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Holly LaFon
Holly LaFon
Articles (9009)  | Author's Website |

Prem Watsa's Fairfax Financial 2017 Shareholder Letter

Investor shares his thoughts on the year

March 13, 2018 | About:

To Our Shareholders,

We had a record year in 2017 in spite of a spate of hurricanes and other catastrophes that cost us $1.3 billion(1). We earned a record $1.7 billion in 2017, our book value per share increased 24.7% (adjusted for the $10 per share dividend paid) to $450 per share and we ended the year with a record $2.4 billion in cash and marketable securities in the holding company. Since we began in 1985, our book value per share has compounded at 19.5% annually while our common stock price has compounded at 18.1% annually. Our company is in great shape.

Here’s how our insurance companies performed in 2017:

The second half of 2017 reminded us yet again that ours is a risk business. During the third quarter of 2017, the insurance industry experienced some of the largest catastrophe losses in its history as a result of Hurricanes Harvey, Irma and Maria and earthquakes in Mexico. During the fourth quarter, the industry suffered losses from the California wildfires, resulting in total catastrophe losses of about $130 billion for the industry in 2017 – close to the largest losses the industry has suffered in its history. Catastrophe losses cost us 13.7% of net premiums earned in 2017 versus 4.6% in 2016. Over the past ten years, catastrophe losses have cost us 7.7% of net premiums earned. The table below shows you our 2017 losses from the major catastrophes (we acquired Allied World only in July 2017):

As you can see, catastrophe losses for Fairfax amounted to $1.3 billion or 13.7% of net premiums earned; Allied World’s losses as a percentage of net premiums earned were magnified as the losses were on only six months of premiums: for the year, Allied World’s catastrophe losses were 25.1% of net premiums earned – higher than our own experience. We do not expect this to be the case in the future. Our combined ratio for Fairfax, including Allied World, was 106.6%, of which catastrophe losses accounted for 13.7%. Excluding Allied World, our catastrophe losses were

9.1% of net premiums earned – within the range you would expect in a very severe catastrophe year like 2017. Our combined ratio excluding Allied World was 100.6%.

With the exception of Brit, which demonstrated a combined ratio under 100% excluding catastrophe losses, all of our pre-existing major insurance subsidiaries continued to achieve a combined ratio under 100%, with Zenith and Fairfax Asia at 85.6% and 88.4% respectively. But special mention must be made of OdysseyRe, whose business is significantly subject to catastrophe risk.

OdysseyRe had an outstanding year in 2017, with a combined ratio of 97.4% in spite of the catastrophes, and premiums growing by 17%. This was the first time in OdysseyRe’s history that its combined ratio was less than 100% in a year of major catastrophe losses. A big round of applause for Brian Young and his team. It helped that Brian had Hudson Insurance, which we began essentially from scratch in 2002 and which is run by Chris Gallagher, with $1 billion in premium in 2017 at a combined ratio of 92%!

We have always told you that our results will be lumpy, and this was demonstrated in spades by our two large capital gains in 2017:

  1. from the reduction in our ownership of ICICI Lombard from 35% to 9.9%; and
  1. from our strategic alliance with Mitsui Sumitomo Insurance Company and our sale of First Capital to them. Why did we make these two sales?

ICICI Lombard is an Indian insurance company that we began in 2001 from scratch as a minority partner with ICICI Bank. Over the following 16 years, ICICI Lombard went on to become the largest non-government-owned property and casualty insurance company in India. Until fairly recently, our ownership interest was limited to 26% by government mandate. About three years ago, the government allowed the foreign ownership to go to 49%, which resulted in our going to 35% by buying 9% from ICICI Bank. Since then, given ICICI Lombard’s intent to go public, ICICI Bank wanting to control ICICI Lombard with at least 55% ownership, and Indian law requiring that the public own at least 25% of a public company, our ownership would be reduced to a mere 20%. As property and casualty insurance is our core business and we are very optimistic about the growth prospects in India, and as Indian law does not permit an ownership of 10% or more in more than one insurance company, we agreed with ICICI Bank that we would reduce our interest in ICICI Lombard to below 10% so that we could start our own property and casualty company in India, Digit. ICICI Lombard is a great company led by an exceptional leader, Bhargav Dasgupta, and we wish them much success in the years to come. We have thoroughly enjoyed our partnership with ICICI Bank and its CEO Chanda Kochhar and we wish them also much success in the future.

The reduction in our equity interest in ICICI Lombard from 35% to 9.9% resulted in cash proceeds of $909 million plus our continuing to own 45 million shares of ICICI Lombard worth $450 million at the IPO (now worth about $550 million) resulting in an after-tax gain of $930 million.

For the past two years, Mr. Athappan has come to me saying that he had taken First Capital as far as he could in the commercial property and casualty business in Singapore and that he needed a partner like Mitsui with a brand name to build the personal lines business. I refused him twice as I really did not want to sell First Capital. His continued persistence, his position as the founder of the company, and the fact that he would continue to run Fairfax Asia and First Capital and we would have a 25% quota share in the business of First Capital going forward persuaded us, with unanimous support from our officers and directors, to form a global alliance with Mitsui Sumitomo Insurance Company and sell First Capital to them. We worked very closely with Matsumoto san, the Senior Executive Officer of International Business of Mitsui Sumitomo, and his team, and the partnership is going very well. Through our cooperation agreement with Mitsui Sumitomo, we have been working together on a number of fronts including opportunities on reinsurance, shared business and products and innovation to name a few. We are very excited to be a partner with Mitsui Sumitomo. Total proceeds from the sale of First Capital were $1.7 billion, resulting in an after-tax gain of $1.0 billion. I do want to emphasize that we agreed to this global alliance and sale only because of its truly unique circumstances and we do not see this being repeated! Our companies are not for sale, period!

By the way, Mr. Athappan has had an incredible record with us in building First Capital. We provided $35 million in 2002 to let him establish First Capital; 15 years later, with no additional capital having been added, he had grown First Capital to be the largest P&C company in Singapore and with the Mitsui Sumitomo deal, gave us back $1.7 billion. That’s a compound rate of return of approximately 30% annually. A fantastic track record by Mr. Athappan!

While catastrophes in 2017 led to huge losses for us and the P&C industry, the following table shows the record of OdysseyRe’s property book from 2000 to 2017 on an underwriting year basis (on this basis, losses are attributed to the year when the insurance contract generating those losses was entered into, which may be the year prior to the year when the loss was incurred):

In spite of September 11 in 2001, hurricanes in 2005, the Tokyo earthquake, Thai floods and New Zealand earthquakes in 2011, Super Storm Sandy in 2012 and the catastrophes of 2017, the cumulative combined ratio of OdysseyRe’s property business over the last 18 years on an underwriting year basis was 85%. Catastrophes are the foremost risk that a P&C company faces and we take great care to monitor our exposures carefully.

As I mentioned in the section on ICICI Lombard earlier, we are very excited to welcome Kamesh Goyal and his more than 240 employees at Digit to Fairfax. Kamesh built Bajaj Allianz from scratch to be the second largest non-government-owned P&C company in India and then spent a total of 17 years at Allianz, the last five years in Munich operating at the highest levels. He is building a digital property and casualty insurance company in India, which was created in December 2016 and has begun actively selling policies. We are very excited about the prospects of Digit.

We closed our acquisition of Allied World on July 6, 2017 and we welcomed Scott Carmilani and Allied World’s 1,430 employees to the Fairfax family. As you know, Allied World is the largest acquisition that we have done and we pursued this acquisition because of Allied World’s outstanding track record over its 15 years of existence and the quality of its management team. We are very thankful to our financing partners OMERS ($1 billion), AIMCO ($0.5 billion) and two others. We issued a total of 5.1 million shares for Allied World. The effect of this acquisition is shown in the table below, which was previously presented to you at our 2017 annual shareholders’ meeting:

Continue reading the letter here.

About the author:

Holly LaFon
I'm a financial journalist with a master of science in journalism from Medill at Northwestern University.

Visit Holly LaFon's Website

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