DBRS Limited (DBRS Morningstar) confirmed Fairfax Financial Holdings Limited’s (Fairfax or the Company) Issuer Rating at BBB (high), Senior Unsecured Debt rating at BBB (high), and Preferred Shares rating at Pfd-3 (high). DBRS Morningstar also confirmed the rating of Fairfax (US) Inc.’s Senior Unsecured Notes, which are guaranteed by Fairfax, at BBB (high). In addition, DBRS Morningstar confirmed the Issuer Rating and Financial Strength Rating (FSR) of Northbridge General Insurance Corporation (Northbridge) and the FSR of Federated Insurance Company of Canada, the Canadian operating subsidiaries of Fairfax, at “A”. All trends are Stable.
KEY RATING CONSIDERATIONS
The ratings confirmation and Stable trend reflect the Company’s resilient, diversified franchise, strong liquidity position, and sound regulatory capital. Indeed, Fairfax is a major international property and casualty (P&C) insurance and reinsurance player with a significant presence in key global markets through its geographically diversified insurance and reinsurance operating subsidiaries. The Company has a strong enterprise risk-management framework that reflects its operational and product complexity. Fairfax maintains ample cashable assets at both the holding and operating companies, as well as access to committed banking lines of credit. The ratings also consider Fairfax’s relatively high exposures to equities, as well as lower rated bonds. Moreover, the equity exposures contributes to earnings volatility, as evidenced by the large unrealized losses incurred in Q1 2020. Lastly, the Company’s financial leverage ratio as calculated by DBRS Morningstar is elevated at 38.2% as of the first nine months of 2020 (9M 2020), up from 34.6% for the prior year.
DBRS Morningstar would upgrade the ratings if there is (1) a sustained material improvement in overall profitability while maintaining strong regulatory capital ratios and (2) a material reduction in financial leverage below 25%.
Conversely, the ratings would be downgraded if there is (1) a sustained material deterioration in underwriting profitability evidenced by a combined ratio being consistently above 100%, (2) a material decline in the regulatory capital ratios of Fairfax’s operating subsidiaries combined with a significant reduction in holding-company liquidity levels, and (3) higher leverage that further reduces Fairfax’s financial flexibility.
Fairfax has developed an extensive portfolio of global insurance and reinsurance subsidiaries over time, which the Company continues to expand through organic growth and strategic acquisitions. Management of the Company’s insurance and reinsurance operating subsidiaries is decentralized with each organization having its own autonomous management team. DBRS Morningstar considers this an advantage because it mitigates post-acquisition integration risk and helps maintain performance continuity. Gross premiums written have steadily been increasing reaching $17.5 billion reported for year-end (YE) 2019 and are diversified. Specifically, casualty, the largest business line, contributed 54.5% of this total, while property and specialty contributed 36.1% and 9.4%, respectively. Overall, the Company ranks amongst the top five providers of commercial P&C insurance in Canada based on 2019 direct premiums written, and Fairfax’s largest U.S.-based subsidiary, Odyssey Group, ranks among the top 25 largest global P&C reinsurers. The Company’s United Kingdom subsidiary, Brit Limited (Brit), is a large Lloyd’s of London syndicate and a market leader in specialty insurance and reinsurance.
Fairfax’s good risk profile is supported by the Company’s strong underwriting and risk-limit controls, effective claims management, and appropriate reinsurance coverage for aggregate claim events or large losses. Moreover, Fairfax has appropriate internal controls and has been able to operate successfully in multiple jurisdictions. A ratings constraint, Fairfax’s investment strategy that includes equities, as well as a higher proportion of lower rated bonds, adds volatility to its income as a result of the fluctuating market valuations of its investments.
DBRS Morningstar assesses Fairfax’s earnings ability as Good/Moderate. The Company is characterized by disciplined underwriting, supported by a long-term value-investing approach. Fairfax continues to develop processes to improve its pricing through enhanced use of data and risk segmentation. As noted, the Company’s earnings can be volatile, with Fairfax reporting a year-to-date net loss of $921 million as of 9M 2020. This reflects net unrealized investment losses caused by significant declines in global financial markets as a result of the Coronavirus Disease (COVID-19) pandemic with the bulk of the losses taken in the first quarter of the year. Most recently, Fairfax reported Q3 2020 net income of $42 million, a 43% reduction compared with Q3 2019. While unrealized investment losses have been a headwind, the Company continues to maintain its strong underwriting track record. Specifically, the Company reported a combined ratio of 98.6% for 9M 2020, a slight increase from 9M 2019 (97.1%).
Fairfax maintains a strong financial position at the holding company level with cash and investments totalling $1.2 billion in Q3 2020. The Company has a policy of maintaining a minimum of $1.0 billion balance in cash and marketable securities at the holding-company level. DBRS Morningstar considers this level of cash and investments as providing an important liquidity cushion for any potential uptick in insurance claims from the subsidiaries derived from the ongoing coronavirus pandemic. The Company maintains a committed credit facility of $2 billion that is available to support liquidity needs. After initially drawing down on this line at the beginning of the pandemic, as at September 30, 2020, the Company had $700 million outstanding, leaving $1.3 billion of capacity.
DBRS Morningstar assesses the capitalization of Fairfax as Good/Moderate. The Company’s insurance and reinsurance operating subsidiaries are appropriately capitalized with each major subsidiary having available capital in excess of the required regulatory minimums. As a result of a $650 million unsecured senior notes issued in April 2020, the financial leverage ratio as calculated by DBRS Morningstar increased to 38.2% as of 9M 2020 from 34.6% the prior year. Fairfax’s fixed-charge coverage ratios have been volatile over time because of the impact of International Financial Reporting Standards’ accounting treatment of unrealized capital gains and losses within the investment portfolio resulting in a three-year weighted average fixed charge coverage of 4.9 times for YE2019.
Environmental concerns related to climate and weather risks are key drivers behind the rating action. As a P&C insurer, Fairfax is exposed to catastrophe loss from natural events such as wind, wildfires, hail, flooding, and other extreme weather events. These events can lead to earnings volatility and increased insurance costs. This ESG factor is primarily considered as part of product risk when assessing the Company’s risk profile, but can also affect Earnings Ability, Liquidity, and Capitalization.
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.
The Grid Summary Grades for Fairfax are as follows: Franchise Strength – Strong/Good; Risk Profile – Good; Earnings Ability – Good/Moderate; Liquidity – Strong/Good; Capitalization – Good/Moderate.
All figures are in U.S. dollars unless otherwise noted.
The principal methodologies are the Global Methodology for Rating Life and P&C Insurance Companies and Insurance Organizations (July 21, 2020: https://www.dbrsmorningstar.com/research/364260/global-methodology-for-rating-life-and-pc-insurance-companies-and-insurance-organizations) and DBRS Morningstar Criteria: Guarantees and Other Forms of Support (January 22, 2020: https://www.dbrsmorningstar.com/research/355780/dbrs-morningstar-criteria-guarantees-and-other-forms-of-support).
For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.
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.dbrsmorningstar.com.
The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.
This rating is endorsed by DBRS Ratings Limited (DBRS Morningstar) for use in the European Union. The following additional regulatory disclosures apply to endorsed ratings:
Each of the principal methodologies/principal asset class methodologies employed in the analysis addressed one or more particular risks or aspects of the rating and were factored into the rating decision. Specifically, the Global Methodology for Rating Life and P&C Insurance Companies and Insurance Organizations (July 21, 2020) was utilized to evaluate the Issuers, while the DBRS Morningstar Criteria: Guarantees and Other Forms of Support (January 22, 2020) was used to rate subsidiary debt issuances guaranteed by Fairfax Financial Holdings Limited.
The last rating action on this issuer took place on December 13, 2019, when DBRS Morningstar confirmed all ratings.
Generally, the conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are monitored.
For further information on DBRS Morningstar historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.
Lead Analyst: Victor Adesanya, Vice President
Rating Committee Chair: Michael Driscoll, Managing Director, Head of NA FIG
Initial Rating Date: November 8, 1993
For more information on this credit or on this industry, visit www.dbrsmorningstar.com.
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