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It'd be interesting to start a discussion on how severe inflation might affect Fairfax. You have at least a few competing dynamics here - on one hand, they are on the stronger side financially (compared to the industry as a whole), have a lot of capacity to write new premium (extreme inflation would cause rates to rise to compensate, albeit in a delayed fashion), and have several billion in shorter maturities that could be re-deployed as interest rates rose.

 

On the other hand, widespread inflation would also inflate claims costs on the current book, a phenomenon on display in the 1970's which caused insurers to struggle for some time. It'd also hurt their bond portfolio, which I noticed as been somewhat lengthened in maturity this year.

 

So the question is, on balance, is Fairfax a struggling company or a thriving competitor if we see a big bout of inflation? I realize H-W has made a bet in the other direction based on their views of deleveraging and deflation, but it's worth thinking about. Hopefully there are lots of thoughts on both sides.

 

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http://www.amazon.com/Value-Investing-Balanced-Martin-Whitman/dp/0471162922

Martin Whitman wrote briefly about insurance companies in rising inflation environments in his Value Investing (2000) book.  Essentially, there is a period where claims and bond durations in the investment portfolio may be mismatched.  This can cause insurance companies to be seen as less valuable (market cap).  However, in roughly a 2-3 year timeframe, portfolios will start to roll over to bonds at increasing rates where interest investment income rises.  There is also likely to be an increase in premium rates accompanying inflation.  The market will begin to revalue insurance companies based on the increased income stream and increased premiums.  Obviously Whitman is writing about the 1970's experience and this is a general theory.  Individual companies may be better positioned in their portfolios for inflation.  With increased availability and use of hedges, the experience could be dramatically different from the 1970's.  No doubt there will be opportunities to find mispriced securities as the herd flees.

 

-O

 

On the other hand, widespread inflation would also inflate claims costs on the current book, a phenomenon on display in the 1970's which caused insurers to struggle for some time. It'd also hurt their bond portfolio, which I noticed as been somewhat lengthened in maturity this year.

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I think FFHs' bond duration lengthened due to the Zenith takeover.  I am betting that in the past few weeks FFh was selling some of the treasuries out of the Zenith portfolio in favour of something more lucrative. 

 

I am pretty sure that FFH has thought through the possibility of inflation.  To that end I dont expect you will see interest rates rise much for years yet so this shouldn't be an issue.  The greater issue is going to be for insurers who are doing poor underwriting and getting no yield.   

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I am pretty sure that FFH has thought through the possibility of inflation.  To that end I dont expect you will see interest rates rise much for years yet so this shouldn't be an issue.  The greater issue is going to be for insurers who are doing poor underwriting and getting no yield.   

 

I don't disagree. I just wanted to explore the scenario where the opposite happens...

 

Interesting perspective from Whitman's book. I suspect Fairfax is better off than most if interest rates go through the roof due to inflation, but it's something to think about. In any commodity industry, a shakeout ultimately benefits the strongest.

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