Hedging hurts Fairfax bottom line

Fairfax Financial Holdings Ltd. says fluctuating stock and bond markets led to a $364.6 million (U.S.) net loss in its fourth quarter, and "lumpy" earnings throughout 2010.

The company said Friday that it booked $683.9 million in investment losses in the three months ended Dec. 31, primarily from equity hedging and bond markets, but that was partially offset by gains from stocks.

That compared to an investment loss of $30.3 million in the year-earlier period.

Fairfax's efforts to hedge against volatile equity markets protect the company against market slumps, which can cause a huge hit to the bottom line. However, when markets improve, such as in the fourth quarter, hedging can reduce gains from rising stocks.

Meanwhile, bond prices, which are tied to long-term interest rates, fell during the quarter, affecting the company's realized and municipal bond investments.

"We are very vigilant in stock markets to make sure we immediately increase reserves if we see any inadequacy," said chairman and chief executive Prem Watsa said in a conference call Friday.

"Our focus continues to be on underwriting profits with good reserving and not on market share. In the right market, we have the ability to expand significantly. In the meantime, we are patient."

He explained that the company's earnings per share have varied widely throughout each quarter of fiscal 2010.

"With fluctuating markets and mark to-market accounting, we don't see how results can be anything but lumpy. As we said before many, many times, we prefer a lumpy 15 per cent to a smooth 12 per cent over the long term."

Fairfax, one of Canada's largest property and casualty insurance groups, said it is also dealing with challenging insurance underwriting conditions.

It benefited from a lack of major hurricanes in the United States, but did have "above average catastrophe losses," of $331 million, due to earthquakes in Chile and New Zealand last year.

The Toronto-based company said Thursday that its fourth quarter loss amounted to $18.43 per share, compared to $1.65 per share a year ago.