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Letter to Shareholders From Annual Report 2011 FINAL_v001_j939zn

Letter to Shareholders From Annual Report 2011 FINAL_v001_j939zn

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Published by Dheeraj Grover
Prem Watsa (Warren Buffett of Canada) Annual Shareholder Letter 2011
Prem Watsa (Warren Buffett of Canada) Annual Shareholder Letter 2011

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Published by: Dheeraj Grover on Mar 13, 2012
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To Our Shareholders:
We marked time in 2011 as our book value per share was essentially flat (including the $10
per common sharedividend paid in 2011), mainly because of a record level of catastrophe claims. Book value ended the year at $365per share, down from $376 per share at the end of 2010. Common shareholders’ equity was $7.4 billion, downfrom $7.7 billion. We ended the year with approximately $1 billion in cash and marketable securities at the hold-ing company level. Our results have always been lumpy but our long term results, measured by the increase in ourbook value per share, have been excellent, as shown in the table below:
As of December 31, 20115 years 10 years 15 years 20 yearsFromInception
Compound Annual Growth in Book Value 19.4% 12.0% 12.4% 16.1% 23.5%In 2011, our operating companies coped with losses from unprecedented natural disasters and continuing softmarket conditions. Catastrophe claims for the industry exceeded $105 billion, the most ever with the exceptionof 2005 when Hurricanes Katrina, Rita and Wilma struck the United States. The year began with floods inAustralia ($2.3 billion) and a devastating earthquake in Christchurch, New Zealand ($12 billion). It continued inMarch with the Tohoku earthquake and tsunami in Japan ($35 billion), followed in the spring with a series of deadly tornadoes in the south and midwest regions of the United States ($14 billion). Hurricane Irene ($5 billion)hit the eastern seaboard at the end of the summer, and finally, near year-end, unprecedented flooding ravagedThailand ($15 billion). All told, these events cost Fairfax approximately $1 billion, our largest catastrophe lossyear ever.We have always sought to manage our exposure to catastrophe loss so that we don’t lose more than our expectedincome for the year. Fortunately, in spite of the frequency and severity of the major natural disaster losses in2011, we achieved that result, both at the individual companies and on a consolidated basis. We continue tomonitor our catastrophe exposure very carefully.In our industry, catastrophes happen, they are unpredictable and they can destroy companies. Years ago (in our2005 Annual Report), we discussed the plight of 20
Century Insurance which, in the Northridge earthquake,basically lost the capital it had accumulated over 30 years. In 2011, Thai Re, which had had an outstanding trackrecord for over 20 years, suffered the same fate with the Thai floods (more on this later).Our major catastrophe losses in 2011 are shown in the table below: Japan Tohoku earthquake and tsunami 470Thailand floods 202U.S. tornadoes 70New Zealand earthquake 63Hurricane Irene 31Australian floods 27Other 158Total 1,021The $1 billion in catastrophe claims in 2011 cost us 19.3 percentage points on our combined ratio versus ananticipated cost of approximately six percentage points in an average year. In 2005, Hurricanes Katrina, Rita andWilma cost us 15.3 combined ratio points. So why, you may ask, do we take on this business? Well, here is the
 Amounts in this letter are in U.S. dollars unless specified otherwise. Numbers in the tables in this letter are inU.S. dollars and $ millions except as otherwise indicated.
track record at OdysseyRe, the largest source of our catastrophe exposure, for all of its property business writtensince 2000. This table shows the results for each underwriting year since 2000, and in total for all twelve years.
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Total
Gross premiums written 136 353 491 580 629 716 584 616 637 662 755 798
Combined ratio 78.9% 103.4% 75.3% 70.0% 101.5% 151.4% 63.1% 81.7% 90.5% 87.2% 127.5% 97.5%
As you can see, over the past twelve years OdysseyRe has written approximately $7 billion of property premium ata cumulative combined ratio of 96.7%, notwithstanding the losses from the World Trade Center in 2001, theFlorida hurricanes in 2004, Hurrricanes Katrina, Rita and Wilma in 2005, Hurricanes Ike and Gustav in 2009, theChilean earthquake in 2010 and, of course, the string of disasters in 2011.OdysseyRe is continually fine tuning its underwriting of this business, and is poised to benefit handsomely from amuch improved pricing environment for catastrophe risk. Nevertheless, be aware that whenever a major disasterstrikes, Fairfax will likely be affected.Out of adversity, opportunity arises. In addition to the benefits of a rising rate environment, we have made animportant investment in the aforementioned Thai Re. From 1991 to 2010, Thai Re was run admirably by SurachaiSirivallop. Over those years, Surachai averaged a combined ratio in the mid 80s. Following the 2011 flood lossessuffered by Thai Re, we have participated in a recapitalization, investing $70 million at 3 baht per share for a 25%stake in the company. With two Board seats and an ability to help in the investment area, we are excited to beSurachai’s partner for the long term.We are very pleased that the Fairfax team throughout the organization continued to work very well together in2011, with several smooth internal transitions and operational evolutions. Under Silvy Wright, a 16-year veteranwho became CEO of our Canadian operations after many years of excellent leadership by Mark Ram, NorthbridgeInsurance was formed from the merger of our Canadian insurance companies, under the established Northbridgename, to better serve our clients and brokers. Stanley Zax, with an outstanding record over more than 30 years,moved to Chairman of Zenith National and passed the CEO title to Jack Miller, who has worked with Stanley for14 years. At Crum & Forster, Doug Libby, along with Marc Adee, Richard Smith and Steve Strange Sr., successfullyintegrated the operations of First Mercury and its AMC subsidiary. Jim Migliorini, who helped build HudsonInsurance and was critical to many other projects at Fairfax before retiring three years ago, came back to runAdvent. Scott Donovan, who recently retired as CFO of OdysseyRe, returned to support our investment in China,where Sam Chan has recently become President of Alltrust at Chairman Henry Du’s request. And Andy Barnard,in the first year of his new role overseeing all of Fairfax’s insurance and reinsurance operations and working withour presidents on strategy and coordination, has created a Fairfax Leadership Council, under his Chairmanship, of Fairfax presidents and officers. I am excited about the possibilities in our insurance and reinsurance businessunder Andy’s leadership.The results of our major operating subsidiaries in 2011 are shown in the table below:
CombinedRatio NetEarnings(loss)Return onAverageShareholders’Equity
Northbridge 102.8% (86.8) (5.3)%Crum & Forster 107.9% (1.8) (0.2)%Zenith National 127.5% 54.3 4.9%OdysseyRe 116.7% 14.3 0.4%Fairfax Asia 83.2% (6.9) (1.6)%On a consolidated basis, Fairfax posted a combined ratio of 114.2% in 2011, including a 19.3% charge for catas-trophe claims. Various of our companies have faced continuing challenges from the prolonged soft market and in2011 earnings were also affected by mark to market accounting. That’s the bad news. On the positive side, we seesigns of improvement ahead. Rates in most classes are either stabilizing or going up – and we are growing again!Net premiums written were up 23.4% – 10.9% excluding acquisitions. Crum & Forster, excluding First Mercury,was up 14.4% and Zenith National (acquired in May 2010) was up 27.4% in the second half of 2011. Fairfax Asia(excluding Malaysia) was up 13.6%. As business becomes more attractive, we have the ability across our group of 5
companies to materially expand our writings. Our companies are currently writing business at a rate of only 0.67times policyholders’ surplus, versus a capacity of 1.5 times or higher. The costs of the unprecedented catastrophesof 2011, record low interest rates and the dwindling reservoir of reserve redundancies from the hard market, willforce pricing to improve. We may still be a year or two away from a genuine broad based hard market, but thattime is drawing nearer.In spite of 2011, all four of our operating subsidiaries which we have owned for some time (we only acquiredZenith in 2010) have compounded book value over the past 10 years (adjusted by including distributions toshareholders) at attractive rates, as shown in the table below:
2001 –2011Compound AnnualGrowth Rate
Northbridge 14.7%Crum & Forster 14.4%OdysseyRe 18.3%Fairfax Asia
(1) Based on IFRS or U.S. GAAP, except Crum & Forster, which is based on statutory surplus.(2) 2002 – 2011, as Fairfax Asia began in 2002 with the purchase of First Capital.
The table below shows you how our international operations have grown since we began with Falcon in HongKong in 1998:
Fairfax International Operations as of and for the Year Ended December 31, 2011
Shareholders’EquityGrossPremiumsWrittenInvestmentPortfolioFairfaxOwnershipFairfax ShareShareholders’EquityGross PremiumsWritten
Fairfax Asia
Falcon Insurance (Hong Kong) 57.8 66.8 131.4 100% 57.8 66.8Pacific Insurance (Malaysia) 42.9 51.9 81.2 100% 42.9 51.9First Capital (Singapore) 252.7 347.6 521.8 98% 247.6 340.6Falcon Thailand
8.7 21.3 25.0 41% 3.6 8.7ICICI Lombard (India)
258.1 1,168.1 1,170.5 26% 67.1 303.7
Insurance – Other
Fairfax Brasil 32.4 102.8 62.5 100% 32.4 102.8Alliance Insurance (Dubai) 87.9 76.3 246.0 20% 17.6 15.3Gulf Insurance (Kuwait)
238.8 484.3 490.0 41% 97.9 198.6Alltrust Insurance (China)
250.2 817.1 717.9 15% 37.5 122.6
Reinsurance – Other
Advent Capital (United Kingdom) 142.0 326.1 584.2 100% 142.0 326.1Polish Re 57.8 105.2 129.9 100% 57.8 105.2
Total International Operations
1,429.3 3,567.5 4,160.4 804.2 1,642.3
(1) These associated companies are carried on an equity accounted basis.(2) All dollar amounts are as at or for the 12 months ended September 30, 2011.(3) Alltrust is carried at fair value.
As you will note, our international operations have $1.4 billion in shareholders’ equity (of which Fairfax’s share is$0.8 billion), gross premiums written of $3.6 billion (of which Fairfax’s share is $1.6 billion) and an investmentportfolio of $4.2 billion. The majority of these operations are in emerging market countries with huge long termpotential because of very low insurance penetration and significant GDP growth potential. Particular praise isowed our Mr. Athappan, who runs First Capital Insurance in Singapore, as well as overseeing all of our interests inthe Asian markets through Fairfax Asia. Mr. Athappan’s underwriting acumen is truly extraordinary, as he has6

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