1st Qtr. earnings out

[T-bone1]

Prem said on the call that the impact of the Gulf oil spill is not expected to be significant for them. I think he said at the AGM that the Chilean earthquake wasn't significant (please correct me if I'm wrong on this) . . . so I would guess that they have exposure and its around $100 Million, but this is just a wild guess.

[ERICOPOLY]

Cardboard,

If they are competing head to head with Chubb then the issue at hand is not one of underwriting discipline -- it would be either reputational or for some reason Chubb' clients have special loyalty.

 

Chubb is much larger than Crum and Crum's volume is plummeting.  There is some reason why Crum is losing business despite offering policies at lower prices.  Call it the same pond if you wish, but there is something going on in the marketplace other than simply price. 

 

Does it make sense to explain the divergence as mere pricing discipline

at Crum when Crum's volumes are dropping through the floor at a faster rate than that of the larger Chubb?

[Cardboard]

Onyx1,

 

The triangles are shown in the 10K. I don't know if you will find the details you are looking for in their 10Q but, why digging so much? Here is the combined ratio for Chubb for each year between 1997 and 2009 from a version of Value Line that I have and their 10K:

 

1997: 96.9%

1998: 102.3%

1999: 102.8%

2000: 100.4%

2001: 113.4%

2002: 106.7%

2003: 98.0%

2004: 92.3%

2005: 92.3%

2006: 84.2%

2007: 82.3%

2008: 88.5%

2009: 85.6%

 

Also, these guys have been shrinking their net premiums earned in each year since 2005. If they were playing games, should it not appear somewhere in a 13 year span? Buffett also held that stock in 1999-2000 telling me that he has some respect for the firm.

 

I am starting to think that the problem is that Fairfax expands much faster than the industry in the upturns, but isn't reducing enough during the downturns. Start with 100 at 105%, go to 200 at 95%, shrink to 150 at ???. Insurance demand and pricing is likely growing right in line with GDP and inflation. That is why we see the combined ratio never get really low during the upturns, but it gets really high during the downturns. It seems like a different strategy than "traditional" conservative and disciplined underwriting where the goal is to get an underwriting profit under whatever condition. Also, if it was all head count related, it would show only in the expense ratio, but we are seeing an increase in the loss ratio.

 

It is more like trying to accummulate a ton of float during the upturns and retaining as much as possible while trying to minimize the cost during the downturns. I don't have a problem with that. Of course, it is more risky if you get poor investment results and poor underwriting results at the same time. You can unwind many good years of profits and growth in book value if that happens: a lumpy 15% is better than a smooth 12%. But, a lumpy 12% vs a smooth 12% is what?

 

I would simply like management to state what they are trying to achieve since others in the industry striving for disciplined underwriting seem to use a different method and are obtaining different results.

 

Cardboard

[onyx1]

Thanks Cardboard.  I was interested in this quarters impact.  Since favorable development in the last 5 years has really improved CR's, I have a habit of breaking out the prior years to get a feeling for the current years performance.  Some, like FFH, provide this level of transparency even on a quarterly basis, but unfortunately other don't.

[niels12think]

Cardboard,

If they are competing head to head with Chubb then the issue at hand is not one of underwriting discipline -- it would be either reputational or for some reason Chubb' clients have special loyalty.

 

Or maybe the price of the insurances at Chubb and Crum are in reality equivalent, but Crum just chooses to set aside higher reserves, leading to an apparently higher CR?

 

Cheers!

[ourkid8]

Based on these results, is anyone adding to their FFH position?

[Uccmal]

I generally wouldn't buy FFh ahead of the hurricane season.  It could get cheaper FWIW.  Not advice, just what I would do. 

 

RE: Hard Market/CR/etc.

 

I postulate that we may not know the answer to the Chubb vs. FFH vs. MKL argument until a hard market has been in force awhile.  Then you may see a difference.  By that you could see Chubb's results moderated by reserve add ons during the hard market while FFH enjoys a perfect storm.

 

RE: AIG subs - I am not convinced that they are the source of the soft market.  If they are the government wants its money back ASAP and AIG will eventually back itself into non-existence.  Since they have isolated the derivatives segment the US Gov't probably doesn't care if the insurance subs go into runoff, as long as they get most of their 'investment' back.

 

Soft markets in insurance are the same as soft markets in oil, steel, or credit.  At some point the market will reverse and the ensuing hard market will be a complete juxtaposition of the present state.  In the meantime you have an insurer which is breaking even more or less on its CRs. 

 

Each 300 Million in capital gains begets more quarterly compound interest and dividends, as it is added to the overall float which is a virtuous circle in the hands of HWIC. 

[ERICOPOLY]

Chubb is a big cookie.  Cardboard has been putting up their numbers for the entity as a whole, but here are the results for their commercial lines in 2009:

 

        Chubb's 4 commercial classes of business (42% of Chubb's premiums written in 2009)

        Multiple peril (85.8% combined ratio)

        Casualty (96.7% combined ratio)

        Workers' comp (92.7% combined ratio)

        Property and marine (83.3% combined ratio)

        Total commercial (89.9%)

 

Chubb's casualty business (it's worst measured by combined ratio) in 2008 and 2007 had combined ratios of 95% and 98.6%.  

 

The pond analogy might stick, or at least it might explain a lot of it -- for example, why is Chubb's casualty combined ratio so much worse than their Property&Marine?  Further, if their overall commercial ratio is 89.9%, which is 6.8% better than their casualty combined ratio, are they doing most of their business in multiple peril and property and marine?  And how does that compare to Crum&Forster?  Is it the same pond?  Does Crum&Forster write a heavy amount of multiple peril and property and marine?  Or is C&F more weighted towards Casualty?

 

 

Then, another topic is to notice that C&F's expense ratio was 4.3% higher than Chubb's during 2009.  Unfortunately, the Chubb annual report does not mention what the expense ratio was for it's commercial lines, but rather merely states it for the company as a whole.

 

Now, C&F had a combined ratio of 102.2% in 2009.  If you strip off that 4.3% from it's higher expense ratio you get a CR of 97.9% for all of C&F compared to Chubb's 89.9% for it's commercial lines.  But are the ponds the same?  

 

I think the choice of not discounting the reserves is making at least a 1% impact on CR, and that further knocks C&F down to 96.9% compared to Chubb's 89.9%.  That's a difference of 7% overall, but again how much business does Crum write in the areas of Property and Marine and Multiple Peril (Chubb's best lines).

 

Crum's adjusted CR is not that much higher than Crum's CR in it's Casualty line (2/10 of a percent difference), and it's 4.2% higher than Chubb's workers' comp number.

 

Unfortunately, I can't find a breakdown of the CR's for C&F's different business classes.

 

[ERICOPOLY]

Also, these guys have been shrinking their net premiums earned in each year since 2005.

 

You are correct, Chubb has been shrinking their net premiums.  Their commercial lines declined just 2% in 2008 and a further 7% in 2009.  But as Chubb states in their 10-k, some of that is due to foreign currency changes.

 

Crum shrank by 16% in 2008 and a further 22% in 2009!  I doubt it was foreign currency either.

 

 

 

 

[Guest misterstockwell]

 

 

Soft markets in insurance are the same as soft markets in oil, steel, or credit.  At some point the market will reverse and the ensuing hard market will be a complete juxtaposition of the present state.  In the meantime you have an insurer which is breaking even more or less on its CRs. 

 

111 is not 100, more or less. That is very expensive float. You are in the business of insurance, earthquakes are part of the business, so you can't keep saying "except for." Their underwriting cost them a lot of money, plain and simple.

[Viking]

I think we can all agree that underwriting is not yet a strength of FFH. I also do not expect them to finish the year with a CR = 111%; it will be better than this. Q1 2010 was off the chart in terms of catastrophes so I can accept a CR that is off the chart.

 

It is instructive to me that C&F is paying the largest share of the Zenith purchase ($130 in Q1 and $350 in Q2 = $480 million). I think we can all agree that Zenith has solid underwriting. This purchase gives me confidence that underwriting overall at FFH will improve in future years.   

 

 

[T-bone1]

I think with this oil spill Q2 is shaping up to be a pretty terrible underwriting quarter for the industry as well . . . but that which does not kill us only serves to harden the market.

[SharperDingaan]

Interest and dividend income are now high enough to more than outweigh the effect of high (110%) combined ratios . . .

 

Look closer at the Q1 earnings: Q1 had a fortunate offsetting gain that generated a net 278.8M (415.6M investment gain - 136.8M Chilean charge). Subtract the 278.8M from the total 290.2M reported & only 11.4M is attributable to everything else. But what if HW had only been able to realize 30%, or less, of the investment gain in Q1 (125.4)? That Q1 BV change would have been 0, or even negative, & the multiple would have dropped.

 

11.4M isn't enough of a MOS to absorb the adverse normal course quarterly MTM-UW variation, when it invariably occurrs. Agreed its artifically low because of higher than normal expenses, but to get a healthy cushion we really need additional interest income (either more $ to FI, or a higher cash yield).

 

So long as rates are low the odds on a specific quarter generating a negative BV hit are higher than normal. We're offsetting that with HW's ability to realize enough of a gain in that same quarter; somedays we'll win, other days we will not.

 

Different take.

 

SD   

   

 

 

[Cardboard]

BMO just raised its target on Fairfax to $420 a share from $400 CDN. They came out very impressed with their investment gains and mention that their forecast could be beat if investment gains continue at this pace. They are worried however about coming Zenith and its "troublesome" 123% combined ratio.

 

Here is the hiccup and why I am trying to bring to the board some attention to underwriting results.

 

BMO's target is 1.0 time book value of what they think book value will be a year from now assuming investment gains of $4-5 a quarter. They essentially have no clue what it will be just like most of us. It is a guess. Book value then becomes the only valuation metric that they are using and that is what is so damaging. There is no premium attached for investing acumen or for any possible upside. It trades like a closed end fund or whatever the easiest approximation of liquidation value is at any given point.

 

Other insurers trade based on book, but also based on a multiple of earnings. That is how they manage to trade above book.

 

So if you don't mind the company trading right at book value for the majority of its lifetime (we are 70-80% of the time in a soft market), that is fine since growth in book value should deliver you good results. But, if you were looking for a revaluation of Fairfax, like I was, I think that it will be disappointing.

 

Cardboard

[Viking]

T-bone, you have hit the nail on the head. There is too much capacity today. That is causing the soft market. Until capacity falls materially then we will not see a hard market.

 

I have listened to a couple of insurer/re-insurer conference calls:

- the Q1 cat losses are an income statement event NOT a balance sheet event (not bad enough to lead to higher pricing).

- the rig disaster should lead to higher pricing in that segment

- the chile earthquake should lead to higher pricing in that region

- almost EVERYONE has been buying back large amounts of shares; this is shrinking some capacity!

- almost everyone has been announcing very large reserve releases (AND THEY ARE SHRINKING year over year)

 

Cardboad, yes, posted CR are not nearly as bad today as they were in 2000. However, bond yields were much, much higher in 2000 especially on the short end of the yield curve (as many insurers have an average portfolio duration of about 3.5 years). On an accident year basis, Berkley is currently underwriting at 100%. He feels the P&C industry is underwriting at about 110% (they just do not know it yet). He is calling for the hard market to begin in Q4 of this year. Who knows? I know that Berkley knows more than me... I will be happy if we get a hard market in the next 24 months.

 

Publicly traded companies have a huge incentive to hit the quarterly numbers. They are not focussed on growing book value over the long term. At this stage in the insurance cycle they have a huge incentive to post favourable CR's so why would we expect anything different. Fortunately, at some point the losses will show. We will see in the coming year who has been swimming naked. In the meantime FFH continues to buy time with the exceptional return on its investment portfolio.

[Grenville]

 

Unfortunately, I can't find a breakdown of the CR's for C&F's different business classes.

 

 

Eric,

 

Here is C&F 2009 10K found on their website. It may have the breakdowns you are looking for.

http://www.cfins.com/assets/downloads/financial/CFHC-10K-02262010.pdf

 

http://www.cfins.com/financialinformation.html

 

[Uccmal]

 

 

Soft markets in insurance are the same as soft markets in oil, steel, or credit.  At some point the market will reverse and the ensuing hard market will be a complete juxtaposition of the present state.  In the meantime you have an insurer which is breaking even more or less on its CRs.

 

111 is not 100, more or less. That is very expensive float. You are in the business of insurance, earthquakes are part of the business, so you can't keep saying "except for." Their underwriting cost them a lot of money, plain and simple.

 

The combined ratio is not made in one quarter is it?

 

When there are some major hurricanes or perhaps this coastal disaster you will see combined ratios from Chubb for a single quarter that exceed 111% absolutely, and WRB, and MKL.  After 911 and during 2004/2005 every company was reporting CRs in the 100s and higher. 

[ERICOPOLY]

Cardboard,

Regarding that pond...

 

I found some facts on C&F's product mix.  They have a much lighter mix of the business where Chubb has it's best CRs (Property & Multi-peril)

 

In 2009 gross premiums written at C&F were $863.8m.  $87.4m was in property and $81.5m was in multi-peril.  So that represents only 19.5% of their business.

 

Chub wrote $1,121m in Multiple Peril (85.8% CR) and $1,264 in Property and Marine (83.3% CR).  That's 51.18% of their total $4,660m commercial business!

 

Remember what I posted before about Chubb (look at where their sub-90 CRs come from):

 

        Chubb's 4 commercial classes of business:

        Multiple peril (85.8% combined ratio)

        Casualty (96.7% combined ratio)

        Workers' comp (92.7% combined ratio)

        Property and marine (83.3% combined ratio)

        Total commercial (89.9%)

 

 

Also, I discovered that 23% of Chubb's market is "international" (South America, Australia, Asia).  Don't know whether the pricing is better in those markets, but it looks pretty good in Asia judging by what Fairfax Asia produces.

 

[Cardboard]

I remember in the old days that Odyssey Re was opportunistic in terms of where to deploy its underwriting capacity.

 

If there is no to little competition in the lines issued by Chubb, then why not go after these? C&F should be a smaller, more entrepreneurial organization. Based on what you found, they are already knowledgeable about these lines, it is just that they are underweighted.

 

There is also the tail of course. Casualty and workers compensation have a longer tail than property (longer time holding cash before paying claims) and that may explain some of the difference. Are they going more after these? However, you have to remember that you need to hold more capital to write these so there is a trade off.

 

I don't know. I have been following this company for over 10 years, held it for many of these years and have been at times a fervent defender. I have never seen them deliver much underwriting profits, more the opposite. It seems that we always have to get into complex explanations to explain the unexplicable.

 

The Street has stopped beating its head against the wall and has decided that 1.0 book value is it. Since they are the ones deciding what you can get for your shares might as well accept it.

 

Cardboard

[Guest misterstockwell]

 

The combined ratio is not made in one quarter is it?

 

When there are some major hurricanes or perhaps this coastal disaster you will see combined ratios from Chubb for a single quarter that exceed 111% absolutely, and WRB, and MKL.  After 911 and during 2004/2005 every company was reporting CRs in the 100s and higher.  

 

I looked at the last 10 years for FFH--they averaged 105, which includes all the "except for's", as it should. I will give them a few more years as they now have a fairly stable group of companies that they can work with to improve their underwriting. Hopefully they learned their lesson about buying trash and will never do that again. If they still average 105 CR's, I maintain that they are far better off just being a hedge fund. Why bother with the insurance side if it does not provide free float, or pay for your float?

 

Along the same lines, if Prem said he was selling FFH and starting a hedge fund, would you give him your money to invest? Would you more likely give him all your money to invest vs. putting all your money into FFH stock? Is he a better investor than insurance operator?

[T-bone1]

Interest and dividend income are now high enough to more than outweigh the effect of high (110%) combined ratios . . .

 

Look closer at the Q1 earnings: Q1 had a fortunate offsetting gain that generated a net 278.8M (415.6M investment gain - 136.8M Chilean charge). Subtract the 278.8M from the total 290.2M reported & only 11.4M is attributable to everything else. But what if HW had only been able to realize 30%, or less, of the investment gain in Q1 (125.4)? That Q1 BV change would have been 0, or even negative, & the multiple would have dropped.

 

11.4M isn't enough of a MOS to absorb the adverse normal course quarterly MTM-UW variation, when it invariably occurrs. Agreed its artifically low because of higher than normal expenses, but to get a healthy cushion we really need additional interest income (either more $ to FI, or a higher cash yield).

 

 

 

SD, I didn't mean to imply that its enough interest and dividend income to provide a margin of safety at 111% combined ratios. I think about the company as two seperate parts: one is the insurance company and all of the bonds, the other is the stocks - basically a mutual find. My point was that bonds (and possibly stock dividends) now provide enough interest and divs that the insurance half can "break even" at a 111% combined ratio.

 

I think this insurance half of the company will have better combined ratios going forward, but my point was that it is unlikely to lose money (net of received interest and div income) over any significant period of time. I think this means it must have a positive value . .  which I think argues for a valuation today somewhere above book.

 

I am not complaining about the present value though, just trying to have a discussion to find holes in my own arguments. I am happy to buy at these prices and I suspect we will find that Prem is too.

[vinod1]

Instead of thinking in terms of absolute reduction in volumes, maybe, Prem is thinking more in terms of overall insurance leverage. There has been a pretty dramatic reduction in leverage to the point it is same as Markel. So viewing it this way, Fairfax has dramatically reduced its business compared to available capacity when compared to Markel and probably other insurers.

 

            Loss Reserves/Equity    Loss Reserves/Equity

                (2000-2006 avg)                YE 2009

 

Fairfax                7.5                            1.9

 

Markel                3.2                            1.9

 

 

              Premium Earned/Equity  Premium Earned/Equity

                (2000-2006 avg)                YE 2009

 

Fairfax                2.0                              0.6

 

Markel                1.1                              0.6

 

 

Vinod

[ERICOPOLY]

When you have CR of 105 on 4b written, you lose 200m to underwriting.

 

But when you also are making 5% yield on 12b float, you wind up with 600m income.

 

This nets out to 400m a year in profit from insurance operations.

 

Some people think they are losing money from their insurance operations but I'm not in your club.

[cwericb]

The whole idea of reducing business in a soft market seems a little short sighted to me. All industries have their ups and downs, but one thing we all share in common is that customers are much easier to turn away than they are to recapture when markets turn hard. One soon realizes the value of retaining customers when you look at the cost in advertising dollars it takes to bring in each new customer. Before you start reducing your customer base, you better be darn sure you are not going to need them somewhere down the road.

 

[Uccmal]

 

The combined ratio is not made in one quarter is it?

 

When there are some major hurricanes or perhaps this coastal disaster you will see combined ratios from Chubb for a single quarter that exceed 111% absolutely, and WRB, and MKL.  After 911 and during 2004/2005 every company was reporting CRs in the 100s and higher.  

 

I looked at the last 10 years for FFH--they averaged 105, which includes all the "except for's", as it should. I will give them a few more years as they now have a fairly stable group of companies that they can work with to improve their underwriting. Hopefully they learned their lesson about buying trash and will never do that again. If they still average 105 CR's, I maintain that they are far better off just being a hedge fund. Why bother with the insurance side if it does not provide free float, or pay for your float?

 

Along the same lines, if Prem said he was selling FFH and starting a hedge fund, would you give him your money to invest? Would you more likely give him all your money to invest vs. putting all your money into FFH stock? Is he a better investor than insurance operator?

 

To answer your question.  Yes, so far they are better investors than insurance operators.   I have said as much in posts around a year ago.  

 

Some of the benefit of the float is lost in the argument over combined ratios however.  During the crash last year the only people with significant money to invest were BRK and FFH.  No one else had capital.  The insurance float allowed them to keep alot of money in cash for a long time and invest strategically when the time came.  Most hedge funds and value funds were frozen due to inability to raise cash at that point in time.  Not FFH though.