Prem Watsa: Big Disconnect Between Markets, Fundamentals

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Prem Watsa’s Fairfax Financial Holdings Ltd (TSE:FFH) reported earnings earlier today. The earnings for the Canadian insurer beat estimates of analysts. Prem Watsa has been able to steer the company forward even as he remains deeply concerned about the global economy. On the conference call for Fairfax Financial today, Prem Watsa had some insightful (and scary) comments about the global economy. Below are some select highlights from Watsa from the call itself as well as the Q&A segment.

Prem Watsa of Fairfax Financial Holdings Ltd (TSE:FFH)

First quarter of 2013 book value per share increased by 1.3% adjusted for the $10 per share, dividend paid in the first quarter of 2013. We had a strong underwriting results in the first quarter of 2013 on increased premiums while maintaining disciplined underwriting.

We are maintaining our defensive equity hedges as we remain concerned about the financial markets and the economic outlook. We continue to be soundly financed with quarter and cash and marketable securities as the holding company in excess of $1.2 billion. Net premiums written by the Company’ s insurance and reinsurance operations in the first quarter 2013 increased by 5.5% to 1.606 bilge $1.6 billion property business continued year-over-year rate increase that zenith modest growth and increased premium retention at Northbridge and modest growth at Fairfax Asia.

Prem Watsa on Fairfax Financial Holdings Ltd (TSE:FFH) Subsidiaries

At the subsidiary level net premiums written in quarter 12013 and combined ratios were as follows. OdysseyRe up 13.6% with a combined ratio of 82.9% foster premiums down 5.6% with a combined ratio a little below 100%, 99.7% Northbridge, premiums were up 6.5% with a combined ratio of 100.5%. Zenith, premiums were up 11.9% with the combined ratio of 110.2% and Fairfax Asia, premiums were up 4.5% with a combined ratio of 91%.

Just a quick comment on zenith, it’s combined ratio is still 110.2%. Over 30 years before our purchase, so prior to our purchase, 30 years of history, Zenith had a combined ratio on average of 95%. And it’s loss ratio over that 30 years was 15 to 20 points better than industry. And so it’s a terrific track record. Since our purchase because the business has been shrunk has come down significantly, the combined ratios have been running at 125% to 130% come down to 110% and we think Zenith is well on its way.

Prem Watsa: No place to hide for industry

So in the first quarter we continued to grow, very low interest rates and the reduced reserve redundancies means there is no place to hide for the industry. As I’ve said before. Combined ratios have to drop well below 100% for the industry to make a single digit return on equity with these low interest rates. While the short term is always tough to predict, fundamentals will eventually play out.

Prem Watsa on investments

Net investment gains of $9.4 million in the first quarter of 2013 consisted of the following.

You’ll see in that table net gains on equity and equity related investments of $698 million were predominately unrealized and when neutralized by net unrealized losses of $593 million on our equity hedges. After unrealized bond losses of $119 million and $32 million in unrealized CPI linked derivative losses resulting in a net gain of $9.4 million. All unrealized.

Prem Watsa on realized gains

Realized gains from stocks and bonds during the quarter were $165.3 million.

The Company held in excess of $1.2 billion of cash, short-term investments and marketable securities at the holding company level at March 31, 2013. Finally we continue to be approximately 100% hedged in relation to our equity and equity related securities which includes convertible bonds and convertible preferred stock.

Prem Watsa on macro

We continue to be very concerned about the prospects for the financial markets and the economies of North America and Western Europe. Accentuated by potential weakness in China. There continues to be a big disconnect between the financial markets and the underlying economic fundamentals. As of March 31, 2013, we have over 27% or $7 billion in cash and short-term investments in our portfolios to take advantage of opportunities that come our way. In the short-term, our investment in income will we be reduced.

Prem Watsa on Q&A

Prem Watsa’, you’ve mentioned that the insurance industry may have no place to hide going forward here.

We’re starting to see some data that commercial line’s pricing is in pruning improving some of the board and I’m just wondering on a near-term basis here what you believe is the outlook for this year and into next year for a more definitive hardening in the commercial market? South of the border?

Prem Watsa


So just to explain that comment, interest rates today five-year treasury rates are 0.65% like less than 70 basis points, Jeff.

Versus about 5% five or six years ago. The hard market reserves depending on how you define it 2003 to 2006 or 2003 to 2008 is between 10% and 20% of total reserves that exist on property-casualty insurance companies balance sheet today so there’s the ability to have the redundancies as reduced significantly.

And so when you take those two into account and you look at the interplay of those two factors, even at a 95% combined ratio, you get a single digit return on equity. And so it just means that prices have to continue to go up. They’re going depending on the line, 5% maybe a little higher and workers compensation is higher, 10% plus. California’s a little higher than that.

But we think the underlying fundamentals are attractive but when you have a hard market, you have prices going up much more than that. We’re not in that type of hard market. We’re in a market that prices appear to be going up. Now, some prices may come down.

Property tax prices have gone up significantly after 2011. The Japanese tsunami and the other catastrophes, second largest cat year in 2011, well, they’re tending to flatten out and come down, so you have these fluctuations but broadly speaking the property-casualty industry that we operate in the pricing is improving and our business is improving. We’ve been growing now for a couple of years and the first quarter we grew about 5%. In total for all our companies.


And maybe, Prem contrast that with candidate seems like Canada’s taking longer to start to get any momentum behind it and you’ve been doing a lot of work at Northbridge how do you feel in the process of that effort in Northbridge where it stands today and how the Company there is positioned to move forward?

Prem Watsa

Northbridge for us — we’ve been in Canada we started in Canada we had 27 years.

Our Company is in very good shape. All our companies by the way have really good reserving which is very important. If you didn’t, you’re going to see companies show reserve development. So Northbridge came out with a combined ratio a little above 100% and we’re comfortable with where the Company is, focused on getting it below 100 under Sylvia Wright’s leadership but Canada’s always light, Jeff, the West. The US goes down a lot more than us and then comes back up also significantly. We don’t go down as much and we like the United States.

I must also say — we said this at the annual meeting — that our new structure with Andy Bernard responsible for our insurance companies property-casualty insurance companies worldwide is also a big plus in terms of the focus on underwriting p rofitability. We’ve also always had a focus on underwriting profitability. It’s accentuated by the fact that Andy’s responsible for these companies all over the world.

So yes, Jeff, we’re very positive positive about what’s happening at Northbridge.

Just one question for you, Prem Watsa’.

You’ve talked about reserve releases for the industry and it looks like probably that they’re running out on redundancies. And we’ve seen them pretty high favorable reserve development as out of Fairfax Financial Holdings Ltd (TSE:FFH) for the last four consecutive quarters now. Is there much more room for Fairfax to be able to release reserves, or is that pretty much played out as well?

Prem Watsa

Well, this is a good question, Jeff.

What we try to do is we always keep our accident loss ratios combined ratios which we’ve shown you buy company at a high level and with the idea that over time, we might have some redundancies.

But it’s fair to say that for the industry and ourselves, that the surpluss of the hard market are much reduced so it’s hard to say. We just have a very strong reserving policy at Fairfax Financial Holdings Ltd (TSE:FFH) that over time as I’ve showed you in our annual report, we need to see redundancies as opposed to efficiencies in hard markets and soft markets, so that is the policy we’ve got, but your point’s well taken, those will be more difficult for us to show as time goes by. But our policy’s very much in place.

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