Fairfax investment merits and concerns

[Munger_Disciple]

I am a relatively new member to this board. I have read most of the publicly available information about Fairfax, Prem, etc. I have also found this board to be very informative and the discussions to be of high quality in general. As I see it, the following are the things I like about Fairfax:

 

Positives:

 

1. Prem is smart, humble and seems a very capable investor. As a fellow alumni from the Indian Institute of Technology, I am very proud of his accomplishments to date.

 

2. Prem owns ~10% of the stock, his salary at Fairfax is reasonable, and takes no stock options. Therefore his interests are completely aligned with those of the shareholders. I know of very few company CEOs other than Berkshire that can claim this. In most of the companies the management enriches themselves at the expense of shareholders.

 

3. Prem's track record of increasing Fairfax's book value to-date is very impressive.

 

I have however the following concerns as I evaluate Fairfax as a potential investment:

 

Concerns:

 

1. The insurance underwriting results appear to be not very impressive. I also did not like the excuses provided in the 2009 AGM presentation (except for this loss and that loss, etc., the results would have been great) for poor underwriting results. i am hoping that (given that Prem is a smart CEO) they will improve upon these results in the future.

 

2. Fairfax appears to have a very large premium revenue compared to book value (almost 2x). This may put them in a potentially adverse situation in the future if there is a significant loss.

 

3. While the overall investment results are very impressive, they seem be making (small) investments in very iffy situations like Bowater, Canwest, etc. It seems to me that given the steep drop in equity markets, you can go first-class in terms of quality of companies invested in. I do not quite understand the thinking here.

 

I respect the opinions of all the members on this board, so your feedback will be greatly appreciated.

 

Regards,

-Sreen Raghavan

 

[UhuruPeak]

Concerns:

1. The insurance underwriting results appear to be not very impressive. I also did not like the excuses provided in the 2009 AGM presentation (except for this loss and that loss, etc., the results would have been great) for poor underwriting results. i am hoping that (given that Prem is a smart CEO) they will improve upon these results in the future.

 

Hello, welcome.  Please let me address this concern since I think I finally saw the light on this reasoning.

 

Unexpected losses will always be around - this is why insurance companies exist in the first place of course.  While some of the losses are just "business as usual", there are also the cat ones that can make or break a year.  How do we know if the underwriting is good when such a cat comes?  There are basically only two ways: (1) "proof is in the pudding", the losses are manageable and lower than our competitors'; or (2) "let's look at it without the cat losses, and then you can add a few % points to smooth out the normal cat impacts".

 

 

BRK and some others are such good underwriters that most years they will just show a negative cost of float.  I think you need to see FFH's explanation as just a tool to help you understand their underwriting score, not as an excuse for sub-par performance; perhaps you can add 5% annually to account for the average impact of cats.

 

 

 

Does that help?

[ValueBuff]

Welcome!

 

as for the investments, FFH has their majoirty of their money in the quality you mention.  They own almost 1\2 billion worth of JNJ.  Also, they own WFC, BNI, GE and so forth.  you can find the list on the SEC website.  I forget what it is called..a 10K? or something as such.  Someone here will most likly have the link!

 

cheers

[ValueBuff]

SEE THE "FAIRFAX YTD" thread for your US holdings.  its already there

[oldye]

Good underwriting is all about pricing risk properly, what does last years Combined Ratio tell you about their underwriting potential?  Does it help you figure out their cost of float over the next 10 years?

 

 

[Munger_Disciple]

Thanks for your suggestion of accounting for the impact of CAT loss in the underwriting results over a period of time (good as well as bad). I have reviewed Fairfax's underwriting results for the past 10 years, and I think there is room for improvement especially when compared to Berkshire. I think Prem sounds so much like a younger version of Warren that I have no doubt that he will only get better with time.

 

Thanks also to others for their comments.

[benhacker]

Screenr, I think you need to take the last 10 years in context with their large and failed acquisitions in the mid/late 90's.  Looks at different subsidiaries independantly will help with your overall understanding of what is the 'norm' and what is the exception.

 

But insurance is a tough one to handicap.  We'll only know if we are right 5-10 years from now.  If you can't trust fully an insurance company management (even FFH) just walk away.

 

Ben

[UhuruPeak]

sreenr,

 

I too think underwriting at FFH has room for improvement; definitely!

 

 

oldye,

 

I'm not sure what your point is?  I'm a little sleep deprived, so that will be my excuse :)

[oldye]

My point is that last years Combined Ratios won't tell you whether the underwriting was any good.  If an insurer took risks where they were being compensated properly and turned down business where it wasn't than they have good underwriting.

 

An insurers Combined ratio could be 70 on any given year, but if they took bad risks than their underwriting was poor! 

 

  Look for little behaviors like reducing premiums during soft markets.  You really can't have a bunch of idiots running an insurer and expect good results.  You really need to trust management in this business.

[UhuruPeak]

got it - thx

[cheapguy]

Trust is the most fundamental thing in considering to buy Insurance companies stock.

 

what would be a list of subtle things to note ?

 

It is not like McDonalds or coke, where you can see if they discounting or doing some give aways which going to reduce the profits.

 

In insurance companies, how can we know what is the contracts they are entering, at what price and to know as a stock holder if that is adequate pricing...?

[Munger_Disciple]

Oldye:

 

The combined ratio includes charges for estimated losses and underwriting expenses. I agree with you that the combined ratio for any given year, while important, will not tell us the whole story for an insurer. However, a table of combined ratios for the past N years (N>=10) will present a pretty good picture of an insurer's underwriting effectiveness. If the insurer took uncompensated risks, this table will look ugly.

[Partner24]

Hi Sreen,

 

Welcome to this board!  :)

 

Regarding your concerns:

 

1. Your insurance business is a lemon if it's cost of float is higher than the government cost of funds. The long term average cost of float of Fairfax is lower than government by few percentages points, wich is good, but granted not great.

 

2. I would rather check the reserves to equity to have a better insight about their potential damage that underestimating insurance risk could have on our equity. The lower this ratio is, the lower the "oops" risk is.  So here are those numbers for the companies that have P&C insurance subsidiaries that I follow:

 

Markel, 2,5 x

Berkshire 0,5 X

W.R. Berkley 2,95 X

Fairfax 3 X

White Mountains 2,55

Alleghany 0,97 X

 

All corrections and specifications are very welcomed.

 

3. Yes, I think they have falled in some value traps recently and it has cost us a decent amount of money recently. That being said, when you take a look at the big picture, so far their long term track record is terrific AND most of their actual stock portfolio is not in Abitibi kind of businesses.

 

Cheers!

 

 

[SharperDingaan]

 

Welcome to the site.

 

3 things you might want to consider:

 

- Don't look at one thing (UW) in isolation. FFH does far better at investing that it does at UW, but there would be no investing were there no UW float. Looser UW produces more float, but as long as the cost of that float is < the cost of wholesale funding - you're better off.

 

- Look at the UW triangles, but put more emphasis on the pre acquisition triangles. They are a 'truer' representation, & given that those bad acquisitions almost cost Prem the company - he's highly unlikely to ever go with such poor quality again.

 

- Everybody makes dud picks, but they are only duds because you (1) either paid to much for them, or (2) they take longer to pay off, & required a lot more work than originally anticipated. It's hard to imagine that those companies will not 'be there' 5 years out, but it's pretty much expected that they will look very different from what they look like today.

 

Cheers

SD

 

 

[Munger_Disciple]

Thanks for a warm welcome to the group & valuable feedback.

[netnet]

SD,

 

What is an underwriting triangle?

[indirect]

A bank or insurance co. is only as good as the reserves it makes for bad debt or UW loss. So essentially they are a estimate, which is as good as trusting the management say on those numbers. One way to look for it is how was reserve in previous yrs ( estimated vs actual for each of past yrs)  This is where the triangle come in which is called claim reserve development. Educated courtsey of CM and FFH annual reports

[Crip1]

Netnet,

 

http://www.fairfax.ca/Assets/Downloads/AR2008.pdf

 

See pages 117 through 126 (or 119 - 128 where acrobat counts the cover and inside cover as pages one and two), the areas labeled "**** Accident Year Claims Reserve Development".

 

-Crip