Fairfax 2024

[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

[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, 2024 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 April 29, 2024 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. 

[Viking]

Brit Insurance publishes its own financial reports. These reports provide a wealth of information on the company:

• Brit 2023AR: https://www.annualreports.com/HostedData/AnnualReports/PDF/LSE_BRE_2023.pdf
• Brit Web Site: https://www.britinsurance.com
• Ki Web Site: https://ki-insurance.com

—————

For Fairfax’s various insurance operations, the ‘surprise performance award’ for 2023 goes to Brit. Importantly, the surprise this year was a very good one for Fairfax shareholders.

 

In 2023, Brit delivered group profit after tax of $895.4 million. This is a monster number.

• Insurance operating results (ex discounting) = $405.7 million; CR = 85.3
• Investment return = $394 million = 6.2%
• Gain on sale of Ambridge = $259.1 million

Dividends paid

 

During 2023, Brit paid dividends totalling of $413.6m (2022: $18.7m) in accordance with the Brit Limited shareholders’ agreement.

• Class A shareholders (OMERS) = $40.6m (2022: $18.7m)
• Class B shareholders (Fairfax) = $373.0m (2022: $nil)

Despite this payment, Brit’s “capital position remains strong, with a surplus over management entity capital requirements of $1,050.5m or 54.5% (2022: $709.8m or 39.9%).” Source: Brit’s 2023AR

 

On 21 March 2024, interim dividends of $187.9m were declared, of which:

• Class A shareholders (OMERS) = $12.9m
• Class B shareholders (Fairfax) = $175.0m

A total of $601.5 million has been paid in dividends by Brit over the past 15 months. 

 

Other Notes:

 

“Highly successful third year of trading for Ki, recording insurance premium written of $877.0m (2022: $834.1m), a combined ratio after discounting of 83.2% (2022: 91.1%) and an undiscounted combined ratio of 89.4% (2022: 95.0%).” Source: Brit’s 2023AR

 

Why was Brit the recipient of the ‘surprise performance award’ in 2023?

 

Over the 2 years of 2017 and 2018, Brit had an average combined ratio of 107.5%. Pretty bad. However, the company was executing an improvement plan and in 2019 the CR improved to 95.8%. But Brit was hit especially hard by Covid in 2020 (due to legal rulings in the UK) and the CR jumped to 112.7% in 2020. In 2023, Brit successfully executed a plan to reduce its catastrophe exposure and exit underperforming businesses. The CR in 2023 was a stellar 85.3%. It will be interesting to see how Brit does in 2024. Let’s hope they can continue the strong performance.

Context

 

As a reminder, Brit was purchased by Fairfax in 2015 for a total of $1.657 billion. So the fact the company earned $895.4 million in 2023 is significant.

 

Ownership Structure of Brit at December 31, 2023

 

At December 31, 2023, Fairfax owned 86.2% of Brit and OMERS owned the remaining 13.8%.

 

Below is my understanding of how the partnership agreement with OMERS works. My notes are based on Jen Allen’s comments made on Fairfax’s 2023YE conference call. She was referencing Odyssey and my assumptions is the Brit/OMERS deal is structured in a similar manner:

• The shares are classified as equity under IFRS.
• Fairfax has no obligation to redeem those shares.
• Fairfax has a call option - this gives Fairfax the option to buy back OMERS stake at a specified price within a specific time period. “Fairfax has the option to purchase OMERS’ interest in Brit at certain dates from October 2023.” Source: Brit’s 2023AR
• OMERS does not have the right to put the shares back to Fairfax, and Fairfax is under no obligation to exercise its call options.
• After Fairfax’s call options expire, a minority investor may IPO their shares or, failing that, request sale of the operating company with a priority on the proceeds.
• OMERS receives a dividend payment each year.

The current deal with OMERS was struck in 2021. Fairfax was paid $375 million and OMERS received an ownership interest of 13.8% in Brit. In Fairfax’s 2023AR, under ‘non-controlling interests,’ OMERS 13.8% stake in Brit has a carrying value of $881.2 million (2022: $736.4 million).

 

What will it cost Fairfax to take out OMERS and what will the accounting look like?

 

I am not sure how the accounting will work when Fairfax takes OMERS out. When Fairfax bought a chunk of Allied World back in 2022 there was a sizeable write down to equity (see quote below). Perhaps we see something similar here. Do other board members have thoughts?

 

From Fairfax’s 2023AR: “On September 27, 2022 the company increased its ownership interest in Allied World to 82.9% from 70.9% for total consideration of $733.5, inclusive of the fair value of a call option exercised and an accrued dividend paid, and recorded a loss in retained earnings of $163.3 in net changes in capitalization in the consolidated statement of changes in equity.”

 

The value of the call options for Fairfax at Dec 31, 2023: In ‘Other Assets’, the value of ‘call options on non-controlling interests’ = $306.6 million (2022: $167.4 million). This total is for Brit, Allied World and Odyssey. See quote below for more information.

 

From Fairfax’s 2023AR: “Comprised of call options on the non-controlling interests in Allied World, Brit and Odyssey Group, which expire in 2026, 2027 and 2029, respectively. At certain dates subsequent to expiry of a call option, the non-controlling interests may request an initial public offering of their shares, the structure, process and timing of which will be controlled by the company; in certain circumstances, the non-controlling interests may request a sale of the respective operating company to a third party.”

 

—————

From page 1 of Brit’s 2023AR - the page was titled ‘2023 - A Record Result’

 

------------

-----------

 

Edited April 29, 2024 by Viking

[Xerxes]

On 4/27/2024 at 8:30 PM, Viking said:

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.

 

 

 

 

Chris Bloomstran would argue very strongly against the #4 statement.

 

Issuing stock at 3.0x BV to buy a large chunk of bond-portfolio that allowed Berkshire to "diversify" its highly skewed equity exposure to Coca Cola and others without selling it. 

 

Whether Buffett agrees with that or not, it is irrelevant. He went through the unpleasant exercise of dealing with General Reinsurance derivative portfolio, so he may have a bias.

 

But the end results is that he issued expensive equity at the right time and diversify away, whether he intended or not.

At the end he was right for the wrong reasons, ... and sometimes it is like that. You take it.

 

 

[SafetyinNumbers]

19 minutes ago, Xerxes said:

 

 

Chris Bloomstran would argue very strongly against the #4 statement.

 

Issuing stock at 3.0x BV to buy a large chunk of bond-portfolio that allowed Berkshire to "diversify" its highly skewed equity exposure to Coca Cola and others without selling it. 

 

Whether Buffett agrees with that or not, it is irrelevant. He went through the unpleasant exercise of dealing with General Reinsurance derivative portfolio, so he may have a bias.

 

But the end results is that he issued expensive equity at the right time and diversify away, whether he intended or not.

At the end he was right for the wrong reasons, ... and sometimes it is like that. You take it.

 

 

Fairfax also used expensive stock in the late 1990s to do a series of insurance acquisitions in part to pick up cheap float. A smart move by both BRK and FFH, IMO.

[Viking]

38 minutes ago, Xerxes said:

Chris Bloomstran would argue very strongly against the #4 statement.

 

Issuing stock at 3.0x BV to buy a large chunk of bond-portfolio that allowed Berkshire to "diversify" its highly skewed equity exposure to Coca Cola and others without selling it. 

 

Whether Buffett agrees with that or not, it is irrelevant. He went through the unpleasant exercise of dealing with General Reinsurance derivative portfolio, so he may have a bias.

 

But the end results is that he issued expensive equity at the right time and diversify away, whether he intended or not.

At the end he was right for the wrong reasons, ... and sometimes it is like that. You take it.

@Xerxes point taken. One of the things i love about investing is important things can meaningfully change over time. That is why getting anchored to a narrative (as an investor) can be so detrimental. 
 

It often takes 5 years or longer to properly evaluate the meaningful capital allocation decisions. Sometimes, what looks like a poor decision in the short term looks brilliant and few years later. 

 

I think a big factor is simply being in the game. Being in the game allows you to capitalize on opportunities. Luck also is a factor. Sometimes Mr Market will let you flip a poor decision into a good decision. But the most important factor is execution - at the end of the day the management team has to execute well over time.
 

What cracks me up with so many Fairfax detractors (haters?) is they gave up following the company years ago. So their views on the company are completely stale dated/wrong. So much at Fairfax has changed (insurance and investments) - and they don’t see it… because they refuse to do the work/look at things with an open mind. Of course, that kind of thinking is what has given us all such a home run with Fairfax over the past 4 years. So i am actually very thankful to Fairfax’s many detractors/haters… couldn’t have done it without you!

[Viking]

3 hours ago, SafetyinNumbers said:

Fairfax also used expensive stock in the late 1990s to do a series of insurance acquisitions in part to pick up cheap float. A smart move by both BRK and FFH, IMO.

 

@SafetyinNumbers I did not understand Fairfax's approach to using their own equity. You taught me this.   Fairfax really tries to take advantage of Mr. Market's mood swings - when the shares are valued high they issue and when the shares are valued low they buy back. Especially pre-2000. 

 

This is also something they do with their equity and insurance holdings. I think it stems from having a basic value investing framework in how they do everything. Something to keep in mind moving forward. 

Edited April 30, 2024 by Viking

[SafetyinNumbers]

1 hour ago, Viking said:

 

@SafetyinNumbers I did not understand Fairfax's approach to using their own equity. You taught me this.   Fairfax really tries to take advantage of Mr. Market's mood swings - when the shares are valued high they issue and when the shares are valued low they buy back. Especially pre-2000. 

 

This is also something they do with their equity and insurance holdings. I think it stems from having a basic value investing framework in how they do everything. Something to keep in mind moving forward. 

It’s one of things that gets me very excited about owning shares for a long time and being very resistant to selling too soon. In the late 1990’s we used expensive equity to buy float cheap but the combined ratios were high. The equity got expensive because FFH booked 4 years in a row of 20%+ ROE. Back then, the starting point was 1.8x BV and the stock went to 5x BV.
 

It was really smart to sell back then but this time the earnings quality is so much higher. Instead of buying underperforming insurance companies if our stock gets expensive we may buy large quality companies at a fair price. This will dramatically increase surplus capital and increase returns. The snowball could get huge quickly which should probably be expected to happen easier in Canada vs Omaha from the same starting point.

 

[Jaygo]

7 hours ago, SafetyinNumbers said:

The snowball could get huge quickly which should probably be expected to happen easier in Canada vs Omaha from the same starting point.

Just curious on why that could be easier this side of the border. Valuation? Less scrutiny? 

[Hoodlum]

National Bank Analyst Jaeme Gloyn increased his target to $2100 Cdn.

https://www.theglobeandmail.com/investing/markets/inside-the-market/article-tuesdays-analyst-upgrades-and-downgrades-for-april-30/?login=true

 

Quote

“We expect continued outperformance through 2024 driven by three catalysts ... i) significantly increased operating income, ii) valuation re-rate, and iii) potential S&P/TSX 60 Index inclusion,” he said. “While we expect softer than consensus results in Q1-24, largely due to unrealized losses on fixed income assets, robust underwriting performance and outlook commentary will support our longer-term view.”

 

Mr. Gloyn increased his target for Fairfax shares to a Street-high of $2,100 from $2,000, keeping an “outperform” rating.

 

[SafetyinNumbers]

2 hours ago, Jaygo said:

Just curious on why that could be easier this side of the border. Valuation? Less scrutiny? 

It was a dumb joke that we get more snow in Toronto than Omaha (about 2x actually!). 

In reality, when BRK first hit the same market cap as FFH is now in 1995, it wasn’t set up as well as FFH is. BRK was trading at ~2.5x BV and had insurance premiums of only $3b. With that set up, I think FFH has a good chance of outperforming what BRK already accomplished in the last 29 years.

[nwoodman]

43 minutes ago, Hoodlum said:

National Bank Analyst Jaeme Gloyn increased his target to $2100 Cdn.

https://www.theglobeandmail.com/investing/markets/inside-the-market/article-tuesdays-analyst-upgrades-and-downgrades-for-april-30/?login=true

 

 

Thanks for posting the rump of the article .  Agree there will be a hit to the bond portfolio.  My guesstimate is $40 per share but not phased +\-$10.  It is all moving in the right direction.

[Hoodlum]

7 minutes ago, nwoodman said:

Thanks for posting the rump of the article .  Agree there will be a hit to the bond portfolio.  My guesstimate is $40 per share but not phased +\-$10.  It is all moving in the right direction.

 

But would it be that large under IFRS reporting?

[gfp]

3 minutes ago, Hoodlum said:

 

But would it be that large under IFRS reporting?

 

I don't think Q1 will be that bad.  Partly because of the offsetting IFRS discount effect but primarily because the real meat of the bond sell-off started the day after the quarter ended.  Q1 was pretty tame.  We'll see how Q2 and the rest of the year unfolds but I'm not expecting 2-7 year treasuries to stick around with a 5-handle on the yield for more than a few days.  There is a lot of demand for those securities at 5%.  I know I'm a broken record on that but watch the 2 year - at 5% buyers come flooding back in, which is unsurprising.

[nwoodman]

6 minutes ago, gfp said:

I know I'm a broken record on that but watch the 2 year - at 5% buyers come flooding back in, which is unsurprising.

You have a pretty good handle on these things, so keep that record spinning