Fairfax 2024

[gfp]

55 minutes ago, Viking said:

OK. So after all that… What is an investor to do?

 

Go short because IFRS is confusing?

[Cigarbutt]

7 hours ago, Tommm50 said:

The reserve triangles show current reserves for each calendar year are less than the original reserves put up that year except 2018.  JFan may be referring to the penultimate (I don't often get to use that word) line which shows negative development for several years...By this metric only 2018 shows a modest deterioration.

If several years start to show current reserves are more than the initial reserves then that bears watching...

...Like Fairfax.

Interesting. Let's build on that using net reserves (ie where reserve development stays with the company instead of being ceded to another party):

So using the same line of reasoning, FFH has reserves reported (as of end of 2023) at higher levels than initially reported for the 2018, 2019, 2020 and 2021 years. And up to the 2019 year included, the end-2023 number is 410.5 M higher than the initial estimate. Also, the adverse movement from 2017 to 2018 was 1165.1 M ((254.6)-910.5). Not exactly catastrophic and not remotely as horrific as the late 1990s and early 2000s years (Ranger (ouch!), generic Crum, nauseating TIG etc) but still quite significant. No wonder (now), the late 2010s years were ripe for hardening.

So, the same conclusion applies but (opinion) the net reserves trend smooth out significant older and softer adverse development as a result of more recent and harder favorable development.

i'd simply add that this appreciation may help to guess the kind of underwriting contribution to the ROE of future years.

@jfan, the best thing now would be that someone comes along and tries to establish an opposing view.

 

 

[Crip1]

The question of whether or not we we fully understood Fairfax is complicated to say the least. Below are a few aspects of Fairfax along with some commentary:

 

·         Did we foresee the interest rate environment? I don't think so.

·         Did we foresee the hard market continuing as long as it has? Again, I don't believe so.

·         Did we think Fairfax was executing well and was well positioned? For the most part, yes, we did. We may have under estimated how well they were executing, but we did see that the company was in a much better place.

 

Many things have gone well for the company over the past four years, some of those things were within their control and some of other things were outside of their control. To the question of whether or not we understood what Fairfax was four years ago, we likely didn't. Part of the reason was the exogenous factors that, as investors, we never want to assume that everything's going to be wonderful because that doesn't always work out. To your point about underestimating the company, we likely did, but healthy pessimism was part of the reason.

 

While typing this, something else popped into my head. Viking, you've been commended many times over for your analysis of Fairfax, and said commendations were definitely deserved. One other aspect of your posting that was really impactful is talking me out of being "grounded" to a stock price from months past. Many times in my investing life I've sold part of a position with the theory that a recent run-up was temporary and that I could re-buy at a price 10% of so lower than the current price. I was tempted to do that with Fairfax, but you reasoned me out of it. I really appreciate that.

 

-Crip

 

 

[Tommm50]

2 hours ago, Cigarbutt said:

Interesting. Let's build on that using net reserves (ie where reserve development stays with the company instead of being ceded to another party):

So using the same line of reasoning, FFH has reserves reported (as of end of 2023) at higher levels than initially reported for the 2018, 2019, 2020 and 2021 years. And up to the 2019 year included, the end-2023 number is 410.5 M higher than the initial estimate. Also, the adverse movement from 2017 to 2018 was 1165.1 M ((254.6)-910.5). Not exactly catastrophic and not remotely as horrific as the late 1990s and early 2000s years (Ranger (ouch!), generic Crum, nauseating TIG etc) but still quite significant. No wonder (now), the late 2010s years were ripe for hardening.

So, the same conclusion applies but (opinion) the net reserves trend smooth out significant older and softer adverse development as a result of more recent and harder favorable development.

i'd simply add that this appreciation may help to guess the kind of underwriting contribution to the ROE of future years.

@jfan, the best thing now would be that someone comes along and tries to establish an opposing view.

 

 

I tend to think in terms of gross reserves as the overall test of reserving performance but I take your point, the net reserves are not quite as rosy. Putting the negative adverse development you cite in context of the size of the book however ($130M over 6 years, $110M leaving out the excellent 2017) being about $1M off is less than 1% of the total reserves and, in my view, pretty damn good at predicting the future.

 

[LC]

The million Canadian dollar question: are investors here buying, holding, or selling? 
 

What % if your portfolio is Fairfax compared to say, 6 or 12 months ago?

 

Partly rhetorical - but is Fairfax as easy of a “buy” today, versus 6, 12, 24 months ago? 

[MMM20]

14 hours ago, Viking said:

As Peter Lynch would say ‘The story just keeps getting better’. But kind of on steroids.

What do we make of the argument that, like a bodybuilder on steroids who ends up popping a bicep tendon, such rapid growth might inherently introduce fragility into their operations? Is it too much too fast for a staid insurance biz? Is Fairfax more susceptible to a black swan event than they were five years ago?

 

Edited April 15 by MMM20

[Cigarbutt]

10 hours ago, Tommm50 said:

I tend to think in terms of gross reserves as the overall test of reserving performance but I take your point, the net reserves are not quite as rosy. Putting the negative adverse development you cite in context of the size of the book however ($130M over 6 years, $110M leaving out the excellent 2017) being about $1M off is less than 1% of the total reserves and, in my view, pretty damn good at predicting the future.

Yes, i think this is correct.

It's becoming clear that the 2017-9 years were written with a semi-conscious expectation that premiums were insufficient to meet profit objectives and the shortfall could be compensated by investment income. In the industry, they call this cash flow underwriting and this is based on the same foundation as the need to remain fully invested at all times at the individual level.

For the industry, it appears that the eventually realized underwriting losses for those years were compensated by float investment income. See the following graph showing the yield on invested assets. For the industry, add a median 0.5% per year for realized gains:

For FFH:

It's interesting to note (it's becoming clear now) that, for those years, FFH did better (relatively) than the industry both for the reserves management and the float management. 

-----

Nuff said about triangles i guess. The relevant uncertain questions about the future are bound to be related to the asset side, i would venture to say, but what do i know?

Edited April 15 by Cigarbutt
spelling

[jfan]

Thanks @Cigarbutt and @Tommm50 for your replies and insight. The idea of writing policies in a soft market with just adequate pricing (with the expectation of some adverse loss developments) when there are good opportunities to use those premiums to invest in their portfolio for more attractive returns was helpful. 

 

Spending the morning watching videos on insurance triangles, paid/case reserves/incurred but no reported, basic methodologies to estimate of IBNR to derive loss reserves (case reserves + IBNR), and how to interpret loss development trends was particularly stimulating. 

 

Looking back at the 2 tables that I posted. A few amateur observations were made:

 

1) looking down the columns for each calendar year:

 

a) It appears that ~ 70% of cumulative paid losses occur within 6 years (6-year cumulative payment divided by 6-year re-estimated reserves)

b) Unfortunately, they don't report the entire table in 2023 AR, in the 2022 AR, after 8-9 years, the proportion of cumulative payments is mid-to-high 70% of re-estimated reserves). This suggests to me a fairly long-lag of actual payout to claimants. I'd assume this is because of the longer-tail nature of their specialty insurance focus.

c) Eyeballing the re-estimated reserves down each calendar year, there is little variability year-to-year as time goes by, within ~ $500 M at most up or down (in the range of $100 - 300 M most the time). Coupling what was said earlier about the soft market, it seems that there is not much pricing power, or too much social/judicial/cost inflation to be able to adjust reserves in a favorable manner.

 

2)  Looking at the diagonals for cumulative payments (gross table, not net)

 

a) The sum of diagonal (latest) minus the sum of the diagonal (previous year) = the payment made for losses in the most current calendar year. Using the 2022 AR, they paid out $25.5 B and had a final year end reserve of $38.3 B (ie ~ 66% or for every $1 of reserves set aside, they paid ~ $0.66 that year). Using the 2023 AR (which of there are only 6 years), they paid out $28.1 B and had a final year end reserve of $41.2 B (ie ~ 68%). This seems to me that their baseline underwriting assumptions are that 2/3 of their reserves will be paid out ~ 6 - 9 years. 

 

     I have not compared to their prior years nor other insurance companies, but is this in the opinion of the experts here, conservative? 

 

     I would imagine that if their underwriting deteriorated and they were not re-estimating their reserves properly, then these ratios should deviate from their baseline over time. I think this might be more useful than just looking at the reported magnitude of adverse/favorable loss reserve developments which is more retrospective than prospective.

Edited April 15 by jfan

[Hoodlum]

It looks like the loan to IIFL is for 3 years @ 9.5% 

https://economictimes.indiatimes.com/industry/banking/finance/fairfax-arm-infuses-rs-500-crore-into-iifl-finance/articleshow/109323304.cms

[Hoodlum]

Private Equity firm Birch Hill Equity is going to sell CCM and expects to sell it for a significant multiple of the $110M they paid for it in in 2017.   This is interesting as CCM own 40% of the hockey equipment market and Fairfax through Bauer at Peak Achievement also own 40% of the hockey equipment market.  This could provide an interesting valuation for the 43% of Peak Achievement that Fairfax has on their books for $129M ($226 Market value according to shareholder letter).  Peak investment is also a minority shareholder of Rawlings that was valued at $395M in 2018, but I cannot determine the percentage of their ownership in Rawlings.

 

https://www.theglobeandmail.com/business/article-hockey-gear-ccm-sale-private-equity/

 

Quote

On the eve of the NHL playoffs, private equity fund manager Birch Hill Equity Partners has placed CCM Hockey on the auction block. CCM, one of two dominant hockey-gear companies, is expected to fetch a price that is a significant multiple to the $110-million Birch Hill paid for the business seven years ago.

Toronto-based Birch Hill recently hired U.S. investment bank Robert W. Baird & Co. Inc. to run the potential sale, according to two sources involved in the process. The Globe and Mail is not naming the sources because they are not permitted to speak for the companies.

Birch Hill decided to shop Montreal-based CCM after receiving several unsolicited offers for the gear maker from private equity funds, the sources said. They said there is no guarantee the process will result in a sale. Spokespersons for Birch Hill, CCM and Baird declined to comment.

CCM’s potential buyers include sports equipment manufacturers and large private equity funds, according to the sources. One said Birch Hill expects to conclude the process, with or without a sale, by the summer, to avoid a prolonged period of uncertainty around ownership. According to a recent press release, CCM has 500 employees.

 

Edited April 15 by Hoodlum

[Cigarbutt]

7 hours ago, jfan said:

Thanks @Cigarbutt and @Tommm50 for your replies and insight. The idea of writing policies in a soft market with just adequate pricing (with the expectation of some adverse loss developments) when there are good opportunities to use those premiums to invest in their portfolio for more attractive returns was helpful. 

 

Spending the morning watching videos on insurance triangles, paid/case reserves/incurred but no reported, basic methodologies to estimate of IBNR to derive loss reserves (case reserves + IBNR), and how to interpret loss development trends was particularly stimulating. 

 

Looking back at the 2 tables that I posted. A few amateur observations were made:

 

1) looking down the columns for each calendar year:

 

a) It appears that ~ 70% of cumulative paid losses occur within 6 years (6-year cumulative payment divided by 6-year re-estimated reserves)

b) Unfortunately, they don't report the entire table in 2023 AR, in the 2022 AR, after 8-9 years, the proportion of cumulative payments is mid-to-high 70% of re-estimated reserves). This suggests to me a fairly long-lag of actual payout to claimants. I'd assume this is because of the longer-tail nature of their specialty insurance focus.

c) Eyeballing the re-estimated reserves down each calendar year, there is little variability year-to-year as time goes by, within ~ $500 M at most up or down (in the range of $100 - 300 M most the time). Coupling what was said earlier about the soft market, it seems that there is not much pricing power, or too much social/judicial/cost inflation to be able to adjust reserves in a favorable manner.

 

2)  Looking at the diagonals for cumulative payments (gross table, not net)

 

a) The sum of diagonal (latest) minus the sum of the diagonal (previous year) = the payment made for losses in the most current calendar year. Using the 2022 AR, they paid out $25.5 B and had a final year end reserve of $38.3 B (ie ~ 66% or for every $1 of reserves set aside, they paid ~ $0.66 that year). Using the 2023 AR (which of there are only 6 years), they paid out $28.1 B and had a final year end reserve of $41.2 B (ie ~ 68%). This seems to me that their baseline underwriting assumptions are that 2/3 of their reserves will be paid out ~ 6 - 9 years. 

 

     I have not compared to their prior years nor other insurance companies, but is this in the opinion of the experts here, conservative? 

 

     I would imagine that if their underwriting deteriorated and they were not re-estimating their reserves properly, then these ratios should deviate from their baseline over time. I think this might be more useful than just looking at the reported magnitude of adverse/favorable loss reserve developments which is more retrospective than prospective.

The prospective measure you're looking for may be an elusive goal. The diagonal measure you describe could reveal some info but IMO not more than the current accident year combined ratio and the ratio you compute could be influenced by recent growth in premiums written which, in itself, would increase the ratio as the payment curve is not bell-shaped with more payments early on and then a long tail to the right. Example:

The idea is to try, for each years and trend-wise, to identify a deviation from the expected trajectory. This is not easy and insurers may be slow to recognize developing issues. For example, look at the following which is a significant pattern that started to develop in the late 90s for medical malpractice claims:

Over time, it became clear that developing trends would become very costly. BTW, this cumulative payment curve is sort of representative for the average long-tail type of lines that FFH carries (duration and shape).

Up to 2013, FFH reported accident year reserve development and that was helpful but it's not a requirement and is no longer reported by them. It's possible to figure it out but it takes some effort.

 

 

[giulio]

7 hours ago, Hoodlum said:

It looks like the loan to IIFL is for 3 years @ 9.5% 

https://economictimes.indiatimes.com/industry/banking/finance/fairfax-arm-infuses-rs-500-crore-into-iifl-finance/articleshow/109323304.cms

Thanks for sharing. Interesting because Odyseey is providing the loan, not fih.

I guess fih will subscribe their portion of the rights issue.

[petec]

On 4/14/2024 at 11:00 PM, Viking said:

What do board members think… Do we collectively have a good handle on Fairfax today?

 

Personal view but I think the board has a good handle on the facts, but the psychology has swung about 70% of the way from focussing on the bad to focussing on the good.

 

We aren't talking much about the risks (big ones for me would be falling interest rates, which impact the terminal value of float and which I believe are correlated with lower combined ratios for a double hit to earnings, and a major cat loss).

 

We are talking lots about how good the investments are, forgetting (maybe?) that these are often the same investments we dissed 5 years ago, but they're more expensive now (Eurobank and Stelco come to mind here - I am not sure the earnings power of either business has improved much over the last few years, but the share prices sure have).

 

None of this is a criticism - there's some great work on the board. But the mood has swung, as it so often does, procyclically. We have got more exited as the stock has got closer to intrinsic value, not less. Weird how the human brain works.

 

You can argue that the risks have fallen because the certainty of outcomes has risen. I agree, to a degree. But 5 years ago FFH was a Faberge egg, with value inside value inside value. All it needed was patience. Now, it needs things to keep going right. I am fairly sure they will, and this remains my biggest position at 17%, but I am shifting into the "when do I reduce" mode rather than "how can I buy more". 

[thowed]

Thanks @petec, I am relatively new to Fairfax, and am excited for the future, but agree that it's good to have a balanced view on things (or just that we should always keep trying to 'kill' our favourite investments?).

 

On the other hand, I suppose my other question would be - what does one replace Fairfax with?  I struggle to find assets of such quality that are any cheaper?  But of course always interested in ideas to look at.

 

A tiny bit of scuttlebutt for Eurobank & Greece: I was talking to some Greeks recently, and things are certainly booming there, and of course they started from a low point in 2011.  However the smart view seemed to be that things were already starting to get out of hand, as they do, particularly with the property market, and so while things always last longer than one expects, there is the feeling that at some point things will turn from boom to bust.

Edited April 16 by thowed

[Viking]

On 4/15/2024 at 5:26 AM, MMM20 said:

What do we make of the argument that, like a bodybuilder on steroids who ends up popping a bicep tendon, such rapid growth might inherently introduce fragility into their operations? Is it too much too fast for a staid insurance biz? Is Fairfax more susceptible to a black swan event than they were five years ago?

@MMM20 My steroid comment was directed more at the growth that we are seeing in earnings, particularly operating income. Probably the wrong way to phrase it.

 

In terms of fragility, i don’t think Fairfax is more susceptible today to a black swan event than they were five years ago.

 

The hard market in insurance has likely given Fairfax (and all insurers) the opportunity to get their reserves more in order (from the soft market years pre-2019). Terms and conditions on policies have also likely improved on business written over the past 4 years.

 

The fixed income portfolio is locked and loaded with about $2 billion in interest income coming each year over the next 4 years.  That is a big, big shock absorber.

 

Within the equity portfolio, most of the holdings have moved up the quality ladder. At the same time, mark to market holdings are now less than 50% of the holdings - this will significantly reduce volatility moving forward. 

 

Bottom line, today Fairfax’s looks much better positioned today to deal with any future adversity / black swan event than they were 5 years ago. 

Edited April 16 by Viking

[Viking]

On 4/14/2024 at 7:01 PM, LC said:

Partly rhetorical - but is Fairfax as easy of a “buy” today, versus 6, 12, 24 months ago? 

@LC This is a great question. 
 

Your answer will depend of your assessment of three things:

1.) what Fairfax has accomplished over the past year

2.) what the company is worth today

3.) how the company should be valued. 
 

Fairfax earned $189/share in 2023. My view is intrinsic value went up by more than that. The earnings visibility of Fairfax has improved markedly (with extending the duration of the fixed income portfolio). I think the quality of the company is better today than it was a year ago - we had another 12 months to grade management.
 

One of the reasons i go to the AGM i get the opportunity to talk to really smart investors. Most people i talked to said they felt Fairfax was probably worth about 1.5x book value. This is a higher multiple than last year. 
—————

“is Fairfax as easy of a “buy” today, versus 6, 12, 24 months ago?” That depends on whether or not you view Fairfax as a higher quality company today than what you thought a year ago (use whatever time-frame you want here). And whether it deserves a higher multiple than you thought a year ago. 
 

Fairfax trades today at a P/BV of about 1.1 (to my estimated March 31 BV) and a PE of 6.6 x (my estimated 2023 earnings of $160). Is it cheap? Yup.

Edited April 16 by Viking

[Viking]

16 hours ago, petec said:

 

Personal view but I think the board has a good handle on the facts, but the psychology has swung about 70% of the way from focussing on the bad to focussing on the good.

 

We aren't talking much about the risks (big ones for me would be falling interest rates, which impact the terminal value of float and which I believe are correlated with lower combined ratios for a double hit to earnings, and a major cat loss).

 

We are talking lots about how good the investments are, forgetting (maybe?) that these are often the same investments we dissed 5 years ago, but they're more expensive now (Eurobank and Stelco come to mind here - I am not sure the earnings power of either business has improved much over the last few years, but the share prices sure have).

 

None of this is a criticism - there's some great work on the board. But the mood has swung, as it so often does, procyclically. We have got more exited as the stock has got closer to intrinsic value, not less. Weird how the human brain works.

 

You can argue that the risks have fallen because the certainty of outcomes has risen. I agree, to a degree. But 5 years ago FFH was a Faberge egg, with value inside value inside value. All it needed was patience. Now, it needs things to keep going right. I am fairly sure they will, and this remains my biggest position at 17%, but I am shifting into the "when do I reduce" mode rather than "how can I buy more". 

@petec great comment. Lots of interesting ideas to discuss/debate. 

 

“Personal view but I think the board has a good handle on the facts, but the psychology has swung about 70% of the way from focussing on the bad to focussing on the good.”

 

I agree that the psychology of people on the board has shifted. My view is the shift has happened because execution, fundamentals and results have been steadily improving at Fairfax.

 

Most of the discussions on the board are focussed on what has been happening at Fairfax - the facts. Fairfax has been executing exceptionally well. The fundamentals keep getting better every year. Reported results have been excellent. As a result most of the posts in recent years have had a positive spin.  

 

Now i don’t expect this to continue forever. I do expect at some point the Disney movie called ‘Fairfax Financial’ will end - and Fairfax will become a regular boring company. And the posts on the board will reflect that reality and become a little more balanced. 

 

I am trying to find the bad. But it is really hard right now. Yes, that is a bizarre statement to make. Especially when it comes to Fairfax. But today, the important tailwinds greatly outnumber the important headwinds. Still.

 

Importantly, i am not going to make bad stuff up. So i can tick the ‘bad stuff’ box in my analysis of the company. When you make stuff up (both good and bad) it gets into your head. And likely warps your valuation of the company - and position size. Making stuff up is dangerous - i know this from personal experience. 

 

Following Fairfax right now is like watching Michael Jordan in his prime. Now back in the day, when watching Jordan play, i could have tried to find a bunch of things that he was doing poorly. Would that have been helpful?

 

I have two questions:

 

1.) If investors understand the facts so well today why does Fairfax trade at a P/BV of 1.1 x (ext. March 31 book value) and a PE of 6.7 x (est 2024 earnings)? 

 

For the past 3 years, Fairfax has been playing like Michael Jordan in his prime. But Fairfax’s stock is being valued today like they are a bench player. That makes no sense.

 

2.) If investors understand the facts so well why are so many people thinking/discussing selling down their position? 

 

Now i do understand that people only buy a stock for one reason - they think it’s going to go up in price. And yes, people sell a stock for a multitude of reasons:

• It is fully valued
• They find another stock they like more (offers better value)
• They are way overweight
• Tax reasons
• Need the cash
• Take profits - “That suckers gone up a lot”

But i think a lot of people are thinking about selling just because the stock has gone up a lot. Their mental process has less to do with facts and more to do with fear/greed/psychology. 

—————-

Now i do have a long list of risks for Fairfax that i am monitoring/managing. I have discussed many of these risks over the past 3 years. My biggest risk owning Fairfax today is my concentrated position. But that risk has much more to do with me than it does with Fairfax. This post is long enough already. Let’s leave the discussion of risks to another day.

Edited April 16 by Viking

[jfan]

https://www.cbc.ca/news/politics/federal-budget-2024-main-1.7175052

 

This might have an impact on Fairfax....

[Daphne]

They put a special tax on insurance cos and banks in last years budget

[Mick92]

Just pay your "fair" share, that's all the government wants.  

[Junior R]

how does the capital gains inclusion rate change Fairfax Investments 

[SafetyinNumbers]

7 minutes ago, juniorr said:

how does the capital gains inclusion rate change Fairfax Investments 

 

My guess is it should increase the deferred tax liability all else being equal by the increase in the inclusion rate. Anyone have a better idea?

 

If my estimate is right it would increase the deferred tax liability by ~$412m or ~$18/share. 

[Maverick47]

From an economic standpoint, as long as Fairfax continues to prefer to hold equity investments for the long term and allow the gains to compound on the balance sheet unrealized, there should be no dramatic reduction in reported after tax income.  But if as you’ve noted, the deferred tax liability would increase by $18 per share, the book value ought to drop by an equal amount.

 

However, in my opinion, that is a somewhat misleading effect.  A deferred tax liability is an interest free loan from the government which has to be paid back only when gains are realized.  And a deferred tax asset is an interest free loan to the government that only is  paid back to the company as future income is generated and able to be shielded from taxes because of the prepaid tax asset.

 

Neither of these are present valued on the balance sheet.  An asset that earns no interest is not worth as much in my opinion as a similar amount invested in 5% government bonds.  Similarly, a no interest loan that might not have to be paid off until years in the future is not as large a liability as a similar amount borrowed by means of a 6% interest 10 year bond issue.

 

Fairfax has about a $1 billion net deferred tax liability (interest free loan from the taxing authority) on the balance sheet at year end 2023.  That is a sign of a savvy insurance company in my opinion, and if the liability grows to $1.4 billion after a tax change, it just makes the comparison with peer insurance companies that often record net deferred tax assets on their balance sheets that much more favorable.

[Haryana]

The net effect is likely a ~3% increase in tax paid on realized gains.

(66%-50%=16%, 19% on 16% = 3%)

 

[Haryana]

(Assuming total effective tax rate of 19%)

So even if they have an unlikely $1 billion in realized gain, the impact of new tax rule is limited to $30 million.

 

Also, the tax rates are lower outside Canada, and it is likely the local tax rates that will apply on associate transactions.

"Provision for income taxes of $813.4 million with an effective tax rate of 13.8% principally reflected non-taxable investment income that included the benefit of the gain on the sale of Ambridge by Brit, the tax rate differential on income and losses outside Canada primarily related to income taxed at lower rates in the U.S., Bermuda and Mauritius, and the change in tax rate for deferred income taxes related to deferred tax assets recognized as a result of new tax laws in Bermuda during the fourth quarter of 2023 including the introduction of a 15% corporate income tax effective January 1, 2025."