Fairfax Financial (FRFHF) 4th Quarter 2015 Earnings Call Notes

Fairfax Financial (FRFHF) CEO Prem Watsa said the company posted its most profitable insurance underwriting year in its 30 year history

Our underwriting results in 2015 were the best in our 30-year history, with record underwriting profit of $705 and net earnings of $568 million. We had a record low combined ratio of 89.9% with OdysseyRe at 84.7% and all our major insurance companies having combined ratios less than 100%.”

Fairfax Financial (FRFHF) CEO Prem Watsa said the investment portfolio remains conservatively positioned (their equities are hedged and they own primarily US Treasury bonds) in light of what they believe to be a deflationary environment

We are maintaining our defensive equity hedges and deflation protection, as we remain concerned about the financial markets and the economic outlook in this global deflationary environment.  Our common stock portfolios continued to be hedged at approximately 90%. Early in 2016, we increased the hedge to 100%.”  

Fairfax Financial (FRFHF) CEO Prem Watsa said they are seeing evidence of deflation

CPI inflation continues to be at or below 1% in the United States and Europe, levels that we have not seen since the 1950s. In fact, it may surprise many of you to know that in the second-half of 2015, the U.S. had deflation of 0.9% at an annualized rate of 1.8%, and Europe at a 0.5% or an annual rate of 1%, that’s deflation. This is to say prices went down in the second-half of 2015, at an annualized rate of 1.8% in the United States and 1% in Europe.  This is in spite of QE 1, 2, and 3. Long bond – long-term government bond rates in Europe are making record lows, quite often the lowest in 200 years. In Germany, more than half of the German government bond market is yielding negative interest rates. Also, eight countries in Europe already experiencing deflation. 30-year loan German bond rates are currently below 1%. In Japan, 10-year government bond rates are below 0%, that is negative yields.”

Fairfax Financial (FRFHF) CEO Prem Watsa is worried about the unintended consequences of Central Bank policy

We continued to be concerned about the prospects of the financial markets and the economies of North America and Western Europe. Accentuated as we have said many times before by the potential weakness in China. Early in 2016, these concerns are being reflected in the marketplace with the Russell 2000 being down more than 10%. We see the potential for major dislocations in the marketplace with many significant unintended consequences, and we want to protect our company from them.”

Fairfax Financial (FRFHF) CEO Prem Watsa said he has the company positioned to survive worst case scenarios

What we’re trying to do is protect our company from worst-case events. And deflation is the very difficult environment to make a return in. You’re seeing interest rates in Japan, rates are negative. German rates are below 0.3% like below 0.3 like 30 basis points, for 10 years.  So in that environment it’s very difficult to make a return and we’re trying to protect, and there’s all sorts of unintended consequences and so we’re protecting our company from that.”

They are avoiding take any credit risk in the bond portfolio in favor of taking duration risk. 

“One of the things we don’t want to do in this environment is take credit risk. So when we acquired Brit one of the first things we did was to eliminate credit risk and invest in government bonds and in this case U.S. government bonds.  But we do take duration risk we, we buy a long U.S. government bonds.”

Fairfax Financial (FRFHF) CEO Prem Watsa is massively worried about macro events in China & Japan

China we’ve been worried about for many years and their foreign exchange reserves have come down by one whole billion or trillion dollars as you know.  And that the foreign exchange market, the stock market, the bond market, the residential housing market, so all of those markets that they’re trying to support. You got Japan with negative interest rates. And the effect on banks is very significant, so bank stocks have dropped 30% plus in Japan.”