DBRS Morningstar Upgrades Credit Ratings on Fairfax Financial Holdings Limited to A (low) and its Affiliates to A (high); Changes Trends to Stable from Positive

DBRS Limited (DBRS Morningstar) upgraded Fairfax Financial Holdings Limited’s (Fairfax or the Company) Issuer Rating to A (low) from BBB (high). DBRS Morningstar also upgraded the Issuer Rating and the Financial Strength Ratings (FSR) of Fairfax’s subsidiaries Northbridge General Insurance Corporation (Northbridge) and Federated Insurance Company of Canada to A (high). The trends on all ratings were changed to Stable from Positive.

KEY CREDIT RATING CONSIDERATIONS
The credit rating upgrades reflect Fairfax’s consistent and improving underwriting profitability particularly at Brit, the Company’s UK subsidiary where Fairfax has curtailed risk and improved results. Moreover, better overall results have also improved earnings metrics and modestly reduced leverage. Demonstrating improved execution through both acquisitions and organic growth, the reported gross premiums written for YE2022 have more than doubled over the past five years to $27.6 billion (from $12.2 billion in 2017).

The credit ratings and Stable trends reflect Fairfax’s resilient, diversified, and growing franchise, including an expanding market position as a major international Property and Casualty (P&C) insurance and reinsurance group. Higher interest rates have increased risk-adjusted investment income substantially. The Company maintains ample liquid assets at both the holding and operating companies, as well as access to committed lines of credit. Its subsidiaries maintain appropriate regulatory capital ratios with buffers above required solvency levels, allowing Fairfax to handle adverse events.

The credit ratings and Stable trends also consider Fairfax’s earnings volatility that could be caused by exposure to natural catastrophe losses and the impact of financial market fluctuations on unrealized investment gains and losses. Moreover, Fairfax is a large provider of cyber insurance cover in the U.S., ranked number 2 by the NAIC in 2022, which presents some concentration risk.

CREDIT RATING DRIVERS
Over the longer term, less volatile earnings and an improvement in the Company’s risk profile would result in a credit ratings upgrade.

Conversely, the credit ratings would be downgraded if there was a sustained material deterioration in the Company’s risk profile, and overall profitability or capitalization.

CREDIT RATING RATIONALE
Fairfax has developed an extensive and diverse portfolio of global insurance and reinsurance subsidiaries over time, which the Company continues to expand through organic growth and prudent strategic acquisitions. Management of the Company’s insurance and reinsurance operating subsidiaries is decentralized, with each organization having its own autonomous management team. The breakdown of premiums written by line of business has remained consistent over the past five years, with casualty insurance accounting for more than half of the gross premiums written. Gross premiums written from insurance operations in 2022 comprised three broad categories: casualty (56.9%), property (35.2%), and specialty (7.9%).

Fairfax’s risk profile is supported by the Company’s strong underwriting and risk-limit controls, effective claims management, and reinsurance coverage for aggregate claim events or large losses. Moreover, Fairfax has strong internal controls and has been able to operate successfully in multiple jurisdictions. Fairfax’s investment portfolio has good credit quality. The Company continues to hold a significant amount of AAA-rated bonds, which account for more than half of its total fixed income assets as at 9M 2023; however, we note that there has been an increase in the proportion of bonds rated BBB and below as well. This was partly driven by the recent acquisition of approximately 95% interest in specific real estate construction loans from California-based Pacific Western Bank. While this asset class has been under pressure, we note that the loans are secured by real estate located in the United States with a conservative average loan-to-value ratio of approximately 51% and are supported by completion guarantees issued by the project equity sponsors. DBRS Morningstar notes that Fairfax is a large provider of Cyber insurance cover in the U.S., which DBRS Morningstar took into consideration in its assessment of product risk.

The Company reported strong results for the first nine months of 2023 (9M 2023). Fairfax has been successful in transforming Brit’s underwriting results, which has helped improve overall underwriting profitability. The Company is on track for a record year in 2023 with a consolidated net income of $3.4 billion as of 9M 2023 driven by strong underwriting results and positive investment income. The ongoing favorable insurance pricing environment coupled with higher reinsurance prices that benefit its significant reinsurance businesses is expected to contribute positively to Fairfax’s earnings in the short to medium term.

Fairfax’s credit ratings benefit from a sizable holding of liquid assets at the parent-holding company level with approximately $1.2 billion in total for cash and liquid investments as at 9M 2023. DBRS Morningstar considers this level of cash and investments as providing an important liquidity cushion for any potential uptick in insurance claims from the Company's subsidiaries or potential catastrophe losses. Additionally, Fairfax maintains a committed credit facility of $2 billion that is available to support liquidity needs. The credit facility was undrawn as at September 30, 2023.

Fairfax’s insurance and reinsurance operating subsidiaries are appropriately capitalized, with each major subsidiary having available capital exceeding the required regulatory targets. The Company’s fixed-charge coverage ratios have been volatile over time because of the impact of the accounting treatment of unrealized capital gains and losses within the investment portfolio. The volatility is partly mitigated by the holding company’s strong liquidity position, which provides comfort that fixed charges can be paid under stressed market conditions. The Company's financial leverage ratio (calculated by DBRS Morningstar on a consolidated basis as debt plus preferred shares to capital) decreased to 29.1% at 9M 2023, in part because of the material improvement in net earnings, and the transition to IFRS 17. The main drivers were adjustments for the discounting of provision for losses and loss adjustment expenses on transition to IFRS 17, which resulted in an increase in common shareholders' equity.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
Environmental (E) Factors
Environmental concerns regarding Climate and Weather Risks are relevant to Fairfax's rating as a P&C insurer but did not affect the assigned credit rating or trend. As part of its P&C product offering, the Company is exposed to weather-related losses from natural catastrophic events such as wind, wildfire, hail, flooding, and other extreme weather events. These events can lead to earnings volatility and increased reinsurance cost. DBRS Morningstar considered this ESG factor as part of product risk when assessing the Company’s risk profile. Fairfax has not adopted the processes of the Task Force on Climate-Related Financial Disclosures.

There were no Social/Governance factors that had a significant or relevant effect on the credit analysis.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at (July 4, 2023) (https://www.dbrsmorningstar.com/research/416784).

The Grid Summary Grades for Fairfax Financial Holdings Limited are as follows: Franchise Strength – Strong/Good; Risk Profile – Good; Earnings Ability – Strong/Good; Liquidity – Strong/Good; Capitalization – Good.

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

The principal methodology is the Global Methodology for Rating Insurance Companies and Insurance Organizations (July 14, 2023) (https://www.dbrsmorningstar.com/research/417109). In addition, DBRS Morningstar uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (https://www.dbrsmorningstar.com/research/416784) in its consideration of ESG factors.

The following methodologies have also been applied
DBRS Morningstar Global Criteria: Guarantees and Other Forms of Support (March 28, 2023) (https://www.dbrsmorningstar.com/research/411694)

The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

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 credit rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit rating action.

DBRS Morningstar had access to the accounts, management and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.

This is a solicited credit rating.

This credit rating is endorsed by DBRS Ratings Limited for use in the United Kingdom, and by DBRS Ratings GmbH for use in the European Union, respectively. The following additional regulatory disclosures apply to endorsed ratings:
The last credit rating action on this issuer took place on (December 6, 2022), when DBRS Morningstar Changed the Trends on Fairfax and its Affiliates to Positive from Stable, and Confirmed the Ratings.

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 credit 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: https://registers.esma.europa.eu/cerep-publication. For further information on DBRS Morningstar historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

Lead Analyst: Victor Adesanya, Vice President, Global Financial Institutions Group
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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