Fitch Ratings has assigned an Issuer Default Rating (IDR) of 'BBB+' to Fairfax Financial Holdings Limited (Fairfax).

Additionally, Fitch has assigned Fairfax a senior debt rating of 'BBB' and a preferred stock rating of 'BB+'. The Rating Outlook is Stable.

Key Rating Drivers

Earnings Volatility from Investments: Fairfax's financial performance and earnings are strong, but exhibit volatility from investments and catastrophe loss events over time. Fairfax posted net income of $1.1 billion in 2022 (7.3% ROAE), down from $3.4 billion in 2021 (24.3% ROAE), as earnings in 2022 were dampened by $1.7 billion of pre-tax investment losses in both bonds from rising interest rates and in common stocks from a decline in market values. Earnings in 2021 benefited from $3.4 billion of net pre-tax gains on investments.

Underwriting Profitability: Fairfax has posted underwriting profitability in each of the last five years, with an average combined ratio of 96.3% from 2018-2022. This result includes 94.7% in 2022 (2021 95.0%), with catastrophe losses adding 6.1 points (2021 7.5 points), the largest event being Hurricane Ian (2.8 points), and favorable reserve development of 0.9 points (2021 2.2 points). The underlying combined ratio excluding catastrophes and reserve development is favorable at 89.5% for 2022, compared with 89.7% for 2021.

High Financial Leverage: Fairfax's financial leverage ratio (FLR) was 31.3% at Dec. 31, 2022, up slightly from 29.2% at Dec. 31, 2021, as debt increased 11%, while common shareholders' equity grew 2%. Excluding non-insurance company debt, which is non-recourse to Fairfax, the FLR reduces to 28.0% at Dec. 31, 2022.

Sizable Holding Company Cash: Fairfax continues to maintain a sizable amount of holding company cash and investments of $1.2 billion at Dec. 31, 2022. Fitch believes this provides Fairfax with a sufficient cushion in meeting potential subsidiary cash flow shortages and liquidity to service its debt.

Low Earnings-Based Interest Coverage: Fixed charge coverage has averaged 2.6x from 2018-2022, as operating earnings have been more limited, although coverage improved to 5.4x for 2022. Including sizable holding company cash, fixed charge coverage has been better, averaging a strong 5.3x from 2018-2022, including 7.9x in 2022.

Favorable Company Profile: Fitch views Fairfax's overall business profile as favorable compared to that of all other U.S./Canadian (re)insurance organizations. Competitive positioning is favorable with a substantive business franchise and larger operating scale. Fitch considers Fairfax's business risk profile to be moderate, with favorable diversification.

High-Quality Investments with Risky Assets: Fairfax's current investment focus is on high-quality bonds and cash/short-term investments at 71% of the portfolio, with 80% of the fixed-income portfolio investment grade and 69% rated 'A' or better at Dec. 31, 2022. The company's risky asset ratio of 89% at Dec. 31, 2022 is higher than peers and includes investments in associates, non-investment grade/unrated bonds, common stocks, derivatives and other invested assets.

Favorable Reserve Development: Fairfax posted overall favorable reserve development in each of the past 12 years (2011-2022) totaling $3.8 billion. This follows overall adverse development in each of the previous eight years (2003-2010) totaling $1.7 billion, mostly from runoff segments. Ongoing operations have had overall favorable prior year development since 2007.

Debt/Preferred Notching: A baseline recovery assumption of Below Average was applied to Fairfax's senior notes. Standard notching relative to the holding company IDR was used. For preferred shares issued by Fairfax, a baseline recovery assumption of Poor and a nonperformance risk assessment of Minimal were used for a ring-fenced environment. Notching of three was applied relative to the IDR, which was based on two for recovery and one for nonperformance risk. Under Fitch's rating methodology, Fairfax's preferred shares receive 100% credit in Fitch's capital adequacy ratio and 50% equity credit in evaluating financial leverage as dividends are cumulative.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Sustained operating earnings-based fixed charge coverage of at least 6x;

Combined ratios of 95% or better;

Flat to favorable reserve development;

FLR maintained at or below 25%.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Operating earnings plus holding company cash-based fixed charge coverage of less than 6x;

Sizable adverse reserve development;

Combined ratios of 102% or worse or below-average investment performance;

FLR maintained above 30%;

A decline in the holding company's cash position to less than $1 billion;

Significant acquisitions that reduce financial flexibility.

Best/Worst Case Rating Scenario

International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

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