The late 90’s was a period awash in rich valuations for the stock market, but it was also a period of “soft pricing” in the reinsurance market. As the name implies the softness relates to a diminished pricing in premiums as insurers jump over each other for business. Watsa’s Fairfax Financial had purchased two struggling businesses in 1997 that would later falter. One of the companies, Crum and Foster, suffered huge losses on claims after the 9/11 attacks. Its combined ratio shot up to 131%, pulling the combined ratio for Fairfax up to 121%.
Conditions eventually improved and the combined ratios dropped for both Crum and Fairfax. But later in 2002 a report was released showing Fairfax did not adequately cover its reserves (which cover future insurance claims). The reserve shortfall was estimated by some short sellers around the order of $3 billion. Fitch would later downgrade Fairfax bonds to junk status and Fairfax would retaliate by barring Fitch from analyst briefings. Another red flag pointed to the asset “recoverable from reinsurers” which ranked 2 in size on Fairfax’s balance sheet. The recoverables were 28% of all assets and this figure was much higher than the industry average.
Fairfax was shorted by one of the most well known short sellers in Jim Chanos and he was quoted as saying “We think this [Fairfax] is a zero.” In 2003 just over 11% of the outstanding Fairfax stock on the NYSE was being shorted. Fast forward to 2005 and Hurricanes Katrina and Rita both drop a bomb on reinsurance balance sheets. Fairfax survived the claims, but took a $220 million loss in the 3rd quarter and was forced to issue new shares at below book value.
Watsa has since transcended these troubles as Standard & Poors in 2009 upgraded Fairfax’s Crum & Forster insurance units to A- from BBB+. That same year Watsa also made the decision to delist Fairfax from the NYSE. His claim was that the markets were sufficiently liquid and their shareholders and employees would not require the additional listing. That may be so, but not being under the microscope also offers its own benefits.
Disclosure: No Holding In Fairfax