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1st Qtr. earnings out


gaf63
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Every time we have a big cat loss, somebody always grumbles that Fairfax states what the combined ratio would have been were it not for the big event.  This quarter will not let you down, as there was the Chile quake and they state:

 

The combined ratio of the company's insurance and reinsurance operationswas 111.5% on a consolidated basis, producing an underwriting loss of$122.6 million

 

Prior to giving effect to theimpact of the Chilean earthquake losses, the company generated acombined ratio of 98.7% and an underwriting profit of $14.2 million.

 

Okay, so it's time for somebody to step up and grumble about this again  :)

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At 31 March 2010 there were 20,546,935 shares outstanding.  

At 31 December 2009 there were 19,988,870 shares outstanding for a difference of 558,065.  

Shares issued in the $200M offer were 563,381.  

It looks like 5,316 shares were bought in for a rough total of ~$2M (say $375/share average).  Not significant, but a start.

 

-O

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Buybacks given out to officers for retention/awards do not help us out though.  They buy shares every year for that reason.  Not sure if they bought them for that reason this time, but at that pace it's probabably safe to say that they will give award at least that many shares in any given year.

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.

 

Okay, so it's time for somebody to step up and grumble about this again  :)

 

I actually was about to write "I wish they would stop doing this..."

 

Then, I just discarded the post :-\

 

Why is it bad to provide extra information?  FWIW, it doesn't bother me at all to know what their Chile losses amounted to.

 

SJ

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I do not think there is any issue with providing the additional information. The problem is how it is presented and seemed to be viewed by management as in:

 

"We are pleased with the way our company has performed so far in 2010," said Prem Watsa, Chairman and Chief Executive Officer of Fairfax. "With a 98.7% combined ratio, excluding the impact of the Chilean earthquake, our insurance and reinsurance operations are off to a promising start, despite challenging industry conditions and the soft economy."

 

Until Prem acknowledges and thinks of this as an issue, we would continue to have these kinds of underwriting results. Imagine, Oakmark Select's Bill Nygren saying to investors, excluding the effect of Washington Mutual, we have handily outperformed the market. We are proud of this performance and....

 

If Prem really thinks that it is better to have a little higher CR's since there are better investment opportunities available or for whatever other reason, I do not have any issue. He definitely has earned my confidence and would give him the benefit of the doubt if he comes out and says it.

 

Thanks

 

Vinod

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The only bright spot in this picture is that virtually all

of the underreserving revealed in 1984 occurred in the

reinsurance area - and there, in very large part, in a few

contracts that were discontinued several years ago.  This

explanation, however, recalls all too well a story told me many

years ago by the then Chairman of General Reinsurance Company. 

He said that every year his managers told him that “except for

the Florida hurricane” or “except for Midwestern tornadoes”, they

would have had a terrific year.  Finally he called the group

together and suggested that they form a new operation - the

Except-For Insurance Company - in which they would henceforth

place all of the business that they later wouldn’t want to count.

 

    In any business, insurance or otherwise, “except for” should

be excised from the lexicon.  If you are going to play the game,

you must count the runs scored against you in all nine innings. 

Any manager who consistently says “except for” and then reports

on the lessons he has learned from his mistakes may be missing

the only important lesson - namely, that the real mistake is not

the act, but the actor.

 

Inevitably, of course, business errors will occur and the

wise manager will try to find the proper lessons in them.  But

the trick is to learn most lessons from the experiences of

others.  Managers who have learned much from personal experience

in the past usually are destined to learn much from personal

experience in the future.

 

- Buffett, 1984 or 1985 Annual Letter

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Sure, fair enough. 

 

To give Prem a modicum of credit (and IMO, he's earned it), FFH makes it pretty clear that the change in BV + divvy should be 15%+, and it is on this basis that they wish to be judged.  Frankly, if Prem can do that over the long term, then I'm a happy guy...irrespective of Chilean earthquakes!

 

SJ

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Personally, I make use of the "except for" number to see whether the underlying trend of underwriting is getting better or worse.  That's why it is valuable to me and I believe that is why it is valuable to Prem.

 

You are misunderstanding his motives I think.

 

Stated differently, Prem turns to his presidents and says, "Stop bullshitting me gentleman.  I'm tired of you guys always obscuring your overall performance behind a big cat loss.  You can't be a major league player unless you can consistently field and hit well.  So you'll tell me how bad things are even without this big loss."

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Book value is $383.83 U.S. per share.

 

IMO, that is really the only thing that matters at this point. So, the shares will likely trade closer to that amount over the coming days and then you might want to sell and then buy again if we see a gap again between their holdings vs the market. They may pop and go a bit higher than book, but I suspect that they will trend back toward book.

 

If you want a more classic insurance company, then look at Chubb, Markel or others. These companies will also tell you the impact of q1 catastrophes, but you will notice that they are still well below 100% on the combined ratio including these (93.6% including 12.3% of catastrophes for Chubb). By the way, I doubt that they are undisciplined, cheating with reserves or that discounting reserves or not explains much on the massive gap.

 

The end result is simple, no living analyst will ever assign any value to Fairfax's insurance businesses since they almost never generate any profit. How do you value that? Then you have some interest and dividend income that looks repeatable, but then most of it is used to pay off interest charges, runoff costs and underwriting losses. A multiple of earnings? What earnings? The only thing that goes up is the value of their portfolio holdings, but that is highly erratic. So, what we are left with is something very similar to a closed end fund where all that matters is the gap between its trading price and NAV which in this case is book value since it is the quickest, dirtiest way to get an handle on it.

 

The market likes simple yardsticks and doing complex math like we have seen on the MKL vs FFH post is not its thing. Simply listen to the analysts questions tomorrow and you will see what I mean. Most of the time, they don't even know half of the company's details being discussed here on this board.

 

Now, this may change when we enter a hard market since at that point Fairfax should generate underwriting profits. However, I suspect that there will remain a gap in the combined ratio between them and some of their best competitors, so Fairfax could trade at some multiple of book (say 1.5), but the competitors may then trade at 2.0.

 

Conclusion: Fairfax should deliver over time a better rate of return to its shareholders than its competitors since they are very good investors. Growth in book value will be the key indicator. However, you will need a lot of faith in their continued investing outperformance since it is not more boring figures such as underwriting profits and interest that are very cummulative that will drive return on equity.

 

For me, the run is over. I knew that they would show good investment results and was hoping that this would finally help close the gap in valuation between them and some of their competitors. At least get some recognition for their investing talent but, based on the above, I will stop hoping.

 

Cardboard

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Prem discussed underwriting in detail during the AGM.  He said that their combined ratios will appear to be very high, but that is because they are contracting their book of business dramatically at the moment, while expenses are not going to contract as fast.  You cannot reduce customer service to existing clients, even though you are decreasing underwriting because of poor premium rates.  When premium rates harden, you will see the momentum in Fairfax's underwriting.  The market will miss this because they will be preoccupied with the higher CR's right now.  Wait till you see what these guys do in a hard market!  Cheers!

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Can someone explain to me how they are going to finance the Zenith purchase.  I count about 700 Million so far (1.7-1.0 B at holdco) out of 1.4 Billion.  Where is the rest coming from?  Another share issue or will they pull cash up from the subs?

 

 

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The numbers vary so much.  Fairfax Asia always has tremendous underwriting, whereas C&F is high CR.  Asia keeps growing whereas the falling volumes and high expense ratio at C&F is killing them.  In the very long term, Asia will overshadow C&F.

 

Don't fault Prem. C&F seems to be what it is -- not the same pond as Asia.  I would bet that if you hired the Chubb underwriters to run Crum you likely would get the same CRs.  I think it is a Carp pond where you catch carp, not trout. 

 

Now, if you double volume in a hard market you'll get underwriting profits at Crum high enough to fill in the holes you see today.

 

I'm using Crum as a metaphore for all of their operations that earn high CRs. Not just picking on them.  Generaly, their underwriting is far better than what existed prior to acquisition.  So they have discipline, but I think they bought carp ponds and they won't produce trout. 

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Al, FFH states any remaining funds required for the Zenith purchase will be dividended up from the subs by the end of Q2.

 

Yes, when I saw the underwriting CR I was disappointed. And then I saw the investment results and was blown away. BV = $383.83

 

We can also estimate Q2 BV gain is likely in the $15 range which gives us a current BV close to $400. Shares are trading at $370. P/BV = 0.925. Cheap. That is much better than what I was hoping.

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I believe that we need to reconsider the likelihood of a hard market in the near future. To me, the Chubb results are very telling and I encourage you to at least read this short press release:

 

http://finance.yahoo.com/news/Chubb-Reports-First-Quarter-prnews-3367809713.html?x=0&.v=1

 

These are not the type of numbers that we saw at the end of the 90's which was then followed by 911 leading to the hard market of the early 00's. For Chubb it was running between 100-103%. We are nowhere near depressed conditions. What if the hard market is 3 to 5 years out? We are currently running 17.9% higher than these guys on the combined ratio.

 

By the way, these guys are not fishing in some kind of special pond. Their net premiums written are about 2.5 times the size of Fairfax and their biggest division is their commercial unit which should be in direct competition with Crum & Forster unless I am completely wrong. For their commercial unit vs C&F the differential in combined ratio is 13.4%. In q1, their net premiums written declined 1% while C&F increased 3.6%.

 

Cardboard

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Cardboard: Very good posts.

 

Re UW: There are only 3 ways to increase UW gains (1) Higher Premiums (2) Lower expenses (3) Higher Income. Sustained premium growth is highly unlikely; AIG is still out there, & most will cut rates to generate float as soon as there is any market hardening. Expenses are growing at > inflation, & we're pretty much at the limits of consolidation. Income can realistically only increase if interest rates rise.

 

If we have a global rise in interest rates, UW profitability should be more reliable; but how likely is this when almost every global sovereign badly needs low rates to minimize the debt service on their inflated borrowings? And in the meantime ..... why would you NOT expect higher volatility from erratic UW results?

 

Buy & hold, vs buy & hedge, just does not make a lot of sense.

 

SD 

 

 

 

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"...There are only 3 ways to increase UW gains (1) Higher Premiums (2) Lower expenses (3) Higher Income."

 

Sharper, if FFH is taking higher reserves, would that be in the expenses  ie would their UW performance be poor because their expenses are higher because they are taking more conservative reserves. Sorry, may be a fundamental question that I should know the answer to, but I am still learning about insurance companies.

 

Also as noted above, is FFH expenses not higher because they have reduced business without decreasing their head count (they have not cut overhead relative to the reduced  revenue---choosing not to write unprofitable business)

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Prem discussed underwriting in detail during the AGM.  He said that their combined ratios will appear to be very high, but that is because they are contracting their book of business dramatically at the moment, while expenses are not going to contract as fast.  You cannot reduce customer service to existing clients, even though you are decreasing underwriting because of poor premium rates.  When premium rates harden, you will see the momentum in Fairfax's underwriting.  The market will miss this because they will be preoccupied with the higher CR's right now.  Wait till you see what these guys do in a hard market!  Cheers!

 

I couldn't have said it better myself. Interest and dividend income are now high enough to more than outweigh the effect of high (110%) combined ratios . . . and no one seems to believe that we will see low ratios. At a 90% company-wide combined ratio (which would probably be the peak), we are looking at UW+interest+divs of close to $500 Million per quarter (I am assuming they will be writing almost twice as much business at this point) . . . I'm willing to pay a little over book to own a business that will perform at this level at some unknown time in the future.

 

 

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Overall very satisfying results!  ;D

 

I agree with most of the members that expressed their disatisfaction about the "except for" comment. While I agree it is important to put the chilean event impact in context, but to cheer up about what would have been the results without that is another thing.

 

But I'm used to that and don't expect that attitude to change. I take a look at the big picture and I'm very satisfied with it  :)

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