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FFH Valuation


Viking
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I looks to me that FFH is (once again) getting to look like a pretty fat pitch.

 

Jim Rogers said the way you make money is when you see a $20 bill lying on the ground you pick it up.

 

Since January, FFH's US stock holdings are up about $650 million. Add in gains from Canadian holdings and corporate bonds (US and Canadian) and my guess is the number is likely in the $800 million range = $40 per share pre-tax. Yes, they have hedged 30% of equities and there is a cost and we do not know what they have done in the past 4 months. My view is at current levels FFH is a great way to play the current bull market in risk assets. Should corporate Q1 earnings surprise to the upside (as Intel did today) there is more room to the upside.

 

I also just read Stanley Zachs (Zenith) letter to shareholders in 2009 Annual report. This company appears to be a gem and will drive solid earnings growth for FFH in the future.

 

I expect underwriting to disappoint (for most insurers); however, interest & dividend income will be very good and realized & unrealized gains will be very good (much better than competitors). FFH looks to me to be a pretty compelling value trading today at book value (in US & CAN $). And in the past, when the stars have aligned (as they look to be doing right now), this has also been a very profitable time to buy. 

 

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While this is not an exact science, below is from p83 of 2009 AR. Hedge was set when S&P was at 1,062 and today it was at 1,210 = 14% increase. Of interest FFH US portfolio is up 18% (from Dec 31 to today).

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

The table that follows summarizes the potential impact of a 10% change in the company’s year-end holdings of equity and equity-related investments (including equity hedges where appropriate) on the company’s other comprehensive income and net earnings for the year ended December 31, 2009. Based on an analysis of the 15-year return on various equity indices and the company’s knowledge of global equity markets, a 10% variation is considered reasonably possible. Certain shortcomings are inherent in the method of analysis presented, as the analysis is based on the assumptions that the equity and equity-related holdings had increased/decreased by 10% with all other variables held constant and that all the company’s equity and equity-related holdings move according to a one-to-one correlation with global equity markets.

 

Change in global equity markets/Effect on other comprehensive income/Effect on net earnings

10% increase          333.1          (89.5)

10% decrease        (333.1)          93.5

 

Generally, a 10% decline in global equity markets would decrease the value of the company’s equity and equityrelated holdings resulting in decreases, in the company’s other comprehensive income as the majority of the company’s equity inv stment holdings are classified as available for sale. Conversely, a 10% increase in global equity markets would generally increase the value of the company’s equity investment holdings resulting in increases in the company’s other comprehensive income. For the year ended December 31, 2009, approximately 30% of the effect of changes in global equity markets on other comprehensive income would have been offset by the effect on net earnings resulting from the company’s equity hedges effected through short positions in equity index total return swaps and equity total return swaps.

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Wondering if someone on the board could give me some insight into how the CDN$/U$ impacts the value of FFH? From a Canadian point of view I would think that as our dollar increases, this would tend to devalue the company (in CDN$ terms) considering the amount of US holdings and operations FFH has - and the fact that it states it's figures in U$. But with FFH becoming more global all the time, I don't have any idea how significant the effect of our rising dollar has on the overall value of the company. Seeing the share price drop these days is no surprise as it seems to be an annual ritual this time of year, but is some of that as a result of the loonies increase?

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I was just about to post before i saw this thread so:

 

"who else thinks Prem is adding to the Hedges at this point?"

 

This would be par for the course. Things do not look rosy any time soon and this can only mean one thing in a few months...

 

FIRRRRRRREEEEEEEEEEEEEEEEEEEEEEE

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Grenville, I am expecting ORH to report some losses regarding Chile and Europe Windstorms (impacting most reinsurers). C&F will likely post ugly underwriting results given past quarters and continuing soft market in US P&C. NB will likely also post poor results, driven by soft pricing and FOREX (although it looks to me that pricing in Canada P&C may be firming). Zenith also will likely post poor underwriting results (although FFH does not own them yet this is now relevant).

 

We have a classic catch 22 situation. The industry has too much capital chasing too few premiums. What they need is a really ugly year on the loss side to soak up some capital. I also think that William Berkley is a smart guy and he feels insurers have been under-reserving and also aggressively using prior year development to report a low CR. I will be watching results to see if large reserve releases continue.

 

With interest rates so low ( = low interest & dividend income) and the conservative nature of most investment portfolios (= limited investment gains) when CR's move above 100 many P&C companies will see their earnings plummet. This is when we will find out who has been swimming naked. We should know what is going on by the end of the year (especially if we have an above average hurricane season).   

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Guys please tell me if my logic is correct.

 

Insurers are cutting their margin to increase policy count/revenues.

Since policies are sold trough brookers then policy count/revenues growth comes from reduced margins to get new policies. (I don't think sales forces really make a difference in this market, am I right?)

Therefore, get:

 

-An insurer that did not show any organic policy count/revenues growth for the last 5 years.

-Well diversified.

-Well capitalized.

-Well managed (good underwriting, good investing)

 

And you will likely get a winner when the tide goes away.

 

BeerBaron

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The attached spreadsheet might save you some time in your search.  It's an insurance screen I run that covers 5 year stats for a number of insurance/reinsurance companies.  Included is P/BV growth vs share price growth,  current P/BV vs average P/BV, level of insider ownership, and GAAP combined ratios and net written premiums for the last 5 years.  I think 5 years is a good time frame since it includes stressors 2005 Katrina, 2008 Gustav/Ike, the 2008 market meltdown, soft premium pricing market, and very low investment rates.  

 

I wouldn't take every bit of data as gospel since it is pulled from a general data source, but rather use it as a starting point for your research.

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Grenville, I am expecting ORH to report some losses regarding Chile and Europe Windstorms (impacting most reinsurers). C&F will likely post ugly underwriting results given past quarters and continuing soft market in US P&C. NB will likely also post poor results, driven by soft pricing and FOREX (although it looks to me that pricing in Canada P&C may be firming). Zenith also will likely post poor underwriting results (although FFH does not own them yet this is now relevant).

 

We have a classic catch 22 situation. The industry has too much capital chasing too few premiums. What they need is a really ugly year on the loss side to soak up some capital. I also think that William Berkley is a smart guy and he feels insurers have been under-reserving and also aggressively using prior year development to report a low CR. I will be watching results to see if large reserve releases continue.

 

With interest rates so low ( = low interest & dividend income) and the conservative nature of most investment portfolios (= limited investment gains) when CR's move above 100 many P&C companies will see their earnings plummet. This is when we will find out who has been swimming naked. We should know what is going on by the end of the year (especially if we have an above average hurricane season).    

 

Viking,

 

Thanks for your comments. I do think the ongoing volcanic eruption in Iceland could have more adverse consequences. There is a much larger sister volcano next to the one that has erupted and has shown in the past to be affected by its neighbor. The key will be if it continues to emit the volcanic ash. According to what I read, the emission of the volcanic ash has reduced.

 

The volcanic ash is wreaking havoc on flights all through Europe as major airports have been shut down.

 

Here are some links:

Iceland Volcano Eruption May Result in Significant Insurance Claims By Ravi Nagarajan

http://www.rationalwalk.com/?p=6360

 

Europe flights could be grounded into weekend by ash

http://news.bbc.co.uk/2/hi/europe/8623534.stm

 

Iceland Volcano Eruption Could Mean Business, Cat Claims

http://www.property-casualty.com/News/2010/4/Pages/Iceland-Volcano-Eruption-Could-Mean-Business-Cat-Claims-.aspx

 

"Mr. McGuire said the last eruption from this volcano lasted more than 12 months, so if this eruption has a similar duration, the ash could periodically present a problem to U.K. air space."

 

Fairfax:

On the flip side, the strong performance of Fairfax's investment portfolio should lighten the effect of the higher CR and insurance losses.

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onyx1,

 

Thanks for sharing the screen with us.

 

Very enlightening. Thank you very much onyx!

 

The first thing that came in my mind is how poorly we compare to the rest of the group regarding underwriting. We're not on that chart because of our underwriting discipline and expertise advantages, but mostly because of our investing acumen.

 

I'm not saying that I'm overall unsatisfied shareholder, but I must face the brutal facts of reality.

 

That being said, there is a IF. The only thing that could change my mind is the reserves. If our reserves are conservatively stated and our competitors reserves are very understated, then that underwriting picture could change significantly. But that's just a IF, time will tell and you don't give medals to athletes before they get to the finish line. So far, we have not been the fast runner on that point.

 

But I'm very confident that we deserve the gold medal on the investing front.

 

 

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    Something that strikes me is that despite the 6-year soft pricing market, there are a heck of alot of CR's less than 100%.  Premiums growth is flat/down in most cases so underwriting disipline may have something to do with it.  But my personal suspicion is that Berkley may very well be on to something when he says underwriting results are too good to be true.  When the industry runs out of prior year development to assist current calander year results, a hard market must follow.  If I recall correctly, he claims the we are already at that point.

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Grenville, I am expecting ORH to report some losses regarding Chile and Europe Windstorms (impacting most reinsurers). C&F will likely post ugly underwriting results given past quarters and continuing soft market in US P&C. NB will likely also post poor results, driven by soft pricing and FOREX (although it looks to me that pricing in Canada P&C may be firming). Zenith also will likely post poor underwriting results (although FFH does not own them yet this is now relevant).

 

We have a classic catch 22 situation. The industry has too much capital chasing too few premiums. What they need is a really ugly year on the loss side to soak up some capital. I also think that William Berkley is a smart guy and he feels insurers have been under-reserving and also aggressively using prior year development to report a low CR. I will be watching results to see if large reserve releases continue.

 

With interest rates so low ( = low interest & dividend income) and the conservative nature of most investment portfolios (= limited investment gains) when CR's move above 100 many P&C companies will see their earnings plummet. This is when we will find out who has been swimming naked. We should know what is going on by the end of the year (especially if we have an above average hurricane season).    

 

Viking,

 

Thanks for your comments. I do think the ongoing volcanic eruption in Iceland could have more adverse consequences. There is a much larger sister volcano next to the one that has erupted and has shown in the past to be affected by its neighbor. The key will be if it continues to emit the volcanic ash. According to what I read, the emission of the volcanic ash has reduced.

 

The volcanic ash is wreaking havoc on flights all through Europe as major airports have been shut down.

 

Here are some links:

Iceland Volcano Eruption May Result in Significant Insurance Claims By Ravi Nagarajan

http://www.rationalwalk.com/?p=6360

 

Europe flights could be grounded into weekend by ash

http://news.bbc.co.uk/2/hi/europe/8623534.stm

 

Iceland Volcano Eruption Could Mean Business, Cat Claims

http://www.property-casualty.com/News/2010/4/Pages/Iceland-Volcano-Eruption-Could-Mean-Business-Cat-Claims-.aspx

 

"Mr. McGuire said the last eruption from this volcano lasted more than 12 months, so if this eruption has a similar duration, the ash could periodically present a problem to U.K. air space."

 

Fairfax:

On the flip side, the strong performance of Fairfax's investment portfolio should lighten the effect of the higher CR and insurance losses.

 

The havoc continues!

Europe Cuts 70% of Flights; Relief May Come April 22 (Update2)

http://www.bloomberg.com/apps/news?pid=20601087&sid=aN_UBn1azuKs&pos=8

 

“Expect ongoing interruptions for the next four or five days,” Teitur Atlason, at the Icelandic meteorological office, said in a telephone interview today. “The eruption is still in full swing, and the volcano is spewing pretty dark ashes as high into the air as 5 to 6 kilometers.”

....

Deutsche Lufthansa AG cancelled all flights to and from German airports today. All long-distance flights to Germany with a scheduled arrival until 2 p.m. tomorrow were also cancelled, the company said in a statement on its Web site today.

....

Hubs serving 2 million people and 48 percent of Europe’s air traffic have been affected by the disruption, the Airports Council International industry group said yesterday in a statement."

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Onyx1, thanks for your Excel spreadsheet. I have updated it to show averages and Balance sheet reserves.

 

Here is what caught my eye.

 

-Combined Ratios were very low in the last 5 years at about 91.8% average for the group. These results cannot continue forever, therefore, using trailing PE for insurance stocks seems bad.

 

-Insurers as a group performed really well in the last 5 years.

 

Fairfax as noted before has been a poor underwriter compared with it's peers. But here is what worries me:

-It's net premium written stayed flat at 98% (including ORH acquisition)

-It's reserves actually decreased by 11%.

 

Judging by those 2 facts it seems to me like FFH might have released a lot of reserve and is now under-reserved. Is there something I don't understand correctly here?

 

BeerBaron

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Onyx1, thanks for your Excel spreadsheet. I have updated it to show averages and Balance sheet reserves.

 

Here is what caught my eye.

 

-Combined Ratios were very low in the last 5 years at about 91.8% average for the group. These results cannot continue forever, therefore, using trailing PE for insurance stocks seems bad.

 

-Insurers as a group performed really well in the last 5 years.

 

Fairfax as noted before has been a poor underwriter compared with it's peers. But here is what worries me:

-It's net premium written stayed flat at 98% (including ORH acquisition)

-It's reserves actually decreased by 11%.

 

Judging by those 2 facts it seems to me like FFH might have released a lot of reserve and is now under-reserved. Is there something I don't understand correctly here?

 

BeerBaron

You are comparing apples to oranges, you can find info about when reserves have been released by looking at the positive developments in the reserve triangles in the 10k.

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FFH has an excess of regulatory capital, from pg. 163 of the 09 AR,

 

At December 31, 2009, the

U.S. insurance, reinsurance and runoff subsidiaries had capital and surplus in excess of the regulatory minimum

requirement of two times the authorized control level – each subsidiary had capital and surplus in excess of 5.3 times

the authorized control level, except for TIG (2.4 times).

In Canada, property and casualty companies are regulated by the Office of the Superintendent of Financial

Institutions on the basis of a minimum supervisory target of 150% of a minimum capital test (MCT) formula. At

December 31, 2009, Northbridge’s subsidiaries had a weighted average MCT ratio of 240% of the minimum statutory

capital required, compared to 224% at December 31, 2008, well in excess of the 150% minimum supervisory target.

 

By another measure , premiums written to equity they are also in good shape(pg. 163 AR09)

 

A common measure of capital adequacy in the property and casualty industry is the ratio of premiums to surplus (or

total shareholders’ equity). These ratios are shown for the insurance and reinsurance operating companies of Fairfax

for the most recent five years in the following table:

2009 2008 2007 2006 2005

Net premiums written to surplus

(total shareholders’ equity)

                             2009 2008 2007 2006 2005

 

Northbridge (Canada) 0.7   1.0   0.7   1.0   1.1

Crum & Forster (U.S.) 0.5   0.8   0.8   1.0   .09

Fairmont (U.S.)(1)                                    0.9

Fairfax Asia               0.4    0.3   0.4   0.5

Reinsurance

OdysseyRe                0.5    0.7   0.8   1.1   1.5

Other(2)                   1.1   0.6    0.6   1.2   1.1

Canadian                  1.0   1.0    1.0   1.0   1.1

insurance industry

U.S. insurance           0.8   1.0    0.9   0.9   1.0

 

Also a look at the loss/LAE triangles shows LAE shows more than adequate reserves to cumilative losses,

and finally , Prem Watsa has stated many times that FFH  is conservatively reserved, and I trust the man!

 

So, dont believe under reserving to be a problem

 

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I'm not shooting FFH, I'm just trying to understand. I'll be more then glad to learn from some more experienced insurance investor.

 

Here is an hypothetical insurance company scenario. Please tell me what I'm missing.

 

Company X insures company Y against a 1000$ event happening once every 5 years in average. It sells the policy at 1000$ at Day 1, interest rate is fixed at 5% for 5 years. Event happens at end of year 5. Company had 1000$ Equity to begin with.

 

        Day 1  Year 1  Year 2    Year 3    Year 4    Year 5       

Assets

Cash      2000$    2100$    2205$  2315$    2430$    1551$

 

Liabilities

Provision 1000$    800$      600$    400$      200$    0$

Equity    1000$    1200$    1605$  1915$    2230$  1551$

 

Now lets assume that company X made a mistake in underwriting and the event ends up costing 2000$ at the end of the 5th year.

 

        Day 1  Year 1  Year 2    Year 3    Year 4    Year 5       

Assets

Cash      2000$    2100$    2205$  2315$    2430$    1551$

 

Liabilities

Provision 1000$    800$      600$    400$      200$    0$

Equity    1000$    1200$    1605$  1915$    2230$  551$

 

As you can see, from day 1 to year 4 the equity is identical, therefore, the Net Premium to surplus would have been stated identically under both scenarios. But the outcome at year 5 is totally different.

 

We know:

Rates have been declining in insurers

Fairfax has 98% of Net Premium Written from 5 years ago.

Their recorded policy liabilities are now 90% of what they were 5 years ago.

 

So the reduction in the liabilities is one of the following:

-FFH has now shorter tail insurance (reduces the liabilities).

-FFH has under estimated it's past claims, boosting the income/equity but it could come and hunt them back.

-FFH had much bigger liabilities in 2005 then today (maybe some leftover from 9/11 or Katrina???).

-FFH has a great sales force capable of selling lower claim insurance at a similar price while the rest of the world is reducing their price.

 

It would make sense to assume that it's either for reason 2 or 3.

 

I personnally think it's likely they had some liabilities trailing from 2001, 2004 and 2005 which had the impact of boosting their claim liabilities and reducing their earnings from 2001 to 2005.

 

BeerBaron

 

 

 

 

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"Their recorded policy liabilities are now 90% of what they were 5 years ago."

 

Subtract the reinsurance receivables from the asset side of the BS from your calculated policy liabilities.  It will show that net loss reserves & LAE have increased over the last five years.

 

 

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"Their recorded policy liabilities are now 90% of what they were 5 years ago."

 

Subtract the reinsurance receivables from the asset side of the BS from your calculated policy liabilities.  It will show that net loss reserves & LAE have increased over the last five years.

 

 

 

Thanks, that's the missing link I was searching!

 

BeerBaron

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