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I was at the FFH annual and like lotsofcoke I came away generally impressed. The most important thing is that underwriting is improving in the current market and for 1Q/2002 the overall CR is less than 105. Nothing Watsa said was particularly unexpected, so you can imagine that I was a surprised to see that the stock had come to 165 during the meeting. Some items from my scribbled notes (in a basically random order): Prem re-emphasised that ffh does not give out stock options of any kind. There have been very few stock sales from officers and directors. Ranger has had a very high expense ratio. This is being dealt with by merging Ranger with TIG. Long term expectations for ROE are being dropped to 15% from 20% to reflect larger capital base. At the end of 2001 investments/share stood at $1111 – roughly 5x book. Prem apologized for the reserve increases. Seems that no additional reserve increases will be required, although there is still lingering doubt about TIG. Reserves at TIG are within the ‘acceptable range’ but nothing is guaranteed. Prem talked about how in spite of the tough environment of the past 5 yrs the company has developed as follows:
End of 1997 book/sh = $125
End of 1997 investments/sh $521
End of 1997 stock price $320 Prem believes that the poor stock performance reflects poor earnings and when earnings improve, the stock will follow. Prem spoke about how ffh no matter what is happening always provides full disclosure to shareholders. Prem mentioned that over the past 3 yrs no president or officer that the company wanted to keep has quit, although 1 retired. Currently there is a huge focus on underwriting. CR above 100 is unacceptable. Prem used some of WEB’s language and stated that he will not “deploy capital” to any sub that cannot deliver 100 CR. Prem believes that the P/C cycle has turned for the next few years due to world trade centre, low interest rates, asset problems due to falling stock prices, etc etc. More asset problems are still to come. European insurers are heavily invested in common stock. Also there is a lot of shaky overrated debt in existence. With low rates and poor equity returns, the industry needs 100 CR just to make a average 6-7% ROE. Over the next 3 yrs Prem is looking for significant internal growth. Prem did not mention the $500/sh price requirement for major acquisitions, but it does seem that major acquisitions are not likely. FFH needs all the money that they have to take advantage of the hard market. With the hard market ffh subs are retaining a lot more business for themselves and reinsuring less. Prem presented the following for 1Q/2002 Change in NPW
Canada greater than 25% growth
C&F less than 5% growth
TIG decline of 25%
ORE approx 20% growth Combined Ratios
Canada 100
C&F less than 105
TIG 110
ORE below 100
Consolidated less than 105
Key risks include 11B reinsurance recoverables. 9B is from A- or higher. Bad debt allowance is on the books for 28% of B++ or lower. Prem is comfortable with the 28%.
The C&F IPO is in S1 registration. The IPO will allow Prem to increase cash at the holding company, and it will add flexibility in case of an emergency requirement for cash. As well, Prem talked a lot about the IPO being good for ratings and how ORE had its rating increased to A- right after its IPO was completed. Prem believes that the transparency, value and market profile of ORE increased due to the IPO and C&F will behave similarly. $275mm is left on the Swiss Re cover. Expectation is that this won’t be needed. Holding company cash was $833mm at end of 2001, but will fall to 500mm in 1Q/2002 before rising again due to dividends and C&F IPO. Cash is down due the $$ put into TIG and Swiss Re payments. Realized capital gains have historically been 4% of portfolio. In 2000 they were 2% and in 2001 they were 1%. I suspect that this partially reflects the low equity component in the portfolio. As we already know ffh gains $800mm with a 1% drop in long rates. Prem feels that short rates are low but long rates can fall further. I am not sure if I agree with Prem. The yield curve is currently quite steep but this can be lessened with a rise in short rates rather than a drop at the long end. Terrorism coverage is an issue. In some states primary carriers cannot exclude terrorism, while reinsurers can. FFH has exposure to this. All they can do is manage it. Prem admitted that not locking in a significant gain on the S&P puts in the immediate post 9/11 timeframe was a mistake. US listing for FFH will come in the next year. Steve Brett, new CEO of TIG, spoke. He came across very well -- a Jack Byrne style hands on underwriter who delivered 28 yrs unbroken profitability at Fireman’s fund. He hates the MGA structure that TIG has used in the past and wants to “control the pen”. He is quite confident in reserves and pointed out that they have been audited by reinsurers, outside auditors, actuaries and consultants. Program business in Dallas is down by 50%. I was surprised (but pleased) to see that much of a drop. Overall TIG is looking as a drop in NPW from $1.024B in 2001 to $675-700mm in 2002. The B++ AM Best rating has had a very significant effect on TIG. TIG needs to get back to A-. TIG has had to engage in fronting arrangements with inside and outside companies to provide A paper as needed. The B++ was one of the toughest issues which FFH faced in 2001. The main TIG problems have been MGAs, reserve deficiencies and management credibility. I believe that all 3 have been addressed and results will follow. Buying companies in other industries is not in the short or medium term future. The head guy in charge of the bond portfolio is Brian Bradsberry. I may have spelt the name wrong as I have never heard of the guy but if anyone knows anything I would be interested. The f/x contracts will result in $50-$100mm cash outflow if cdn$ does not move. Obviously the ffh currency hedges have gone against the company with the low cdn$.
At least Prem was hedging not speculating. Prem responded to a shareholder who asked about worst case situations. Prem’s description of a worst case situation involves an 8.0 Richter scale earthquake in California combined with a category 5 windstorm in Miami. This would be a completely unlikely scenario but costs to FFH would be 1B US gross loss or $500mm US net loss. Watsa is still bearish on the US economy saying that it is not as sound as most people think. Prem cited Jack Byrne (CEO WTM) in saying that managers and owners in the P/C industry has never been closer. In other words, the personal wealth of P/C executives is tied to the performance of their P/C companies through equity positions to a greater degree than ever before. Lets hope this works to our advantage.
Best of luck, Dave
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