Fairfax underwriting track record

[ap1234]

I recently attended the Fairfax AGM. Aside from the typical discussion on investing which is usually insightful, I was intrigued by some of the remarks by Andy Barndard (and the presidents of the insurance subs) suggesting that they believe they can generate an underwriting profit over a full cycle. I used to think of Fairfax as a mediocre insurer who would write at 102-105 and use the cheap float to invest.

 

I decided to take a look at Faifax’s underwriting record over the past decade. I noticed a considerable discrepancy between the reported results (calendar year data) and the accident year combined ratios. I'd be interested to hear thoughts from members of the board on how to interpret the historical underwriting data.

 

The following data is the 10 year average combined ratio  on a calendar year basis (GAAP reporting).

 

Northbridge: 99.1%

Crum & Forster: 104.6%

Fairfax Asia: 87.6%

Odyssey Re: 100.3%

Reinsurance/other: 111.4%

Consolidated: 101.8%

 

The following data is the 10 year average combined ratio on an accident year basis (pg. 13 of the annual report);

 

Northbridge: 97.4%

Crum & Forster: 101.5%

Fairfax Asia: 87.1%

Odyssey Re: 92.8%

Consolidated: 95.8%

 

The calendar year combined ratios don't appear that impressive. The accident year ratios on the other hand look quite good especially given the prolonged soft market since 2006. For example, Odyssey Re has a 100% average calendar year CR and a 93% average accident year CR.

 

I assume the calendar year combined ratios are higher because they include the legacy books from Fairfax's prior acquistions (ex. C&F). In other words, prior to 2003, there were policies that were underreserved (ex. asbestors liabilities) that resulted in negative reserve developments that impacted the Fairfax's calendar year CRs from 2003-2008. The accident year CRs would not be impacted by business written prior to 2003.   

 

My questions for members of the board are:

 

1. Fairfax provides the annual calendar year CR for each sub and on an consolidated basis. Is there any way I can find the same data on an accident year basis? In other words, I want to be able to get the annual data that the table on pg. 13 of the annual report is using (i.e. annual data rather than just taking the 10 year averages). I notieced Fairfax provides accident year reserve development triangles in their notes but I can't find the initial accident year CRs for 2003,2004,2005, etc. to be able to get the data I am looking for. 

 

2. Do people believe that the 96% average accident year CR over the past 10 years is more representative of the company's future results? in other words, if the company does not acquire any more troubled insurers, is their any reason not to look at the accident year results as opposed to the calendar year results?   

 

3. If the accident year results are the best guage of the company's underwriting record, when will the improved results show up in the calendar year CR? As far as I can tell, the pace of negative reserve developments from pre-2003 business has slowed down dramatically.

 

 

 

 

 

 

 

 

[giofranchi]

I recently attended the Fairfax AGM. Aside from the typical discussion on investing which is usually insightful, I was intrigued by some of the remarks by Andy Barndard (and the presidents of the insurance subs) suggesting that they believe they can generate an underwriting profit over a full cycle. I used to think of Fairfax as a mediocre insurer who would write at 102-105 and use the cheap float to invest.

 

I decided to take a look at Faifax’s underwriting record over the past decade. I noticed a considerable discrepancy between the reported results (calendar year data) and the accident year combined ratios. I'd be interested to hear thoughts from members of the board on how to interpret the historical underwriting data.

 

The following data is the 10 year average combined ratio  on a calendar year basis (GAAP reporting).

 

Northbridge: 99.1%

Crum & Forster: 104.6%

Fairfax Asia: 87.6%

Odyssey Re: 100.3%

Reinsurance/other: 111.4%

Consolidated: 101.8%

 

The following data is the 10 year average combined ratio on an accident year basis (pg. 13 of the annual report);

 

Northbridge: 97.4%

Crum & Forster: 101.5%

Fairfax Asia: 87.1%

Odyssey Re: 92.8%

Consolidated: 95.8%

 

The calendar year combined ratios don't appear that impressive. The accident year ratios on the other hand look quite good especially given the prolonged soft market since 2006. For example, Odyssey Re has a 100% average calendar year CR and a 93% average accident year CR.

 

I assume the calendar year combined ratios are higher because they include the legacy books from Fairfax's prior acquistions (ex. C&F). In other words, prior to 2003, there were policies that were underreserved (ex. asbestors liabilities) that resulted in negative reserve developments that impacted the Fairfax's calendar year CRs from 2003-2008. The accident year CRs would not be impacted by business written prior to 2003.   

 

My questions for members of the board are:

 

1. Fairfax provides the annual calendar year CR for each sub and on an consolidated basis. Is there any way I can find the same data on an accident year basis? In other words, I want to be able to get the annual data that the table on pg. 13 of the annual report is using (i.e. annual data rather than just taking the 10 year averages). I notieced Fairfax provides accident year reserve development triangles in their notes but I can't find the initial accident year CRs for 2003,2004,2005, etc. to be able to get the data I am looking for. 

 

2. Do people believe that the 96% average accident year CR over the past 10 years is more representative of the company's future results? in other words, if the company does not acquire any more troubled insurers, is their any reason not to look at the accident year results as opposed to the calendar year results?   

 

3. If the accident year results are the best guage of the company's underwriting record, when will the improved results show up in the calendar year CR? As far as I can tell, the pace of negative reserve developments from pre-2003 business has slowed down dramatically.

 

 

 

 

Hi ap1234!

Though I cannot answer to your first question, I have argued for some time on the board that I believe FFH under the supervision of Mr. Barnard can achieve an underwriting profit in the future. He has done a wonderful job at Odyssey Re, and he will replicate that performance now he is supervising all of FFH insurance operations. When you buy troubled insurance companies, you are going to struggle fixing past mistakes for many years, either you are called Fairfax or you are called Berkshire. There is no easy way to cope with past mistakes for anyone. Though I cannot be sure about the timing, so I cannot answer to your third question either, I really think FFH has taken all the right steps to achieve a good underwriting performance in the years ahead. I want my firm to be a long-term shareholder of FFH, so I don’t dwell too much on timing, and I don’t even dwell much on quarterly or yearly results. Instead, I dwell a lot on their process. And there is nothing that I can see there, which I don’t like.   :)

 

giofranchi

 

[original mungerville]

Just to add to Giofranchi's comment. If you are Prem 20 years ago, assuming premiums to book value are 1:1 for the acquiree, you are thinking the following:

 

1. Do I want to acquire at 70% of book and sustain god awful combined ratios of 1.10% for 4 years following the acquisition? or

 

2. Do I want to acquire at 130% of book?

 

Prem rightfully chose #1 for a total price of 1.1 times book with only 0.7 paid upfront (saving 0.2 times book relative to #2 plus another 0.1 times or so for time value of money on the 0.4 paid over four years). Also note that the 10% of the combined ratio is earned income which is deductible for tax whereas the capital investment of 1.3 is already after tax dollars (so that potentially adds further to this logic).

 

Of course analysts and rating agencies (and many investors) can't do this simple math. They can not see that there is no difference between a higher capital outlay for an acquiree versus one below book but including combined ratios over 100% for a few years - they just have their little myopic view that combined ratios well over 100, with the negative earnings for the quarter/year that they imply are a big problem and think there is something wrong.

 

Now Prem is saying, yes I have been saving 20-30% on acquisitions for 20 years but its a real pain in the ass. Now that I can grow organically, I don't necessarily need acquisitions. Further the Crum and TIG ones almost brought me down. So I don't want to go back to zero, I want to buy a well-run company with good management already in place and that will also allow me to focus on capital allocation rather than dealing with the turnaround and these myopic stakeholders.

[giofranchi]

Just to add to Giofranchi's comment. If you are Prem 20 years ago, assuming premiums to book value are 1:1 for the acquiree, you are thinking the following:

 

1. Do I want to acquire at 70% of book and sustain god awful combined ratios of 1.10% for 4 years following the acquisition? or

 

2. Do I want to acquire at 130% of book?

 

Prem rightfully chose #1 for a total price of 1.1 times book with only 0.7 paid upfront (saving 0.2 times book relative to #2 plus another 0.1 times or so for time value of money on the 0.4 paid over four years). Also note that the 10% of the combined ratio is earned income which is deductible for tax whereas the capital investment of 1.3 is already after tax dollars (so that potentially adds further to this logic).

 

Of course analysts and rating agencies (and many investors) can't do this simple math. They can not see that there is no difference between a higher capital outlay for an acquiree versus one below book but including combined ratios over 100% for a few years - they just have their little myopic view that combined ratios well over 100, with the negative earnings for the quarter/year that they imply are a big problem and think there is something wrong.

 

Now Prem is saying, yes I have been saving 20-30% on acquisitions for 20 years but its a real pain in the ass. Now that I can grow organically, I don't necessarily need acquisitions. Further the Crum and TIG ones almost brought me down. So I don't want to go back to zero, I want to buy a well-run company with good management already in place and that will also allow me to focus on capital allocation rather than dealing with the turnaround and these myopic stakeholders.

 

Thank you original mungerville,

wonderful post!!  :)

 

giofranchi

[twacowfca]

Just to add to Giofranchi's comment. If you are Prem 20 years ago, assuming premiums to book value are 1:1 for the acquiree, you are thinking the following:

 

1. Do I want to acquire at 70% of book and sustain god awful combined ratios of 1.10% for 4 years following the acquisition? or

 

2. Do I want to acquire at 130% of book?

 

Prem rightfully chose #1 for a total price of 1.1 times book with only 0.7 paid upfront (saving 0.2 times book relative to #2 plus another 0.1 times or so for time value of money on the 0.4 paid over four years). Also note that the 10% of the combined ratio is earned income which is deductible for tax whereas the capital investment of 1.3 is already after tax dollars (so that potentially adds further to this logic).

 

Of course analysts and rating agencies (and many investors) can't do this simple math. They can not see that there is no difference between a higher capital outlay for an acquiree versus one below book but including combined ratios over 100% for a few years - they just have their little myopic view that combined ratios well over 100, with the negative earnings for the quarter/year that they imply are a big problem and think there is something wrong.

 

Now Prem is saying, yes I have been saving 20-30% on acquisitions for 20 years but its a real pain in the ass. Now that I can grow organically, I don't necessarily need acquisitions. Further the Crum and TIG ones almost brought me down. So I don't want to go back to zero, I want to buy a well-run company with good management already in place and that will also allow me to focus on capital allocation rather than dealing with the turnaround and these myopic stakeholders.

 

Thank you original mungerville,

wonderful post!!  :)

 

giofranchi

 

Yes!  Great post, Original Mungerville.

 

With a focus especially on companies like Lancashire that are mostly free of income tax, I had overlooked the tax advantages of Fairfax acquiring insurance companies with lousy CR's for a price significantly below book value.  Now Prem's focus is starting to make sense.  A few years ago, I asked Prem privately if he might be interested in acquiring an outstanding property insurer with an awesome underwriting record at a modest premium to book ( instead of all the crappy companies he had a history of acquiring as I was thinking ). I was surprised at his lack of interest.

 

Now, I understand better.  With Andy Barnard and team it really does make sense to buy fixer uppers because they generally can eventually get them fixed, and in the meantime their tax bill is lower.

 

ps

ap1234  The reason for the difference between the CR's and the accident year CR's has to do with things like A&E liability.  That's the gift that keeps on giving. --  One of the occult hazards that may be present when buying crappy companies that could have mystery meat in their freezer.

 

 

[giofranchi]

A few years ago, I asked Prem privately if he might be interested in acquiring an outstanding property insurer with an awesome underwriting record at a modest premium to book ( instead of all the crappy companies he had a history of acquiring as I was thinking ). I was surprised at his lack of interest.

 

You really did that?! WOW!! The fact this wonderful board is attended by such outstanding investors (the Superinvestors of the Corner of Berkshire and Fairfax!) is really a unique learning experience for the rest of us!  :)

 

giofranchi

[JEast]

If you are a newbie to FFH, I would not conclude anything by just looking at the annual, or even past annuals.  Over the years there has been so much movement that one could not, with any accuracy, conclude assumptions going forward on insurance.  On the other hand, difficulty with accuracy on assumptions is the case with nearly any non-monoline insurance business.  That said, almost any comment (including mine) on underwriting should be taken with a side of salt and is probably poo-poo.  My bête noire has, since about 2000, always been Crum & Forster.  The numbers above are actually worse than stated for C&F after one adds back in the movements, discontinued operations, run-off, the mystery meat that keeps giving, etc. 

 

No need to regurgitate the past as we are living in the present, but things have hints of improving at C&R.  One can not tell it today, but the ship may, emphasis on may, be actually turning to port or starboard, I care not, just turn please with Doug Libby at the helm. (It takes at least three years to turn a line around and 2013 is Doug's third year).  The emphasis on C&R is because I have always seen them as the tipping point for FFH's insurance.  If we can finally correct the listing of this ship, truly good things can happen to the overall bottom line at FFH.

 

Cheers

JEast

 

Long FFH

[twacowfca]

A few years ago, I asked Prem privately if he might be interested in acquiring an outstanding property insurer with an awesome underwriting record at a modest premium to book ( instead of all the crappy companies he had a history of acquiring as I was thinking ). I was surprised at his lack of interest.

 

You really did that?! WOW!! The fact this wonderful board is attended by such outstanding investors (the Superinvestors of the Corner of Berkshire and Fairfax!) is really a unique learning experience for the rest of us!  :)

 

giofranchi

 

Prem is quite available and approachable around the time of the AGM. Ask him any question that isn't off limits, and he'll give you a straight answer.  :)

[beerbaron]

A few years ago, I asked Prem privately if he might be interested in acquiring an outstanding property insurer with an awesome underwriting record at a modest premium to book ( instead of all the crappy companies he had a history of acquiring as I was thinking ). I was surprised at his lack of interest.

 

You really did that?! WOW!! The fact this wonderful board is attended by such outstanding investors (the Superinvestors of the Corner of Berkshire and Fairfax!) is really a unique learning experience for the rest of us!  :)

 

giofranchi

 

Prem is quite available and approachable around the time of the AGM. Ask him any question that isn't off limits, and he'll give you a straight answer.  :)

 

The insurer was Lancashire! You posted it on this board :)

 

BeerBaron

[twacowfca]

A few years ago, I asked Prem privately if he might be interested in acquiring an outstanding property insurer with an awesome underwriting record at a modest premium to book ( instead of all the crappy companies he had a history of acquiring as I was thinking ). I was surprised at his lack of interest.

 

You really did that?! WOW!! The fact this wonderful board is attended by such outstanding investors (the Superinvestors of the Corner of Berkshire and Fairfax!) is really a unique learning experience for the rest of us!  :)

 

giofranchi

 

Prem is quite available and approachable around the time of the AGM. Ask him any question that isn't off limits, and he'll give you a straight answer.  :)

 

The insurer was Lancashire! You posted it on this board :)

 

BeerBaron

 

My question to Prem was phrased generally, not mentioning any company by name, simply to see if a great underwriter at a modest premium to book would be as attractive to him as a decent company at book or a not so good underwriter at a substantial discount to book.  To the best of my knowledge my favorite smaller insurer isn't on the market, although management has periodically said they are willing to listen to attractive offers.  I doubt the current market would support an offer they couldn't refuse.

[Tommm50]

To reply to your question about calendar year vs accident year. Annual statements required by state regulators look at January 1 to January 1. Remember unlike conventional businesses using GAAP which looks at a company as a "going concern", insurance company accounting starts with the question, "What happens if you go out of business tomorrow?".  It's focus is to be sure policy holders get their losses paid in that event. Calendar year results match premium received and earned in the calendar year vs losses paid and reserved in the same calendar year, both of which can be coming from prior years policies. Makes sense for your average business but muddy as hell for an insurance company. Accident year is a bit better as it matches premiums earned in the calendar year to losses occurring in that year. If the company is not growing or shrinking Accident Year is a reasonable proxy for what's really going on. The only true measure of underwriting for an insurance company is Policy Year. It matches premiums earned for all policies effective in a given year to all losses arising out of those policies. Go luck trying to find those numbers.

 

But to answer your question, Accident Year numbers are more representative of what's going on than Calendar Year numbers.

 

As for Fairfax's purchase of Crum & Forster and TIG in the same year, they did use the strategy of buying at 70% of book rather than 130%. It worked well for them in Canada. What they didn't learn until it was too late was both companies "book value" was bogus. They were not equipped to do the deep uw and claims audits required to determine what a big U.S. P&C insurer's true book value was. They needed to buy them at 40 to 50% of "book value" to have a go at it.

 

It's an enduring testament to their investment skill and their key financial supporters that they survived the experience.

 

Full disclosure: I'm all in on Fairfax.

[twacowfca]

To reply to your question about calendar year vs accident year. Annual statements required by state regulators look at January 1 to January 1. Remember unlike conventional businesses using GAAP which looks at a company as a "going concern", insurance company accounting starts with the question, "What happens if you go out of business tomorrow?".  It's focus is to be sure policy holders get their losses paid in that event. Calendar year results match premium received and earned in the calendar year vs losses paid and reserved in the same calendar year, both of which can be coming from prior years policies. Makes sense for your average business but muddy as hell for an insurance company. Accident year is a bit better as it matches premiums earned in the calendar year to losses occurring in that year. If the company is not growing or shrinking Accident Year is a reasonable proxy for what's really going on. The only true measure of underwriting for an insurance company is Policy Year. It matches premiums earned for all policies effective in a given year to all losses arising out of those policies. Go luck trying to find those numbers.

 

But to answer your question, Accident Year numbers are more representative of what's going on than Calendar Year numbers.

 

As for Fairfax's purchase of Crum & Forster and TIG in the same year, they did use the strategy of buying at 70% of book rather than 130%. It worked well for them in Canada. What they didn't learn until it was too late was both companies "book value" was bogus. They were not equipped to do the deep uw and claims audits required to determine what a big U.S. P&C insurer's true book value was. They needed to buy them at 40 to 50% of "book value" to have a go at it.

 

It's an enduring testament to their investment skill and their key financial supporters that they survived the experience.

 

Full disclosure: I'm all in on Fairfax.

 

That's a great account that elucidates what I have been only generally aware of.  I have mulled over in my mind the idea of a concept like "policy year" being more accurate than accident year because of possible lags and disconnections between receipt and recognition of premiums matching the months of coverage on policies.  Can you explain more about the concept and how it helps remove possible distortions in reporting results? Why isn't this more accurate way of accounting reported?

 

Interestingly, National Indemnity recently had an issue with Swiss Re similar to Fairfax's buying the TIG and C&F pigs in a poke several years ago.  NICO was concerned about reserving issues on a seasoned life insurance book they bought from Swiss Re. They did a thorough analysis and found glaring reserve inadequacies.  They had to file suit against Swiss Re to finally get an adjustment.

 

I found that to be astonishing because Swiss Re had asked BRK to bail them out during the financial crisis.  How's that for repaying BRK!

[ap1234]

Thank you for sharing your insights!! That makes a lot of sense.

 

Is there any reasson NOT to use the 10 year averaged accident year data below (pg. 13 of the annual report) as a gauge for the company's underwriting going forward (i.e. assuming they don't acquire any more troubled insurers)? I assume the past 10 years is a reasonable proxy for a full insurance cycle as it captures a very hard market following 9/11 and a prolonged soft market from 2006 onwards.

 

Northbridge: 97.4%

Crum & Forster: 101.5%

Fairfax Asia: 87.1%

Odyssey Re: 92.8%

Consolidated: 95.8%

 

[giofranchi]

Thank you for sharing your insights!! That makes a lot of sense.

 

Is there any reasson NOT to use the 10 year averaged accident year data below (pg. 13 of the annual report) as a gauge for the company's underwriting going forward (i.e. assuming they don't acquire any more troubled insurers)? I assume the past 10 years is a reasonable proxy for a full insurance cycle as it captures a very hard market following 9/11 and a prolonged soft market from 2006 onwards.

 

Northbridge: 97.4%

Crum & Forster: 101.5%

Fairfax Asia: 87.1%

Odyssey Re: 92.8%

Consolidated: 95.8%

 

It makes sense to me! Still, Mr. Barnard has just started overseeing all insurance operations, so I hope he will bring some pleasant surprises in the future and FFH will deliver even better results!  :)

 

giofranchi

[WhoIsWarren]

I recently attended the Fairfax AGM. Aside from the typical discussion on investing which is usually insightful, I was intrigued by some of the remarks by Andy Barndard (and the presidents of the insurance subs) suggesting that they believe they can generate an underwriting profit over a full cycle. I used to think of Fairfax as a mediocre insurer who would write at 102-105 and use the cheap float to invest.

 

 

I think Andy's comments on underwriting were for me the most interesting take out from the AGM.  He said something about wanting the underwriting side of the business to be as well-regarded for excellence as the investment side.  And that he expects underwriting results to be better....potentially significantly better.  These weren't the exact words used, but I think are close.  I take that to mean much more than just an over-the-cycle 100% CR.

 

Then Andy asked a number of the individual insurance heads up, starting with Doug Libby at C&F who outlined how the business 5 years ago (or so) was 15% specialty and that now it's 85% specialty, which I interpret as less competitive and hopefully more profitable over a cycle.  Unfortunately the rest of the insurance heads were not nearly as insightful, but my impression is that there's a plan in place to focus on more profitable over-the-cycle niches.

 

Anyway, if Andy and his team manage to implement their plan there is enormous upside for the stock.

 

As this was my first Fairfax AGM, I'm particularly interested in hearing from the 'old heads'.  Is Fairfax prone to perpetually talking up their underwriting potential?

 

Thanks

[giofranchi]

He said something about wanting the underwriting side of the business to be as well-regarded for excellence as the investment side.

 

Just GREAT!!

 

Thank you WhoIsWarren! :)

 

giofranchi

[twacowfca]

I recently attended the Fairfax AGM. Aside from the typical discussion on investing which is usually insightful, I was intrigued by some of the remarks by Andy Barndard (and the presidents of the insurance subs) suggesting that they believe they can generate an underwriting profit over a full cycle. I used to think of Fairfax as a mediocre insurer who would write at 102-105 and use the cheap float to invest.

 

 

I think Andy's comments on underwriting were for me the most interesting take out from the AGM.  He said something about wanting the underwriting side of the business to be as well-regarded for excellence as the investment side.  And that he expects underwriting results to be better....potentially significantly better.  These weren't the exact words used, but I think are close.  I take that to mean much more than just an over-the-cycle 100% CR.

 

Then Andy asked a number of the individual insurance heads up, starting with Doug Libby at C&F who outlined how the business 5 years ago (or so) was 15% specialty and that now it's 85% specialty, which I interpret as less competitive and hopefully more profitable over a cycle.  Unfortunately the rest of the insurance heads were not nearly as insightful, but my impression is that there's a plan in place to focus on more profitable over-the-cycle niches.

 

Anyway, if Andy and his team manage to implement their plan there is enormous upside for the stock.

 

As this was my first Fairfax AGM, I'm particularly interested in hearing from the 'old heads'.  Is Fairfax prone to perpetually talking up their underwriting potential?

 

Thanks

 

Not at all in my opinion.  They do emphasize underwriting as crucial to their long term success.  Actions speak louder than words.  The big improvement in their 10 year accident year CR's is impressive.  When CR's can't be improved to meet their standards, they'll put a company or a line of business into runoff.  It makes sense to take their 10 year accident year record as being representative of their underwriting going forward.  :)

[warrior]

at AGM  they were  all enthusiastic about improving  combined ratio from all of its business units. (Indeed, they have room for an improvement). With the FFH in capital preservation and defensive mode, likely resulting in low investment returns, it makes sense that more emphasis is placed on improved underwriting  to generate ROE and book value growth.

[Tommm50]

To reply to your question about calendar year vs accident year. Annual statements required by state regulators look at January 1 to January 1. Remember unlike conventional businesses using GAAP which looks at a company as a "going concern", insurance company accounting starts with the question, "What happens if you go out of business tomorrow?".  It's focus is to be sure policy holders get their losses paid in that event. Calendar year results match premium received and earned in the calendar year vs losses paid and reserved in the same calendar year, both of which can be coming from prior years policies. Makes sense for your average business but muddy as hell for an insurance company. Accident year is a bit better as it matches premiums earned in the calendar year to losses occurring in that year. If the company is not growing or shrinking Accident Year is a reasonable proxy for what's really going on. The only true measure of underwriting for an insurance company is Policy Year. It matches premiums earned for all policies effective in a given year to all losses arising out of those policies. Go luck trying to find those numbers.

 

But to answer your question, Accident Year numbers are more representative of what's going on than Calendar Year numbers.

 

As for Fairfax's purchase of Crum & Forster and TIG in the same year, they did use the strategy of buying at 70% of book rather than 130%. It worked well for them in Canada. What they didn't learn until it was too late was both companies "book value" was bogus. They were not equipped to do the deep uw and claims audits required to determine what a big U.S. P&C insurer's true book value was. They needed to buy them at 40 to 50% of "book value" to have a go at it.

 

It's an enduring testament to their investment skill and their key financial supporters that they survived the experience.

 

Full disclosure: I'm all in on Fairfax.

 

That's a great account that elucidates what I have been only generally aware of.  I have mulled over in my mind the idea of a concept like "policy year" being more accurate than accident year because of possible lags and disconnections between receipt and recognition of premiums matching the months of coverage on policies.  Can you explain more about the concept and how it helps remove possible distortions in reporting results? Why isn't this more accurate way of accounting reported?

 

Interestingly, National Indemnity recently had an issue with Swiss Re similar to Fairfax's buying the TIG and C&F pigs in a poke several years ago.  NICO was concerned about reserving issues on a seasoned life insurance book they bought from Swiss Re. They did a thorough analysis and found glaring reserve inadequacies.  They had to file suit against Swiss Re to finally get an adjustment.

 

I found that to be astonishing because Swiss Re had asked BRK to bail them out during the financial crisis.  How's that for repaying BRK!

 

Policy Year data takes premium for all policies effective in a given year and matches it against all losses generated from those policies. It's the most accurate measure of UW results. The problem with it from an accounting/reporting viewpoint is it takes a long time to be complete or even close to complete. On the premium side it will take two calendar years to earn out a policy year's written premium (that policy effective in late December of the policy year has to run to it's expiration late the following  calendar year). On the loss side claims are occurring over the same two calendar years. Then they have to be reported to the insurance company, initial reserves set, investigated, settled, litigated if necessary etc. All this takes time, 5 to 7 years or more depending on the line of business. Until the policy year is mature (all claims settled) you're looking at estimates of the ultimate losses (reserves).

 

It's been a long time since I've looked at an annual statement (each U.S. insurer has to file one with the state in which they are domiciled), it's not anything like the annual report stockholders receive. I believe you can go through the schedules in the annual statements and construct policy year results but as I say it's been quite a while. For a group of companies, only some of which are U.S. , this presents some challenges.

[Tommm50]

Thank you for sharing your insights!! That makes a lot of sense.

 

Is there any reasson NOT to use the 10 year averaged accident year data below (pg. 13 of the annual report) as a gauge for the company's underwriting going forward (i.e. assuming they don't acquire any more troubled insurers)? I assume the past 10 years is a reasonable proxy for a full insurance cycle as it captures a very hard market following 9/11 and a prolonged soft market from 2006 onwards.

 

Northbridge: 97.4%

Crum & Forster: 101.5%

Fairfax Asia: 87.1%

Odyssey Re: 92.8%

Consolidated: 95.8%

 

No, the 10 year accident year ratios are good indicators but what I find frustrating (And believe me I want to drink the Kool-Aid) is Crum and Forster's and Zenith's results over the last few years. Showing the 10 year numbers puts them in the best light but they only look good due to "hard market" results from earlier in that period. I do not buy the "high expense ratio" justification for Zenith and Crum and Forster's transition to more of a specialty insurer will have a great deal more credibility when it shows up in results. Specialty insurers lose money too if you don't know what you are doing.

 

I hope Andy Barnard is the answer but he's a reinsurance guy managing insurance operations and it's not quite the same skill set.

[JEast]

Well, if you really want to feel/see what is the 'true' story (if there is such a thing in insurance), one needs to go thru the NAIC's Schedule P for the underwriter.  The Schedule P breaks down the line of business in more detail and by state, at least for the US line of business.  Leucadia used to own Colonial Penn and I would review the Schedule Ps for my DD on LUK.  Oy vey! -- would reading that blow your mind.

 

At the end of the day, it all falls back to the management.  If you do not trust the management, walk away and very fast. 

 

Cheers

JEast

[twacowfca]

Thank you Tommm50, jEast and others for your helpful replies.

[ap1234]

Thank you for the replies. That is very insightful and provides me with a lot more insight on how to think about their historical results.

 

Tommm50 -  I have two follow-up questions. You seem to be very knowledgable about the P&C space so I'd love to hear your thoughts.

 

1. I understand your concerns re: the results of Crum as their transition to a specialty insurer (discussed at the recent AGM) sounds interesting but the results have yet to show up in their underwriting results. In terms of Zenith, why are you concered about their results? According to mgmt., their loss ratios are amongst the best in the industry and it is the expense ratios that are elevated. The level of premiums are clearly down from the peak of the hard market. Do you not believe that their CR will drop significantly during a hard market as volumes & price go up?

 

2. You mentioned that "showing the 10 year numbers puts them in the best light but they only look good due to "hard market" results from earlier in the period."

 

Over the past 10 years, we have had a hard market from 2003-2005, a soft market from 2006-2010 and some modest hardening in 2011-2012. Do you think that the past 10 years is not a good indication for an average insurance cycle (i.e. capturing peak and trough experiences)?

 

[Tommm50]

Thank you for the replies. That is very insightful and provides me with a lot more insight on how to think about their historical results.

 

Tommm50 -  I have two follow-up questions. You seem to be very knowledgable about the P&C space so I'd love to hear your thoughts.

 

1. I understand your concerns re: the results of Crum as their transition to a specialty insurer (discussed at the recent AGM) sounds interesting but the results have yet to show up in their underwriting results. In terms of Zenith, why are you concered about their results? According to mgmt., their loss ratios are amongst the best in the industry and it is the expense ratios that are elevated. The level of premiums are clearly down from the peak of the hard market. Do you not believe that their CR will drop significantly during a hard market as volumes & price go up?

 

2. You mentioned that "showing the 10 year numbers puts them in the best light but they only look good due to "hard market" results from earlier in the period."

 

Over the past 10 years, we have had a hard market from 2003-2005, a soft market from 2006-2010 and some modest hardening in 2011-2012. Do you think that the past 10 years is not a good indication for an average insurance cycle (i.e. capturing peak and trough experiences)?

 

1. I didn't see much analysis of the Zenith expense ratios in the annual report or their loss ratios for that matter. On page 11 of the annual report they note Zenith's combined ratios as 136.4 in 2010, 127.5 in 2010, and 115.6 in 2012. I managed uw operations writing WC for the Hartford for about 20 years. We always sought to hit 60% loss ratio or better. We didn't always manage it. The annual report describes Zenith as the best in the business but doesn't provide any backup for the contention. Let's say they think 70% is a good loss ratio. That means they're dragging 63.4%, 57.5%, and 45.6% as expense ratios over the past three years. That's outrageous on a book of $600 million GWP. If you look at the notes on page 134 they break out the expense components of Fairfax Asia. I didn't see anything comparable for Zenith (I'd be happy if someone pointed it out to me).

 

Certainly if they write more premium that will help their expense ratio but I would have liked a lot more insight into why it's so high now.

 

2. To answer your question about my view of the market cycle I'm attaching a speech I gave to an insurance company attorneys' group on just that issue. Understand I'm just a guy who's been in this business a while and trying to give the attorneys a broader view of the environment in which they operate. It's not designed for this forum so you'll have to jump back and forth between the text and the slides. Bottom line: I don't see insurance companies being able to rely on "hard markets" to help them. They've got to manage themselves as it the past three years (and I mean Zenith) will go one forever.

CLM_Keynote_Speech.doc

CLM_Keynote.ppt

[nwoodman]

Understand I'm just a guy who's been in this business a while and trying to give the attorneys a broader view of the environment in which they operate.

 

Thank-you for posting this, it is very generous of you. The graph of the PC industry profitability over the longer term is very helpful

 

cheers

nwoodman