Fairfax 2017

[TwoCitiesCapital]

Twocitiescapital,

Perhaps so, but my point was those set of factors would be the same at odysseyre and the other legacy Insurance subsidiaries and the relative underperformance was what was unnerving. I just listened to the conference call recording from earlier this morning and Prem obviously projected confidence and seemed unperturbed. He said Andy Barnard and other senior execs. visited with AWH after the close and were happy with operations.

He did mention a $20m negative reserve development at AWH and without that and Cat losses they would’ve been a CR of 96%.

He mentioned their historically very conservative and redundant reserving. Mentioned Scott Carmelani’s Long track record etc.

To me that was a bit self-contradictory but .....

At any rate, not rushing to judgement here but certainly something to keep an eye on going forward. I mean how many times haven’t we seen an insurance purchase go wrong initially even if it eventually works out. Sometimes one wonders if that’s not an industry way to bring out the dirty laundry! It happened to Prem and Fairfax before and

it happened to no less than one WEB and Berkshire Hathaway right?

On a more positive note, he mentioned his view that he thought the discrepancy between BV and IV was at its largest in its 32yr history. That’s quite a statement considering Fairfax has traded at as much as 2.5-3x BV in the past and generally at a much higher ratio than its current multiple. Perhaps one could argue that it was overvalued then but it’s quite obvious that atleast Prem thinks shares are undervalued. And considering market valuations you would be hard pressed to disagree. My 2c is that if AWH and Brit turn out over time to be as good operations as their other Insurance subsidiaries have been of late, given current market valuations etc, 1.5BV is certainly not unreasonable for this. If we get a hard underwriting market and/or other investment holdings perform well, then Prem may well turn out to be right in his assessment. Some ifs in there for sure but the market certainly is more than pricing those risks in at current levels. It will be an interesting next 12mths for sure and a lot more should be clear to us by then.

 

I get it - but Fairfax stopped underwriting cat on the coast of Florida awhile back. Maybe they haven't had time to let similar policies roll off or reinsurance wasn't attractive to get AWH and Brit out before the storms? That alone would explain why their results were worse. I get that Fairfax's prior insurance acquisitions before the past decade were iffy, but these are companies that have had a long-term track record of success in this industry and I don't buy that one quarter of multiple cats is worth the concern.

 

Also, less related, I'm not sure we will see another hard market in insurance - there's a good argument for why financial markets are better able to underwrite cat risks. It could be the industry evolves, like banking has, where the insurance companies underwrite the risk and then simply securitize a good bit of it and sell to investors. I would hope that there might be one good bull market left, but how long has it been? Over a decade since the last hard market? The industry has been making fundamental changes during that time and hard markets may be more coincident with bear markets/access to capital then they are with cat risk.

 

Anyways, my basic thesis for Fairfax is that the earnings picture changes dramatically once they invest that $10-11B on the balance sheet. Particularly if you believe they haven't lost their investment talent. 

 

 

[Txvestor]

By that measure with the amount of easy money floating around, we likely won’t see any hardening of the markets anytime in the near future. I’m not sure that’s the primary correlation.

Let’s see, but taking 100B + out from an industry with a 750B or so capital base generally should be impactful.

[gary17]

fairfax book value is $573 cad after q3 and if account for First capital sale ... so would put today’s price of 674$ at about 1.17x book. 

seems cheap

but the Underwriting Loss was very significant.

Berkshire was 3b loss

while fairfax is 900m. wow

[Sullivcd]

Your book value number is not including the unrealized gains of over 1b

[gary17]

i don’t count those unrealized because that’s true for many conglomerate

it could fluctuate

[Sullivcd]

I wonder whether Prem does when saying bvps is at a huge discount to iv? I haven't been able to find a conference call transcript to find any clues to this question. It would go a long way to determining where the buyback is in place at. My guess is 1.1x bvps.

[SharperDingaan]

Not to piss on the party - but you might want to reconsider the cat/super-cat insurance.

 

These big losses are telling you that they have run through their reinsurance cover; the unknowns are 1) is there another band of cover above  them?, & 2) how far are they from it? Another 1-2 hurricanes/tropical storms showing up over the US mainland this quarter, could really screw up your day. 

 

SD

 

[Txvestor]

fairfax book value is $573 cad after q3 and if account for First capital sale ... so would put today’s price of 674$ at about 1.17x book. 

seems cheap

but the Underwriting Loss was very significant.

Berkshire was 3b loss

while fairfax is 900m. wow

 

Yes and around half of that 930m loss was from the most recent two acquisitions.

[Jurgis]

Not to piss on the party - but you might want to reconsider the cat/super-cat insurance.

 

These big losses are telling you that they have run through their reinsurance cover; the unknowns are 1) is there another band of cover above  them?, & 2) how far are they from it? Another 1-2 hurricanes/tropical storms showing up over the US mainland this quarter, could really screw up your day. 

 

SD

 

Not much of hurricane season left: https://en.wikipedia.org/wiki/2017_Atlantic_hurricane_season

But who knows...  8)

[Cigarbutt]

"These big losses are telling you that they have run through their reinsurance cover; the unknowns are 1) is there another band of cover above  them?, & 2) how far are they from it? Another 1-2 hurricanes/tropical storms showing up over the US mainland this quarter, could really screw up your day."

 

Contrarian thought provoking.

 

Speaking of covers, it looks like the sector is suffering to some extent as the earnings events are starting to look like capital events for some.

Probably not enough for a material hard market in the days of ultra loose and centrally planned easy money. Maybe getting there slowly.

 

In no way hoping for natural catastrophes but big hits in Q4 may reveal more as some may be more naked than others.

 

The comment made me look at my 2005 notes about a previous holding which I still follow. For the long term minded, in 2005, Wilma was the 4th category 5 hurricane of the season and landed in Q4. When you look at the numbers, even if Wilma was relatively less costly than Katrina, losses reported by industry players including FFH revealed the potential problem related to relatively saturated layers. As always, the context then was not completely comparable. Retrospectively looking, Q4 events (and others) gave rise to an opportunity to participate in a secondary IPO with shares priced at 162,75 (USD). And that proved to be expensive for a short while.

 

Still, hardship can give rise to opportunities.

 

To address the underlying concern more fundamentally, from the operations standpoint, would humbly submit that risk management is not only related to the setup of layers and layout of covers. Have to look at the diversification of streams and overall capitalization. 2017 vs 2005 = different strokes.

 

 

[SharperDingaan]

The risk here is three-fold 1) as Txvestor points out the bulk of this came from the acquisitions, 2) there are more floods, they are bigger, the 'season' is getting later, & there are so many black swans today - that they have almost become the norm, & 3) it's highly likely they have already burned through almost all the cover they thought they would need for the year. We would suggest the current cat/super-cat exposure is simply an unintended consequence of the acquisitions.

 

If a late hurricane, or even a scandal around the industry's handling of existing hurricane/storm claims, drops the current price by 10%; it's a loss of roughly $C 65. If the intent was to buy & hold for the Jan ex-dividend date, you might benefit by roughly $C 13 (after FX). Hence, if you haven't bought yet - there is an incentive to wait as long as possible in anticipation of another natural disaster.

 

Nothing to do with the company.

Simply an opportunity.

 

SD

 

 

 

[Txvestor]

The risk here is three-fold 1) as Txvestor points out the bulk of this came from the acquisitions, 2) there are more floods, they are bigger, the 'season' is getting later, & there are so many black swans today - that they have almost become the norm, & 3) it's highly likely they have already burned through almost all the cover they thought they would need for the year. We would suggest the current cat/super-cat exposure is simply an unintended consequence of the acquisitions.

 

If a late hurricane, or even a scandal around the industry's handling of existing hurricane/storm claims, drops the current price by 10%; it's a loss of roughly $C 65. If the intent was to buy & hold for the Jan ex-dividend date, you might benefit by roughly $C 13 (after FX). Hence, if you haven't bought yet - there is an incentive to wait as long as possible in anticipation of another natural disaster.

 

Nothing to do with the company.

Simply an opportunity.

 

SD

 

 

True but the odds of another major in the rest of the year are rather small. These super cat years come along every decade or so, and in that context a Q is a very tiny part. But yeah another one will certainly be more impactful.

From the outside, there appears to be room for some dispersion of underwriting prowess from legacy units to acquired ones. Andy Barnard has some work to do!

[SharperDingaan]

The risk here is three-fold 1) as Txvestor points out the bulk of this came from the acquisitions, 2) there are more floods, they are bigger, the 'season' is getting later, & there are so many black swans today - that they have almost become the norm, & 3) it's highly likely they have already burned through almost all the cover they thought they would need for the year. We would suggest the current cat/super-cat exposure is simply an unintended consequence of the acquisitions.

 

If a late hurricane, or even a scandal around the industry's handling of existing hurricane/storm claims, drops the current price by 10%; it's a loss of roughly $C 65. If the intent was to buy & hold for the Jan ex-dividend date, you might benefit by roughly $C 13 (after FX). Hence, if you haven't bought yet - there is an incentive to wait as long as possible in anticipation of another natural disaster.

 

Nothing to do with the company.

Simply an opportunity.

 

SD

 

 

True but the odds of another major in the rest of the year are rather small. These super cat years come along every decade or so, and in that context a Q is a very tiny part. But yeah another one will certainly be more impactful.

From the outside, there appears to be room for some dispersion of underwriting prowess from legacy units to acquired ones. Andy Barnard has some work to do!

 

Agreed.

 

Right now it's more a recognition that during the remaining stub of the coverage, their UW risk is more elevated than normal. Our own thoughts are that the risk is also more likely to be on the claims side (Puerto Rico &/or Ireland?) versus another weather event.

 

SD

 

 

[Txvestor]

Sharperdingaan,

Do you have any reason to think specifically about that? Historically reserving at both Fairfax insurance subs. as well as AWH/Brit has been conservative and usually gone the other way. Why are you thinking it might be different this time? And what was the Cat. loss in Ireland you are referring to?

[DooDiligence]

Sharperdingaan,

Do you have any reason to think specifically about that? Historically reserving at both Fairfax insurance subs. as well as AWH/Brit has been conservative and usually gone the other way. Why are you thinking it might be different this time? And what was the Cat. loss in Ireland you are referring to?

 

Hurricane Ophelia

[SharperDingaan]

Sharperdingaan,

Do you have any reason to think specifically about that? Historically reserving at both Fairfax insurance subs. as well as AWH/Brit has been conservative and usually gone the other way. Why are you thinking it might be different this time? And what was the Cat. loss in Ireland you are referring to?

 

We think claim adjusters will be hard balling in the affected areas, and Puerto Rico in particular. May/may not be appropriate - but we would expect that it quickly gets ugly, the concern will be the adequacy of reserves, & that the industry will have to 'wear it'. An ebbing tide that lowers everyone's boat; arc or rowboat. 

 

Ophelia hit Ireland as a heavy storm. Have to think there was damage, & that it's making its way up the reinsurance chain

https://www.theguardian.com/world/video/2017/oct/16/storm-ophelia-makes-landfall-in-ireland-video-report

 

SD

 

[petec]

Not to piss on the party - but you might want to reconsider the cat/super-cat insurance.

 

These big losses are telling you that they have run through their reinsurance cover; the unknowns are 1) is there another band of cover above  them?, & 2) how far are they from it? Another 1-2 hurricanes/tropical storms showing up over the US mainland this quarter, could really screw up your day. 

 

SD

 

Yeah, without knowing the answer to (1) I don't think you can assume they've blown through their cover. It may only kick in above the current level of losses. And we don't know whether the cover was concentrated in any particular subsids. For example, they may not have bought cover at AWH given they've only had it a few weeks.

 

They may also have "kitchen sinked" AWH this q given it is their first q with control over the reserving. Too many unknowns to draw conclusions sadly.

[gary17]

How do we know AWH has really been underwriting well, and not just getting lucky the past decade -- ?

When I initially looked at AWH, I was also looking at Tower and AmTrust - this was like 7 or 8 years ago -- they all had a nice run, but then Tower and AmTrust are both doing very poorly now (Tower went out of business I believe).  If FFH bought a lemon with AWH.... what would happen to FFH's business?

[bsilly]

If you look up AWH quarterly statements you will find estimates for probable maximum loss due to hurricane. The estimate for 1:100 year PML for a given year in the latest report was $392 million, which compares to $386 million of actual hurricane losses this year, just under 10% of total capital. Now I haven't crunched the numbers, but this has to be something close to a 1:100 hurricane loss year.

[petec]

How do we know AWH has really been underwriting well, and not just getting lucky the past decade -- ?

 

 

How do we know any insurer (or investor for that matter) has skill not luck? We don't. What we can say is that results are (or are not) more or less as expected given the strategy. Everyone knows an insurer of this sort will suffer major losses occasionally. That's not cause to question skill.

 

If those losses persist, it will be.

[gary17]

Thanks for your responses.  I guess what I am wondering is if at the time of considering the acquisition , Prem’s team did more due diligence — are they relying on financial disclosures from AWH or did they go a step further to see if things are as wonderful as they seem to be.  Thanks

[bsilly]

I should add that the number is just an educated guess at this point. My point is that there shouldn't be anything particularly surprising. The surprise will come later when the actual claims get settled. There will be an adjustment & we'll find out how good the reserving was. In AWH case, they have a solid history of favourable reserve development. The caveat is they started the business in the hard market, so the future may not be as bright as the past.

[bsilly]

Adding to that - I don't think there is a better way to judge the company other than track record - which is good, and the CEO has been the same since 2004. The edge that Fairfax would have as an industry insider is to have seen their behaviour in the market place & have some knowledge of the management team. Ulimately I think there is a lot of faith involved.

[maxthetrade]

I should add that the number is just an educated guess at this point. My point is that there shouldn't be anything particularly surprising. The surprise will come later when the actual claims get settled. There will be an adjustment & we'll find out how good the reserving was. In AWH case, they have a solid history of favourable reserve development. The caveat is they started the business in the hard market, so the future may not be as bright as the past.

 

Not only did they start the business in a hard market but the last 10 years had extremely low hurricane activity, the solid UW results may very well be a mirage. Here is a chart that shows just how exceptional the last 10 years really were:

http://s2.q4cdn.com/121571286/files/doc_financials/2017/q3/2017-Third-Quarter-Letter-to-Shareholders.pdf

 

[bsilly]

Yep - good discussion in the Alleghany Q3. The report they referenced is a good read on hurricane stats.

 

Anyway - on other subject Fairfax really blew the timing selling OSTK back in Q1. Whoops.