WTC Commentary:
raveninvestment.com
Given our exposure to insurance companies, most notably Fairfax Financial and Berkshire Hathaway, I thought it appropriate to make some comments. The recent World Trade Center disaster has put insurance companies in the foreground of the financial press. With heavy weightings in Berkshire Hathaway (BRK.A/ NYSE, BRK.B/NYSE) and Fairfax Financial Holdings (FFH/TSE), our portfolio(s) will have exposure to the insurance industry losses which have been estimated at anywhere from US $5 billion to US $30 billion. At this juncture, it is impossible for anyone (including the insurers themselves) to know the exact costs of this event. Maurice R. "Hank" Greenberg, chairman of insurance and financial-services titan American International Group Inc., recently commented to the Wall Street Journal:
"Everybody's trying to figure out what their exposures are. Anybody who gives you numbers today is just picking them out of the air. We'll have losses, but it will not in any way have a material impact on AIG's strength. Some [insurance] companies will have more difficulties than others. Smaller companies and the reinsurance industry will certainly take a big knock." (Insurers' Loss Estimate Soars Above $20 Billion by Christopher Oster & Devon Spurgeon, Wall Street Journal, September 12, 2001)
Notwithstanding, insurers have a responsibility to make educated approximations so that shareholders can be made aware of potential losses and have done so.
Berkshire Hathaway
On September 12, Berkshire Hathaway issued a news release (link) estimating that they would be liable for 3 to 5 percent of the cost associated with the disaster. Given the highest current estimate of US $30 billion, and Mr. Buffett's highest approximation of 5%, Berkshire is facing an estimated loss of US $1.5 billion. While that is a lot of money to you and me, we must remember to consider it in the context of Berkshire Hathaway's value as an ongoing business.
Over the last 12 month period, Berkshire Hathaway has been generating over US $1 billion of operating cash flow per quarter. Furthermore, Berkshire Hathaway has one of the strongest balance sheets in corporate North America with a book value of US $55 billion and, at last look, a US $41 billion surplus for its insurance subsidiaries including US $27 billion allocated to General Re.
Furthermore, Mr. Buffett made the following comment in the news release which is of importance:
"In addition to the normal problems involved in estimating catastrophe losses from natural events, in this case there will be additional complicated issues in respect to coverage and liability that will take years to fully resolve." (emphasis mine)
The importance of this statement is that any final liability will take years to be established which means that the funds will likely still be in the coffers generating excess returns for Berkshire. What this means to us as shareholders is that the eventual liability will be somewhat offset in true economic terms by the funds as they are allocated to investable assets by Mr. Buffett.
In any case, the losses for Berkshire Hathaway are not threatening to the business nor the long term value of it as an ongoing business. As Mr. Munger (Vice Chairman of Berkshire) once stated; such losses would be "annoying" but not significantly harmful to the value of Berkshire Hathaway. Let's not forget, as an insurer, you are in the business of writing claim cheques. If you never wrote any - you'd never have any business. What's most important is that you be careful with your underwriting, manage your costs carefully to optimize profits and be in a position where the cheque will clear.
At Berkshire Hathaway - the cheque will clear.
Fairfax Financial
On September 14, Fairfax issued a news release (link) in which the following was stated:
"The company recognizes that at this early stage it is not possible to make a calculation of its financial exposure to claims arising out of these events with a high degree of certainty. However, based on a preliminary review by all of its insurance and reinsurance companies, it estimates on a preliminary basis that its aggregate exposure, after reinsurance, may be in the range of US$100 to US$125 million before tax (US$65 million to US$80 million after tax)." (emphasis mine)
It is my judgement that given such an estimated liability, the intrinsic value of Fairfax was not materially affected. Furthermore, given its corporate balance sheet and the recent actions of management, the selloff by investors which has seen Fairfax's stock fall from a recent price of $236 CND per share to a close of $199.99 CND today was neither rational nor justified.
Closing comments
Despite the losses, this event will likely prove bullish for insurance companies:
weak insurance companies may topple under the burden of losses meaning less competition (and more business) for the strongest and most stable insurers
many North American businesses will likely reconsider current coverage and opt for more thus increasing premium inflows,
insurers will demand higher rates going forward
As a backdrop to all of this; Both Mr. Watsa and Mr. Buffett have historically generated their best returns on capital during difficult markets. With the stock markets taking it on the chin, it's easy to make an argument that Berkshire and Fairfax are a great place to have one's capital. I encourage you to remember the concept of delayed gratification.
As for the tangible threat of war which currently looms ahead - I would like to offer the following thoughts...
Our largest holdings consist of businesses which are interwoven within the fabric of society. As such, as long as one believes that the fabric of society will hold - the stock market is still a valid vehicle for commitment of capital. History has repeatedly demonstrated that war has not been a great reason to exit the stock market. Therefore, it is wiser to rely on rational judgement and forego sentiment which has a tendency to cause humans to act in a manner not to their own benefit. Granted, no one has ever promised us an easy ride. While it may seem callous at times, the rational judgement of pertinent facts paired with an adherence to the concept of "margin of safety" is the best method of capital preservation.
John Zemanovich |
