer to anyone.

- or where a group of disinterested board members care more about board compensation and notoriety (elephant bumping) than they care about holding the CEO accountable (see the majority of S&P 500 boards for examples).

Edited September 13, 2023 by Thrifty3000

UK · September 14, 2023

On 9/12/2023 at 5:40 PM, SafetyinNumbers said:

Lauren Templeton just dropped a new podcast featuring Ben Watsa

https://podcasts.apple.com/ca/podcast/investing-the-templeton-way/id1604395168?i=1000627607421

It’s a terrific listen for long term Fairfax and Fairfax India shareholders. He makes a very good case why India is a tremendous investment opportunity and provides comfort that Fairfax will have controlling shareholders that keeps the culture that his father has fostered.

Thanks! Very interesting!

Do I understand correctly, that letters of Marval Capital are available only for its clients?

Edited September 14, 2023 by UK

Hamburg Investor · September 14, 2023

On 9/1/2023 at 8:27 PM, Thrifty3000 said:

@Viking FYI as of the end of the second quarter the portfolio value had already surpassed your estimate for next year. I think you'll probably have to bump those numbers up, especially - as you mentioned - with GIG. (And, the portfolio excludes the spare billion sitting at the holding company, which is earning another $50 mil annually these days.)

Hi, this is my first post here, as I just joined, but have been following here for a long time. I am a Fairfax Shareholder since 2013. It's always been one of my Top5 holdings. Over the last year I bought more and more and it's my biggest stock holding today. I am German and live in Hamburg (sorry for my english...).

Totally agree, @Thrifty. I replied to Viking at Seeking Alpha regarding the assets topic here; unfortunately they kicked Vikings and my postings (don't know why...?) and as Viking asked me to join I just did and now I just thought to write that down again, why I think Assets should grow way stronger and more in a range of $4bn to $9bn per year over the next couple of years:

At the core my question was, if asset growth isn't a function of earnings and growth (... decline. ..) of float. So maybe something like: Add 1. Earnings (Dividends, interest, Earnings from profitability in insurance) to 2. return of stock portfolio (e. g. assuming 10% growth but subtracting dividends again, so not double counting) to 3. the swap (so assuming a price increase of Fairfax of e. g. 10%/year for being conservative and do the math, how the Swap as an asset develops from year to year...) to 4. growth of float (GIG to come...). Subtract taxes, overhead costs, runoff dividends, buybacks (although the last too add to growth of intrinsic value, but not to asset growth; but buybacks help accelerating the "per share" assets. One could assume reinvesting the dividends, for getting the IRR...). I am pretty sure I missed something and might be wrong with this or that, but maybe the direction of thinking is ok? Anyway, if one does that, you'll get way more assets growth from year to year. As Thrifty shows here, the asset base has grown around $3bn per year since 2 years, and then there have been headwinds to asset growth like the massive devaluation of bonds. So why should assets growth go back to $1bn?

Another perspective regarding asset growth could be to just look at Prems outspoken goal to grow Fairfax intrinsic value with a rate of return of 15% on average over the very longterm. If you think he'd manages that, then the assets (minus dividend, minus buybacks) should roughly grow at the same pace. So maybe 15% growth minus 1.5% (div) minus 3.5% (buybacks) for 10% asset growth/year (and around 13.5% assets per share growth). If you'd invest the divs back to Fairfax and leave away taxes and assume a buying price of 1.0 book, then the investors personal growth in Fairfax assets would again roughly equal that 15%.

And then I think, Prem wouldn't tell us shareholders 15% as a goal, if he would assume, reaching 15% being a "hard to do" thing. My best guess is that he'd communicate with a margin of safety. He'd tell us 15%, if he'd think that's safe and 16% or even 18% being a "maybe", but not the other way around. In fact he has reached some percentage points over that 15% CAGR over 37 years and this with just over a decade of zero rate interest in the rearview mirror (so just leaving a pretty hard time for insureres behind us, not to mention the soft market, growth beating value, the deflation insurance, that I wouldn't call a bet...). Look at Prems CAGR before interest went down.

And then there's another question: When, if not now, should Prem make over 15% to get to that average of 15%? When if not in a hard market, in times where value outperforms growth, when the companies CR is well below the first 20 years of Fairfax and below the 37y average? And then there's GIG, Digit, Eurobank, the Swap, Fairfax India at depressed valuation, all those wholly owned little insurance companies over the world really growing strong on average... Long story short: I think, Fairfax might grow intrinsic value (and asset base + divs + buybacks) well over 15% and should grow not below 15%. Therefore personally I think 15% for the next few years being conservative, so with a margin of safety included (of course it still could come worse as always, but I think this being a nice margin of safety, others may disagree, which is fine).

One note regarding relative valuation: The S&P500 is valued a bit above a PE of 25. Fairfax is valued at a PE of 6 (or 5). At the same time Fairfax roe (15%) might be above that of the S&P500 (return has been around 11.8% on average, so roe should be around that percentage too...). So Mr. Market seems a little bit weird again wanting 4 (or 5) times as much from me for each share of the markets "okay" earnings then for Fairfax "good earnings". If Fairfax would triple tomorrow and I had to choose either taking the S&P500 or Fairfax as a holding for 10 years, I personally wouldn't bet on the S&P500 being the better investamnt over the next 10 years.

Edited September 14, 2023 by Hamburg Investor

UK · September 15, 2023

On 9/14/2023 at 11:56 AM, UK said:

Thanks! Very interesting!

Do I understand correctly, that letters of Marval Capital are available only for its clients?

Also found this one: https://www.marvalcapital.com/interviews or https://vimeo.com/862872315

Edited September 15, 2023 by UK

Viking · September 15, 2023

On 9/14/2023 at 8:14 AM, Hamburg Investor said:

Hi, this is my first post here, as I just joined, but have been following here for a long time. I am a Fairfax Shareholder since 2013. It's always been one of my Top5 holdings. Over the last year I bought more and more and it's my biggest stock holding today. I am German and live in Hamburg (sorry for my english...).

Totally agree, @Thrifty. I replied to Viking at Seeking Alpha regarding the assets topic here; unfortunately they kicked Vikings and my postings (don't know why...?) and as Viking asked me to join I just did and now I just thought to write that down again, why I think Assets should grow way stronger and more in a range of $4bn to $9bn per year over the next couple of years:

At the core my question was, if asset growth isn't a function of earnings and growth (... decline. ..) of float. So maybe something like: Add 1. Earnings (Dividends, interest, Earnings from profitability in insurance) to 2. return of stock portfolio (e. g. assuming 10% growth but subtracting dividends again, so not double counting) to 3. the swap (so assuming a price increase of Fairfax of e. g. 10%/year for being conservative and do the math, how the Swap as an asset develops from year to year...) to 4. growth of float (GIG to come...). Subtract taxes, overhead costs, runoff dividends, buybacks (although the last too add to growth of intrinsic value, but not to asset growth; but buybacks help accelerating the "per share" assets. One could assume reinvesting the dividends, for getting the IRR...). I am pretty sure I missed something and might be wrong with this or that, but maybe the direction of thinking is ok? Anyway, if one does that, you'll get way more assets growth from year to year. As Thrifty shows here, the asset base has grown around $3bn per year since 2 years, and then there have been headwinds to asset growth like the massive devaluation of bonds. So why should assets growth go back to $1bn?

Another perspective regarding asset growth could be to just look at Prems outspoken goal to grow Fairfax intrinsic value with a rate of return of 15% on average over the very longterm. If you think he'd manages that, then the assets (minus dividend, minus buybacks) should roughly grow at the same pace. So maybe 15% growth minus 1.5% (div) minus 3.5% (buybacks) for 10% asset growth/year (and around 13.5% assets per share growth). If you'd invest the divs back to Fairfax and leave away taxes and assume a buying price of 1.0 book, then the investors personal growth in Fairfax assets would again roughly equal that 15%.

And then I think, Prem wouldn't tell us shareholders 15% as a goal, if he would assume, reaching 15% being a "hard to do" thing. My best guess is that he'd communicate with a margin of safety. He'd tell us 15%, if he'd think that's safe and 16% or even 18% being a "maybe", but not the other way around. In fact he has reached some percentage points over that 15% CAGR over 37 years and this with just over a decade of zero rate interest in the rearview mirror (so just leaving a pretty hard time for insureres behind us, not to mention the soft market, growth beating value, the deflation insurance, that I wouldn't call a bet...). Look at Prems CAGR before interest went down.

And then there's another question: When, if not now, should Prem make over 15% to get to that average of 15%? When if not in a hard market, in times where value outperforms growth, when the companies CR is well below the first 20 years of Fairfax and below the 37y average? And then there's GIG, Digit, Eurobank, the Swap, Fairfax India at depressed valuation, all those wholly owned little insurance companies over the world really growing strong on average... Long story short: I think, Fairfax might grow intrinsic value (and asset base + divs + buybacks) well over 15% and should grow not below 15%. Therefore personally I think 15% for the next few years being conservative, so with a margin of safety included (of course it still could come worse as always, but I think this being a nice margin of safety, others may disagree, which is fine).

One note regarding relative valuation: The S&P500 is valued a bit above a PE of 25. Fairfax is valued at a PE of 6 (or 5). At the same time Fairfax roe (15%) might be above that of the S&P500 (return has been around 11.8% on average, so roe should be around that percentage too...). So Mr. Market seems a little bit weird again wanting 4 (or 5) times as much from me for each share of the markets "okay" earnings then for Fairfax "good earnings". If Fairfax would triple tomorrow and I had to choose either taking the S&P500 or Fairfax as a holding for 10 years, I personally wouldn't bet on the S&P500 being the better investamnt over the next 10 years.

@Hamburg Investor thank you for coming over to the dark side and joining CofBF. The more discussion and debate we can get the better. We are all trying to learn (and hopefully make a little money along the way).

Your post above outlines a major flaw with my 3 year forecasts for Fairfax: i am likely being too conservative for 2024 and 2025. Part of this was by design. When i started at Kraft many years ago one of my first bosses taught us newbies the art of sandbagging when building a forecast (very important when your quarterly bonus payout was tied to it).

On reflection i likely need to make some adjustments to parts of my 3 year forecast (i feel a little like i am getting my hand slapped by senior management - a little sandbagging was ok… but too much got you into trouble).

What am i missing? Two things:

1.) capital allocation skills of Hamblin Watsa: they have been hitting the ball out of the part since 2018 when it comes to capital allocation.

2.) power of compounding - well understood by members on this board:

- a 15% return per year is a double in less than 5 years.

- a 20% return is a double in about 3.5 years.

So yes, i need to get more realistic with my estimate for how fast investments (and returns from those bigger numbers) will be growing in the coming years. Growth of growth is the secret sauce that is now kicking in at Fairfax (due to double digit growth in insurance and investments AND improving underwriting and much higher investment returns).

Today, Fairfax is delivering a 20% ROE. I think they will be able to deliver a high teens ROE over the next three years (2023-2025).

I like my earnings per share estimate of $160/share for 2023. My estimates for 2024 ($165) and 2025 ($174) need to move higher.

Edited September 15, 2023 by Viking

SafetyinNumbers · September 15, 2023

4 hours ago, Viking said:

@Hamburg Investor thank you for coming over to the dark side and joining CofBF. The more discussion and debate we can get the better. We are all trying to learn (and hopefully make a little money along the way).

Your post above outlines a major flaw with my 3 year forecasts for Fairfax: i am likely being too conservative for 2024 and 2025. Part of this was by design. When i started at Kraft many years ago one of my first bosses taught us newbies the art of sandbagging when building a forecast (very important when your quarterly bonus payout was tied to it).

On reflection i likely need to make some adjustments to parts of my 3 year forecast (i feel a little like i am getting my hand slapped by senior management - a little sandbagging was ok… but too much got you into trouble).

What am i missing? Two things:

1.) capital allocation skills of Hamblin Watsa: they have been hitting the ball out of the part since 2018 when it comes to capital allocation.

2.) power of compounding - well understood by members on this board:

- a 15% return per year is a double in less than 5 years.

- a 20% return is a double in about 3.5 years.

So yes, i need to get more realistic with my estimate for how fast investments (and returns from those bigger numbers) will be growing in the coming years. Growth of growth is the secret sauce that is now kicking in at Fairfax (due to double digit growth in insurance and investments AND improving underwriting and much higher investment returns).

Today, Fairfax is delivering a 20% ROE. I think they will be able to deliver a high teens ROE over the next three years (2023-2025).

I like my earnings per share estimate of $160/share for 2023. My estimates for 2024 ($165) and 2025 ($174) need to move higher.

Just a reminder that consensus is much lower and if you are wondering which analyst has the low estimate for the next 5 years (only for the last three), it’s our friend at Morningstar. The declining earnings estimates (and historical volatility in earnings) basically makes it unownable for quants and for active institutional investors who use the same screens as quants in order to compete with them.

ValueMaven · September 15, 2023

Grants Interest Rate has a very compelling piece on the reinsurance industry and the hard pricing market current occurring. While FFH is not specifically mentioned, there are some interesting nuggets in the article.

Munger_Disciple · September 15, 2023

18 minutes ago, ValueMaven said:

Grants Interest Rate has a very compelling piece on the reinsurance industry and the hard pricing market current occurring. While FFH is not specifically mentioned, there are some interesting nuggets in the article.

Can you please provide a more detailed summary? Thanks

Viking · September 16, 2023

Like Indiana Jones, today we are going to set out on an adventure in search of long lost treasure. Something that most investors appear to have forgotten about. What do the legends tell us? Does it really exist or is it just a myth?

What am i talking about?

P/C insurance float (I’ll just call it ‘float’ moving forward).

Float is such a big (and important) topic we are going to tackle it in two posts. The first post (below) will focus on the theory - what it is and why P/C investors should care. The second post will then apply the theory to today using a real company - Fairfax Financial. My plan is to have the second post completed and out on Sunday.

Ancient history

Thirty years ago, talking about float was all the rage for P/C investors. Read old articles on investing in P/C insurance companies and a discussion of float will usually be front and center. And the champion of float from that era was, of course, Warren Buffett and his company Berkshire Hathaway.

So what happened?

Why has float apparently settled into into the dustbin of history and become a relic of the past?

Due to competitive insurance markets, industrywide underwriting profit has remained illusive for the past decade. At the same time, top line organic growth slowed to a crawl.
Returns on investments fell: P/C insurers put most of their investments into fixed income instruments. In their battle with deflation, global central banks took interest rates all the way into negative territory. The US 10 year treasury traded at a yield below 0.60% in August of 2020 and traded with a yield below 1.5% for much of 2021.

S&P Global: US P&C Insurance Market Report

Float lost its value

Breaking even on underwriting for a decade while returns on investments plummeted made having float far less valuable than at any point in recent history.

Another smaller factor: over the years, P/C insurance has become a much smaller part of Berkshire Hathaway’s business model. What did Buffett have to say about float in his 2022 letter to shareholders? Float is mentioned 4 times in one short paragraph - telling investors to go somewhere else if they wanted to learn more. Does this sound important to you? So ‘float’ also lost its biggest cheerleader.

Does this mean… Float is dead? Long live float?

No, of course not. Just because float is no longer appreciated (or followed) doesn’t mean it doesn’t matter. In fact, for those paying attention, the world has changed again. The conditions that made float a big deal 30 years ago have returned:

Insurance has been in a hard market since about Q4 of 2019 - above average insurance companies are seeing improving underwriting results (cost of float) and significant top-line growth (supply of float) over the past four years.
Global central banks now have an inflation fight on their hands - and ‘higher for longer’ is becoming the new mantra for interest rates. Fixed income yields have spiked higher across the curve. The 10 year US treasury closed today with a yield of 4.32%, a level where it last traded at in 2007. As a result, returns on float are improving greatly.

Both of these developments make having float today extremely valuable.

Except remember… pretty much everyone has forgotten about float.

What’s old will be new again.

Well, my guess is this is about to change. I think investors are going to get interested in float again.

What is going to cause the change?

A new generation of investors are about to discover something Warren Buffett hit on when he bought National Indemnity back in 1967: float, under certain conditions, can be a license to print money. Those ‘certain conditions’ have returned. And in recent years some insurance companies have started up the printing presses and are now starting to print money. More than anyone imagined possible.

==========

P/C insurance float: the basics

Let’s first do a quick review of float. Float is deceptive. It is kind of like compound interest as a concept. It is easy to define but very hard to actually understand.

Who better to teach us about P/C insurance float than the old master, Warren Buffett himself.

Float: the basic building block to use to evaluate a P/C insurance company

Back in the 1990’s, Warren Buffett was using P/C insurance as the core engine to drive Berkshire Hathaway’s profit growth. GEICO was purchased in 1996 and General Re was purchased in 1998. Given P/C insurance’s importance to Berkshire Hathaway shareholders, Buffett provided the following as a guide to help them understand P/C insurance as an investment.

BRK 1998AR: “With the acquisition of General Re — and with GEICO’s business mushrooming — it becomes more important than ever that you understand how to evaluate an insurance company. The key determinants are:

1.) the amount of float that the business generates;

2.) its cost; and

3.) most important of all, the long-term outlook for both of these factors.”

Well, Warren appears to be saying float is the most important thing to understand when evaluating an insurance company. Interesting, given how little press float gets today from analysts and investors.

What is float?

BRK 1998AR: “To begin with, float is money we hold but don't own. In an insurance operation, float arises because premiums are received before losses are paid, an interval that sometimes extends over many years.”

Float is money a P/C insurer has that it can use to invest. It is an asset but it is a liability (not equity). It is kind of like a very sticky deposit at a bank (a deposit is also a liability for the bank).

Because float is a liability, it is also leverage. Like all leverage (i.e. debt), float can be both good or bad - and this depends on the cost paid over time to hold the float.

What is the cost of float?

BRK 1998AR: “Typically, this pleasant activity (the insurance business) carries with it a downside: The premiums that an insurer takes in usually do not cover the losses and expenses it eventually must pay. That leaves it running an "underwriting loss," which is the cost of float. An insurance business has value if its cost of float over time is less than the cost the company would otherwise incur to obtain funds. But the business is a lemon if its cost of float is higher than market rates for money.”

Underwriting determines the ‘cost’ of float.

This point is critical. Over time, if an insurer can produce an underwriting profit on its insurance business that means the cost of its float is actually a benefit - that is better than free. That means the insurer is actually getting paid to hold the float. This is far better than ‘the cost the company would otherwise incur to obtain the funds.’

Float is a pile of money that an insurance company can actually earn two income streams from: underwriting (if float is obtained at a benefit) and investing.

Sounds like Buffett was on to something.

To summarize: according to Buffett, a good P/C insurance company:

Has a large amount of float
Is a good underwriter - is able to generates the float at a favourable cost (ideally a benefit)
Has a good long term track record - of both growing float and as a solid underwriter

Buffett’s secret sauce: P/C insurance float

Buffett’s genius has really been two pronged:

Use P/C insurance float as an ever-increasing low cost (free) source of capital/leverage used to push profits even higher.
These growing profits were then continuously reinvested into great companies/equities (outside of insurance) that have also become compounding machines over time and pushed profits even higher.

OK. So there is a quick review of float, explained with the help of Warren Buffett.

To help us understand float even better, let’s look at it now from a balance sheet perspective.

==========

Float and the balance sheet

Let’s create an imaginary insurance company - called Random P/C Insurance Co - and create a fictitious balance sheet.

Our company has $80 billion in assets, with $60 billion in liabilities and $20 billion in common shareholders’ equity. Of the total liabilities of $60 billion, float is $30 billion. The summary of the balance sheet is below:

We are also going to assume common shareholders’ equity = book value.

We are going to make up more numbers below. We are using numbers that make our calculations easy. Please don’t focus too much on the exact numbers. Instead, focus on the information they are trying to convey - especially about leverage.

Cost of float

Let’s assume our insurance company is a slightly above average underwriter with a combined ratio (CR) of 96 - this translates into a ‘benefit’ of float (better than free - our company is actually getting paid to hold their float).

Return on investments (which includes float)

Let’s assume our insurance company is above average in terms of the return it earns from its total investments (which includes float) - let’s assume it earns 8% on average.

We are also going to assume there are no taxes.

The return of Random P/C Insurance Co

When we put the two together we get:

Benefit of float (CR of 96)
Return on investments = 8%

Let’s assume Random P/C Insurance Co earns a total return of 10% on its float.

This means our insurance company is earning the following:

$30 billion float x 10% = $3 billion.

Can we calculate the actual leverage provided by the float?

Yes. Total earnings from float of $3 billion will flow though the income statement and increase retained earnings, which will then flow though to the balance sheet and increase both assets and common shareholder equity by $3 billion.

So a return from float of 10% results in an increase in common shareholders' equity of 15%.

The leverage can be calculated as follows: total float / common shareholders' equity.

In our example

float of $30 billion / common shareholders' equity of $20 billion = 1.5 x leverage

Common equity, debt and total investments

The above increase in common shareholders' equity was driven solely by float. A company is also going to generate earnings from its common shareholders’ equity - the funds provided by shareholders. Perhaps it also uses a little debt to generate more earnings. Any returns generated by its other investments (those other than float) need to be added to the numbers above.

==========

Below Buffett summarizes how float fits into the big picture

Berkshire Hathaway 1995AR: “In more years than not, our cost of funds has been less than nothing. This access to "free" money has boosted Berkshire's performance in a major way.

“Any company's level of profitability is determined by three items:

1.) what its assets earn;

2.) what its liabilities cost; and

3.) its utilization of "leverage" - that is, the degree to which its assets are funded by liabilities rather than by equity.

“Over the years, we have done well on Point 1, having produced high returns on our assets. But we have also benefitted greatly - to a degree that is not generally well-understood - because our liabilities have cost us very little. An important reason for this low cost is that we have obtained float on very advantageous terms. The same cannot be said by many other property and casualty insurers, who may generate plenty of float, but at a cost that exceeds what the funds are worth to them. In those circumstances, leverage becomes a disadvantage.

“Since our float has cost us virtually nothing over the years, it has in effect served as equity. Of course, it differs from true equity in that it doesn't belong to us. Nevertheless, let's assume that instead of our having $3.4 billion of float at the end of 1994, we had replaced it with $3.4 billion of equity. Under this scenario, we would have owned no more assets than we did during 1995. We would, however, have had somewhat lower earnings because the cost of float was negative last year. That is, our float threw off profits. And, of course, to obtain the replacement equity, we would have needed to sell many new shares of Berkshire. The net result - more shares, equal assets and lower earnings - would have materially reduced the value of our stock. So you can understand why float wonderfully benefits a business - if it is obtained at a low cost.”

Float is better than equity?

This question is a bit of a mind bender. Because of its unique ‘cost’ (i.e. low cost or even a benefit), in the past Buffett has said that he views float as being better than equity.

BRK 1997AR: “Since 1967, when we entered the insurance business, our float has grown at an annual compounded rate of 21.7%. Better yet, it has cost us nothing, and in fact has made us money. Therein lies an accounting irony: Though our float is shown on our balance sheet as a liability, it has had a value to Berkshire greater than an equal amount of net worth would have had.”

Well, suggesting float is better than equity is perhaps a bridge too far. However, I think we can conclude that float matters a great deal. Especially today (in a high interest rate world).

Conclusion

OK. So now we know what float is and the key metrics to use to evaluate P/C insurers. Who should we start with? That is an easy question to answer. In our next post (coming Sunday), we will do a deep dive on float at Fairfax Financial to see what we can learn.

==========

How Warren Buffett Achieves Great Returns Every Year - Advantages of Insurance Float

Edited September 16, 2023 by Viking

UK · September 16, 2023

17 hours ago, SafetyinNumbers said:

Just a reminder that consensus is much lower and if you are wondering which analyst has the low estimate for the next 5 years (only for the last three), it’s our friend at Morningstar. The declining earnings estimates (and historical volatility in earnings) basically makes it unownable for quants and for active institutional investors who use the same screens as quants in order to compete with them.

Wow, what a passimism from 2025, never saw this, what is the source of this table?

dealraker · September 16, 2023

8 minutes ago, UK said:

Wow, what a passimism from 2025, never saw this, what is the source of this table?

Morningstar's analysts have cycled through euphoria and despair as to their insurance underwriters, the re-insurers longer tail float types particularly. They seem to have either forgotten or fully upended their past "float is equity" presentations with and gone to another model. As interest rates change it would seem some sort of adaptation to their somewhat current model of "float don't count no more" would evolve.

But anyway in the long ago they had the better insurers valued at investments per share which at the time was about 3x book value for some.

UK · September 16, 2023

9 hours ago, Viking said:

Like Indiana Jones, today we are going to set out on an adventure in search of long lost treasure. Something that most investors appear to have forgotten about. What do the legends tell us? Does it really exist or is it just a myth?

What am i talking about?

P/C insurance float (I’ll just call it ‘float’ moving forward).

Float is such a big (and important) topic we are going to tackle it in two posts. The first post (below) will focus on the theory - what it is and why P/C investors should care. The second post will then apply the theory to today using a real company - Fairfax Financial. My plan is to have the second post completed and out on Sunday.

Ancient history

Thirty years ago, talking about float was all the rage for P/C investors. Read old articles on investing in P/C insurance companies and a discussion of float will usually be front and center. And the champion of float from that era was, of course, Warren Buffett and his company Berkshire Hathaway.

So what happened?

Why has float apparently settled into into the dustbin of history and become a relic of the past?

Due to competitive insurance markets, industrywide underwriting profit has remained illusive for the past decade. At the same time, top line organic growth slowed to a crawl.

Returns on investments fell: P/C insurers put most of their investments into fixed income instruments. In their battle with deflation, global central banks took interest rates all the way into negative territory. The US 10 year treasury traded at a yield below 0.60% in August of 2020 and traded with a yield below 1.5% for much of 2021.

S&P Global: US P&C Insurance Market Report

Float lost its value

Breaking even on underwriting for a decade while returns on investments plummeted made having float far less valuable than at any point in recent history.

Another smaller factor: over the years, P/C insurance has become a much smaller part of Berkshire Hathaway’s business model. What did Buffett have to say about float in his 2022 letter to shareholders? Float is mentioned 4 times in one short paragraph - telling investors to go somewhere else if they wanted to learn more. Does this sound important to you? So ‘float’ also lost its biggest cheerleader.

Does this mean… Float is dead? Long live float?

No, of course not. Just because float is no longer appreciated (or followed) doesn’t mean it doesn’t matter. In fact, for those paying attention, the world has changed again. The conditions that made float a big deal 30 years ago have returned:

Insurance has been in a hard market since about Q4 of 2019 - above average insurance companies are seeing improving underwriting results (cost of float) and significant top-line growth (supply of float) over the past four years.

Global central banks now have an inflation fight on their hands - and ‘higher for longer’ is becoming the new mantra for interest rates. Fixed income yields have spiked higher across the curve. The 10 year US treasury closed today with a yield of 4.32%, a level where it last traded at in 2007. As a result, returns on float are improving greatly.

Both of these developments make having float today extremely valuable.

Except remember… pretty much everyone has forgotten about float.

What’s old will be new again.

Well, my guess is this is about to change. I think investors are going to get interested in float again.

What is going to cause the change?

A new generation of investors are about to discover something Warren Buffett hit on when he bought National Indemnity back in 1967: float, under certain conditions, can be a license to print money. Those ‘certain conditions’ have returned. And in recent years some insurance companies have started up the printing presses and are now starting to print money. More than anyone imagined possible.

==========

P/C insurance float: the basics

Let’s first do a quick review of float. Float is deceptive. It is kind of like compound interest as a concept. It is easy to define but very hard to actually understand.

Who better to teach us about P/C insurance float than the old master, Warren Buffett himself.

Float: the basic building block to use to evaluate a P/C insurance company

Back in the 1990’s, Warren Buffett was using P/C insurance as the core engine to drive Berkshire Hathaway’s profit growth. GEICO was purchased in 1996 and General Re was purchased in 1998. Given P/C insurance’s importance to Berkshire Hathaway shareholders, Buffett provided the following as a guide to help them understand P/C insurance as an investment.

BRK 1998AR: “With the acquisition of General Re — and with GEICO’s business mushrooming — it becomes more important than ever that you understand how to evaluate an insurance company. The key determinants are:

1.) the amount of float that the business generates;

2.) its cost; and

3.) most important of all, the long-term outlook for both of these factors.”

Well, Warren appears to be saying float is the most important thing to understand when evaluating an insurance company. Interesting, given how little press float gets today from analysts and investors.

What is float?

BRK 1998AR: “To begin with, float is money we hold but don't own. In an insurance operation, float arises because premiums are received before losses are paid, an interval that sometimes extends over many years.”

Float is money a P/C insurer has that it can use to invest. It is an asset but it is a liability (not equity). It is kind of like a very sticky deposit at a bank (a deposit is also a liability for the bank).

Because float is a liability, it is also leverage. Like all leverage (i.e. debt), float can be both good or bad - and this depends on the cost paid over time to hold the float.

What is the cost of float?

BRK 1998AR: “Typically, this pleasant activity (the insurance business) carries with it a downside: The premiums that an insurer takes in usually do not cover the losses and expenses it eventually must pay. That leaves it running an "underwriting loss," which is the cost of float. An insurance business has value if its cost of float over time is less than the cost the company would otherwise incur to obtain funds. But the business is a lemon if its cost of float is higher than market rates for money.”

Underwriting determines the ‘cost’ of float.

This point is critical. Over time, if an insurer can produce an underwriting profit on its insurance business that means the cost of its float is actually a benefit - that is better than free. That means the insurer is actually getting paid to hold the float. This is far better than ‘the cost the company would otherwise incur to obtain the funds.’

Float is a pile of money that an insurance company can actually earn two income streams from: underwriting (if float is obtained at a benefit) and investing.

Sounds like Buffett was on to something.

To summarize: according to Buffett, a good P/C insurance company:

Has a large amount of float

Is a good underwriter - is able to generates the float at a favourable cost (ideally a benefit)

Has a good long term track record - of both growing float and as a solid underwriter

Buffett’s secret sauce: P/C insurance float

Buffett’s genius has really been two pronged:

Use P/C insurance float as an ever-increasing low cost (free) source of capital/leverage used to push profits even higher.

These growing profits were then continuously reinvested into great companies/equities (outside of insurance) that have also become compounding machines over time and pushed profits even higher.

OK. So there is a quick review of float, explained with the help of Warren Buffett.

To help us understand float even better, let’s look at it now from a balance sheet perspective.

==========

Float and the balance sheet

Let’s create an imaginary insurance company - called Random P/C Insurance Co - and create a fictitious balance sheet.

Our company has $80 billion in assets, with $60 billion in liabilities and $20 billion in common shareholders’ equity. Of the total liabilities of $60 billion, float is $30 billion. The summary of the balance sheet is below:

We are also going to assume common shareholders’ equity = book value.

We are going to make up more numbers below. We are using numbers that make our calculations easy. Please don’t focus too much on the exact numbers. Instead, focus on the information they are trying to convey - especially about leverage.

Cost of float

Let’s assume our insurance company is a slightly above average underwriter with a combined ratio (CR) of 96 - this translates into a ‘benefit’ of float (better than free - our company is actually getting paid to hold their float).

Return on investments (which includes float)

Let’s assume our insurance company is above average in terms of the return it earns from its total investments (which includes float) - let’s assume it earns 8% on average.

We are also going to assume there are no taxes.

The return of Random P/C Insurance Co

When we put the two together we get:

Benefit of float (CR of 96)

Return on investments = 8%

Let’s assume Random P/C Insurance Co earns a total return of 10% on its float.

This means our insurance company is earning the following:

$30 billion float x 10% = $3 billion.

Can we calculate the actual leverage provided by the float?

Yes. Total earnings from float of $3 billion will flow though the income statement and increase retained earnings, which will then flow though to the balance sheet and increase both assets and common shareholder equity by $3 billion.

So a return from float of 10% results in an increase in common shareholders' equity of 15%.

The leverage can be calculated as follows: total float / common shareholders' equity.

In our example

float of $30 billion / common shareholders' equity of $20 billion = 1.5 x leverage

Common equity, debt and total investments

The above increase in common shareholders' equity was driven solely by float. A company is also going to generate earnings from its common shareholders’ equity - the funds provided by shareholders. Perhaps it also uses a little debt to generate more earnings. Any returns generated by its other investments (those other than float) need to be added to the numbers above.

==========

Below Buffett summarizes how float fits into the big picture

Berkshire Hathaway 1995AR: “In more years than not, our cost of funds has been less than nothing. This access to "free" money has boosted Berkshire's performance in a major way.

“Any company's level of profitability is determined by three items:

1.) what its assets earn;

2.) what its liabilities cost; and

3.) its utilization of "leverage" - that is, the degree to which its assets are funded by liabilities rather than by equity.

“Over the years, we have done well on Point 1, having produced high returns on our assets. But we have also benefitted greatly - to a degree that is not generally well-understood - because our liabilities have cost us very little. An important reason for this low cost is that we have obtained float on very advantageous terms. The same cannot be said by many other property and casualty insurers, who may generate plenty of float, but at a cost that exceeds what the funds are worth to them. In those circumstances, leverage becomes a disadvantage.

“Since our float has cost us virtually nothing over the years, it has in effect served as equity. Of course, it differs from true equity in that it doesn't belong to us. Nevertheless, let's assume that instead of our having $3.4 billion of float at the end of 1994, we had replaced it with $3.4 billion of equity. Under this scenario, we would have owned no more assets than we did during 1995. We would, however, have had somewhat lower earnings because the cost of float was negative last year. That is, our float threw off profits. And, of course, to obtain the replacement equity, we would have needed to sell many new shares of Berkshire. The net result - more shares, equal assets and lower earnings - would have materially reduced the value of our stock. So you can understand why float wonderfully benefits a business - if it is obtained at a low cost.”

Float is better than equity?

This question is a bit of a mind bender. Because of its unique ‘cost’ (i.e. low cost or even a benefit), in the past Buffett has said that he views float as being better than equity.

BRK 1997AR: “Since 1967, when we entered the insurance business, our float has grown at an annual compounded rate of 21.7%. Better yet, it has cost us nothing, and in fact has made us money. Therein lies an accounting irony: Though our float is shown on our balance sheet as a liability, it has had a value to Berkshire greater than an equal amount of net worth would have had.”

Well, suggesting float is better than equity is perhaps a bridge too far. However, I think we can conclude that float matters a great deal. Especially today (in a high interest rate world).

Conclusion

OK. So now we know what float is and the key metrics to use to evaluate P/C insurers. Who should we start with? That is an easy question to answer. In our next post (coming Sunday), we will do a deep dive on float at Fairfax Financial to see what we can learn.

==========

How Warren Buffett Achieves Great Returns Every Year - Advantages of Insurance Float

Thanks!

Viking · September 16, 2023

2 hours ago, UK said:

Wow, what a passimism from 2025, never saw this, what is the source of this table?

US P&C Insurance Market Report: Profitability to remain elusive in 2023

- https://www.spglobal.com/marketintelligence/en/news-insights/research/us-pc-insurance-market-report-profitability-to-remain-elusive-in-2023

MMM20 · September 16, 2023

2 hours ago, Viking said:

US P&C Insurance Market Report: Profitability to remain elusive in 2023

- https://www.spglobal.com/marketintelligence/en/news-insights/research/us-pc-insurance-market-report-profitability-to-remain-elusive-in-2023

Doesn't sound like it's worth starting my new P&C insurer yet then.

Is that good for FFH? Asking for a friend.

Fairfax 2023

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