Canadian insurance group Fairfax Financial Holdings announced on July 27 that it will have to restate its results. This comes on top of the announcement on the same day that Fairfax subsidiary Odyssey Re will be restating its results for a second time. The newly-found errors at Fairfax relate mostly to 2001 and previous years.
Fairfax discovered the mistakes when it was assessing the effect of commuting a US$1 billion reinsurance contract provided to it by Swiss Re. It found that the contract had been entered into its then-new accounting system incorrectly, and found other associated non-cash accounting errors at the same time. The company estimates that the restatement will reduce the shareholders’ equity amount reported on March 31, 2006, by between US$225 million and US$240 million. This figure includes US$50 million relating to previously unrecorded errors that existed at March 31.
The value of the Fairfax shares listed on the Toronto Stock Exchange fell to C$125.58 (US$111.24) on July 27 from C$130.90 (US$115.96)on July 26. The share price closed at C$120.92 (US$107.11) on July 31.
Although news of the restatement was not positive, some believe it is not a big cause for concern. “No restatement is a good restatement,” says Mark Dwelle, analyst at investment bank Ferris, Baker Watts. “That said, to the extent that the estimate holds up, the amount to be restated is roughly equal to the amount made in the second quarter. That should allow the book value at the end of the year to be back where it was in the quarter ended March 31, on a U.S. GAAP basis.”
Fairfax made a net profit of US$223.6 million in the second quarter of this year, and US$421.7 million in the first half.
The news of the restatement was also sweetened by the announcement that Fairfax has commuted the US$1 billion reinsurance coverage from Swiss Re. As a result, nSpire Re, Fairfax’s Ireland-based run-off business, will receive US$585 million that was held in trust under the terms of the coverage in cash and treasury bonds. nSpire will use US$450 million of this to settle reinsurance obligations to other Fairfax subsidiaries. These are covered by a letter-of-credit facility, which will be terminated, reducing Fairfax’s debt.
The commutation will cost Fairfax US$415 million before tax on a Canadian GAAP basis, but only US$16 million under U.S. GAAP, making it a positive for US investors. “The Swiss Re contract has been a source of investor confusion and concern,” says Dwelle. “Eliminating this contract goes a long way to clearing the air around the run-off operations and on a U.S. GAAP basis it has almost no impact. It is an inexpensive solution to something that had been a source of concern.”
Odyssey Re will restate its results between 2001 and 2005 to correct the accounting treatment for certain equity and convertible bond investment securities. Odyssey Re says the restatement will have no effect on shareholders’ equity through March 31, 2006, but will increase net income for the first-quarter of this year by US$9.8 million and increase the net loss for 2005 by US$6.7 million.
The reinsurer had to delay the filing of its annual report with the U.S. Securities and Exchange Commission earlier in the year because of a results restatement.
