Prem Watsa's Fairfax 2023 Annual Shareholder Letter: Part 1

To Our Shareholders:

We had, by far, the best year in our history. Fairfax (TSX:FFH, Financial) has transformed itself to become one of the largest property and casualty companies in the world with $32 billion¹ in gross written premium, including the acquisition of Gulf Insurance. We posted a record underwriting profit of $1.5 billion and record net earnings of $4.4 billion, or $173 per share. Book value per share increased 25% to $940 a share. In the last three years, our book value per share has doubled and our stock price has almost tripled. More importantly, our adjusted operating income (undiscounted underwriting profit, interest and dividends plus income from associates) of $3.9 billion may continue at these levels for the next four years (more on this later).

Since we began in 1985, 38 years ago, our book value per share has compounded by 18.9% per year (including dividends) while our common stock price has compounded at 18.2% (including dividends) annually. Our success throughout our history, and again in 2023, has come under a decentralized structure with outstanding management executing a disciplined approach to underwriting.

The table below shows our growth since 2017, after we purchased Allied World. We have benefited greatly from a hard market in insurance that began in 2019.

We have more than doubled our premium since 2017 – and almost all the growth has been organic! We paid $4.2 billion for Allied World in 2017 (which had $3.1 billion in gross premiums at the time) and $1.6 billion for Brit in 2015 (with $2.0 billion in gross premiums at the time). That's $5.8 billion spent for $5.1 billion in gross premiums. But those assets have been instrumental in helping to drive $15.1 billion in added gross premiums in the last six years – at no cost. The build-up of intrinsic value, or the ability of our assets to drive future top-line and bottom-line growth is very significant, as shown in the table below:

As you can see, as a result of a more than doubling of gross premiums since 2017, our float has increased 53% and the investment portfolio is up 65%. Underwriting profit improved from a loss to $1.5 billion in profit, interest and dividend income has seen a threefold increase, profit from associates is up fivefold and adjusted operating income managed to swing from a loss to $3.9 billion profit. This is what I mean by the very significant increase in intrinsic value!

Of course, this has been magnified on a per-share basis as shares outstanding have decreased by 17% since 2017.

We can see sustaining our adjusted operating income for the next four years at $4.0 billion (no guarantees), consisting of: underwriting profit of $1.25 billion or more; interest and dividend income of at least $2.0 billion; and income from associates of $750 million, or about $125 per share after taxes, interest expense, corporate overhead and other costs. These figures are all, of course, before fluctuations in realized and unrealized gains in stocks and bonds!

On a per-share basis, our shareholders' equity or book value per share has increased 109% over the same period and the operating income of our insurance and reinsurance operations (before fluctuations in stock and bond prices) increased from a loss of $8 per share to a gain of $171 per share. To be clear, we expect to make significant profits from our common stock positions – but only in the long term! Remember we have $15.5 billion in common stock investments which we expect to realize significant profits over time. Since inception, we have made approximately $8.5 billion in common stock profits! Our operating income will give us a lot of stability going forward, but stock profits, even though lumpy, will be significant in the long term.

Here's how our insurance companies performed in 2023 (on an undiscounted basis):

We had record underwriting profit again in 2023 of $1.5 billion as all our major insurance companies had a combined ratio, in the mid 90s or below, despite absorbing catastrophe losses of $900 million. At 4 combined ratio points catastrophe losses were lower than the average 5.6 combined ratio points in the past decade. Our reserves continue to be very strong with favourable development in 2023 of $310 million, with average favourable development of more than $450 million annually over the last 10 years. Premium growth moderated in 2023 with gross premium up 5%, as our companies remained disciplined in writing only profitable business. Odyssey Group, for example, had a 3% decline in premium due to the non-renewal of a large-quota-share account over pricing. Profitable underwriting continues to be key at Fairfax, not just growing the top line!

In 2023, like in 2022, Northbridge and Allied World had the lowest combined ratios of 91% and 89%, respectively, with Allied World producing record underwriting profits. With gross premiums of $6.8 billion and $6.3 billion, respectively, Allied World and Odyssey Group were our largest companies.

Brit had an excellent combined ratio of 92% in 2023, almost making up for the cumulative underwriting losses we have had since we acquired them – in one year! Brit's premium dropped in 2023 as it reduced and rebalanced its catastrophe exposures and the benefits can be seen on the bottom line.

These record underwriting results were due to the outstanding Presidents and management teams we have at each of our decentralized insurance companies (26 in total). We list them here for you and the tenure of each of the Presidents.

Given the record results we have achieved at Fairfax in 2023 ($4.4 billion in net income), we thought it appropriate to show you the full Team Fairfax that runs our company:

• All members of the Fairfax Executive Committee

On your behalf, I want to thank our outstanding Team Fairfax for the transformation that has taken place in our company.

One of the best moves we have made was having Andy Barnard join our holding company team as President of our Insurance Group in 2011 – with all of our insurance Presidents reporting directly or indirectly to him. Over these past 13 years we have written close to $200 billion of gross premium and produced cumulative underwriting profits of $5.3 billion with reserve redundancies each and every year. An outstanding track record!

As I mentioned last year, Andy Barnard and Peter Clarke decided it was time to have Brian Young work with Andy, overseeing our insurance business all over the world. Just as it made sense in 2011 to create a holding company position for Andy to supervise our companies, it made sense in 2023, after years of significant expansion, to add depth to that position. Andy will move to Chairman of the Fairfax Insurance Group and Brian Young will become President. Brian has done an outstanding job in his first year formally working with Andy and Peter, while at the same time remaining the CEO of Odyssey Group. His knowledge of the insurance industry and experience will be a huge asset for the group going forward.

Succession at Odyssey Group is going very well with Carl Overy becoming Global Reinsurance CEO of Odyssey Re and Bob Pollock running Odyssey Group's London Market division. Succession is always internal! Hudson Insurance continues to be run by Chris Gallagher.

Kamesh Goyal and his team at Digit had another great year surpassing $1 billion in premium for the first time. Remember, Digit only began six years ago and now has over 4,000 employees, including a team of 650 people focused on its digital strategy and data science. Most impressive is the company has been profitable again – with the help of investment income. Digit continues to explore and prepare for a potential IPO and we are very excited about their future prospects.

In October 2022, I got a call from Sheikha Dana, the Group CEO at KIPCO. KIPCO had made a decision to sell their 46% ownership of Gulf Insurance (GIG) – preferably to Fairfax! With some negotiation, we came to an agreement on April 19, 2023 to pay KIPCO 2KD per share (approximately 2.4x book value) – $200 million at closing and four equal payments of $165 million annually beginning in December 2024 and ending in 2027. We paid approximately 13x normalized earnings. We closed the deal on December 26, 2023 and now own 90% of GIG. We have made a follow-up offer to the public shareholders recently and expect the offer to close in the second quarter of 2024. We will continue to have a public company in Kuwait.

GIG closed the year 2023 with gross premiums of approximately $3 billion with a combined ratio of 93.7%. The company has made an annual underwriting profit since we first became a shareholder in 2010. With an investment portfolio of $2.4 billion, and a well-capitalized balance sheet, we expect dividends from GIG to contribute to the annual installments in the next four years. We thank Sheikha Dana for being an excellent partner and wish her and Kipco well in the future. We will always take a call from her! Our strategy of waiting for the phone to ring continues!

We are thrilled to have GIG and its experienced and talented team led by Khaled Saoud Al Hasan and Paul Adamson join the Fairfax group. GIG has a very strong presence in the Middle East and North Africa region, operating in over 13 different countries. GIG's position in the region was further cemented with their acquisition of Axa Gulf's operations in 2021. We know GIG very well, having had an ownership position in them for the past 13 years and they have an outstanding track record with a 94% combined ratio and a 15% return on equity over this time period. We look forward to working with Khaled, Paul and the entire GIG team to further develop GIG's business over the long term.

In 2023, we continued to have positive movement in our ratings on the back of a number of positive movements in 2022. Our debt ratings were upgraded by Moody's to Baa2, by A.M. Best to bbb+ and by DBRS to A (low), in addition to upgrades in the financial strength ratings of several of our insurance operations. In 2022, Standard & Poor's increased our subsidiary financial strength ratings to A and our debt rating to BBB, and in late 2023 Standard & Poor's placed our ratings on CreditWatch positive following the release of their new insurance capital model. In May of 2023, Fitch began rating Fairfax and assigned an initial senior debt rating of BBB. The strength of Fairfax and our insurance and reinsurance operations is being reflected in our ratings and we are focused on increasing them further.

This year we had the most significant accounting change in our history, moving from IFRS 4 to IFRS 17 (International Financial Reporting Standards). This resulted in some major changes to the financials with the discounting of our insurance contract liabilities and establishment of a risk adjustment having the most significant effects. As I have said many times, we have never been a fan of discounting but, unfortunately, we do not have a choice. At a high level, we now are required to discount our current-year claims, which is partially offset by applying a risk adjustment. For prior years, we unwind the discount as claims are paid, and as we move closer to the time of payment, and we adjust the discount on prior-year claims for changes in interest rates. These movements are all reflected in our earnings for the year and can have a positive or negative effect. We discount our net liabilities basically using government bond yields as a base that matches our payout patterns by the line of business and the geography of our net insurance liabilities. The risk adjustment is calculated using standard actuarial methods that set the undiscounted insurance liabilities at approximately an 84% confidence level – this can vary over time based on a variety of factors.

On the adoption of IFRS 17 ( January 1, 2022 being the first balance sheet re-valued under this accounting change), our shareholders' equity increased by $150 million. The benefit was relatively small as interest rates at that time were very low and the establishment of our risk adjustment offset the impact of discounting. The table below shows the net benefit from discounting in our 2022 and 2023 financials and how the effect of changes in interest rates on discounting offsets the investment gains (losses) on our bonds. (The net gains or losses on bonds were always reported through income under IFRS 4.)

In 2023, the net effect of discounting and risk adjustment benefited pre-tax earnings by $210 million. Included in this was a loss from the effect of the change in interest rates (interest rates decreased slightly in 2023) on prior-year insurance liabilities of $218 million, which somewhat offset the gain on our bond portfolio of $714 million. In 2022, the net effect of discounting benefited pre-tax earnings by $3.0 billion, which included a gain of $1.9 billion from the effect of the change in interest rates on prior-year insurance liabilities (interest rates increased dramatically in 2022), which more than offset our bond losses of $1.1 billion in 2022. IFRS 17 brings to the financials the matching of marking our bond portfolio and our net liabilities to fair value so both assets and liabilities reflect change in interest rates. The volatility from bond gains or losses going forward will be cushioned by the discounting of our insurance liabilities – not a bad thing!

The table below shows the net discount (discount less risk adjustment) embedded in our discounted net claim liabilities carried on our balance sheet for years ending 2023, 2022 and January 1^st 2022 (first balance sheet restated under IFRS 17).

The discount recorded on our balance sheet increased considerably from our initial IFRS 17 balance sheet, primarily due to the significant increase in interest rates (for example three-year treasuries increased from 0.97% on January 1, 2022 to 4.01% at December 31, 2023). Also contributing to the increase was the growth in net premium written and corresponding increase in net claim liabilities over this time period. The increase in the risk adjustment was generally related to the increase in business volume. The table below reconciles the pre-tax effect of discounting and risk adjustment ($210 million in 2023, $3.0 billion in 2022) to the change in the net discount for the years 2023 ($104 million) and 2022 ($3.1 billion)

As I have previously said, please be assured we will continue to manage our insurance business on an undiscounted basis focusing on underwriting profit and strong reserving before the effect of discounting.

Final item on IFRS 17, preparing for this transition has been a massive amount of work over multiple years for our accounting, actuarial and finance teams all across the world and no more so than for Jenn Allen and her small team at Fairfax – a big thank you from us all!

That brings me to a major mea culpa! We began investing in Blackberry (TSX:BB, Financial) in 2010 and helped John Chen becomeCEO in November 2013 by investing $500 million in a convertible debenture at the same time. Blackberry had come down from $148 per share (down 95%) and had $10 billion in sales. I joined the Board in 2013. Our total investment in BlackBerry early in 2014 was $1.375 billion ($500 million in the convertible and $787 million in common shares).

When John joined the company, BlackBerry reported a loss of $1.0 billion – in one quarter and most analysts were predicting bankruptcy! BlackBerry was indeed in difficulty! John saved the company by quickly bringing it to breakeven on a cash basis and then on a net income basis. No CEO worked harder but, unfortunately, John could not make it grow! Revenues for the year ending February 2023 were $656 million. John retired from the company at the end of his contract on November 14, 2023 and I retired from the Board on February 15, 2024. We got our money back on our convertible ($167 million in 2020, $183 million in 2023 and $150 million in 2024) plus cumulative interest income of approximately $200 million. Our common stock position as of 2023 ($162 million or 8% of the company) which was acquired at a cost of $17.16 per share was valued on our balance sheet at $3.54 per share. Another horrendous investment by your Chairman. To make matters worse, imagine if we had invested it in the FAANG stocks! The opportunity cost to you our shareholder was huge! Please don't do the calculation! No technology investment for me!

During 2023, we invested in a leading United Kingdom-based manufacturer of food ingredients, Meadow Foods Limited. Founded by the Chantler family, Meadow has a 30+ year history of partnering exclusively (in the U.K.) with the world's leading food manufacturers and brands such as Cadbury, Ben & Jerry's and Nestle. It provides bespoke dairy, confectionery and plant ingredients. Led by its CEO Raj Tugnait, the company and its people are trusted for their ability to solve customers' most complex food challenges, from maintaining a secure and stable supply base to creating niche ingredients at scale. Under Raj, the company has professionalized operations and grown sales to £510 million with a record £40 million EBITDA in 2023. We expect to leverage Raj's three decades of experience in the food sector to further scale the business in the United Kingdom and internationally. We are thrilled to partner with the management team and the Chantler family as we continue to build Meadow for long-term success. Meadow Foods is carried at 11x enterprise value-to-EBITDA on our balance sheet.

Recipe was taken private on October 28, 2022 with 99% of shareholders voting in favour. Atlas (now called Poseidon) was taken private on March 28, 2023 with 85% of shareholders voting in favour.

On May 9^th, 2023 the telephone rang again! Bill McMorrow from Kennedy Wilson was considering some real estate construction loans from Pacific Western Bank (a team he knew very well), subject to due diligence. Our Wade Burton worked with Bill and Matt Windisch and, in only three weeks, we announced on June 5, 2023 that we had partnered with Kennedy Wilson to acquire an approximately 95% interest in 65 U.S. first-mortgage real estate construction loans amounting to $2.0 billion with future funding obligations of approximately $1.7 billion. The loans are first mortgages (on average 51% loan to value) on mainly multi-family residential buildings with an average all-in yield of about 10% over approximately three years. In connection with this transaction, Fairfax purchased $200 million in preferred shares from Kennedy Wilson with a 6% dividend rate and seven-year warrants exercisable at $16.21 per share. When Bill McMorrow calls, we listen! As you know, we have had a very successful partnership with Bill since 2010! At December 31, 2023, we had $4.6 billion in first mortgages on mainly multi-family buildings. By the way, Kennedy Wilson owns and manages 40,000 apartments in the U.S. So, if we have any problems with the construction loans, they know how to finish the construction!

Early in 2023 we announced the sale of Ambridge Group to Amynta Group, a Managing General Underwriter (MGU) that offers transactional, specialty casualty, cyber, professional liability and reinsurance coverages and writes on behalf of Brit and a number of other global insurers. Brit received total proceeds of $379 million, comprised of cash of $266 million and a promissory note of $113 million. Brit acquired 50% of Ambridge in 2015 for $29 million and the remaining 50% in 2019 for $47 million. Amynta, which, by the way, is run by Rob Giammarco whom we have known for almost 30 years, will be great owners of Ambridge in building a high-quality MGU business with expanding markets and carriers. Ambridge and Amynta remain key partners for Brit, and we look forward to continuing our strong relationship with them as an independent MGU. We wish Rob Giammarco, Jess Pryor, Jeff Cowhey and the rest of the team all the best in the future.

In November 2023, we entered into our second deal of the year with Rob and the Amynta Group, signing a definitive agreement to sell Brit's 49%-owned Sutton Special Risk. It is expected to close in the first quarter of 2024 after customary closing conditions. Sutton is a managing general underwriter (MGU) in Canada that offers a broad range of accident and health coverages, including personal accident, disability, critical illness and specialty coverages focused on professional sports and entertainment. The proceeds are expected to be approximately $30 million for our 49% interest based on Sutton's audited 2023 EBITDA, payable half on close and the remainder over the next two years. We purchased our 49% interest in Sutton in January 2019 for $13 million. Brit will continue to participate on Sutton's business and we look forward to a long-term relationship. A big thank-you to Greg Sutton and his team. We wish them all the best in the future.

After 38 years, here's what our insurance business looks like worldwide.

• Results shown above for Falcon Thailand and GIG represent the full twelve months ended December 31, 2023 (Falcon Thailand was consolidated on July 11, 2023, and GIG was consolidated on December 26, 2023)
• Includes Life insurance, Run-off, and other investments in associates

• As at and for the twelve months ended September 30, 2023

• 68% upon conversion of securities, once regulatory approval is received

• Based on 100% level

As the table shows, including our non-consolidated insurance companies, we have $33 billion in gross premiums written with an investment portfolio of $67 billion. As I said previously, our size ranks us in the top 20 property and casualty insurance companies in the world. Over 38 years, we have never focused on size but it's amazing what compounding does over time! We have built one of the premier insurance businesses in the world – fully decentralized and run by our Presidents. We have forgone the cost synergies that might have come from consolidation and centralization, in exchange for highly-empowered entrepreneurial companies that are nimble, team-oriented and provide outstanding service to our customers all over the world. And they do it all within our unique fair and friendly culture! We value people, not expense savings, at Fairfax!

With the addition of added business from GIG, the $32 billion in consolidated gross premiums written is generated through our more than 225 profit centres across the group. Each profit centre is focused on a unique set of customers, geographies or products that benefit from market leadership, product knowledge and the ability to provide excellent customer service. These profit centres facilitate transparency, enabling Andy Barnard, Brian Young and Peter Clarke to effectively monitor the insurance operations. Empowerment thrives at Fairfax.

Of the $32 billion of our consolidated gross premiums, North America continues to account for 68%. Brit at Lloyd's accounts for 12% and the remaining 20% is widely dispersed in the Middle East (9%), Asia (3%), Latin America (4%) and other international locations (4%).

We continue to expect significant growth in our insurance operations in under-penetrated markets in countries outside North America and Europe.

Our Ukrainian operations continue to thrive, notwithstanding the difficulties that continue in their country from the horrifying effects of this on-going brutal invasion. Our three Presidents in Ukraine – Andrey Peretyazhko, Oleksiy Muzychko and Svyatoslav Yaroshevych – continue to do an outstanding job looking after the safety of our employees and their families, while producing record results. Our thoughts and prayers continue to be with our employees, their families and all of the people of Ukraine and we hope we can say this war is over when I write next year's shareholders letter.

In 2023, only three small international companies of our 26 consolidated insurance companies had a combined ratio more than 100%. We expect them to be back below 100% in the years to come. More in the insurance section.

The big strength we have in insurance is the float that it generates. Here's our growth since 1985:

In the last three years, our gross premiums per share has increased by 75% and float per share by 65%. They have compounded at 17.2% and 18.4% annually, respectively, since inception. As I have said previously, float continues to be a massive benefit to Fairfax for the long term (discussed in a later section).

Since 2021, we have shown the table below of our largest common stock holdings in each of three buckets: common stocks, which are marked to market; common stocks of associates, which are equity accounted; and common stocks, which are consolidated. The table shows you for each bucket, as at December 31, 2023, the shares we own and the per-share carrying values and market values of those shares. At year-end, the total market value of these common stock holdings exceeded their total carrying value by $1.0 billion. As at March 1^st, 2024, the total market value exceeded the total year-end carrying value by approximately $1.3 billion.

Common Stock Holdings as at December 31, 2023

• Excludes 2.5 million shares from convertible debentures
• Excludes 25.4 million warrants

• Market value shown for unlisted consolidated stocks is Fairfax's carrying value

So, for example, until we sell Eurobank (ATH:EUROB, Financial) (carrying value $1.66 per share, year-end market value $1.78 per share), which is in the equity-accounted bucket, the gain will not be realized in our income statement. Similarly, until we sell Quess (NSE:QUESS, Financial) (carrying value of $8.40 per share, market value of $6.28 per share), this loss will not be realized in our income statement unless an impairment is deemed appropriate or the shares are sold at this price. Our investment in Farmers Edge (TSX:FDGE, Financial) (included in Other in the consolidated bucket) is carried at zero.

When you compare total carrying values to market values at the end of 2023, market values exceed carrying values by $1.0 billion – a $604 million excess for equity-accounted associates plus a $402 million excess for consolidated investments (see the associate income by company in note 6 to our financial statements).

As the table on page 15 shows, the consolidated investments include the following: Recipe, Fairfax India, Grivalia Hospitality, Thomas Cook India, Dexterra Group and Boat Rocker Media. Our consolidated investments are significant, producing total revenue of $6.6 billion and pre-tax income of $271 million in 2023. Fairfax India had pre-tax income of $380 million, Recipe $38 million, Thomas Cook $27 million and Dexterra $29 million. Those were offset by losses at Grivalia of $66 million, Boat Rocker $26 million and Farmers Edge of $112 million which included impairments of $64 million.

Continued in part two.