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Viking

By Viking
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Thrifty3000 Proficient

Thrifty3000

Posted
Posted
1 hour ago, Haryana said:

Despite all the positives, the current annual earnings of about 4 billion are lower than expectations.

While there are assets carried at lower valuation, the earnings still flow through to the bottom line.

The annual earnings should average about 6 billion despite unrealized losses and unusual catastrophes.

Not sure where you’re getting the 6 bil expectation from. Please elaborate. And, don’t forget to factor in 8 bil of intangible assets.

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Viking
Viking

Fairfax Q2-2025 Earning Results - 7 High-Level Thoughts    I thought this would be a good time to get out of the weeds. Instead, with our review of Q2 results at Fairfax, we are going to zoo

djokovic1
djokovic1

Met Ben Watsa at a Europe value investor conference. Asked him why Fairfax was short duration at high rates. Mostly comes down to protecting the downside as they see potential for an inflationary spik

Maverick47
Maverick47

Good question, @Viking…and the answer has to be that it is much better for Fairfax to buy out minority owners of the high quality insurers they already know and trust than to pay higher multiples for

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SafetyinNumbers Veteran

SafetyinNumbers

Posted
Posted
54 minutes ago, Haryana said:

@SafetyinNumbers features in TGAM again

https://www.theglobeandmail.com/investing/investment-ideas/article-tfsa-investment-stocks-risk-reward
Finance professional grows his TFSA to a million dollars with a handful of stocks

MKO-X    Mako Mining Corp
FISH-X   Sailfish Royalty Corp
FFH-T    Fairfax Financial Holdings Ltd


Thanks for posting. I continue to spread the gospel of Fairfax 🤓

 

Gift link if anyone is interested: https://www.theglobeandmail.com/gift/b04eb1bcd666173196423362ad31a8785d529ba1ad1cee14b25891c6ca2ccfbf/G3PN2B5YXJDDHEOB4QK4JLQX7Q/

gfp Grand Master

gfp

Posted
Posted
18 minutes ago, SafetyinNumbers said:


Thanks for posting. I continue to spread the gospel of Fairfax 🤓

 

Gift link if anyone is interested: https://www.theglobeandmail.com/gift/b04eb1bcd666173196423362ad31a8785d529ba1ad1cee14b25891c6ca2ccfbf/G3PN2B5YXJDDHEOB4QK4JLQX7Q/

 

thanks for sharing that - nice article.

 

Is this a correct characterization?

"Approximately 94 per cent of its premiums (i.e., the combined ratio) has gone to pay for insurance claims and company operations in recent years. The remaining 6 per cent has gone into the float, where the premiums are held until they are paid out and, in the interim, invested to generate gains and income."

gfp Grand Master

gfp

Posted
Posted
6 minutes ago, Haryana said:

I guess you are trying to make the point that 94 is Not just the claims paid but combined ratio which is total of claims paid plus the operating expenses. 

 

No not really.  I think that is not an accurate characterization of what float is and the 6% actually goes to equity, not float.  6% in that example is the profit. 

nwoodman Mentor

nwoodman

Posted
Posted
57 minutes ago, Haryana said:

Thanks for the gift link. 

Great fun reading comments there and your live responses. 

Found comment by Viking.

(Wondering who there is ChipCondor, s/o Prem) 

Thanks for the heads up.  I didn’t realise there was a comments section.  Damn there are some toxic assholes out there. You kind of forget what the rest of the world is like after spending a high proportion of your time here.

Hoodlum Experienced

Hoodlum

Posted
Posted

Does anyone have access to this article.   I believe it mentioned Fairfax and Brit as a comparison, but would like to see the details that they discussed.  

 

https://www.insuranceinsider.com/article/2eva1nhemef30ufv9ibk0/all-topics/m-a/probitas-talent-outflow-underscores-takeover-challenges-for-aviva

 

Frustration is growing around a promised independent operating model and staff reward.

 

A significant mismatch in expectation around the operational model for Probitas post-Aviva takeover is contributing to staff outflows and dissatisfaction.  

LC Grand Master

LC

Posted
Posted

Just reading your quoted piece:

The first half pretty much says, "Hey Chubb, stop telling other people how to run their business!"

Then the second half says, "Hey Chubb, here is how you should run your business!"

 

Personally I think political risk, reputation risk...is a real risk and should be accounted for by insurers at both the policy level and the group level. If Chubb or anyone else thinks long tail exposure is too great due to political risk in O&G for example, they can choose not to write that business. If Chubb thinks just being exposed to gun ownership will have some reputational backlash, again they can choose not to write that business.

Viking Grand Master

Viking

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Posted (edited)

Leverage and Fairfax - A deep dive - Part 1

 

Introduction

 

“Give me a lever long enough and a fulcrum on which to place it, and I shall move the world.” Greek philosopher Archimedes

 

The fulcrum needs to be rock solid and well placed.  The longer the lever the more power it can exert. Used properly, leverage allows one person (or a company in our example today) to figuratively move the world.

 

IMG_0049.thumb.png.f2d8f9c3d74bbfe7ec4efcea10eb1278.png

 

—————

 

Leverage

 

In our post today we are going to explore the concept of leverage. And what it means for Fairfax. To see what we can learn about the company today - and what it might mean for the company looking into the future.

 

Getting back to our picture above…

 

The fulcrum is Fairfax’s business model. (Company structure. P/C insurance business. Investment management business. People. Culture.) The lever is a sum of the various forms of leverage that Fairfax uses.

 

Let’s get started.

 

—————

 

Definition of leverage

 

We are going to define leverage in a very broad way:

 

Using other people and/or their money to boost returns and/or improve the quality of the company.

 

The expectation is the return achieved will be greater than the cost involved.

 

This definition allows us to include both financial and non-financial aspects of leverage (financial capital AND human capital). 

 

When investors think of leverage they tend to focus on/think only about the financial piece, and debt specifically. That is true (debt is one kind of leverage). But that is also a very narrow way to think about leverage. Especially when it comes to a company like Fairfax.

 

There are many different kinds of financial leverage. Like float. There are also many different kinds of non-financial leverage. Like having access to a large network of exceptional capital allocators/entrepreneurs - outside of Fairfax (think deal flow).

 

In this post we are going to review the many different ways that Fairfax uses leverage. We are going to stretch the definition - so much so that you might even disagree with us. I hope that happens - and you share your thinking. After all, engaging in constructive debate is how we all learn and get better as investors.

 

If we want to make people uncomfortable, a good way to do it is to challenge conventional wisdom.

 

—————-

 

Buffett and leverage

 

“If you’re smart you don’t need leverage; if you’re dumb, it will ruin you.” Warren Buffett

 

“My partner Charlie says there is only three ways a smart person can go broke: liquor, ladies, and leverage. Now the truth is, the first two he just added because they started with ‘L’ – It’s leverage.” Warren Buffett

 

Before we go any further we need to deal with the elephant in the room - yes, that guy named Warren Buffett.

 

Buffett is the GOAT. Many P/C investors worship at the altar of Buffett. I am (generally) one of them.

 

What does Buffett have to say about leverage?

 

If you do a search online, Buffett probably has more great quotes on leverage than just about any other topic - and he is almost always telling investors that it is the devil and should not be used.

 

Is this true? Does Buffett really dislike leverage?

 

No, of course not. Buffett loves leverage. Buffett has said repeatedly that P/C insurance was the core engine that drove the fantastic returns that Berkshire Hathaway was able to deliver over the past 59 years.

 

What was it about the P/C insurance business that Buffett liked so much?

 

It was the low cost and growing float that it provided. And float is leverage.

 

Context matters

 

The lesson is leverage is not a four letter word - it is not inherently good or bad. Yes, leverage can be bad. But it can also be good. Obviously, which one it is (good or bad) depends on how it is being used.

 

I know it sounds like blasphemy, but as investors there are some things we need to unlearn when it comes to Buffett’s teachings. How to think about leverage is one of them (in the context of our post today).

 

Readers should try and keep an open mind as they keep reading…

 

—————

 

A (short) review of the different types of leverage that Fairfax uses

 

The goal of this post is to provide readers with an overview of the topic. I am also going to try and keep this post to a reasonable length (having said that, it is still going to be long). As a result, my review of each type of leverage that Fairfax uses is going to be very top line.

 

This post will be broken into the following pieces:

 

Financial

  1. Debt - At the holding company & re/insurance operating company level
  2. Float - From P/C insurance
  3. Equity - Minority partners (2015-2017)
  4. Fairfax total return swaps (late 2020/early 2021)
  5. Dutch auction (late 2021) - Minority partner
  6. Debt - Held by the equity holdings (public and private)

Non-financial (human capital)

  1. External relationships/partnerships Fairfax has cultivated

We are going to tackle the topic in three posts. This is the first and it introduces the topic and goes into the first two items listed above: debt and float. The second post should be out in the next week or so and will review items #3, 4 and 5 on our list above. The final post will review the remaining items and summarize what we have learned on the topic.

 

Let’s get started.

 

——————

 

Debt - At the holding company & re/insurance operating company level

 

Fairfax borrows money to boost the returns it earns for shareholders.

 

At December 31, 2024, Fairfax had borrowed a total of $8.86 billion - at the holding company and re/insurance company level.

 

Fairfax-DebtSummary.png.cdc94f74019f4dae60846a42743aed18.png 

 

This does not include the debt of the non-insurance operating companies (like Recipe or Thomas Cook India) as Fairfax does not guarantee this debt. We will come back to this topic later in the post.

 

What is the cost of the debt?

 

In 2024 total interest paid by Fairfax on this debt was $456.6 million. My very rough guess is Fairfax is paying an average interest rate on its debt of around 5.6%.

 

Importantly, the total amount of interest paid is tax deductible. So the after-tax rate paid by Fairfax is lower.

 

Common shareholders’ equity (CSE) and debt

 

Common shareholders equity at Fairfax totalled $23 billion at December 31, 2024 or $1,064/share. By using debt, Fairfax now has $31.8/billion, or $1,474/share it can use to generate a return for shareholders.

 

Fairfax-CommonShareholdersEquityandDebt.png.9d6fad5b91c91caa1cdd60242e7a5865.png 

What return is Fairfax delivering on its investments?

 

Fairfax is current generating a total return of about 7.5% on its total investment portfolio. This return is well in excess of its cost to borrow (which I estimated earlier at about 5.6% pre-tax).

 

Should an investor in Fairfax be worried about the amount of debt Fairfax is carrying?

 

For help here, we can lean on the ratings agencies. Specifically AM Best (they are focussed on the P/C insurance industry).

 

What does AM Best think?

 

They have upgraded Fairfax’s credit rating twice in the past 2 years. Why?

 

“The outlook revision to positive for Fairfax reflects the improved earnings profile of the consolidated group. Fairfax deployed significant cash into highly rated fixed income instruments as interest rates increased in 2022. This resulted in dividend and interest income run rate more than tripling by year-end 2023. This improved investment cash flow, coupled with continued stabilization of underwriting earnings at various operating subsidiaries, has resulted in improved operating performance metrics relative to peers in recent years, and prospectively.”

Over the past 4 years, operating earnings at Fairfax have spiked higher. From an average of $1 billion per year (from 2016 to 2020) to $5.3 billion in 2024. That is a seismic improvement. The quality of the earnings that Fairfax is delivering has never been better. And look poised to grow further from here.   

 

As we reviewed, Fairfax’s total interest cost on its borrowings was $456.6 million in 2024. This is a small number compared to the operating earnings that Fairfax is delivering ($5.3 billion in 2024).

 

SharesOutstandingDec31.png.0351bb7ead4047865d1065cd9b113144.png 

Debt is an important source of leverage for Fairfax. But it is not its most important source (by far).

 

Float

 

Fairfax has $36.9 billion in float. This is $1,703/share. In the last 4 years, float per share has increased by 84% = CAGR of 16%.

 

Yes, the size of float is massive. And it is growing in size.

 

Abigstrengthwehaveininsuranceisthefloatitgencrates.Heresourgrowthsince1985..thumb.png.91fa33d2fb66a60fdfd46ecd6a049e46.png 

What is the cost of float?

 

The cost of float is measured by looking at the combined ratio (CR). Fairfax’s insurance companies delivered a CR of 93% in 2024, or an underwriting profit of $1.79 billion. This is also a measure of the quality of Fairfax’s P/C insurance franchise - like other parts of the company, it has been increasing in quality over the past 5 years.

 

This means the cost of Fairfax’s float is zero. Actually, it is much better than that. Fairfax is getting paid to hold its float - it was paid about $1.79 billion in 2024.

 

So Fairfax has $36.9 billion in float. And it is getting paid to hold it. Crazy but true.

 

Consolidated.thumb.png.103443ad680ea78f4edfa7bba1eea3f2.png 

What can Fairfax do with its float?

 

It can invest it. And keep what it earns. Wow!

 

This explains the power of the P/C insurance model

 

Warren Buffett has said repeatedly that P/C insurance (and the growing, low cost float that it provides) was the engine that propelled Berkshire Hathaway’s unbelievable growth since National Indemnity was purchased in 1967.

 

Common shareholders’ equity (CSE), debt and float

 

Fairfax has a large and growing float. It is getting paid handsomely to hold it. And it gets to keep everything it earns from it.

 

Given its size (and cost), float is by far the most important kind of leverage Fairfax uses. Float is 1.6 x (larger) than the size of shareholders’ equity.

 

Adding all three together (CSE + debt + float), Fairfax has $69 billion, or $3,171 per share, that it is able to invest to earn a return for shareholders.

 

Fairfax-CommonShareholdersEquityDebtandFloat.png.96b72f44332a98e6cb52386a42ed87a1.png 

Investment leverage

 

We can measure Fairfax’s investment leverage by dividing the total by CSE.

  • $68.7 billion / $23 billion = 3.0x

Fairfax has very high investment leverage. This amplifies the impact of Fairfax’s investment returns on its return on equity.

 

What is the return of the investment portfolio?

 

Fairfax has an investment portfolio of $69 billion

 

Fairfax’s investment portfolio is currently generating a pre-tax return of about 7.5% or about $5.175 billion per year. This is $240 per Fairfax share.

  • Cost of debt was $457 million in 2024.
  • ‘Cost’ of float was a benefit (underwriting profit) of $1.8 billion in 2024.

Is Fairfax’s use of leverage boosting the earnings of the company?

 

Yes. Big time. This is a very powerful combination / result.

 

Fairfax’s use of debt and float are examples of structural uses of leverage for Fairfax - a permanent part of the capital structure of the company. Debt and float fall on the liability side of Fairfax’s balance sheet.

 

Next, we will review some examples of leverage that Fairfax employs that are more tactical in nature - temporary, to take advantage of a short term opportunities when they pop up. With our next example, we are going to review how they use the asset side of their balance sheet to get leverage.

 

We will review the remaining ways that Fairfax uses leverage in part 2 of our post. It should be out in about a week.

Edited by Viking
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Maverick47 Collaborator

Maverick47

Posted
Posted

Thanks for sharing this @Viking!

 

I like this way of looking at leverage as any sort of use of other people’s money….along with estimating the cost of each source of leverage.  I think for too long I’ve thought of leverage only as debt, but using your way of looking at this we can approximate the pre-tax cost of debt as 5.6% as you noted.

 

Likewise, the cost of the float can be estimated as a negative interest rate.  In 2024, that would be the negative value of the underwriting profit divided by the float, or (-1.79 billion/36.9 billion) = -4.85%.  

 

Only when there is an underwriting loss would this actually be a positive cost of debt as we usually think of this.

 

I will mention one small additional source of other people’s money, and that would be the deferred tax liability on unrealized capital gains.  Taxes are paid on realized capital gains only when the underlying equities are sold at a profit.  Until that happens, the deferred tax liability on the unrealized gain continues to be held by and invested for the benefit of the company and its shareholders.  No interest has to be paid on this “loan” from the Federal government.

 

Some companies show both deferred tax assets and deferred tax liabilities on their balance sheets.  Others net these two out against each other, and only show one or the other.  When both appear on a balance sheet we can net them ourselves.

 

A deferred tax asset is just a tax owed which has been prepaid…like a zero percent interest loan TO the government, while a deferred tax liability is just a zero percent interest loan FROM the government.  

 

Obviously it is far better to receive an interest free loan from the tax authorities than it is to make an interest free loan to them.  On balance, I’d much prefer the insurance company I own to have received a net loan from the government at a zero percent interest rate.

And while an interest free loan from the government is better than paying 5.6% pre-tax to our other debt holders, it is still not as valuable as the much larger amount of float with a negative effective interest rate (which is the case whenever an underwriting profit is recorded).

 

Of course, once in a while, we can expect a large insurance catastrophe that might result in an underwriting loss.  Suppose we had an underwriting loss of $3 billion in a year with $36.9 billion of float.  Then that year the pre-tax cost of the float would be -(-3/36.9) = 8.1%.

 

In that individual year, the cost of the float would exceed that of the 5.6% cost of borrowing from the debt markets.   Not great, but as long as there are many more years with underwriting profits than years with underwriting losses, then the company will still be a wonderful one, for which time is a powerful friend.

 

 

 

 

djokovic1 Collaborator

djokovic1

Posted
Posted

@Viking

 

Thanks for your great analysis as always. I completely agree, that prudent use of leverage can significantly improve ROE and shareholder returns.  And exactly on that topic, Fairfax has 3:1 leverage, Markel ~2:1 leverage and Berkshire ~1:1 leverage (although Markel and especially Berkshire have a much higher equities (higher expected return) proportion in their book). All else equal, the Fairfax model should outperform Markel and Berkshire due to the higher investment leverage when interest rates are meaningfully high as they are now. The benefit decreases at lower interest rates.

 

SafetyinNumbers Veteran

SafetyinNumbers

Posted
Posted
12 minutes ago, MMM20 said:

 

Off topic @SafetyinNumbers, but you own ELF.TO outside this account / it didn't contribute to that ~10x? 


No ELF would have been a drag. I never owned it in the TFSA. Part of why the TFSA has done much better than my unregistered accounts.

 

In terms of profits contribution FFH ~30%, MKO ~20%, FISH ~10%. The rest was pretty spread out and nothing over 5%. 

dartmonkey Proficient

dartmonkey

Posted
Posted
49 minutes ago, Dipesh Patel said:


 

IMG_3362.jpeg

Thanks for posting that, I hadn't been able to see it with the expired link.

 

I can see that the G&M reporter doesn't quite get what float is, but that's not SafetyinNumber's fault.

 

There is one statement about Fairfax's size, relative to Berkshire's, that is interesting to think about - it says that Fairfax is now about the size that Berkshire was in 1995. By my calculation, Berkshire had a market cap of $43.8B (USD) at the end of 1995, while Fairfax's market cap is US$37.9, so that seems about right. But if you adjust for CPI inflation, Berkshire would have been worth about $91.5b. If Fairfax grows its share price 20%/year, it would need almost 5 years to be Berkshire's 1995 equivalent size, putting Fairfax 35 years behind Berkshire.

 

In my opinion, Berkshire has been pretty limited in terms of what it can acquire to move the needle, for about the last 10-15 years. That might suggest that Fairfax has a good runway for another 20-25 years, even if it keeps up its recent torrid growth rate. 

SafetyinNumbers Veteran

SafetyinNumbers

Posted
Posted
22 minutes ago, dartmonkey said:

Thanks for posting that, I hadn't been able to see it with the expired link.

 

I can see that the G&M reporter doesn't quite get what float is, but that's not SafetyinNumber's fault.

 

There is one statement about Fairfax's size, relative to Berkshire's, that is interesting to think about - it says that Fairfax is now about the size that Berkshire was in 1995. By my calculation, Berkshire had a market cap of $43.8B (USD) at the end of 1995, while Fairfax's market cap is US$37.9, so that seems about right. But if you adjust for CPI inflation, Berkshire would have been worth about $91.5b. If Fairfax grows its share price 20%/year, it would need almost 5 years to be Berkshire's 1995 equivalent size, putting Fairfax 35 years behind Berkshire.

 

In my opinion, Berkshire has been pretty limited in terms of what it can acquire to move the needle, for about the last 10-15 years. That might suggest that Fairfax has a good runway for another 20-25 years, even if it keeps up its recent torrid growth rate. 


FFH has been putting its excess capital into share buybacks so it’s been shrinking and trades a lot cheaper than BRK did in 1995.

dartmonkey Proficient

dartmonkey

Posted
Posted
2 hours ago, SafetyinNumbers said:

FFH has been putting its excess capital into share buybacks so it’s been shrinking and trades a lot cheaper than BRK did in 1995.

Good point - this is both why Fairfax is so much smaller than Berkshire was at the same age, and also why it is reasonable to hope that Fairfax will not grow its market cap as quickly. 

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