Fairfax vs Markel vs WR Berkley

[Thrifty3000]

How about the Travelers bond portfolio? Woof. Travelers has started inventing terms in their annual report like "core income" and "core book value" where they get to exclude unrealized portfolio losses! Ha ha. It appears this concept of "core" reporting is fairly new for Travelers (how convenient). Talk about moving the goalposts (after reaching for yield).

 

[Thrifty3000]

According to Morningstar Travelers is currently valued at about 1.7X book value.

[Viking]

2 hours ago, Thrifty3000 said:

How about the Travelers bond portfolio? Woof. Travelers has started inventing terms in their annual report like "core income" and "core book value" where they get to exclude unrealized portfolio losses! Ha ha. It appears this concept of "core" reporting is fairly new for Travelers (how convenient). Talk about moving the goalposts (after reaching for yield).

 

Lots of insurers are still sitting on large losses in their bond portfolio. The underwater fixed income securities are held in their held to maturity bucket so the losses have not flowed through the income statement. And the company line is ‘we will hold to maturity so it does not matter’. And that, of course is stupid. And makes no sense. Of course there are significant costs today for all companies that were buying fixed income duration in 2020 and 2021. Saying ‘it doesn’t matter’ is just a crafty psychological trick.

So you buy a 4 or 5 year bond in 2020 or 2021 at a 2.5% yield. Yes, an insurer can hold this bond to maturity. But you hold a fixed income instrument to make money.
1.) what is the real yield on all these bonds? With inflation running 4 or 5%? You are losing money (in terms of purchasing power) on a significant part of your fixed income portfolio. For years. These losses/positioning matter (just ask the ratings agencies).
2.) what is the opportunity cost? If you have a long duration portfolio of 4 or 5 years you also have a limited ability to reinvest at much higher rates. 
 

This also means earnings for these insurance companies are messed up. If you don’t book the loss today, it effectively means your earnings in prior year periods is overstated. There is no free lunch. This also means historical ROE’s from most recent years are overstated. 

 

In the current environment of much higher rates, Fairfax is a huge winner. Because of the actions of its management team. Their management of their fixed income portfolio has been best in class - and it is not debatable. My current estimate is Fairfax is tracking to deliver a return of 8.6% on its $56.5 billion investment portfolio in 2023 and better than 8% in both 2024 and 2025. That is going to blow insurance peers out of the water. Yes, Fairfax’s stock continues to trade at a severe discount to peers. Efficient markets once again demonstrating how inefficient they can be at times.

Edited September 1, 2023 by Viking

[Thrifty3000]

3 hours ago, Viking said:

Lots of insurers are still sitting on large losses in their bond portfolio. The underwater fixed income securities are held in their held to maturity bucket so the losses have not flowed through the income statement. And the company line is ‘we will hold to maturity so it does not matter’. And that, of course is stupid. And makes no sense. Of course there are significant costs today for all companies that were buying fixed income duration in 2020 and 2021. Saying ‘it doesn’t matter’ is just a crafty psychological trick.

So you buy a 4 or 5 year bond in 2020 or 2021 at a 2.5% yield. Yes, an insurer can hold this bond to maturity. But you hold a fixed income instrument to make money.
1.) what is the real yield on all these bonds? With inflation running 4 or 5%? You are losing money (in terms of purchasing power) on a significant part of your fixed income portfolio. For years. These losses/positioning matter (just ask the ratings agencies).
2.) what is the opportunity cost? If you have a long duration portfolio of 4 or 5 years you also have a limited ability to reinvest at much higher rates. 
 

This also means earnings for these insurance companies are messed up. If you don’t book the loss today, it effectively means your earnings in prior year periods is overstated. There is no free lunch. This also means historical ROE’s from most recent years are overstated. 

 

In the current environment of much higher rates, Fairfax is a huge winner. Because of the actions of its management team. Their management of their fixed income portfolio has been best in class - and it is not debatable. My current estimate is Fairfax is tracking to deliver a return of 8.6% on its $56.5 billion investment portfolio in 2023 and better than 8% in both 2024 and 2025. That is going to blow insurance peers out of the water. Yes, Fairfax’s stock continues to trade at a severe discount to peers. Efficient markets once again demonstrating how inefficient they can be at times.

Yes! I recently created a watchlist in Morningstar of about 40 of the top 100 insurance companies, and I’ve been going through 1 by 1, reading the annual & quarterly letters/reports/call transcripts. And, I’ve been sorting and filtering the watchlist by every metric possible. My goal has been to find at least one company as undervalued as Fairfax. I haven’t come close.
 

It’s really eye opening. 

[UK]

7 hours ago, Thrifty3000 said:

According to Morningstar Travelers is currently valued at about 1.7X book value.

 

Precisely.

[UK]

5 hours ago, Viking said:

Lots of insurers are still sitting on large losses in their bond portfolio. The underwater fixed income securities are held in their held to maturity bucket so the losses have not flowed through the income statement. And the company line is ‘we will hold to maturity so it does not matter’. And that, of course is stupid. And makes no sense. Of course there are significant costs today for all companies that were buying fixed income duration in 2020 and 2021. Saying ‘it doesn’t matter’ is just a crafty psychological trick.
 

This also means earnings for these insurance companies are messed up. If you don’t book the loss today, it effectively means your earnings in prior year periods is overstated. There is no free lunch. This also means historical ROE’s from most recent years are overstated. 

 

Perhaps it also means, that despite of not recognising losses, these companies will underearn for years and/or will behave differently in the underwriting side, hopefully keeping the insurance market harder for longer:)

 

Edited September 2, 2023 by UK

[Maverick47]

This strikes me as a very insightful comment. Much of the insurance industry is capital constrained given the unrealized losses on bond portfolios, poor underwriting results, and recent inflationary environment driving significant rate increases to keep up with inflated insured values, loss trends, etc.  Fairfax’s competitors are likely to be wounded for longer than prior patterns of underwriting cycles might lead us to expect.  

[MMM20]

7 hours ago, UK said:

 

Perhaps it also means, that despite of not recognising losses, these companies will underearn for years and/or will behave differently in the underwriting side, hopefully keeping the insurance market harder for longer:)

 

 

+1, this is IMHO the key point many investors overlook by buying the "held to maturity" framing. Look beyond the accounting and ostensible long-termism (and ignore the fact that we weren't thinking long term buying duration in treasuries at historical interest rate lows). There are real economic consequences. Either raise capital at much higher rates or retrench and give up share in a hard market. 

 

Edited September 2, 2023 by MMM20