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Have any of the FFH short sellers said their analysis was wrong?


claphands22
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"I've been wrong. Probably that some honest people lost money because of my "liquidity crunch" wrong point of view about Fairfax Financial Holdings in 2003. For those who have followed my point of view with their hard earned money, I offer my apologies" P. Eavis, February 15th 2053

 

;)

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Hey, Eavis and his ilk just report the news ok!  They don't write this stuff, they just report it.  They didn't tell anyone to sell.  They didn't go up to some senior citizen and say that Fairfax is a fraud and you should sell at $57 a share...Hempton did that!  ;D  Cheers!

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I believe Tilson was the only one.

 

DW

 

 

Tilson didn't exactly say that he was wrong about the short thesis.  I think he said that FFH was the only short position they had closed out and then gone long.

 

Let's be honest with ourselves FFH fans.  We were in deep doo doo a few years ago.  What saved the day was the ethical conduct of Prem and crew plus the help of long time supporters like Cundill, Hawkins and Markel.  The short thesis was not so much wrong that this was a company in trouble as was the subsequent feeding frenzy of those sharks.  Their offense lay in assuming that a company in trouble must be doing something illegal.  Therefore, they crafted a scenario of fictional misconduct that is now being revealed as libel as the truth comes out in court.

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I believe Tilson was the only one.

 

DW

 

 

Their offense lay in assuming that a company in trouble must be doing something illegal.

 

i think its more like 'Their offense lay in assuming that a company in trouble is especially SUSCEPTABLE to making others BELIEVE they must be doing something illegal....its the old pile on theory of increasing your odds to win by kicking every which way from sunday them when they're down. totally unethical, but then as you say we're talking about sharks that smell blood.

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Let's be honest with ourselves FFH fans.  We were in deep doo doo a few years ago.  What saved the day was the ethical conduct of Prem and crew plus the help of long time supporters like Cundill, Hawkins and Markel. 

 

twacowcfa, That sums it up really nicely.  To say that myself and others on this board profited from this situation is an understatement - and we were never short. 

 

 

The finite reinsurance was either illegal, or at least offensive enough to the NY State Attorney, and the DOJ to result in substantial extortion by the regulators and the ouster of a few CEOs include Greenberg father and son.  FFH was treading a fine line and I believe that they agreed to unwind these contracts with Chubb and Swiss Re to placate the regulators.  It was not a pretty situation. 

 

The shorts took this info and ran with it to hell and back taking every advantage they could of the situation, legal and illegal.  Similar to Sino Forest they were extremely vulnerable to short attacks, partly through their own lack of transparency.

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One other thing to note guys about the 'under reserved' claims (and I agree with TWA and Al said above) is that while many claims may have been wild, and the harassment and media alignment was certainly borderline / illegal, we should note that FFH combined ratio has been in the sh1tter for the last several years due to exactly the business issues the shorts were complaining about (wrt to reserving).  They made up a bunch of other crap too that didn't come to pass, but the reserving was real IMO.

 

Just take a gander at ORH's loss reserve development table for their 2009 annual report.  It shows that between 2005-2009, the reserve additions just for business prior to 1999 was over $700m.  Take a look at NB's books (FFH '09 annual has this reserve table) for the '99 and prior bucket compared to the later years.  Crum is a similar looking story, although I don't have the right loss triangle in front of me right now.

 

People keep bitching about the combined ratio, but as FFH has pointed out, if you look at it on a '02-'09 basis, their reserve redundancy has only been moving in the right direction... the reason FFH has still been showing crap results is due partly to the craptastic business they acquired back in the day.

 

Now I haven't run all the numbers, but we didn't see $4B of under reserving (which Gwynn quickly revised to $2B), but it was more than $1B for sure.  And that is intuitively obvious because FFH's investments results would have made a non-reserve adding companies' stock do much better than what we have experienced (not complaining) via book value growth over the last few years.

 

To be clear, Hempton had some things right.  FFH bought some serious garbage, and honestly, they probably knew it along with the shorts.  What FFH viewed as trying to 'earn their way out' the shorts called out as accounting fraud for failure to reserve add upfront, and the shorts saw a company that was in trouble, with illiquid stock, and a fresh listing in a land with more media coverage and hot money, and went to take advantage... they have failed, and crossed many ethical lines in the process, but let's not make the mistake that their words were 100% fabricated lest we lie to ourselves.

 

To say that the analysis was wrong 100%, or that they should apologize for saying reserves were understated... well that is just naive.  FFH reserves were understated... period.  But that doesn't give the shorts a pass.

 

What is interesting is that this confusion about early business ('00 and earlier) doing badly while later business (after FFH got religion from their near death) is showing continuous reserve releases is creating a compelling investment opportunity that people don't respect.  As the bad business runs off, you see the loss development each year turn to a redundancy on average... this will hopefully coincide with a harder market, but we all know that now that I just said that the market will be soft for another 2 years. :)

 

Just trying to provide some balance.  I got to the board just as a few folks here were outing Hempton for posting under a pseudonym (coward).  However, I do value a lot of what Hempton says, even though he uses broad brushes, and has a history of questionable actions.  If he were still short (I don't know, but maybe from what I've gleaned) I would seriously value the opportunity to hear his pitch against FFH.

 

Ben - Materially long FFH, my name is Ben Hacker, not John Hempton. ;-)

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One other thing to note guys about the 'under reserved' claims (and I agree with TWA and Al said above) is that while many claims may have been wild, and the harassment and media alignment was certainly borderline / illegal, we should note that FFH combined ratio has been in the sh1tter for the last several years due to exactly the business issues the shorts were complaining about (wrt to reserving).  They made up a bunch of other crap too that didn't come to pass, but the reserving was real IMO.

 

Just take a gander at ORH's loss reserve development table for their 2009 annual report.  It shows that between 2005-2009, the reserve additions just for business prior to 1999 was over $700m.  Take a look at NB's books (FFH '09 annual has this reserve table) for the '99 and prior bucket compared to the later years.  Crum is a similar looking story, although I don't have the right loss triangle in front of me right now.

 

People keep bitching about the combined ratio, but as FFH has pointed out, if you look at it on a '02-'09 basis, their reserve redundancy has only been moving in the right direction... the reason FFH has still been showing crap results is due partly to the craptastic business they acquired back in the day.

 

Now I haven't run all the numbers, but we didn't see $4B of under reserving (which Gwynn quickly revised to $2B), but it was more than $1B for sure.  And that is intuitively obvious because FFH's investments results would have made a non-reserve adding companies' stock do much better than what we have experienced (not complaining) via book value growth over the last few years.

 

To be clear, Hempton had some things right.  FFH bought some serious garbage, and honestly, they probably knew it along with the shorts.  What FFH viewed as trying to 'earn their way out' the shorts called out as accounting fraud for failure to reserve add upfront, and the shorts saw a company that was in trouble, with illiquid stock, and a fresh listing in a land with more media coverage and hot money, and went to take advantage... they have failed, and crossed many ethical lines in the process, but let's not make the mistake that their words were 100% fabricated lest we lie to ourselves.

 

To say that the analysis was wrong 100%, or that they should apologize for saying reserves were understated... well that is just naive.  FFH reserves were understated... period.  But that doesn't give the shorts a pass.

 

What is interesting is that this confusion about early business ('00 and earlier) doing badly while later business (after FFH got religion from their near death) is showing continuous reserve releases is creating a compelling investment opportunity that people don't respect.  As the bad business runs off, you see the loss development each year turn to a redundancy on average... this will hopefully coincide with a harder market, but we all know that now that I just said that the market will be soft for another 2 years. :)

 

Just trying to provide some balance.  I got to the board just as a few folks here were outing Hempton for posting under a pseudonym (coward).  However, I do value a lot of what Hempton says, even though he uses broad brushes, and has a history of questionable actions.  If he were still short (I don't know, but maybe from what I've gleaned) I would seriously value the opportunity to hear his pitch against FFH.

 

Ben - Materially long FFH, my name is Ben Hacker, not John Hempton. ;-)

 

Thanks for the balanced analysis for those of us who were not there.

 

I expect to get flak with my comments so I'll preface by saying that I am against the "bad" shorts and I hope FFH wins their lawsuit bigtime. But, as Ben pointed out, there were enough "questions and negatives" then to attract "genuine" shorts (i.e. those who were simply trying to profit but not drive FFH out of business.

 

FFH attracted the attention of shorts because of missteps it made but to use a really bad analogy, let's just say the "benign" shorts were hitting on the girl but the "malicious" shorts tried to rape her. No rape can be justified under any circumstances but if you dress provocatively to a party, you should expect people to hit on you.

 

The point I want to make, however, is that current and future FFH shareholders will benefit from that near death experience. Who amongst us does not think that FFH mgmt are much better stewards today because of what happened? In a very perverse way, the shorts have actually paved the way for a much brighter future for FFH.

 

Some may ask, "What if FFH had not survived the attacks?" FFH survived because of the quality and credibility of Prem and his team; it survived because it was not Lehman. I'd like to think this is how capitalism works - it's messy but it works, for the most part. Of course, I was not in the foxholes when the attacks happened so my views might be naively idealistic.

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If FFH was under reserved, doesn't that mean FFH misled the shareholders about how well the company was reserved?

No the company admitted the mistakes they made when the companies were put in run off.

 

 

 

 

 

 

Also proper reserving was a moving target back then with reserves for A&E, for example, being all over the place with various reinsurers.

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Yeah Josh, I'd also argue that if you look at any company, many balance sheet items are estimates - discount rates chosen, loss rate estimates, recovery rates, etc can all drive a range of value around the "real" final number.  There is a very very large difference on the continuum of FRAUD -- AGGRESSIVE -- MODERATE -- CONSERVATIVE -- OVERLY CONSERVATIVE.

 

Just like some banks tweaked their account to show delinquencies later, or pull some profits into the current period during the crisis (I defended this here on this board for WFC at the time), there is a big range between being conservative, and being fraudulent.

 

Others have also noted that FFH never used to put a note in the annual about how they were strongly reserved until around '07 and '08 (can't remember) because, well, they weren't.

 

Just my 2 cents.

 

Ben

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Thanks everyone for their feedback. Especially Ben, uccmal, twacowfca, and ubuy2wron.  I feel almost bad about questioning FFH on this board, and I appreciate someone giving back a nice objective response.

 

From what I understand, no one here thinks FFH misled their shareholders about their reserving. They might have been aggressive and/or might have played on the line, but they did not misled their shareholders. Correct?

 

I have a few other questions about the FFH saga that doesn't seem to add up for me, and I hope someone can piece some things together.

 

1.) If the company was reserved, why did they have to sell shares below book value and sell parts of their subsidiaries?  How can an investor tell the difference from a company that made a reasonable mistake with their reserving policy, and a company abusing the complexity of reserve accounting to make themselves look better than they really are?

 

2.) What would be a legitimate reason for an insurance company to use finite insurance? Did FFH ever give a reason why they used finite insurance?

 

3.) Did John Hempton really have bad intentions? A lot of people have been bashing on short sellers and particular Hempton, yet, I read his whole blog from the first post (took forever...) and he didn't strike me as a bad guy at all, maybe aggressive, but not a bad guy. Just in the span of the three years he uncovered 3 frauds. (1) American currency hedge fund (2) large Australian broker (3) a China RTO.  This seems like something a good guy would do.  You could say he had a financial interest in the Chinese RTO, but not in the first two.  Also he was a senior analyst that specialized in financials who probably worked through the Australian HIH (insurance) fraud, he likely saw FFH and red flags popped up.

 

Also, if an insurance company is committing accounting fraud, that would be a very despicable sort of fraud. If a manufacture or a retailer commits accounting fraud, the people hit are the shareholders, creditors and employees, which is evil. Yet, if an insurance company commits fraud it's on another level of evil.  Not only do the shareholders, creditors and employees get hit, but also the people depending on the insurance. People who depend on their insurance payment are generally not wealthy: sick, old or retired.

 

I am not defending all actions of intense short sellers, but from that angle; I can see why some short sellers could be incredibly zealous about a plausible accounting scandal of an insurance company. 

 

----

 

Anyways, thanks for reading the post/thread. I respect people's thoughts on this board.

 

 

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Claphands,

 

1) Reserving and share issuance.  I dont think the issue had anything to do with intentionally agressive reserving. Alot of insurers were in the same boat and had to recap after the two consecutive years of hurricane cat losses.  In addition FFH was trying to run down TIG and it was costing more than anticipated to say the least.

 

2)Finite Re- dont really know.  It had become fairly common practice for healthy insurers to 'loan' money to those who needed some assistance.  The Chubb re policy had the blessings of the California Regulator to secure parts of TIG.

 

3) Hempton - before my time - understand he posted under Brogalboy and the intentions were to spread malicious rumours. 

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Claphands,

 

        About Hempton, I think you may still be able to find the post in the archive of the old MSN Berkshire board that Sanjeev put up.  Hempton got on the old MSN board and started to engage the old board member. If I remember correctly, there were quite a few exchanges between him on one side and Sanjeev and another member "Bsilly" on the other.

 

        You probably would have to judge yourself.

 

        best regards,

 

        Zippy

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Thanks everyone for their feedback. Especially Ben, uccmal, twacowfca, and ubuy2wron.  I feel almost bad about questioning FFH on this board, and I appreciate someone giving back a nice objective response.

 

From what I understand, no one here thinks FFH misled their shareholders about their reserving. They might have been aggressive and/or might have played on the line, but they did not misled their shareholders. Correct?

 

I have a few other questions about the FFH saga that doesn't seem to add up for me, and I hope someone can piece some things together.

 

1.) If the company was reserved, why did they have to sell shares below book value and sell parts of their subsidiaries?  How can an investor tell the difference from a company that made a reasonable mistake with their reserving policy, and a company abusing the complexity of reserve accounting to make themselves look better than they really are?

 

2.) What would be a legitimate reason for an insurance company to use finite insurance? Did FFH ever give a reason why they used finite insurance?

 

3.) Did John Hempton really have bad intentions? A lot of people have been bashing on short sellers and particular Hempton, yet, I read his whole blog from the first post (took forever...) and he didn't strike me as a bad guy at all, maybe aggressive, but not a bad guy. Just in the span of the three years he uncovered 3 frauds. (1) American currency hedge fund (2) large Australian broker (3) a China RTO.  This seems like something a good guy would do.  You could say he had a financial interest in the Chinese RTO, but not in the first two.  Also he was a senior analyst that specialized in financials who probably worked through the Australian HIH (insurance) fraud, he likely saw FFH and red flags popped up.

 

Also, if an insurance company is committing accounting fraud, that would be a very despicable sort of fraud. If a manufacture or a retailer commits accounting fraud, the people hit are the shareholders, creditors and employees, which is evil. Yet, if an insurance company commits fraud it's on another level of evil.  Not only do the shareholders, creditors and employees get hit, but also the people depending on the insurance. People who depend on their insurance payment are generally not wealthy: sick, old or retired.

 

I am not defending all actions of intense short sellers, but from that angle; I can see why some short sellers could be incredibly zealous about a plausible accounting scandal of an insurance company.  

 

----

 

Anyways, thanks for reading the post/thread. I respect people's thoughts on this board.

 

 

 

 

Here's some info ( if not complete answers ) related to your questions.

 

1)  Properly reserving for long tail casualty lines may be difficult to impossible at times.  Lloyds of London almost closed up and bankrupted many of their "names" for that reason.  Sometimes, lines of business such as asbestos and environmental ( A&E ), for example, experience claims that increase by a degree of magnitude or more within a few years.  The failure to properly reserve for these unforeseen situations doesn't have the same culpability as would be the case with a company that deliberately under reserves for predictable losses.

 

2)  Even now, Lloyds is operating under finite insurance ( within parameters ) provided by BRK.  Finite insurance for loss events that have already happened, but the final amount of the loss is indeterminate, is OK as long as there is significant risk transfer.  Finite insurance can be a way to buy time to see if ultimate losses will be better or worse than they seem to be at a particular point in time.  This can provide a cushion to earn enough to pay claims or it may turn out that the use of finite insurance was, in retrospect, merely wishful thinking.

 

As losses continue to develop, it appears that the huge amount of retrospective, finite insurance that Lloyds bought from BRK is going to work out satisfactorily for both Lloyds and BRK.  :)

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1) Being reserved does not mean that you’re liquid. If you have to sell assets rapidly, into a shallow market, & participants know you need the money, there will be a liquidity discount. And the more complex, or unloved, or unsexy, the asset the higher the discount – if you can sell at all. As many former US Investment Banks discovered, liquidity discounts of 40-50% is not uncommon. Selling shares below book value and parts of their subsidiaries was their best option.

 

2) Finite insurance is the arcane insurance version of regulatory repo arbitrage. I agree to sell you my poor asset (with a high regulatory capital requirement) & repurchase it back from you in X days at $Y. To pay for the transaction you put up your T-Bill (with a low regulatory capital requirement). At month-end I have the same total assets but require less regulatory capital, as the quality of my assets is now higher – but I pay you a fee for the privilege. Easy target, especially when you gloss over that FFH was essentially the guy with the T-Bill (cash coming from TIG in run-off) 

 

3) Uncovering 3 frauds in a row does not make you an expert, you just think you are. No different to being in a casino & correctly predicting red 3 spins in succession. Because you were right on the last 3 spins you must know what you’re doing, so if you predict the 4th spin will be red it MUST be red – it cannot possibly come up black. 

 

SD

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2) Finite insurance is the arcane insurance version of regulatory repo arbitrage. I agree to sell you my poor asset (with a high regulatory capital requirement) & repurchase it back from you in X days at $Y. To pay for the transaction you put up your T-Bill (with a low regulatory capital requirement). At month-end I have the same total assets but require less regulatory capital, as the quality of my assets is now higher – but I pay you a fee for the privilege. Easy target, especially when you gloss over that FFH was essentially the guy with the T-Bill (cash coming from TIG in run-off) 

 

Sharper, aren't you describing the bad form of finite reinsurance, whereby the transaction is used to smooth earnings and as a form of regulatory arbitrage, rather than as a way to transfer the risk of uncertain timing of claims payout, which could create a liquidity crunch, and uncertain total amount of claims payout?

 

I believe analogizing to an agreement to repurchase agreements with a defined repurchase time and amount is essentially saying that side letters are always created in these transactions that effectively create a loan rather than a real transfer of risk.  Gen Re got busted for this with AIG, didn't they?  And MBIA also got slapped for a sham finite reinsurance deal that allowed them to reduce their liabilities improperly.

 

 

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1) Being reserved does not mean that you’re liquid. If you have to sell assets rapidly, into a shallow market, & participants know you need the money, there will be a liquidity discount. And the more complex, or unloved, or unsexy, the asset the higher the discount – if you can sell at all. As many former US Investment Banks discovered, liquidity discounts of 40-50% is not uncommon. Selling shares below book value and parts of their subsidiaries was their best option.

 

SD

 

Yeah, it's interesting that so much regulatory focus is on capital adequacy. That's fine if a "TBTF" bank collapses due to idiosyncratic problems, but the extra percentages will evaporate in a financial crisis. 10+ years from now, the capital requirements might actually increase the odds of another crisis by encouraging banks to get "creative" to keep up with rising market ROEs.

 

Txlaw, that distinction is important. Fairfax shorts circa '03-'05 conveniently painted all finite transactions under the same brush, but that is about as analytically sound as measuring a bank by the dollar amount of its commercial real estate loans. In fact, AIG recently purchased finite coverage for asbestos claims from Berkshire.

 

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Guest Hester

3) Uncovering 3 frauds in a row does not make you an expert, you just think you are. No different to being in a casino & correctly predicting red 3 spins in succession. Because you were right on the last 3 spins you must know what youre doing, so if you predict the 4th spin will be red it MUST be red it cannot possibly come up black. 

 

SD

 

Haha, your post literally made me LOL. You guys really don't like Hempton. Fair enough. But that doesn't mean you should forget basic mathematic probabilities when his name comes up. I mean, this is a message board named after two INSURANCE companies, after all.

 

The odds of the roulette wheel hitting red on one spin is about 47.4%, after rounding. Saying uncovering a fraud is "no different" than hitting red on the roulette wheel is akin to saying that 47.4% of large corporations are frauds.

 

This assumption, if correct, has wide implications for the capital markets I suspect!  :D

 

Actually, Accounting firm Deloitte recently did a study and found that from 2000-2007, about 3.9% of US stocks with a market cap above $100 million were "subject of enforcement actions reported by the U.S. Securities and Exchange Commission" (AKA, they were frauds).

Hempton's uncovered frauds were mostly much bigger than $100 million, and the odds that a larger company/firm is a fraud is smaller, and Hempton's frauds had more fraud and illegal activity than many on the Deloitte report, but we'll be super liberal and assume that just throwing darts at a stock board has a 3.9% of hitting a fraud.

 

Thus, the chances of randomly uncovering 3 frauds in a row (with no skill, all luck) is about 1 in 16,700.

The odds of correctly predicting red on a roulette wheel 3 times in a row is less than 1 in 10. (1 in 9.4 actually).

 

So saying uncovering 3 frauds in a row is "No different to being in a casino & correctly predicting red 3 spins in succession" is, to borrow a word, misleading.

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Uccmal, zippy1, twacowfca, SharperDingaan:

 

Thanks for the reply.

 

--> Uccmal

Makes me wonder if other reinsurance companies that that time need to re-reserve themselves due to the hurricanes; or was FFH re-reserving (am i making a up a word here...?) mostly due to TIG

 

--> zippy1

 

Thanks for the link. I found the old archives here http://msnbrkboardarchive.multiply.com Unfortunately the search option is craptastic. You literally have to go through one page at a time to find what you are looking for. With 490 pages, about 20 posts per page, and comments not visible unless clicked on...going through all that data is going to be a freakin' project.  I did find one post here with Bsilly:http://msnbrkboardarchive.multiply.com/journal/item/5755/Fairfax_Financial_AGM_Notes

 

I have not found any posts yet with Brogalboy, but once again...it's a giant pain searching through this data. Makes me realize how lazy I am and how much my life depends on Google =P

 

--> twacowfca

 

Thanks for explaining about the difficulty of properly reserving. How can an investor know or make an intelligent decision if their insurer is properly reserving?

 

Regarding finite insurance....I still don't quite understand it. I thought finite insurance was a way for insurers to transfer their risks to other reinsurers at a cost; yet with finite insurance neither the ceding party tends not to actually lose much risk since they are still on the hook if the potential liabilities of the risk they transferred is higher than the premiums they originally paid. 

 

I thought the insurance contract Berkshire did with Lloyd's wasn't finite insurance, since Brk is on the hook for all potential asbestos liabilities. No? 

 

Sorry, if you could expand on finite insurance I would appreciate it. The use of finite insurance seems to be at the heart of the old short thesis but I don't completely understand it.

 

--> SharperDingaan

 

How could an insurance company have liquidity problems? I though insurance companies are heavily regulated so they wouldn't have liquidity problems. Banks could be solvent but have liquidity problems, such as a run on a bank, but I don't see how insurance companies could be in the same boat.

 

I don't quite understand your sentence "Easy target, especially when you gloss over that FFH was essentially the guy with the T-Bill (cash coming from TIG in run-off)

 

Are you saying the FFH was the insurer trying to lower their regulatory capital? What do yo mean the cash came from the TIG run-off? Could you expand on this a bit. The way I am reading this is FFH did these contracts in order to lower their regulatory capital and they paid for these contracts with the cash from the TIG run-off.

 

---

 

thanks everyone =)

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