Fairfax Financial Restates Earnings, Commutes $1 Billion Swiss Re Contract

Calling it a very embarrassing moment, the chairman and chief executive officer of Canadian insurance holding company Fairfax Financial Holdings Ltd. told investors the company would restate financial results because of various accounting errors related to a reinsurance contract with Swiss Reinsurance Co.    
   
Prem Watsa said the errors, arising primarily in 2001 and prior years, were discovered recently while Fairfax (NYSE, TSE:FFH) was reviewing the potential accounting impact of commuting the $1 billion reinsurance cover with Swiss Re.    
   
"We previously believed that a consolidation general entry related to the Swiss Re cover was correct. Our auditors had reviewed the entry and the audit committee was fully aware of it," Watsa said during an earnings call. "However, when we began calculating the accounting impact of the commutation to [the] Swiss Re cover, we determined that this historical consolidation general entry did not eliminate, and was instead, associated with other erroneous noncash accounting matters arising primarily in 2001 and prior."    
   
While the restated amounts haven't been finalized, Fairfax estimated the impact would be a decrease in shareholders' equity in the range of $175 million to $190 million, Watsa said.    
   
In addition to the restatement, the Toronto-based Fairfax will proceed to commute the Swiss Re cover, resulting in a $415 million pretax loss to earnings, the company said.    
   
Chief Financial Officer Greg Taylor said the cover was exhausted, had been fully utilized and didn't offer Fairfax any further indemnity protection.    
   
"The commutation offered the opportunity to turn an asset that would have been illiquid to us until 2009 into an immediate source of available cash to meet current claims payments and operating expenses at nSpire and European run-off," Taylor said. nSpire a run-off entity of Fairfax.    
   
The commutation also eliminates the 7% interest expense Fairfax was paying on the fund's withheld balance — a $41 million annual expense based on the current $585 million balance, he said.    
   
In a statement, released shortly after the earnings call, A. M. Best said it wouldn't make any changes to the ratings of Fairfax and its majority and wholly owned subsidiaries, which include Odyssey Re Holdings Corp.    
   
A.M. Best said the decision is based on the general and overall operating stability and appropriate capital levels of all of Fairfax's ongoing business segments and the ability of subsidiaries Odyssey Re, Crum & Forster Holdings Inc. and Northbridge Financial Corp. to timely file their individual financial statements.    
  
Also, A.M. Best said Fairfax's ability to repay its debt — the vast majority of which begins to mature in 2012 — is enhanced by the Swiss Re commutation.  
   
Members of Fairfax Financial (USA) Group currently have Best's Financial Strength Ratings ranging from A (Excellent) to B+ (Very Good).  
  
While this is the first restatement of earnings by the holding company, Odyssey Re said in April it was restating financial results because of incorrect reinsurance accounting. That restatement led to a 1.5% drop in shareholders' equity and added $3.6 million to the company's 2005 net loss (BestWire, April 3, 2006).  
  
On the afternoon of July 28, Fairfax's stock was trading in New York at $107.48 a share, down 3.07% from the previous close.  
  
Fairfax stock price has fallen nearly 40% from the high it reached last August. This week, the company filed a $5 billion lawsuit against a number of hedge funds, alleging they participated in a stock market manipulation scheme involving Fairfax shares.