Fairfax Financial Holdings Limited (PNK:FRFHF) Q3 2023 Earnings Call Transcript November 3, 2023
Operator: Good morning, and welcome to Fairfax’s 2023 Third Quarter Results Conference Call. Your lines have been placed in a listen-only mode. After the presentation, we will conduct a question-and-answer session. [Operator Instructions] Today’s conference is being recorded. [Operator Instructions] Your host for today’s call is Prem Watsa; with opening remarks from Mr. Derek Bulas. And Mr. Bulas, please begin.
Derek Bulas: Good morning and welcome to our call to discuss Fairfax’s 2023 third quarter results. This call may include forward-looking statements. Actual results may differ perhaps materially from those contained in such forward-looking statements as a result of a variety of uncertainties and risk factors, the most foreseeable of which are set out under Risk Factors in our Base Shelf Prospectus, which has been filed with Canadian Securities Regulators and is available on SEDAR. Fairfax disclaims any intention or obligation to update or revise any forward-looking statements except as required by applicable securities law. I’ll now turn the call over to our Chairman and CEO, Prem Watsa.
Prem Watsa: Hey, thank you, Derek. Good morning, ladies and gentlemen. Welcome to Fairfax’s 2023 third quarter conference call. I plan to give you a couple of highlights, and then pass the call on to Peter Clarke, our President and Chief Operating Officer, to comment on the quarter, and Jen Allen, our Chief Financial Officer, to provide some additional financial details. As I’ve said for the last number of quarters, the most important point I can make for you is to repeat what I have said in the past. For the first time in our 37-year history, almost 38 years now, I can say to you we expect, of course no guarantees, our operating income to be more than $3 billion annually for the next three years. Operating income consisting of $1.5 billion-plus from interest and dividend income we earned $1.4 billion year-to-date, $1 billion from underwriting profit, we made $943 million year-to-date, and $500 million from associates and management companies versus $1 billion year-to-date.
This works out to be over $100 per share after interest expenses overhead and taxes. We continue to exceed our expectations for the year with the year-to-date operating income already at $3.1 billion, excluding the effects of discounting and risk margin. Fluctuations in stock and bond prices will be on top of that. And this only really matters, as I’ve said many times, over the long-term. Recently, in October, during spike in treasury yields, we have extended our duration to 3.1 years with an average maturity of approximately 4 years, and yield of 4.9%. In the next four years, we are likely to have a recession in the United States, resulting in corporate spreads widening, allowing us to extend our maturities further. Our fixed income portfolio remains conservatively positioned, with approximately 70% in government securities and 19% primarily in short-dated high-quality corporate bonds.
Insurance and reinsurance operations continue to perform exceptionally well, with gross premiums written for the nine months of $22 billion, up 7.5%, a combined ratio of 94% resulting in an underwriting profit of $943 million for the first nine months. I will now pass the call to Peter Clarke, our President and Chief Operating Officer, for further updates. Peter?
Peter Clarke: Thank you, Prem. We had an outstanding third quarter of 2023, with net earnings of almost $1.1 billion, and our book value increased to $877 per share, an increase of 16.4% from year-end, that’s adjusted for our $10 dividend, and earnings per share in the quarter was $42. The strong performance in the quarter was driven by adjusted operating income of $967 million from our insurance and reinsurance operations generating through underwriting income of $292 million, interest and dividend income of $454 million, and our share of profit of associates of $222 million. Our investment return for the quarter was 1.5% driven by continuing increased interest and dividend income, strong share of profits with associates, while net gains in the quarter were relatively flat.
Consolidated interest and dividend income of $513 million doubled from the third quarter of 2022, benefiting from a very low duration of our fixed income portfolio coming into 2022, and then reinvesting at higher rates, primarily in government bonds. Net gains on investments, of $56 million, were driven by gains on our equity exposures of $273 million, offset by losses on our bond portfolio of $197 million in the third quarter. These losses consisted primarily of losses from U.S. treasures due to increased interest rates in the quarter. Our fixed income duration at the end of the quarter continued to be relatively short at 2.3 years. And as Prem mentioned earlier, in the fourth quarter, we have increased our duration to over three years. Net gains on our equity and equity-related holdings were $273 million in the quarter, driven by unrealized mark-to-market gains on our Fairfax TRS, Commercial International Bank, and [John Keels] (ph), offset by unrealized losses on BlackBerry and Kennedy Wilson.
As mentioned in previous quarters, our book value per share of $877 does not include unrealized gains or losses in our equity-accounted investments and our consolidated investments which are not mark-to-market. At the end of the third quarter, the fair value of these securities is in excess of carrying value by $601 million, and unrealized gain position or approximately $26 per share on a pre-tax basis. Under IFRS 17, our net earnings are affected by the discounting of our insurance liabilities and the application of a risk adjustment. In the third quarter of 2023, our net earnings benefited by $459 million pre-tax from the effects of discounting losses occurring in the current quarter, changes in the risk margin, the unwinding of the discount from previous years, and changes in the discount rate on prior-year insurance liabilities.
As the interest rates move up and down, we will see positive or negative effects on earnings from discounting. Our insurance and reinsurance businesses continue to grow less than previous quarters, although we still see positive momentum as we wrote $7.2 billion of gross premium in the third quarter of 2023. Our gross premiums were up 5% this quarter versus the third quarter of 2022, an increase of $350 million. The growth is driven by continued rate and strong margins that prevail in many of our markets, driven by increased pricing in our reinsurance business and international markets. Our North American Insurance segment increased gross premiums by $196 million or 9.7%. Crum & Forster had double-digit growth at 13% driven by its surplus and specialty lines, accident and health business, and Seneca Insurance.
Northbridge was up almost 10% in Canadian dollars, reflecting excellent customer retention and rate increases. And the premiums were offset by Zenith premiums that were down 5% year-over-year driven by the competitive workers’ compensation market. Our Global Insurer and Reinsurer segment was relatively flat with gross premiums increasing $65 million, up 1.6% in the third quarter versus the third quarter of 2022. Allied World was up 6.5% in the quarter, led by its reinsurance segment which had double-digit growth, while its insurance segment was flat. Odyssey Group was up approximately half a point, with reinsurance up over 10% primarily in North American property, while its insurance business was down 12% principally from Hudson Insurance in its financial and [crop lines] (ph) of business.
Brit’s premium was down 4% largely due to reductions in its casualty and FinPro business, while Ki premium was down a similar amount. The premium of our international operations again posted double-digit growth at 11.2% in the third quarter versus the third quarter of 2022, with gross premium up $848 million. Growth was exceptional strong at Polish Re, Colonade, and Eurolife’s non-life operations, while Fairfax Asia was down on a gross basis due to timing differences, while maintaining strong growth in net premiums written. On closing of our acquisition of an additional 46% of Gulf Insurance, which we expect to occur in the fourth quarter of 2023, we will begin consolidating their results, adding an approximate $2.7 billion in gross premium annually to our international business.
The long-term prospects of our international operations are excellent, and will be a significant source of growth over time, driven by excellent management teams, underpenetrated insurance markets, and strong local economies. Our companies continue to grow into favorable market conditions while we see rate increases moderating or rates reducing in some lines, public D&O, workers’ compensation, and cyber, for example, overall margins remain attractive. The reinsurance market continues to harden, especially for property business, and we expect that will continue into 2024. Our combined ratio was 95% in the third quarter of 2023, producing an underwriting profit of $292 million. The combined ratio included catastrophe losses of $389 million, adding 6.7 combined ratio points primarily from the Hawaii fires, Hurricane Idalia, and attritional catastrophe losses.
This compares to a combined ratio of 100.3% and catastrophe losses of 15 points in the third quarter of 2022. As our premium base has expanded significantly and with the benefits of diversification, we expect to be able to absorb significant catastrophe losses within our underlying underwriting process. Our global insurers and reinsurers posted a combined ratio of 92.7%, led by Allied World who had another great quarter with a combined ratio of 89.3%, with its global insurance segment producing an 88.3% combined ratio, while its reinsurance segment was at 91.4%. Odyssey Group had a solid combined ratio of 94.7%, while Brit produced another strong quarter with a combined ratio of 94%. Our North American insurers had a combined ratio of 98.3%, led by Northbridge who had another strong quarter with a combined ratio of 88.7%.
Crum & Forster had a combined ratio of 105% for the quarter, which included catastrophe losses of 9.4 points, principally from losses from the fires in Hawaii. Crum & Forster has had a strong presence in Hawaii and have been in the market for many years. Zenith had a combined ratio of 92.8, producing an underwriting profit in the quarter while benefiting from favorable reserve development. Our international operations delivered a combined ratio for the quarter of 98.5 with all but one segment producing an underwriting profit. Fairfax Asia had a combined ratio of 93.7. And, our Latin American operations came in at 94.2. Eurolife, non-life operations had a difficult quarter as they were hit hard by catastrophe losses which amounted to $18 million from the wild fires in Greece and Strom Daniel.
Excluding catastrophe losses, our international operations posted a combined ratio of 93.7. For the quarter, our insurance and reinsurance companies recorded favorable reserve development of %56 million, or a benefit of 1 point on our combined ratio. This is compared to $48 million or the benefit of 0.9 points in 2022. Our companies are in the process of doing their extensive annual actuarial reviews which will be reflected in the fourth quarter. Our underwriting expense ratio was up approximately 1.2 combined ratio points in the third quarter of 2023 versus the third quarter of 2022. Partially, due to the affect of inflation on salaries and investments in people and technology, and the timing differences at Brit, offset by increased earned premiums.
Through the first nine months of the year, our underwriting income is approaching $1 billion while continuing to grow profitably. We are led by exceptional management team. And, our companies are positioned very well to capitalize on their opportunities in the respective markets. I’ll now pass the call to Jen Allen, our Chief Financial Officer to comment on our non-insurance company’s performance, overall financial position, and recent transactions.
A close-up of a family receiving life insurance coverage documents.
Jen Allen: Thank you, Peter. As we disclosed in our first quarter 2023 interim report on January 1, 2023, the company adopted the new accounting standard for insurance contracts IFRS 17. Within our Q3, 2023 interim report, please refer to note 3 in sections within the MD&A under the heading, Adoption of IFRS 17 Insurance Contract on January 1, 2023 and the heading Accounting and Disclosure Matters for details on the adoption and the impact on our consolidated financial statement for this new standard. Consistent with our Q1 and Q2 2023 interim reports, the comparative periods in the company’s Q3 2023 interim report have all been restated and presented under the IFRS 17 measurement standard. So, all the comparatives now presented in our Q3 interim report are on the same measurement basis.
In our Q3, 2023 press release, please refer to page 2 and in the MD&A, page 43 where we disclosed tables that reconcile the insurance service result under IFRS 17 for our property and casualty insurance and reinsurance operations to underwriting profit. The key performance measure that the company uses in the property and casualty insurance industry uses in which we operate to evaluate and manage the business. As a reminder, the primary reconciling adjustments presented in these tables are first, we adjust to include other insurance operating expenses which are presented in the consolidated statement of earnings outside of the insurance service results. And second, we adjust for the effects of discounting on net loss on claims and changes in the risk adjustment that are included within the insurance service result in the consolidated statement of earnings.
Our traditional performance measures of underwriting profit and combined ratios were on an undiscounted basis as discussed by Peter. So, I’ll begin my comments for the third quarter of ‘23 on the impact of IFRS 17 within our results. In the third quarter of 2023, net earnings of just under the $1.1 billion and for the nine months just under $3.1 billion included a pre-tax net benefit of $459 million and $991 million respectively, related to IFRS 17. These pre-tax benefits are reported within two financial statement lines in our consolidated statement of earnings. First included within our insurance service result line was the benefit of discounting losses and seeded loss on claims net of changes in risk adjustment that were recorded in the third quarter of 2023 of $467 million and $1.6 billion in the first nine months.
This was partially offset by the second component that we present on a separate line in our financial statements in the net finance expense from insurance and reinsurance contracts of $8 million in the quarter and $595 million in the first nine months. This was comprised of interest accretion or an expense of $369 million in the quarter and approximately $1 billion in the first nine months, resulting from the unwinding of the effects from discounting associated with net claim payments made during the period. And that was partially offset by the effective increase in discount rates during the third quarter and first nine months of ’23, which was a benefit of $362 million and $452 million respectively. This compared to a pre-tax net benefit in the third quarter of 2022 of $772 million and approximately $2.5 billion in the first nine months of 2022, which was comprised of the same components I just commented on for 2023, which was namely the insurance service result benefiting from discounting on loss and seeded loss on claims net of our risk adjustment of $349 million for the quarter ’22 and $916 million for the nine months of 2022.
But unlike 2023, ’22 also benefited from net finance income versus the expense in ’23 of $423 million and just under $1.6 billion for the first nine months. In ’22, it reflected a benefit from the increase in the discount rates in the respective periods of $563 million and approximately $1.8 billion as a result of the interest rate environment being more pronounced in 2022 compared to ’23. And this was offset by the interest accretion or the expense of $140 million and $232 million in the first nine months of 2022 related to the unwinding of those discounts associated with net claim payments made in the period. A final comment on the rising interest rate environment that continued in the first nine months of 2023 and how it impacted our results.
The company’s asset and liability duration is not matched and as a result, earnings before income taxes included a net benefit of $165 million in the third quarter and $169 million in the nine months of 2023 that reflected the longer duration in our net insurance contract liabilities compared to the fixed income portfolio assets. In this rising interest rate environment, as I noted previously, the company reported net finance income from insurance contracts held as a net benefit of $362 million in the third quarter and $452 million in the first nine months of 2023 that related to the effect of the increase in the discount rates on the net insurance contract liabilities that have an average duration of approximately 4 years. This exceeded the net loss on the bonds of $197 million in the third quarter of 2023 and $283 million in the first nine months of 2023 recorded on our shorter duration fixed income portfolio.
Please refer to note four in our Q3 2023 interim report for additional details on the discount rates applied on the losses and ceded loss on claims recorded within the period. Moving on to a few comments on our non-insurance company’s results in the quarter, the operating income of our non-insurance companies in the third quarter of 2023 were comparable to 2022 with strong results of $126 million, excluding the impact of Fairfax India’s performance fees to Fairfax, which was an accrual of $20 million and $5 million in the third quarters of 2023 and 2022 respectively, which are offset upon consolidation. The operating income for the non-insurance companies reporting segment increased to $146 million in the third quarter of ’23 from $130 million in the prior period, principally reflecting higher business volumes and continued stable results produced by our restaurant and retail operating segment.
The operating income of the non-insurance companies reporting segment marginally increased to $162 million in the nine months of ’23 from $160 million in the nine months of ’22. If you exclude the impact of Fairfax India’s performance fees to Fairfax, which was an accrual of $42 million in the first nine months of 2023, and a reversal of a performance fee payable of $45 million in the first nine months of ’22, the operating income increased to $204 million in the first nine months of $23 from $115 million in the first nine months of ’22. With that increase of $89 million reflecting lower losses from our other reporting segment of $60 million, that reflected a non-cash impairment charge related to the company’s investment in Farmers Edge that was recorded in the first nine months of 2022, which was partially offset by higher business volume at AGT.
We also saw higher operating income at Fairfax India of $25 million primarily due to the increase in share profit of associates, and higher operating income at Thomas Cook of $22 million reflecting higher business volumes in all segments, resulting from increased domestic and international travel, as the hospitality industry has continued to show significant recovery in 2023. Turning to our share of profit from investment in associates, in our third quarter, investments in associates modestly decreased in the third quarter of 2023, with share of profits of associates of $292 million compared to $318 million in ’22, reflecting no share of profit from resolute, reduced share of profits from EXCO, partially offset by increased share of profit from Eurobank at $119 million compared to $80 million in the prior year, and Stelco at $21 million compared to no share of profit in the prior year due to the commencement of equity method of accounting in Q3 2022.
Our share of profit from investments in associates increased in the nine months of ’23 to $895 million compared to $764 million in 2022, reflecting increased share of profits at Eurobank about $344 million compared to $230 million in the prior year. EXCO Resources $130 million compared to $43 million, which was partially offset by no share of profit from resolute as a result of our disposition of that investment. And also reduce share of profits of Poseidon, formerly known as Atlas of $102 million compared to $180 million in the prior period, reflecting higher interest rate expenses in transaction costs that related to the first quarter 2023 privatization of Poseidon. And the company expects Poseidon’s earnings will start to normalize and continue to increase throughout the year.
As there are no significant acquisitions or divestitures that close during the third quarter, I’ll close with a few comments on our financial condition. The liquidity position of the company remains strong with our cash and investments at the holding company at $1.2 billion at September 30, 2023 which was principally held in cash and short-dated investments and access to our fully undrawn $2 billion unsecured revolving credit facility. At September 30, 2023, the excess of fair value over carrying value of investments in non-insurance associates and market-traded consolidated non-insurance subsidiaries was $601 million compared to $310 million at December 31, 2022. That pre-tax excess of $601 million is not reflected in the book value per share, but is regularly reviewed by management as an indicator of investment performance.
Please refer to the MD&A on page 67 for additional details. The holding company has no significant holding company debt maturities until August 2024 and our total debt to total cap ratio, excluding the non-insurance companies, improved to 21.6% at September 30, 2023, compared to 23.7% at December 31, 2022 principally as a result of very strong net earnings reported in the first nine months of 2023 of just under the $3.1 billion that reflected the underwriting profit of $943 million, interest in dividends of just under $1.4 billion, and the share profit of associates of $895 million. And lastly, our common shareholders’ equity increased by $2.5 billion to $20.3 billion at September 30, 2023 up from the $17.8 billion at December 31, 2022. And that was principally as a result of our net earnings in the first nine months of ’23 of the $3.1 billion that was partially offset by payments on our common and preferred share dividends of $282 million.
And we purchased approximately 258,000 subordinate voting shares for cancellation for cash consideration of $180 million, approximately $698 per share, with 78,000 purchased in the third quarter of 2023 for cash consideration of $65 million. That concludes my remarks for the third quarter of 2023. And I’ll pass the call back over to Prem. Thank you.
Prem Watsa: Thank you, Jen. We now look forward to answering your questions. Please give us your name and your company name, and try to limit your question to only one so that it’s fair to all on the call. Okay, [Fran] (ph) we’re ready for the questions.
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Q&A Session
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Operator: Thank you so much for those instructions, sir. So, our first question now is from Tom MacKinnon with BMO Capital. Sir, your line is open.
Tom MacKinnon: Yes, thanks very much. Good morning. Just a question here about the top line growth or the gross premium growth, you talk about some pretty good growth in your North American insurance operations, but then we get into reinsurance, well, you’re getting good top line growth in their reinsurance business, per say, in that category. The growth in their insurance business, i.e., at Allied World and at Odyssey [Re] (ph) and at Brit, for that matter, are declining. So, why is it that you’re able to get some growth in your North American insurance business, but then if we look at your reinsurance companies, what’s categorized as insurance in those is not growing. So, may be a little — if you can help us understand that and what you see as growth going forward?
Prem Watsa: Tom, that’s a good question. The reinsurance markets continue to be hard, but, Peter, why don’t you give Tom a sense for what’s happening in the market?
Peter Clarke: Yes, sure. Yes, so in the quarter, our premium was up above 5%, Tom, and about 7.5% for the first nine months. And just to remind everyone, that that’s on the back of three very strong years where we averaged about 16% per year. But as you mentioned, for Odyssey, Allied, and Brit, on the insurance side, their premium relatively flat for the year and in the quarter, but those are the lines of business where they grew significantly the last number of years, specifically cyber, D&O, et cetera. And so in the insurance segment, we have the Crum & Forster and Northbridge. So, Northbridge is Canadian, so that’s a little different than what Allied and Odyssey is writing on the direct book. And Crum & Forster is really more specialty business.
And there, again, seeing a lot of growth in A&H which Odyssey and Allied don’t write a lot of. For Brit, I should mention we talked about this a little bit in the past, that Brit has really done — taken some underwriting actions over the last 12 months, and you see that in their premium. Their premium was down about 3% or 4% in the quarter. But maybe more importantly was their combined ratio was also down. So, we’re seeing those actions come through on the bottom line. And, obviously, that’s what’s most important for us.
Tom MacKinnon: Okay, thanks. And if could just squeeze one more in here, just with respect to more of a stable interest rate environment. Now that you are more matched with respect to your liabilities and your assets, the $459 million net benefit that we saw at least if we take out the changes and the risk adjustment impact, that was still in the area of $380 million or $370 million wouldn’t we find that, overall, that the combination of finance expense, discounting, and changes in market value with the bonds, now that you’re more matched, would there be less noise in this net benefit item, going forward?
Prem Watsa: Yes, so Tom, first of all, what we’re going to do in our annual report, as laid out, I’m going to make sure that everyone understands all the ins and outs, okay? So, we’ll take some time to disclose in enough detail so that you can understand the ins and outs of discounting. But having said that, Peter, you want to add to — do you want to reply to Tom’s question?
Peter Clarke: Yes, sure. I’ll make a couple of comments, and then maybe Jen can add if she wants. But I think generally speaking, Tom, you’re right, that if interest rates are flat, premium is flat, more or less that the discount you put on the current year is more or less offset on the unwinding of the discount from the previous years. And then if by chance the bond maturity is very similar to the duration on our liabilities, that matches as well. When those relationships change you’re going to see movements. But generally speaking, yes, I think as things remain stable you’ll see less noise around the discount. Jen, anything?
