DBRS Upgrades Ratings on Fairfax Financial Holdings Limited and Affiliates; Now BBB (high), Stable

DBRS Limited (DBRS) upgraded Fairfax Financial Holdings Limited’s (Fairfax or the Company) Issuer Rating to BBB (high) from BBB, its Senior Unsecured Debt rating to BBB (high) from BBB and its Preferred Shares rating to Pfd-3 (high) from Pfd-3. The rating of Fairfax (US) Inc.’s Senior Unsecured Notes, which are guaranteed by Fairfax, has also been upgraded to BBB (high) from BBB. In addition, DBRS has upgraded the Issuer Rating and the Financial Strength Rating (FSR) of Northbridge General Insurance Corporation (Northbridge) as well as the FSR of Federated Insurance Company of Canada (Federated), the Canadian operating subsidiaries of Fairfax, to “A” from A (low). All trends have been changed to Stable from Positive.

The upgrade of Fairfax’s ratings primarily reflects the application of the “Global Insurance Methodology” and the assignment of an FSR of “A” to its operating insurance companies. As the parent holding company, Fairfax’s Issuer Rating of BBB (high) is positioned two notches below this FSR. Among other factors, the two-notch differential reflects the structural subordination of the holding company’s creditors to the operating company’s creditors in an insolvency situation and recognizes the reliance of the Company on the upstreaming of earnings from its operating companies. In upgrading the Issuer Rating to BBB (high), DBRS takes into account Fairfax’s good franchise strength and risk profile, including its good net earnings, liquidity and capitalization. DBRS also considered the successful completion of the acquisition of Allied World (AWAC), which enhances the Company’s global market share, product offering and geographic reach while strengthening Fairfax's position in the U.S. Excess & Surplus insurance market, increasing the Company’s rank to within the top five.

Fairfax has eliminated all of its equity index hedges, sold the majority of its long-dated bonds and reduced the duration of its fixed-income portfolios. This is expected to result in more stable investment income and net earnings going forward. Indicative of its franchise strength, the Company is the third-largest commercial property and casualty (P&C) insurer in Canada in terms of market share based on 2016 direct written premiums, and it is one of the top 15 global non-life reinsurers after the acquisition of AWAC.

Fairfax has an extensive global portfolio of insurance and reinsurance entities, which the Company continues to develop and grow through strategic acquisitions. The Canadian operations, through the Northbridge and Federated brands, hold a 5.6% market share of the Canadian commercial P&C insurance market. Fairfax is ranked among the top 15 global non-life reinsurers based on 2016 gross written premiums with the inclusion of the AWAC brand. Risks assumed are broad and diverse, including personal and commercial property, automobile, as well as specialized risks such as workers compensation, marine or pet insurance. Fairfax has made a number of acquisitions recently, including Brit Limited (a global Lloyd’s of London specialty insurer and reinsurer), AWAC and other insurers with operations in Latin America, Eastern and Central Europe, Indonesia and South Africa.

To manage its dispersed global operations, the Company maintains a lean head office structure based on its approach of providing a high degree of autonomy to its business units and maintaining a multi-brand strategy; however, Fairfax’s good risk profile reflects its corporate risk management function, which uses the risk management functions of each of the business operations to collect and monitor information regarding aggregate and emerging risks. Reflecting its strong liquidity position, the holding company maintains a liquid investment pool that helps to ensure that it can meet its capital servicing charges and has the mobility to move capital to recapitalize a subsidiary if required.

Fairfax has a strong focus on underwriting profitability and a willingness to avoid writing new business when it views market pricing as inadequate. Management compensation is tied to underwriting profitability as measured by the Company’s combined ratios, underscoring a disciplined approach to claims and expense management. With the exception of 2017, combined ratios have improved in the past few years and have been consistently below 100% since 2013. The occurrence of significant weather-related catastrophes in 2017 have so far adversely affected the Company’s underwriting results for the year, resulting in a year-to-date aggregate combined ratio of 109% as at September 30, 2017. The impact of the underwriting losses on net earnings was covered by investment gains as a result of the Company’s reduction in its shareholding in ICICI Lombard to approximately 10% during the year, which generated a net after-tax gain of $930 million. Fairfax is noted for its expertise in active investment management, often taking controlling shares in portfolio investments, but it also has a guiding principle to protect the Company from downside risks through asset selection and hedging. The Company’s value-based investment strategy, though effective and historically successful, tends to yield volatile results. Consequently, despite historically stable and profitable underwriting results, the earnings volatility from investment income and past hedging activities are affecting fixed-charge coverage ratios that are averaging 3.0 times (x) lower than desired levels for an “A”-rated company. Fairfax’s high cash balances and the subsidiaries’ dividend capacity alleviate concerns about Fairfax’s meeting its capital servicing requirements.

The Stable trend considers the Company’s improving fundamentals, including its expanding global operations and strengthening franchise as well as its ability to adapt to the current challenging operating environment.

RATING DRIVERS

Positive ratings pressure could arise if the Company demonstrates a sustained improvement in profitability through consistently high returns on equity accompanied by well-managed risk exposures with continuous protection of capital, evidenced by strong regulatory capital ratios, along with material reduction in leverage, significantly improved fixed-charge coverage ratios and a material reduction in investment income volatility. Negative ratings pressure could arise through the inadequate monitoring and oversight of assumed risks, resulting in a material deterioration in underwriting results, a sustained material decline in the regulatory capital ratios of the operating subsidiaries, a material reduction in holdco liquidity levels or a sustained significant deterioration in investment income.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found on the issuer page at www.dbrs.com.

The applicable methodologies are Global Methodology for Rating Life and P&C Insurance Companies and Insurance Organizations (December 2016), DBRS Criteria: Preferred Share and Hybrid Security Criteria for Corporate Issuers (December 2017), DBRS Criteria: Rating Corporate Holding Companies and Their Subsidiaries (December 2017) and DBRS Criteria: Guarantees and Other Forms of Support (February 2017), which can be found on our website under Methodologies.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

Lead Analyst: Stewart McIlwraith, Senior Vice President, Head of Insurance - Global FIG

Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer - Global FIG and Sovereign Ratings

The rated entity or its related entities did participate in the rating process. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities.

For more information on this credit or on this industry, visit www.dbrs.com or contact us at info@dbrs.com.