Fairfax 2024

[Haryana]

10 hours ago, vinod1 said:

 

I ran the numbers a whole while back, ...

 

 

How long while ago back was that?

 

The result should be better if you run the numbers now.

 

[Hamburg Investor]

On 4/18/2024 at 3:12 PM, giulio said:

I cannot claim to be an expert in the field so any input is appreciated, here is my 2c:

 

An insurer would need to write @85% CR or below to achieve those results without a strong performance on the investment side. Some lines of insurance could allow you to achieve that CR. Or a combination of niche expertise and strong technology (i.e. low loss ratio and low expense ratio).

For example, Kinsale has a "standard" $3b portfolio but excels on the uw side.

 

I am not sure if an insurer can scale and still maintain such a CR. 

Another example would be Francis Chou at Wintaii: both strong uw and investment expertise, but he write $50M in premium on $150M of equity.

@Parsad correct me if I am wrong here.

What does Watsa mean when he says that to achieve 15% ROE FFH needs a 95% CR and a 7% return on investment portfolio?

The math is simple: a 7% ROI (both interests, dividends and gains realized and unrealized) translates to 5.1% after tax (26.5% Canadian rate). At 3x leverage (thanks to float and some debt) this equals 15% ROE. 

UW profits would more than cover FFH other expenses (overhead, interests, run off).

Now 75% of the portfolio is fixed income in nature (A) and 25% is equities (B). 

If (A) earns 4% and (B) 16% you get 7% ROI.

 

This is my extremely simplistic view and the way I would look at an insurer with demonstrated uw discipline and a focus on investment performance.

It is not easy to find both these elements. It is even more rare to find an investment team that aims for superior returns in BOTH equities and bonds!

Most insurers just park float in bonds and match liabilities. At FFH we benefit from an incredible astute team that looks for bargains even in bonds. Do not underestimate this.

 

I think the above equation completely melts down in a world of 0-2% return on bonds and an equity portfolio "drowned" in hedges, shorts and some bad investments. Still, Over the last 10 years, FFH BV has compounded at 10%.

 

I remain optimistic about the future and believe that they will achieve their stated goals. 

 

G

 

 

 

 

Totally agree with your conclusion about what 0-2% interest rates mean for insurance.

 

Just some remarks:

- Haven‘t you forgotten premium growth as an important part for how to reach 15% roe? (I don‘t mean acquisitions but internal growth). Another point: The equity returns are not taxed every year; so the overall tax is lower than 26%. And you forget the earnings through a profitable insurance business (cr of e. g. 95)

- You claim 4% roe Bonds / 16% roe stocks. Shouldn’t the bond portfolio yield way higher? Treasuries are higher (and logged in for nearly 4 years) and the corporate bonds even yield higher (like 10%).
- That logic (which I don‘t share)  - needing 16% returns on the inherent stock/business part for getting an overall 15% return for the holding company - seems structurally absurd to me. The whole idea of FFH (and the other insurers investing part of their equity in businesses/stocks) is it to get overall higher returns than the inherent businesses (stocks, wholly owned businesses) returns. So you have two parts (insurance + businesses), both yielding less than the whole. Possible through the magic of float leverage. If one part alone would yield better than the whole - why than not sell the lower yielding one, as that would only be a drag to returns? In other words: If Prem in his own plan would need 16% in the equity part for getting 15% for the holding: Why shouldn‘t he sell the insurance part than and invest the outcome into stocks/wholly owned businesses alone? After doing that he would have a holding with a roe of 16%, before he would have one with a roe of 15%. 

 

 

Edited April 20 by Hamburg Investor

[giulio]

Hi @Hamburg Investor, I appreciate your response.

 

First, let me stress the fact that this is a very high-level, simplistic view of FFH. I basically assume that their uw profits make them break even on all other costs, so you are left with the portfolio returns.

 

That said, you are right

1. there is certainly upside if their uw profits >> than overhead, interests on debt ecc.
2. FFH cash taxes are lower than the cad rate; I have them @ 16% .

Could you clarify your comment on growth? I am not sure how to interpret your question. Are you referring to some kind of operating leverage?

 

On the bonds yield, this is what FFH reported in the AR 2023

The 10% you mention, I think it refers to the IRR they expect to earn on the KW/PacWest loans, i.e. an example of their opportunism. Corporates are not yielding 10%.

Anyway, you can play around with the numbers. I just wanted to show that if Watsa can display a 18%+ CAGR it's not just leverage or uw profits. The equity portfolio, in a lumpy manner, has certainly contributed!

 

On the last part, I did not get your point.

The insurance segment provides the capital for the investment team to put to work. Only part of it can go to equities. During the last segment of the AGM, Watsa talked about the "transformed" FFH and the "stability" of the interest income achieved. He alluded to the possibility of tilting more capital towards equities in the future, but I guess that will depend on the premiums level and regulatory capital.

 

G

 

 

 

[Viking]

WR Berkely reported Q1 results this morning. Results looked good to me. But clearly Mr Market wasn’t happy - the stock is currently down 6%. 2024 is shaping up to be a decent year for the overall insurance market. My guess is we are approaching the tail end of the hard market in the overall P/C insurance market. As a result, i think we see lots of volatility with insurance stocks as they report results. We are also approaching hurricane season, which tends to be a volatile period for P/C insurance stocks. Chubb reports results tomorrow (Wed).
 

Here are some notes from WRB’s conference call:

- “the business is firing on all cylinders”; both investments and insurance

- “enthusiastic about 2024 and the groundwork laid for 2025”

- “better than average chance we can grow top line 10-15% in 2024” ; lots of variability by business line.

 

- top line growth in net premiums written was 10.7%

- increase in rate was 7.8%, above loss cost trend in aggregate.

- 80% renewal ratio

- “record investment income and Q1 underwriting profit”

 

- fixed income book yield = 4.2% (excluding Argentina transaction) and new money rate is currently 5.25% to 5.5%.

- “earnings power of business has considerable upside from here”

- fixed income duration extended from 2.4 to 2.5 years.

- “average life of reserves is just under 4 years”

- adverse development from soft market from 2019 and prior years should largely be in rear view mirror.

 

- share buybacks: do not buy back stock blindly; only when they feel it offers good value. They did not buy back any stock in Q1.

Edited April 23 by Viking

[SafetyinNumbers]

31 minutes ago, Viking said:

WR Berkely reported Q1 results this morning. Results looked good to me. But clearly Mr Market wasn’t happy - the stock is currently down 6%. 2024 is shaping up to be a decent year for the overall insurance market. My guess is we are approaching the tail end of the hard market in the overall P/C insurance market. As a result, i think we see lots of volatility with insurance stocks as they report results. We are also approaching hurricane season, which tends to be a volatile period for P/C insurance stocks. Chubb reports results tomorrow (Wed).
 

Here are some notes from WRB’s conference call:

- “the business is firing on all cylinders”; both investments and insurance

- “enthusiastic about 2024 and the groundwork laid for 2025”

- “better than average chance we can grow top line 10-15% in 2024” ; lots of variability by business line.

 

- top line growth in net premiums written was 10.7%

- increase in rate was 7.8%, above loss cost trend in aggregate.

- 80% renewal ratio

- “record investment income and Q1 underwriting profit”

 

- fixed income book yield = 4.2% (excluding Argentina transaction) and new money rate is currently 5.25% to 5.5%.

- “earnings power of business has considerable upside from here”

- fixed income duration extended from 2.4 to 2.5 years.

- “average life of reserves is just under 4 years”

- adverse development from soft market from 2019 and prior years should largely be in rear view mirror.

 

- share buybacks: do not buy back stock blindly; only when they feel it offers good value. They did not buy back any stock in Q1.

2.5x+ BV starting to seem expensive or is something else going on?

[steph]

....and 15 times earnings.   FFh could double and still be cheaper than WRB. 

[Saluki]

13 minutes ago, steph said:

....and 15 times earnings.   FFh could double and still be cheaper than WRB. 

 

Yes, a couple of months ago a friend asked me about FFH because someone they knew was interested in it. This was right before the Muddy short attack.  I mentioned that if you look at it like most insurance companies (or banks), it's above book, which is not great, but still cheaper than BRK or MKL by that metric.  If you account for future growth which is probable based on history, and profits locked in due to rolling the fixed income portfolio, it's trading at a great price (based on P/E) for anything it looks like a great bet.  

 

I haven't sold any shares, but didn't have the courage to double down during the few days that the price dropped, because it's already a big position for me.  I have been adding to FF India though. It's still at an inexplicable discount to book and they are making some shrewd moves buying back shares and selling things when they are fully priced, like the National Stock Exchange in India. And I appreciate that when the performance fee was due to FFH, that Prem didn't dilute us and take his fee in shares instead of cash.  You wouldn't see that at Brookfield. 

 

Some of the holdings look interesting and kind of mirror each other, like buying ATCO in FFH and the Tanker company whose name I can't remember in FF India.  

[dartmonkey]

1 hour ago, SafetyinNumbers said:

fixed income book yield = 4.2% (excluding Argentina transaction) and new money rate is currently 5.25% to 5.5%.

 

Does anyone know what this ‘Argentina transaction‘ is?

[Viking]

3 hours ago, dartmonkey said:

 

Does anyone know what this ‘Argentina transaction‘ is?

@dartmonkey here is what was said near the end of the Q1 conference call. I think Rob’s comments at the end of the conversation were meant to be in jest…

 

Brian Meredith

Yes, thanks. Hi, good morning. Two questions. Rich, I'm just curious, could you just give us the actual income that you generated from the Argentina inflation bonds in the quarter? Just so I don't have to do the math.

 

Rich Baio

Rob, I'm not sure we've then generally given that level of detail. I'm not sure if...

 

Brian Meredith

I can back into it with what you said in the yield, but I just wanted to know what the actual number was.

 

Rich Baio

Why don't we take it offline?

 

Rob Berkley

Yes, Brian, he's just going to check with an attorney and call you back. How about that?

 

Brian Meredith

Okay, fair.

[Viking]

5 hours ago, SafetyinNumbers said:

2.5x+ BV starting to seem expensive or is something else going on?

@SafetyinNumbers , the short answer is i am not sure. On their calls, WRB typically tries and stay very top line. They are going to make a lot of money over the next 2 years. 
 

The analysts want to get into the weeds. So it appears the analysts found some things in the weeds that they don’t like. WRB might have done some reserve strengthening from 2019 and prior years? It appears the total insurance market is softening… yet WRB guided to 10 to 15% growth for 2024 (‘trust us’)? The average duration of the fixed income portfolio is only at 2.5 years? 

[SafetyinNumbers]

31 minutes ago, Viking said:

@SafetyinNumbers , the short answer is i am not sure. On their calls, WRB typically tries and stay very top line. They are going to make a lot of money over the next 2 years. 
 

The analysts want to get into the weeds. So it appears the analysts found some things in the weeds that they don’t like. WRB might have done some reserve strengthening from 2019 and prior years? It appears the total insurance market is softening… yet WRB guided to 10 to 15% growth for 2024 (‘trust us’)? The average duration of the fixed income portfolio is only at 2.5 years? 

My guess is that if estimates go up post quarter that eventually the stock will resume moving higher but thankfully I don’t have to bet on it.

[Daphne]

* Fairfax Financial Holdings Ltd. (

FFH-T +0.63%increase

 

) to $2,000 from $1,900. Average: $1,828.09.

 

Analyst: “We believe Fairfax’s current valuation does not fully reflect the company’s earnings potential and remains an attractive opportunity for investors. We believe the stock should garner a sustainable re-rate on the back of the organic expansion in its insurance operations, which likely enhances the company’s ROE and the growth rate potential of its book value, and potentially adds greater consistency to both metrics. The company is likely well positioned for the current rate environment and has locked in a much higher run-rate of operating investment income as a result of the rise in bond yields and its short-duration portfolio. Further, given its value investing approach, we think it has the potential to continue to generate outsized investment returns – even against a backdrop of more modest equity market returns. The company has demonstrated resilience through the business cycle and turbulent financial markets, but we view it as a less defensive play than more traditional publicly listed insurers. At this stage of the market cycle, this likely provides an attractive balance: downside protection thanks to the relative resilience of insurance operations through a potential recession, and upside potential when markets recover. We believe the company is overlooked or unloved by investors, and continues to trade well below its intrinsic value. We are bullish on the name and believe Fairfax is well positioned to successfully navigate the current environment and remains one of our top ideas for 2024. Fairfax’s valuation discount remains wide despite showing strong growth and enhanced ROE potential.

 

FROM TODAYS GLOBE AND MAIL

[netcash1]

was the Globe and Mail comments AI Generated?

[Daphne]

It was a part of a larger analysis on what to expect from cdn insurers this reporting season

[Haryana]

^ this was from Phil Hardie of Scotia Capital.

 

https://www.theglobeandmail.com/investing/markets/inside-the-market/article-fridays-analyst-upgrades-and-downgrades-for-april-26/

 

[gamma78]

 

Hey guys.....newbie to writing on this board (though I've been following for ages and ages.....thank you so much for the wonderful learning opportunities here). 

 

There was some time ago discussion about "high quality" investments vs low quality investments that Fairfax has vs the Berkshire portfolio. One of the statements by Prem that caught my eye in the Fairfax AGM was the following, on what he learned from Charlie Munger.... to me it sounds almost like they are thinking about how in the future their returns will depend increasingly on operating income from high return on capital investments they can carry for a long long long time rather than only on float increase and investment (with great CR%). Sounds like replication of Berkshire over time. 

 

"The big one was just -- Charlie made this point years ago, 2 points. One was that, earlier on, like us, they depended on stock gains, bond gains. In fact, it's like when they began years ago. And then they got the ability to be a railroad company, Burlington Northern, to get operating income, but one of the biggest [ pluses ], biggest questions that -- answers that you suggested was that you have to have patience. And when you see an opportunity, you're going big when you understand it. And when you don't understand it, just stay away. So all insurance people, of course, when they saw that opportunity, we double our premium, right? Interest rates, when we saw the opportunity, [ we went 4 years ], but going forward -- it's a very good question. We're big now. And the idea of buying good businesses at fair prices, big positions, compounding for a long period of time, we're focused on that, looking at that. We've got good investments like we've had with Kennedy Wilson and with Seaspan Poseidon, but we'd be looking at -- and this is not an environment right now that you can find them because the prices are high, but we're looking at getting positions in companies where we can compound for a lot of -- without any tax, as they say. But we learned a lot from Berkshire and Charlie. I mean we followed them for a long, long time."

 

 

[gamma78]

Oh.....and this came out today which is worth keeping an eye out for...

 

https://www.thehindubusinessline.com/economy/logistics/adani-gmr-and-fairfax-in-pre-bid-process-to-develop-puri-airport/article68110793.ece

 

[SafetyinNumbers]

41 minutes ago, gamma78 said:

 

Hey guys.....newbie to writing on this board (though I've been following for ages and ages.....thank you so much for the wonderful learning opportunities here). 

 

There was some time ago discussion about "high quality" investments vs low quality investments that Fairfax has vs the Berkshire portfolio. One of the statements by Prem that caught my eye in the Fairfax AGM was the following, on what he learned from Charlie Munger.... to me it sounds almost like they are thinking about how in the future their returns will depend increasingly on operating income from high return on capital investments they can carry for a long long long time rather than only on float increase and investment (with great CR%). Sounds like replication of Berkshire over time. 

 

"The big one was just -- Charlie made this point years ago, 2 points. One was that, earlier on, like us, they depended on stock gains, bond gains. In fact, it's like when they began years ago. And then they got the ability to be a railroad company, Burlington Northern, to get operating income, but one of the biggest [ pluses ], biggest questions that -- answers that you suggested was that you have to have patience. And when you see an opportunity, you're going big when you understand it. And when you don't understand it, just stay away. So all insurance people, of course, when they saw that opportunity, we double our premium, right? Interest rates, when we saw the opportunity, [ we went 4 years ], but going forward -- it's a very good question. We're big now. And the idea of buying good businesses at fair prices, big positions, compounding for a long period of time, we're focused on that, looking at that. We've got good investments like we've had with Kennedy Wilson and with Seaspan Poseidon, but we'd be looking at -- and this is not an environment right now that you can find them because the prices are high, but we're looking at getting positions in companies where we can compound for a lot of -- without any tax, as they say. But we learned a lot from Berkshire and Charlie. I mean we followed them for a long, long time."

 

 

I think they are telling us their sweet spot is quality at a fair price and they are waiting for fat pitch. That should send the multiple higher but the market might wait until they actually pull the trigger. 
 

Does anyone have an estimate of how much they could deploy into equities from fixed income if an opportunity presented itself?

[Maverick47]

I don’t have an estimate of how much could be deployed from fixed income to equities, but I think it’s not uncommon for insurance company managements to choose to hold their insurance loss, and expense reserves (and unearned premium reserves) in the form of relatively secure fixed income instruments.  The amount of float held by Fairfax might be a reasonable approximation for such a lower bound on fixed income — roughly $35 billion?  I’d be surprised if they chose to hold fixed income investments in an aggregate amount less than that.  I think they currently hold over $40 billion in bonds?
 

in addition, there may well be some regulatory or rating agency constraints on investments in equities.  There’s often an implicit trade off between underwriting and investment risk for a company.  When a company expands its premiums written such that they become sizeable relative to supporting surplus or equity, then they generally have less of an ability to accept risk on the investment side of the house by moving into equities.  A company such as Progressive, with premiums to surplus/equity ratios in the high 2+  area (sometimes close to 3.0) takes much of its risk on the underwriting side, so not surprisingly will not hold a sizable investment in equities.

 

Fairfax has written premiums of about $29 billion, and equity including both preferred and common of about $24 billion.  So they can be heavier into equities than a company like Progressive, and they are…with about $15 billion invested in equity-like instruments, associates, etc.  If they anticipated opportunities to grow premiums dramatically, then they’d probably hold off on a further move from fixed to equities.  But if they anticipated a soft market in which they even saw premiums shrinking, they might well choose to offset a reduction in insurance  related risk with an increase in investment risk via a shift from bonds to equities.

[TwoCitiesCapital]

1 hour ago, Maverick47 said:

I don’t have an estimate of how much could be deployed from fixed income to equities, but I think it’s not uncommon for insurance company managements to choose to hold their insurance loss, and expense reserves (and unearned premium reserves) in the form of relatively secure fixed income instruments.  The amount of float held by Fairfax might be a reasonable approximation for such a lower bound on fixed income — roughly $35 billion?  I’d be surprised if they chose to hold fixed income investments in an aggregate amount less than that.  I think they currently hold over $40 billion in bonds?
 

in addition, there may well be some regulatory or rating agency constraints on investments in equities.  There’s often an implicit trade off between underwriting and investment risk for a company.  When a company expands its premiums written such that they become sizeable relative to supporting surplus or equity, then they generally have less of an ability to accept risk on the investment side of the house by moving into equities.  A company such as Progressive, with premiums to surplus/equity ratios in the high 2+  area (sometimes close to 3.0) takes much of its risk on the underwriting side, so not surprisingly will not hold a sizable investment in equities.

 

Fairfax has written premiums of about $29 billion, and equity including both preferred and common of about $24 billion.  So they can be heavier into equities than a company like Progressive, and they are…with about $15 billion invested in equity-like instruments, associates, etc.  If they anticipated opportunities to grow premiums dramatically, then they’d probably hold off on a further move from fixed to equities.  But if they anticipated a soft market in which they even saw premiums shrinking, they might well choose to offset a reduction in insurance  related risk with an increase in investment risk via a shift from bonds to equities.

 

Isn't the rule of thumb that they can invest roughly the accounting equity of the business in equities? The remainder is reserves/float for the insurance? 

 

So they could probably add another $10B in equity if push comes to shove. Maybe more as long as we avoid major catastrophes over the next year or two. 

 

I think the big win will NOT necessarily be from adding $10B of equities - but being able to roll a large portion of the $35B+ in fixed income into corporates/mortgages opportunistically to add another ~1-2% to the portfolio yield as well as the realized capital gains when the opportunity presents itself. 

[Viking]

P/C Insurance - Growth by Acquisition - A Review of 2015 to 2017

 

Capital allocation is the most important responsibility of a management team. Why? Capital allocation decisions are what drive the long-term performance of a company and important metrics like reported earnings, growth in book value and return on equity. In turn, these metrics drive the multiple given to the stock by Mr. Market - and finally the share price and investment returns for shareholders.

 

When done well, capital allocation does two important things:

1. Delivers a solid return.
2. Improves the quality of the company.

Therefore, the fundamental task of an investor is to determine if management, over time, is making intelligent decisions regarding capital allocation.

 

How good is Fairfax at Capital allocation?

 

This is where the story gets really interesting. Fairfax has compounded book value per share at a compound annual growth rate of 18.4% over the past 38 years (since 1985). This performance puts the company in the top 1% of all publicly traded equities over this time span. Their long term record when it comes to capital allocation is exceptional.

 

But what about today?

 

There is a narrative today that Fairfax can’t be trusted - the gang at Hamblin Watsa are a bunch of ‘cowboys’ - when it comes to capital allocation. This view is based largely on the disastrous ‘equity hedge’ trade that Fairfax put on from 2010 to 2016.

 

From 2010 to 2016, I probably would have agreed with this view. Also in 2017. And probably even in 2018. But by 2019, it was clear the Fairfax super tanker was slowly starting to get back on track with its capital allocation decisions. In late 2020 the last of the short positions was removed - and Fairfax publicly promised it would no longer hedge/short market indices or individual stocks.

 

Mistakes are going to be made when playing this game. Even Buffett has made his share of big mistakes:

1. 1965: buying Berkshire Hathaway itself.
2. 1987: buying Solomon preferred shares ("What we do have a strong feeling about is the ability and integrity of John Gutfreund, CEO of Salomon Inc. Charlie and I like, admire and trust John." WB 1987)
3. 1993: buying Dexter Shoe Company; compounded by paying for it with Berkshire stock.
4. 1998: buying General Reinsurance; compounded by paying for it with Berkshire stock.

So, yes, Fairfax messed up badly with the equity hedges from 2010 to 2016. But they have admitted and learned from their mistake (and long ago exited the position). And the team at Hamblin Watsa is once again executing exceptionally well when it comes to capital allocation. Well, for those who are paying attention.

 

Below are a few of the larger examples of what the team at Fairfax has done when it comes to capital allocation over the past four years:

• 2020 to 2023: ex-SIB in 2021, effective shares outstanding reduced by 1.8 million at average cost of about $465/share.
• 2020- 2021: initiated FFH-TRS - giving it exposure to 1.96 million Fairfax shares at a cost basis of $373/share.
• 2020 & 2021: sale of European runoff insurance operations for $1.3 billion plus $236 million CVR.
• 2021: reduced average duration of fixed income portfolio to 1.2 years in Q4, which  protected balance sheet (saved billions in unrealized losses).
• 2021: SIB stock buyback - 2 million Fairfax shares at $500/share.
• 2022: sale of pet insurance for $1.4 billion - resulting in $1 billion gain after tax.
• 2022: sale of Resolute Forest products for $626 million plus $183 million CVR; sold for a premium at the top of the lumber cycle.
• 2023: increased average duration of fixed income portfolio to +3 years in Q4 2023 - locked in $2 billion in interest income for the next 4 years.

These transactions all delivered significant value to shareholders. They also highlight the many levers at the disposal of the management team at Fairfax. Fairfax has many more levers to pull to drive shareholder value than traditional P/C insurance companies.

 

My view is that Fairfax is best-in-class among P/C insurers when it comes to capital allocation. That is what the facts and the fundamentals of the business tell me. I follow facts and fundamentals when I invest.

 

It often takes years to properly evaluate the decisions made by a management team (that 'facts' thing). 

 

Capital allocation - Growth by acquisition - 2015 to 2017

 

“Someone’s sitting in the shade today because someone planted a tree a long time ago.” Warren Buffett

 

From 2015 to 2017, Fairfax executed on a bold plan to significantly grow the size of their international P/C insurance footprint. That is what we are going to review today.

 

What was the cost? What did Fairfax do? How did it work out? How is the company positioned today? Enough time has passed that we can now properly evaluate the decisions and performance of the management team at Fairfax.

 

What was the total cost?

 

Over the three year period from 2015 to 2017, Fairfax made a total of 11 different purchases of insurance companies. The total cost was $7.6 billion.

 

The three biggest purchases were Allied World ($4.9 billion), Brit ($1.7 billion) and Eurolife ($361 million).

 

 

What did Fairfax do?

 

The acquisitions dramatically built out Fairfax’s international P/C insurance footprint. While also strengthening its US and Canadian operations.

• Lloyds of London/UK - Brit
• Asia (Sri Lanka, Vietnam, Malaysia, Indonesia)
• Greece - Eurolife
• Eastern Europe - AIG
• Latin America - AIG
• South Africa - Zurich
• Allied World - Bermuda

India: 2017 was also the year Fairfax made a bold move with the strategic positioning of its P/C insurance business in India. It pivoted from ICICI Lombard to Digit, in what has become a brilliant move. We will not include this move in this post. But this move (and the timing) does fit the ‘built out the international P/C insurance platform’ theme.

 

The timing of the purchases

 

To state the obvious - the timing of an acquisition is very important. In general, the worst time to buy an insurance company is probably at the end of a hard market. Profitability and stock prices are at peak levels. And a big premium will likely need to be paid. There is little margin of safety. The best time to buy an insurance company is in a soft market. Profitability and stock prices are usually at more acceptable levels. The premium is reasonable. There is more of a margin of safety.

 

With hindsight, 2015-2017 was the perfect time to buy P/C insurance companies. At the time, P/C insurance was in a soft market - not great for underwriting profit. And interest rates were low - not great for investment results. As a result, well run P/C insurance companies were available for purchase at reasonable prices.

 

The evolution of a value investor - quality at a fair price

 

“It’s far better to buy a wonderful company at a fair price, than a fair company at a wonderful price.” Warren Buffett

 

Fairfax are value investors. It permeates everything they do (both insurance and investments). However, Fairfax is also a 38 year old company - it has evolved and changed in important ways.

 

In the past, Fairfax’s style could be best described as ‘deep value.’ Today, Fairfax’s style could perhaps be best described as ‘quality at a fair price.’ This is becoming more apparent with how Fairfax has been managing their equity investments over the past 6 years.

 

Of interest, ‘quality at a fair price’ has been in place on the insurance side of Fairfax since the Zenith acquisition back in 2010. Importantly, from 2015-2017, Fairfax paid up a little to buy decent to good insurance companies. Allied World, the largest purchase by far at 64% of the total, was a well run insurance company.

 

Fairfax’s shift to ‘quality at a fair price’ is not yet well understood by investors. This shift will have an important impact not only on Fairfax’s future earnings (more predictable) but also on their volatility (lower).

 

The size of the purchases

 

“Opportunities come infrequently. When it rains gold, put out the bucket, not the thimble.” Warren Buffett

 

Let’s put $7.6 billion into perspective. At the end of 2014, common shareholders’ equity at Fairfax was $8.36 billion. Net premiums written were $6.1 billion. At the time, spending $7.6 billion on 11 different P/C insurance acquisitions was an extremely aggressive move by Fairfax. They were acting with conviction.

 

How did Fairfax come up with the money?

 

But remember, this was also the time when Fairfax’s investment portfolio was underperforming (booking significant losses from equity hedges/short positions). So, Fairfax did not have a lot of spare cash just lying around.

 

How do you go on an acquisition spree when you are short on cash?

 

This highlights one of the greatest and under appreciated strengths of the management team at Fairfax. They are very creative/resourceful in finding solutions to challenges.

 

Fairfax came up with the cash for its insurance acquisitions in four basic ways:

 

1.) Equity: From 2015-2017, Fairfax raised $3.3 billion from issuing common shares. The total share count increased 34.3%. The average issue price was about $456/share. Shares were issued (on average) at a small premium to book value.

 

 

2.) Debt: From 2015-2017, net debt at Fairfax increased by $2.1 billion. From 2015 to 2017, Fairfax did 4 separate debt offerings, raising a total of $1.85 billion at an average rate of interest of 4.55% with an average maturity of about 9 years. Looking back, due to the very low rates, this was an ideal time to use debt.

 

 

3.) Asset monetizations: Fairfax sold First Capital at a premium valuation and realized a gain of $900 million after tax. As part of its strategic shift in India, Fairfax also sold down its position in ICICI Lombard which resulted in a gain of $950 million after tax (including gain on 9.9% stake still owned). Fairfax bought low and at the same time sold high.

 

The First Capital transaction deserves a special shout-out. Most people didn’t even know Fairfax owned this business, let alone that it could be sold for such a large sum.

 

And as we mentioned earlier, the pivot in India was a second brilliant move.

 

The next time you run into a Fairfax detractor, ask them if they have ever heard of First Capital. And then ask them what they think of Fairfax’s pivot with their P/C insurance business in India in 2017 (selling ICICI Lombard, booking a $1 billion gain after tax, and seeding Digit, which has since increased in value by $2 billion). Facts matter.

 

 

4.) Minority partners: Fairfax brought in minority partners who contributed a significant portion of the up-front purchase price. For the three big acquisitions, partners contributed $2.3 billion (33%) of the $6.9 billion total.

 

The big benefit of using minority partners is it allowed Fairfax, when the time was right, to buy more (control positions) for less (up front money). This strategy can be especially important/beneficial if you are a little short on cash when the opportunity is ripe.

 

A P/C insurer using minority partners, like Fairfax did, was unheard of at the time. It was classic capital allocation by Fairfax - very unorthodox but highly effective. Eight years later, most investors still do not understand or appreciate the significance of this move. But as Fairfax continues to take out its minority partners in the coming years - and earnings available to common shareholders magically pops higher - the brilliance of what Fairfax has accomplished will come into better focus for investors.

 

 

How much did Fairfax’s P/C insurance business grow from 2014 to 2018?

 

From 2014-2018, P/C insurance was in a soft market. As a result, most P/C insurers experienced tepid growth in their top line numbers.

 

As a result of its many acquisitions, Fairfax was able to double net premiums written (NPW) from $6.1 billion in 2014 to $12 billion in 2018.  Due to a 28% increase in the share count, NPW/share increased by 53%. 

 

 

How much did Fairfax’s business grow from 2018 to 2023?

 

P/C insurance began its hard market in late 2019. Hard markets are the best of times for insurance companies. However, they happen very infrequently - the last hard market was 2002-2007.

 

Driven primarily by organic growth, Fairfax was able to almost double NPW from $12 billion in 2018 to $22.9 billion in 2023. Due to a 15% decrease in the share count, NPW/share increased by 125% to $996/share.

 

 

Summary

 

Net premiums written at Fairfax have increased from $6.1 billion in 2014 to $22.9 billion in 2023, an increase of 274% which is a CAGR of 15.8%. From 2014 to 2018, growth was driven primarily by acquisitions. From 2018-2023, growth was mostly organic. Fairfax has been able to substantially increase the size of its insurance business over the past 9 years.

 

As a result of the significant growth in Fairfax’s insurance business, float has grown to $35 billion and total investments has increased to $65 billion.

 

And with the spike in interest rates, the value of float and investments has also increased significantly. As a result, Fairfax delivered record net income in 2023. And the outlook for earnings in the coming years has never looked better.

 

Fairfax’s insurance and investment businesses have never been better positioned than what they are today.

 

 

Capital allocation

 

We come full circle. Thanks for hanging in there - this has been a long post. But Fairfax’s story needs to be told. Fairfax continues to be misunderstood and under appreciated both as a company and as an investment. This will only change as more people come to understand the facts.

 

The genesis of the exceptional positioning that Fairfax finds itself in today was its aggressive acquisition phase from 2015-2017 where it significantly expanded its global insurance platform. Perfectly timed - right before the onset of the hard market. Perfectly sized. Buy quality at a fair price. Creative with the execution - inclusion of minority partners.

 

Did Fairfax’s aggressive P/C insurance expansion from 2015-2017:

• Deliver a solid return? Yes.
• Improves the quality of the company? Yes.

Fairfax gets an ‘A’ grade when it comes to capital allocation for what it has accomplished with this set of decisions. Fairfax’s capital allocation record in recent years has been exceptional - this is just another in a long list of examples.

 

Record earnings + best-in-class capital allocation team = great set-up for Fairfax shareholders.

 

One more thing…

 

And this good news story is not over yet. That is because Fairfax has set the table perfectly for its next big move: the takeout of its minority partners in its P/C insurance businesses (Brit, Allied World and Odyssey) over the next couple of years. Low risk. Nicely accretive to earnings. That will be the subject of a future post.

 

Edited April 28 by Viking

[wondering]

The gross premiums written / # of outstanding shares is an interesting way of gauging the value of the insurance company purchases which I never thought of.

 

As always, excellent analysis.

[Viking]

14 hours ago, wondering said:

The gross premiums written / # of outstanding shares is an interesting way of gauging the value of the insurance company purchases which I never thought of.

 

As always, excellent analysis.

@wondering there are so many interesting storylines regarding what has happened at Fairfax, especially over the past 4 years. With hindsight, the fact that the shares got so undervalued and stayed so undervalued for years was a massive gift. Fairfax knew shares were wicked cheap and absolutely backed up the truck. This allowed them to buy back the 5 million shares they issued to buy Allied World at almost the same price that they were issued at 5 years earlier. Even though the company was clearly worth much, much more (hence why Fairfax backed up the truck). 
 

This doesn’t include the 1.96 million FFH-TRS shares that Fairfax has exposure to. Imagine if Fairfax actually buys these back in 2025 or 2026. I have never viewed this as something they would do (given the amount it would cost). But some pretty smart people that i was talking to at the Fairfax AGM thought this is a real possibility. If Fairfax can buy these 1.96 million shares from the counterparties (Canadian banks) and not have to pay a premium then this might happen. I am not sure the mechanics of a TRS. But by 2025 or 2026 Fairfax will likely be swimming in cash as the insurance subs won’t need it for growth (as the hard market will likely be over). 
 

Another opportunity for Fairfax will be to take out their minority P/C insurance partners. Imagine a Fairfax at the end of 2027 where effective shares outstanding are under 20 million and all the minority P/C insurance partners have been taken out. The amount of per share earnings that accrue to common shareholders would get three big boosts:

1.) higher total earnings

2.) much lower share count

3.) elimination of minority interests in P/C insurance

 

This is not my base case. But it is interesting to think about…

Edited Monday at 03:39 PM by Viking

[gamma78]

@Viking am I right in saying that taking out the minority interests actually has a benefit on capital allocation as well? I think I recall Prem saying that when an insurance sub is majority and not wholly owned then Hamblin Watsa does not manage their float investment. If that is the case then an associated (not small) benefit would be management of the float (not just consolidation of result). Not 100% sure I'm right.....

[Viking]

7 hours ago, gamma78 said:

@Viking am I right in saying that taking out the minority interests actually has a benefit on capital allocation as well? I think I recall Prem saying that when an insurance sub is majority and not wholly owned then Hamblin Watsa does not manage their float investment. If that is the case then an associated (not small) benefit would be management of the float (not just consolidation of result). Not 100% sure I'm right.....

@gamma78 i think Prem was referring to GIG. When Fairfax was the minority partner (44%) it did not manage the float. Today Fairfax is the controlling shareholder (+90%) and now manages the float. For GIG it will be interesting to see how this impacts the yield earned on the portfolio over time.
 

Fairfax has minority partners in Odyssey, Allied and Brit. But Fairfax is the controlling shareholder in all three and manages the float.