Fairfax Financial Annual Report 2006

FY2006 Annual Report · Fairfax Financial
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2006 Annual Report

Contents

Five Year Financial Highlights**********************

Corporate Proﬁle **********************************

Chairman’s Letter to Shareholders******************

Management’s Responsibility for the Financial

Statements and Management’s Report on Internal
Control over Financial Reporting*****************

Auditors’ Report to the Shareholders ***************

Valuation Actuary’s Report ************************

Fairfax Consolidated Financial Statements **********

Notes to Consolidated Financial Statements*********

1

2

4

16

18

20

21

27

Management’s Discussion and Analysis of Financial

Condition and Results of Operations *************

58

Appendix A – Fairfax Guiding Principles ************ 139

Consolidated Financial Summary******************* 140

Corporate Information **************************** 141

2006 Annual Report

Five Year Financial Highlights

(in US$ millions except share and per share data or as otherwise indicated)
2002

2003

2006

2005

2004

Revenue

Net earnings (loss)

6,803.7

227.5

5,900.5

(446.6)

5,829.7

53.1

5,731.2

288.6

5,104.7

252.8

Total assets

26,576.5

27,542.0

26,271.2

24,877.1

22,173.2

Common shareholders’

equity

Common shares

outstanding – year-

end (millions)

Return on average

equity

Per share

Diluted net earnings

(loss)

Common

2,662.4

2,448.2

2,605.7

2,264.6

1,760.4

17.7

17.8

16.0

13.8

14.1

8.5%

(18.1)%

1.8%

13.9%

14.5%

11.92

(27.75)

3.11

19.51

17.49

shareholders’ equity

150.16

Dividends paid

Market prices

TSX – Cdn$

High

Low

Close

NYSE – US$

High

Low

Close

1.40

241.00

100.00

231.67

209.00

88.87

198.50

(1) Since listing on December 18, 2002.

137.50

1.40

162.76

1.40

163.70

0.98

125.25

0.63

250.00

147.71

202.24

187.20

116.00

168.50

248.55

57.00

226.11

178.50

46.71

174.51

195.00

104.99

121.11

90.20(1)
77.00(1)
77.01(1)

218.50

158.29

168.00

179.90

126.73

143.36

1

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

Corporate Proﬁle

Fairfax  Financial  Holdings  Limited  is  a  ﬁnancial  services  holding  company  whose
corporate  objective  is  to  build  long  term  shareholder  value  by  achieving  a  high  rate  of
compound growth in mark-to-market book value per share over the long term. The company
has been under present management since September 1985.

Canadian insurance – Northbridge

Northbridge  Financial,  based  in  Toronto,  provides  property  and  casualty  insurance
products through its Commonwealth, Federated, Lombard and Markel subsidiaries, primarily
in the Canadian market as well as in selected U.S. and international markets. It is one of the
largest commercial property and casualty insurers in Canada based on gross premiums written.
In  2006,  Northbridge’s  net  premiums  written  were  Cdn$1,148.2  million.  At  year-end,  the
company had capital of Cdn$1,164.0 million and there were 1,561 employees.

U.S. insurance – Crum & Forster

Crum & Forster (C&F), based in Morristown, New Jersey, is a national commercial property
and  casualty  insurance  company  in  the  United  States  writing  a  broad  range  of  commercial
coverages.  Its  subsidiary  Seneca  Insurance  provides  property  and  casualty  insurance  to  small
businesses and certain specialty coverages. Since January 1, 2006, the specialty niche property
and  casualty  and  accident  and  health  insurance  business  formerly  carried  on  by  Fairmont
Insurance  is  being  carried  on  as  the  Fairmont  Specialty  division  of  C&F.  In  2006,  C&F’s  net
premiums  written  were  US$1,196.5  million.  At  year-end,  the  company  had  capital  of
US$1,214.0 million ($1,093.1 million on a US GAAP basis) and there were 1,345 employees.

Asian insurance – Fairfax Asia

Falcon  Insurance,  based  in  Hong  Kong,  writes  property  and  casualty  insurance  to  niche
markets  in  Hong  Kong.  In  2006,  Falcon’s  net  premiums  written  were  HK$224.2  million
(approximately  HK$7.8  =  US$1).  At  year-end,  the  company  had  capital  and  surplus  of
HK$347.7 million and there were 99 employees.

First  Capital,  based  in  Singapore,  writes  property  and  casualty  insurance  primarily  to
Singapore  markets.  In  2006,  First  Capital’s  net  premiums  written  were  SGD50.4  million
(approximately  SGD1.6  =  US$1).  At  year-end,  the  company  had  capital  and  surplus  of
SGD112.6 million and there were 52 employees.

Reinsurance – OdysseyRe

OdysseyRe, based in Stamford, Connecticut, underwrites treaty and facultative reinsurance as
well  as  specialty  insurance  business,  with  principal  locations  in  the  United  States,  Toronto,
London, Paris, Singapore and Latin America. In 2006, OdysseyRe’s net premiums written were
US$2,160.9  million.  At  year-end,  the  company  had  capital  of  US$2,012.6  million
(US$2,083.6 million on a US GAAP basis) and there were 610 employees.

Runoff and Group Re

The U.S. runoff group consists of the company resulting from the December 2002 merger of
TIG and International Insurance and the Fairmont legal entities placed in runoff on January 1,
2006. At year-end, the merged company had capital of US$1,375.1 million (statutory capital
and surplus of US$683.4 million).

2

The  European  runoff  group  consists  of  RiverStone  Insurance  UK  and  Dublin,  Ireland-
based nSpire Re. At year-end, this group had combined capital (including amounts related to
nSpire Re’s ﬁnancing of the acquisition of Fairfax’s U.S. insurance and reinsurance companies)
of US$1.3 billion.

The  Resolution  Group  (TRG)  and  the  RiverStone  Group  (run  by  TRG  management)
manage the U.S. and the European runoff groups. TRG/RiverStone has 244 employees in the
U.S., located primarily in Manchester, New Hampshire and Dallas, Texas and 102 employees in
its ofﬁces in the United Kingdom.

Group Re primarily  constitutes  the  participation  by  CRC  (Bermuda),  Wentworth  (based  in
Barbados) and nSpire Re in the reinsurance of Fairfax’s subsidiaries by quota share or through
participation in those subsidiaries’ third party reinsurance programs on the same terms as the
third party reinsurers. In 2006, its net premiums written were US$314.5 million.

Other

Cunningham  Lindsey  provides  a  wide  range  of  independent  insurance  claims  services,
including  claims  adjusting,  appraisal  and  claims  and  risk  management  services,  through  a
worldwide  network  of  branches  in  Canada,  the  United  States,  the  United  Kingdom,
continental Europe, the Far East, Latin America and the Middle East. In 2006, revenue totaled
Cdn$420.7 million. At year-end, the group had 3,862 employees located in 357 ofﬁces.

MFXchange, established in 2002 and based in Parsippany, New Jersey with ofﬁces in Toronto,
Dallas  and  Ireland,  designs,  creates  and  markets  a  full  range  of  state  of  the  art  technology
products  and  services  for  the  insurance  industry,  including  the  insurance,  reinsurance  and
runoff subsidiaries of Fairfax.

Hamblin  Watsa  Investment  Counsel  was  founded  in  1984  and  provides  investment
management to the insurance, reinsurance and runoff subsidiaries of Fairfax.

Notes:

(1) All  companies  are  wholly  owned  except  for  three  public  companies:  59.2%-owned  Northbridge
Financial,  59.6%-owned  OdysseyRe,  and  81.0%-owned  Cunningham  Lindsey  at  December  31,
2006.

(2) The  foregoing  lists  all  of  Fairfax’s  operating  subsidiaries.  The  Fairfax  corporate  structure  (i.e.,
excluding a 26.0% interest in ICICI Lombard and investments in Hub International and Advent)
includes  a  number  of  companies,  principally  investment  or  intermediate  holding  companies
(including companies located in various jurisdictions outside North America), which are not part
of  these  operating  groups.  These  companies  had  no  insurance,  reinsurance,  runoff  or  other
operations.

3

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

To Our Shareholders:

Our  biblical  seven  lean  years  are  over.  2006  was  an  excellent  year  for  Fairfax  as  we  earned
$227.5 million* after tax or $11.92 per diluted share after a non-cash charge of approximately
$413 million after tax on the commutation of our Swiss Re corporate cover. We earned 8.5% on
average shareholders’ equity in 2006 (22.8% prior to the charge for the Swiss Re commutation)
compared to approximate returns on average equity of 16.9% for the S&P 500 and 17.7% for the
S&P/TSX  Composite.  Book  value  of  $150.16  per  basic  share  was  up  9.2%  after  the  Swiss  Re
commutation and the restatement (more on that later) – book value per share is about 100 times
what  we  began  with  in  1985,  representing  a  compound  growth  rate  of  approximately  24%
annually. Our share price increased 38% in 2006 to $198.50 per share – a compound growth rate
of 23% annually since inception from $2.38 (Cdn$3.25) about 21 years ago.

The Swiss Re commutation masked the excellent results produced by our subsidiaries in 2006,
as shown in the table below.

Northbridge
Crum & Forster (US GAAP)
OdysseyRe (US GAAP)

Combined
Ratio

98.0%
90.5%
94.4%

Net
Earnings
after Tax

147.3
312.3
507.9

Return on
Average
Shareholders’
Equity

15.3%
30.4%
28.3%

Crum & Forster and OdysseyRe earned record proﬁts as underwriting results, and investment
income (including realized gains), were all at record levels. Of course, in 2006 we had no major
hurricanes  which,  in  2005,  cost  us  14.0  points  on  the  consolidated  combined  ratio  (or
$610 million pre-tax).

The  table  below  shows  the  growth  in  book  value  over  the  past  ﬁve  years  (per  share  for
Northbridge and OdysseyRe) adjusted by including distributions to shareholders.

Northbridge
Crum & Forster (US GAAP)
OdysseyRe (US GAAP)

2001 – 2006
Annual Compound
Growth Rate

21.3%
17.5%
18.7%

These are excellent absolute growth rates but also stack up well against the competition – only
a few have been able to do better! Note that these results were produced in a very challenging
environment,  which  included  the  Katrina,  Rita  and  Wilma  hurricanes  in  2005,  the  four
hurricanes  in  2004,  and  asbestos  and  other  reserve  development  for  2001  and  prior.  While
many of you might have expected these results at Northbridge and OdysseyRe, you might be
surprised at the 17.5% compound growth rate for Crum & Forster. At the end of 2001, Crum &
Forster’s US GAAP book value was $720 million. At the end of 2006, it was $1.6 billion after
including  cumulative  distributions  to  Fairfax.  A  big  thank  you  to  Mark  Ram,  Nick
Antonopoulos and Andy Barnard and their management teams for these outstanding results.

*

Amounts in this letter are in U.S. dollars unless speciﬁed otherwise. Numbers in the tables in this
letter are in U.S. dollars and $ millions except as otherwise indicated.

4

Over the past few years, many of you have asked me if we made a mistake in acquiring Crum &
Forster and TIG in 1998/1999. I have always said it might be a mistake but it was too soon to
tell,  as  we  were  only  at  the  end  of  the  third  inning  in  a  nine  inning  ball  game.  There  is  no
question  that  the  turnaround  took  longer  than  expected,  that  we  were  understaffed  for  the
challenges in 1998/1999 and that it was a very trying period for all of us, which I never want to
repeat. Having said that, Crum & Forster has been turned around, TIG’s reinsurance operations
permitted  OdysseyRe  to  become  a  substantial  reinsurer,  and  we  now  have  very  signiﬁcant,
underwriting-focused,  disciplined  companies  in  Crum  &  Forster  and  OdysseyRe  that  should
continue to beneﬁt our shareholders in the future. The long term continues to be our focus.

A few comments on the Swiss Re commutation and our restatement. At our annual meeting
last  May,  in  reply  to  a  question,  we  discussed  the  possibility  of  commuting  Swiss  Re.  We
continued to review it, and given that the cover was fully utilized and there was no economic
beneﬁt  to  keeping  it  in  place,  we  did  commute  it  in  August  2006.  As  we  said  in  our  press
release, the approximately $585 million cash proceeds from the commutation should result in
the European runoff not needing any cash from Fairfax through 2007 and, based on current
projections, it is expected that any annual cash support required from Fairfax after 2007 will
not be signiﬁcant in relation to holding company cash. The Swiss Re commutation resulted in
an  after-tax  loss  of  approximately  $413  million  under  Canadian  GAAP  (approximately
$11 million under US GAAP). Please review page 82 in the MD&A for further details.

As  for  our  restatement,  we  take  very  seriously  our  obligation  to  provide  accurate  ﬁnancial
results,  so  the  restatement  was  embarrassing  for  us,  even  though  it  reﬂected  only  honest
mistakes,  which  we  identiﬁed  in  our  own  reviews,  involving  accounting  errors  arising
primarily in 2001 and prior. The restatement resulted in a decrease in shareholders’ equity as at
March  31,  2006  of  $235.3  million  (of  which  more  than  half  related  to  a  decrease  in  the
currency translation account), but did not impact our cash ﬂows or the fundamental strength
of our business, as our operating and investment performance continued to be strong. Further
details regarding the restatement and our remediation process appear beginning on page 125
in the MD&A – sufﬁce it to say that we hope that we will never again repeat this embarrassing
mistake.

Turning to runoff, Dennis Gibbs and his team have achieved outstanding results since we put
TIG into runoff in 2002. In 2006, as explained on page 84 in the MD&A, Runoff and Other
effectively  achieved  our  objective  of  breaking  even.  As  mentioned  earlier,  based  on  current
projections,  the  Swiss  Re  commutation  should  result  in  there  being  no  future  year  in  which
European runoff has a requirement for cash from Fairfax which will be signiﬁcant in relation to
holding  company  cash.  Going  forward,  Group  Re  will  no  longer  be  included  in  the  Runoff
segment,  but  will  be  reported  as  a  separate  unit  that  primarily  uses  Wentworth  for  its
opportunistic  underwriting  (given  the  insurance  cycle,  Group  Re  will  likely  shrink  in  the
foreseeable future).

We  had  an  excellent  year  in  2006  on  the  investment  front  even  while  maintaining  the
protection we have built against the 1 in 50 or 1 in 100 year storm in the ﬁnancial markets.
Total  investment  income  in  2006  (including  at  the  holding  company)  was  $1.5  billion  or
$86.47 per share. Interest and dividend income from our investment portfolios increased by
60.2% to $746.5 million or $42.03 per share due to higher interest rates and a 13.1% increase
in  the  investment  portfolios.  Total  net  realized  gains  (including  realized  losses  and  mark-to-
market declines on our S&P 500 hedges and our credit default swaps, as well as other one-time
adjustments  noted  on  page  120  in  the  MD&A)  amounted  to  $789.4  million  or  $44.44  per
share.  The  total  return  on  our  investment  portfolios  in  2006  (including  changes  in  net
unrealized gains) was 8.1% – higher than the 6.5% achieved in 2005 but still below our long
term average of 9.3%. The carrying value of our investment portfolios, net of $783.3 million of
liabilities for the S&P 500 hedges, increased by 13.1% to $16.8 billion or $948.62 per share.

5

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

This  is  perhaps  a  great  lead-in  to  our  ﬁnancial  objectives  going  forward.  As  you  know,  for
21  years  we  have  had  an  objective  based  on  the  return  on  shareholders’  equity.  Under
Canadian  GAAP,  shareholders’  equity  (book  value)  was  not  impacted  by  unrealized  gains  or
losses, but commencing in 2007 Canadian GAAP has introduced mark-to-market accounting in
determining  shareholders’  equity  (this  is  already  the  case  under  US  GAAP).  This  change,
together with our belated recognition of the signiﬁcant favourable impact of compounding on
investments held over the long term, has resulted in our focusing in the future on a 15% per
annum  compound  growth  in  mark-to-market  book  value  per  share  over  the  long  term.  This
means  that  annual  return  on  shareholders’  equity  may  be  penalized  even  if  book  value  per
share  compounds  at  15%  because  we  may  not  be  harvesting  our  unrealized  gains.  As  stock
prices  ﬂuctuate  in  the  short  term  and  only  reﬂect  underlying  intrinsic  values  over  time,  our
results by deﬁnition have to be measured over long periods of time.

I  wanted  to  highlight  two  valuable  assets  that  you  may  not  have  focused  on  since  they  are
small.

1.

Seneca (a wholly owned subsidiary of Crum & Forster)

Led  by  Doug  Libby,  the  results  of  this  company  over  the  last  15  years  have  been
nothing short of spectacular. We purchased Seneca in 2000 for $65 million, a modest
premium  to  underlying  book  value  of  $59  million,  with  no  protection  for  reserve
development. Since our purchase, the company has had an average combined ratio
of 86.8%, there have been net reserve redundancies of $36.9 million and US GAAP
book  value  (excluding  goodwill  relating  to  the  purchase)  has  compounded  by
16.0%  annually  to  $152.0  million  after  including  cumulative  dividends  paid.  The
long  term  track  record  is  even  more  impressive.  When  Doug  took  over  Seneca  in
1989, it was basically bankrupt. It took three years to get the combined ratio down to
103.1%  from  more  than  125%  and  since  then,  Seneca  has  rarely  had  a  combined
ratio  over  100%.  Over  the  1993-2006  time  period,  its  combined  ratio  averaged
92.0% and net premiums written grew from $14.2 million to $111.6 million. When
we purchased Seneca, Bruce Esselborn and Nick Antonopoulos, who had previously
been on the board of Seneca for ﬁve years, said that Doug was one of the few people
to whom they would trust their wallet. Rightly so!

2.

Fairfax Asia

(a)

Falcon

We  began  this  in  1998  with  Kenneth  Kwok  at  the  helm,  establishing  our
insurance operations in Asia. Kenneth has taken Falcon from a standing start to
an established insurance operation in Hong Kong. In the last ﬁve years, Falcon
has had an average combined ratio of approximately 100%.

(b)

First Capital

In  2002,  Fairfax  purchased  First  Capital  Insurance  Limited  in  Singapore.  In
January  2003,  Fairfax  purchased  Winterthur  Insurance’s  Singapore  operations
and subsequently transferred those assets and liabilities to First Capital at the
end  of  2003.  Mr.  Athappan  began  managing  the  business  in  2002  through  a
management contract with India International and then joined us in 2006. The
record has simply been outstanding. In the ﬁve years ended 2006, the combined
ratio has averaged 72.5% and book value has doubled to $69.4 million. With
over $100 million in gross premiums written in 2006, First Capital is one of the
top insurance companies in Singapore.

6

(c)

ICICI Lombard

This  joint  venture  in  a  general  insurance  company  in  India  has  been  a  home
run for us. First discussed in our 2000 annual report, this joint venture was a
huge  Fairfax-wide  team  effort  led  by  Chandran  Ratnaswami  and  Sam  Chan
from Fairfax, Byron Messier, Rick Patina and Kim Tan from Lombard, and Jim
Dowd  and  Jim  Migliorini  from  OdysseyRe,  and  involved  the  participation  of
many,  many  others.  From  a  standing  start  in  2000,  ICICI  Lombard,  under
Sandeep Bakhshi’s leadership, has become the largest private general insurance
company in India with a 12.5% market share. It has built a huge infrastructure
that includes 220 ofﬁces and 5,000 employees, has 4.5 million customers and is
expected  to  write  approximately  $700  million  in  gross  premiums  for  the  year
ending  March  2007.  In  spite  of  the  buildup  of  infrastructure,  the  outlays  for
which  have  been  expensed  immediately,  ICICI  Lombard  has  averaged  a
combined ratio of 96% over the time period (97% in 2006) under Indian GAAP,
which  uses  expenses  compared  to  net  premiums  written  (rather  than  net
premiums earned) in calculating the expense ratio. We are very excited about
the prospects for this company. Unfortunately, we are currently restricted to a
26% ownership level by Indian government mandate.

ICICI Bank, a hugely successful bank in India led by K.V. Kamath, has been a
dream  partner  for  us.  We  look  forward  to  a  very  long  relationship  with  the
Bank.

Please see pages 124 and 125 in the MD&A for a description of the status of the investigation
pursuant to which Fairfax has received subpoenas from the SEC and the lawsuits seeking class
action status ﬁled against Fairfax in 2006.

The Insurance Cycle

The hard market, which began after September 11, 2001 and was prolonged by Katrina, is now
deﬁnitely  on  the  downswing.  Price  decreases  across  the  industry  are  common  even  though
price adequacy (i.e., prices in relation to exposure) continues to be acceptable. However, you
should be prepared to see our top line shrink as we lose business to competitors at signiﬁcant
discounts to our prices. The mandate for our presidents is very clear: do not write business at
inadequate  prices.  The  downside  of  this  cycle  may  be  mitigated  by  low  interest  rates  and
reinsurer  discipline;  however,  our  industry’s  past  record  in  exercising  price  discipline  leaves
much to be desired!

Insurance and Reinsurance Operations

Combined Ratio
Year Ended December 31

2006
2005
2004
98.0%
87.7%
92.9%
92.3% 100.9% 105.4%
91.9%
78.4%
93.0%
97.0%
96.5% 117.5%

95.5% 107.7%

96.9%

Net Premiums
Written
% change in
2006

3.4%
16.6%
30.1%
(6.2%)

1.5%

Northbridge
Crum & Forster
Fairfax Asia
OdysseyRe

Consolidated

This table shows you that each of our operating companies had excellent combined ratios in
2006,  reﬂecting  in  the  main  the  absence  of  KRW-type  hurricane  losses  (which  cost  us  14.0
combined  ratio  points  in  2005) and  also  the  dramatic  hardening  in  the  hurricane-exposed
property  markets  of  Florida  and  the  Gulf  Coast.  It  is  very  likely  that  our  premium  base  has
peaked in 2006 and that it will decrease in 2007 as the insurance market continues to soften.

7

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

There was signiﬁcant capital raised after the hurricanes in 2005, and given a ‘‘good’’ year in
2006  and  a  signiﬁcant  increase  in  homeowner  exposures  being  underwritten  by  the  Florida
state government, if history is any guide, pricing in the industry should be on the downswing.
All our companies are disciplined and focused on underwriting proﬁtability, and their mandate
is to let premiums go at rates below price adequacy. Northbridge’s combined ratio in 2006 was
impacted by $91.3 million or 8.9 points of development from the KRW hurricanes. Crum &
Forster had an outstanding year with a combined ratio of 92.3% reﬂecting signiﬁcant reserve
redundancies.  Although  small,  Fairfax  Asia  (not  including  ICICI  Lombard,  which  is  equity
accounted)  had  an  excellent  year  with  a  combined  ratio  of  78.4%  and  30%  growth,  mainly
because of First Capital’s outstanding performance. OdysseyRe’s excellent underwriting results
were after absorbing $185.4 million or 8.3 points of net adverse reserve development from the
soft market years of 1997 - 2001.

Statutory capital for all three of our major companies increased signiﬁcantly in 2006. As shown
in the table below, they are all very well capitalized.

Net Premiums
Written

1,012.3
1,196.5
2,160.9

Statutory
Surplus
1,000.3(1)
1,406.8
2,501.6

Net
Premiums/
Statutory
Surplus

1.0
0.9
0.9

Northbridge
Crum & Forster
OdysseyRe

(1) Canadian GAAP shareholders’ equity

We have updated the ﬂoat table for our operating companies that we showed you last year.

Underwriting
proﬁt (loss)

Average
ﬂoat

Beneﬁt
(Cost)
of ﬂoat

Average
long
term
Canada
treasury
bond
yield

2.5

21.6

11.6%

9.6%

(31.9)
95.1
134.8
(333.9)
198.2

4,402.0
4,443.2
5,371.4
6,615.7
7,533.4

(0.7%)
2.1%
2.5%
(5.0%)
2.6%

5.7%
5.4%
5.2%
4.4%
4.3%

(3.5%)

5.5%

Year

1986
↕
2002
2003
2004
2005
2006
Weighted average since

inception

Fairfax weighted average ﬁnancing differential since inception: 2.0%

Float  is  the  sum  of  loss  reserves,  including  loss  adjustment  expense  reserves,  and  unearned
premium  reserves,  less  accounts  receivable,  reinsurance  recoverables  and  deferred  premium
acquisition costs. As the table shows, the average ﬂoat from our operating companies increased
13.9% in 2006 at no cost (in fact, we were paid 2.6% on the ﬂoat in 2006!). Our long term goal
is to increase the ﬂoat at no cost to our shareholders. This, combined with our ability to invest
the ﬂoat well over the long term, is why we could achieve our objective of a 15% per annum

8

compounding of book value per share over time. The table below shows you the breakdown of
our total year-end ﬂoat for the past ﬁve years.

Canadian
Insurance

U.S.
Insurance

811.7
1,021.1
1,404.2
1,461.8
1,586.0

1,552.6
1,546.9
1,657.1
1,884.9
1,853.8

Asian

Total
Insurance
and

Insurance Reinsurance Reinsurance Runoff

Total

59.2
88.0
119.7
120.2
85.4

1,770.2
2,036.7
2,869.0
3,714.4
4,360.2

4,193.7 1,781.8 5,975.5
4,692.7 1,905.4 6,598.1
6,050.0 1,371.0 7,421.0
7,181.3 1,575.3 8,756.6
7,885.4 2,633.4 10,518.8

2002
2003
2004
2005
2006

In 2006, the Canadian insurance ﬂoat increased by 8.5%, the U.S. insurance ﬂoat decreased by
1.6%, the Asian insurance ﬂoat decreased by 29.0% (largely due to an increase in reinsurance
recoverables)  and  the  reinsurance  ﬂoat  increased  by  17.4%,  all  at  no  cost.  The  runoff  ﬂoat
increased by 67.2% due primarily to the Swiss Re commutation and, on a total basis, our ﬂoat
increased by 20.1% to $10.5 billion at year-end 2006. Total ﬂoat for Fairfax is up 81% over the
past ﬁve years.

We are particularly pleased with the strengthening of our balance sheet and our reduction of
ﬁnancial  risk  that  took  place  since  the  beginning  of  2006.  In  this  regard,  we  have  done  the
following:

1. We  commuted  the  Swiss  Re  cover,  thus  alleviating  concerns  that  European  runoff
would  be  a  material  cash  drain  on  Fairfax  in  future  years.  European  runoff  should
now  not  need  cash  from  Fairfax  in  2007,  and  after  2007,  based  on  current
projections,  any  annual  cash  requirements  for  European  runoff  should  not  be
signiﬁcant  in  relation  to  Fairfax’s  holding  company  cash.  The  commutation  also
eliminated  the  funds  withheld  interest  expense  and  other  fees  and  expenses  of
approximately $45 million annually. The commutation contributed meaningfully to
the dramatic declines in reinsurance recoverables and funds withheld on our balance
sheet.  Our  goal  of  simpliﬁcation  and  transparency  has  also  been  enhanced  by  this
commutation.

2. With the approval of the California Department of Insurance, TIG is dividending out
our  $122.5  million  note  owing  to  it  and  we  will  cancel  that  note.  Annual  cash
interest savings on the note for the holding company will amount to approximately
$9 million.

3. With  the  U.S.  tax  loss  carryforwards  almost  eliminated  by  the  end  of  August  2006
(only $118.7 million as of December 31, 2006), we deconsolidated OdysseyRe from
the U.S. tax group and subsequently in December reduced our interest in OdysseyRe
from approximately 80% to approximately 60% through the sale of 10.165 million
shares at $34.60 per share. Net cash proceeds were approximately $338 million.

4. We reduced holding company debt by $210.1 million in 2006 and by $60.4 million

in early 2007, and we have no signiﬁcant debt maturities prior to 2012.

5. We ended the year with a record $767.4 million in cash, short term investments and
marketable securities at the holding company level, which provides us with excellent
protection against the unexpected.

As in the past few years, we have included segmented income statements and balance sheets in
the  MD&A  beginning  on  page  62.  As  you  will  note,  Fairfax’s  total  capital  of  $6.5  billion  is
invested approximately 15% in Northbridge, 23% in Crum & Forster, 3% in Fairfax Asia and
39% in OdysseyRe, for a total of 80% in our insurance and reinsurance operations (vs. 75%  in
2005). The remaining 20% is mainly in our Runoff operations.

9

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

The  table  below  shows  the  sources  of  our  net  earnings  with  Cunningham  Lindsey  equity
accounted. This table, like various others in this letter, is set out in a format which we have
consistently used and we believe assists you in understanding Fairfax.

Underwriting

Insurance – Canada (Northbridge)
– U.S.(Crum & Forster)
– Asia (Fairfax Asia)

Reinsurance (OdysseyRe)

Underwriting income (loss)
Interest and dividends

Operating income
Realized gains
Runoff and Other
Claims adjusting (Fairfax portion)
Interest expense
Corporate overhead and other

Pre-tax income (loss)
Income taxes
Non-controlling interests

Net earnings (loss)

2006

2005

20.5
86.2
14.5
77.0

198.2
559.0

757.2
683.7
(321.8)
–
(195.7)
(47.2)

876.2
(483.2)
(165.5)

68.2
(9.1)
4.8
(397.8)

(333.9)
345.4

11.5
324.1
(618.4)
5.4
(184.6)
(8.4)

(470.4)
68.9
(45.1)

227.5

(446.6)

The table shows the results from our insurance and reinsurance (underwriting and interest and
dividends),  Runoff  and  Other,  and  non-insurance  operations.  Runoff  and  Other  operations
include  the  U.S.  runoff  group,  the  European  runoff  group  and  our  participation  in  our
subsidiaries’ third party reinsurance programs and in selected third party reinsurance (referred
to  as  ‘‘Group  Re’’).  Claims  adjusting  shows  our  equity-accounted  share  of  Cunningham
Lindsey’s  after-tax  results.  Also  shown  separately  are  net  realized  gains  other  than  at  Runoff
and Other, so that you can better understand our earnings from our insurance and reinsurance
operations.  Underwriting  income  increased  to  record  levels  in  2006  –  we  have  never  before
made $198 million in underwriting proﬁt. With increased investment income (up 62%) from
higher interest rates and larger investment portfolios, operating income increased to a record
$757.2 million. This is in spite of not reaching for yield!

Net  realized  gains  other  than  at  Runoff  and  Other  increased  signiﬁcantly  in  2006  to
$683.7 million from $324.1 million in 2005. Runoff and Other lost $321.8 million due to the
Swiss Re commutation which cost $412.6 million. Excluding that commutation from Runoff
and  Other  results,  and  otherwise  as  explained  on  page  84  in  the  MD&A,  Runoff  and  Other
effectively achieved our objective of breaking even for the year.

Reserving

Our companies are all reserved well. We think that our reserving is the strongest it has been in
recent years, and we continue to work towards all of our operating companies achieving the
Northbridge ‘‘gold standard’’ – Northbridge has had an annual weighted average net reserve
redundancy of 2.8% for the last ten accident years. Please see Provision for Claims beginning
on page 90 in the MD&A for more details on our reserves.

As  we  said  last  year,  2001  and  prior  reserves  are  declining  –  they  are  now  only  19%  of  our
operating  company  reserves.  Due  to  the  commutation  of  Swiss  Re,  runoff  reserves  as  a
percentage of total net reserves increased a little to 29% at the end of 2006 from 26% at the end
of 2005.

10

Financial Position

Cash, short term investments and

marketable securities

Holding company debt
Subsidiary debt
Purchase consideration payable
Trust preferred securities of subsidiaries

Total debt

Net debt

Common shareholders’ equity
Preferred equity
Non-controlling interests

Total equity and non-controlling interests

Net debt/equity and non-controlling interests
Net debt/net total capital
Total debt/total capital
Interest coverage

2006

2005

767.4

559.0

1,202.6
981.3
179.2
17.9

1,365.3
933.2
192.1
52.4

2,381.0

2,543.0

1,613.6

1,984.0

2,720.3
136.6
1,292.9

2,507.6
136.6
751.4

4,149.8

3,395.6

38.9%
28.0%
36.5%
5.2x

58.4%
36.9%
42.8%
N/A

During 2006, as discussed earlier, cash, short term investments and marketable securities in the
holding  company  increased  to  record  levels.  Total  holding  company  debt  decreased  by
$210  million,  comprised  of  reductions  in  holding  company  debt  ($163  million),  trust
preferreds  ($34  million)  and  purchase  consideration  payable  ($13  million).  Subsidiary  debt
increased  by  $48  million  due  to  increased  net  debt  at  OdysseyRe  ($44  million)  and
Cunningham Lindsey ($4 million).

Net debt decreased signiﬁcantly to $1,613.6 million from $1,984.0 million, and our leverage
ratios also dropped signiﬁcantly. We expect this trend to continue. Given the high level of cash
in  the  holding  company,  the  previously  discussed  anticipated  signiﬁcant  reduction  in
European runoff’s cash requirements and the fact that Northbridge and OdysseyRe, as public
companies have their own access to capital, our ﬁnancial strength and ﬂexibility have again
increased signiﬁcantly in 2006.

Investments

The  table  below  shows  the  time-weighted  returns  (excluding  hedging) achieved  by  Hamblin
Watsa Investment Counsel (Fairfax’s wholly-owned investment manager) on stocks and bonds
managed  by  it  during  the  past  15  years  for  our  insurance  and  reinsurance  companies,
compared to the benchmark index in each case.

Common stocks
S&P 500

Bonds

Merrill Lynch U.S. corporate (1-10 year) index

5 Years

10 Years

15 Years

24.6%
6.2%

11.6%
5.5%

17.7%
8.4%

9.0%
6.5%

17.2%
10.6%

9.1%
6.7%

2006  was  another  very  good  year  for  Hamblin  Watsa’s  investment  results.  In  spite  of  our
caution about the U.S. markets, our long term results continue to be excellent. These results are
due to the outstanding investment management team that we have at Hamblin Watsa, led by
Roger  Lace,  Brian  Bradstreet,  Chandran  Ratnaswami  and  Sam  Mitchell.  With  the  beneﬁt  of
hindsight,  we  should  have  had  more  in  common  stocks  with  no  hedge!  Unfortunately,  we

11

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

continue to be very concerned about the U.S. economic environment and the U.S. ﬁnancial
markets.

We have highlighted those concerns for you for many years. Last year, we highlighted all the
risks we saw in the U.S. They have not changed and are as prevalent as they were a year ago. As
we  said,  the  many  and  varied  risks  ‘‘emanate  from  the  fact  that  we  have  had  the  longest
economic recovery with the shortest recession in living memory.’’ We continued, ‘‘We see all
the  signs  of  a  bubble  in  the  housing  market.’’ Currently,  we  are  seeing  a  reversal  of  the
speculation in the housing market, particularly in the sub-prime segment. As the inventory of
unsold homes has risen to record levels, house prices have come down and many originators of
sub-prime  mortgage  loans  have  gone  bankrupt.  One  mortgage  originator,  reﬂecting  on  his
company’s  bankruptcy,  said  ‘‘The  market  is  paying  me  to  do  a  no-income-veriﬁcation  loan
more than it is paying me to do the full documentation loans. What would you do?’’ We feel
the reversal of the U.S. housing markets has just begun and has a long way to go. In spite of
spectacular growth in China and India, both economies together account for only 7% of world
GDP vs. 20% for the U.S. consumer sector. We have learnt that when markets are optimistic
and not focusing on the downside, that is the time to be cautious. As Warren Buffett has said,
‘‘you pay a high price for a cheery consensus.’’

In  2006,  pretty  well  every  stock  market  in  the  world  had  a  high  double-digit  return.  Private
equity ﬁrms appear to be buying companies at almost any size and price. If stock markets do
not go higher in the next ﬁve years, the planned exit for private equity ﬁrms, particularly after
those ﬁrms’ very large fees, may not be there to provide the ﬁrms’ institutional investors with
an acceptable return.

The  markets  are  very  tuned  to  inﬂation  and  react  immediately  at  even  a  small  whiff  of  it.
However, as our friends from Hoisington Investment Management have said, since the fall of
the Berlin Wall in 1989, most of the world has become free and joined the world capitalistic
system  to  one  degree  or  another.  China,  India,  Russia  and  Latin  America  now  provide  huge
worldwide capacity for any commodity or product. Given this signiﬁcant production capacity,
inﬂation is unlikely to be the problem the world faces. It seems to us that we need to keep a
watch on the opposite side of the scale – deﬂation. Still early, but probably worth keeping an
eye on it.

Finally,  we  continue  to  worry  about  the  unprecedented  issuance  of  collateralized  bonds,
mortgages and loans (we hold none!). The assumption in the marketplace is that ‘‘structure’’
will  eliminate  or  signiﬁcantly  reduce  all  risks.  So  a  portfolio  of  100%  non-investment  grade
bonds,  sub-prime  mortgages  or  non-investment  grade  corporate  loans,  by  sophisticated
structuring, can transform into securities of which 80% or more are rated A or above. This has
resulted  in  thousands  of  collateralized  bond  issues  being  rated  AAA  while  fewer  than
10 corporations in the U.S. are AAA! We see an explosion coming but unfortunately cannot
predict when. As Grant’s Interest Rate Observer said in its December 15, 2006 issue, ‘‘Blame for
the distress at the fringes of subprime, we judge, cannot be laid at the feet of the U.S. economy.
It should, rather, attach to the lenders and borrowers who piled debt on debt until the ediﬁce
sways even in a dead calm.’’

Our concerns about the U.S. ﬁnancial markets are why we continue to protect our shareholders
from a 1 in 50 or 1 in 100 year event. With about half our equity exposure hedged against the
S&P 500 (there are some basis risks as our stock positions are worldwide), our investment of
$276 million  in  credit  default  swaps  (with  a  notional  value  of  $13.1  billion),  and
approximately 78% of our investment portfolios consisting of government bonds and cash, we
feel that we have effectively protected our investment portfolios from a potential (though low
probability) ﬁnancial market disaster.

Last  year,  we  gave  you  a  treatise  on  credit  default  swaps.  In  2006,  as  spreads  narrowed  even
further, we lost $87.1 million on these swaps! Since our original purchase, we have lost 74% of

12

our original investment of $276 million. Fortunately, these losses are predominantly only on a
mark-to-market  basis.  On  average,  we  still  have  four  years  left  on  the  swaps.  As  this  goes  to
press, spreads have begun to widen considerably and we have recouped some of our mark-to-
market losses. Also, we continued to maintain our S&P 500 hedges in 2006. Those hedges cost
us  $159.0  million  in  2006,  and  $296.0  million  cumulatively  since  2004.  However,  if  not  for
those  hedges,  we  would  not  feel  comfortable  having  approximately  $2.3  billion  in  equities.
Some of you have wondered – sometimes loudly – why we bother with these hedges and credit
default swaps. Besides our comfort in having this protection, we continue to think that this
insurance policy may pay dividends – perhaps sooner than you think!

In spite of the headwind from S&P 500 hedges and credit default swaps, our investments had a
tremendous  year  in  2006.  Gross  realized  gains  in  2006  (excluding  the  realized  gain  of
$69.7  million  on  the  OdysseyRe  secondary  offering)  totaled  $1,093.3  million.  After  realized
losses  of  $289.9  million  (including  $251.0  million  of  losses,  including  mark-to-market
adjustments recorded as realized losses, related to the company’s economic hedges against a
decline  in  the  equity  markets  and  other  derivatives  in  the  company’s  investment  portfolio,
primarily credit default swaps and bond warrants), provisions of $37.8 million, and other one-
time adjustments noted on page 120 in the MD&A, net realized gains were $789.4 million. Net
gains from ﬁxed income securities were $207.7 million (after $92.0 million of mark-to-market
losses on credit default swaps and bond warrants), while net gains from common stocks and
other  derivatives  were  $509.2  million  (after  $159.0  million  of  mark-to-market  losses  on  our
equity hedges).

The principal contributors to bond realized gains were Level 3 ($121 million, a gain of 26%)
and  Calpine  ($46  million,  a  gain  of  34%),  and  the  principal  contributors  to  common  stock
gains were ICICI Bank ($283 million, a gain of 204%), Zenith National ($137 million, a gain of
243%),  Hindustan  Lever  ($72  million,  a  gain  of  50%),  Merck  ($65  million,  a  gain  of  18%),
DirectTV ($44 million, a gain of 46%) and GSW ($19 million, a gain of 552%). Our total gains
from the sale of the Zenith National shares which we purchased in 1998 were $339 million,
due to the tremendous performance of Stanley Zax, Zenith’s long-serving CEO. Our cumulative
net  gains  from  investing  in  India  now  total  over  $500  million,  and  from  investing  outside
North America and Europe (including India), over $1 billion. Chandran Ratnaswami has taken
a leadership role in these investments since he joined us in 1995 and you can see why we are
very happy he did!

Our net unrealized gains (losses) by asset class at year-end were as follows:

Bonds
Preferred stocks
Common stocks
Strategic investments*
Real estate

2006

2005

(132.6)
3.2
229.7
208.9
1.4

(89.0)
0.8
431.1
214.7
0.8

310.6

558.4

* Hub International, ICICI Lombard and Advent and, in 2005, Zenith National

In spite of our generally cautious views on stock markets, we do own some common stocks that
ﬁt our long term value-oriented philosophy. Here are our common stock investments broken

13

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

down by country. As mentioned earlier, approximately 55% of our common stock position (at
market value) is protected through equity hedges.

United States
Canada
Other

Miscellaneous

Carrying Value

Market Value

1,106.5
496.2
484.6

2,087.3

1,167.2
595.1
554.7

2,317.0

For several years we have paid a nominal annual dividend between $1 to $2 per share. This
year,  we  paid  $2.75  per  share,  partly  as  a  sign  of  conﬁdence  in  the  future  resulting  from
positive developments in 2006, and partly to reﬂect a minor change in our dividend policy.
Under  this  policy,  we  will  review  the  circumstances  prevailing  at  the  end  of  each  year  and
determine  whether  those  circumstances  warrant  an  extra  dividend  payment  beyond  the
nominal  $1  to  $2  per  share.  Our  dividend  continues  to  be  modest  as  a  percentage  of  book
value.

One  major  strength  that  we  have  at  Fairfax  is  a  small  group  of  hardworking,  team-oriented
ofﬁcers who work together with no ego. Going forward, we have reorganized the group a little
more  formally.  Brad  Martin  has  become  our  Chief  Operating  Ofﬁcer,  responsible  for
monitoring  all  our  operations;  all  the  ﬁnancial  functions  report  to  Greg  Taylor,  our  Chief
Financial  Ofﬁcer;  and  all  the  actuarial  functions  report  to  Jean  Cloutier,  our  Chief  Actuary.
Peter  Clarke  is  now  our  Chief  Risk  Ofﬁcer,  David  Bonham  is  our  Vice  President,  Financial
Reporting  and  Paul  Rivett,  in  addition  to  being  a  Fairfax  ofﬁcer,  has  become  the  Chief
Operating  Ofﬁcer  of  Hamblin  Watsa  Investment  Counsel.  He,  by  the  way,  is  responsible  for
leading our efforts on our lawsuit against certain hedge funds and others (more on that below).
Rick Salsberg, who best embodies the qualities of a Fairfax ofﬁcer, continues as our consigliere.
Our ofﬁcer group, which has been responsible for our past success and will deﬁnitely be the
reason for our future success, is what makes Fairfax so special.

In  July  2006,  we  ﬁled  a  lawsuit  against  certain  hedge  funds  and  others.  As  I  have  said
previously, we have absolutely no problem with short selling or short sellers generally. Short
selling can be a valid and appropriate component of an investment or hedging strategy. In fact,
we  currently  have  short  positions  in  our  portfolio.  However,  using  manipulation  and
intimidation, as we have alleged, for proﬁt or otherwise, should never be tolerated. This is only
the second lawsuit that we have commenced in our 21 years. You may remember that in the
ﬁrst one we alleged illegal market manipulation in the insurance business in London, England,
and that we pursued that case to the end and won a total victory.

We are very pleased to welcome Bob Gunn and David Johnston to our Board of Directors. Bob
served as the CEO and COO of Royal & SunAlliance plc in London, England, and before that
had  been  the  President  and  CEO  of  Royal  &  SunAlliance  Canada  for  more  than  ten  years.
David has been the President and Vice-Chancellor of the University of Waterloo since 1999,
and earlier had been the Principal and Vice-Chancellor of McGill University for about 15 years.
We also want to thank Frank Bennett for his strong support of our company, and we wish him
well as he retires from our Board.

We will very much look forward to seeing you at the annual meeting in Toronto at 9:30 a.m.
on  Wednesday,  April  18,  2007  in  the  Glenn  Gould  Studio  at  the  Canadian  Broadcasting
Centre, 250 Front Street West.

14

I want to again highlight our website for you (www.fairfax.ca) and remind you that all of our
annual  reports  since  1985  are  available  there,  as  well  as  our  corporate  governance
documentation and links to the informative websites of our various operating companies. Our
press releases and published ﬁnancial statements are posted to our website immediately upon
issuance.

I would like to thank the Board and the management and employees of all our companies for
their  outstanding  efforts  during  2006.  We  look  forward  to  continuing  to  build  shareholder
value for you over the long term.

March 9, 2007

V. Prem Watsa
Chairman and Chief Executive Ofﬁcer

15

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

Management’s Responsibility for the Financial Statements

The  preparation  and  presentation  of  the  accompanying  consolidated  ﬁnancial  statements,
Management’s  Discussion  and  Analysis  (‘‘MD&A’’)  and  all  ﬁnancial  information  are  the
responsibility of management and have been approved by the Board of Directors.

The  consolidated  ﬁnancial  statements  have  been  prepared  in  accordance  with  Canadian
generally accepted accounting principles. Financial statements, by nature, are not precise since
they include certain amounts based upon estimates and judgments. When alternative methods
exist, management has chosen those it deems to be the most appropriate in the circumstances.

We, as Fairfax’s Chief Executive Ofﬁcer and Chief Financial Ofﬁcer, will certify Fairfax’s annual
disclosure  document  ﬁled  with  the  SEC  (Form  40-F)  in  accordance  with  the  United  States
Sarbanes-Oxley Act of 2002.

The Board of Directors is responsible for ensuring that management fulﬁlls its responsibilities
for  ﬁnancial  reporting  and  is  ultimately  responsible  for  reviewing  and  approving  the
consolidated ﬁnancial statements. The Board carries out this responsibility principally through
its Audit Committee which is independent from management.

The  Audit  Committee  is  appointed  by  the  Board  of  Directors  and  reviews  the  consolidated
ﬁnancial  statements  and  MD&A;  considers  the  report  of  the  external  auditors;  assesses  the
adequacy  of  the  internal  controls  of  the  company,  including  management’s  assessment
described  below;  examines  the  fees  and  expenses  for  audit  services;  and  recommends  to  the
Board  the  independent  auditors  for  appointment  by  the  shareholders.  The  independent
auditors  have  full  and  free  access  to  the  Audit  Committee  and  meet  with  it  to  discuss  their
audit work, Fairfax’s internal control over ﬁnancial reporting and ﬁnancial reporting matters.
The Audit Committee reports its ﬁndings to the Board for consideration when approving the
consolidated  ﬁnancial  statements  for  issuance  to  the  shareholders  and  management’s
assessment of the internal control over ﬁnancial reporting.

Management’s Report on Internal Control over Financial Reporting

Management  is  responsible  for  establishing  and  maintaining  adequate  internal  control  over
ﬁnancial reporting.

Management  has  assessed  the  effectiveness  of  the  company’s  internal  control  over  ﬁnancial
reporting as of December 31, 2005 using criteria established in Internal Control – Integrated
Framework  issued  by  the  Committee  of  Sponsoring  Organizations  of  the  Treadway
Commission (‘‘COSO’’). A material weakness is a control deﬁciency or combination of control
deﬁciencies that results in more than a remote likelihood that a material misstatement of the
annual or interim ﬁnancial statements will not be prevented or detected.

During 2006 the company restated its consolidated ﬁnancial statements as at and for the years
ended December 31, 2001 through 2005 and all related disclosures including interim periods
therein.  In  connection  with  the  restatement,  the  company’s  management  identiﬁed  four
material  weaknesses  in  its  internal  control  over  ﬁnancial  reporting  relating  to  ﬁnancial
reporting  organizational  structure  and  personnel,  head  ofﬁce  consolidation  controls,
investment accounting in accordance with US GAAP and accounting for income taxes. As of
December  31,  2006  and  as  described  under  Remediation  of  Material  Weaknesses  in  Internal
Control Over Financial Reporting below, the two material weaknesses relating to investment
accounting  in  accordance  with  US  GAAP  and  accounting  for  income  taxes  had  been
remediated, and the material weaknesses relating to a sufﬁcient complement of personnel and
lines of communication within the organization and certain head ofﬁce consolidation controls
had not been remediated.

16

As  of  December  31,  2006,  the  following  two  material  weaknesses  have  been identiﬁed  and
included in management’s assessment:

1.

2.

The company did not maintain a sufﬁcient complement of accounting personnel to
support  the  activities  of  the  company  and  lines  of  communication  between  the
company’s operations and accounting and ﬁnance personnel at head ofﬁce and the
subsidiaries were not adequate to raise issues to the appropriate level of accounting
personnel.  Further,  the  company  did  not  maintain  personnel  with  an  appropriate
level  of  accounting  knowledge,  experience  and  training  to  support  the  size  and
complexity of the organization and its ﬁnancial reporting requirements. This control
deﬁciency contributed to the other material weaknesses identiﬁed.

The  company  did  not  maintain  effective  controls  over  the  completeness  and
accuracy  of  period-end  ﬁnancial  reporting  and  period-end  close  processes  at  the
Fairfax  head  ofﬁce  consolidation  level.  Speciﬁcally,  the  company  did  not  maintain
effective  review  and  monitoring  processes  and  documentation  relating  to  the
(i)  recording  of  recurring  and  non-recurring  journal  entries  and  (ii)  translation  of
foreign currency transactions and subsidiary company results.

Each  of  the  control  deﬁciencies  described  above  could  result  in  misstatements  of  any  of  the
company’s  ﬁnancial  statement  accounts  and  disclosures  that  would  result  in  a  material
misstatement  to  the  annual  or  interim  consolidated  ﬁnancial  statements  that  would  not  be
prevented  or  detected.  Accordingly,  management  has  determined  that  each  of  the  control
deﬁciencies constitutes a material weakness.

Management’s assessment of the effectiveness of the company’s internal control over ﬁnancial
reporting  as  of  December  31,  2006  has  been  audited  by  PricewaterhouseCoopers  LLP,  an
independent registered public accounting ﬁrm, as stated in its report which appears herein.

March 9, 2007

V. Prem Watsa
Chairman and Chief Executive Ofﬁcer

Greg Taylor
Vice President and Chief Financial Ofﬁcer

17

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

Auditors’ Report

To the Shareholders of Fairfax Financial Holdings Limited

We  have  completed  integrated  audits  of  Fairfax  Financial  Holdings  Limited’s  December  31,
2006,  2005  and  2004  consolidated  ﬁnancial  statements  and  of  its  internal  control  over
ﬁnancial reporting as of December 31, 2006. Our opinions, based on our audits, are presented
below.

Consolidated ﬁnancial statements

We have audited the accompanying consolidated balance sheets of Fairfax Financial Holdings
Limited  as  of  December  31,  2006  and  2005,  and  the  related  consolidated  statements  of
earnings, shareholders’ equity and cash ﬂows for each of the three years in the period ended
December  31,  2006.  These  ﬁnancial  statements  are  the  responsibility  of  the  company’s
management. Our responsibility is to express an opinion on these ﬁnancial statements based
on our audits.

We conducted our audits of the company’s ﬁnancial statements as of December 31, 2006 and
2005  and  for  each  of  the  three  years  in  the  period  ended  December  31,  2006  in  accordance
with Canadian generally accepted auditing standards and the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan and perform
an  audit  to  obtain  reasonable  assurance  about  whether  the  ﬁnancial  statements  are  free  of
material  misstatement.  An  audit  of  ﬁnancial  statements  includes  examining,  on  a  test  basis,
evidence  supporting  the  amounts  and  disclosures  in  the  ﬁnancial  statements.  A  ﬁnancial
statement audit also includes assessing the accounting principles used and signiﬁcant estimates
made by management, and evaluating the overall ﬁnancial statement presentation. We believe
that our audit provides a reasonable basis for our opinion.

In  our  opinion,  the  consolidated  ﬁnancial  statements  referred  to  above  present  fairly,  in  all
material respects, the ﬁnancial position of the company as of December 31, 2006 and 2005 and
the results of its operations and its cash ﬂows for each of the three years in the period ended
December 31, 2006 in accordance with Canadian generally accepted accounting principles.

Internal control over ﬁnancial reporting

We have also audited management’s assessment, included in Management’s Report on Internal
Control over Financial Reporting, that the company did not maintain effective internal control
over ﬁnancial reporting as of December 31, 2006, because of the material weaknesses referred
to below, based on criteria established in Internal Control – Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO). The company’s
management is responsible for maintaining effective internal control over ﬁnancial reporting
and  for  its  assessment  of  the  effectiveness  of  internal  control  over  ﬁnancial  reporting.  Our
responsibility is to express opinions on management’s assessment and on the effectiveness of
the company’s internal control over ﬁnancial reporting based on our audit.

We  conducted  our  audit  of  internal  control  over  ﬁnancial  reporting  in  accordance  with  the
standards of the Public Company Accounting Oversight Board (United States). Those standards
require  that  we  plan  and  perform  the  audit  to  obtain  reasonable  assurance  about  whether
effective internal control over ﬁnancial reporting was maintained in all material respects. An
audit  of  internal  control  over  ﬁnancial  reporting  includes  obtaining  an  understanding  of
internal  control  over  ﬁnancial  reporting,  evaluating  management’s  assessment,  testing  and
evaluating  the  design  and  operating  effectiveness  of  internal  control,  and  performing  such
other  procedures  as  we  consider  necessary  in  the  circumstances.  We  believe  that  our  audit
provides a reasonable basis for our opinions.

18

A  company’s  internal  control  over  ﬁnancial  reporting  is  a  process  designed  to  provide
reasonable  assurance  regarding  the  reliability  of  ﬁnancial  reporting  and  the  preparation  of
ﬁnancial statements for external purposes in accordance with generally accepted accounting
principles. A company’s internal control over ﬁnancial reporting includes those policies and
procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately
and  fairly  reﬂect  the  transactions  and  dispositions  of  the  assets  of  the  company;  (2)  provide
reasonable  assurance  that  transactions  are  recorded  as  necessary  to  permit  preparation  of
ﬁnancial  statements  in  accordance  with  generally  accepted  accounting  principles,  and  that
receipts  and  expenditures  of  the  company  are  being  made  only  in  accordance  with
authorizations  of  management  and  directors  of  the  company;  and  (3)  provide  reasonable
assurance  regarding  prevention  or  timely  detection  of  unauthorized  acquisition,  use,  or
disposition  of  the  company’s  assets  that  could  have  a  material  effect  on  the  ﬁnancial
statements.

Because of its inherent limitations, internal control over ﬁnancial reporting may not prevent or
detect misstatements. Also, projections of any evaluation of effectiveness to future periods are
subject to the risk that controls may become inadequate because of changes in conditions, or
that the degree of compliance with the policies or procedures may deteriorate.

A material weakness is a control deﬁciency, or combination of control deﬁciencies, that results
in  more  than  a  remote  likelihood  that  a  material  misstatement  of  the  annual  or  interim
ﬁnancial statements will not be prevented or detected. The following material weaknesses have
been identiﬁed and included in management’s assessment:

1.

2.

The company did not maintain a sufﬁcient complement of accounting personnel to
support  the  activities  of  the  company  and  lines  of  communication  between  the
company’s operations and accounting and ﬁnance personnel at head ofﬁce and the
subsidiaries were not adequate to raise issues to the appropriate level of accounting
personnel.  Further,  the  company  did  not  maintain  personnel  with  an  appropriate
level  of  accounting  knowledge,  experience  and  training  to  support  the  size  and
complexity of the organization and its ﬁnancial reporting requirements. This control
deﬁciency contributed to the other material weakness identiﬁed.

The  company  did  not  maintain  effective  controls  over  the  completeness  and
accuracy  of  period-end  ﬁnancial  reporting  and  period-end  close  processes  at  the
Fairfax  head  ofﬁce  consolidation  level.  Speciﬁcally,  the  company  did  not  maintain
effective  review  and  monitoring  processes  and  documentation  relating  to  the
(i)  recording  of  recurring  and  non-recurring  journal  entries,  and  (ii)  translation  of
foreign currency transactions and subsidiary company results.

Each  of  these  control  deﬁciencies  could  result  in  misstatements  of  the  company’s  ﬁnancial
statement accounts and disclosures that would result in a material misstatement to the annual
consolidated  ﬁnancial  statements  that  would  not  be  prevented  or  detected.  These  material
weaknesses  were  considered  in  determining  the  nature,  timing,  and  extent  of  audit  tests
applied in our audit of the 2006 consolidated ﬁnancial statements, and our opinion regarding
the effectiveness of the company’s internal control over ﬁnancial reporting does not affect our
opinion on those consolidated ﬁnancial statements.

In  our  opinion,  management’s  assessment  that  the  company  did  not  maintain  effective
internal control over ﬁnancial reporting as of December 31, 2006 is fairly stated, in all material
respects, based on criteria established in Internal Control – Integrated Framework issued by the
COSO. Furthermore, in our opinion because of the effects of the material weaknesses described
above  on  the  achievement  of  the  objectives  of  the  control  criteria,  the  company  has  not

19

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

maintained effective internal control over ﬁnancial reporting as of December 31, 2006 based
on criteria established in Internal Control – Integrated Framework issued by the COSO.

Chartered Accountants
Toronto, Ontario

March 9, 2007

Comment by Auditors for United States Readers on Canada – United States
Accounting Differences

Accounting principles generally accepted in Canada  vary in certain signiﬁcant respects from
accounting principles generally accepted in the United States of America. Information related
to the nature and effect of such differences is presented in note 20 to the consolidated ﬁnancial
statements.

Chartered Accountants
Toronto, Ontario

March 9, 2007

Valuation Actuary’s Report

I  have  reviewed  management’s  valuation,  including  management’s  selection  of  appropriate
assumptions and methods, of the policy liabilities of the subsidiary insurance and reinsurance
companies  of  Fairfax  Financial  Holdings  Limited  in  its  consolidated  balance  sheet  as  at
December 31, 2006 and their change as reﬂected in its consolidated statement of earnings for
the year then ended, in accordance with Canadian accepted actuarial practice.

In  my  opinion,  management’s  valuation  is  appropriate,  except  as  noted  in  the  following
paragraph, and the consolidated ﬁnancial statements fairly present its results.

Under Canadian accepted actuarial practice, the valuation of policy liabilities reﬂects the time
value  of  money.  Management  has  chosen  not  to  reﬂect  the  time  value  of  money  in  its
valuation of the policy liabilities.

Richard Gauthier, FCIA, FCAS
PricewaterhouseCoopers LLP
Toronto, Canada
February 20, 2007

20

Consolidated Financial Statements

Consolidated Balance Sheets
as at December 31, 2006 and 2005

Assets
Cash, short term investments and marketable securities
Accounts receivable and other
Recoverable from reinsurers (including recoverables on paid

losses – $395.4; 2005 – $535.3)

Portfolio investments
Subsidiary cash and short term investments (market value –

$5,432.0; 2005 – $4,526.3)

Bonds (market value – $8,811.4; 2005 – $8,038.4)
Preferred stocks (market value – $19.6; 2005 – $16.6)
Common stocks (market value – $2,317.0; 2005 – $2,514.5)
Strategic investments (market value – $546.8; 2005 – $455.3)
Real estate (market value – $19.4; 2005 – $18.0)

2006

2005

(US$ millions)

767.4
1,892.8

559.0
2,380.4

5,506.5

7,655.7

8,166.7

10,595.1

5,432.0
8,944.0
16.4
2,087.3
337.9
18.0

4,526.3
8,127.4
15.8
2,083.4
240.6
17.2

Total (market value – $17,146.2; 2005 – $15,569.1)

16,835.6

15,010.7

Deferred premium acquisition costs
Future income taxes
Premises and equipment
Goodwill
Other assets

See accompanying notes.

Signed on behalf of the Board

369.0
771.3
86.0
239.2
108.7

385.1
1,118.8
95.7
228.4
108.2

26,576.5

27,542.0

Director

Director

21

2006
(US$ millions)

2005

68.2
1,091.2
783.3
370.0

63.9
1,167.3
700.3
1,054.4

2,312.7

2,985.9

15,502.3
2,298.9
1,202.6
913.1
179.2
17.9

16,235.1
2,446.3
1,365.3
869.3
192.1
52.4

20,114.0

21,160.5

1,292.9

751.4

2,071.9
57.9
(18.3)
136.6
596.6
12.2

2,079.6
59.4
(17.3)
136.6
405.6
(19.7)

2,856.9

2,644.2

26,576.5

27,542.0

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

Liabilities
Subsidiary indebtedness
Accounts payable and accrued liabilities
Securities sold but not yet purchased
Funds withheld payable to reinsurers

Provision for claims
Unearned premiums
Long term debt – holding company borrowings
Long term debt – subsidiary company borrowings
Purchase consideration payable
Trust preferred securities of subsidiaries

Non-controlling interests

Contingencies and commitments (note 13)
Shareholders’ Equity
Common stock
Other paid in capital
Treasury stock, at cost
Preferred stock
Retained earnings
Currency translation account

See accompanying notes.

22

Consolidated Statements of Earnings
for the years ended December 31, 2006, 2005 and 2004

Revenue

Gross premiums written

Net premiums written

Net premiums earned
Interest and dividends
Realized gains on investments
Realized gain on secondary offering
Claims fees

Expenses

Losses on claims
Operating expenses
Commissions, net
Interest expense

Earnings (loss) from operations before income

taxes

Provision for (recovery of) income taxes

Net earnings (loss) before non-controlling

interests

Non-controlling interests

Net earnings (loss)

Net earnings (loss) per share
Net earnings (loss) per diluted share
Cash dividends paid per share

See accompanying notes.

2006

2005

2004

(US$ millions except
per share amounts)

5,460.6

5,559.1

5,603.1

4,763.7

4,694.6

4,785.7

4,850.6
746.5
765.6
69.7
371.3

4,692.5
466.1
385.7
–
356.2

4,804.3
375.7
273.5
40.1
336.1

6,803.7

5,900.5

5,829.7

3,822.4
1,111.6
780.7
210.4

4,370.9
1,059.7
736.0
200.4

3,507.5
1,030.6
827.3
176.7

5,925.1

6,367.0

5,542.1

878.6
485.6

(466.5)
(66.3)

287.6
154.9

393.0
(165.5)

(400.2)
(46.4)

132.7
(79.6)

227.5

(446.6)

$ 12.17
$ 11.92
1.40
$

$ (27.75)
$ (27.75)
1.40
$

$
$
$

53.1

3.11
3.11
1.40

23

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

Consolidated Statements of Shareholders’ Equity
for the years ended December 31, 2006, 2005 and 2004

Common stock –
Subordinate voting shares – beginning of year
Issuances during the year
Purchases during the year

Subordinate voting shares – end of year

Multiple voting shares – beginning and end of

year

Common stock

Other paid in capital – beginning of year
Purchases of convertible senior debenture

Other paid in capital – end of year

Treasury shares (at cost) – beginning of

year

Purchases during the year
Reissuances during the year

Treasury shares (at cost) – end of year

Preferred stock –
Series A – beginning of year
Conversion to Series B preferred shares

Series A – end of year

Series B – beginning of year
Conversion from Series A preferred shares

Series B – end of year

Preferred stock

Retained earnings – beginning of year
Net earnings (loss) for the year
Excess over stated value of shares purchased

for cancellation

Common share dividends
Preferred share dividends

Retained earnings – end of year

Currency translation account – beginning

of year

Foreign exchange impact from foreign
currency denominated net assets

Currency translation account – end of

year

2006

2005
(US$ millions)

2004

2,075.8
–
(7.7)

2,068.1

1,783.1
299.8
(7.1)

2,075.8

1,511.3
299.7
(27.9)

1,783.1

3.8

3.8

3.8

2,071.9

2,079.6

1,786.9

59.4
(1.5)

57.9

(17.3)
(2.1)
1.1

(18.3)

51.2
–

51.2

85.4
–

85.4

136.6

405.6
227.5

–
(25.1)
(11.4)

596.6

59.4
–

59.4

(17.4)
(1.2)
1.3

(17.3)

51.2
–

51.2

85.4
–

85.4

136.6

862.3
(446.6)

(0.3)
–
(9.8)

405.6

62.7
(3.3)

59.4

(18.7)
(7.8)
9.1

(17.4)

136.6
(85.4)

51.2

–
85.4

85.4

136.6

865.0
53.1

(3.6)
(42.1)
(10.1)

862.3

(19.7)

(26.1)

(96.8)

31.9

12.2

6.4

70.7

(19.7)

(26.1)

Total shareholders’ equity

2,856.9

2,644.2

2,801.7

24

Number of shares outstanding
Common stock –
Subordinate voting shares – beginning of year
Issuances during the year
Purchases during the year
Net treasury shares reissued (acquired)

Subordinate voting shares – end of year
Multiple voting shares – beginning and end of

2006

2005
(US$ millions)

2004

17,056,856
–
(67,800)
(7,086)

15,260,625
1,843,318
(49,800)
2,713

13,085,210
2,406,741
(215,200)
(16,126)

16,981,970

17,056,856

15,260,625

year

1,548,000

1,548,000

1,548,000

Interest in shares held through ownership

interest in shareholder

(799,230)

(799,230)

(799,230)

Common stock effectively outstanding – end

of year

17,730,740

17,805,626

16,009,395

Preferred stock –
Series A – beginning of year
Conversion to Series B preferred shares

3,000,000
–

3,000,000
–

8,000,000
(5,000,000)

Series A – end of year

3,000,000

3,000,000

3,000,000

Series B – beginning of year
Conversion from Series A preferred shares

5,000,000
–

5,000,000
–

–
5,000,000

Series B – end of year

5,000,000

5,000,000

5,000,000

See accompanying notes.

25

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

Consolidated Statements of Cash Flows
for the years ended December 31, 2006, 2005 and 2004

Operating activities

Earnings (loss) before non-controlling interests
Amortization
Bond discount amortization
Equity (earnings) losses on strategic investments
Future income taxes
Loss on signiﬁcant commutations
Gains on investments

Changes in:

Provision for claims
Unearned premiums
Accounts receivable and other
Recoverable from reinsurers
Funds withheld payable to reinsurers
Accounts payable and accrued liabilities
Other

Cash provided by operating activities

Investing activities

Investments – purchases

– sales

Sale (purchase) of marketable securities
Sale of Zenith National shares
Purchase of Advent shares
Purchase of ICICI Lombard shares
Purchase of premises and equipment
Purchase of subsidiaries, net of cash
Net proceeds on secondary offering
Disposition of Cunningham Lindsey TPA business

2006

2005

2004

(US$ millions)

393.0
24.9
(67.9)
(16.0)
375.2
412.6
(835.3)

286.5

(741.2)
(150.5)
555.6
1,154.2
(97.5)
(102.0)
(22.1)

883.0

(3,971.3)
3,866.7
51.3
193.8
(28.7)
(27.4)
(13.2)
–
337.6
–

(400.2)
26.2
(28.2)
39.0
(151.8)
103.1
(385.7)

(797.6)

974.9
28.9
4.7
437.1
18.6
(58.8)
4.0

611.8

132.7
40.7
(15.7)
9.6
77.5
–
(313.6)

(68.8)

311.6
(127.0)
(36.9)
301.7
(76.5)
(287.5)
85.3

101.9

(6,198.2)
5,503.7
(263.4)
218.5
(34.1)
–
(20.5)
(52.0)
–
–

(6,883.2)
4,610.9
1.4
127.6
–
–
(37.0)
(33.7)
104.8
(22.2)

Cash provided by (used in) investing activities

408.8

(846.0)

(2,131.4)

Financing activities

Subordinate voting shares issued
Subordinate voting shares repurchased
Purchase of treasury shares
Trust preferred securities of subsidiary repurchased
Non-controlling interests
Long term debt – repayment

Holding company
Subsidiary company

Long term debt – issuances

Holding company
Subsidiary company

Purchase consideration payable
Subsidiary indebtedness
Common share dividends
Preferred share dividends

Cash provided by (used in) ﬁnancing activities

Foreign currency translation

Increase (decrease) in cash resources
Cash resources – beginning of year

Cash resources – end of year

See accompanying notes.

–
(7.7)
(2.1)
(29.2)
–

(115.7)
(59.3)

–
140.0
(14.5)
4.3
(25.1)
(11.4)

(120.7)

2.3

299.8
(7.4)
(1.2)
–
112.4

(50.7)
(34.2)

–
125.0
(3.1)
(25.3)
(22.5)
(9.8)

383.0

11.9

299.7
(31.5)
(7.8)
(27.4)
–

(240.2)
–

308.6
–
(5.4)
71.5
(19.5)
(10.1)

337.9

17.0

1,173.4
4,590.4

5,763.8

160.7
4,429.7

4,590.4

(1,674.6)
6,104.3

4,429.7

Cash resources consist of cash and short term investments, including subsidiary cash and short term
investments, and excludes $208.4 ($216.4 at December 31, 2005; $169.7 at December 31, 2004) of
subsidiary cash and short term investments pledged for securities sold but not yet purchased, which is
restricted. Short term investments are readily convertible into cash and have maturities of three months
or less.

26

Notes to Consolidated Financial Statements
for the years ended December 31, 2006, 2005 and 2004

(in US$ millions except per share amounts and as otherwise indicated)

1. Business Operations
The  company  is  a  ﬁnancial  services  holding  company  which,  through  its  subsidiaries,  is
principally  engaged  in  property  and  casualty  insurance  and  reinsurance,  investment
management and insurance claims management.

2. Summary of Signiﬁcant Accounting Policies
The preparation of consolidated ﬁnancial statements in accordance with Canadian generally
accepted  accounting  principles  (‘‘GAAP’’)  requires  management  to  make  estimates  and
assumptions that affect reported amounts of assets and liabilities and disclosures of contingent
assets and liabilities as at the date of the consolidated ﬁnancial statements and the reported
amounts  of  revenue  and  expenses  during  the  reporting  periods  covered  by  the  ﬁnancial
statements. The principal ﬁnancial statement components subject to measurement uncertainty
include  other-than-temporary  declines  in  the  value  of  investments  (note  4),  goodwill,  the
provision  for  claims  (note  5),  the  allowance  for  unrecoverable  reinsurance  (note  7)  and  the
carrying value of future tax assets (note 11). Actual results could differ from those estimates.

Principles of consolidation
The  consolidated  ﬁnancial  statements  include  the  accounts  of  the  company  and  all  of  its
subsidiaries at December 31, 2006:

Canadian Insurance

Reinsurance

Northbridge Financial Corporation

Odyssey Re Holdings Corp. (OdysseyRe)

(Northbridge)

U.S. Insurance

Crum & Forster Holdings Corp. (C&F)

Asian Insurance

Fairfax Asia consists of:

Falcon Insurance Company Limited

First Capital Insurance Limited

ICICI Lombard General Insurance

Company Limited
(26.0% interest) (ICICI Lombard)

Other

Runoff and Other

U.S. runoff consists of:

TIG Insurance Company (TIG)

Fairmont Specialty Group (Fairmont)

European runoff consists of:

nSpire Re Limited (nSpire Re)

(excluding Group Re)

RiverStone Insurance (UK) Limited

(RiverStone (UK))

RiverStone Managing Agency

Syndicate 3500

Hamblin Watsa Investment Counsel Ltd.
(Hamblin Watsa) (investment management)

Group Re underwrites business in:

CRC (Bermuda) Reinsurance Limited

Cunningham Lindsey Group Inc.
(Cunningham Lindsey) (insurance
claims management)

(CRC (Bermuda))

Wentworth Insurance Company Ltd.

(Wentworth)

nSpire Re

All subsidiaries are wholly-owned except for OdysseyRe with a 59.6% interest (2005 – 80.1%;
2004 – 80.8%), Northbridge with a 59.2% interest (2005 and 2004 – 59.2%) and Cunningham
Lindsey with an 81.0% interest (2005 – 81.0%; 2004 – 75.0%). Strategic investments, which are
accounted  for  on  the  equity  basis,  include  the  company’s  investments  in  Hub  International
Limited  (‘‘Hub’’)  with  a  26.1%  interest  (2005  –  25.9%;  2004  –  26.1%),  Advent  Capital
(Holdings) PLC (‘‘Advent’’) with a 44.5% interest (2005 and 2004 – 46.8%), and ICICI Lombard

27

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

with  a  26.0%  (2005  and  2004  –  26.0%).  During  2006,  the  company  sold  its  10.3%  (2005  –
14.1%  sold;  2004  –  17.6%  sold)  interest  in  Zenith  National  Insurance  Corp.  (‘‘Zenith
National’’) which previously was included in strategic investments on the cost basis.

Acquisitions  are  accounted  for  by  the  purchase  method,  whereby  the  results  of  acquired
companies are included only from the date of acquisition. Divestitures are included up to the
date of disposal.

Premiums
Insurance  and  reinsurance  premiums  are  taken  into  income  evenly  throughout  the  terms  of
the related policies after deductions for premiums to reinsurers.

Deferred premium acquisition costs
Certain  costs  of  acquiring  insurance  premiums,  consisting  of  brokers’  commissions  and
premium taxes are deferred, to the extent that they are considered recoverable, and charged to
income  as  the  premiums  are  earned.  The  ultimate  recoverability  of  deferred  premium
acquisition costs is determined without regard to investment income.

Investments
Investment  transactions  are  recorded  on  their  trade  date  with  balances  pending  settlement
reﬂected in the balance sheet in accounts receivable and other or accounts payable and accrued
liabilities.

Bonds are carried at amortized cost providing for the amortization of the discount or premium
on  a  yield  to  maturity  basis.  Preferred  and  common  stocks  are  carried  at  cost.  Real  estate  is
carried  at  cost.  When  there  has  been  a  loss  in  value  of  an  investment  that  is  other  than
temporary,  the  investment  is  written  down  to  its  estimated  net  realizable  value.  Such
writedowns are reﬂected in realized gains (losses) on investments.

Securities sold but not yet purchased
Securities sold but not yet purchased represent obligations to deliver securities which were not
owned at the time of the sale. These obligations are carried at fair value with changes in fair
value recorded in realized gains (losses) on investments.

Derivative ﬁnancial instruments
The company uses derivatives to mitigate ﬁnancial risks arising principally from its investment
holdings and receivables. Derivatives that are not speciﬁcally designated or that do not meet
the  requirements  for  hedge  accounting  are  carried  at  fair  value  on  the  consolidated  balance
sheet  and  changes  in  fair  value  are  recorded  in  realized  gains  on  investments  in  the
consolidated  statement  of  earnings.  All  derivatives  are  monitored  by  the  company  for
effectiveness in achieving their risk management objectives. During 2006, 2005 and 2004, the
company did not designate any derivatives as accounting hedges.

Provision for claims
Claim provisions are established by the case method as claims are reported. For reinsurance,
the provision for claims is based on reports and individual case estimates received from ceding
companies. The estimates are regularly reviewed and updated as additional information on the
estimated claims becomes known and any resulting adjustments are included in earnings. A
provision  is  also  made  for  management’s  calculation  of  factors  affecting  the  future
development of claims including claims incurred but not reported (IBNR) based on the volume
of business currently in force and the historical experience on claims.

28

Translation of foreign currencies
The operations of the company’s subsidiaries (principally in Canada, the United States and the
United Kingdom) are self-sustaining. As a result, the assets and liabilities of the non U.S. dollar
denominated  subsidiaries  are  translated  at  the  year-end  rates  of  exchange.  Revenue  and
expenses are translated at the average rate of exchange for the year. The net unrealized gains or
losses which result from translation are deferred and included in shareholders’ equity.

Goodwill
The company assesses the carrying value of goodwill based on the underlying discounted cash
ﬂows and operating results of its subsidiaries. The carrying value of goodwill will be charged to
earnings  if  and  to  the  extent  that  it  is  determined  that  an  impairment  in  value  exists.
Management has compared the carrying value of goodwill balances as at December 31, 2006
and the estimated fair values of the underlying operations and concluded that there was no
impairment in the value of goodwill. The estimated fair values are sensitive to the cash ﬂow
projections  and  discount  rates  used  in  the  valuation  and  more  speciﬁcally  the  ability  of
Cunningham Lindsey’s U.K. operations to meet their proﬁt and cash ﬂow forecasts for 2007
and future years.

Negative  goodwill  arising  on  acquisitions  during  the  year  is  recognized  in  the  consolidated
statement of earnings as an extraordinary item.

Reinsurance
Third party reinsurance balances are reﬂected on the balance sheet on a gross basis to indicate
the extent of credit risk related to third party reinsurance and its obligations to policyholders
and  on  a  net  basis  in  the  statement  of  earnings  to  indicate  the  results  of  its  retention  of
premiums written.

In order to control the company’s exposure to loss from adverse development of reserves or
reinsurance  recoverables  on  pre-acquisition  reserves  of  companies  acquired  or  from  future
adverse  development  on  long  tail  latent  or  other  potentially  volatile  claims,  and  to  protect
capital,  the  company  obtains  vendor  indemnities  or  purchases  excess  of  loss  reinsurance
protection  from  reinsurers.  For  excess  of  loss  reinsurance  treaties  (other  than  vendor
indemnities),  the  company  generally  pays  the  reinsurer  a  premium  as  losses  from  adverse
development are ceded under the treaty. The company records both the premium charge and
the  related  reinsurance  recovery  in  its  consolidated  statement  of  earnings  in  the  period  in
which the adverse development is ceded to the reinsurer.

Income taxes
Income taxes reﬂect the expected future tax consequences of temporary differences between
the carrying amounts of assets and liabilities and their tax bases based on tax rates which are
expected to be in effect when the asset or liability is settled. A valuation allowance is recorded
if it is more likely than not all, or some portion of, the beneﬁts related to deﬁned tax asset will
not be realized.

Pensions
Accrued  beneﬁt  obligations  for  pensions  and  other  post  retirement  beneﬁts  are  actuarially
determined  using  the  projected  beneﬁt  method  prorated  on  service  and  incorporates
management’s best estimate of future salary levels, other cost escalation, retirement ages of the
employees and other actuarial factors.

Expected return on plan assets is calculated based on the fair value of those assets.

Actuarial  gains  (losses)  arise  from  the  difference  between  the  actual  long  term  rate  of  return
and the expected long term rate of return on plan assets for that period or from changes in
actuarial assumptions used to determine the accrued beneﬁt obligation. The excess of the net

29

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

accumulated actuarial gain (loss) over 10 percent of the greater of the beneﬁt obligation and
the fair value of plan assets is amortized over the average remaining service period of active
employees.

Past service costs arising from plan amendments are deferred and amortized on a straight line
basis over the average remaining service period of employees active at the date of amendment.

Restatements
The company has completed two restatements of its ﬁnancial statements (the Restatements).
In  connection  with  the  ﬁrst  restatement  included  in  the  Restated  Audited  Consolidated
Financial  Statements  for  the  year  ended  December  31,  2005  ﬁled  on  September  1,  2006,  the
company restated its consolidated ﬁnancial statements for the years ended December 31, 2001
through 2005, the quarters ended March 31, 2006 and the quarters ended March 31, June 30
and  September  30,  2005.  In  the  second  restatement  included  in  the  Restated  Audited
Consolidated Financial Statements ﬁled on November 10, 2006, the company restated its US
GAAP reconciliation for the year ended December 31, 2005 and the quarters ended March 31,
2006  and  June  30,  2006  and  September  30,  2005.  These  consolidated  ﬁnancial  statements
reﬂect the Restatements.

Future accounting changes
The  Canadian  Institute  of  Chartered  Accountants  (CICA)  has  issued  three  new  accounting
standards: Financial Instruments – Recognition and Measurement, Hedges and Comprehensive
Income which the company will adopt effective January 1, 2007.

Financial  Instruments  –  Recognition  and  Measurement.  Certain  of  the  company’s  ﬁnancial
assets  and  liabilities  will  be  carried  at  fair  value  in  its  consolidated  balance  sheet  including
portfolio  investments  which  are  quoted  in  an  active  market  but  excluding  investments
accounted for using the equity method. Receivables and non-trading ﬁnancial liabilities, will
be carried at amortized cost. Realized and unrealized gains and losses on ﬁnancial assets and
liabilities which are held for trading will be recorded in the consolidated statement of earnings.
Unrealized  gains  and  losses  on  ﬁnancial  assets  which  are  held  as  available  for  sale  will  be
recorded  in  other  comprehensive  income  until  realized  or  until  an  other-than-temporary
decline in the value of the investment occurs, at which time the gain or loss will be recorded in
the  consolidated  statement  of  earnings.  When  unrealized  losses  on  investments  are
determined  to  be  other-than-temporary,  the  ﬁnancial  asset  will  be  written  down  to  market
value with the change recorded as realized losses on investments in the consolidated statement
of  earnings.  All  derivatives,  including  instruments  with  embedded  derivatives  which  the
company has designated as held for trading under a fair value option will be recorded at fair
value in the consolidated balance sheet with changes in fair value recorded in the consolidated
statement of earnings.

Hedges – For fair value hedges, the change in fair value of the hedging derivative will be offset
in the consolidated statement of earnings against the change in the fair value of the hedged
item relating to the hedged risk. For cash ﬂow hedges, the change in fair value of the derivative
to  the  extent  effective  will  be  recorded  in  other  comprehensive  income  until  the  asset  or
liability being hedged affects the consolidated statement of earnings, at which time the related
change  in  fair  value  of  the  derivative  will  also  be  recorded  in  the  consolidated  statement  of
earnings. Any hedge ineffectiveness will be recorded in the consolidated statement of earnings.

Comprehensive Income – Unrealized gains and losses on ﬁnancial assets which are classiﬁed as
available for sale, unrealized foreign currency translation amounts arising from self-sustaining
foreign  operations,  and  changes  in  the  fair  value  of  cash  ﬂow  hedging  instruments  will  be
recorded in a statement of other comprehensive income and will be included in accumulated
other  comprehensive  income  until  recognized  in  the  consolidated  statement  of  earnings.
Accumulated other comprehensive income will form part of shareholders’ equity.

30

As at January 1, 2007 the company will recognize all of its ﬁnancial assets and liabilities in the
consolidated  balance  sheet  according  to  their  classiﬁcation.  The  estimated  impact  of
remeasuring  ﬁnancial  assets  classiﬁed  as  available  for  sale  at  fair  value  will  be  to  increase
portfolio  investments  and  marketable  securities  by  approximately  $56.2,  decrease  future
income  taxes  by  $12.9 and  increase  the  opening  accumulated  other  comprehensive  income
balance  on  an  after-tax  basis  by  approximately  $43.3.  The  estimated  impact  of  remeasuring
ﬁnancial assets and liabilities classiﬁed as held for trading under the fair value option will be to
increase portfolio investments by $60.2, decrease future income taxes by $20.8, increase non-
controlling interests by $8.4 and increase opening retained earnings by $31.0. The company,
upon adoption of the new accounting requirements for transaction costs, will reclassify $28.2
of unamortized debt issuance costs, currently classiﬁed as other assets as a reduction of long
term debt.

3. Cash, Short Term Investments and Marketable Securities
Cash, short term investments and marketable securities are as follows:

Cash and short term investments
Marketable securities

2006

2005

540.2
227.2

280.5
278.5

767.4

559.0

Marketable securities include corporate bonds and equities, with a fair value of $243.4 (2005 –
$284.5).

31

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

4. Portfolio investments

Portfolio investments are comprised as follows, with the estimated fair values of debt securities
and preferred and common stocks based on quoted market values.

2006

Gross

Gross

2005

Gross

Gross

Carrying Unrealized Unrealized Estimated Carrying Unrealized Unrealized Estimated

Value

Gains

Losses Fair Value

Value

Gains

Losses Fair Value

Subsidiary cash and short term

investments

4,602.7

Subsidiary cash and short term

investments pledged for
securities sold but not yet
purchased

Bonds

829.3

–

–

–

–

4,602.7

3,788.9

829.3

737.4

–

–

–

–

3,788.9

737.4

Canadian – government

1,597.3

70.6

(9.6)

1,658.3

1,345.1

87.2

(2.2)

1,430.1

– government
bonds pledged for
securities sold but
not yet purchased

– corporate

U.S. – government

– government bonds
pledged for securities
sold but not yet
purchased

– corporate

Other – government

– corporate

Preferred stocks

Canadian

U.S.

Other

Common stocks

Canadian

U.S.

Other

Strategic investments

Real estate

58.7

124.3

5,777.0

135.7

907.1

312.1

31.8

10.8

0.1

5.5

496.2

1,106.5

484.6

337.9

18.0

–

3.4

6.2

–

82.9

24.2

0.9

0.5

–

2.7

112.8

70.5

70.1

208.9

1.4

–

(0.2)

58.7

127.5

84.7

185.4

(299.0)

5,484.2

4,574.4

(5.6)

(5.8)

(0.6)

–

–

–

–

(13.9)

(9.8)

–

–

–

130.1

984.2

335.7

32.7

11.3

0.1

8.2

595.1

1,167.2

554.7

546.8

19.4

184.0

1,400.4

316.8

36.6

15.8

–

–

273.9

854.1

955.4

240.6

17.2

4.7

33.0

4.9

–

27.5

9.0

0.5

0.8

–

–

95.7

47.3

351.5

214.7

0.8

–

–

89.4

218.4

(143.6)

4,435.7

(1.5)

182.5

(100.8)

1,327.1

(6.3)

(1.4)

–

–

–

(5.4)

(43.2)

(14.8)

–

–

319.5

35.7

16.6

–

–

364.2

858.2

1,292.1

455.3

18.0

16,835.6

655.1

(344.5)

17,146.2 15,010.7

877.6

(319.2)

15,569.1

The number of continuous months in which securities have been in unrealized loss positions
as at December 31, 2006 and 2005 is as follows:

December 31, 2006

Less than 12 Months

Greater than 12 Months

Total

Estimated

Gross

Number Estimated

Gross

Number Estimated

Gross

Number

Fair Unrealized

of

Fair Unrealized

of

Fair Unrealized

of

Value

Losses Securities

Value

Losses Securities

Value

Losses Securities

Bonds

Canadian – government 1,053.1

– corporate

5.2

U.S.

– government 1,963.4

– corporate

Other

– government

Common stocks

Canadian

U.S.

Total

148.4

39.6

180.8

569.8

(9.6)

(0.2)

(28.9)

(1.2)

(0.6)

(13.9)

(9.8)

5

1

21

12

7

4

5

–

–

–

–

3,545.6

(275.7)

50.7

(4.6)

–

–

–

–

–

–

–

–

33

18

–

–

–

1,053.1

5.2

(9.6)

(0.2)

5,509.0

(304.6)

199.1

39.6

180.8

569.8

(5.8)

(0.6)

(13.9)

(9.8)

5

1

54

30

7

4

5

3,960.3

(64.2)

55

3,596.3

(280.3)

51

7,556.6

(344.5)

106

32

December 31, 2005

Less than 12 Months

Greater than 12 Months

Total

Estimated

Gross

Number Estimated

Gross

Number Estimated

Gross

Number

Fair Unrealized

of

Fair Unrealized

of

Fair Unrealized

of

Value

Losses Securities

Value

Losses Securities

Value

Losses Securities

Bonds

Canadian – government

420.2

U.S.

– government 4,107.9

– corporate

Other

– government

– corporate

Common stocks

Canadian

U.S.

Other

328.5

193.6

12.0

78.0

439.6

171.4

(2.2)

(144.4)

(50.1)

(6.3)

(1.4)

(5.4)

(43.2)

(14.3)

2

36

47

7

2

5

8

8

–

15.8

630.3

–

(0.7)

(50.7)

–

–

–

–

–

–

–

–

2.8

(0.5)

–

5

18

–

–

–

–

4

420.2

4,123.7

958.8

193.6

12.0

78.0

439.6

174.2

(2.2)

(145.1)

(100.8)

(6.3)

(1.4)

(5.4)

(43.2)

(14.8)

Total

5,751.2

(267.3)

115

648.9

(51.9)

27

6,400.1

(319.2)

2

41

65

7

2

5

8

12

142

Management has reviewed currently available information regarding those investments whose
estimated  fair  value  is  less  than  carrying  value  at  December  31,  2006.  Debt  securities  whose
carrying  value  exceeds  market  value  are  expected  to  be  held  until  maturity  or  until  market
value  exceeds  carrying  value.  All  investments  have  been  reviewed  to  ensure  that  corporate
performance expectations have not changed signiﬁcantly to adversely affect the market value
of these securities other than on a temporary basis. The company makes investments in certain
high  yield  debt  securities  for  which  the  market  value  of  the  investments  may  be  below  the
carrying  value  to  the  company.  The  company  writes  down  the  carrying  value  of  these
investments  to  reﬂect  other  than  temporary  declines  in  value.  The  carrying  values  may  be
written  down  to  the  company’s  assessment  of  the  underlying  fair  value  of  the  investments
when the company does not view the current quoted market value as being reﬂective of the
underlying  value  of  the  investments.  At  December  31,  2006,  the  company  had  total  bonds
rated less than investment grade with an aggregate carrying value of $262.6 (2005 – $674.7),
aggregate  quoted  market  value  of  $297.4  (2005  –  $644.5),  gross  unrealized  gains  of  $39.6
(2005 – $43.1) and gross unrealized losses of $(4.8) (2005 – $73.2).

At  December  31,  2006,  as  protection  against  a  decline  in  equity  markets,  the  company  had
short positions in Standard & Poor’s Depository Receipts (‘‘SPDRs’’) and U.S. listed common
stocks  of  $500.0  and  $99.6,  respectively  (2005 –  $500.0  and  $60.3,  respectively)  and  equity
index  swaps  with  a  total  notional  amount  of  $681.4  (2005 –  $550.0).  The  company  has
purchased near dated call options to limit the potential loss on the SPDR short positions and
the equity index swaps to $131.1 and $31.6, respectively, at December 31, 2006 (2005 – $112.1
and  $110.0,  respectively)  and  as  general  protection  against  the  short  position  in  common
stocks. The fair value of the SPDRs and the equity index swaps is included in securities sold but
not yet purchased and the fair value of the call options is included in common stocks on the
consolidated balance sheets. At December 31, 2006, common stocks and strategic investments
in the company’s portfolio aggregated $2,425.2 with a market value of $2,863.8.

Assets have been pledged as collateral for the obligations to purchase securities sold short and
equity index swaps equal to their fair value of $1,018.1 (2005 –$1,009.3) as listed in the table
above.

The company also has purchased credit default swaps and bond warrants which are carried at
fair value of $93.7 (2005 – $142.2) and are classiﬁed as bonds in the table above.

33

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

Changes in the fair value for the transactions described above and other derivatives have been
included  in  realized  gains  on  investments  in  the  consolidated  statements  of  earnings  as
follows:

SPDRs, common stocks and related options
Swaps and related options
Credit default swaps
Bond warrants and other

Gains (losses)

2006

(66.9)
69.9
(76.4)
(3.5)

2005

(20.7)
(25.8)
(101.6)
(10.6)

2004

(36.9)
(38.2)
(13.7)
25.5

(76.9)

(158.7)

(63.3)

In addition to the amounts disclosed in note 13, the company’s subsidiaries have pledged cash
and investments of $2.2 billion inclusive of trust funds and regulatory deposits as security for
their own obligations to pay claims or make premium payments (these pledges are either direct
or  to  support  letters  of  credit).  These  pledges  are  in  the  normal  course  of  business  and  are
generally released when the payment obligation is fulﬁlled.

Liquidity and Interest Rate Risk

Within 1
Year

1 to 5
Years

6 to 10 Over 10
Years

Years

2006
Total

Maturity proﬁle as at December 31, 2006:
Bonds (market value)
Bonds (carrying value)
Effective interest rate

26.4 2,088.3
26.8 2,119.7

1,753.5
1,779.9

4,943.2
5,017.6

8,811.4
8,944.0
4.8%

Within 1
Year

1 to 5
Years

6 to 10 Over 10
Years

Years

2005
Total

Maturity proﬁle as at December 31, 2005:
Bonds (market value)
Bonds (carrying value)
Effective interest rate

321.5
325.1

683.3
674.6

1,197.7
1,154.1

5,835.9
5,973.6

8,038.4
8,127.4
5.0%

Bonds are classiﬁed at the earliest of the available maturity dates.

34

Investment Income

Interest and dividends:

Cash and short term investments
Bonds
Preferred stocks
Common stocks

Expenses

Realized gains on investments:

Bonds – gain
– (loss)

Derivatives

Preferred stocks – gain
– (loss)
Common stocks – gain
– (loss)
– gain
– (loss)
Mark to market on derivative instruments
Repurchase of debt
Secondary offerings (2006 – OdysseyRe, 2004 – Northbridge)
Other

Provision for losses and writedowns

Net investment income

2006

2005

2004

268.6
356.4
0.7
149.9

118.5
313.3
3.7
52.1

55.2
241.0
3.7
90.4

775.6
(29.1)

487.6
(21.5)

390.3
(14.6)

746.5

466.1

375.7

216.3
(7.3)
1.6
–
799.4
(4.3)
11.6
(185.7)
(76.9)
(15.7)
69.7
64.4
(37.8)

323.5
(27.7)
–
–
274.4
(20.0)
66.6
(15.7)
(158.7)
0.5
–
(8.7)
(48.5)

147.1
(11.2)
–
(0.1)
263.1
(7.0)
–
(6.4)
(63.3)
(27.0)
40.1
9.9
(31.6)

835.3

385.7

313.6

1,581.8

851.8

689.3

Equity  earnings  (losses)  for  Hub,  Advent  and  ICICI  Lombard  of  $12.5,  $6.1  and  ($2.6)
respectively, for the year ended December 31, 2006 (2005 – $3.7, $(45.1) and $2.4, respectively;
2004  –  $5.5,  $4.1  and  nil,  respectively)  are  included  in  interest  and  dividends  –  common
stocks.  Included  in  realized  gains  on  investments  –  other  are  a  dilution  loss  of  $8.1  and  a
dilution  gain  of  $15.8  related  to  changes  in  the  company’s  proportional  ownership  of
OdysseyRe and Hub, respectively.

5. Provision for Claims

The provisions for unpaid claims and adjustment expenses and for the third party reinsurers’
share thereof are estimates subject to variability, and the variability could be material in the
near term. The variability arises because all events affecting the ultimate settlement of claims
have not taken place and may not take place for some time. Variability can be caused by receipt
of  additional  claim  information,  changes  in  judicial  interpretation  of  contracts  or  liability,
signiﬁcant  changes  in  severity  or  frequency  of  claims  from  historical  trends,  expansion  of
coverage to include unanticipated exposures, or a variety of other reasons. The estimates are
principally  based  on  the  company’s  historical  experience.  Methods  of  estimation  have  been
used which the company believes produce reasonable results given current information.

35

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

Changes  in  claim  liabilities  recorded  on  the  consolidated  balance  sheets  as  at  December  31,
2006,  2005  and  2004  and  their  impact  on  unpaid  claims  and  allocated  loss  adjustment
expenses for these two years are as shown in the following table:

Unpaid claim liabilities – beginning of year – net
Foreign exchange effect of change in claim liabilities
Increase in estimated losses and expenses for losses

occurring in prior years

Incurred loss occurring due to Swiss Re commutation
Provision for losses and expenses on claims occurring in the

current year

Paid on claims occurring during:

the current year
prior years

Proceeds from the Swiss Re commutation
Unpaid claims liabilities of acquired companies at

December 31

Unpaid claim liabilities – end of year – net
Unpaid claims liabilities at December 31, of Federated Life

Unpaid claims liabilities – end of year – net
Reinsurance gross-up

2006

2005

2004

9,362.2
78.2

7,821.5
16.8

7,161.2
168.4

285.1
412.6

558.3
–

265.2
(3.9)

3,126.9

3,784.5

3,224.7

(748.4)
(2,445.4)
587.4

(854.4)
(2,002.7)
–

(703.2)
(2,384.2)
–

–

38.2

93.3

10,658.6
–

10,658.6
4,843.7

9,362.2
–

9,362.2
6,872.9

7,821.5
26.2

7,847.7
7,318.3

Unpaid claim liabilities – end of year – gross

15,502.3 16,235.1 15,166.0

The  foreign  exchange  effect  of  change  in  claim  liabilities  results  from  the  ﬂuctuation  of  the
value of the U.S. dollar in relation to primarily the Canadian dollar and European currencies.
The commutation of the $1 billion Swiss Re corporate insurance cover resulted in an incurred
loss of $412.6 and net proceeds of $587.4.

The basic assumptions made in establishing actuarial liabilities are best estimates of possible
outcomes.  The  company  uses  tabular  reserving  for  workers’  compensation  liabilities  that  are
considered ﬁxed and determinable, and discounts such reserves using interest rates of 3.5% to
5.0% and standard mortality assumptions. Otherwise, the company presents its claims on an
undiscounted basis.

6. Signiﬁcant Commutations

On  July  27,  2006,  Fairfax  exercised  its  right  to  commute  the  Swiss  Re  corporate  insurance
cover,  as  it  had  determined  that  based  on  projected  payout  patterns  and  other  ﬁnancial
considerations,  the  Swiss  Re  corporate  insurance  cover  no  longer  provided  it  with  a
commercial  or  economic  advantage.  At  the  time  of  the  commutation  on  August  3,  2006,
Fairfax also terminated its $450 letter of credit facility effectively secured by the assets held in
trust  derived  from  the  premiums  on  the  Swiss  Re  corporate  insurance  cover  and  the
accumulated interest thereon. By virtue of the commutation, the $587.4 of funds withheld in
trust  under  the  Swiss  Re  corporate  insurance  cover  were  paid  to  nSpire  Re.  nSpire  Re  has
deployed  approximately  $450  of  those  funds  to  secure  or  settle  $450  of  its  reinsurance
obligations to other Fairfax subsidiaries previously secured by letters of credit issued under the
former letter of credit facility. The accounting effect of the commutation was a non-cash pre-
tax and after-tax charge of $412.6. The commutation resulted in a $1 billion decrease in the
balance  recoverable  from  reinsurers  and  a  $587.4  decrease  in  funds  withheld  payable  to
reinsurers.

36

TIG’s commutation with Chubb Re in 2005 resulted in a $103.1 pre-tax charge to earnings. Net
reserves  were  increased  by  the  amount  of  reserves  which  were  formerly  reinsured  and  TIG’s
cash increased by the $197.0 cash it received on the commutation.

7. Reinsurance

The  company  follows  the  policy  of  underwriting  and  reinsuring  contracts  of  insurance  and
reinsurance  which,  depending  on  the  type  of  contract,  generally  limits  the  liability  of  the
individual insurance and reinsurance subsidiaries to a maximum amount on any one loss of
$15.0 for OdysseyRe, $5.0 (excluding workers’ compensation) for Crum & Forster and $3.8 for
Northbridge. Reinsurance is generally placed on an excess of loss basis in several layers. The
company’s reinsurance does not, however, relieve the company of its primary obligation to the
policyholders.

The company has guidelines and a review process in place to assess the creditworthiness of the
companies to which it cedes.

The  company  makes  speciﬁc  provisions  against  reinsurance  recoverables  from  companies
considered to be in ﬁnancial difﬁculty. In addition, the company records a general allowance
based  upon  analysis  of  historical  recoveries,  the  level  of  allowance  already  in  place  and
management’s judgment on future collectibility. The allocation of the allowance for loss is as
follows:

Speciﬁc
General

Total

2006

2005

340.0
92.3

377.6
54.9

432.3

432.5

To  support  gross  reinsurance  balances  (excluding  pools  and  associations),  Fairfax  has  the
beneﬁt  of  letters  of  credit,  trust  funds  or  offsetting  balances  payable  totaling  $1,667.4  as
follows:

)

)

)

for  reinsurers  rated  A-  or  better,  Fairfax  has  security  of  $1,284.9  against  outstanding
reinsurance recoverable of $4,604.4;

for  reinsurers  rated  B++  or  lower,  Fairfax  has  security  of  $31.6  against  outstanding
reinsurance recoverable of $263.0; and

for  unrated  reinsurers,  Fairfax  has  security  of  $350.9  against  outstanding  reinsurance
recoverable of $945.2.

The company has an aggregate provision for uncollectible reinsurance of $423.2 relating to the
exposure of reinsurers rated B++ or lower or which are unrated, leaving a net exposure after the
consideration of security held of $402.5 (as compared to $619.4 in 2005).

During  the  year,  the  company  ceded  premiums  earned  of  $747.2  (2005 –  $860.1;  2004 –
$862.7)  and  claims  incurred  of  ($98.0),  including  ($412.6)  from  the  Swiss  Re  commutation
(2005 – $1,522.9; 2004 – $1,166.9). For the last three years, Fairfax had reinsurance bad debts of
$46.5 for 2006, $51.1 for 2005 and $62.8 for 2004.

37

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

8. Long Term Debt

The long term debt at December 31 consists of the following balances:

Fairfax unsecured senior notes at 7.375% due March 15, 2006(1)(2)
Fairfax 445.7 secured debt at 2.5% due February 27, 2007 (effectively a

433.6 debt at 8%)(5)

Fairfax unsecured senior notes at 6.875% due April 15, 2008(2)(3)
Fairfax unsecured senior notes at 7.75% due April 15, 2012(1)
Fairfax unsecured senior notes at 8.25% due October 1, 2015(3)
Fairfax unsecured senior notes at 7.375% due April 15, 2018(2)(3)(4)
Fairfax unsecured senior notes at 8.30% due April 15, 2026(1)(3)
Fairfax unsecured senior notes at 7.75% due July 15, 2037(2)(3)
Fairfax 5% convertible senior debentures due July 15, 2023(1)(6)
Fairfax Inc. 3.15% exchangeable debenture due November 19, 2009(7)
Other debt – 6.15% secured loan due January 28, 2009

2006

–

60.4
62.1
464.2
100.0
184.2
91.8
91.3
135.4
–
13.2

2005

60.6

51.3
62.1
466.4
100.0
184.2
97.6
91.3
137.4
101.0
13.4

Long term debt – holding company borrowings

1,202.6

1,365.3

OdysseyRe unsecured senior non-callable notes at 7.49% due

November 30, 2006(1)

OdysseyRe unsecured senior notes at 6.875% due May 1, 2015(2)(8)
OdysseyRe convertible senior debentures at 4.375% due

June 22, 2022(1)(2)(9)

OdysseyRe unsecured senior notes at 7.65% due November 1, 2013(8)
OdysseyRe unsecured senior notes, Series A, ﬂoating rate due

March 15, 2021(1)

OdysseyRe unsecured senior notes, Series B, ﬂoating rate due

March 15, 2016(1)

OdysseyRe unsecured senior notes, Series C, ﬂoating rate due

December 15, 2021(1)

Crum & Forster unsecured senior notes at 10.375% due

June 15, 2013(11)

Cunningham Lindsey unsecured Series B debentures of Cdn$125 at

7.0% due June 16, 2008

Other long term debt of Cunningham Lindsey

Less: Cunningham Lindsey debentures held by Fairfax

Long term debt – subsidiary company borrowings

–
125.0

23.5
225.0

50.0

50.0

40.0

40.0
125.0

79.5
225.0

–

–

–

300.0

300.0

107.4
0.3

921.2

107.0
0.3

876.8

(8.1)

(7.5)

913.1

869.3

2,115.7

2,234.6

(1) During  2006,  the  company  or  one  its  subsidiaries  completed  the  following  transactions  with

respect to its debt:
(a) The company purchased $2.2 of its notes due in 2012 and $5.8 of its notes due in 2026 for
cash  consideration  of  $7.4  and  repaid  the  outstanding  $60.6  of  its  7.375%  notes  which
matured on March 15, 2006.

(b) The  company  purchased  for  cancellation  $5.0  principal  amount  of  its  convertible  senior
debentures due in 2023 for a cash payment of $4.3. This repurchase was recorded as a $3.6
and $1.5 reduction of long term debt and other paid in capital respectively.

(c) The  principal  amount  of  $39.1  of  OdysseyRe’s  4.375%  senior  debentures  due  2022  was
converted by the senior debenture holders into common stock of OdysseyRe. OdysseyRe also

38

repurchased  $16.9  principal  amount  of  its  4.375%  senior  debentures  due  2022  for  cash
payments aggregating $19.3. Refer also to (9) within this note.

(d) OdysseyRe  issued  $100.0  of  senior  unsecured  notes  on  February  22,  2006.  The  notes  were
sold  in  two  tranches:  $50.0  Series  A  due  in  2021  and  $50.0  Series  B  due  in  2016.  The
Series A and Series B notes are callable by OdysseyRe in 2011 and 2009, respectively at their
par value plus accrued and unpaid interest. The interest rate on each series of debentures is
equal to three month LIBOR, which is calculated on a quarterly basis, plus 2.20%. OdysseyRe
issued $40.0 of senior unsecured notes on November 28, 2006. The Series C notes are due in
2021  and  are  callable  by  OdysseyRe  in  2011  at  their  par  value  plus  accrued  and  unpaid
interest. The interest rate is equal to three month LIBOR plus 2.5% and is reset after every
payment date.

(e) OdysseyRe repaid the outstanding $40.0 of its 7.49% notes which matured on November 30,

2006.

(2) During  2005,  the  company  or  one  of  its  subsidiaries  completed  the  following  transactions  with

respect to its debt:
(a) The company purchased $7.0 of its notes due in 2006, $0.6 of its notes due in 2008, $6.0 of
its notes due in 2018 and $14.2 of its notes due in 2037 and repaid the $27.3 of TIG senior
notes which matured for cash payments of $50.7.

(b) OdysseyRe issued $125.0 principal amount of 6.875% senior notes due in 2015.
(c) OdysseyRe repurchased $30.4 principal amount of its 4.375% convertible senior debentures

due 2022 for cash payments of $34.2.

(3) During 2002, the company closed out the swaps for this debt and deferred the resulting gain which
is  amortized  to  earnings  over  the  remaining  term  to  maturity.  The  unamortized  balance  at
December 31, 2006 is $39.3 (2005 – $44.6).

(4) During 1998, the company swapped $125.0 of its debt due 2018 for Japanese yen denominated
debt  of  the  same  maturity.  The  company  pays  ﬁxed  interest  at  3.93%  on  ¥16.5  billion  and
receives  a  ﬁxed  rate  interest  at  9.2%  on  a  notional  amount  of  $125.0.  Inception  to  date,  this
instrument has yielded income of $4.9 (2005 – $5.3), all of which has been settled except for $1.0
(2005 – $0.4) which is due from the counter party at year end.

(5) Letters of credit pledged as security. Repaid subsequent to year end on February 7, 2007.
(6) Each  $1,000  principal  amount  of  debentures  is  convertible  under  certain  circumstances  into
4.7057 subordinate voting shares ($212.51 per share). Prior to July 15, 2008, the company may
redeem  the  debentures  (effectively  forcing  conversion)  if  the  share  price  exceeds  $293.12  for  20
trading days in any 30-day trading period. The company may redeem the debentures at any time
commencing July 15, 2008, and the debenture holders can put their debentures to the company for
repayment on July 15, 2008, 2013 and 2018. The company has the option to repay the debentures
in  cash,  subordinate  voting  shares  or  a  combination  thereof.  These  convertible  debentures  are
recorded as components of debt and equity. The amount currently recorded as long term debt will
accrete to the $188.5 face value of the debt over the remaining term to maturity ending in 2023.
(7) During 2004, the company, through one if its subsidiaries, purchased its $78.0 principal amount
of  3.15%  exchangeable  debentures  due  2010  in  a  private  transaction.  As  consideration,  the
subsidiary  issued  $101.0  principal  amount  of  new  3.15%  exchangeable  debentures  due  2009
which were collectively exchangeable at the option of the holders into an aggregate of 4,300,000
OdysseyRe  common  shares  in  August  2006  (with  respect  to  $32.9  principal  amount  of  new
debentures) and November 2006 (with respect to $68.1 principal amount of new debentures). In
June and August 2006, the company repurchased $32.9 of these exchangeable debentures for cash
consideration  of  $43.4  and  in  November  2006,  the  holder  of  $68.1  principal  amount  of
debentures exercised its right to receive 2.9 million OdysseyRe common shares which extinguished
the remaining indebtedness under the exchangeable debentures.

(8) Redeemable at OdysseyRe’s option at any time.
(9) Redeemable  at  OdysseyRe’s  option  since  June  2005.  Each  holder  may,  at  its  option,  require
OdysseyRe to repurchase all or a portion of this debt (for cash or OdysseyRe common shares, at
OdysseyRe’s option) on June 22, 2007, 2009, 2012 and 2017. The debentures are convertible at

39

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

the holder’s option, under certain circumstances, into OdysseyRe common shares in the ratio of
46.9925  OdysseyRe  shares  for  every  $1,000  principal  amount  of  this  debt  ($21.28  per  share).
OdysseyRe is permitted to satisfy the obligation in stock or cash, or a combination thereof. The
conversion circumstances have been satisﬁed and the notes are currently convertible.

(10) In September 2005, OdysseyRe entered into a three-year $150.0 credit facility with a syndicate of
lenders, of which $55 was used by issuing letters of credit. During 2006, Northbridge entered into
a  revolving  demand  credit  facility  with  a  Canadian  chartered  bank  for  up  to  Cdn$40.0.
Subsidiaries  of  Cunningham  Lindsey  have  demand  lines  of  credit  in  the  United  Kingdom  and
Europe of £6.5 and 75.7, respectively of which $5.7 was drawn at year-end.

(11) The notes are redeemable by Crum & Forster at any time on or after June 15, 2008 at speciﬁed

redemption prices.

Interest  expense  on  long  term  debt  amounted  to  $203.4  (2005 –  $191.8;  2004 –  $170.5).
Interest expense on Cunningham Lindsey’s total indebtedness amounted to $7.0 (2005 – $8.6;
2004 – $6.2).

Principal repayments are due as follows:

2007
2008
2009
2010
2011
Thereafter

60.4
161.7
13.2
–
–
1,880.4

9. Trust Preferred Securities of Subsidiaries and Purchase Consideration

Payable

TIG  Holdings  had  issued  8.597%  junior  subordinated  debentures  to  TIG  Capital  Trust  (a
statutory  business  trust  subsidiary  of  TIG  Holdings)  which,  in  turn,  has  issued  8.597%
mandatory  redeemable  capital  securities,  maturing  in  2027.  During  2006,  the  company
acquired $34.5 (2005 – nil; 2004 – $27.4) of these trust preferred securities for cash payments of
$29.2 (2005 – nil; 2004 – $27.4), with $17.9 and $52.4 outstanding at December 31, 2006 and
2005, respectively.

On December 16, 2002, the company acquired Xerox’s 72.5% economic interest in TRG, the
holding company of International Insurance Company (‘‘IIC’’), in exchange for payments over
the next 15 years of $424.4 ($203.9 at December 16, 2002 using a discount rate of 9.0% per
annum), payable approximately $5.0 a quarter from 2003 to 2017 and approximately $128.2
on  December  16,  2017.  Upon  this  acquisition,  Xerox’s  non-voting  shares  were  amended  to
make  them  mandatorily  redeemable  for  the  payments  described  above  and  to  eliminate
Xerox’s  participation  in  the  operations  of  IIC,  and  a  direct  contractual  obligation  was
effectively created from the company to Xerox. On December 16, 2002, TIG merged with IIC.
In addition to normal course repayments, during the year, the company repaid an additional
$9.1 of its purchase consideration payable for cash payments of $10.7.

10. Shareholders’ Equity

Capital Stock

Authorized capital

The  authorized  share  capital  of  the  company  consists  of  an  unlimited  number  of  preferred
shares issuable in series, an unlimited number of multiple voting shares carrying ten votes per
share and an unlimited number of subordinate voting shares carrying one vote per share.

40

Issued capital

Issued capital includes both multiple and subordinate voting shares, Series A preferred shares
and Series B preferred shares.

Series A preferred shares are ﬂoating (previously ﬁxed/ﬂoating) rate cumulative redeemable (at
the company’s option) preferred shares with an annual dividend rate based on the prime rate,
but in any event not less than 5% per annum and with stated capital of Cdn$25 per share.

Series  B  preferred  shares  are  ﬁxed  rate  cumulative  redeemable  (at  the  company’s  option)
preferred  shares  with  a  dividend  rate  of  6.5%  per  annum  until  November  30,  2009  and
thereafter at an annual rate based upon the yield of ﬁve year Government of Canada bonds,
and stated capital of Cdn$25 per share.

Treasury shares

The company acquires its own subordinate voting shares on the open market to be used in its
various senior share plans which are discussed more fully in note 13.

Capital transactions

(a) Under  the  terms  of  normal  course  issuer  bids  approved  by  the  Toronto  Stock
Exchange, during 2006 the company purchased and cancelled 67,800 (2005 – 49,800;
2004 – 215,200) subordinate voting shares for an aggregate cost of $7.7 (2005 – $7.4;
2004  –  $31.5),  of  which  $nil  (2005  –  $0.3;  2004  –  $3.6)  was  charged  to  retained
earnings.

(b) On  October  5,  2005,  the  company  issued  1,843,318  subordinate  voting  shares  at

$162.75 per share for net proceeds after issue costs (net of tax) of $299.8.

(c) On December 16, 2004, the company issued 2,406,741 subordinate voting shares at

$124.65 per share for net proceeds after issue costs (net of tax) of $299.7.

(d) During 2004, certain holders of the preferred shares elected to convert 5,000,000 of
Series  A  preferred  shares  into  Series  B  preferred  shares  on  a  one-for-one  basis.  At
November  30,  2009  and  every  ﬁve  years  thereafter,  the  holders  of  the  preferred
shares – both Series A and B – have the right to convert to the other Series.

Income Taxes

11.
The company’s provision for (recovery of) income taxes is as follows:

Current
Future

2006

110.4
375.2

485.6

2005

2004

85.5
(151.8)

77.4
77.5

(66.3)

154.9

The provision for income taxes differs from the statutory tax rate as certain sources of income
are  exempt  from  tax  or  are  taxed  at  rates  other  than  the  statutory  rate.  A  reconciliation  of

41

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

income tax calculated at the statutory tax rate with the income tax provision at the effective
tax rate in the ﬁnancial statements is summarized in the following table:

2006

2005

2004

Provision for (recovery of) income taxes at the

statutory income tax rate

Non-taxable investment income
Non-taxable portion of OdysseyRe sale
Tax rate differential on losses incurred (income

earned) outside Canada

Foreign exchange
Change in tax rate for future income taxes
(Recovery) relating to prior years reassessment
Unrecorded tax beneﬁt of losses and movement

in valuation allowance

Other including permanent differences

317.3
(8.0)
(22.7)

98.3
(0.9)
13.4
(42.2)

91.2
39.2

(168.5)
(20.2)
–

104.7
(19.7)
–

74.9
0.6
–
–

47.6
(0.7)

25.8
20.1
–
–

16.4
7.6

Provision for (recovery of) income taxes

485.6

(66.3)

154.9

Future income taxes of the company are as follows:

Operating and capital losses
Claims discount
Unearned premium reserve
Deferred premium acquisition cost
Allowance for doubtful accounts
Investments and other

2006

338.9
292.3
85.4
(76.6)
21.5
109.8

2005

624.8
298.7
88.3
(88.4)
22.0
173.4

Future income taxes

771.3

1,118.8

The  company  has  net  loss  carryforwards  in  the  U.S.  of  approximately  $118.7,  all  of  which
expire after 2018, in Canada of approximately $232.5 expiring from 2007 to 2015, in Ireland of
$657.8 with no expiry date and in the U.K. of $329.0 with no expiry date.

Management reviews the valuation of the future income taxes on an ongoing basis and adjusts
the valuation allowance, as necessary, to reﬂect its anticipated realization. As at December 31,
2006, management has recorded a valuation allowance against operating and capital losses of
$231.9 (2005 – $120.3), of which $42.7 relates to losses of Cunningham Lindsey and $189.2
relates to losses incurred primarily in the U.K. and Ireland. Management expects that recorded
future income taxes will be realized in the normal course of operations. There are no valuation
allowances related to the Canadian and U.S. operating companies.

12. Statutory Requirements

The  retained  earnings  of  the  company  are  largely  represented  by  retained  earnings  at  the
insurance and reinsurance subsidiaries. The company’s insurance and reinsurance subsidiaries
are subject to certain requirements and restrictions under their respective insurance company
Acts including minimum capital requirements and dividend restrictions. The company’s share
of  dividends  paid  in  2006  by  the  subsidiaries  which  are  eliminated  on  consolidation  was
$142.8  (2005 –  $121.7).  The  company’s  ability  to  receive  funds  from  OdysseyRe  and
Northbridge  is  limited,  as  these  are  public  companies  with  independent  boards  of  directors
who  control  dividend  policies.  At  December  31,  2006,  the  company  has  access  to  $138.4  of
dividend capacity at Crum & Forster.

42

13. Contingencies and Commitments

SEC Subpoenas

On  September  7,  2005,  the  company  announced  that  it  had  received  a  subpoena  from  the
U.S.  Securities  and  Exchange  Commission  (the  ‘‘SEC’’)  requesting  documents  regarding  any
nontraditional  insurance  or  reinsurance  product  transactions  entered  into  by  the  entities  in
the consolidated group and any non-traditional insurance or reinsurance products offered by
the  entities  in  that  group.  On  September  26,  2005,  the  company  announced  that  it  had
received a further subpoena from the SEC as part of its investigation into such loss mitigation
products,  requesting  documents  regarding  any  transactions  in  the  company’s  securities,  the
compensation for such transactions and the trading volume or share price of such securities.
Previously,  on  June  24,  2005,  the  company  announced  that  the  company’s  Fairmont
subsidiary  had  received  a  subpoena  from  the  SEC  requesting  documents  regarding  any
nontraditional  insurance  product  transactions  entered  into  by  Fairmont  with  General  Re
Corporation  or  afﬁliates  thereof.  The  U.S.  Attorney’s  ofﬁce  for  the  Southern  District  of  New
York is reviewing documents produced by the company to the SEC and is participating in the
investigation  of  these  matters.  The  company  is  cooperating  fully  with  these  requests.  The
company  has  prepared  presentations  and  provided  documents  to  the  SEC  and  the
U.S. Attorney’s ofﬁce, and its employees, including senior ofﬁcers, have attended or have been
requested to attend interviews conducted by the SEC and the U.S. Attorney’s ofﬁce.

The  company  and  Prem  Watsa,  the  company’s  Chief  Executive  Ofﬁcer,  received  subpoenas
from the SEC in connection with the answer to a question on the February 10, 2006 investor
conference call concerning the review of the company’s ﬁnite reinsurance contracts. In the fall
of 2005, Fairfax and its subsidiaries prepared and provided to the SEC a list intended to identify
certain  ﬁnite  contracts  and  contracts  with  other  non-traditional  features  of  all  Fairfax  group
companies.  As  part  of  the  2005  year-end  reporting  and  closing  process,  Fairfax  and  its
subsidiaries internally reviewed all of the contracts on the list provided to the SEC and some
additional  contracts  as  deemed  appropriate.  That  review  led  to  a  restatement  by  OdysseyRe.
That  review  also  led  to  some  changes  in  accounting  for  certain  contracts  at  nSpire  Re.
Subsequently,  during  2006,  following  an  internal  review  of  the  company’s  consolidated
ﬁnancial  statements  and  accounting  records  that  was  undertaken  in  contemplation  of  the
commutation of the Swiss Re corporate insurance cover, the company also restated various of
its  previously  reported  consolidated  ﬁnancial  statements  and  related  disclosures.  That
restatement  included  a  restatement  of  the  accounting  for  certain  reinsurance  contracts  that
were commuted in 2004 to apply the deposit method of accounting rather than reinsurance
accounting.  All  of  the  above  noted  items  and  related  adjustments  are  reﬂected  in  the
company’s comparative results. The company continues to respond to requests for information
from the SEC and there can be no assurance that the SEC’s review of documents provided will
not give rise to further adjustments.

The company understands that the SEC has issued subpoenas to various third parties involved
in the matters which are the subject of the SEC subpoenas issued to the company, including
the  company’s  independent  auditors  (which  in  Canada  received  a  letter  requesting
cooperation  and  in  the  U.S.  received  a  subpoena)  and  a  shareholder  (that  has  previously
disclosed  receipt  of  a  subpoena).  In  addition,  it  is  possible  that  other  governmental  and
enforcement  agencies  will  seek  to  review  information  related  to  these  matters,  or  that  the
company,  or  other  parties  with  whom  it  interacts,  such  as  customers  or  shareholders,  may
become subject to direct requests for information or other inquiries by such agencies.

These  inquiries  are  ongoing  and  the  company  continues  to  comply  with  requests  for
information  from  the  SEC  and  the  U.S.  Attorney’s  ofﬁce.  At  the  present  time  the  company
cannot  predict  the  outcome  from  these  continuing  inquiries  or  the  ultimate  effect  on  its
business,  operations  or  ﬁnancial  condition,  which  effect  could  be  material  and  adverse.  The

43

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

ﬁnancial cost to the company to address these matters has been and is likely to continue to be
signiﬁcant.  The  company  expects  that  these  matters  will  continue  to  require  signiﬁcant
management attention, which could divert management’s attention away from the company’s
business. In addition, the company could be materially adversely affected by negative publicity
related to these inquiries or any similar proceedings. Any of the possible consequences noted
above, or the perception that any of them could occur, could have an adverse effect upon the
market price for the company’s securities.

Lawsuits

(a) During 2006, several lawsuits seeking class action status were ﬁled against Fairfax and
certain of its ofﬁcers and directors in the United States District Court for the Southern
District  of  New  York.  The  Court  made  an  order  consolidating  the  various  pending
lawsuits and granted the single remaining motion for appointment as lead plaintiffs.
The Court also issued orders approving scheduling stipulations ﬁled by the parties to
the consolidated lawsuit. On February 8, 2007, the lead plaintiffs ﬁled an amended
consolidated complaint (the ‘‘Amended Consolidated Complaint’’), which states that
the lead plaintiffs seek to represent a class of all purchasers and acquirers of securities
of  Fairfax  between  May  21,  2003  and  March  22,  2006  inclusive.  The  Amended
Consolidated  Complaint  names  as  defendants  Fairfax,  certain  of  its  ofﬁcers  and
directors, OdysseyRe and Fairfax’s auditors. The Amended Consolidated Complaint
alleges  that  the  defendants  violated  U.S.  federal  securities  laws  by  making  material
misstatements  or  failing  to  disclose  certain  material  information  regarding,  among
other  things,  Fairfax’s  and  OdysseyRe’s  assets,  earnings,  losses,  ﬁnancial  condition,
and internal ﬁnancial controls. The Amended Consolidated Complaint seeks, among
other  things,  certiﬁcation  of  the  putative  class;  unspeciﬁed  compensatory  damages
(including  interest);  unspeciﬁed  monetary  restitution;  unspeciﬁed  extraordinary,
equitable  and/or  injunctive  relief;  and  costs  (including  reasonable  attorneys’  fees).
These claims are at a preliminary stage. The court has scheduled the next conference
for April 5, 2007, and pursuant to the scheduling stipulations, the defendants will ﬁle
their  answers  or  motions  to  dismiss  the  Amended  Consolidated  Complaint  on  or
before May 10, 2007. The ultimate outcome of any litigation is uncertain and should
the consolidated lawsuit be successful, the defendants may be subject to an award of
signiﬁcant damages, which could have a material adverse effect on Fairfax’s business,
results of operations and ﬁnancial condition. The consolidated lawsuit may require
signiﬁcant management attention, which could divert management’s attention away
from  the  company’s  business.  In  addition,  the  company  could  be  materially
adversely  affected  by  negative  publicity  related  to  this  lawsuit.  Any  of  the  possible
consequences  noted  above,  or  the  perception  that  any  of  them  could  occur,  could
have  an  adverse  effect  upon  the  market  price  for  the  company’s  securities.  Fairfax,
OdysseyRe and the named ofﬁcers and directors intend to vigorously defend against
the  consolidated  lawsuit  and  the  company’s  ﬁnancial  statements  include  no
provision for loss.

(b) On July 26, 2006, Fairfax ﬁled a lawsuit seeking $6 billion in damages from a number
of  defendants  who,  the  complaint  alleges,  participated  in  a  stock  market
manipulation  scheme  involving  Fairfax  shares.  The  complaint,  ﬁled  in  Superior
Court, Morris County, New Jersey, alleges violations of various state laws, including
the  New  Jersey  Racketeer  Inﬂuenced  and  Corrupt  Organizations  Act,  pursuant  to
which treble damages may be available. The defendants have removed this lawsuit to
the  District  Court  for  the  District  of  New  Jersey,  and  Fairfax  has  ﬁled  a  motion  to
remand  the  lawsuit  to  Superior  Court,  Morris  County,  New  Jersey.  The  ultimate
outcome of any litigation is uncertain.

44

Other

Subsidiaries of the company are defendants in several damage suits and have been named as
third  party  in  other  suits.  The  uninsured  exposure  to  the  company  is  not  considered  to  be
material to the company’s ﬁnancial position.

In January 2006, Odyssey America received assets with a par value of $48.6 (£38.0) representing
a  permanent  reduction  and  unconditional  release  of  such  amount,  prior  to  the  stated
termination  date,  following  the  deposit  by  Advent  of  £38.0 in  new  funds  at  Lloyd’s.  In
September 2006, Odyssey America received assets with a par value of $10.7 (£7.5) representing
a  permanent  reduction  and  unconditional  release  of  such  amount,  prior  to  the  stated
termination  date,  following  the  deposit  by  Advent  of  such  amount  in  new  funds  at  Lloyd’s.
Following these returns of assets, and as of December 31, 2006, Odyssey America continues to
have a par value of $102.7 (£52.5) pledged to Lloyd’s in support of Advent and will continue to
receive a fee for pledging these assets. The fair value of the pledged assets as of December 31,
2006 is $128.2 ( £65.5). The company believes that the ﬁnancial resources of Advent provide
adequate protection to support its liabilities in the ordinary course of business.

Included within subsidiary indebtedness is $62.5 (Cdn$72.8) (2005 – $62.3 (Cdn$72.8)) owed
by a subsidiary of Cunningham Lindsey under an unsecured non-revolving term credit facility
maturing March 31, 2008. Fairfax has a letter of support to Cunningham Lindsey with respect
to the repayment of this credit facility.

The  company  under  certain  circumstances  may  be  obligated  to  assume  loans  to  ofﬁcers  and
directors  of  the  company  and  its  subsidiaries  from  Canadian  chartered  banks  totalling  $8.5
(2005 – $9.5) for which 196,586 (2005 – 214,186) subordinate voting shares of the company
with  a  year-end  market  value  of  $39.1  (2005  –  $30.8)  have  been  pledged  as  security  by  the
borrowers.

The  company  also  has  restricted  stock  plans  or  equivalent  for  management  of  the  holding
company and its subsidiaries with vesting periods of up to ten years from the date of grant. At
December 31, 2006, 257,942 (2005 – 245,858) subordinate voting shares had been purchased
for  the  plans  at  a  cost  of  $56.4  (2005  –  $54.1).  Shares  for  the  above-mentioned  plans  are
purchased  on  the  open  market.  The  costs  of  these  plans  are  amortized  to  compensation
expense over the vesting period. Amortization expense for the year for these plans amounted
to $5.9 (2005 – $6.7; 2004 – $10.5).

14. Pensions

The company’s subsidiaries have various pension and post retirement beneﬁt plans for their
employees.  These  plans  are  a  combination  of  deﬁned  beneﬁt  plans  which  use  various
measurement  dates  between  September  30,  2006  and  December  31,  2006  and  deﬁned
contribution plans. The investment policy for the deﬁned beneﬁt pension plans is to invest in
highly rated, lower risk securities that preserve the investment asset value of the plans while
seeking to maximize the return on those invested assets. The plans’ assets as of December 31,
2006 and 2005 are invested principally in highly rated ﬁxed income securities. The long term
rate of return assumption is based on the ﬁxed income securities portfolio. The actual return
on  assets  has  historically  been  in  line  with  the  company’s  assumptions  of  expected  returns.
The  following  tables  set  forth  the  funded  status  of  the  company’s  beneﬁt  plans  along  with

45

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

amounts  recognized  in  the  company’s  consolidated  ﬁnancial  statements  for  both  pension
plans and post retirement beneﬁt plans as of December 31, 2006 and 2005.

Deﬁned Beneﬁt
Pension Plans

Post Retirement
Beneﬁt Plans

2006

2005

2006

2005

Accrued beneﬁt obligation:
Balance – beginning of year

Current service cost
Interest cost
Actuarial (gains) losses
Beneﬁts paid
Plan amendments
Curtailments
Foreign exchange (gain) loss

Balance – end of year

Fair value of plan assets:

Balance – beginning of year
Return on plan assets
Employer contributions
Employee contributions
Beneﬁts paid
Foreign exchange gain (loss)

Balance – end of year

529.1
19.0
27.1
(12.3)
(20.6)
1.3
(1.4)
40.5

582.7

410.6
30.6
17.7
1.8
(20.6)
35.0

475.1

Funded status of plans – surplus (deﬁcit) (107.6)
79.9
1.6
(8.5)

Unamortized net actuarial loss
Unamortized past service costs
Unamortized transitional obligation

Accrued beneﬁt asset (liability)

(34.6)

Plan assets consist of:
Fixed income securities
Equity securities
Real estate
Other

299.6
142.9
27.6
5.0

475.1

446.1
15.0
23.7
80.5
(10.7)
0.1
–
(25.6)

529.1

387.1
41.6
13.7
1.8
(10.7)
(22.9)

410.6

(118.5)
96.4
1.3
(9.5)

(30.3)

274.4
107.5
20.4
8.3

410.6

67.1
4.1
3.5
0.9
(4.7)
0.1
(2.1)
–

68.9

–
–
3.4
1.3
(4.7)
–

–

(68.9)
11.1
(1.9)
8.2

(51.5)

–
–
–
–

–

64.9
3.6
3.4
(0.3)
(5.2)
–
–
0.7

67.1

–
–
3.9
1.3
(5.2)
–

–

(67.1)
12.5
(7.9)
9.2

(53.3)

–
–
–
–

–

The accumulated beneﬁt obligation for the deﬁned pension plans noted above is $516.3 and
$456.2  at  December  31,  2006  and  December  31,  2005,  respectively.  Plans  with  accumulated
beneﬁt obligations in excess of the fair value of plan assets have deﬁcits of $52.5 and $45.6 at
December 31, 2006 and December 31, 2005, respectively.

Plans with accrued beneﬁt obligations in excess of the fair value of plan assets are as follows:

Accrued beneﬁt obligation
Fair value of plan assets

Deﬁned Beneﬁt
Pension Plans

Post Retirement
Beneﬁt Plans

2006

(582.7)
475.1

(107.6)

2005

(529.1)
410.6

(118.5)

2006

(68.9)
–

(68.9)

2005

(67.1)
–

(67.1)

46

Elements of expense recognized in the year are as follows:

Deﬁned Beneﬁt
Pension Plans

Post Retirement
Beneﬁt Plans

2006

2005

2006

2005

17.2
27.1
(30.6)
(12.3)
1.3
(1.4)

13.2
23.7
(41.6)
80.5
0.1
–

2.8
3.5
–
0.9
0.1
(2.1)

2.3
3.4
–
(0.3)
–
–

1.3

75.9

5.2

5.4

Current service cost, net of employee

contributions

Interest cost
Actual return on plan assets
Actuarial losses
Plan amendments
Curtailments

Elements of employee future beneﬁts cost before
adjustments to recognize the long term nature
of these costs

Adjustments to recognize the long term nature

of employee future beneﬁts costs:

Difference between expected return and actual

return on plan assets for year

6.3

18.8

–

–

Difference between actuarial (gain) loss

recognized for the year and actuarial (gain)
loss on accrued beneﬁt obligation for year
Difference between amortization of past service
costs for year and actuarial plan amendments
for year

Amortization of the transitional obligation

Deﬁned beneﬁt plans expense

15.7

(74.9)

1.4

1.9

(0.3)
(0.9)

20.8

22.1

0.9
(1.2)

(56.4)

19.5

(5.9)
1.1

(3.4)

1.8

(1.1)
1.1

1.9

7.3

The signiﬁcant assumptions used are as follows (weighted average):

Deﬁned Beneﬁt
Pension Plans

2006

2005

Post Retirement
Beneﬁt Plans

2006

2005

Accrued beneﬁt obligation as of December 31:
Discount rate
Rate of compensation increase
Beneﬁt costs for year ended December 31:
Discount rate
Expected long term rate of return on plan assets
Rate of compensation increase

5.1%
4.3%

4.9%
5.6%
4.3%

5.1%
4.4%

5.7%
6.1%
4.5%

5.4%
4.6%

5.3%
–
4.0%

5.3%
4.0%

5.9%
–
4.0%

The total expense recognized for the companies’ deﬁned contribution plans for the year was
$21.0 (2005 – $18.5).

47

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

15. Operating Leases

Aggregate  future  minimum  commitments  at  December  31,  2006  under  operating  leases
relating  to  premises,  automobiles  and  equipment  for  various  terms  up  to  ten  years  are  as
follows:

2007
2008
2009
2010
2011
Thereafter

77.6
64.9
49.9
40.3
33.9
117.9

16. Earnings per Share

Earnings per share are calculated after providing for dividends on the Series A ﬂoating and the
Series B ﬁxed cumulative redeemable preferred shares.

The weighted average number of shares for 2006 was 17,762,742 (2005 – 16,448,995; 2004 –
13,827,874).

Diluted  earnings  per  share  calculations  in  2006  include  the  impact  of  converting  the
convertible debentures into 895,848 common shares. The impact was anti-dilutive in 2005 and
2004.

17. Acquisitions and Divestitures

Year ended December 31, 2006

On December 14, 2006, the company recorded a pre-tax realized gain of $69.7 on the sale of
10,165,000 common shares of its OdysseyRe subsidiary in an underwritten secondary offering
at a price of $34.60 per share, generating net proceeds of $337.6. This transaction reduced the
company’s ownership of OdysseyRe from 80.1% to 59.6% at December 31, 2006.

On February 7, 2006, subsidiaries of the company sold their remaining 3.8 million shares of
Zenith National common stock at $50.38 per share for net proceeds of $193.8, resulting in a
pre-tax realized gain of $137.3.

On January 5, 2006, Advent, through an underwritten secondary public offering, raised gross
proceeds of $51.5 (£30.0) of equity at $0.34 (20 pence) per share with the company purchasing
its pro rata share at a cost of $24.7 (£14.0). On December 12, 2006, Advent raised additional
gross proceeds through an underwritten secondary public offering of $18.7 (£9.6) of equity at
$0.51 (26 pence) per share with the company purchasing shares at a cost of approximately $4.0
(£2.0). This transaction reduced the company’s ownership of Advent from 46.8% to 44.5% at
December 31, 2006.

Subsequent  to  year  end,  on  February  26,  2007,  the  company  announced  that  Hub
International Limited had entered into an agreement pursuant to which Hub shares would be
acquired for $40.00 per share in cash. Pursuant to an agreement entered into in connection
with  the  transaction,  it  was  agreed  that  the  10.3  million  Hub  shares  held  by  the  company
would  be  voted  in  favour  of  the  proposed  acquisition.  Upon  completion,  the  company  is
expected to realize cash proceeds of approximately $413 and an estimated pre-tax gain on sale
of  approximately  $220.  The  transaction  is  subject  to  Hub  shareholder  approval,  Canadian
court  approval,  other  regulatory  approvals  in  the  United  States  and  Canada  and  customary
closing conditions. The transaction is expected to be completed during the second quarter of
2007.

48

Year ended December 31, 2005

On  October  21,  2005,  OdysseyRe  issued  2.0  million  8.125%  Series  A  preferred  shares  and
2.0 million ﬂoating rate Series B preferred shares for net proceeds of $97.5. The Series A and
Series B preferred shares each have a liquidation preference of $25.00 per share. A subsidiary of
the  company  subscribed  for  530,000  Series  A  preferred  shares  and  70,000  Series  B  preferred
shares. As at December 31, 2006, 276,401 of the Series A preferred shares had been sold at no
gain or loss.

On October 6, 2005, OdysseyRe, through an underwritten public offering, raised net proceeds
of $102.1 through the issuance of 4.1 million shares of common stock at an offering price of
$24.96 per share. The company purchased 3.1 million of the shares issued, which decreased its
percentage  ownership  of  OdysseyRe  from  80.4%  to  80.1%.  This  share  offering  closed  on
October 12, 2005.

For each of the OdysseyRe transactions described above, the ﬁnancing raised from unrelated
parties has been recorded in non-controlling interests on the balance sheet.

On  August  31,  2005,  Cunningham  Lindsey  completed  its  rights  offering,  issuing  a  total  of
7,791,712  subordinate  voting  shares  at  Cdn$4.25  per  share  for  net  proceeds,  after  offering
expenses, of $27.1 (Cdn$32.2). The net proceeds of the offering were used to partially repay the
Cdn$105.0 million of borrowings by a subsidiary of Cunningham Lindsey under an unsecured
non-revolving term credit facility due March 31, 2006. The company exercised all rights issued
to  it,  purchasing  7,154,628  subordinate  voting  shares  at  a  cost  of  $25.6  (Cdn$30.4),  which
increased its percentage ownership of Cunningham Lindsey from 75.0% to 81.0%.

On  August  2,  2005,  subsidiaries  of  the  company  sold  2.0  million  shares  of  Zenith  National
common stock at $66.00 per share. Net proceeds from the transaction were $132.0, resulting in
a pre-tax realized gain of $86.1. On September 23, 2005, subsidiaries of the company sold an
additional 157,524 shares of Zenith National common stock at $63.70 per share and $30.0 par
value of debentures convertible into the common stock of Zenith National for net proceeds of
$86.5,  resulting  in  a  pre-tax  realized  gain  of  $53.3.  These  two  transactions  reduced  the
company’s ownership of Zenith National from 24.4% to 10.3% at December 31, 2005.

On  June  3,  2005,  Advent,  through  an  underwritten  public  offering,  raised  gross  proceeds  of
$118.4 (£65.0): $72.9 (£40.0) of equity at $0.64 (35 pence) per share and $45.5 (£25.0) of debt.
Concurrent with the equity issue, the shares were listed on the Alternative Investments Market
of  the  London  Stock  Exchange.  The  company  maintained  its  46.8%  interest  in  Advent  by
purchasing its pro rata share of this equity at a total cost of $34.1 (£18.7).

On December 29, 2004, the company agreed to acquire 100% of the issued and outstanding
common  shares  of  Compagnie  de  R´eassurance  d’Ile  de  France  (‘‘Corifrance’’),  a  French
reinsurance company, for $59.8 (444.0) payable on April 7, 2005. As at January 11, 2005 (the
date  of  acquisition),  the  fair  value  of  assets  and  liabilities  acquired  was  $122.2  (489.9)  and
$62.4 (445.9) respectively, resulting in no goodwill. In addition, the seller agreed to indemnify
the company, up to the purchase price, for any adverse development on acquired net reserves.

Year ended December 31, 2004

On November 15, 2004, OdysseyRe acquired Overseas Partners U.S. Reinsurance Company, a
reinsurance company domiciled in the state of Delaware, for $43.0. The fair value of assets and
liabilities acquired was $237.8 and $194.8 respectively, resulting in no goodwill.

Subsidiaries  of  the  company  sold  3.1  million  shares  of  common  stock  of  Zenith  National  at
$43 per share, in an underwritten public offering which closed on July 30, 2004, resulting in a
pre-tax realized gain after expenses of $62.5 and net proceeds of $127.6.

49

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

On May 18, 2004, the company recorded a pre-tax realized gain of $40.1 (Cdn$53.5) on the
sale of 6.0 million common shares of its Northbridge subsidiary in an underwritten secondary
offering at a price of Cdn$25.60 per share, generating net proceeds of $104.8 (Cdn$146.0) and
reducing the company’s ownership of Northbridge from 71.0% to 59.2%.

On  March  14,  2004,  Cunningham  Lindsey  completed  the  sale  of  its  U.S.  third  party  claims
administration business for a cash payment by Cunningham Lindsey of $22.0. The disposition
of this business resulted in a charge to earnings of $13.4, consisting of a $3.6 loss on the sale of
the business and other related accruals, including lease termination costs, of $9.8. This cost has
been included in operating expenses.

18. Segmented Information

The  company  is  a  ﬁnancial  services  holding  company  which,  through  its  subsidiaries,  is
engaged  in  property  and  casualty  insurance  conducted  on  a  direct  and  reinsurance  basis,
runoff operations and insurance claims management. The runoff business segment comprises
nSpire  Re  (which  fully  reinsures  the  U.K.  and  international  runoff  operations,  conducted
primarily through RiverStone (UK)) and the U.S. runoff company formed on the merger of TIG
and IIC combined with Old Lyme and Fairmont (Fairmont transferred to U.S. runoff effective
January  1,  2006).  The  U.K.  and  international  runoff  operations  have  reinsured  their
reinsurance  portfolios  to  nSpire  Re  to  provide  consolidated  investment  and  liquidity
management  services,  with  the  RiverStone  Group  retaining  full  responsibility  for  all  other
aspects  of  the  business.  Included  in  the  runoff  segment  is  Group  Re  which,  through  CRC
(Bermuda)  (Canadian  business),  Wentworth  (international  business)  and  nSpire  Re
(U.S. business), writes and retains insurance business written by other Fairfax subsidiaries. The
company also provides claims adjusting, appraisal and loss management services.

50

Revenue
Net premiums earned
Insurance – Canada

– U.S.
– Asia

Reinsurance
Runoff and Group Re

Interest and dividends
Realized gains
Claims fees

Allocation of revenue
Earnings (loss)

before income
taxes

Underwriting results
Insurance – Canada

– U.S.
– Asia

Reinsurance

Interest and dividends

Operating income
Realized gains (losses)

Runoff and Group Re
Claims adjusting
Interest expense
Corporate and other

Identiﬁable assets
Insurance
Reinsurance
Runoff and Group Re
Claims adjusting
Corporate

Amortization

Canada
2005

2006

United States

International

2004

2006

2005

2004

2006

2005

2004

950.0
–
–
37.7
235.9

891.0
–
–
50.9
221.4

835.7
–
–
46.2
154.9

61.5
1,114.0
–
1,323.2
171.6

57.4
1,053.1
–
1,324.6
68.7

76.9
1,027.6
–
1,384.0
277.4

14.3
–
67.3
864.9
10.2

10.8
–
68.2
900.4
46.0

26.4
–
57.8
893.0
24.4

1,223.6 1,163.3 1,036.8

2,670.3

2,503.8

2,765.9

956.7 1,025.4 1,001.6

25.2% 24.8% 21.6%

55.1%

53.3%

57.6% 19.7% 21.9% 20.8%

Corporate and other
2006

2005

2004

–
–
–
–
–

–

–
–
–
–

–
–

–
–
–
–
–

–

–
–
–
–

–
–

–
–
–
–
–

–

–
–
–
–

–
–

Total

2006

2005

2004

1,025.8
1,114.0
67.3
2,225.8
417.7

959.2
1,053.1
68.2
2,275.9
336.1

939.0
1,027.6
57.8
2,323.2
456.7

4,850.6

4,692.5

4,804.3

746.5
835.3
371.3

466.1
385.7
356.2

375.7
313.6
336.1

6,803.7

5,900.5

5,829.7

20.5
86.2
14.5
77.0

198.2
559.0

757.2
683.7

1,440.9
(321.8)
2.4
(195.7)
(47.2)

68.2
(9.1)
4.8
(397.8)

(333.9)
345.4

11.5
324.1

335.6
(618.4)
9.3
(184.6)
(8.4)

115.5
(55.0)
4.7
69.6

134.8
301.4

436.2
171.1

607.3
(70.0)
(12.2)
(163.4)
(74.1)

122.1
–
–
6.6

128.7
104.5

233.2
115.4

348.6
23.4
(11.5)
–
(10.0)

125.9
–
–
1.6

127.5
67.4

194.9
106.4

301.3
41.5
(18.4)
–
(14.6)

105.9
–
–
3.7

109.6
61.2

170.8
34.7

205.5
11.6
(16.4)
–
(8.3)

(7.3)
86.2
–
(70.9)

8.0
394.3

402.3
603.1

1,005.4
(276.4)
1.6
(70.5)
(26.9)

(45.3)
(9.1)
–
(396.6)

(451.0)
228.5

(222.5)
217.8

(4.7)
(435.2)
(0.7)
(62.9)
(27.5)

9.2
(55.0)
–
(16.5)

(62.3)
217.3

155.0
141.2

296.2
(28.2)
(18.4)
(58.8)
(20.8)

(94.3)
–
14.5
141.3

61.5
60.2

121.7
54.5

176.2
(68.8)
12.3
–
(3.4)

(12.4)
–
4.8
(2.8)

(10.4)
49.5

0.4
–
4.7
82.4

87.5
22.9

39.1
(2.2)

110.4
7.3

–
(89.3)

–
2.1

–
(12.1)

36.9
(224.7)
28.4
–
(2.4)

117.7
(53.4)
22.6
–
(2.8)

2.1
–
–

(89.3)
–
–

(12.1)
–
–
(125.2) (121.7) (104.6)
(42.2)
36.1

(6.9)

350.5

309.8

192.4

633.2

(531.0)

170.0

116.3

(161.8)

84.1

(221.4)

(83.5) (158.9)

878.6

(466.5)

287.6

3,673.8 3,380.7 2,683.1
169.7
145.3
464.9
463.4
43.4
37.7
–
–

191.8
481.3
19.4
–

6,324.9
6,736.8
4,469.3
45.6
–

6,718.3
6,593.1
4,785.8
36.0
–

320.9

548.9

6,567.4
326.3
5,399.9 1,711.4 1,321.7 1,457.2
5,078.8 1,045.6 2,678.2 2,979.5
282.3

33.3
–

306.4
–

253.9
–

–
–
–
–
– 1,021.3

–
–
–
–
807.0

– 10,547.6 10,419.9
8,060.1
–
7,927.4
–
327.6
–
807.0
785.4

8,640.0
5,996.2
371.4
1,021.3

9,576.8
7,026.8
8,523.2
359.0
785.4

4,366.3 4,027.1 3,361.1 17,576.6 18,133.2 17,079.4 3,612.3 4,574.7 5,045.3 1,021.3

807.0

785.4 26,576.5 27,542.0 26,271.2

3.9% 2.9% 3.0%
–

–

–

24.9

26.2

40.7

16.4% 14.6% 12.8%
11.1

7.2

7.4

66.1%
11.4

65.9%
14.0

65.0% 13.6% 16.6% 19.2%
13.0

16.6

6.3

4.8

51

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

Interest and dividend income for the Canadian Insurance, U.S. Insurance, Asian Insurance and
Reinsurance segments is $100.8, $156.5, $3.3 and $298.4, respectively (2005 – $65.7, $105.0,
$7.5  and  $167.2)  (2004 – $60.9,  $81.3,  $2.9  and  $156.3).  Included  in  interest  and  dividend
income for Canadian Insurance, U.S. Insurance, Asian Insurance and Reinsurance segments are
equity earnings (losses) of $6.1, $0.1, ($2.6) and $7.2, respectively (2005 – $1.7, ($16.8), $2.4
and ($12.6) (2004 – $2.5, $1.5, nil and $4.1).

Realized  gains  for  the  Canadian  Insurance,  U.S.  Insurance,  Asian  Insurance  and  Reinsurance
segments are $115.1, $271.4, $14.2 and $358.9, respectively (2005 – $104.0, $113.9, $1.0 and
$103.2) (2004 – $22.6, $85.5, nil and $75.1).

Interest expense for the Canadian Insurance, U.S. Insurance, Asian Insurance and Reinsurance
segments is nil, $33.0, nil and $37.5, respectively (2005 – nil, $32.9, nil and $30.0) (2004 – nil,
$33.2, nil and $25.6).

Geographic  premiums  are  determined  based  on  the  domicile  of  the  various  subsidiaries  and
where the primary underlying risk of the business resides.

Corporate  and  other  includes  the  company’s  interest  expense  and  corporate  overhead.
Corporate assets include cash and short term investments and miscellaneous other assets in the
holding company.

19. Fair Value

Information on the fair values of ﬁnancial instruments of the company, including where those
values  differ  from  their  carrying  values  in  the  ﬁnancial  statements  at  December  31,  2006,
include:

Marketable securities at holding company

Portfolio investments

Securities sold but not yet purchased

Long term debt

Trust preferred securities of subsidiaries

Purchase consideration payable

Note
Reference

Carrying
Value

Estimated
Fair Value

3

4

4

8

9

9

227.2

243.4

16,835.6

17,146.2

783.3

2,115.7

17.9

179.2

783.3

2,146.3

15.8

179.2

The  amounts  above  do  not  include  the  fair  value  of  underlying  lines  of  business. While  fair
value amounts are designed to represent estimates of the amounts at which instruments could
be  exchanged  in  current  transactions  between  willing  parties,  certain  of  the  company’s
ﬁnancial instruments lack an available trading market. Therefore, these instruments have been
valued  on  a  going  concern  basis.  Fair  value  information  on  the  provision  for  claims  and
reinsurance recoverables are not determinable.

These fair values have not been reﬂected in the ﬁnancial statements.

20. US GAAP Reconciliation

The consolidated ﬁnancial statements of the company have been prepared in accordance with
Canadian  GAAP  which  are  different  in  some  respects  from  those  applicable  in  the  United
States, as described below.

52

Consolidated Statements of Earnings GAAP differences

The  effect  of  the  signiﬁcant  differences  between  consolidated  net  earnings  under  Canadian
GAAP and consolidated net earnings under US GAAP are as follows:

(a) Under Canadian GAAP, recoveries on certain stop loss reinsurance treaties (including
the  former  Swiss  Re  corporate  insurance  cover)  protecting  Fairfax,  Crum  &  Forster
and TIG are recorded at the same time as the claims incurred are ceded. Under US
GAAP,  these  recoveries,  which  are  considered  to  be  retroactive  reinsurance,  are
recorded  up  to  the  amount  of  the  premium  paid  with  the  excess  of  the  ceded
liabilities  over  the  premium  paid  recorded  as  a  deferred  gain.  The  deferred  gain  is
amortized to income over the estimated settlement period over which the company
expects  to  receive  the  recoveries  and  is  recorded  in  accounts  payable  and  accrued
liabilities.  The  Swiss  Re  corporate  insurance  cover  was  commuted  as  described  in
note  6  in  July  2006.  The  loss  of  $412.6  recorded  under  Canadian  GAAP  has  been
reversed  and  the  related  deferred  gain  of  $429.9  at  that  date  under  US  GAAP  was
eliminated.  The  pre-tax  US  GAAP  gain  related  to  the  commutation  of  the  Swiss  Re
corporate  insurance  cover  was  $17.3.  During  2005,  the  Canadian  GAAP  loss  on
commutation  of  the  Chubb  Re  treaty  was  eliminated  for  $88.7.  At  December  31,
2006,  the  deferred  gain  included  in  accounts  payable  and  accrued  liabilities  was
$168.0 (2005 – $633.8).

(b) Other than temporary declines are recorded in earnings. Declines in fair values are
generally presumed to be other than temporary if they have persisted over a period of
time  and  factors  indicate  that  recovery  is  uncertain.  Under  Canadian  GAAP,  other
than  temporary  declines  in  the  value  of  investment  securities  to  fair  value  are
recorded in earnings. Under US GAAP, securities are written down to quoted market
value when an other than temporary decline occurs. Any differences in the amounts
recorded between Canadian and US GAAP are reversed when the related securities are
sold.

(c) Under Canadian GAAP, convertible bond securities and other ﬁxed income securities
with  embedded  derivatives  which  are  held  as  investments  are  carried  at  amortized
cost. Under US GAAP, changes in the fair value attributable to the embedded option
in  a  convertible  bond  or  other  security  is  recognized  in  earnings  through  realized
gains or losses on investments with the host instrument accounting being recorded
as described in (i) below.

(d)

(e)

Included  in  other  differences  are  cost  basis  adjustments  of  $10.3  recognized  in
connection with the OdysseyRe secondary offering which would reduce the realized
gain  on  the  OdysseyRe  secondary  offering  from  $69.7  under  Canadian  GAAP  to
$59.4 under US GAAP.

For deﬁned beneﬁt plans, US GAAP requires that an unfunded accumulated beneﬁt
obligation  be  recorded  as  additional  minimum  liability  and  the  excess  of  the
unfunded accumulated beneﬁt obligation over the unrecognized prior service cost be
recorded in other comprehensive income. The actuarial valuation of the accumulated
beneﬁt  obligation  is  based  on  current  and  past  compensation  levels  and  service
rendered to date.

53

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

The following shows the net earnings in accordance with US GAAP:

Net earnings (loss), Canadian GAAP

Recoveries on retroactive reinsurance (a)

Other than temporary declines (b)

Embedded bond investment derivatives (c)

Other differences (d)

Tax effect

2006

227.5

465.8

7.9

(3.1)

(6.5)

(37.2)

2005

(446.6)

169.8

21.7

4.9

(2.0)

(61.2)

Net earnings (loss), US GAAP

654.4

(313.4)

Unrealized net appreciation (depreciation) of investments

(221.9)

Change in currency translation account

Minimum pension liability (e)

31.9

(5.2)

2.4

6.4

(10.9)

2004

53.1

(15.1)

28.1

12.6

(14.5)

12.6

76.8

75.5

70.7

1.4

Other comprehensive income (loss)

(195.2)

(2.1)

147.6

Comprehensive income (loss), US GAAP

459.2

(315.5)

224.4

Net earnings (loss) per share, US GAAP

$ 36.20

$ (19.65)

$ 4.82

Net earnings (loss) per diluted share, US GAAP

$ 34.73

$ (19.65)

$ 4.82

Consolidated Balance Sheets

(i)

In  Canada,  portfolio  investments  are  carried  at  cost  or  amortized  cost  with  a
provision  for  declines  in  value  which  are  considered  to  be  other  than  temporary.
Strategic  investments  include  Hub,  ICICI  Lombard  and  Advent  which  are  equity
accounted for and Zenith National which was carried at cost. In the U.S., portfolio
investments and strategic investments (excluding equity accounted investments) are
classiﬁed as available for sale and recorded at their fair value based on quoted market
prices  with  unrealized  gains  and  losses,  net  of  taxes,  included  in  other
comprehensive income through shareholders’ equity.

(ii) As  described  in  footnote  (6)  in  note  8,  under  Canadian  GAAP  the  value  of  the
conversion option of the company’s 5% convertible senior debentures is included in
Other paid in capital. Under US GAAP the full principal amount of the debentures is
included in debt.

(iii) Foreign exchange losses realized on foreign exchange contracts that hedged the 1999
acquisition  funding  for  TIG  were  recorded  as  goodwill  for  Canadian  GAAP.  These
foreign exchange contracts are not considered a hedge for purposes of US GAAP and
as a result, the goodwill recognized under Canadian GAAP has been reclassiﬁed as a
charge to opening retained earnings for US GAAP.

(iv) Under US GAAP, FASB Statement No. 158, Employers’ Accounting for Deﬁned Beneﬁt
Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87,
88, 106 and 132(R) (‘‘SFAS 158’’), the company recognizes a net liability or asset to
report  the  funded  status  of  their  deﬁned  beneﬁt  pension  and  other  postretirement
beneﬁt plans on its balance sheet with an offsetting adjustment to accumulated other
comprehensive  income  in  shareholders’  equity.  Beginning  January  1,  2008,  the
company  will  adopt  the  SFAS  158  requirement  to  measure  the  funded  status  of  all
beneﬁt plans as of the date of its year-end balance sheet.

54

The following table summarizes the incremental effect of applying FASB Statement No. 158 on
individual line items in the consolidated US GAAP balance sheet:

Before Application of
Statement 158

Adjustments

After Application of
Statement 158

Accounts payable and
accrued liabilities
Future income taxes
Total liabilities
Accumulated other

comprehensive income

Shareholders’ equity

1,277.6
789.2
22,487.0

48.2
2,794.5

72.3
22.4
72.3

(49.9)
(49.9)

1,349.9
811.6
22,559.3

(1.7)
2,744.6

Amounts recognized in accumulated other comprehensive income relating to deﬁned beneﬁt
pension and other post retirement beneﬁt plans consist of:

Net actuarial loss
Transitional obligation
Past service costs
Reversal of additional minimum pension liability

Total

2006

(91.0)
0.3
0.3
18.1

(72.3)

Recent Accounting Pronouncements

In June 2006, the Financial Accounting Standards Board (‘‘FASB’’) issued FASB Interpretation
No.  48,  Accounting  for  Uncertainty  in  Income  Taxes  –  an  interpretation  of  FASB  No.  109
(‘‘FIN  48’’)  which  clariﬁes  the  accounting  for  uncertainty  in  income  taxes  recognized  in  a
company’s  ﬁnancial  statements.  Speciﬁcally,  the  pronouncement  prescribes  a  recognition
threshold  and  a  measurement  attribute  for  the  ﬁnancial  statement  recognition  and
measurement of a tax position taken or expected to be taken in a tax return. The interpretation
also  provides  guidance  on  the  related  derecognition,  classiﬁcation,  interest  and  penalties,
accounting  for  interim  periods,  disclosure  and  transition  of  uncertain  tax  positions.  The
interpretation  is  effective  for  ﬁscal  years  beginning  after  December  15,  2006.  The  company
expects no material adjustments as a result of adopting FIN 48 on its results of operations and
ﬁnancial position.

In  February  2006,  FASB  issued  SFAS  155,  Accounting  for  Certain  Hybrid  Instruments  an
Amendment of SFAS 133 and 140 which allows companies to elect to measure certain hybrid
ﬁnancial instruments at fair value in their entirety, with any changes in fair value recognized
in  earnings.  The  fair  value  election  will  eliminate  the  need  to  separately  recognize  certain
derivatives  embedded  in  hybrid  ﬁnancial  instruments  under  FASB  Statement  No.  133,
Accounting for Derivative Instruments and Hedging Activities. The new rules will be adopted
prospectively on January 1, 2007 and the company will elect to adopt fair value measurement
for all applicable existing and new instruments. The effect of adopting SFAS 155 together with
the  impact  of  adopting  new  Canadian  GAAP  pronouncements  with  respect  to  the  fair  value
option,  as  described  in  note  2,  is  a  net  of  tax  adjustment  to  decrease  opening  cumulative
reduction  in  net  earnings  under  US  GAAP  by  $11.3  with  an  offsetting  increase  in  opening
accumulated other comprehensive income.

In  September  2006,  FASB  issued  SFAS  157  Fair  Value  Measurements  (‘‘SFAS  157’’),  which
deﬁnes  fair  value,  establishes  a  framework  for  measuring  fair  value,  and  expands  disclosures
about  assets  and  liabilities  measured  at  fair  value.  SFAS  157  becomes  effective  for  ﬁscal
years  beginning  after  November  15,  2007.  The  company  plans  to  adopt  SFAS  157  on

55

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

January  1,  2008.  The  company  is  currently  evaluating  the  effects  of  SFAS  157  but  does  not
expect its implementation to have a material impact on its consolidated ﬁnancial position and
results of operations.

The  following  shows  the  balance  sheet  amounts  in  accordance  with  US  GAAP,  setting  out
individual amounts where different from the amounts reported under Canadian GAAP:

Assets

Marketable securities

Portfolio investments

Subsidiary cash and short term investments

Bonds

Preferred stocks

Common stocks

Strategic investments

2006

2005

243.4

287.1

4,602.7

8,622.6

19.6

3,788.9

7,766.5

16.6

2,317.0

2,514.5

350.6

364.0

Investments (including subsidiary cash and short term

investments) pledged for securities sold but not yet purchased

1,018.1

1,009.3

Total portfolio investments

Future income taxes

Goodwill

All other assets

Total assets

Liabilities

Accounts payable and accrued liabilities

Securities sold but not yet purchased

Long term debt – holding company borrowings

Long term debt – subsidiary company borrowings

All other liabilities

Total liabilities

Mandatorily redeemable shares of TRG

Non-controlling interests

Shareholders’ Equity

16,930.6

15,459.8

811.6

268.8

1,051.4

268.3

8,521.6

10,922.9

26,776.0

27,989.5

1,349.9

1,818.1

783.3

702.9

1,255.7

1,424.7

913.1

869.3

18,257.3

19,852.1

22,559.3

24,667.1

179.2

1,292.9

1,472.1

192.1

749.8

941.9

2,744.6

2,380.5

26,776.0

27,989.5

56

The difference in consolidated shareholders’ equity is as follows:

Shareholders’ equity based on Canadian GAAP
Accumulated other comprehensive income (excluding

currency translation account)
Reduction of other paid in capital
Cumulative reduction in net earnings under US GAAP

2006

2005

2004

2,856.9

2,644.2

2,801.7

(1.7)
(57.9)
(52.7)

275.3
(59.4)
(479.6)

283.8
(59.4)
(612.8)

Shareholders’ equity based on US GAAP

2,744.6

2,380.5

2,413.3

Statement  of  Financial  Accounting  Standards  No.  130,  ‘‘Reporting  Comprehensive  Income’’,
requires  the  company  to  disclose  items  of  other  comprehensive  income  in  a  ﬁnancial
statement and to disclose accumulated balances of other comprehensive income in the equity
section of ﬁnancial statements. A new Canadian GAAP standard will require this presentation
to be adopted in 2007 (see Future accounting changes in note 2). Other comprehensive income
includes (besides the currency translation account, which is disclosed under Canadian GAAP)
unrealized gains and losses on investments and other items, as follows:

Unrealized gain on investments available for sale

Minimum pension liability

Adjustment to initially apply FASB Statement No. 158

Related deferred income taxes

2006

99.1

(18.1)

(72.3)

2005

447.0

2004

436.5

(17.6)

(2.0)

–

–

(10.4)

(154.1)

(150.7)

(1.7)

275.3

283.8

Disclosure of Interest and Income Taxes Paid
The aggregate amount of interest paid for the years ended December 31, 2006, 2005 and 2004
was $214.6, $198.4 and $175.1, respectively. The aggregate amount of income taxes paid for
the  years  ended  December  31,  2006,  2005  and  2004  was  $117.6,  $102.4  and  $132.6,
respectively.

Statement of Cash Flows
There  are  no  signiﬁcant  differences  on  the  statement  of  cash  ﬂows  under  US  GAAP  as
compared to Canadian GAAP.

21. Comparative Figures

Certain prior year comparative ﬁgures have been reclassiﬁed to be consistent with the current
year’s presentation.

57

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

Management’s Discussion and Analysis of Financial Condition and
Results of Operations (as of March 9, 2007 except as otherwise indicated)
(Figures and amounts are in US$ and $ millions except per share amounts and as otherwise
indicated. Figures may not add due to rounding.)

Notes: (1) Readers of the Management’s Discussion and Analysis of Financial Condition and
Results  of  Operations  should  review  the  entire  Annual  Report  for  additional
commentary  and  information.  Additional  information  relating  to  the  company,
including its annual information form, can be found on SEDAR at www.sedar.com,
which can also be accessed from the company’s website www.fairfax.ca.

(2) Management  analyzes  and  assesses  the  underlying  insurance,  reinsurance  and
runoff and other operations and the ﬁnancial position of the consolidated group in
various  ways.  Certain  of  these  measures  provided  in  this  Annual  Report,  which
have been used historically and disclosed regularly in Fairfax’s Annual Reports and
interim ﬁnancial reporting, are non-GAAP measures; these measures include tables
showing the company’s sources of net earnings with Cunningham Lindsey equity
accounted.  Where  non-GAAP  measures  are  provided,  descriptions  are  clearly
provided in the commentary as to the nature of the adjustments made.

(3) The combined ratio – which may be calculated differently by different companies
and is calculated by the company as the sum of the loss ratio (claims losses and loss
adjustment expenses expressed as a percentage of net premiums earned) and the
expense  ratio  (commissions,  premium  acquisition  costs  and  other  underwriting
expenses as a percentage of net premiums earned) – is the traditional measure of
underwriting results of property and casualty companies, but is regarded as a non-
GAAP measure.

(4) References to other documents or certain websites do not constitute incorporation
for reference in this MD&A of all or any portion of those documents or websites.

(5) References in this MD&A to Fairfax’s insurance and reinsurance operations do not

include Fairfax’s Runoff and Other operations.

Restatement of Consolidated Financial Statements

As disclosed in note 2 to the consolidated ﬁnancial statements, in 2006 the company restated
its  previously  reported  consolidated  ﬁnancial  statements  as  at  and  for  the  years  ended
December  31,  2001  through  2005  and  all  related  disclosures.  The  restatements  of  the
company’s  consolidated  ﬁnancial  statements  followed  an  internal  review  of  the  company’s
consolidated  ﬁnancial  statements  and  accounting  records  that  was  undertaken  in
contemplation  of  the  commutation  of  the  Swiss  Re  corporate  insurance  cover  and  the  2006
third quarter review and that identiﬁed an overstatement of the consolidated net assets of the
company  as  at  December  31,  2005  and  2004  and  errors  in  accounting  in  the  periodic
consolidated  earnings  statements.  The  effects  of  the  restatements  are  reﬂected  in  the
company’s  consolidated  ﬁnancial  statements  and  accompanying  notes  included  herein.
Accordingly, where appropriate, the effects of the restatements, including the correction of all
errors, are reﬂected in this MD&A.

In  connection  with  the  restatements,  the  company’s  management  identiﬁed  four  material
weaknesses  in  its  internal  control  over  ﬁnancial  reporting  which  management  concluded
existed  at  December  31,  2005.  As  a  result  of  its  assessment  of  the  effectiveness  of  internal
control  over  ﬁnancial  reporting,  the  company’s  management  determined  that  as  of
December 31, 2006, two material weaknesses, relating to investment accounting in accordance
with  US  GAAP  and  accounting  for  income  taxes,  had  been  remediated,  and  two  material
weaknesses,  relating  to  a  sufﬁcient  complement  of  accounting  personnel  and  lines  of

58

communication within the organization and head ofﬁce consolidation controls, had not been
remediated. See Management’s Report on Internal Control Over Financial Reporting.

Sources of Revenue

Revenues reﬂected in the consolidated ﬁnancial statements for the past three years are shown
in the table that follows (claims fees are earned by Cunningham Lindsey).

Net premiums earned

Insurance – Canada (Northbridge)
Insurance – U.S. (Crum & Forster)
Insurance – Asia (Fairfax Asia)
Reinsurance (OdysseyRe)
Runoff and Other

Interest and dividends
Realized gains
Claims fees

2006

2005

2004

1,025.8
1,114.0
67.3
2,225.8
417.7

4,850.6
746.5
835.3
371.3

959.2
1,053.1
68.2
2,275.9
336.1

4,692.5
466.1
385.7
356.2

939.0
1,027.6
57.8
2,323.2
456.7

4,804.3
375.7
313.6
336.1

6,803.7

5,900.5

5,829.7

Revenue  in  2006  increased  to  $6,803.7  from  $5,900.5  in  2005,  principally  as  a  result  of
increases in investment income and net premiums earned. Total investment income, including
interest  and  dividends  and  net  realized  gains,  increased  to  $1,581.8  in  2006  from  $851.8  in
2005, an increase of 85.7% (excluding the $69.7 gain on the OdysseyRe secondary offering in
2006, the increase was 77.5%). During 2006, net premiums written by Northbridge, Crum &
Forster  and  Fairfax  Asia  increased  3.4%,  16.6%  and  30.1%  respectively  from  2005  while  net
premiums written by OdysseyRe declined by 6.2%. Consolidated net premiums written in 2006
increased by 1.5% to $4,763.7 from $4,694.6 in 2005. Net premiums earned from the insurance
and  reinsurance  operations  increased  by  1.8%  to  $4,432.9  in  2006  from  $4,356.4  in  2005.
Increased  net  premiums  earned  by  Runoff  and  Other  in  2006  reﬂected  the  impact  of  the
unearned  premiums  acquired  upon  the  transfer  of  the  Fairmont  legal  entities  to  U.S.  runoff
effective January 1, 2006.

Claims  fees  for  2006  increased  by  4.2%  over  2005,  denominated  in  U.S.  dollars.  Claims  fees
revenues denominated in their respective local currencies increased in 2006 compared to 2005
in  the  U.K.,  the  U.S.  and  Canada  and  declined  modestly  in  the  European  and  International
divisions.

As presented in note 18 to the consolidated ﬁnancial statements, on a geographic basis, United
States,  Canadian,  and  International  operations  accounted  for  55.1%,  25.2%  and  19.7%,
respectively,  of  net  premiums  earned  in  2006  compared  with  53.3%,  24.8%  and  21.9%,
respectively, in 2005.

Net premiums earned for 2006 compared with 2005 in the respective geographic areas changed
signiﬁcantly. The assumption of the Fairmont business by Crum & Forster on January 1, 2006
and  the  resulting  transfer  of  the  Fairmont  legal  entities  to  U.S.  runoff  partially  offset  the
premium growth at Crum & Forster and increased earned premium in the Runoff and Other
segment. The growth in Canadian net premiums earned from $1,163.3 in 2005 to $1,223.6 in
2006 was due primarily to the strengthening of the Canadian dollar against the U.S. dollar. The
decline in net Reinsurance premiums earned primarily reﬂects decreased premiums generated
by OdysseyRe’s reinsurance operations in Europe and Asia.

Net  premiums  earned  for  2005  compared  with  2004  in  the  various  geographic  areas  also
changed signiﬁcantly. The growth in Canadian net premiums earned from $1,036.8 in 2004 to

59

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

$1,163.3  in  2005  was  due  primarily  to  the  strengthening  of  the  Canadian  dollar  against  the
U.S. dollar in respect of the Northbridge premiums and to increased Canadian-based business
in Group Re. The decrease in U.S. net premiums earned by Runoff and Other from $277.4 in
2004 to $68.7 in 2005 was due primarily to a reduction of earned premiums in U.S. runoff and
less third party reinsurance business in Group Re. The increase in International net premiums
earned  by  Runoff  and  Other  from  $24.4  in  2004  to  $46.0  in  2005  was  due  primarily  to  the
acquisition of Compagnie de R´eassurance d’Ile de France by the Runoff group.

Net Earnings

Combined ratios and sources of net earnings (with Cunningham Lindsey equity accounted) for
the  most  recent  three  years  are  presented  in  the  table  that  follows  and  commentary  on
combined  ratios  and  on  operating  income  by  segment  is  provided  in  the  section  entitled
Underwriting and Operating Income.

The following table presents the combined ratios and underwriting and operating results for
each of the company’s insurance and reinsurance operations and, as applicable, for its Runoff
and Other operations, as well as the earnings contributions from its claims adjusting, appraisal
and  loss  management  services  (Cunningham  Lindsey).  In  that  table,  interest  and  dividends
and  realized  gains  on  the  consolidated  statements  of  earnings  are  broken  out  so  that  those
items are shown separately as they relate to the insurance and reinsurance operating results,
and are comprised in Runoff and Other as they relate to that segment.

Combined ratios (1)(2)

Insurance – Canada (Northbridge)
– U.S. (Crum & Forster)
– Asia (Fairfax Asia)

Reinsurance (OdysseyRe)

Consolidated

Sources of net earnings

Underwriting

Insurance – Canada (Northbridge)
– U.S. (Crum & Forster)
– Asia (Fairfax Asia)

Reinsurance (OdysseyRe)

Underwriting income (loss)
Interest and dividends

Operating income
Realized gains
Runoff and Other
Claims adjusting (Fairfax portion)
Interest expense
Corporate overhead and other

Pre-tax income (loss)
Income taxes
Non-controlling interests

Net earnings (loss)

2006

2005

2004

98.0%
92.3%
78.4%
96.5%

92.9%
100.9%
93.0%
117.5%

87.7%
105.4%
91.9%
97.0%

95.5%

107.7%

96.9%

20.5
86.2
14.5
77.0

198.2
559.0

757.2
683.7
(321.8)
–
(195.7)
(47.2)

876.2
(483.2)
(165.5)

68.2
(9.1)
4.8
(397.8)

(333.9)
345.4

11.5
324.1
(618.4)
5.4
(184.6)
(8.4)

(470.4)
68.9
(45.1)

115.5
(55.0)
4.7
69.6

134.8
301.4

436.2
171.1
(70.0)
(15.4)
(163.4)
(74.1)

284.4
(146.5)
(84.8)

227.5

(446.6)

53.1

(1) The  2005  combined  ratios  include  7.9  combined  ratio  points  for  Canadian  insurance,  8.9
combined  ratio  points  for  U.S.  insurance,  19.2  combined  ratio  points  for  reinsurance  and  14.0
consolidated combined ratio points arising from the 2005 hurricane losses.

60

(2) The  2004  combined  ratios  include  2.9  combined  ratio  points  for  Canadian  insurance,  9.4
combined  ratio  points  for  U.S.  insurance,  4.2  combined  ratio  points  for  reinsurance  and  5.1
consolidated combined ratio points arising from the 2004 hurricane losses.

In 2006, the company’s insurance and reinsurance operations generated underwriting proﬁt of
$198.2  and  a  combined  ratio  of  95.5%.  In  2005,  the  company’s  insurance  and  reinsurance
operations  incurred  an  underwriting  loss  of  $333.9,  reﬂecting  the  impact  of  $609.9  of  net
losses  from  Hurricanes  Katrina,  Rita  and  Wilma  (‘‘the  2005  hurricanes’’),  and  produced  a
combined ratio of 107.7%. Prior to giving effect to the 2005 hurricane losses, those operations
would  have  generated  an  underwriting  proﬁt  of  $276.0  and  a  combined  ratio  of  93.7%.  In
2004, the company’s insurance and reinsurance operations achieved a net underwriting proﬁt
of $134.8 (an underwriting proﬁt of $356.9 prior to giving effect to the losses during the third
quarter of 2004 from Hurricanes Charley, Frances, Ivan and Jeanne (‘‘the 2004 hurricanes’’))
and a combined ratio of 96.9% (91.8% prior to giving effect to the 2004 hurricane losses).

The 2006 pre-tax loss of $321.8 for Runoff and Other included a $412.6 non-cash pre-tax and
after-tax  loss  on  the  commutation  of  the  SwissRe  corporate  insurance  cover  and  a  $111.6
pre-tax  gain  on  OdysseyRe  common  shares  sold  by  runoff  companies  to  facilitate  the
company’s  OdysseyRe  secondary  offering.  Runoff  and  Other’s  2005  pre-tax  loss  of  $618.4
included  signiﬁcant  charges  related  to  strengthening  of  prior  periods’  reserves,  losses  on
reinsurance commutations and settlements of reinsurance disputes, and losses arising from the
2005 hurricanes. The 2004 pre-tax loss of $70.0 included charges related to strengthening of
prior years’ reserves as well as signiﬁcant gains realized on sales of Zenith National shares and
Northbridge common shares sold to facilitate the company’s Northbridge secondary offering,
as discussed in the Runoff and Other section.

Net  earnings  for  2006  of  $227.5  ($11.92  per  diluted  share)  reﬂected  improved  underwriting
proﬁt and signiﬁcantly increased investment income compared to 2005. The net loss in 2005
of $446.6 ($27.75 per diluted share) included signiﬁcant catastrophe losses and runoff charges
and  featured  lower  investment  income  by  comparison.  Prior  to  the  impact  of  $715.5  of
consolidated  losses  resulting  from  the  2005  hurricanes  and  $420.5  of  charges  resulting  from
actions  taken  in  runoff,  earnings  from  operations  before  income  taxes  in  2005  would  have
been  $669.5,  compared  to  $540.3  in  2004  prior  to  giving  effect  to  $252.7  in  losses  resulting
from the 2004 hurricanes.

Of the $1,111.6 of consolidated operating expenses in 2006 ($1,059.7 in 2005), $757.9 ($726.4
in  2005)  related  to  insurance,  reinsurance,  Runoff  and  Other  operations  and  to  corporate
overhead, while the balance of $353.7 ($333.3 in 2005) related to Cunningham Lindsey.

Cash  ﬂow  from  operations  for  the  year  ended  December  31,  2006  amounted  to  $189.4  for
Northbridge  ($346.0  in  2005),  $89.4  for  Crum  &  Forster  ($9.1  in  2005)  and  $745.2  for
OdysseyRe ($397.3 in 2005). Decreased operating cash ﬂows at Northbridge primarily reﬂected
the  general  decline  in  Northbridge’s  business  activity (gross  premiums  written  and  net
premiums  written  declined  in  2006  relative  to  2005  by  2.7%  and  3.4%  respectively  in
Canadian  dollar  terms).  Increased  operating  cash  ﬂows  at  Crum  &  Forster  reﬂected  general
business expansion driven by the assumption of Fairmont business, partially offset by higher
payments  of  income  taxes.  Increased  operating  cash  ﬂows  at  OdysseyRe  reﬂected  increased
operating  income,  collections  of  reinsurance  recoverable  and  income  taxes  receivable  offset
somewhat  by  decreases  in  funds  withheld  under  reinsurance  contracts  and  reinsurance
balances payable.

The above sources of net earnings (with Cunningham Lindsey equity accounted) presented by
business segment were as set out in the tables below for the years ended December 31, 2006,
2005  and  2004.  The  intercompany  adjustment  for  gross  premiums  written  eliminates
premiums  on  reinsurance  ceded  within  the  group,  primarily  to  OdysseyRe,  nSpire  Re  and

61

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

Group  Re.  The  intercompany  adjustment  for  realized  gains  eliminates  gains  or  losses  on
purchase and sale transactions within the group.

Year ended December 31, 2006

Northbridge

Insurance

Asia OdysseyRe Operations

Other

Intercompany

Other Consolidated

U.S.

Fairfax

Ongoing Runoff &

Corporate &

Gross premiums written

1,609.9

1,351.6

134.8

2,335.7

5,432.0

486.8

(458.2)

Net premiums written

1,012.3

1,196.5

60.5

2,160.9

4,430.2

333.5

Net premiums earned

1,025.8

1,114.0

67.3

2,225.8

4,432.9

417.7

20.5
100.8

121.3
115.1
–
–
–
(9.8)

86.2
156.5

242.7
271.4
–
–
(33.0)
(8.1)

14.5
3.3

17.8
14.2
–
–
–
(3.3)

77.0
298.4

375.4
358.9
–
–
(37.5)
(18.8)

198.2
559.0

757.2
759.6
–
–
(70.5)
(40.0)

–
–

–
151.6
(473.4)
–
–
–

226.6

473.0

28.7

678.0

1,406.3

(321.8)

(111.9)

(96.4)

–

–

–

–
–

–
36.0
–
–
(125.2)
(7.2)

–

–

–
–

–
(111.9)
–
–
–
–

5,460.6

4,763.7

4,850.6

198.2
559.0

757.2
835.3
(473.4)
–
(195.7)
(47.2)

876.2
(483.2)
(165.5)

227.5

Underwriting proﬁt
Interest and dividends

Operating income before:
Realized gains
Runoff and Other operating loss
Claims adjusting
Interest expense
Corporate overhead and other

Pre-tax income (loss)
Income taxes
Non-controlling interests

Net earnings

Year ended December 31, 2005

Northbridge

Insurance

Asia OdysseyRe Operations

Other

Intercompany

Other Consolidated

U.S.

Fairfax

Ongoing Runoff &

Corporate &

Gross premiums written

1,545.2

1,303.6

76.6

2,628.5

5,553.9

377.6

(372.4)

Net premiums written

978.8

1,026.0

46.5

2,303.3

4,354.6

340.0

Net premiums earned

959.2

1,053.1

68.2

2,275.9

4,356.4

336.1

Underwriting proﬁt (loss)
Interest and dividends

Operating income (loss) before:
Realized gains
Runoff and Other operating loss
Claims adjusting
Interest expense
Corporate overhead and other

Pre-tax income (loss)
Income taxes
Non-controlling interests

Net earnings (loss)

68.2
65.7

133.9
104.0
–
–
–
(14.6)

(9.1)
105.0

95.9
113.9
–
–
(32.9)
(2.5)

4.8
7.5

12.3
1.0
–
–
–
(2.4)

(397.8)
167.2

(230.6)
103.2
–
–
(30.0)
(25.0)

(333.9)
345.4

11.5
322.1
–
–
(62.9)
(44.5)

–
–

–
59.2
(677.6)
–
–
–

223.3

174.4

10.9

(182.4)

226.2

(618.4)

–

–

–
–

–
(15.7)
–
–
–
–

(15.7)

–

–

–

–
–

–
17.7
–
5.4
(121.7)
36.1

(62.5)

5,559.1

4,694.6

4,692.5

(333.9)
345.4

11.5
383.3
(677.6)
5.4
(184.6)
(8.4)

(470.4)
68.9
(45.1)

(446.6)

62

Year ended December 31, 2004

Northbridge

Insurance

Asia OdysseyRe Operations

Other

Intercompany

Other Consolidated

U.S.

Fairfax

Ongoing Runoff &

Corporate &

Gross premiums written

1,483.1

1,345.1

86.7

2,625.9

5,540.8

584.2

(521.9)

Net premiums written

957.6

1,036.0

59.6

2,348.8

4,402.0

383.7

Net premiums earned

939.0

1,027.6

57.8

2,323.2

4,347.6

456.7

115.5
60.9

176.4
22.6
–
–
–
(8.3)

(55.0)
81.3

26.3
85.5
–
–
(33.2)
(8.4)

4.7
2.9

7.6
–
–
–
–
(2.8)

69.6
156.3

225.9
75.1
–
–
(25.6)
(12.4)

134.8
301.4

436.2
183.2
–
–
(58.8)
(31.9)

–
–

–
142.5
(212.5)
–
–
–

190.7

70.2

4.8

263.0

528.7

(70.0)

(43.8)

(130.5)

–

–

–

–
–

–
31.7
–
(15.4)
(104.6)
(42.2)

–

–

–
–

–
(43.8)
–
–
–
–

5,603.1

4,785.7

4,804.3

134.8
301.4

436.2
313.6
(212.5)
(15.4)
(163.4)
(74.1)

284.4
(146.5)
(84.8)

53.1

Underwriting proﬁt (loss)
Interest and dividends

Operating income before:
Realized gains
Runoff and Other operating loss
Claims adjusting
Interest expense
Corporate overhead and other

Pre-tax income (loss)
Income taxes
Non-controlling interests

Net earnings

Reference is made to note 2, as well as note 20, to the consolidated ﬁnancial statements for a
discussion of future accounting changes.

63

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

Segmented Balance Sheets

The company’s segmented balance sheets as at December 31, 2006 and 2005 present the assets
and  liabilities  of,  and  the  capital  invested  by  the  company  in,  each  of  the  company’s  major
segments. The segmented balance sheets have been prepared on the following basis:

(a)

(b)

The  balance  sheet  for  each  segment  is  on  a  legal  entity  basis  for  the  subsidiaries
within  the  segment  (except  for  nSpire  Re  in  Runoff  and  Other,  which  excludes
balances  related  to  U.S.  acquisition  ﬁnancing),  prepared  in  accordance  with
Canadian  GAAP  and  Fairfax’s  accounting  policies  and  basis  of  accounting.
Accordingly, these segmented balance sheets differ from those published by Crum &
Forster and OdysseyRe due to differences between Canadian and US GAAP.

Investments  in  afﬁliates,  which  are  carried  at  cost,  are  disclosed  in  the  ﬁnancial
information  accompanying  the  discussion  of  the  company’s  business  segments.
Afﬁliated  insurance  and  reinsurance  balances,  including  premiums  receivable,
reinsurance recoverable, deferred premium acquisition costs, funds withheld payable
to reinsurers, provision for claims and unearned premiums are not shown separately
but are eliminated in Corporate and Other.

(c) Corporate and Other includes Fairfax entity and its subsidiary intermediate holding
companies  as  well  as  the  consolidating  and  eliminating  entries  required  under
Canadian GAAP to prepare consolidated ﬁnancial statements. The most signiﬁcant of
those  entries  are  derived  from  the  elimination  of  intercompany  reinsurance
(primarily  consisting  of  reinsurance  provided  by  Group  Re,  reinsurance  between
OdysseyRe  and  the  primary  insurers,  and  reinsurance  related  to  pre-acquisition
reinsurance  arrangements),  which  affects  recoverable  from  reinsurers,  provision  for
claims and unearned premiums. The $1,392.8 corporate and other long term debt as
at December 31, 2006 consists primarily of Fairfax debt of $1,202.6 (see note 8 to the
consolidated ﬁnancial statements), TIG trust preferred securities of $17.9 (see note 9
to  the  consolidated  ﬁnancial  statements)  and  purchase  consideration  payable  of
$179.2  (related  to  the  TRG  acquisition  referred  to  in  note  9  to  the  consolidated
ﬁnancial statements).

64

Segmented Balance Sheet as at December 31, 2006

Insurance

Reinsurance

Crum & Fairfax

Operating

Runoff and

Cunningham Corporate

Northbridge

Forster

Asia

OdysseyRe

Companies

Other

Lindsey

and Other

Fairfax

Assets
Cash, short term

investments and
marketable securities
Accounts receivable and

other

Recoverable from

reinsurers

Portfolio investments
Deferred premium
acquisition costs
Future income taxes
Premises and equipment
Goodwill
Due from afﬁliates
Other assets
Investments in Fairfax

afﬁliates

Total assets

Liabilities
Cunningham Lindsey

indebtedness

Accounts payable and
accrued liabilities
Securities sold but not

yet purchased
Due to afﬁliates
Funds withheld payable

to reinsurers

Provision for claims
Unearned premiums
Deferred taxes payable
Long term debt

–

1.8

–

–

1.8

–

–

765.6

767.4

455.1

348.4

33.4

710.3

1,547.2

292.8

140.4

(87.6)

1,892.8

1,250.2
2,760.6

1,769.4
3,832.7

61.3
286.7

849.3
6,862.3

3,930.2
13,742.3

2,705.1
3,104.2

–
9.0

(1,128.8)

5,506.5
(19.9) 16,835.6

123.1
54.3
13.7
13.4
–
1.3

84.0
220.8
4.5
7.3
–
23.7

–

109.7

5.0
2.6
1.0
5.4
0.4
–

–

149.9
238.0
10.3
11.5
–
21.7

362.0
515.7
29.5
37.6
0.4
46.7

7.0
759.9
6.1
–
117.5
19.7

–
5.7
13.1
193.6
1.9
9.6

–
(510.0)
37.3
8.0
(119.8)
32.7

369.0
771.3
86.0
239.2
–
108.7

88.5

198.2

351.2

–

(549.4)

–

4,671.7

6,402.3

395.8

8,941.8

20,411.6

7,363.5

373.3

(1,571.9) 26,576.5

–

–

–

–

–

68.2

–

68.2

188.4

275.5

44.4

256.1

764.4

265.1

102.7

(41.0)

1,091.2

259.1
–

400.2
12.9

56.4
2,329.5
832.4
5.6
–

252.0
3,371.5
576.2
–
300.0

–
–

0.9
123.5
56.1
–
–

120.3
3.5

108.0
5,142.2
786.8
–
512.3

779.6
16.4

417.3
10,966.7
2,251.5
5.6
812.3

3.7
–

37.3
5,511.9
162.7
–
–

–
–

–
–
–
0.9
107.7

279.5

–
(16.4)

783.3
–

(84.6)

370.0
(976.3) 15,502.3
2,298.9
(115.3)
–
(6.5)
2,312.8
1,392.8

152.7

22,426.7

Total liabilities

3,671.4

5,188.3

224.9

6,929.2

16,013.8

5,980.7

Non-controlling interests

–

–

7.3

–

7.3

–

1.5

1,284.1

1,292.9

Shareholders’ equity

1,000.3

1,214.0

163.6

2,012.6

4,390.5

1,382.8

92.3

(3,008.7)

2,856.9

Total liabilities and

shareholders’ equity

4,671.7

6,402.3

395.8

8,941.8

20,411.6

7,363.5

373.3

(1,571.9) 26,576.5

Capital
Debt
Non-controlling interests
Investments in Fairfax

afﬁliates

Shareholders’ equity

–
408.1

300.0
–

–
–

–
592.2

109.7
1,104.3

–
163.6

512.3
863.1

88.5
1,061.0

812.3
1,271.2

198.2
2,921.1

–
–

351.2
1,031.6

175.9
17.6

–
74.7

1,392.8
4.1

2,381.0
1,292.9

(549.4)
(1,170.5)

–
2,856.9

Total capital

1,000.3

1,514.0

163.6

2,524.9

5,202.8

1,382.8

268.2

(323.0)

6,530.8

% of total capital

15.3%

23.2%

2.5%

38.7%

79.7%

21.2%

4.1%

(5.0)% 100.0%

65

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

Segmented Balance Sheet as at December 31, 2005

Insurance

Reinsurance

Assets
Cash, short term

investments and
marketable securities
Accounts receivable and

other

Recoverable from

reinsurers

Portfolio investments
Deferred premium
acquisition costs
Future income taxes
Premises and equipment
Goodwill
Due from afﬁliates
Other assets
Investments in Fairfax

afﬁliates

Total assets

Liabilities
Cunningham Lindsey

indebtedness

Accounts payable and
accrued liabilities

Securities sold but not yet

purchased
Due to afﬁliates
Funds withheld payable

to reinsurers

Provision for claims
Unearned premiums
Deferred taxes payable
Long term debt

Northbridge

U.S.

Asia

OdysseyRe

Companies

Other

Lindsey

and Other

Fairfax

Fairfax

Operating

Runoff and

Cunningham Corporate

–

1.7

–

–

1.7

–

–

557.3

559.0

438.0

382.9

38.2

872.4

1,731.5

654.6

115.7

(121.4)

2,380.4

1,330.3
2,447.7

2,244.9
3,769.3

48.7
190.7

1,478.0
5,668.1

5,101.9
12,075.8

4,078.3
2,924.8

122.0
61.8
15.0
16.1
–
1.3

78.5
187.8
4.2
7.3
–
25.6

–

118.8

6.7
0.5
1.0
5.4
2.5
–

–

167.2
217.5
12.2
12.2
–
24.5

374.4
467.6
32.4
41.0
2.5
51.4

10.7
797.3
8.5
–
94.5
14.9

–
10.0

–
2.4
11.2
175.6
2.1
8.8

(1,524.5)
0.1

7,655.7
15,010.7

–
(148.5)
43.6
11.8
(99.1)
33.1

385.1
1,118.8
95.7
228.4
–
108.2

4,432.2

6,821.0

293.7

8,540.6

20,087.5

9,071.2

325.8

(1,942.5) 27,542.0

88.5

207.3

487.6

–

(694.9)

–

–

–

–

–

–

–

208.2

256.3

21.1

149.8

635.4

308.6

227.5
3.3

329.7
6.8

58.7
2,198.1
852.1
5.3
–

301.1
3,896.8
560.2
–
300.0

–
–

0.1
114.7
58.3
–
–

139.2
3.3

192.7
5,109.1
951.0
–
469.5

696.4
13.4

552.6
11,318.7
2,421.6
5.3
769.5

3.9
–

620.4
6,280.1
155.7
–
–

63.9

82.2

–
–

–
–
–
3.0
107.3

256.4

–

63.9

141.1

1,167.3

–
(13.4)

700.3
–

(118.6)

1,054.4
(1,363.7) 16,235.1
2,446.3
–
2,479.1

(131.0)
(8.3)
1,602.3

108.4

24,146.4

Total liabilities

3,553.2

5,650.9

194.2

7,014.6

16,412.9

7,368.7

Non-controlling interests

–

–

7.2

–

7.2

–

1.0

743.2

751.4

Shareholders’ equity

879.0

1,170.1

92.3

1,526.0

3,667.4

1,702.5

68.4

(2,794.1)

2,644.2

Total liabilities and

shareholders’ equity

4,432.2

6,821.0

293.7

8,540.6

20,087.5

9,071.2

325.8

(1,942.5) 27,542.0

Capital
Debt
Non-controlling interests
Investments in Fairfax

afﬁliates

Shareholders’ equity

Total capital

–
358.6

300.0
–

–
520.4

118.8
1,051.3

879.0

1,470.1

–
–

–
92.3

92.3

469.5
371.5

769.5
730.1

–
–

88.5
1,066.0

207.3
2,730.0

487.6
1,214.9

171.2
13.0

–
55.4

1,602.3
8.3

2,543.0
751.4

(694.9)
(1,356.1)

–
2,644.2

1,995.5

4,436.9

1,702.5

239.6

(440.4)

5,938.6

% of total capital

14.8%

24.7%

1.6%

33.6%

74.7%

28.7%

4.0%

(7.4%)

100.0%

66

Accounts receivable and other declined by $487.6 in 2006 principally as the result of the
receipt of the cash proceeds of $373.3 on the closing of the 2005 commutation of the Ridge Re
adverse development cover by TIG in March 2006.

Reinsurance recoverables declined to $5,506.5 in 2006 from $7,655.7 at the end of 2005
primarily as a result of the commutation of the Swiss Re corporate insurance cover balance of
$1  billion,  collections  from  reinsurers  related  to  paid  claims  on  2005  hurricane  losses  and
continuing collections of runoff reinsurance recoverable balances.

Future  income  taxes  represent  amounts  expected  to  be  recovered  in  future  years.  At
December  31,  2006  future  income  taxes  of  $771.3  (of  which  $600.6  related  to  Fairfax  Inc.,
Fairfax’s  U.S.  holding  company,  and  its  subsidiaries  in  the  U.S.  consolidated  tax  group  and
OdysseyRe)  consisted  of  $338.9  of  capitalized  operating  and  capital  losses,  and  temporary
differences of $432.4 which primarily represent expenses recorded in the ﬁnancial statements
but  not  yet  deducted  for  income  tax  purposes.  The  tax-effected  operating  and  capital  losses
(before valuation allowance) relate primarily to Fairfax Inc. and its U.S. subsidiaries other than
OdysseyRe ($41.5), where all of the losses expire after 2018, the Canadian holding company
($85.7) and European runoff ($180.9), with the remainder relating primarily to Cunningham
Lindsey.

To facilitate the utilization of its future U.S. income taxes asset and to optimize the cash ﬂow
from  U.S.  tax  sharing  payments,  the  company  had  increased  its  interest  in  OdysseyRe  to  in
excess of 80% in 2003, to permit OdysseyRe to be included in Fairfax’s U.S. consolidated tax
group. During 2006, Fairfax determined that OdysseyRe’s inclusion in the U.S. tax group was
no  longer  necessary,  and  effective  August  28,  2006,  OdysseyRe  was  deconsolidated  from  the
U.S. tax group.

Consolidated future income taxes decreased by $347.5 in 2006 as a result of the utilization of
capitalized operating and capital losses (resulting from taxable income generated in 2006 and
from  increases  in  valuation  allowances  of  certain  subsidiaries)  and  a  decline  in  the  ordinary
course for temporary differences as a result of variations in business volumes. The portion of
Fairfax’s future income taxes asset consisting of capitalized operating and capital losses related
to  its  U.S.  consolidated  tax  group  decreased  by  $364.2  in  2006  as  a  result  of  the  signiﬁcant
taxable income generated by the members of the U.S. consolidated tax group.

The company’s valuation allowance on its future income taxes asset as at December 31, 2006
was $231.9, of which $189.2 related to losses incurred primarily in the U.K. and Ireland, and
the  remainder  related  primarily  to  losses  incurred  at  Cunningham  Lindsey.  Differences
between  expected  and  actual  future  operating  results  could  adversely  impact  the  company’s
ability  to  realize  the  future  income  taxes  asset  within  a  reasonable  period  of  time  given  the
inherent uncertainty in projecting operating company earnings and industry conditions. The
company  expects  to  realize  the  beneﬁt  of  these  capitalized  losses  from  future  proﬁtable
operations.

In determining the need for a valuation allowance, management considers primarily current
and  expected  proﬁtability  of  the  companies.  Management  reviews  the  recoverability  of  the
future  income  taxes  asset  and  the  valuation  allowance  on  a  quarterly  basis.  The  temporary
differences  principally  relate  to  insurance-related  balances  such  as  claims,  deferred  premium
acquisition costs and unearned premiums and to investment-related balances such as realized
and unrealized gains and losses. Such temporary differences are expected to continue for the
foreseeable future in light of the company’s ongoing operations.

Portfolio  investments  include  strategic  investments  in  26.1%-owned  Hub  International
Limited (‘‘Hub’’) ($183.5) and 44.5%-owned Advent Capital Holdings PLC ($115.9), which are
publicly  listed  companies,  and  26.0%-owned  ICICI  Lombard  General  Insurance  Company
Limited  ($38.5).  Strategic  investments  at  December  31,  2005  included,  in  addition  to  Hub,

67

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

Advent and ICICI Lombard, the company’s remaining holdings of Zenith National Insurance
Corp.  (‘‘Zenith  National’’).  The  company  sold  its  remaining  holdings  of  Zenith  National  in
2006 for a pre-tax gain of $137.3, bringing the total gains realized between 2004 and 2006 on
the company’s Zenith National investment to $339.2.

Subsequent to year end, on February 26, 2007 the company announced that Hub had entered
into an agreement pursuant to which Hub shares would be acquired for $40.00 per share in
cash. Pursuant to an agreement entered into in connection with the transaction, it was agreed
that  the  10.3  million  Hub  shares  held  by  the  company  would  be  voted  in  favour  of  the
proposed acquisition. Upon completion, the company is expected to realize cash proceeds of
approximately  $413  and  an  estimated  pre-tax  gain  on  sale  of  approximately  $220.  The
transaction is subject to Hub shareholder approval, Canadian court approval, other regulatory
approvals in the United States and Canada and customary closing conditions. The transaction
is expected to be completed during the second quarter of 2007.

Goodwill  increased  to  $239.2  (of  which  $193.6  relates  to  Cunningham  Lindsey)  at
December 31, 2006 from $228.4 at December 31, 2005, due principally to the strengthening of
the U.K. pound sterling against the U.S. dollar during 2006.

Components of Net Earnings

Underwriting and Operating Income

Set out and discussed in the sections that follow are the 2006, 2005 and 2004 underwriting and
operating results of Fairfax’s insurance and reinsurance operations on a summarized company-
by-company basis.

Canadian Insurance – Northbridge

Underwriting proﬁt

Combined ratio

Loss & LAE
Commissions
Underwriting expense

Gross premiums written

Net premiums written

Net premiums earned

Underwriting proﬁt
Interest and dividends

Operating income
Realized gains

Pre-tax income before interest and other

Net income after taxes

2006

20.5

2005

68.2

2004

115.5

71.8%
8.1%
18.1%

67.9%
6.3%
18.7%

62.2%
7.3%
18.2%

98.0%

92.9%

87.7%

1,609.9

1,545.2

1,483.1

1,012.3

1,025.8

20.5
100.8

121.3
115.1

236.4

147.3

978.8

959.2

68.2
65.7

133.9
104.0

237.9

163.4

957.6

939.0

115.5
60.9

176.4
22.6

199.0

124.3

In 2006, Northbridge earned underwriting proﬁt of $20.5, representing a 69.9% decline from
underwriting  proﬁt  of  $68.2  earned  in  2005.  The  2006  loss  ratio  of  71.8%,  compared  to  the
2005 loss ratio of 67.9%, included 8.9 points primarily attributable to net adverse development
of prior years’ reserves for the 2005 hurricane losses. During 2006, Commonwealth Insurance
substantially  withdrew  from  the  majority  of  the  business  formerly  underwritten  by  its
Energy & International division, which business had been a signiﬁcant source of recent years’

68

incurred  catastrophe  losses.  Underwriting  performance  achieved  by  the  Northbridge
subsidiaries  other  than  Commonwealth  Insurance  in  2006  was  favourable,  with  combined
ratios for Federated Insurance, Lombard Insurance and Markel Insurance of 84.0%, 90.1% and
91.2%  respectively  (compared  to  90.7%,  88.5%  and  88.2%,  respectively  in  2005).
Commonwealth Insurance produced combined ratios of 153.7% in 2006 and 123.3% in 2005.
In  2005,  Northbridge  earned  underwriting  proﬁt  of  $68.2,  a  41.0%  decline  relative  to
underwriting  proﬁt  of  $115.5  earned  in  2004.  Although  2005  underwriting  proﬁt  increased
from 2004 levels at three of Northbridge’s four operating subsidiaries, the underwriting year
was affected by the unprecedented 2005 hurricanes. Despite an adverse underwriting impact
aggregating 7.9 combined ratio points from Hurricanes Katrina, Rita and Wilma, Northbridge
produced a combined ratio of 92.9% in 2005, compared to 87.7% in 2004.

Net  premiums  written  and  net  premiums  earned  in  2006  increased  by  3.4%  and  6.9%
respectively over 2005 premiums, primarily due to the effect of foreign currency translation of
Northbridge’s predominantly Canadian dollar-denominated premiums (net premiums written
and  net  premiums  earned  in  2006  decreased  by  3.4%  and  0.1%  respectively  over  2005
premiums  in  Canadian  dollar  terms).  Net  premiums  written  and  net  premiums  earned  by
Northbridge in 2005 declined 5.0% (measured in Canadian dollars) relative to 2004 premiums
as a result of a repositioning of its personal lines segment, reinstatement premiums triggered
under  certain  reinsurance  treaties,  reduced  proﬁt  sharing  premium  and  generally  increased
competitive market conditions.

Operating  income  declined  in  2006  to  $121.3  from  $133.9  in  2005,  reﬂecting  a  decline  in
underwriting  proﬁt  partially  offset  by  an  increase  in  interest  and  dividend  income.  Pre-tax
income  before  interest  and  other  was  largely  unchanged  in  2006  compared  to  2005  ($236.4
compared to $237.9) but net earnings declined in 2006 to $147.3 from $163.4 in 2005, with
the  decline  primarily  attributable  to  the  effect  of  a  lower  effective  tax  rate  in  2005  resulting
from  the  reduced  taxation  of  certain  realized  gains  on  portfolio  investments.  Northbridge’s
operating income declined to $133.9 in 2005 from $176.4 in 2004, largely as a result of the
impact of the 2005 hurricanes. However, net income after taxes for 2005 at $163.4 improved
31.5% from $124.3 in 2004, primarily as a result of signiﬁcant net realized gains on portfolio
investments and a reduced effective tax rate. Northbridge’s 2006 results produced a return on
average  equity,  while  remaining  debt  free,  of  15.3%  (expressed  in  Canadian  dollars).
Northbridge’s average annual return on average equity over the past 21 years since inception in
1985 is 16.4% (expressed in Canadian dollars).

69

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

Set out below are the balance sheets (in U.S. dollars) for Northbridge as at December 31, 2006
and 2005.

Assets

Accounts receivable and other

Recoverable from reinsurers

Portfolio investments

Deferred premium acquisition costs

Future income taxes

Premises and equipment

Goodwill

Other assets

Total assets

Liabilities

Accounts payable and accrued liabilities

Securities sold but not yet purchased

Due to afﬁliates

Funds withheld payable to reinsurers

Provision for claims

Unearned premiums

Deferred taxes payable

Total liabilities

Shareholders’ equity

Total liabilities and shareholders’ equity

2006

2005

455.1

438.0

1,250.2

1,330.3

2,760.6

2,447.7

123.1

122.0

54.3

13.7

13.4

1.3

61.8

15.0

16.1

1.3

4,671.7

4,432.2

188.4

259.1

–

56.4

208.2

227.5

3.3

58.7

2,329.5

2,198.1

832.4

852.1

5.6

5.3

3,671.4

3,553.2

1,000.3

879.0

4,671.7

4,432.2

Northbridge’s  assets  and  liabilities  increased  in  2006  due  to  continued  proﬁtability,  positive
operating cash ﬂow generation and favourable investment performance. Portfolio investments
at December 31, 2006 totaled $2,760.6, an increase of 12.8% over December 31, 2005, driven
by  the  generation  of  cash  from  operations  including  increased  investment  income,  and
signiﬁcant  net  realized  gains.  Amounts  recoverable  from  reinsurers  decreased  $80.1  in  2006
from 2005, primarily as a result of collections of paid losses related to the 2005 hurricanes.

Provision for claims increased in 2006, primarily as a result of the net adverse movement in
prior years’ reserves arising from the 2005 hurricanes, to $2,329.5 at December 31, 2006 from
$2,198.1  a  year  earlier.  Common  shareholders’  equity  at  December  31,  2006  was  $1,000.3
compared to $879.0 at December 31, 2005 as a result of 2006 earnings of $147.3, less dividends
paid in 2006 of $29.6.

For more information on Northbridge’s results, please see its 2006 annual report posted on its
website www.norﬁn.com.

70

U.S. Insurance – Crum & Forster(1)(2)

Year ended December 31, 2006

Underwriting proﬁt (loss)

Combined ratio

Loss & LAE
Commissions
Underwriting expense

Gross premiums written

Net premiums written

Net premiums earned

Underwriting proﬁt
Interest and dividends

Operating income
Realized gains

Pre-tax income before interest and other

Net income after taxes

Year ended December 31, 2005

Underwriting proﬁt (loss)

Combined ratio

Loss & LAE
Commissions
Underwriting expense

Gross premiums written

Net premiums written

Net premiums earned

Underwriting proﬁt (loss)
Interest and dividends

Operating income
Realized gains

Pre-tax income before interest and other

Net income after taxes

Crum &
Forster

86.2

64.1%
11.1%
17.1%

92.3%

1,351.6

1,196.5

1,114.0

86.2
156.5

242.7
271.4

514.1

314.6

Crum &
Forster

Fairmont

Total

(12.6)

3.5

(9.1)

73.2%
10.3%
17.9%

63.2%
11.7%
22.9%

71.7%
10.5%
18.7%

101.4%

97.8% 100.9%

1,097.8

205.8

1,303.6

866.9

892.1

(12.6)
100.4

87.8
103.9

191.7

106.6

159.1

1,026.0

161.0

1,053.1

3.5
4.6

8.1
10.0

18.1

11.8

(9.1)
105.0

95.9
113.9

209.8

118.4

71

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

Year ended December 31, 2004

Underwriting proﬁt (loss)

Combined ratio

Loss & LAE
Commissions
Underwriting expense

Gross premiums written

Net premiums written

Net premiums earned

Underwriting proﬁt (loss)
Interest and dividends

Operating income
Realized gains

Pre-tax income before interest and other

Net income after taxes

Crum &
Forster

Fairmont

Total

(56.2)

1.2

(55.0)

77.1%
10.5%
18.9%

64.4%
13.8%
21.1%

75.0%
11.2%
19.2%

106.5%

99.3% 105.4%

1,139.0

206.1

1,345.1

869.6

859.0

(56.2)
73.0

16.8
78.3

95.1

38.6

166.4

1,036.0

168.6

1,027.6

1.2
8.3

9.5
7.2

16.7

11.2

(55.0)
81.3

26.3
85.5

111.8

49.8

(1) These  results  differ  from  those  published  by  Crum  &  Forster  Holdings  Corp.,  primarily  due  to
differences  between  Canadian  and  US  GAAP  relating  principally  to  the  treatment  of  retroactive
reinsurance.

(2) Effective January 1, 2006, Fairmont’s business was carried on as the Fairmont Specialty division of

Crum & Forster, and the Fairmont legal entities were placed into runoff.

Underwriting  results  for  Crum  &  Forster  (including  the  results  of  Fairmont,  the  business  of
which  was  assumed  by  Crum  &  Forster  effective  January  1,  2006)  improved  signiﬁcantly  in
2006,  generating  underwriting  proﬁt  of  $86.2  compared  to  an  underwriting  loss  of  $9.1  in
2005  and  producing  a  combined  ratio  of  92.3%  in  2006  compared  to  100.9%  in  2005.
Underwriting  results  in  2006  reﬂected  net  beneﬁts  of  $78.9  or  7.1  combined  ratio  points,
comprised  of  $48.9  of  net  favourable  development  of  prior  years’  loss  reserves  and  $30.0  of
return premium related to reduced cessions to aggregate reinsurance treaties. The beneﬁts arose
primarily from favourable loss development across all major casualty lines, partially offset by
adverse development in lines of business with latent exposures. The U.S. insurance segment’s
2005 combined ratio was 100.9% (including 8.9 combined ratio points arising from the 2005
hurricanes) compared to 105.4% in 2004 (including 9.4 combined ratio points arising from the
2004 hurricanes).

Crum  &  Forster’s  combined  ratio  of  101.4%  in  2005  included  10.4  combined  ratio  points
arising from the 2005 hurricanes. Underwriting results in 2005 also reﬂected a net beneﬁt of
$31.7  or  3.4  combined  ratio  points  related  to  favourable  development  of  prior  years’  loss
reserves, primarily with respect to the 2004 hurricanes. The 2005 reported combined ratio of
101.4% was 5.1 combined ratio points lower than the 2004 combined ratio of 106.5%. Prior to
giving  effect  to  the  2005  hurricanes  and  the  2004  hurricanes,  the  2005  combined  ratio
improved  to  91.0%  from  95.4%  in  2004,  reﬂecting  the  aforementioned  favourable  reserve
development  in  2005  and  management’s  strict  underwriting  discipline  and  expense  focus.
Crum  &  Forster’s  combined  ratio  of  106.5%  in  2004  included  11.1  combined  ratio  points
arising from the 2004 hurricanes. Underwriting results in 2004 also reﬂected a net cost of $25.0

72

or 2.4 combined ratio points related to development of prior years’ loss reserves. Such net prior
year loss development included redundancies as well as $100.0 of APH strengthening, recorded
following  an  independent  ground-up  study,  all  of  which  was  covered  by  aggregate  stop  loss
reinsurance.

Fairmont’s  2005  combined  ratio  of  97.8%  (improved  from  99.3%  in  2004)  reﬂected  its
continued  focus  on  underwriting  proﬁtability  and  its  disciplined  response  to  increased
competitive  conditions,  which  resulted  in  a  decrease  in  net  premiums  written  to  $159.1  in
2005 from $166.4 in 2004. Effective January 1, 2006, Fairmont’s business was carried on as the
Fairmont Specialty division of Crum & Forster, and the Fairmont legal entities were placed into
runoff.

Crum & Forster’s principal operating subsidiaries (United States Fire Insurance and North River
Insurance)  paid  combined  dividends  in  2006  to  their  parent  holding  company  of  $127.0
compared to $93.4 in 2005 ($80.0 in 2004). Crum & Forster paid dividends to Fairfax of $90.0
in  2006  and  $73.5  in  2005  ($61.5  in  2004).  The  subsidiaries’  combined  2007  maximum
dividend capacity, without prior regulatory approval, is $138.4.

Cash ﬂow from operations at Crum & Forster was $89.4 in 2006 ($9.1 in 2005 and $94.7 in
2004). The increase in 2006 reﬂected general business expansion driven by the assumption of
Fairmont business, partially offset by higher payments of income taxes. The decline in 2005
relative to 2004 was attributable to lower proceeds from reinsurance commutations and higher
catastrophe  losses  and  asbestos  payments,  partially  offset  by  a  reduction  in  all  other  claims
payments.

Net premiums written by Crum & Forster in 2006 increased by 16.6% to $1,196.5 compared to
$1,026.0 in net premiums written by the U.S. insurance segment in 2005, as a result of new
business  premium  in  Crum  &  Forster’s  property,  umbrella  and  specialty  casualty  lines  of
business,  $30.0  of  return  premiums  related  to  reduced  cessions  to  aggregate  reinsurance
treaties,  reduced  ceded  premium  attributable  to  increased  retentions  on  various  lines  of
business,  and  the  impact  of  restatement  premiums  paid  in  2005.  Net  premiums  written  by
U.S.  insurance  remained  relatively  stable  in  2005  compared  to  2004,  reﬂecting  increased
competition for both new and renewal business.

Net income for 2006 increased substantially to $314.6 compared to 2005 net income for the
U.S. insurance segment of $118.4. The largest contributor to the increase was an increase in net
realized  gains  to  $271.4  from  $113.9  in  2005,  augmented  by  an  increase  in  interest  and
dividend income to $156.5 from $105.0, in addition to the aforementioned $95.3 year-over-
year  improvement  in  underwriting  proﬁtability.  Crum  &  Forster’s  net  income  for  the  year
ended  December  31,  2006  produced  a  return  on  average  equity  of  28.6%  (2005  –  11.0%).
Crum & Forster’s cumulative earnings since acquisition on August 13, 1998 have been $795.5,
from which it has paid dividends to Fairfax of $442.9, and its annual return on average equity
since acquisition has been 10.6%.

73

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

Set out below are the balance sheets for U.S. insurance as at December 31, 2006 and 2005.

December 31,
2006

December 31, 2005

Crum &
Forster(1)

Crum &
Forster(1) Fairmont

Intrasegment
Eliminations

U.S.
Insurance

Assets
Cash, short term

investments and
marketable securities
Accounts receivable and

other

Recoverable from

reinsurers

Portfolio investments
Deferred premium
acquisition costs
Future income taxes
Premises and equipment
Goodwill
Other assets
Investments in Fairfax

afﬁliates

Total assets

Liabilities
Accounts payable and
accrued liabilities

Securities sold but not yet

purchased
Due to afﬁliates
Funds withheld payable

to reinsurers

Provision for claims
Unearned premiums
Long term debt

Total liabilities
Shareholders’ equity

Total liabilities and

1.8

1.7

–

348.4

336.0

46.9

–

–

1.7

382.9

1,769.4
3,832.7

2,152.0
3,466.1

107.8
303.2

(14.9)
–

2,244.9
3,769.3

84.0
220.8
4.5
7.3
23.7

70.8
160.1
4.2
7.3
24.1

109.7

111.6

7.7
27.7
–
–
1.5

7.2

–
–
–
–
–

–

78.5
187.8
4.2
7.3
25.6

118.8

6,402.3

6,333.9

502.0

(14.9)

6,821.0

275.5

237.6

18.8

(0.1)

256.3

400.2
12.9

252.0
3,371.5
576.2
300.0

5,188.3
1,214.0

329.7
8.3

296.7
3,672.5
499.6
300.0

5,344.4
989.5

–
(1.5)

4.5
239.0
60.6
–

321.4
180.6

–
–

329.7
6.8

(0.1)
(14.7)
–
–

(14.9)
–

301.1
3,896.8
560.2
300.0

5,650.9
1,170.1

shareholders’ equity

6,402.3

6,333.9

502.0

(14.9)

6,821.0

(1) These balance sheets differ from those published by Crum & Forster Holdings Corp., primarily due
to differences between Canadian and US GAAP relating principally to the treatment of retroactive
reinsurance.

Signiﬁcant changes to Crum & Forster’s balance sheet as at December 31, 2006 as compared to
its  2005  balance  sheet  (Fairmont’s  ongoing  business  (excluding  its  assets  and  liabilities)  was
assumed by Crum & Forster and the Fairmont legal entities were placed into runoff effective
January 1, 2006, hence the relevant comparison is to the 2005 Crum & Forster balance sheet
and  not  the  2005  U.S.  insurance  segment  balance  sheet)  include  a  $382.6  decrease  in
reinsurance  recoverables  and  a  $301.0  decrease  in  provision  for  claims,  both  primarily
attributable  to  reduced  balances  related  to  paid  claims  arising  from  the  2005  hurricanes.
Growth in Crum & Forster’s business activity in 2006 (increased new and renewal business in

74

addition to increases due to Crum & Forster’s assumption of the ongoing business of Fairmont)
contributed to balance sheet changes including an increase in portfolio investments of $366.6
(a $296.1 increase net of the $70.5 increase in securities sold but not yet purchased), a $76.6
increase  in  unearned  premiums  and  a  $60.7  increase  in  the  future  income  taxes  asset.
Shareholders’  equity  increased  by  $224.5,  reﬂecting  net  earnings  of  $314.6  and  $90.0  of
dividends paid during 2006.

Crum & Forster’s investments in Fairfax afﬁliates consist of:

Afﬁliate

% interest

Northbridge (common shares)
OdysseyRe (common shares)
TRG Holdings (Class 1 shares)
MFX

15.2
1.1
5.2
9.3

For  more  information  on  Crum  &  Forster,  please  see  its  10-K  report  for  2006  which  will  be
posted on its website www.cﬁns.com.

Asian Insurance – Fairfax Asia

Underwriting proﬁt

Combined ratio

Loss & LAE
Commissions
Underwriting expense

Gross premiums written

Net premiums written

Net premiums earned

Underwriting proﬁt
Interest and dividends

Operating income
Realized gains

Pre-tax income before interest and other

Net income after taxes

2006

14.5

2005

2004

4.8

4.7

55.7% 65.5% 55.9%
7.5% 12.3% 18.0%
15.2% 15.2% 18.0%

78.4% 93.0% 91.9%

134.8

60.5

67.3

14.5
3.3

17.8
14.2

32.0

23.0

76.6

46.5

68.2

4.8
7.5

12.3
1.0

13.3

7.3

86.7

59.6

57.8

4.7
2.9

7.6
–

7.6

4.1

Fairfax  Asia  comprises  the  company’s  Asian  holdings  and  operations:  Singapore-based  First
Capital Insurance Limited, Hong Kong-based Falcon Insurance Company (Hong Kong) Limited
and  a  26.0%  equity-accounted  interest  in  Mumbai-based  ICICI  Lombard  General  Insurance
Company,  India’s  largest  (by  market  share)  private  general  insurer  (the  remaining  74.0%
interest is held by ICICI Bank, India’s second largest commercial bank).

Fairfax Asia’s 2006 underwriting proﬁt rose to $14.5 compared to $4.8 in 2005, and operating
income increased to $17.8 from $12.3. The improved results reﬂect 2006 underwriting proﬁt at
First Capital of $22.6 (underwriting proﬁt of $3.9 in 2005), offset by an underwriting loss of
$5.2 at Falcon (underwriting proﬁt of $0.6 in 2005). First Capital’s underwriting results include
net  favourable  development  of  prior  periods’  reserves  of  $2.6,  while  Falcon’s  underwriting
results  include  net  adverse  development  of  $5.4  primarily  related  to  its  employees’
compensation insurance line of business. Net premiums written by Fairfax Asia in 2006 grew
by  30.1%  to  $60.5,  driven  primarily  by  growth  at  First  Capital.  Net  realized  gains  of  $14.2

75

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

during  2006  (compared  to  $1.0  in  2005),  combined  with  signiﬁcantly  higher  underwriting
proﬁt and operating income, resulted in 2006 net earnings of $23.0 for Fairfax Asia, compared
to $7.3 in 2005.

Underwriting proﬁt of $4.8 and Fairfax Asia’s combined ratio of 93.0% in 2005 compared to
91.9% in 2004 reﬂected an increase in Falcon’s combined ratio to 98.7% in 2005 from 95.0% in
2004, principally as a result of its employees’ compensation insurance line of business, partially
offset  by  First  Capital’s  underwriting  performance  and  combined  ratio  of  82.0%  on
substantially  increased  net  premiums  earned.  The  decline  in  2005  gross  and  net  premiums
written  compared  to  2004  reﬂected  Falcon’s  response  to  further  rate  softening  in  the  Hong
Kong  market.  The  increase  in  investment  income  from  2004  to  2005  related  mainly  to  an
increase in the equity-accounted earnings pickup from Fairfax Asia’s 26.0% interest in ICICI
Lombard.

Fairfax Asia’s share of ICICI Lombard’s net earnings or loss on an equity-accounted basis was a
net loss of $2.6 in 2006, net income of $2.4 in 2005 and nil in 2004. During the twelve-month
period ended December 31, 2006 ICICI Lombard’s gross premium written (in U.S. dollar terms)
increased  by  82.8%  over  the  comparable  2005  period  to  approximately  $593.6  from
approximately $324.8.

Set out below are the balance sheets for Fairfax Asia as at December 31, 2006 and 2005:

Assets
Accounts receivable and other
Recoverable from reinsurers
Portfolio investments
Deferred premium acquisition costs
Future income taxes
Premises and equipment
Goodwill
Due from afﬁliates

Total assets

Liabilities
Accounts payable and accrued liabilities
Funds withheld payable to reinsurers
Provision for claims
Unearned premiums

Total liabilities
Non-controlling interests
Shareholders’ equity

Total liabilities and shareholders’ equity

2006

2005

33.4
61.3
286.7
5.0
2.6
1.0
5.4
0.4

38.2
48.7
190.7
6.7
0.5
1.0
5.4
2.5

395.8

293.7

44.4
0.9
123.5
56.1

224.9
7.3
163.6

21.1
0.1
114.7
58.3

194.2
7.2
92.3

395.8

293.7

Signiﬁcant changes in Fairfax Asia’s balance sheet reﬂected increased business activity during
2006 and included a $96.0 increase in portfolio investments and increased accounts payable
and  accrued  liabilities,  recoverable  from  reinsurers  and  provision  for  claims.  Shareholders’
equity increased by $71.3 as a result of 2006 earnings and the issuance of $41.8 of additional
equity capital to the company to fund the $24.5 increase in Fairfax Asia’s investment in ICICI
Lombard and to provide capital for the general growth in Fairfax Asia’s business.

76

Reinsurance – OdysseyRe(1)

Underwriting proﬁt (loss)

Combined ratio

Loss & LAE
Commissions
Underwriting expense

Gross premiums written

Net premiums written

Net premiums earned

Underwriting proﬁt (loss)
Interest and dividends

Operating income (loss)
Realized gains

Pre-tax income (loss) before interest and other

2006

77.0

2005

(397.8)

2004

69.6

68.7%
20.8%
7.0%

90.5%
20.8%
6.2%

69.6%
22.6%
4.8%

96.5% 117.5%

97.0%

2,335.7

2,628.5

2,625.9

2,160.9

2,303.3

2,348.8

2,225.8

2,275.9

2,323.2

77.0
298.4

375.4
358.9

734.3

(397.8)
167.2

(230.6)
103.2

(127.4)

69.6
156.3

225.9
75.1

301.0

Net income (loss) after taxes

470.7

(110.2)

177.6

(1) These  results  differ  from  those  published  by  Odyssey  Re  Holdings  Corp.  primarily  due  to
differences  between  Canadian  and  US  GAAP  relating  principally  to  the  treatment  of  retroactive
reinsurance,  and  the  exclusion  of  First  Capital’s  results  in  2004 (First  Capital’s  results  are
included in the results of Fairfax Asia above).

During  2006,  OdysseyRe’s  worldwide  reinsurance  and  insurance  operations  generated
underwriting proﬁt of $77.0 and a combined ratio of 96.5%, compared to an underwriting loss
of  $397.8  and  a  combined  ratio  of  117.5%  in  2005.  OdysseyRe’s  results  in  2005,  a  year  of
unprecedented catastrophe losses industry-wide, included 19.2 combined ratio points ($436.0
of  pre-tax  losses,  net  of  applicable  reinstatement  premiums  and  reinsurance)  arising  from
Hurricanes  Katrina,  Rita  and  Wilma.  OdysseyRe’s  2006  underwriting  results  included  8.3
combined  ratio  points  ($185.4  pre-tax,  including  a  third  quarter  $33.8  pre-tax  loss  on  the
commutation  of  an  intercompany  reinsurance  treaty)  in  net  adverse  development  of  prior
years’  loss  reserves  arising  primarily  from  2001  and  prior  years’  U.S.  casualty  and  latent
reserves,  partially  offset  by  favourable  development  of  recent  years’  business  in  the
U.S. Insurance, London Market and EuroAsia divisions. This compares to a combined ratio of
97.0% in 2004, which included 4.2 combined ratio points arising from the 2004 hurricanes.
OdysseyRe’s combined ratio in 2005 included 7.3 combined ratio points ($166.5 of net pre-tax
losses) in adverse development of prior years’ loss reserves.

Gross premiums written by OdysseyRe in 2006 of $2,335.7 declined by 11.1% from $2,628.5 in
2005 (excluding reinstatement premiums in 2006 and 2005, the decline was 8.8%). The decline
primarily  reﬂects  a  reduction  in  the  amount  of  reinsurance  business  written  in  2006  on  a
proportional basis in certain classes of business, particularly for catastrophe-exposed property
business in the U.S., and OdysseyRe’s decision to migrate certain proportional business to an
excess  of  loss  basis,  which  had  the  effect  of  reducing  written  premiums  attributable  to  the
coverage.  In  addition,  the  absence  of  major  catastrophes  in  2006  resulted  in  a  decrease  in
reinstatement  premiums.  Lastly,  OdysseyRe  experienced  a  decline  in  casualty  classes  of
business,  reﬂecting  lower  levels  of  reinsurance  purchased  by  its  customers  and  generally
increased competition in certain specialty classes. Gross premiums written increased modestly
(by less than 1%) in 2005 compared to 2004, following a compound annual increase of 31.5%

77

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

from 2002 to 2004 and an increase in net premiums written during this period at a compound
annual growth rate of 34.9%. During this three year period, OdysseyRe signiﬁcantly expanded
its presence in the global marketplace through a deliberate strategy of product and geographic
diversiﬁcation.

Increased  2006  net  operating  cash  ﬂows  of  $745.2  (compared  to  $397.3  in  2005)  reﬂected
increased  operating  income  and  collections  of  reinsurance  recoverable  and  income  taxes
receivable,  offset  somewhat  by  decreases  in  funds  withheld  payable  to  reinsurers  and
reinsurance  balances  payable.  OdysseyRe’s  net  operating  cash  ﬂow  was  $397.3  in  2005  as
compared to $603.2 in 2004, the decline reﬂecting an increase in paid losses related to 2004
and 2005 catastrophes, principally the 2005 hurricanes.

Signiﬁcantly increased 2006 interest and dividend income (a 78.5% increase to $298.4 in 2006
from $167.2 in 2005, due primarily to an increased portfolio, a higher proportion of interest-
bearing investment assets and higher short term interest rates) and net realized gains ($358.9
in  2006  compared  to  $103.2  in  2005)  combined  with  the  turnaround  in  underwriting
proﬁtability produced record net earnings for OdysseyRe of $470.7 in 2006 compared to a net
loss of $110.2 in 2005 and net earnings of $177.6 in 2004.

Set out below are the balance sheets for OdysseyRe as at December 31, 2006 and 2005:

Assets
Accounts receivable and other
Recoverable from reinsurers
Portfolio investments
Deferred premium acquisition costs
Future income taxes
Premises and equipment
Goodwill
Other assets
Investments in Fairfax afﬁliates

Total assets

Liabilities
Accounts payable and accrued liabilities
Securities sold but not yet purchased
Due to afﬁliates
Funds withheld payable to reinsurers
Provision for claims
Unearned premiums
Long term debt

Total liabilities
Shareholders’ equity

2006

2005

710.3
849.3
6,862.3
149.9
238.0
10.3
11.5
21.7
88.5

872.4
1,478.0
5,668.1
167.2
217.5
12.2
12.2
24.5
88.5

8,941.8

8,540.6

256.1
120.3
3.5
108.0
5,142.2
786.8
512.3

6,929.2
2,012.6

149.8
139.2
3.3
192.7
5,109.1
951.0
469.5

7,014.6
1,526.0

Total liabilities and shareholders’ equity

8,941.8

8,540.6

(1) These balance sheets differ from those published by Odyssey Re Holdings Corp. primarily due to
differences  between  Canadian  and  US  GAAP  relating  principally  to  the  treatment  of  retroactive
reinsurance,  and  the  exclusion  of  First  Capital’s  results  in  2004  (First  Capital’s  results  are
included in Fairfax Asia above).

Signiﬁcant  changes  to  OdysseyRe’s  2006  balance  sheet  reﬂected  the  aforementioned
contraction  of  certain  of  OdysseyRe’s  reinsurance  classes  of  business  in  2006,  certain  capital
management  and  reﬁnancing  initiatives,  and  its  record  earnings  performance.  Portfolio

78

investments  increased  during  2006  by  $1,194.2  ($1,213.1  net  of  the  $18.9  reduction  in
securities  sold  but  not  yet  purchased),  reﬂecting  signiﬁcantly  increased  net  operating  cash
ﬂows  and  substantial  increases  in  interest  and  dividend  income  and  net  realized  gains.  The
$628.7  decline  in  balances  recoverable  from  reinsurers  primarily  reﬂected  OdysseyRe’s  2006
operating  decision  to  selectively  increase  its  own  retentions,  commutations  of  certain  ceded
business,  and  collections  of  paid  losses  related  to  ceded  2005  hurricane  losses.  The  $164.2
decline  in  unearned  premiums  reﬂected  OdysseyRe’s  decision  to  migrate  certain  of  its
proportional reinsurance business to an excess of loss basis, which contributed to the general
decline in written premium. Long term debt increased by a net $42.8 primarily as a result of
the issuance of $100.0 of ﬂoating rate senior notes, partially offset by a $56.0 reduction in its
outstanding convertible debentures as a result of 2006 conversions by holders. Shareholders’
equity  increased  by  $486.6,  reﬂecting  changes  including  net  earnings  of  $470.7  and  the
aforementioned increase in common equity due to conversions of convertible debentures, less
common  and  preferred  dividends  paid  during  the  year  of  $16.9.  Including  its  record  net
earnings achieved in 2006, since the end of 2001 (the year of OdysseyRe’s IPO) OdysseyRe’s
common shareholders’ equity has grown at a compounded annual rate of 20.4% on a US GAAP
basis while book value per common share has grown at a compounded annual rate of 18.2%.

OdysseyRe’s investments in Fairfax afﬁliates consist of:

Afﬁliate

TRG Holdings (Class 1 shares)
Fairfax Asia
MFX

% interest

47.4
29.5
7.4

For more information on OdysseyRe’s results, please see its 10-K report for 2006 and its 2006
annual report, both of which will be posted on its website www.odysseyre.com.

Interest and Dividends

Interest and dividend income earned by the company’s insurance and reinsurance operations
in 2006 increased to $559.0 from $345.4 in 2005 (2004 – $301.4), due primarily to higher short
term  interest  rates  and  increased  investment  portfolios  resulting  from  subsidiaries’  positive
cash  ﬂow  from  operations,  as  well  as  the  reduction  in  2005  interest  and  dividend  income
caused by recording the company’s share of Advent’s $45.1 hurricane-affected 2005 net loss.
Increased interest and dividend income in 2005 compared to 2004 was primarily due to higher
short term interest rates and increased investment portfolios reﬂecting positive cash ﬂow from
operations,  partially  offset  by  the  aforementioned  company’s  share  of  Advent’s  hurricane-
affected loss.

Realized Gains

Net realized gains earned by the company’s insurance and reinsurance operations increased in
2006 to $759.6 from $322.1 in 2005 (2004 – $183.2). Consolidated net realized gains in 2006 of
$835.3 (comprised of net realized gains on portfolio investments of $765.6 and the $69.7 gain
on  the  company’s  OdysseyRe  secondary  offering)  included  net  realized  gains  on  portfolio
investments in the Runoff and Other segment of $151.6 (including $111.6 related to common
shares  of  OdysseyRe  sold  in  the  secondary  offering,  a  portion  of  which  was  eliminated  on
consolidation  resulting  in  a  $69.7  gain  on  a  consolidated  basis).  Consolidated  net  realized
gains of $385.7 in 2005 included net realized gains on portfolio investments in the Runoff and
Other segment of $59.2. Consolidated net realized gains of $313.6 in 2004 (comprised of net
realized  gains  on  portfolio  investments  of  $273.5  and  the  $40.1  gain  on  the  company’s
Northbridge  secondary  offering)  included  net  realized  gains  on  portfolio  investments  in  the
Runoff and Other segment of $142.5. Consolidated net realized gains in 2006 included $251.0
(2005 – $107.8; 2004 – $69.7) of net losses (including mark-to-market adjustments recorded as

79

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

realized  losses),  related  to  the  company’s  economic  hedges  against  a  decline  in  the  equity
markets and other derivatives in the company’s investment portfolio, primarily credit default
swaps and bond warrants. Included in consolidated net realized gains for 2006 was a provision
of $37.8 (2005 – $48.5; 2004 – $31.6) for other than temporary impairments and writedowns of
certain bonds and common stocks.

Runoff and Other

The  runoff  business  segment  was  formed  with  the  acquisition  on  August  11,  1999  of  the
company’s  interest  in  The  Resolution  Group  (TRG),  which  was  comprised  of  the  runoff
management  expertise  and  experienced  personnel  of  TRG,  and  a  wholly-owned  insurance
subsidiary in runoff, International Insurance Company (IIC). The Runoff and Other segment
currently consists of three groups: the U.S. runoff group, consisting primarily of TIG Insurance
Company  (TIG)  and  the  business  of  Fairmont  placed  in  runoff  on  January  1,  2006;  the
European  runoff  group  (RiverStone  Insurance  UK  and  nSpire  Re);  and  Group  Re,  which
predominantly  constitutes  the  participation  by  CRC  (Bermuda),  Wentworth  (based  in
Barbados) and nSpire Re in certain of the reinsurance of Fairfax’s subsidiaries, which may be
effected by quota share or through participation in those subsidiaries’ third party reinsurance
programs.  The  U.S.  and  European  runoff  groups  are  managed  by  the  dedicated  TRG  runoff
management  operation,  identiﬁed  under  the  RiverStone  name,  which  has  346  full-time
employees in the U.S. and Europe. Group Re’s activities are managed by Fairfax.

U.S. runoff group

The  U.S.  runoff  group  consists  of  TIG,  Fairmont and  Old  Lyme  Insurance (which  is  not
signiﬁcant). TIG, as it exists today, is the result of its merger with IIC, which was acquired via
the  TRG  acquisition,  27.5%  in  1999  and  72.5%  in  2002.  For  a  detailed  description  of  the
history of the U.S. runoff group, please refer to page 62 of Fairfax’s 2004 Annual Report.

During 2005, the trust established for the beneﬁt of TIG at the commencement of TIG’s runoff
in  December  2002  was  terminated  and  the  remaining  assets  in  the  trust  were  released.  The
assets  released  were  all  the  shares  of  the  Fairmont  companies  and  the  remaining  2  million
common shares of OdysseyRe.

Effective December 31, 2005, all the shares of the Fairmont legal entities were transferred to
TIG  from  its  immediate  parent  company  in  exchange  for  7.7  million  common  shares  of
OdysseyRe (with a market value of $193.1 at December 31, 2005). As a result, the runoff of the
Fairmont  entities’  historical  business  was  reported  as  part  of  the  Runoff  and  Other  segment
effective  January  1,  2006  (as  noted  previously,  Fairmont’s  business  continued,  beginning  in
2006, as the Fairmont Specialty division of Crum & Forster).

Subsequent to year-end, on March 8, 2007 TIG’s application to the California Department of
Insurance (its principal regulator) to pay an extraordinary dividend to its parent company in
the amount of approximately $124.8 was approved. The dividend payment will be in the form
of notes held by TIG issued by the company with face amounts totalling $122.5 plus accrued
interest of approximately $2.3. After the dividend, the notes will be cancelled by the company.
After  giving  effect  to  these  transactions,  it  is  expected  that  TIG  will  continue  to  have
policyholder  surplus  and  risk-based  capital  that  satisfy  the  requirements  of  the  California
Department  of  Insurance.  These  intercompany  transactions  will  have  no  impact  on  the
company’s consolidated ﬁnancial statements.

80

European runoff group

The European runoff group consists principally of RiverStone Insurance UK and nSpire Re.

RiverStone Insurance UK includes Sphere Drake Insurance and Syndicate 3500. Sphere Drake
Insurance ceased underwriting and was put into runoff in 1999. In 2004, substantially all of
Sphere  Drake  Insurance’s  insurance  and  reinsurance  portfolio  was  amalgamated  into
RiverStone Insurance UK, forming the uniﬁed European runoff portfolio. RiverStone Insurance
UK  resulted  from  the  amalgamation  during  2002  of  RiverStone  Stockholm,  Sphere  Drake
Bermuda and CTR’s non-life operations, all of which ceased underwriting and were put into
runoff between 1999 and 2001. In November 2003, RiverStone formed a new runoff syndicate
at Lloyd’s of London, Syndicate 3500, to provide reinsurance-to-close for the 2000 and prior
underwriting years of Kingsmead syndicates 271 and 506 for which TIG, along with third party
capital providers, had provided underwriting capacity for 2000 and prior underwriting years.
In 2005, gross and net provisions for claims of $32.7 and $20.2, respectively, were transferred
to  Syndicate  3500  as  a  result  of  the  reinsurance-to-close  of  the  2001  year  of  account  of
Syndicate 506. RiverStone Insurance UK reinsures the insurance and reinsurance portfolio of
Syndicate 3500. This transaction allowed RiverStone to integrate direct management of these
liabilities into the European runoff platform.

During 2005, RiverStone Insurance UK obtained U.S. court sanction for the previously English
court-approved transfer of certain obligations from an afﬁliate, to facilitate its carrying on the
European  runoff  as  described  above.  The  obtaining  of  these  approvals  will  not  result  in  the
acceleration  of  the  making  or  payment  of  claims  or  have  any  other  material  effect  on  the
operation of the European runoff.

nSpire  Re,  headquartered  in  Ireland,  reinsures  the  insurance  and  reinsurance  portfolios  of
RiverStone Insurance UK. nSpire Re’s insurance and reinsurance obligations are guaranteed by
Fairfax.  RiverStone  Insurance  UK,  with  102  full-time  employees  in  its  ofﬁces  in  the  United
Kingdom, provides the management (including claims handling) of nSpire Re’s insurance and
reinsurance liabilities and the collection and management of its reinsurance assets. nSpire Re
provides consolidated investment and liquidity management services to the European runoff
group. In addition to its role in the consolidation of the European runoff companies, nSpire Re
also has two other mandates, described in the following paragraph and under Group Re below.

nSpire  Re  served  as  the  entity  through  which  Fairfax  primarily  provided  ﬁnancing  for  the
acquisition  of  its  U.S.  insurance  and  reinsurance  companies.  nSpire  Re’s  capital  and  surplus
includes $1.5 billion of equity in Fairfax’s U.S. holding company and company debt resulting
from those acquisitions. For each of its U.S. acquisitions, Fairfax ﬁnanced the acquisition, at
the  Canadian  holding  company,  with  an  issue  of  subordinate  voting  shares  and  long  term
debt. The proceeds of this long term ﬁnancing were invested in nSpire Re’s capital which then
provided  the  acquisition  ﬁnancing  to  Fairfax’s  U.S.  holding  company  to  complete  the
acquisition.

Related party transactions of nSpire Re, including its provision of reinsurance to afﬁliates, is
effected on market terms and at market prices, and require approval by nSpire Re’s board of
directors,  three  of  whose  ﬁve  members  are  unrelated  to  Fairfax.  nSpire  Re’s  accounts  are
audited  annually  by  PricewaterhouseCoopers  LLP,  and  its  reserves  are  certiﬁed  annually  by
Milliman USA and are included in the consolidated reserves on which PricewaterhouseCoopers
LLP provides an annual valuation actuary’s report.

In  January  2005,  the  European  runoff  group  purchased  Compagnie  de  R´eassurance  d’Ile  de
France (Corifrance), a French reinsurance company in runoff, for $59.8 (444.0). The purchase
price was the amount by which the $122.2 (489.9) fair value of Corifrance’s assets exceeded the
$62.4 (445.9) fair value of Corifrance’s liabilities. As part of the consideration for the purchase,
the European runoff group received an indemnity from the seller, capped at the amount of the

81

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

purchase  price  and  expiring  on  December  31,  2007  for  any  adverse  development  of  the  net
reserves acquired.

Group Re

Consistent  with  the  company’s  objective  of  retaining  more  business  for  its  own  account  in
favourable market conditions, CRC (Bermuda), Wentworth and nSpire Re may participate in
certain of the reinsurance of Fairfax’s subsidiaries, by quota share or through participation in
those subsidiaries’ third party reinsurance programs on the same terms and pricing as the third
party  reinsurers.  The  provision  of  such  reinsurance,  which  may  vary  by  program  and  by
subsidiary,  is  reported  as  ‘‘Group  Re’’.  Since  2004,  Group  Re,  through  nSpire  Re,  CRC  and
Wentworth, has also written third party business. Group Re’s cumulative pre-tax income since
its inception in 2002 is $80.5, notwithstanding its hurricane-related $80.0 pre-tax loss in 2005.

Swiss Re Corporate Insurance Cover

As  part  of  its  acquisition  of  TIG  effective  April  13,  1999,  Fairfax  purchased  a  $1  billion
corporate  insurance  cover  ultimately  reinsured  with  a  Swiss  Re  subsidiary  (the  Swiss  Re
corporate insurance cover), protecting it, on an aggregate basis, from adverse development of
claims  and  uncollectible  reinsurance  above  the  aggregate  reserves  set  up  by  all  of  its
subsidiaries  (including  TIG,  but  not  including  other  subsidiaries  acquired  after  1998)  at
December  31,  1998.  At  December  31,  2004,  the  company  had  ceded  losses  under  this  cover
utilizing the full $1 billion limit of that cover.

As of December 31, 2002, Fairfax assigned the full beneﬁt of the Swiss Re corporate insurance
cover to nSpire Re which had previously provided the indirect beneﬁt of the Swiss Re corporate
insurance cover to TIG and the European runoff companies. Although Fairfax remained legally
liable for its original obligations with respect to the Swiss Re corporate insurance cover, under
the terms of the assignment agreement, nSpire Re was responsible to Fairfax for all premium
and  interest  payments  after  2002  for  any  additional  losses  ceded  to  the  Swiss  Re  corporate
insurance cover.

On July 27, 2006, nSpire Re exercised its right to commute the Swiss Re corporate insurance
cover,  as  it  had  determined  with  Fairfax  that  based  on  projected  payout  patterns  and  other
ﬁnancial considerations, that the cover no longer provided it with a commercial or economic
advantage. At the time of the commutation on August 3, 2006, Fairfax also terminated its $450
letter of credit facility effectively secured by the assets held in trust derived from the premiums
on the Swiss Re corporate insurance cover and the accumulated interest thereon. By virtue of
the  commutation,  the  $587.4  of  funds  withheld  in  trust  under  the  Swiss  Re  corporate
insurance cover were paid to nSpire Re. nSpire Re deployed approximately $450 of those funds
to  secure  or  settle  $450  of  its  reinsurance  obligations  to  other  Fairfax  subsidiaries  previously
secured by letters of credit issued under the former letter of credit facility.

Commutations

On August 3, 2006, nSpire Re commuted the Swiss Re corporate insurance cover, as described
in the immediately preceding section. The accounting effect of the commutation, recorded in
2006,  was  a  non-cash  pre-tax  and  after-tax  loss  of  $412.6.  The  commutation  resulted  in  a
$1 billion decrease in the balance recoverable from reinsurers and a $587.4 decrease in funds
withheld payable to reinsurers.

During  2005,  in  pursuance  of  Fairfax’s  goal  of  simplifying  its  runoff  structure  and  in
recognition  of  the  strength  and  stability  achieved  by  TIG  (U.S.  runoff)  since  the
commencement of TIG’s runoff in December 2002, TIG commuted the adverse development
covers provided to it by Chubb Re soon after the commencement of its runoff, and agreed to
commute the adverse development cover provided to IIC (with which TIG merged soon after

82

the commencement of its runoff) by Ridge Re (a subsidiary of Xerox) at the time of Xerox’s
restructuring of its ﬁnancial services businesses in 1992. The Chubb Re commutation resulted
in a $103.1 operating loss recorded in 2005 (the inception of the Chubb Re cover had resulted
in an $89.2 operating gain in 2003), while the Ridge Re commutation had no material effect on
income.  Effects  of  the  commutations  were  that  TIG’s  provision  for  claims  increased  by  the
amount  of  reserves  that  were  formerly  reinsured,  and  TIG’s  cash  increased  by  the  cash  it
received  on  the  commutation  –  approximately  $197  from  the  Chubb  Re  commutation  and
$373.3 from the Ridge Re commutation, which was agreed to during the fourth quarter of 2005
and  which  closed  in  2006.  The  $373.3  cash  proceeds  on  the  Ridge  Re  commutation  was
received in March 2006 and was included in accounts receivable and other at December 31,
2005.

Results and balance sheet

Set out below is a summary of the operating results of Runoff and Other for the years ended
December 31, 2006, 2005 and 2004.

Year ended December 31, 2006

Gross premiums written

Net premiums written

Net premiums earned
Losses on claims (excluding the reinsurance

commutation below)

Operating expenses
Interest and dividends

Operating income (loss)
Realized gains (except as noted below)

Pre-tax income (loss) before the undernoted
Loss on reinsurance commutation(1)
Realized gain on sale of OdysseyRe shares(2)

Pre-tax income (loss) before interest and other

Year ended December 31, 2005

Gross premiums written

Net premiums written

Net premiums earned
Losses on claims (excluding the reinsurance

commutation below)

Operating expenses
Interest and dividends

Operating income (loss)
Realized gains (losses)

Pre-tax loss before the undernoted
Loss on reinsurance commutation(1)

U.S.

Europe

Group Re

163.2

20.3

86.3

(129.4)
(41.2)
79.9

(4.4)
11.7

7.3
–
111.6

118.9

U.S.

14.8

(15.2)

(20.1)

(181.4)
(20.8)
49.0

(173.3)
(0.1)

(173.4)
(103.1)

(2.3)

(1.3)

(1.0)

(39.7)
(66.6)
9.4

(97.9)
9.4

(88.5)
(412.6)
–

(501.1)

325.9

314.5

332.4

(223.9)
(94.1)
27.1

41.5
18.9

60.4
–
–

60.4

Europe

Group Re

28.6

28.7

41.3

(247.0)
(85.5)
(16.3)

(307.5)
45.6

(261.9)
–

334.2

326.5

314.9

(337.9)
(80.6)
9.9

(93.7)
13.7

(80.0)
–

Total

486.8

333.5

417.7

(393.0)
(201.9)
116.4

(60.8)
40.0

(20.8)
(412.6)
111.6

(321.8)

Total

377.6

340.0

336.1

(766.3)
(186.9)
42.6

(574.5)
59.2

(515.3)
(103.1)

Pre-tax loss before interest and other

(276.5)

(261.9)

(80.0)

(618.4)

83

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

Year ended December 31, 2004

Gross premiums written

Net premiums written

Net premiums earned
Losses on claims
Operating expenses
Interest and dividends

Operating income (loss)
Realized gains (except as noted below)

U.S.

67.8

17.1

66.3
(62.7)
(55.3)
32.4

(19.3)
74.9

117.1

25.2

45.2
(187.8)
(72.1)
(14.2)

(228.9)
1.3

Pre-tax income (loss) before the undernoted
Realized gains (losses) on intra-group sales

55.6
61.6(3)

(227.6)
(10.3)(4)

Pre-tax income (loss) before interest and other

117.2

(237.9)

Europe

Group Re

399.3

341.4

345.2
(254.2)
(78.4)
23.1

35.7
15.0

50.7
–

50.7

Total

584.2

383.7

456.7
(504.7)
(205.8)
41.3

(212.5)
91.2

(121.3)
51.3

(70.0)

(1) See ‘‘Commutations’’ discussion preceding this section.

(2) Realized gain on the sale in 2006 of OdysseyRe shares by U.S. runoff companies to facilitate the
company’s  OdysseyRe  secondary  offering  (a  portion  of  which  was  eliminated  on  consolidation,
resulting in a $69.7 gain on a consolidated basis).

(3) Realized gain on the sale in 2004 of Northbridge shares by U.S. runoff companies to other Fairfax
group  companies  to  facilitate  the  company’s  Northbridge  secondary  offering  (this  gain  was
eliminated on consolidation).

(4) Realized  loss  on  a  sale  in  2004  of  bonds  by  European  runoff  companies  to  other  Fairfax  group

companies (this loss was eliminated on consolidation).

The  Runoff  and  Other  segment’s  2006  pre-tax  loss  of  $321.8  included  the  undernoted
transactions with a net negative ﬁnancial impact of $301.0. Excluding these transactions, the
2006 pre-tax loss for the Runoff and Other segment amounted to $20.8.

) $412.6 non-cash pre-tax and after-tax loss on the commutation of the Swiss Re corporate

insurance cover in the third quarter; and

) $111.6 pre-tax gain on OdysseyRe common shares sold by runoff companies to facilitate the

company’s OdysseyRe secondary offering in the fourth quarter.

The  $20.8  pre-tax  loss  in  2006  for  the  Runoff  and  Other  segment  remaining  after  the  two
transactions noted above included the following:

) $60.4 of pre-tax income earned by Group Re during 2006, including underwriting proﬁt of

$14.4, interest and dividends of $27.1 and net realized gains of $18.9;

) $60.6 of pre-tax charges for net reserve strengthening in U.S. runoff, primarily attributable
to  strengthening  of  workers’  compensation  and  general  liability  reserves  as  well  as  ULAE
reserves;

) $15.2 of pre-tax charges for net reserve strengthening in European runoff, primarily arising
from U.S. construction defect and public entity excess claims and including a $33.8 pre-tax
gain  on  the  commutation  of  an  intercompany  reinsurance  treaty  with  OdysseyRe  during
the third quarter (this gain was eliminated in the consolidation of 2006 Fairfax results);

) $14.7  of  pre-tax  charges  related  to  the  restructuring  and  downsizing  of  the  worldwide

runoff organization announced during the fourth quarter; and

) $9.3  of  pre-tax  income  representing  the  excess  of  interest  and  dividend  income  and  net

realized gains over runoff operating and other costs incurred during 2006.

84

The  2005  Runoff  and  Other  pre-tax  loss  of  $618.4  included  the  following  charges  totaling
$526.1:

) $105.6 of Group Re losses arising from Hurricanes Katrina, Rita and Wilma;

) $78.0 of reserve strengthening on certain U.S. runoff discontinued program business;

) $43.8 of mark-to-market adjustments on runoff derivative securities positions;

) $138.8 of reserve strengthening in European runoff;

) $139.2  as  the  result  of  reinsurance  commutations  and  the  settlement  of  reinsurance

disputes; and

) $20.7 in connection with the closure and consolidation of claims processing locations.

The remaining amount of 2005 pre-tax loss resulted from operating and other costs in excess of
net investment income, partially offset by net realized gains on securities sold.

The Runoff and Other segment’s 2004 pre-tax loss of $70.0 included pre-tax income generated
by  Group  Re  of  $50.7  despite  the  impact  of  the  2004  hurricanes.  Excluding  the  gain  on
Northbridge  shares  sold  to  facilitate  the  company’s  2004  secondary  offering,  the  U.S.  runoff
group’s pre-tax income of $55.6 in 2004 reﬂected operating and other costs in excess of net
investment income, substantially offset by realized gains (including the $59.5 gain on the sale
of Zenith National shares). Excluding the footnoted loss on intercompany sales of bonds, for
the year ended December 31, 2004 the European runoff group had a pre-tax loss of $227.6, of
which  $75.0  reﬂected  a  strengthening  of  U.S.  construction  defect  reserves,  $22.5  related  to
various  costs  and  losses  allocated  to  the  European  runoff  group  and  the  remainder  was
primarily attributable to operating and other costs in excess of net investment income and to
the  investment  income  being  reduced  as  a  result  of  funds  withheld  requirements  under  the
Swiss Re corporate insurance cover.

Runoff cash ﬂow is volatile and ensuring its sufﬁciency requires constant focus. This situation
stems  principally  from  the  requirement  to  pay  gross  claims  initially  while  third  party
reinsurance  is  only  collected  subsequently  in  accordance  with  its  terms  and  from  the  delay,
until some time after claims are paid, of the release of assets pledged to secure the payment of
those claims. During 2006, the runoff group required cash ﬂow funding from Fairfax of $160.0
prior  to  the  commutation  of  the  Swiss  Re  corporate  insurance  cover  in  the  third  quarter.
(During  2005,  the  runoff  group  required  cash  ﬂow  funding  from  Fairfax  of  approximately
$163.5,  excluding  $75.0  in  connection  with  Group  Re  hurricane  losses).  As  a  result  of  the
commutation  of  the  Swiss  Re  corporate  insurance  cover,  based  upon  European  runoff’s
projected  plans  and  absent  unplanned  adverse  developments,  it  is  expected  that  European
runoff will not require any cash from Fairfax for at least the 2007 ﬁscal year. After 2007, the
amount of cash support which may be required will depend on a number of factors including
investment income, further expense reductions, development of reserves and timing of claim
payments,  but  based  on  current  projections,  it  is  expected  that  any  annual  cash  support
required from Fairfax would not be signiﬁcant in relation to holding company cash resources.

85

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

Set out below are the balance sheets for Runoff and Other as at December 31, 2006 and 2005.

Fairfax afﬁliates

160.2

Total assets

5,179.1

1,610.2

December 31, 2006

Assets
Accounts receivable

and other

Recoverable from

reinsurers

Portfolio

investments
Deferred premium
acquisition costs
Future income taxes
Premises and
equipment

Due from afﬁliates
Other assets
Investments in

Liabilities
Accounts payable
and accrued
liabilities

Securities sold but

not yet purchased

Due to afﬁliates
Funds withheld
payable to
reinsurers

Provision for claims
Unearned premiums

Total liabilities

Shareholders’

equity

Total liabilities and
shareholders’
equity

U.S.
Runoff

European
Runoff

Group Re

Intrasegment
Eliminations

Runoff and
Other

53.5

175.3

2,376.2

440.4

62.9

0.4

1.1

292.8

(111.9)

2,705.1

1,733.5

821.5

549.2

–
728.9

0.4
124.0
2.4

5.5
31.0

5.7
65.3
17.3

48.2

85.7

179.2

3.7
–

–
–

14.7
3,656.7
43.2

3,804.0

18.4
1,568.4
22.5

1,788.5

1.5
–

–
–
–

142.8

756.8

0.2

–
71.8

3.1
398.7
97.0

570.8

–

–
–

–
(71.8)
–

–

(182.6)

3,104.2

7.0
759.9

6.1
117.5
19.7

351.2

7,363.5

–

265.1

–
(71.8)

1.1
(111.9)
–

(182.6)

3.7
–

37.3
5,511.9
162.7

5,980.7

1,375.1

(178.3)

186.0

–

1,382.8

5,179.1

1,610.2

756.8

(182.6)

7,363.5

86

Fairfax afﬁliates

340.7

Total assets

5,414.9

3,156.0

U.S.
Runoff

European
Runoff

Group Re

Intrasegment
Eliminations

Runoff and
Other

420.6

189.9

2,519.2

1,629.0

46.3

40.4

(2.2)

654.6

(110.3)

4,078.3

1,313.8

1,113.5

497.5

–
697.7

0.7
122.2
–

10.6
98.9

7.8
43.3
14.9

48.1

102.4

201.4

3.9
–

–
–

16.0
3,926.4
23.1

4,071.8

603.4
2,078.6
41.7

2,925.1

0.1
0.7

–
–
–

98.8

683.8

4.8

–
71.0

3.2
385.4
90.9

555.3

–

–
–

–
(71.0)
–

–

(183.5)

2,924.8

10.7
797.3

8.5
94.5
14.9

487.6

9,071.2

–

308.6

–
(71.0)

(2.2)
(110.3)
–

(183.5)

3.9
–

620.4
6,280.1
155.7

7,368.7

December 31, 2005

Assets
Accounts receivable

and other

Recoverable from

reinsurers

Portfolio

investments
Deferred premium
acquisition costs
Future income taxes
Premises and
equipment

Due from afﬁliates
Other assets
Investments in

Liabilities
Accounts payable
and accrued
liabilities

Securities sold but

not yet purchased

Due to afﬁliates
Funds withheld
payable to
reinsurers

Provision for claims
Unearned premiums

Total liabilities

Shareholders’

equity

Total liabilities and
shareholders’
equity

1,343.1

230.9

128.5

–

1,702.5

5,414.9

3,156.0

683.8

(183.5)

9,071.2

The balance sheet for Runoff and Other represents the sum of individual entity balance sheets
even though the individual entities are not necessarily a part of the same ownership structure.
The European runoff balance sheet excludes the $1.5 billion of capital, as previously discussed,
which was provided to nSpire Re to facilitate the acquisitions of U.S. insurance and reinsurance
companies. The following commentary relates to the balance sheet as at December 31, 2006.

Approximately  $664.2  and  $252.1  of  the  cash  and  short  term  investments  and  portfolio
investments held by U.S. runoff and European runoff, respectively, are pledged in the ordinary
course  of  carrying  on  their  business,  to  support  insurance  and  reinsurance  obligations.
Reinsurance  recoverables  include,  in  the  U.S.  runoff  segment,  $504.1  emanating  from  IIC,
predominantly representing reinsurance recoverables on asbestos, pollution and health hazard

87

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

(APH) claims, and include, in the European runoff segment, $41.3 of reinsurance recoverables
on APH claims.

Signiﬁcant changes to the 2006 balance sheet of the Runoff and Other segment compared to
the  2005  balance  sheet  are  primarily  related  to  the  commutations  of  the  Swiss  Re  corporate
insurance cover and the Ridge Re adverse development cover and to the transfer to U.S. runoff
of  the  Fairmont  legal  entities  effective  January  1,  2006  (Fairmont’s  ongoing  business  was
continued  as  the  Fairmont  Specialty  division  of  Crum  &  Forster).  The  commutation  of  the
Swiss Re corporate insurance cover resulted in a $1 billion decrease in the balance recoverable
from reinsurers and a $587.4 decrease in funds withheld payable to reinsurers. The $412.6 pre-
tax and after-tax loss on the commutation contributed to the 2006 $321.8 pre-tax loss for the
Runoff  and  Other  segment,  reﬂected  in  the  $319.7  decrease  in  shareholders’  equity  of  the
segment. The $361.8 decrease in accounts receivable and other primarily reﬂects the receipt on
closing in March 2006 of the $373.3 cash proceeds of TIG’s 2005 commutation of the Ridge Re
adverse development cover. U.S. runoff’s acquisition of the Fairmont legal entities contributed
to  the  increase  in  portfolio  investments  and  added  to  its  provision  for  claims  (which
experienced a net decrease of $768.2 as a result of the continuing claims runoff).

The $759.9 future income taxes asset consists of $728.9 in the U.S. runoff segment and $31.0
in  the  European  runoff  segment.  The  $728.9  future  income  taxes  asset  on  the  U.S.  runoff
balance  sheet  consists  principally  of  approximately  $101.9  of  temporary  differences  and
approximately  $627.0  of  capitalized  U.S.  operating  losses  which  have  already  substantially
been  used  by  other  Fairfax  subsidiaries  within  the  U.S.  consolidated  tax  return  (and  have
therefore been eliminated in the preparation of the company’s consolidated balance sheet) but
which remain with the U.S. runoff companies on a stand-alone basis. The unused portion of
the  future  income  taxes  asset  may  be  realized  (as  it  has  been  in  recent  years)  by  ﬁling  a
consolidated tax return whereby TIG’s net operating loss carryforwards are available to offset
taxable income at Crum & Forster and other Fairfax subsidiaries within the U.S. consolidated
tax return. (As previously discussed, OdysseyRe was deconsolidated from the U.S. consolidated
tax group on August 28, 2006.)

Runoff and Other’s investments in Fairfax afﬁliates consist of:

Afﬁliate

OdysseyRe (TIG)
Cunningham Lindsey (nSpire Re, CRC (Bermuda), TIG,

Fairmont)

Fairfax Asia (Wentworth)
TRG Holdings (Class 1 shares) (nSpire Re, CRC (Bermuda),

Wentworth)

% interest

14.0

81.0
70.5

47.4

U.S.  runoff’s  consolidated  GAAP  shareholders’  equity  of  $1,375.1  as  at  December  31,  2006,
shown  in  the  balance  sheet  above,  differs  from  TIG’s  standalone  statutory  surplus  of  $683.4
primarily because it includes future income taxes (TIG’s standalone $606.2 of the U.S. runoff’s
consolidated  $728.9  of  future  income  taxes)  and  the  reinsurance  recoverables  which  are
eliminated  from  the  statutory  surplus  pursuant  to  a  statutory  schedule  F  penalty  ($102.7,
principally  reinsurance  due  from  non-U.S.  reinsurers  which  are  not  licensed  in  the  United
States).

Interest expense

Consolidated interest expense increased to $210.4 for the year ended December 31, 2006 from
$200.4  in  2005,  primarily  reﬂecting  additional  interest  expense  on  $100.0  of  senior  notes
issued  by  OdysseyRe  in  the  ﬁrst  quarter  of  2006.  Interest  expense  increased  in  2005  as
compared to 2004, reﬂecting interest expense on the additional Fairfax debt issued during 2004

88

and the OdysseyRe debt issued in the second quarter of 2005. Consolidated interest expense
comprised the following:

Fairfax
Crum & Forster
OdysseyRe
Cunningham Lindsey

2006

2005

2004

125.2
33.0
37.5
14.7

121.7
32.9
30.0
15.8

104.6
33.2
25.6
13.3

210.4

200.4

176.7

Corporate overhead and other

Corporate overhead and other consists of the expenses of all of the group holding companies
net  of  the  company’s  investment  management  and  administration  fees  and  investment
income  earned  on  Fairfax’s  cash,  short  term  investments  and  marketable  securities,  and
comprised the following:

2006

2005

2004

Fairfax corporate overhead (net of investment income)
Investment management and administration fees
Corporate overhead of subsidiary holding companies
Internet and technology expenses
Other

61.6
(55.0)
40.0
0.6
–

25.6
(55.8)
44.5
2.8
(8.7)

56.9
(32.7)
31.9
9.6
8.4

47.2

8.4

74.1

Fairfax corporate overhead costs increased signiﬁcantly in 2006 over 2005 primarily as a result
of increased professional fees (legal, audit and consulting) related to ongoing SEC subpoenas,
litigation  matters  and  restatements  as  well  as  to  increased  personnel  costs  and  capital  taxes.
The  decline  in  corporate  overhead  costs  of  subsidiary  holding  companies  reﬂects  reduced
professional fees and personnel costs, partially offset by increased charitable contributions.

Corporate  overhead  costs  in  2005  decreased  at  Fairfax  relative  to  2004  due  to  increased
investment income. Subsidiary corporate overhead costs increased in 2005 compared to 2004
primarily as a result of additional professional fees and personnel retirement costs. Investment
management  and  administration  fees  increased  due  to  the  growth  of  investment  assets  and
higher incentive performance fees earned. Internet and technology expenses decreased in 2005
as  revenues  and  earnings  of  MFX,  the  company’s  technology  subsidiary,  were  increasingly
derived from a signiﬁcant number of third party clients.

Income Taxes

Income tax expense of $485.6 was recorded in 2006 compared to an income tax recovery of
$66.3 in 2005, reﬂecting, in 2006, improved underwriting proﬁtability, signiﬁcantly increased
interest,  dividends  and  net  realized  gains,  reduced  catastrophe  losses  and  reduced  charges
related  to  the  company’s  runoff  unit.  The  effective  income  tax  rate  in  2006  exceeded  the
company’s statutory income tax rate as a result of signiﬁcant losses having been incurred in
jurisdictions with relatively lower corporate income tax rates (including the pre-tax and after-
tax  $412.6  loss  on  the  commutation  of  the  Swiss  Re  corporate  insurance  cover  which  was
incurred  in  the  company’s  nSpire  Re  subsidiary),  combined  with  recording  of  valuation
allowances (primarily in the U.K. and Ireland).

89

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

Non-controlling interests

The non-controlling interests on the company’s consolidated statements of earnings represent
the  public  minority  interests  in  the  net  earnings  or  loss  of  Northbridge,  OdysseyRe  and
Cunningham Lindsey, as summarized in the table below.

Northbridge
OdysseyRe
Cunningham Lindsey

2006

2005

2004

59.5
106.0
–

165.5

66.7
(21.6)
1.3

48.5
36.2
(5.1)

46.4

79.6

Non-controlling interests on the consolidated balance sheet as at December 31, 2006 represent
the minority shareholders’ 40.8% share of the underlying net assets of Northbridge ($408.1),
40.4%  share  of  the  underlying  net  assets  of  OdysseyRe  ($863.1)  and  19.0%  share  of  the
underlying  net  assets  of  Cunningham  Lindsey  ($17.6).  All  of  the  assets  and  liabilities,
including  long  term  debt,  of  these  companies  are  included  in  the  company’s  consolidated
balance sheet.

Provision for Claims

Since 1985, in order to ensure so far as possible that the company’s provision for claims (often
called ‘‘reserves’’) is adequate, management has established procedures so that the provision
for claims at the company’s insurance, reinsurance and runoff operations are subject to several
reviews, including by one or more independent actuaries. The reserves are reviewed separately
by, and must be acceptable to, internal actuaries at each operating company, the chief actuary
at  Fairfax’s  head  ofﬁce,  and  one  or  more  independent  actuaries,  including  an  independent
valuation actuary whose report appears in each Annual Report.

In the ordinary course of carrying on their business, Fairfax’s insurance, reinsurance and runoff
companies  pledge  their  own  assets  as  security  for  their  own  obligations  to  pay  claims  or  to
make  premium  (and  accrued  interest)  payments.  Common  situations  where  assets  are  so
pledged,  either  directly,  or  to  support  letters  of  credit  issued  for  the  following  purposes,  are
regulatory deposits (such as with states for workers’ compensation business), deposits of funds
at Lloyd’s in support of London market underwriting, and the provision of security as a non-
admitted company, as security for claims assumed or to support funds withheld obligations.
Generally, the pledged assets are released as the underlying payment obligation is fulﬁlled. The
$2.2  billion  of  cash  and  investments  pledged  by  the  company’s  subsidiaries,  referred  to  in
note  4  to  the  consolidated  ﬁnancial  statements,  represents  the  aggregate  amount  as  at  the
balance sheet date that has been pledged in the ordinary course of business to support each
pledging  subsidiary’s  respective  obligations,  as  described  in  this  paragraph  (these  pledges  do
not  involve  the  cross-collateralization  by  one  group  company  of  another  group  company’s
obligations).

Claims provisions are established by our primary insurance companies by the case method as
claims  are  initially  reported.  The  provisions  are  subsequently  adjusted  as  additional
information  on  the  estimated  amount  of  a  claim  becomes  known  during  the  course  of  its
settlement. Our reinsurance companies rely on initial and subsequent claims reports received
from ceding companies to establish our estimated provisions. In determining our provision to
cover  the  estimated  ultimate  liability  for  all  of  our  insurance  and  reinsurance  obligations,  a
provision  is  also  made  for  management’s  calculation  of  factors  affecting  the  future
development  of  claims  including  IBNR  (incurred  but  not  reported)  based  on  the  volume  of
business currently in force and the historical experience on claims.

90

As time passes, more information about the claims becomes known and provision estimates are
consequently adjusted upward or downward. Because of the estimation elements encompassed
in this process, and the time it takes to settle many of the more substantial claims, several years
may be required before a meaningful comparison of actual losses to the original provisions can
be developed.

The development of the provision for claims is shown by the difference between estimates of
reserves as of the initial year-end and the re-estimated liability at each subsequent year-end.
This is based on actual payments in full or partial settlement of claims, plus re-estimates of the
reserves  required  for  claims  still  open  or  claims  still  unreported.  Favourable  development
(redundancies)  means  that  subsequent  reserve  estimates  are  lower  than  originally  indicated,
while  unfavourable  development  means  that  the  original  reserve  estimates  were  lower  than
subsequently  indicated.  The  $285.1  aggregate  net  unfavourable  development  in  2006
(excluding  the  effects  of  the  commutation  of  the  Swiss  Re  corporate  insurance  cover)  is
comprised as shown in the following table:

(Favourable)/Unfavourable

Canadian Insurance -

Northbridge

U.S. insurance – Crum &

Forster
Fairfax Asia
Reinsurance – OdysseyRe
Runoff and Other

Total

2006

47.8

(48.9)
2.8
185.4
98.0

285.1

2005

(31.4)

(31.3)(1)
5.1
166.5
449.4

558.3

(1) Net of $26.7 of redundancies inuring to the beneﬁt of aggregate stop loss covers.

91

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

The following table presents a reconciliation of the provision for claims and loss adjustment
expense (LAE) for the insurance, reinsurance and Runoff and Other lines of business for the
past ﬁve years. As shown in the table, the sum of the provision for claims for all of Fairfax’s
insurance,  reinsurance  and  Runoff  and  Other  operations  is  $15,502.3  as  at  December  31,
2006 – the amount shown as provision for claims on Fairfax’s consolidated balance sheet.

Reconciliation of Provision for Claims and LAE as at December 31

Insurance subsidiaries owned

throughout the year
Insurance subsidiaries

2006

2005

2004

2003

2002

3,184.0

3,037.3

2,699.8

2,356.7

1,932.1

acquired during the year

–

–

21.1

–

–

Total insurance subsidiaries

3,184.0

3,037.3

2,720.9

2,356.7

1,932.1

Reinsurance subsidiaries
owned throughout the
year

Reinsurance subsidiaries

4,403.1

3,865.4

3,055.4

2,340.9

1,834.3

acquired during the year

–

–

77.1

–

10.3

Total reinsurance subsidiaries

4,403.1

3,865.4

3,132.5

2,340.9

1,844.6

Runoff and Other

subsidiaries owned
throughout the year

Runoff and Other

subsidiaries acquired
during the year

Total Runoff and Other

subsidiaries

Federated Life(1)

Total provision for claims

and LAE

Reinsurance gross-up

3,071.5

2,421.3

1,968.1

2,463.6

3,343.6

–

38.2

–

–

40.5

3,071.5

2,459.5

1,968.1

2,463.6

3,384.1

–

–

26.2

24.1

18.3

10,658.6
4,843.7

9,362.2
6,872.9

7,847.7
7,318.3

7,185.3
7,386.9

7,179.1
6,232.5

Total including gross-up

15,502.3

16,235.1

15,166.0

14,572.2

13,411.6

(1) Former Northbridge life insurance subsidiary sold in 2005.

The  nine  tables  that  follow  show  the  reconciliation  and  the  reserve  development  of
Northbridge  (Canadian  insurance),  Crum  &  Forster  (U.S.  insurance),  Fairfax  Asia  (Asian
insurance), OdysseyRe (Reinsurance) and Runoff and Other’s net provision for claims. Because
business  is  written  in  various  locations,  there  will  necessarily  be  some  distortions  caused  by
foreign  currency  ﬂuctuations.  The  insurance  operations’  tables  are  presented  in  Canadian
dollars for Northbridge (Canadian insurance) and in U.S. dollars for U.S. and Asian insurance.
The OdysseyRe (Reinsurance) and Runoff and Other tables are presented in U.S. dollars as the
reinsurance and runoff businesses are substantially transacted in that currency.

In all cases, the company strives to establish adequate provisions at the original valuation date,
so  that  if  there  is  any  development  from  the  past,  it  will  be  favourable  development.  The
reserves will always be subject to upward or downward development in the future, and future
development could be signiﬁcantly different from the past due to many unknown factors.

With regard to the four tables below showing claims reserve development, note that when in
any  year  there  is  a  redundancy  or  reserve  strengthening  for  a  prior  year,  the  amount  of  the

92

change in favourable (unfavourable) development thereby reﬂected for that prior year is also
reﬂected in the favourable (unfavourable) development for each year thereafter.

Canadian Insurance – Northbridge

The following table shows for Northbridge (excluding Federated Life, which was sold in 2005)
the  provision  for  claims  liability  for  unpaid  losses  and  LAE  as  originally  and  as  currently
estimated for the years 2002 through 2006. The favourable or unfavourable development from
prior years is credited or charged to each year’s earnings.

Reconciliation of Provision for Claims – Northbridge

2006

2005
(In Cdn $ except as indicated)

2004

2003

2002

Provision for claims and LAE at

January 1

1,408.7

1,153.9

855.4

728.9

621.9

Incurred losses on claims and LAE
Provision for current accident

year’s claims

Foreign exchange effect on claims
Increase (decrease) in provision for

780.8
0.8

825.9
(5.8)

736.3
(13.3)

619.6
(27.2)

525.5
(1.5)

prior accident years’ claims

54.1

(38.1)

15.0

19.2

8.2

Total incurred losses on claims and

LAE

835.7

782.0

738.0

611.6

532.2

Payments for losses on claims and

LAE
Payments on current accident

year’s claims

(251.1)

(248.1)

(206.1)

(211.4)

(224.5)

Payments on prior accident years’

claims

(353.1)

(279.1)

(233.4)

(273.7)

(200.7)

Total payments for losses on claims

and LAE

(604.2)

(527.2)

(439.5)

(485.1)

(425.2)

Provision for claims and LAE at

December 31

Exchange rate
Provision for claims and LAE at

December 31 converted to U.S.
dollars

1,640.2
0.8593

1,408.7
0.8561

1,153.9
0.8347

855.4
0.7738

728.9
0.6330

1,409.5

1,205.9

963.1

661.9

461.4

93

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

The following table shows for Northbridge (excluding Federated Life, which was sold in 2005)
the original provision for claims reserves including LAE at each calendar year-end commencing
in  1996,  the  subsequent  cumulative  payments  made  on  account  of  these  years  and  the
subsequent re-estimated amount of these reserves.

Provision for Northbridge’s Claims Reserve Development

As at
December 31

Provision for claims including

1996 1997 1998 1999 2000 2001 2002 2003

2004

2005

2006

(In Cdn$)

LAE

552.8 569.0 593.3 603.3 585.5 621.9 728.9 855.4 1,153.9 1,408.7 1,640.2

Cumulative payments as of:

One year later

Two years later

Three years later

Four years later

Five years later

Six years later

Seven years later

Eight years later

Nine years later

Ten years later

Reserves re-estimated as of:

One year later

Two years later

Three years later

Four years later

Five years later

Six years later

Seven years later

Eight years later

Nine years later

Ten years later

Favourable

195.0 193.5 196.8 218.9 223.7 200.7 273.7 233.4

298.2 294.4 315.9 334.4 333.8 366.6 396.9 377.9

369.6 377.0 398.3 417.8 458.2 451.4 500.1 493.3

353.1

279.1

441.8

428.6 441.1 455.4 516.9 525.3 527.2 577.1

470.3 487.2 533.1 566.7 573.9 580.6

498.4 545.6 567.4 600.7 609.0

547.0 572.2 590.4 627.3

567.1 588.4 608.7

579.4 601.9

590.1

550.3 561.5 573.9 596.7 617.9 630.1 724.8 864.8 1,114.6 1,461.7

551.2 556.6 574.1 621.6 634.3 672.3 792.1 880.8 1,094.0

552.2 561.0 593.3 638.0 673.9 721.8 812.2 890.1

556.6 580.7 607.3 674.9 717.2 741.6 826.9

567.2 592.3 644.6 711.8 724.5 752.2

579.3 624.8 673.5 714.0 734.8

607.5 650.8 674.4 723.8

630.8 652.2 687.5

631.8 663.7

642.2

(unfavourable) development

(89.4) (94.7) (94.2) (120.5) (149.3) (130.3) (98.0) (34.7)

59.9

(53.0)

Amounts  in  this  paragraph  are  in  Canadian  dollars.  Northbridge  experienced  $53.0  of  net
unfavourable  development  in  2006  mainly  as  a  result  of  new  claims  and  net  claim
development  of  $103.2  on  the  2005  hurricanes,  partially  offset  by  favourable  experience  on
automobile  and  property  lines  of  business,  favourable  development  on  the  industry  Facility
Association  pool  and  favourable  development  on  prior  years’  reserves  of  $1.1  from  foreign
exchange.

As  shown  in  Northbridge’s  annual  report,  on  an  accident  year  basis  (under  which  all  claims
attribute  back  to  the  year  of  loss,  regardless  of  when  they  are  reported  or  adjusted),
Northbridge’s annual weighted average reserve development for the last ten accident years has
been favourable (redundant) by 2.8%.

94

U.S. Insurance – Crum & Forster

The  following  table  shows  for  Fairfax’s  U.S.  insurance  operations  the  provision  for  claims
liability for unpaid losses and LAE as originally and as currently estimated for the years 2002
through 2006. Beginning in 2006, U.S. insurance consists of Crum & Forster only (the years
prior to 2006 include Fairmont, the business of which was assumed by Crum & Forster effective
January 1, 2006 while the Fairmont entities were transferred to U.S. runoff). The favourable or
unfavourable development from prior years is credited or charged to each year’s earnings.

Reconciliation of Provision for Claims – U.S. Insurance

Provision for claims and LAE at

January 1

1,756.7

1,703.1

1,669.7

1,447.6

1,535.5

2006

2005

2004

2003

2002

Transfer of Fairmont to Runoff
Incurred losses on claims and LAE
Provision for current accident

(146.2)

–

–

–

–

year’s claims

762.2

785.9

795.4

585.5

517.4

Increase (decrease) in provision for

prior accident years’ claims

(48.9)

(31.3)

(30.1)(1)

40.5

20.8

Total incurred losses on claims and

LAE

713.3

754.6

765.3

626.0

538.2

Payments for losses on claims and

LAE
Payments on current accident

year’s claims

(158.0)

(171.5)

(185.6)

(123.8)

(148.0)

Payments on prior accident years’

claims

(478.9)

(529.5)

(546.3)

(280.1)

(478.1)

Total payments for losses on claims

and LAE

(636.9)

(701.0)

(731.9)

(403.9)

(626.1)

Provision for claims and LAE at

December 31

1,686.9

1,756.7

1,703.1

1,669.7

1,447.6

(1) Offset in Crum & Forster’s underwriting results by ceding premiums paid on strengthening prior

years’ loss reserves, resulting in a net cost to Crum & Forster of $25.0.

95

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

The  following  table  shows  for  Crum  &  Forster  the  original  provision  for  claims  reserves
including  LAE  at  each  calendar  year-end  commencing  in  1998,  the  subsequent  cumulative
payments made on account of these years and the subsequent re-estimated amounts of these
reserves.

Provision for Crum & Forster’s Claims Reserve Development

As at
December 31

1998

1999

2000

2001

2002

2003

2004

2005

2006

Provision for claims including LAE

2,491.9 2,187.5 1,736.6 1,318.2 1,238.4 1,538.2 1,578.2 1,610.6 1,686.9

Cumulative payments as of:

One year later

Two years later

Three years later

Four years later

Five years later

Six years later

Seven years later

Eight years later

Reserves re-estimated as of:

One year later

Two years later

Three years later

Four years later

Five years later

Six years later

Seven years later

Eight years later

Favourable (unfavourable)

664.5

757.4

667.2

1,228.1 1,301.8 1,012.2

1,640.5 1,568.4 1,083.8

447.0

525.0

812.4

161.3

514.5

460.0

792.2

466.0

796.7

478.9

780.0 1,045.1

1,910.0 1,633.9 1,311.1 1,029.8

970.2

1,911.0 1,855.3 1,483.6 1,185.5

2,074.8 2,023.8 1,613.9

2,223.0 2,151.5

2,333.5

2,507.0 2,263.1 1,691.0 1,337.7 1,278.6 1,508.1 1,546.9 1,561.7

2,523.5 2,269.2 1,708.3 1,411.7 1,285.9 1,536.0 1,509.2

2,526.4 2,282.0 1,754.8 1,420.7 1,308.2 1,513.3

2,540.7 2,325.1 1,765.2 1,438.6 1,296.8

2,577.2 2,348.0 1,779.1 1,437.0

2,603.9 2,361.6 1,794.1

2,616.6 2,368.4

2,633.7

development

(141.8)

(180.9)

(57.5)

(118.8)

(58.4)

24.9

69.0

48.9

In  2006  Crum  &  Forster  experienced  favourable  development  of  prior  years’  loss  reserves  of
$48.9, comprised of net favourable development across all major casualty lines, partially offset
by adverse development of asbestos, environmental and other latent exposures of $33.9. The
largest redundancy was recognized in workers’ compensation and was principally attributable
to  the  favourable  results  in  California  in  accident  years  2005  and  2004,  consistent  with  the
industry’s  experience.  Additional  favourable  development  was  experienced  in  umbrella  and
other general liability exposures, due in part to favourable settlement claims in accident year
2000 and prior and in commercial auto liability for accident year 2005 and prior.

96

Asian Insurance – Fairfax Asia

The following table shows for Fairfax Asia the provision for claims liability for unpaid losses
and  LAE  as  originally  and  as  currently  estimated  for  the  years  2002  through  2006.  The
favourable or unfavourable development from prior years is credited or charged to each year’s
earnings.

Reconciliation of Provision for Claims – Fairfax Asia

Provision for claims and LAE at January 1

74.7

54.7

25.1

23.1

29.6

2006

2005

2004

2003

2002

Incurred losses on claims and LAE

Provision for current accident year’s claims
Foreign exchange effect on claims
Increase (decrease) in provision for prior accident

34.7
2.1

39.6
(0.2)

24.9
–

20.6
–

20.1
–

years’ claims

2.8

5.1

(0.2)

(0.7)

3.2

Total incurred losses on claims and LAE

39.6

44.5

24.7

19.9

23.3

Payments for losses on claims and LAE

Payments on current accident year’s claims
Payments on prior accident years’ claims

(11.1)
(15.6)

(11.2)
(13.3)

(8.3)
(7.9)

(7.8)
(10.1)

(10.8)
(19.0)

Total payments for losses on claims and LAE

(26.7)

(24.5)

(16.2)

(17.9)

(29.8)

Provision for claims and LAE at December 31 before

the undernoted

87.6

74.7

33.6

25.1

23.1

Provision for claims and LAE for First Capital at

December 31

–

–

Provision for claims and LAE at December 31

87.6

74.7

21.1

54.7

–

–

25.1

23.1

The following table shows for Fairfax Asia the original provision for claims reserves including
LAE at each calendar year-end commencing in 1998 (when Fairfax Asia began), the subsequent
cumulative payments made on account of these years and the subsequent re-estimated amount
of  these  reserves.  The  following  Asian  insurance  subsidiaries’  reserves  are  included  from  the
respective years in which such subsidiaries were acquired:

Falcon Insurance
Winterthur (Asia)
First Capital Insurance

Year Acquired

1998
2001
2004

97

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

Provision for Fairfax Asia’s Claims Reserve Development

As at December 31

1998 1999 2000 2001 2002 2003 2004 2005 2006

Provision for claims including LAE

Cumulative payments as of:

5.6

9.2

11.0

29.6

23.1

25.1

54.7

74.7

87.6

One year later

Two years later

Three years later

Four years later

Five years later

Six years later

Seven years later

Eight years later

Reserves re-estimated as of:

One year later

Two years later

Three years later

Four years later

Five years later

Six years later

Seven years later

Eight years later

Favourable (unfavourable) development

0.9

1.4

3.2

3.4

3.4

3.4

3.5

3.5

5.6

3.5

3.8

3.8

3.6

3.5

3.5

3.5

2.1

15.6

13.3

21.9

7.9

13.1

15.9

10.1

14.1

16.5

17.8

79.6

59.6

58.2

24.9

23.1

21.2

22.4

22.2

21.3

20.5

19.0

26.1

27.9

29.1

29.5

32.8

32.3

32.2

31.5

30.8

5.7

7.9

9.7

10.8

11.6

11.6

13.4

14.1

13.6

13.3

12.8

12.3

2.3

5.3

6.3

7.0

7.1

7.2

7.2

8.9

9.1

9.3

8.3

8.0

7.5

7.4

1.8

(1.3)

(1.2)

2.6

3.9

(3.5)

(4.9)

Fairfax  Asia  experienced  net  unfavourable  development  of  $4.9  (including  $2.1  related  to
foreign exchange) in 2006, mainly relating to adverse development of prior years’ loss reserves
for  employees’  compensation  insurance  claims  at  Falcon,  partially  offset  by  net  favourable
development at First Capital.

98

Reinsurance – OdysseyRe

The following table shows for OdysseyRe the provision for claims liability for unpaid losses and
LAE as originally and as currently estimated for the years 2002 through 2006. The favourable or
unfavourable development from prior years is credited or charged to each year’s earnings.

Reconciliation of Provision for Claims –
OdysseyRe

Provision for claims and LAE at

January 1

3,865.4

3,132.5

2,340.9

1,844.6

1,674.4

2006

2005

2004

2003

2002

Incurred losses on claims and

LAE

Provision for current accident

year’s claims
Foreign exchange effect on

1,344.3

1,888.9

1,441.1

1,208.0

920.0

claims

46.6

(28.1)

24.9

14.8

5.1

Increase in provision for prior

accident years’ claims

185.4

166.5

181.2

116.9

66.0

Total incurred losses on claims

and LAE

1,576.3

2,027.3

1,647.2

1,339.7

991.1

Payments for losses on claims

and LAE

Payments on current accident

year’s claims
Payments on prior accident

(251.3)

(380.7)

(300.3)

(241.6)

(215.0)

years’ claims

(787.3)

(913.7)

(632.4)

(601.8)

(616.2)

Total payments for losses on

claims and LAE

(1,038.6)

(1,294.4)

(932.7)

(843.4)

(831.2)

Provision for claims and LAE at

December 31 before the
undernoted

Provision for claims and LAE for
First Capital at December 31
Provision for claims and LAE at
December 31 for Opus Re

Provision for claims and LAE at

4,403.1

3,865.4

3,055.4

2,340.9

1,834.3

–

–

–

–

–

77.1(1)

–

–

10.3

–

December 31

4,403.1

3,865.4

3,132.5

2,340.9

1,844.6

(1) Reﬂects the transfer to the Fairfax Asia segment of First Capital’s provision for claims and LAE.

99

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

The following table shows for OdysseyRe the original provision for claims reserves including
LAE  at  each  calendar  year-end  commencing  in  1996  (the  year  of  Fairfax’s  ﬁrst  reinsurance
company acquisition), the subsequent cumulative payments made on account of these years
and the subsequent re-estimated amount of these reserves.

Provision for OdysseyRe’s Claims Reserve Development

As at
December 31

Provision for claims

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

including LAE

1,991.8 2,134.3 1,987.6 1,831.5

1,666.8

1,674.4 1,844.6 2,340.9 3,132.5 3,865.4 4,403.1

Cumulative

payments as of:

One year later

Two years later

456.8

837.2

546.1

594.1

608.5

596.2

993.7 1,054.6 1,041.3

1,009.9

616.2

985.4

601.8

632.4

913.7

787.3

998.8 1,212.9 1,298.5

Three years later

1,142.1 1,341.5 1,352.9 1,332.8

1,276.4

1,295.5 1,423.6 1,455.7

Four years later

1,349.2 1,517.6 1,546.2 1,505.5

1,553.1

1,601.6 1,562.6

Five years later

1,475.0 1,648.3 1,675.4 1,718.4

1,802.2

1,665.8

Six years later

1,586.2 1,754.9 1,828.1 1,901.2

1,827.3

Seven years later

1,680.3 1,848.5 1,941.1 1,904.4

Eight years later

1,757.7 1,928.5 1,896.4

Nine years later

1,820.3 1,861.3

Ten years later

1,741.5

Reserves re-

estimated as of:

One year later

2,106.7 2,113.0 2,033.8 1,846.2

1,689.9

1,740.4 1,961.5 2,522.1 3,299.0 4,050.8

Two years later

2,121.0 2,151.3 2,043.0 1,862.2

1,768.1

1,904.2 2,201.0 2,782.1 3,537.0

Three years later

2,105.0 2,130.9 2,043.7 1,931.4

1,987.9

2,155.2 2,527.7 3,049.6

Four years later

2,073.6 2,128.2 2,084.8 2,113.2

2,241.1

2,468.0 2,827.3

Five years later

2,065.8 2,150.3 2,215.6 2,292.2

2,535.0

2,725.8

Six years later

2,065.6 2,207.1 2,305.5 2,526.7

2,750.5

Seven years later

2,067.9 2,244.3 2,429.1 2,702.1

Eight years later

2,094.2 2,326.2 2,570.6

Nine years later

2,167.3 2,443.1

Ten years later

2,243.4

Favourable

(unfavourable)

development

(251.6)

(308.8)

(583.0)

(870.6) (1,083.7) (1,051.4)

(982.7)

(708.7)

(404.5)

(185.4)

Net  adverse  development  in  2006  of  $185.4  for  OdysseyRe  was  primarily  attributable  to
U.S. casualty business written by the Americas division in 2001 and prior ($258.2 including the
third  quarter  $33.8  pre-tax  loss  on  the  commutation  of  an  intercompany  reinsurance  treaty
which loss was eliminated on consolidation) partially offset by redundancies in the EuroAsia
division  ($9.0),  London  Market  division  ($24.8)  and  the  U.S.  Insurance  division  ($39.0).
Included in the above $185.4 were $42.6 related to property catastrophes (principally the 2005
hurricanes)  and  $40.6  related  to  asbestos.  OdysseyRe’s  reserve  development  reported  under
Canadian  GAAP  differed  from  its  reserve  development  under  US  GAAP  primarily  due  to  the
$33.8 loss recognized under Canadian GAAP on the commutation and the recognition during
2006  of  the net  deferred  beneﬁt  under  US  GAAP  of  $11.7 relating  to  this  intercompany
reinsurance treaty.

100

Runoff and Other

The following table shows for Fairfax’s Runoff and Other operations the provision for claims
liability for unpaid losses and LAE as originally and as currently estimated for the years 2002
through  2006.  The  favourable  or  unfavourable  development  from  prior  years  is  credited  or
charged to each year’s earnings.

Reconciliation of Provision for Claims – Runoff and Other

Provision for claims and LAE at

January 1

2,459.5

1,968.1

2,463.6

3,384.1

3,309.3

2006

2005

2004

2003

2002

Transfer of Fairmont to Runoff
Incurred losses on claims and LAE

Provision for current accident year’s
claims
Foreign exchange effect on claims
Increase in provision for prior

146.2

–

–

–

–

297.3
29.4

389.8
17.0

399.4
81.1

580.7
66.7

871.2
3.0

accident years’ claims

98.0

449.4

102.8

299.9

241.3

Increase in provision – Swiss Re

commutation

412.6

–

(3.9)

(263.6)

(5.2)

Total incurred losses on claims and

LAE

837.3

856.2

579.4

683.7

1,110.3

Payments for losses on claims and LAE
Payments on current accident year’s
claims
Payments on prior accident years’

(106.6)

(86.7)

(51.2)

(74.2)

(172.3)

claims

(264.9)(2)

(316.3)(1) (1,023.7)

(1,530.0)

(903.7)

Total payments for losses on claims

and LAE

(371.5)

(403.0)

(1,074.9)

(1,604.2)

(1,076.0)

Provision for claims and LAE at

December 31 before the undernoted

3,071.5

2,421.3

1,968.1

2,463.6

3,343.6

Provision for claims and LAE for
Corifrance at December 31

Provision for claims and LAE for Old

Lyme at December 31

Provision for claims and LAE at

–

–

38.2

–

–

–

–

–

–

40.5

December 31

3,071.5

2,459.5

1,968.1

2,463.6

3,384.1

(1)

(2)

Reduced  by  $570.3  of  proceeds  received  and  proceeds  due  from  two  signiﬁcant  commutations
referred to in ‘‘Commutations’’ in the preceding section.

Reduced  by  $587.4  of  proceeds  received  from  the  commutation  of  the  Swiss  Re  corporate
insurance cover.

The  net  unfavourable  development  of  $98.0  in  2006  included  unfavourable  development  of
$18.5 in U.S. runoff mainly due to the strengthening of workers’ compensation and general
liability reserves and provisions for uncollectible reinsurance; $22.1 principally from adverse
development  of  hurricane  losses  at  Group  Re;  $53.4  arising  from  the  strengthening  of
unallocated loss adjustment reserves in U.S. and European runoff; $20.0 from U.S. construction
defect  claims;  and  $14.6  related  to  public  entity  excess  business;  partially  offset  by  $33.8  of
favourable development related to the gain on a commutation of an intercompany reinsurance
treaty (eliminated on consolidation) and other favourable development in European runoff.

101

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

Asbestos, Pollution, and Other Hazards Section

General APH Discussion

A number of Fairfax’s subsidiaries wrote general liability policies and reinsurance prior to their
acquisition  by  Fairfax  under  which  policyholders  continue  to  present  asbestos-related  injury
claims, claims alleging injury, damage or clean up costs arising from environmental pollution,
and  other  health  hazard  or  mass  tort  (APH)  claims.  The  vast  majority  of  these  claims  are
presented under policies written many years ago.

There is a great deal of uncertainty surrounding these types of claims. This uncertainty impacts
the  ability  of  insurers  and  reinsurers  to  estimate  the  ultimate  amount  of  unpaid  claims  and
related settlement expenses. The majority of these claims differ from any other type of claim
because there is little consistent precedent to determine what, if any, coverage exists or which,
if any, policy years and insurers/reinsurers may be liable. These uncertainties are exacerbated
by inconsistent court decisions and judicial and legislative interpretations of coverage that in
some cases have eroded the clear and express intent of the parties to the insurance contracts,
and  in  others  have  expanded  theories  of  liability.  The  industry  as  a  whole  is  engaged  in
extensive  litigation  over  these  coverage  and  liability  issues  and  is  thus  confronted  with
continuing  uncertainty  in  its  efforts  to  quantify  APH  exposures.  Conventional  actuarial
reserving  techniques  cannot  be  used  to  estimate  the  ultimate  cost  of  such  claims,  due  to
inadequate loss development patterns and inconsistent emerging legal doctrine.

Following is an analysis of Fairfax’s gross and net loss and ALAE reserves from APH exposures at
year-end 2006, 2005, and 2004 and the movement in gross and net reserves for those years:

2006

2005

2004

Gross

Net

Gross

Net

Gross

Net

Runoff Companies

Provision for APH claims and ALAE at January 1

1,284.0

365.6

1,440.1

375.0

1,460.0

426.1

Fairmont transfer to Runoff

APH losses and ALAE incurred during the year

2.5

10.3

0.9

7.0

–

112.9

APH losses and ALAE paid during the year

143.7

40.5

269.0

–

45.2

54.6

–

184.4

204.3

–

(0.5)

50.6

Provision for APH claims and ALAE at December 31

1,153.1

333.0

1,284.0

365.6

1,440.1

375.0

Operating Companies

Provision for APH claims and ALAE at January 1

851.2

675.9

878.0

675.6

838.5

654.0

Fairmont transfer to Runoff

APH losses and ALAE incurred during the year

APH losses and ALAE paid during the year

(2.5)

(0.9)

–

113.5

108.3

74.2

89.8

102.9

129.7

–

92.9

92.6

–

–

168.5

125.7

129.0

104.1

Provision for APH claims and ALAE at December 31

853.9

659.4

851.2

675.9

878.0

675.6

Fairfax Total

Provision for APH claims and ALAE at January 1

2,135.2

1,041.5

2,318.1

1,050.6

2,298.5

1,080.1

APH losses and ALAE incurred during the year

123.8

81.2

215.8

138.1

352.9

125.3

APH losses and ALAE paid during the year

252.0

130.3

398.7

147.2

333.3

154.7

Provision for APH claims and ALAE at December 31

2,007.0

992.4

2,135.2

1,041.5

2,318.1

1,050.6

Asbestos Claims Discussion

Asbestos continues to be the most signiﬁcant and difﬁcult mass tort for the insurance industry
in terms of claims volume and dollar exposure. Fairfax believes that the insurance industry has
been  adversely  affected  by  judicial  interpretations  that  have  had  the  effect  of  maximizing
insurance  recoveries  for  asbestos  claims,  from  both  a  coverage  and  liability  perspective.
Generally speaking, only policies underwritten prior to 1987 have potential asbestos exposure,
since most policies underwritten after this date contain an absolute asbestos exclusion.

102

In recent years, especially from 2001 through 2003, the industry had experienced increasing
numbers  of  asbestos  claims,  including  claims  from  individuals  who  do  not  appear  to  be
impaired by asbestos exposure. The rate of new claim ﬁling has slowed signiﬁcantly since 2003.
It  is  possible  that  the  increases  observed  in  the  early  part  of  the  decade  were  triggered  by
various  state  tort  reforms  (discussed  immediately  below).  At  this  point,  it  is  too  early  to  tell
whether claim ﬁlings will return to pre-2004 levels, stabilize, or continue to decrease. Also, it is
not clear whether the decrease in the number of new claims will translate to lower costs for the
insurance  industry;  if  a  greater  proportion  of  new  claims  is  brought  by  individuals  who  are
impaired by asbestos exposure, the average claim cost could rise signiﬁcantly.

Since 2001, several states have proposed, and in many cases enacted, tort reform statutes that
impact  asbestos  litigation  by,  for  example,  making  it  more  difﬁcult  for  a  diverse  group  of
plaintiffs to jointly ﬁle a single case, reducing ‘‘forum-shopping’’ by requiring that a potential
plaintiff  must  have  been  exposed  to  asbestos  in  the  state  in  which  he/she  ﬁles  a  lawsuit,
permitting consolidation of discovery, etc. These statutes typically apply to suits ﬁled after a
stated  date.  When  a  statute  is  proposed  or  enacted,  asbestos  defendants  often  experience  a
marked increase in new lawsuits, as plaintiffs’ attorneys rush to ﬁle before the effective date of
the legislation. Some of this increased claim volume likely represents an acceleration of valid
claims that would have been brought in the future; while some claims will likely prove to have
little  or  no  merit.  As  many  of  these  claims  are  still  pending,  it  is  still  too  early  to  tell  what
portion  of  the  increased  number  of  suits  represents  valid  claims.  Also,  the  acceleration  of
claims  increases  the  uncertainty  surrounding  projections  of  future  claims  in  the  affected
jurisdictions. Fairfax’s reserves include a prudent provision for the ultimate cost of claims ﬁled
in these jurisdictions.

Following  is  an  analysis  of  Fairfax’s  gross  and  net  loss  and  ALAE  reserves  from  asbestos
exposures at year-end 2006, 2005, and 2004 and the movement in gross and net reserves for
those years:

2006

2005

2004

Gross

Net

Gross

Net

Gross

Net

Runoff Companies

Provision for asbestos claims and ALAE at January 1

856.8

248.4

962.0

250.8

901.5

278.1

Fairmont transfer to Runoff

0.6

0.1

–

Asbestos losses and ALAE incurred during the year

(22.9)

(3.6)

105.4

Asbestos losses and ALAE paid during the year

104.7

26.0

210.6

–

39.9

42.3

–

199.9

139.3

–

1.7

29.0

Provision for asbestos claims and ALAE at December 31

729.8

218.9

856.8

248.4

962.0

250.8

Operating Companies

Provision for asbestos claims and ALAE at January 1

702.3

546.0

725.3

538.5

674.9

494.1

Fairmont transfer to Runoff

Asbestos losses and ALAE incurred during the year

Asbestos losses and ALAE paid during the year

(0.6)

(0.1)

–

100.7

89.3

63.3

71.9

83.6

106.6

–

75.7

68.2

–

–

141.4

113.8

91.1

69.4

Provision for asbestos claims and ALAE at December 31

713.1

537.3

702.3

546.0

725.3

538.5

Fairfax Total

Provision for asbestos claims and ALAE at January 1

1,559.1

794.4

1,687.3

789.3

1,576.4

772.2

Asbestos losses and ALAE incurred during the year

Asbestos losses and ALAE paid during the year

77.8

194.0

59.7

97.9

189.0

115.6

341.3

115.5

317.2

110.4

230.4

98.4

Provision for asbestos claims and ALAE at December 31

1,442.9

756.2

1,559.1

794.4

1,687.3

789.3

103

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

Following is an analysis of Fairfax’s U.S.-based subsidiaries gross and net loss and ALAE reserves
for asbestos exposures at year-end 2006, 2005, and 2004 and the movement in gross and net
reserves  for  those  years  (throughout  this  section,  in  the  interests  of  clarity,  TIG  and  IIC  are
presented separately, notwithstanding their merger in December, 2002):

2006

2005

2004

Gross

Net

Gross

Net

Gross

Net

IIC

Provision for asbestos claims and ALAE at January 1

592.8

124.1

687.5

130.0

586.1

132.2

Asbestos losses and ALAE incurred during the year

Asbestos losses and ALAE paid during the year

(0.8)

80.0

0.9

58.4

(2.3)

196.4

10.5

153.1

3.6

95.0

1.8

4.0

Provision for asbestos claims and ALAE at December 31

512.0

114.5

592.8

124.1

687.5

130.0

C&F

Provision for asbestos claims and ALAE at January 1

426.9

376.7

482.2

408.8

458.1

366.4

Asbestos losses and ALAE incurred during the year

Asbestos losses and ALAE paid during the year

38.2

60.7

22.7

51.2

29.7

85.0

31.5

63.6

87.0

62.8

90.5

48.1

Provision for asbestos claims and ALAE at December 31

404.4

348.2

426.9

376.7

482.2

408.8

Odyssey Re(1)

Provision for asbestos claims and ALAE at January 1

274.8

169.1

242.2

129.3

215.7

127.3

Asbestos losses and ALAE incurred during the year

Asbestos losses and ALAE paid during the year

62.5

28.6

40.6

20.7

54.2

21.6

44.4

4.6

54.6

28.1

22.6

20.5

Provision for asbestos claims and ALAE at December 31

308.7

189.0

274.8

169.1

242.2

129.3

TIG

Provision for asbestos claims and ALAE at January 1

Asbestos losses and ALAE incurred during the year

Asbestos losses and ALAE paid during the year

Provision for asbestos claims and ALAE at December 31

Fairmont

Provision for asbestos claims and ALAE at January 1

Asbestos losses and ALAE incurred during the year

Asbestos losses and ALAE paid during the year

Provision for asbestos claims and ALAE at December 31

94.7

(4.6)

8.5

81.6

0.6

0.5

0.1

1.0

11.5

97.7

102.7

11.8

8.5

5.1

2.1

1.4

4.4

0.0

5.0

94.7

11.5

97.7

0.9

(0.3)

0.0

0.6

0.4

(0.3)

0.0

0.1

1.1

(0.1)

0.1

0.9

2.1

5.2

8.4

0.1

0.4

0.0

0.5

0.0

3.3

8.5

0.4

0.8

0.7

0.4

(1) Net  reserves  presented  for  Odyssey  Re  in  2004  and  2005  exclude  cessions  under  a  stop  loss
agreement with nSpire Re Ltd, a wholly-owned subsidiary of Fairfax. This stop loss agreement was
commuted in 2006.

The policyholders with the most signiﬁcant asbestos exposure are traditional defendants who
manufactured,  distributed  or  installed  asbestos  products  on  a  nationwide  basis.  IIC,  which
underwrote insurance generally for Fortune 500 type risks between 1971 and 1986 with mostly
high layer excess liability coverages (as opposed to primary or umbrella policies), is exposed to
these risks and has the bulk of the direct asbestos exposure within Fairfax. While these insureds
are relatively small in number, asbestos exposures for such entities have increased over the past
decade  due  to  the  rising  volume  of  claims,  the  erosion  of  underlying  limits,  and  the
bankruptcies  of  target  defendants.  As  reﬂected  above,  these  direct  liabilities  are  very  highly
reinsured.

Fairfax’s other U.S.-based insurers have asbestos exposure related mostly to less prominent or
‘‘peripheral’’  defendants,  including  a  mix  of  manufacturers,  distributors,  and  installers  of
asbestos-containing products as well as premises owners. For the most part, these insureds are
defendants  on  a  regional  rather  than  nationwide  basis.  Odyssey  Re  has  asbestos  exposure
arising  from  reinsurance  contracts  entered  into  before  1984.  TIG  has  both  direct  and
reinsurance assumed asbestos exposures. TIG’s net retention on its direct exposure is protected

104

by an $89 million APH reinsurance cover provided by Pyramid Insurance Company (owned by
Aegon)  which  is  fully  collateralized  and  reﬂected  in  the  above  table.  Additionally,  TIG’s
assumed exposure is 100% reinsured by ARC Insurance Company (also owned by Aegon); this
reinsurance is fully collateralized and reﬂected in the above table.

Reserves for asbestos cannot be estimated using traditional loss reserving techniques that rely
on historical accident year loss development factors. Because each insured presents different
liability and coverage issues, IIC and C&F, which have the bulk of Fairfax’s asbestos liabilities,
evaluate  their  asbestos  exposure  on  an  insured-by-insured  basis.  Since  the  mid-1990’s  these
entities have utilized a sophisticated, non-traditional methodology that draws upon company
experience  and  supplemental  databases  to  assess  asbestos  liabilities  on  reported  claims.  The
methodology  utilizes  a  comprehensive  ground-up,  exposure-based  analysis  that  constitutes
industry  ‘‘best  practice’’  approach  for  asbestos  reserving.  The  methodology  was  initially
critiqued by outside legal and actuarial consultants and the results are annually reviewed by
independent actuaries, all of whom have consistently found the methodology comprehensive
and the results reasonable.

In  the  course  of  the  insured-by-insured  evaluation  the  following  factors  are  considered:
available insurance coverage, including any umbrella or excess insurance that has been issued
to  the  insured;  limits,  deductibles,  and  self-insured  retentions;  an  analysis  of  each  insured’s
potential liability; the jurisdictions involved; past and anticipated future asbestos claim ﬁlings
against  the  insured;  loss  development  on  pending  claims;  past  settlement  values  of  similar
claims; allocated claim adjustment expenses; and applicable coverage defenses.

In addition to estimating liabilities for reported asbestos claims, IIC and C&F estimate reserves
for additional claims to be reported in the future as well as the reopening of any claim closed in
the  past.  This  component  of  the  total  incurred  but  not  reported  (IBNR)  reserve  is  estimated
using information as to the reporting patterns of known insureds, historical settlement costs
per insured, and characteristics of insureds such as limits exposed, attachment points, and the
number of coverage years.

Since their asbestos exposure is considerably less than that of IIC and C&F, Odyssey Re, TIG,
and Ranger do not use the above methodology to establish asbestos reserves. Case reserves are
established where sufﬁcient information has been developed to indicate the involvement of a
speciﬁc insurance policy, and, at Odyssey Re, may include an additional amount as determined
by that company’s dedicated asbestos and environmental pollution claims unit based on the
claims audits of cedants. In addition, bulk IBNR reserves based on various methods such as loss
development  or  market  share,  utilizing  industry  benchmarks  of  ultimate  liability,  are
established to cover additional exposures on both reported and unasserted claims as well as for
allocated claim adjustment costs.

The early part of this decade saw a rash of bankruptcies among asbestos defendants, primarily
manufacturers and suppliers of asbestos-containing products. As the rate of new claim ﬁlings
has  stabilized,  so  has  the  number  of  defendants  seeking  bankruptcy  protection.  Asbestos-
related bankruptcies now total approximately 72 companies. This number is unchanged from
year-end 2005, and an increase from 71 at year-end 2004.

The United States Congress, starting in 2003, attempted to create a federal solution to address
the ﬂood of asbestos litigation across the country and associated corporate bankruptcies. These
efforts  appeared  to  have  stalled  in  2006.  As  of  this  writing,  it  appears  unlikely  that  federal
asbestos  reform  will  be  enacted  in  the  foreseeable  future.  It  cannot  be  reasonably  predicted
what effect, if any, the enactment of some form of asbestos reform legislation would have on
Fairfax’s  ﬁnancial  statements.  Fairfax’s  asbestos  reserves  do  not  reﬂect  any  impact  from
potential future legislative reforms.

105

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

As a result of the processes, procedures, and analyses described above, management believes
that the reserves carried for asbestos claims at December 31, 2006 are appropriate based upon
known facts and current law. However, there are a number of uncertainties surrounding the
ultimate value of these claims that may result in changes in these estimates as new information
emerges.  Among  these  are:  the  unpredictability  inherent  in  litigation,  impacts  from  the
bankruptcy protection sought by asbestos producers and defendants, uncertainty as to whether
new claim ﬁlings will return to pre-2004 levels, and future developments regarding the ability
to  recover  reinsurance  for  asbestos  claims.  It  is  also  not  possible  to  predict,  nor  has
management assumed, any changes in the legal, social, or economic environments and their
impact on future asbestos claim development.

As part of the overall review of its asbestos exposure, Fairfax compares its level of reserves to
various industry benchmarks. The most widely reported benchmark is the survival ratio, which
represents the outstanding loss and ALAE reserves (including IBNR) at December 31 divided by
the  average  paid  losses  and  ALAE  for  the  past  three  years.  The  resulting  ratio  is  a  simple
measure of the estimated number of years before the year-end loss and ALAE reserves would be
exhausted using recent payment run rates (the higher the ratio, the more years the loss and
ALAE reserves would be expected to cover). The following table presents the asbestos survival
ratios for IIC, C&F and OdysseyRe:

IIC

Net loss and ALAE reserves

3-year average net paid losses and ALAE

3-year Survival Ratio

C&F

Net loss and ALAE reserves

3-year average net paid losses and ALAE

3-year Survival Ratio

OdysseyRe

Net loss and ALAE reserves

3-year average net paid losses and ALAE

3-year Survival Ratio

114.5

6.0

19.0

348.2

54.3

6.4

189.0

15.3

12.4

Environmental Pollution Discussion

Environmental pollution claims represent another signiﬁcant  exposure for Fairfax. However,
claims  against  Fortune  500  companies  are  declining,  and  while  insureds  with  single-site
exposures  are  still  active,  Fairfax  has  resolved  the  majority  of  disputes  with  insureds  with  a
large number of sites. In many cases, claims are being settled for less than initially anticipated
due to improved site remediation technology and effective policy buybacks.

Despite the stability of recent trends, there remains great uncertainty involved in estimating
liabilities  related  to  these  exposures.  First,  the  number  of  waste  sites  subject  to  cleanup  is
unknown.  Today,  approximately  1,243  sites  are  included  on  the  National  Priorities  List
(NPL) of the federal Environmental Protection Agency (an increase of ﬁve from year-end 2005).
State authorities have identiﬁed many additional sites. Second, the liabilities of the insureds
themselves are difﬁcult to estimate. At any given site, the allocation of remediation cost among
the  potentially  responsible  parties  varies  greatly  depending  upon  a  variety  of  factors.  Third,
different  courts  have  been  presented  with  liability  and  coverage  issues  regarding  pollution
claims  and  have  reached  inconsistent  decisions.  There  is  also  uncertainty  as  to  the  federal
‘‘Superfund’’ law itself; at this time, it is not possible to predict what, if any, reforms to this law
might be enacted by Congress, or the effect of any such changes on the insurance industry.

106

Following  is  an  analysis  of  Fairfax’s  gross  and  net  loss  and  ALAE  reserves  from  pollution
exposures at year-end 2006, 2005, and 2004 and the movement in gross and net reserves for
those years:

Runoff Companies

Provision for pollution claims and ALAE at January 1

356.1

89.2

384.1

93.9

443.4

114.1

2006

2005

2004

Gross

Net

Gross

Net

Gross

Net

Fairmont transfer to Runoff

Pollution losses and ALAE incurred during the year

Pollution losses and ALAE paid during the year

1.9

35.6

33.1

Provision for pollution claims and ALAE at December 31

360.5

0.8

12.1

11.8

90.3

Operating Companies

–

6.4

34.4

–

3.0

7.7

–

–

(17.5)

(4.9)

41.8

15.4

93.9

356.1

89.2

384.1

Provision for pollution claims and ALAE at January 1

123.5

105.9

128.5

115.1

135.5

133.2

Fairmont transfer to Runoff

Pollution losses and ALAE incurred during the year

Pollution losses and ALAE paid during the year

(1.9)

(0.8)

11.5

15.3

9.6

14.3

–

12.8

17.8

–

10.8

20.0

–

27.0

34.0

–

11.9

30.0

Provision for pollution claims and ALAE at December 31

117.8

100.4

123.5

105.9

128.5

115.1

Fairfax Total

Provision for pollution claims and ALAE at January 1

479.6

195.1

512.6

209.0

578.8

247.3

Pollution losses and ALAE incurred during the year

Pollution losses and ALAE paid during the year

47.1

48.4

21.7

26.1

19.2

52.2

13.8

27.7

9.6

75.8

7.0

45.4

Provision for pollution claims and ALAE at December 31

478.3

190.7

479.6

195.1

512.6

209.0

107

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

Following is an analysis of Fairfax’s U.S.-based subsidiaries gross and net loss and ALAE reserves
from pollution exposures at year-end 2006, 2005, and 2004 and the movement in gross and
net reserves for those years:

IIC

Provision for pollution claims and ALAE at January 1

248.5

63.5

263.0

63.7

291.2

73.0

2006

2005

2004

Gross

Net

Gross

Net

Gross

Net

Pollution losses and ALAE incurred during the year

Pollution losses and ALAE paid during the year

3.2

10.1

3.4

6.8

0.6

15.1

1.4

1.6

(8.3)

(0.6)

19.9

Provision for pollution claims and ALAE at December 31

241.6

60.1

248.5

63.5

263.0

92.6

6.6

18.0

81.2

29.9

9.7

(0.8)

40.4

C&F

Provision for pollution claims and ALAE at January 1

Pollution losses and ALAE incurred during the year

Pollution losses and ALAE paid during the year

Provision for pollution claims and ALAE at December 31

81.2

12.1

11.4

81.9

74.2

9.9

10.6

73.5

Odyssey Re(1)

Provision for pollution claims and ALAE at January 1

40.4

30.7

Pollution losses and ALAE incurred during the year

(0.6)

(0.3)

Pollution losses and ALAE paid during the year

Provision for pollution claims and ALAE at December 31

TIG

Provision for pollution claims and ALAE at January 1

Pollution losses and ALAE incurred during the year

Pollution losses and ALAE paid during the year

Provision for pollution claims and ALAE at December 31

Fairmont

Provision for pollution claims and ALAE at January 1

Pollution losses and ALAE incurred during the year

Pollution losses and ALAE paid during the year

Provision for pollution claims and ALAE at December 31

3.9

35.9

93.2

16.7

13.9

96.0

1.9

20.1

8.6

13.4

28.2

33.2

33.0

4.4

1.9

2.8

6.2

0.4

5.1

30.7

29.9

28.2

3.7

26.7

12.8

102.1

16.0

116.0

17.4

2.6

0.5

14.9

0.8

10.5

4.0

7.3

(2.2)

6.7

93.2

6.0

(3.5)

0.6

1.9

(6.6)

(3.4)

1.3

15.2

1.3

2.7

12.8

102.1

16.0

1.7

(0.3)

0.6

0.8

4.0

3.5

1.4

6.0

1.5

1.4

1.2

1.7

8.7

63.7

98.9

10.0

23.7

85.2

85.2

6.6

17.6

74.2

98.2

20.8

26.4

92.6

(1) Net  reserves  presented  for  Odyssey  Re  in  2004  and  2005  exclude  cessions  under  a  stop  loss
agreement with nSpire Re Ltd, a wholly-owned subsidiary of Fairfax. This stop loss agreement was
commuted in 2006.

As  with  asbestos  reserves,  exposure  for  pollution  cannot  be  estimated  with  traditional  loss
reserving  techniques  that  rely  on  historical  accident  year  loss  development  factors.  Because
each insured presents different liability and coverage issues, the methodology used by Fairfax’s
subsidiaries to establish pollution reserves is similar to that used for asbestos liabilities. IIC and
C&F  evaluate  the  exposure  presented  by  each  insured  and  the  anticipated  cost  of  resolution
utilizing ground-up, exposure-based analysis that constitutes industry ‘‘best practice’’ approach
for pollution reserving. As with asbestos reserving, this methodology was initially critiqued by
outside legal and actuarial consultants and the results are annually reviewed by independent
actuaries,  all  of  whom  have  consistently  found  the  methodology  comprehensive  and  the
results reasonable.

In  the  course  of  performing  these  individualized  assessments,  the  following  factors  are
considered:  the  insured’s  probable  liability  and  available  coverage,  relevant  judicial
interpretations,  the  nature  of  the  alleged  pollution  activities  of  the  insured  at  each  site,  the
number of sites, the total number of PRPs at each site, the nature of environmental harm and
the  corresponding  remedy  at  each  site,  the  ownership  and  general  use  of  each  site,  the
involvement  of  other  insurers  and  the  potential  for  other  available  coverage,  and  the

108

applicable  law  in  each  jurisdiction.  A  provision  for  IBNR  is  developed,  again  using
methodology  similar  to  that  for  asbestos  liabilities,  and  an  estimate  of  ceded  reinsurance
recoveries is calculated. At Odyssey Re, TIG, and Ranger, a bulk reserving approach is employed
based on industry benchmarks of ultimate liability to establish reserves for both reported and
unasserted claims as well as for allocated claim adjustment costs.

The following table presents the environmental pollution survival ratios on net loss and ALAE
reserves for IIC, C&F, and OdysseyRe:

Net loss and ALAE reserves
3-year average net paid loss and ALAE
3-year Survival Ratio

IIC

C&F

OdysseyRe

60.1
5.7
10.5

73.5
17.3
4.2

26.7
3.6
7.5

Other Mass Tort/Health Hazards Discussion

In  addition  to  asbestos  and  pollution,  Fairfax  faces  exposure  to  other  types  of  mass  tort  or
health hazard claims. Such claims include breast implants, pharmaceutical products, chemical
products, lead-based paint, noise-induced hearing loss, tobacco, mold, and welding fumes. As a
result of its historical underwriting proﬁle and its focus of excess liability coverage on Fortune
500  type  entities,  IIC  has  the  bulk  of  these  potential  exposures  within  Fairfax.  Presently,
management  believes  that  tobacco,  lead  paint,  and,  to  a  lesser  extent,  silica,  are  the  most
signiﬁcant health hazard exposures facing Fairfax.

Tobacco companies have not aggressively pursued insurance coverage for tobacco bodily injury
claims. One notable exception is a Delaware state court coverage action, in which the Supreme
Court  of  Delaware  held  in  favor  of  the  insurers  on  four  issues:  1)  tobacco  health  hazard
exclusions,  2)  products  hazard  exclusions,  3)  advertising  liability  and  4)  named  insured
provision. There are no active claims submitted by tobacco manufacturers to IIC. One tobacco
manufacturer and its parent company have submitted notices of tobacco-related claims to TIG.
One smokeless tobacco manufacturer has submitted notices of tobacco-related claims to C&F
and has brought a declaratory judgment action. This matter has been settled. A small number
of  notices  from  distributors/retailers  have  also  been  submitted  to  TIG  and  C&F.  In  most
instances,  these  distributors/retailers  have  reported  that  they  have  secured  indemniﬁcation
agreements from tobacco manufacturers.

Claims  against  manufacturers  related  to  tobacco  products  include  both  individual  and  class
actions alleging personal injury or wrongful death from tobacco exposure (including exposure
to  second-hand  smoke);  actions  alleging  risk  of  future  injury;  consumer  protection  actions
alleging  the  use  of  the  terms  ‘‘light’’  or  ‘‘ultra  light’’  constitutes  deceptive  and  unfair  trade
practices; health care cost recovery actions brought by governmental and non-governmental
plaintiffs  seeking  reimbursement  for  health  care  expenditures  allegedly  caused  by  cigarette
smoking, and/or disgorgement of proﬁts; and suits alleging violations of the civil RICO statute,
including  a  suit  taken  through  trial  by  the  U.S.  Department  of  Justice.  The  tobacco
manufacturers  generally  continue  to  vigorously  defend  all  claims.  We  are  aware  of  one
settlement  by  a  manufacturer  with  an  individual  smoker  for  a  bodily  injury  claim,  but  the
terms  of  the  settlement  were  not  made  public.  Although  signiﬁcant  judgments  have  been
entered against various tobacco manufacturers, with few exceptions, the judgments are under
appellate review.

Fairfax  subsidiaries  have  received  notices  of  lead  claims  from  former  lead  pigment
manufacturers.  In  addition  to  individual  actions,  governmental  actions  have  been  brought
against  the  pigment  industry  alleging  former  lead  pigment  companies  are  responsible  for
abating the presence of lead paint in buildings and for health care and educational costs for
residents  exposed  to  lead.  In  February  2006,  a  jury  in  Rhode  Island  held  that  three  pigment
manufacturers are responsible for the presence of lead paint in buildings throughout the state

109

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

and  that  they  must  abate  this  public  nuisance.  Fairfax  subsidiaries  insured  two  of  the  three
defendants and are now in coverage litigation with the two insureds. The Rhode Island court
has yet to determine what abatement will be required and has before it motions for a mistrial.
Additionally, new public nuisance suits were ﬁled by municipalities in Ohio and existing suits
are continuing in various jurisdictions, including California and New Jersey. The former lead
paint companies continue to vigorously defend these claims.

In  the  earlier  part  of  the  decade,  it  appeared  that  silica  claims  might  present  a  signiﬁcant
exposure to Fairfax. While there is still a high degree of uncertainty surrounding future costs
for  these  claims,  there  has  been  a  dramatic  decrease  in  the  rate  of  new  claim  ﬁling:  70  new
accounts in 2004, 34 in 2005, and 18 in 2006.

Two major developments in recent years have made the pursuit of silica claims more difﬁcult
for the plaintiff bar. First, in 2005, a number of doctors that were routinely used by plaintiff
attorneys  to  screen  potential  clients  for  silica  related  injuries  came  under  the  scrutiny  of  a
Texas  Federal  Court.  In  hearings  before  that  Court,  several  diagnosing  doctors  openly
disclaimed  their  prior  ﬁndings  of  silicosis  upon  questioning  by  the  judge  and  after  being
unable to explain how permanent signs of asbestosis that they diagnosed years earlier for the
same patients had now disappeared. Secondly, tort reform was enacted in Mississippi in 2004
and in Texas in 2005. Many of the silica claims ﬁled against Fairfax’s insureds are ﬁled in these
two states. The Mississippi reforms deter multi-plaintiff ﬁlings, establish strict venue rules, and
cap  punitive  and  non-economic  damages.  The  Texas  reforms  establish  objective  medical
criteria for silica cases and allow only those claimants who are actually impaired to pursue their
claims in the judicial system, while deferring the claims of those who are not impaired. They
also prevent the ‘‘bundling’’ of multiple plaintiffs for trial.

Following is an analysis of IIC’s and C&F’s gross and net reserves from health hazard exposures
at year-end 2006, 2005, and 2004 and the movement in gross and net reserves for those years:

2006

2005

2004

Gross

Net

Gross

Net

Gross

Net

IIC

Provision for health hazards claims and ALAE at January 1

71.1

28.0

94.0

30.4

115.2

33.9

Health hazards losses and ALAE incurred during the year

Health hazards losses and ALAE paid during the year

(2.4)

(1.5)

5.8

2.6

Provision for health hazards claims and ALAE at December 31

62.9

23.9

1.1

24.0

71.1

2.2

4.6

28.0

2.0

23.2

94.0

2.7

6.2

30.4

C&F

Provision for health hazards claims and ALAE at January 1

25.4

24.1

24.2

22.0

28.2

26.6

Health hazards losses and ALAE incurred during the year

Health hazards losses and ALAE paid during the year

1.3

3.8

1.3

3.6

6.5

5.3

6.5

4.4

0.0

4.0

0.0

4.7

Provision for health hazards claims and ALAE at December 31

22.9

21.8

25.4

24.1

24.2

22.0

Similar to asbestos and pollution, traditional actuarial techniques cannot be used to estimate
ultimate liability for these exposures. Some claim types were ﬁrst identiﬁed ten or more years
ago,  for  example  breast  implants  and  speciﬁc  pharmaceutical  products.  For  these  exposures,
the  reserve  estimation  methodology  at  IIC  is  similar  to  that  for  asbestos  and  pollution:  an
exposure-based  approach  based  on  all  known,  pertinent  facts  underlying  the  claim.  This
methodology  cannot  at  the  present  time  be  applied  to  other  claim  types  such  as  tobacco  or
lead paint as there are a number of signiﬁcant legal issues yet to be resolved, both with respect
to  policyholder  liability  and  the  application  of  insurance  coverage.  For  these  claim  types,  a
bulk  IBNR  reserve  is  developed  based  on  benchmarking  methods  utilizing  the  ultimate  cost
estimates of more mature health hazard claims. The bulk reserve also considers the possibility
of entirely new classes of health hazard claims emerging in the future.

110

Summary

Management  believes  that  the  APH  reserves  reported  at  December  31,  2006  are  reasonable
estimates of the ultimate remaining liability for these claims based on facts currently known,
the  present  state  of  the  law  and  coverage  litigation,  current  assumptions,  and  the  reserving
methodologies employed. These APH reserves are continually monitored by management and
reviewed extensively by independent consulting actuaries. New reserving methodologies and
developments will continue to be evaluated as they arise in order to supplement the ongoing
analysis  and  reviews  of  the  APH  exposures.  However,  to  the  extent  that  future  social,
economic,  legal,  or  legislative  developments  alter  the  volume  of  claims,  the  liabilities  of
policyholders or the original intent of the policies and scope of coverage, particularly as they
relate  to  asbestos  and  pollution  claims,  additional  increases  in  loss  reserves  may  emerge  in
future periods.

Reinsurance Recoverables

Fairfax’s  subsidiaries  purchase  certain  reinsurance  so  as  to  reduce  their  liability  on  the
insurance and reinsurance risks which they write. Fairfax strives to minimize the credit risk of
purchasing  reinsurance  through  adherence  to  its  internal  reinsurance  guidelines.  To  be  an
ongoing reinsurer of Fairfax, generally a company must have high A.M. Best and/or Standard &
Poor’s  ratings  and  maintain  capital  and  surplus  exceeding  $500.  Most  of  the  reinsurance
balances for reinsurers rated B++ and lower or which are not rated were inherited by Fairfax on
acquisition of a subsidiary.

Recoverable from reinsurers on the consolidated balance sheet ($5,506.5 in 2006) consists of
future  recoverables  on  unpaid  claims  ($4.9  billion),  reinsurance  receivable  on  paid  losses
($395.4)  and  unearned  premiums  from  reinsurers  ($230.7).  This  $4.9  billion  of  future
recoverables from reinsurers on unpaid claims at December 31, 2006 declined by $2.0 billion
during 2006 from $6.9 billion at December 31, 2005. The decline is primarily attributable to
the commutation of the Swiss Re corporate insurance cover ($1.0 billion), collections on paid
claims related to ceded 2005 hurricane losses and continued collections and commutations by
the company’s runoff units.

The  following  table  presents  Fairfax’s  top  50  reinsurance  groups  (based  on  gross  reinsurance
recoverable  net  of  speciﬁc  provisions  for  uncollectible  reinsurance)  at  December  31,  2006.
These 50 reinsurance groups represent 83.9% of Fairfax’s total reinsurance recoverable. In the
following table and the other tables in this section, reinsurance recoverables are reported net of
intercompany reinsurance.

Group

Principal Reinsurer

Swiss Re
Munich
Lloyd’s
Nationwide
Aegon
Berkshire Hathaway
HDI
AIG
Ace
Everest
St. Paul Travelers
Paris Re
Global Re
Chubb
SCOR
Arch Capital

Swiss Re America Corp
Munich Re America
Lloyd’s of London Underwriters
Nationwide Mutual Ins Co.
Arc Re
General Reinsurance Corp.
Hannover Rueckversicherung
Transatlantic Re
Insurance Co. of North America
Everest Reinsurance Co.
Travelers Indemnity Co.
AXA Reinsurance Co.
Global International Reinsurance Co.
Federal Insurance Co.
Scor Canada Reinsurance Co.
Arch Reinsurance Ltd.

Net
Reinsurance
A.M. Best
Rating(1) Recoverable(2) Recoverable(3)

Gross
Reinsurance

A+
A
A
A+
(4)
A++
A
A+
A+
A+
A+
A
NR
A++
A–
A

1,161.0
736.7
338.8
271.1
214.1
191.7
184.9
152.7
126.8
111.6
99.7
92.6
87.4
83.8
82.8
82.4

779.8
325.1
284.7
271.1
13.8
177.0
131.1
123.0
122.6
103.1
84.4
63.8
36.7
54.9
73.8
15.3

111

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

Group

Principal Reinsurer

Net
A.M. Best
Reinsurance
Rating(1) Recoverable(2) Recoverable(3)

Gross
Reinsurance

PartnerRe
CNA
White Mountains
XL
Hartford
Allstate
AXA
Manulife
Platinum
Folksam
Liberty Mutual
Aioi
Zurich
Toa Re
American Financial
QBE
Duke’s Place
FM Global
Allianz
WR Berkley
Axis
PMA
Randall & Quilter
CCR
KKR
Brit
Castlewood
Wustenrot
PXRE
Aviva
Converium
Markel

Royal & Sun Alliance
Validus
Other reinsurers

Partner Reinsurance Co. of US
Continental Casualty
Folksamerica Reinsurance Co.
XL Reinsurance America Inc
New England Re
Allstate Insurance Co.
AXA Belgium
John Hancock Life Ins. Co.
Platinum Underwriters Reinsurance Co.
Aterforskrings AB LUAP
Liberty Mutual Ins Co.
Aioi Insurance Co. Ltd.
Zurich Specialties London Ltd.
Toa Reinsurance Co. America
Great American Assurance Co.
QBE Reinsurance Corp
Seaton Insurance Co.
Factory Mutual Insurance Co.
Allianz Cornhill Insurance Plc.
Berkley Insurance Co.
Axis Reinsurance Co.
PMA Capital Insurance Co.
R&Q Reins Co.
Caisse Centrale de Reassurance
Alea North America Insurance Co.
Brit Insurance Ltd.
Harper Insurance Ltd UKB
Wuerttembergische Versicherung
PXRE Reinsurance Co.
CGU Int’l Ins Co. Plc
Converium AG.
Markel International Insurance
Company Ltd.
Security Ins Co. of Hartford
Validus Reinsurance Ltd

Total reinsurance recoverable
Provisions for uncollectible reinsurance

Total reinsurance recoverable after provisions for uncollectible

reinsurance

(1) Of principal reinsurer (or, if principal reinsurer is not rated, of group)

(2) Before speciﬁc provisions for uncollectible reinsurance

A+
A
A–
A+
A+
A+
NR
A++
A
NA
A
A
NR
A
A
A
NR
A+
A+
A
A
B+
NR
A+
NR
A
NR
NR
NR
A+
B++

A–
C++
A–

77.0
73.3
62.8
57.0
43.7
40.0
39.7
39.1
34.6
34.4
33.6
32.0
29.5
24.8
24.2
22.8
20.9
20.8
20.1
19.3
19.1
18.9
18.5
18.0
17.5
17.4
16.5
14.9
14.2
13.5
12.9

58.6
62.1
48.1
47.8
42.5
40.1
36.6
30.4
23.2
26.6
32.9
16.2
17.2
19.9
24.9
17.8
20.2
20.6
8.3
18.7
13.1
17.9
18.6
14.1
14.3
15.2
13.9
12.5
5.0
12.5
1.6

12.6
11.3
11.1
954.7

5,938.8
432.3

11.3
11.1
0.3
835.2

4,269.5
432.3

5,506.5

3,837.2

(3) Net of outstanding balances for which security is held, but before speciﬁc provisions for uncollectible reinsurance

(4) Aegon is rated A+ by S&P; ARC Re is not rated

112

The  following  table  presents  the  classiﬁcation  of  the  $5,506.5  gross  reinsurance  recoverable
shown  above  by  credit  rating  of  the  responsible  reinsurers.  Pools  &  associations,  shown
separately, are generally government or similar insurance funds carrying limited credit risk.

Consolidated Reinsurance Recoverables

A.M. Best
Rating
(or S&P
 equivalent)

Gross
Reinsurance
Recoverable

A++

A+

A

A–

B++

B+

B

Lower than B

Not rated

Pools &

294.8

2,035.9

2,013.0

260.7

72.4

68.4

9.0

113.2

945.2

Outstanding
Balances
for which

Speciﬁc
Provisions
for

Net
Unsecured
Security Uncollectible Reinsurance
Reinsurance Recoverable

is Held

49.6

433.0

745.7

56.6

20.7

7.6

(0.2)

3.5

350.9

0.6

4.7

2.6

1.2

0.5

1.3

0.2

83.1

245.8

244.6

1,598.2

1,264.7

202.9

51.2

59.5

9.0

26.6

348.5

associations

126.2

1.9

–

124.3

5,938.8

1,669.3

340.0

3,929.5

Provisions for uncollectible

reinsurance

 – speciﬁc

 – general

Net reinsurance recoverable

340.0

92.3

5,506.5

To support gross reinsurance recoverable balances, Fairfax has the beneﬁt of letters of credit,
trust funds or offsetting balances payable totalling $1,669.3 as follows:

for  reinsurers  rated  A–  or  better,  Fairfax  has  security  of  $1,284.9  against  outstanding

reinsurance recoverable of $4,604.4;

for  reinsurers  rated  B++  or  lower,  Fairfax  has  security  of  $31.6  against  outstanding

reinsurance recoverable of $263.0; and

for  unrated  reinsurers,  Fairfax  has  security  of  $350.9  against  outstanding  reinsurance

recoverable of $945.2.

Lloyd’s  is  also  required  to  maintain  funds  in  Canada  and  the  United  States  which  are
monitored by the applicable regulatory authorities.

As  shown  above,  excluding  pools  &  associations,  Fairfax  has  gross  outstanding  reinsurance
balances  for  reinsurers  which  are  rated  B++  or  lower  or  which  are  unrated  of  $1,208.2  (as
compared to $1,470.6 at December 31, 2005), for which it holds security of $382.5 and has an
aggregate provision for uncollectible reinsurance of $423.2 (51.3% of the net exposure prior to
such provision, as compared to 40.1% in 2005), leaving a net exposure of $402.5 (as compared
to $619.4 in 2005).

113

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

The  two  following  tables  break  out  the  consolidated  reinsurance  recoverables  for  operating
companies  and  runoff  operations.  As  shown  in  those  tables,  approximately  44.6%  of  the
consolidated reinsurance recoverables relate to runoff operations.

Reinsurance Recoverables – Operating Companies

Outstanding
Balances
for which

Speciﬁc
Provisions
for

Net
Unsecured
Security Uncollectible Reinsurance
Reinsurance Recoverable

is Held

A.M. Best
Rating
(or S&P
equivalent)

Gross
Reinsurance
Recoverable

A++

A+

A

A-

B++

B+

B

Lower than B

Not rated

Pools &

182.5

1,185.5

1,261.3

176.8

39.3

34.5

2.8

29.3

210.6

50.0

399.4

612.9

49.9

17.1

6.6

0.1

1.5

54.5

0.6

4.1

2.1

0.1

0.3

0.6

–

6.7

49.3

–

63.8

131.9

782.0

646.3

126.8

21.9

27.3

2.7

21.1

106.8

20.2

1,887.0

associations

23.0

2.8

3,145.6

1,194.8

Provisions for uncollectible

reinsurance

 – speciﬁc

 – general

Net reinsurance recoverable

63.8

31.3

3,050.5

As  shown  above,  excluding  pools  &  associations,  Fairfax’s  insurance  and  reinsurance
operations have gross outstanding reinsurance balances for reinsurers which are rated B++ or
lower  or  which  are  unrated  of  $316.5,  for  which  they  hold  security  of  $79.8  and  have  an
aggregate provision for uncollectible reinsurance of $88.2 (37.3% of the net exposure prior to
such provision), leaving a net exposure of $148.5.

114

Reinsurance Recoverables – Runoff Operations

Outstanding
Balances
for
which

Speciﬁc
Provisions
for

Net
Unsecured
Security Uncollectible Reinsurance
Reinsurance Recoverable

is Held

(0.4)
33.6
132.8
6.7
3.6
1.0
(0.3)
2.0
296.4

(0.9)

474.5

–
0.6
0.5
1.1
0.2
0.7
0.2
76.4
196.5

112.7
816.2
618.4
76.1
29.3
32.2
6.3
5.5
241.7

–

104.1

276.2

2,042.5

A.M. Best
Rating
(or S&P
equivalent)

A++
A+
A
A-
B++
B+
B
Lower than B
Not rated
Pools &
associations

Gross
Reinsurance
Recoverable

112.3
850.4
751.7
83.9
33.1
33.9
6.2
83.9
734.6

103.2

2,793.2

276.2
61.0

2,456.0

Provisions for uncollectible

reinsurance
 – speciﬁc
 – general

Net reinsurance recoverable

As  shown  above,  excluding  pools  &  associations,  Fairfax’s  runoff  operations  have  gross
outstanding  reinsurance  balances  for  reinsurers  which  are  rated  B++  or  lower  or  which  are
unrated of $891.7, for which they hold security of $302.7 and have an aggregate provision for
uncollectible  reinsurance  of  $335.0  (56.9%  of  the  net  exposure  prior  to  such  provision),
leaving a net exposure of $254.0.

Based on the results of the above analysis of Fairfax’s reinsurance recoverable and on the credit
risk analysis performed by RiverStone as described in the next paragraph, Fairfax believes that
its  provision  for  uncollectible  reinsurance  provides  for  all  likely  losses  arising  from
uncollectible reinsurance at December 31, 2006.

RiverStone, with its dedicated specialized personnel and expertise in analyzing and managing
credit  risk,  is  responsible  for  the  following  with  respect  to  recoverables  from  reinsurers:
evaluating  the  creditworthiness  of  all  reinsurers  and  recommending  to  the  group
management’s reinsurance committee those reinsurers which should be included on the list of
approved reinsurers; on a quarterly basis, monitoring reinsurance recoverable by reinsurer and
by  company,  in  aggregate,  and  recommending  the  appropriate  provision  for  uncollectible
reinsurance; and pursuing collections from, and global commutations with, reinsurers which
are either impaired or considered to be ﬁnancially challenged.

For the last three years, Fairfax has had reinsurance bad debts of $46.5 for 2006, $51.1 for 2005
and $62.8 for 2004.

Float

Fairfax’s ﬂoat is the sum of its loss reserves, including loss adjustment expense reserves, and
unearned  premium  reserves,  less  accounts  receivable,  reinsurance  recoverables  and  deferred
premium  acquisition  costs.  This  ﬂoat  arises  because  an  insurance  or  reinsurance  business
receives premiums in advance of the payment of claims.

115

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

The  table  below  shows  the  ﬂoat  that  Fairfax’s  insurance  and  reinsurance  operations  have
generated and the cost of that ﬂoat. As the table shows, the average ﬂoat increased 13.9% in
2006 to $7.5 billion, at no cost.

Underwriting
proﬁt (loss)

Average ﬂoat

Beneﬁt
(Cost)
of ﬂoat

Average long
term Canada
treasury bond
yield

2.5

21.6

11.6%

Year

1986
↕

9.6%

5.7%
5.4%
5.2%
4.4%
4.3%
5.5%

2002
2003
2004
2005
2006
Weighted average since inception
Fairfax weighted average ﬁnancing differential since inception: 2.0%

4,402.0
4,443.2
5,371.4
6,615.7
7,533.4

(31.9)
95.1
134.8
(333.9)
198.2

(0.7%)
2.1%
2.5%
(5.0%)
2.6%
(3.5%)

The table below shows the breakdown of total year-end ﬂoat for the past ﬁve years.

Canadian
Insurance

U.S.
Insurance

811.7
1,021.1
1,404.2
1,461.8
1,586.0

1,552.6
1,546.9
1,657.1
1,884.9
1,853.8

2002
2003
2004
2005
2006

Asian

Total
Insurance
and

Insurance Reinsurance Reinsurance Runoff

Total

59.2
88.0
119.7
120.2
85.4

1,770.2
2,036.7
2,869.0
3,714.4
4,360.2

5,975.5
4,193.7 1,781.8
6,598.1
4,692.7 1,905.4
7,421.0
6,050.0 1,371.0
7,181.3 1,575.3
8,756.6
7,885.4 2,633.4 10,518.8

In 2006, the Canadian insurance ﬂoat increased by 8.5%, the U.S. insurance ﬂoat decreased by
1.6%, the Asian insurance ﬂoat decreased by 29.0% (largely due to an increase in reinsurance
recoverables)  and  the  reinsurance  ﬂoat  increased  by  17.4%,  all  at  no  cost.  The  runoff  ﬂoat
increased  by  67.2%,  due  primarily  to  the  signiﬁcant  impact  of  the  Swiss  Re  and  Ridge  Re
reinsurance commutations. In the aggregate, total ﬂoat increased by 20.1% to $10.5 billion at
the end of 2006.

Insurance Environment

The  property  and  casualty  insurance  and  reinsurance  industry  reported  improved  core
underwriting proﬁtability in 2006 in the absence of the extreme catastrophe losses experienced
in  2005  and  2004.  Combined  ratios  in  2006  for  Canada,  for  U.S.  commercial  lines  and  for
U.S.  reinsurers  are  expected  to  be  approximately  92.2%,  91.3%  and  93.6%,  respectively.
Despite  the  general  and  widespread  softening  observed  in  recent  years  affecting  rates  other
than for certain catastrophe-exposed property business, insurers continue to beneﬁt from the
compounding effect of annual rate increases that began in 2002, notwithstanding the partially
offsetting  subsequent  decline  in  rates  affecting  certain  lines  of  business  in  recent  years.  The
unprecedented 2005 hurricane losses temporarily stabilized rates in general, with catastrophe-
exposed property rates increasing sharply, but buoyant industry results for 2006, as evidenced
by  improved  underwriting  proﬁtability,  favourable  reserve  development,  improved  net
earnings and resulting increased industry capital, are expected to generate a more competitive
industry  in  2007,  featuring  increased  availability  of  primary  insurance  and  reinsurance
capacity and more competitive rates, terms and conditions in the marketplace.

116

Investments

The  majority  of  interest  and  dividend  income  is  earned  by  the  insurance,  reinsurance  and
runoff companies. Interest and dividend income earned on holding company cash, short term
investments and marketable securities was to $23.9 in 2006 (2005 – 26.9, 2004 – 6.1).

Interest and dividend income in Fairfax’s ﬁrst year and for the past eight years (the period since
Fairfax’s last signiﬁcant acquisition) is presented in the following table.

Interest and Dividend Income

Average
Investments at
Carrying Value

Amount

46.3

3.4

Pre-Tax

Yield
(%)

7.34

Per Share

Amount

0.70

1.8

10,020.3
11,291.5
10,264.3
10,377.9
11,527.5
12,955.8(1)
14,142.5(1)
15,827.0(1)

532.7
534.0
436.9
436.1
331.9
375.7
466.1
746.5

5.32
4.73
4.26
4.20
2.88
2.90
3.30
4.72

39.96
40.54
33.00
30.53
23.78
27.17
28.34
42.03

348.0
377.6
297.1
292.2
215.8
244.3
303.0
485.3

After Tax

Yield
(%)

3.89

3.47
3.34
2.89
2.82
1.87
1.89
2.14
3.07

Per Share

0.38

26.10
28.66
22.44
20.46
15.46
17.66
18.42
27.32

1986
↕
1999
2000
2001
2002
2003
2004
2005
2006

(1) Excludes  $783.3  (2005  –  $700.3;  2004  –  $539.5)  of  cash  and  short  term  investments  arising

from the company’s economic hedges against a decline in the equity markets.

Funds  withheld  payable  to  reinsurers  shown  on  the  consolidated  balance  sheet  ($370.0  in
2006) represents premiums and accumulated accrued interest (at an average interest crediting
rate of approximately 7% per annum) on aggregate stop loss reinsurance treaties, principally
relating to Crum & Forster ($243.3) and OdysseyRe ($96.9). In 2006, $40.0 of interest expense
accrued to reinsurers on funds withheld (including interest on funds withheld related to the
Swiss  Re  corporate  insurance  cover  until  its  commutation);  the  company’s  total  interest  and
dividend income of $746.5 in 2006 was net of this interest expense. Claims payable under such
treaties are paid ﬁrst out of the funds withheld balances.

Interest  and  dividend  income  increased  in  2006  primarily  due  to  higher  short  term  interest
rates  and  increased  investment  portfolios  in  2006,  as  well  as  the  negative  impact  on  2005
interest and dividends of the company’s equity-accounted share of Advent’s 2005 hurricane-
affected $45.1 loss. The gross portfolio yield, before interest on funds withheld of $40.0, was
4.97% for 2006 compared to the 2005 gross portfolio yield, before interest on funds withheld
of $79.6, of 3.86%. The pre-tax interest and dividend income yield achieved by the company’s
investment managers increased to 4.72% in 2006 from 3.30% in 2005, while the after-tax yield
increased  to  3.07%  in  2006  from  2.14%  in  2005.  The  increased  yields  were  primarily
attributable  to  the  impact  of  higher  interest  rates  as  three-month  U.S.  treasury  bill  yields
averaged approximately 4.83% in 2006 compared to approximately 3.20% in 2005. Since 1985,
pre-tax interest and dividend income per share has compounded at a rate of 22.7% per year.

117

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

Investments (including at the holding company) in Fairfax’s ﬁrst year and since 1999, at their
year-end carrying values, are presented in the following table.

Cash and
Short Term
Investments

6.4

1,766.9
1,663.0
1,931.3
2,033.2
6,120.8
4,075.0(1)
4,385.0(1)
5,416.1(1)

Bonds

14.1

9,165.9
7,825.5
7,357.3
7,390.6
4,705.2
7,260.9
8,127.4
8,944.0

Preferred
Stocks

Common
Stocks

Real
Estate

1.0

2.5

–

Total

24.0

Per Share

4.80

92.3
46.7
79.4
160.1
142.3
135.8
15.8
16.4

1,209.0
813.6
811.7
992.1
1,510.7
1,960.9
2,324.0
2,425.2

55.6
50.9
49.1
20.5
12.2
28.0
17.2
18.0

12,289.7
10,399.6
10,228.8
10,596.5
12,491.2
13,460.6(1)
14,869.4(1)
16,819.7(1)

915.35
793.81
712.76
753.90
901.35
840.80(1)
835.11(1)
948.62(1)

1985
↕
1999
2000
2001
2002
2003
2004
2005
2006

(1) Excludes  $783.3  (2005 –  $700.3;  2004 –  $539.5)  of  cash  and  short  term  investments  arising

from the company’s economic hedges against a decline in the equity markets.

Total investments and total investments per share increased at year-end 2006 primarily due to
strong  operating  cash  ﬂows  at  the  insurance  and  reinsurance  companies  and  increased
collections  and  commutations  of  reinsurance  recoverable  balances.  Since  1985,  investments
per share have compounded at a rate of 28.6% per year.

Management  performs  its  own  fundamental  analysis  of  each  proposed  investment,  and
subsequent to investing, reviews at least quarterly the carrying value of each investment whose
market value has been consistently below its carrying value for some time, to assess whether a
provision for other than temporary decline is appropriate. In making this assessment, careful
analysis  is  made  comparing  the  intrinsic  value  of  the  investment  as  initially  assessed  to  the
current  intrinsic  value  based  on  current  outlook  and  all  other  relevant  investment  criteria.
Other considerations in this assessment include the length of time the investment has been
held, the difference between carrying value and market value and the company’s intent with
respect to continuing to hold the investment.

Various  investments  are  pledged  by  the  company’s  subsidiaries  in  the  ordinary  course  of
carrying on their business. These pledges are referred to in note 4 to the consolidated ﬁnancial
statements and are explained in more detail under the heading Provision for Claims. As noted
there,  these  pledges  do  not  involve  any  cross-collateralization  by  one  group  company  of
another group company’s obligations.

The breakdown of the bond portfolio as at December 31, 2006 was as follows (where S&P or
Moody’s credit ratings are available, the higher one is used if they differ):

Credit
Rating

AAA
AA
A
BBB
BB
B
Lower than B and unrated
Credit default swaps
Bond warrants

Total

Carrying
Value

7,434.7
1,047.1
1.4
122.5
10.0
12.3
240.3
54.9
20.8

Market
Value

7,206.0
1,107.6
1.4
123.3
10.0
12.6
274.8
54.9
20.8

8,944.0

8,811.4

Unrealized
Gain (Loss)

(228.7)
60.5
–
0.8
–
0.3
34.5
–
–

(132.6)

118

At  December  31,  2006,  96.2%  of  the  ﬁxed  income  portfolio  at  carrying  value  was  rated
investment grade, with 94.8% (primarily consisting of government obligations) being rated AA
or better.

Subsidiary  portfolio  investments  include $54.9  (at  market;  original  cost  $245.9)  in  5-year  to
7-year  credit  default  swaps  (with  a  remaining  average  life  of  approximately  four  years)
referenced  to  a  number  of  companies,  primarily  ﬁnancial  institutions,  to  provide  protection
against systemic ﬁnancial risk arising from ﬁnancial difﬁculties these entities could experience
in  a  more  difﬁcult  ﬁnancial  environment.  Included  in  cash,  short  term  investments  and
marketable securities the company holds an additional $16.5 (at market; original cost $29.7) in
credit default swaps.

Interest Rate Risk

The company’s ﬁxed income securities portfolio is exposed to interest rate risk. Fluctuations in
interest rates have a direct impact on the market valuation of these securities. As interest rates
rise, market values of ﬁxed income securities portfolios fall and vice versa.

The table below displays the potential impact of market value ﬂuctuations on the ﬁxed income
securities  portfolio  as  at  December  31,  2006  and  December  31,  2005,  based  on  parallel  200
basis point shifts in interest rates up and down, in 100 basis point increments. This analysis
was performed by individual security.

As at December 31, 2006

As at December 31, 2005

Fair
Value of
Fixed

Fair
Value of
Fixed

Change in Interest Rates

200 basis point rise
100 basis point rise
No change
100 basis point decline
200 basis point decline

Income Hypothetical Hypothetical
% Change
$ Change

Portfolio

Income Hypothetical Hypothetical
% Change
$ Change

Portfolio

7,440.6
8,051.4
8,811.4
9,767.5
10,904.8

(1,370.8)
(760.0)
–
956.1
2,093.4

(15.6)
(8.6)
–
10.9
23.8

6,583.4
7,242.6
8,038.4
9,099.5
10,361.5

(1,455.0)
(795.8)
–
1,061.1
2,323.1

(18.1)
(9.9)
–
13.2
28.9

The preceding table indicates an asymmetric market value response to equivalent basis point
shifts  up  and  down  in  interest  rates.  This  partly  reﬂects  exposure  to  ﬁxed  income  securities
containing a put feature. In total these securities represent approximately 13.9% and 15.2% of
the  fair  market  value  of  the  total  ﬁxed  income  portfolio  as  at  December  31,  2006  and
December 31, 2005, respectively. The asymmetric market value response reﬂects the company’s
ability  to  put  these  bonds  back  to  the  issuer  for  early  redemption  in  a  rising  interest  rate
environment (thereby limiting market value loss) or to hold these bonds to their longer full
maturity  dates  in  a  declining  interest  rate  environment  (thereby  maximizing  the  beneﬁt  of
higher market values in that environment). The company also has warrants to purchase long
term bonds with a notional par value of $162.0, which would allow it to beneﬁt from declining
interest rates.

Disclosure about Limitations of Interest Rate Sensitivity Analysis
Computations  of  the  prospective  effects  of  hypothetical  interest  rate  changes  are  based  on
numerous assumptions, including the maintenance of the existing level and composition of
ﬁxed income security assets, and should not be relied on as indicative of future results.

Certain shortcomings are inherent in the method of analysis presented in the computation of
the fair value of ﬁxed rate instruments. Actual values may differ from the projections presented
should market conditions vary from assumptions used in the calculation of the fair value of

119

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

individual securities; such variations include non-parallel shifts in the term structure of interest
rates and a change in individual issuer credit spreads.

Return on the Investment Portfolio

The following table shows the performance of the investment portfolio in Fairfax’s ﬁrst year
and  for  the  past  eight  years  (the  period  since  Fairfax’s  last  signiﬁcant  acquisition).  The  total
return includes all interest and dividend income, gains (losses) on the disposal of securities and
the change in the unrealized gains (losses) during the year.

Realized

Realized Gains

Interest
Average
Investments
and
at Carrying Dividends

Gains Change in
(Losses) Unrealized
Gains
(Losses)

after
 Earned Provisions

Value

Total Return
on Average
Investments
(%)

% of

% of
Interest and
Average Dividends and
Investments Realized Gains
(%)

(%)

1986
↕

1999
2000
2001
2002
2003
2004
2005
2006

46.3

3.4

0.7

(0.2)

3.9

8.4

10,020.3
11,291.5
10,264.3
10,377.9
11,527.5
12,955.8(1)
14,142.5(1)
15,827.0(1)

532.7
534.0
436.9
436.1
331.9
375.7
466.1
746.5

63.8
259.1
121.0
465.0
826.1
300.5(2)
385.7
789.4(3)

(871.4)
584.1
194.0
263.2
142.4
165.6
73.0
(247.8)

(274.9)
1,377.2
751.9
1,164.3
1,300.4
841.8
924.8
1,288.1

(2.7)
12.2
7.3
11.2
11.3
6.5
6.5
8.1

1.5

0.6
2.3
1.2
4.5
7.2
2.3
2.7
5.0

17.1

10.7
32.7
21.7
51.6
71.3
44.4
45.3
51.4

Cumulative from inception

4,671.7

3,887.8

9.3%(4)

3.8%(4)

45.4%

(1) Excludes $783.3 (2005 – $700.3; 2004 – $539.5) of cash and short term investments arising from

the company’s economic hedges against a decline in the equity markets.

(2) Excludes  the  $40.1  realized  gain  on  the  company’s  secondary  offering  of  Northbridge  and  the
$27.0 realized loss in connection with the company’s repurchase of outstanding debt at a premium
to par.

(3) Excludes  the  $69.7  realized  gain  on  the  company’s  secondary  offering  of  OdysseyRe,  the  $15.7
realized loss in connection with the company’s repurchase of outstanding debt at a premium to par
and  the  $8.1  dilution  loss  on  conversions  during  2006  of  the  OdysseyRe  convertible  senior
debenture.

(4) Simple average of the total return on average investments, or percentage of average investments, in

each of the 21 years.

Investment  gains  have  been  an  important  component  of  Fairfax’s  net  earnings  since  1985,
amounting to a net aggregate of $3,887.8. The amount has ﬂuctuated signiﬁcantly from period
to period: the amount of investment gains (losses) for any period has no predictive value and
variations in amount from period to period have no practical analytical value. Since 1985, net
realized  gains  have  averaged  3.8%  of  Fairfax’s  average  investment  portfolio  and  have
accounted  for  45.4%  of  Fairfax’s  combined  interest  and  dividends  and  net  realized  gains.  At
December  31,  2006  the  Fairfax  investment  portfolio  had  a  net  unrealized  gain  of  $310.6
(consisting of unrealized losses on bonds of $132.6 offset by unrealized gains on equities and
other of $443.2), a decrease of $247.8 (after realizing net gains of $789.4) from net unrealized
gains of $558.4 at December 31, 2005.

The company has a long term value-oriented investment philosophy. It continues to expect
ﬂuctuations in the stock market.

120

Capital Resources

At  December  31,  2006,  total  capital,  comprising  shareholders’  equity  and  non-controlling
interests, was $4,149.8, compared to $3,395.6 at December 31, 2005.

The company manages its capital based on the following ﬁnancial measurements and ratios:

Cash, short term investments and

marketable securities

767.4

559.0

566.8

410.2

327.7

2006

2005

2004

2003

2002

Holding company debt
Subsidiary debt
Purchase consideration payable
RHINOS due February 2003
Trust preferred securities of subsidiaries

1,202.6
981.3
179.2
–
17.9

1,365.3
933.2
192.1
–
52.4

1,422.9
862.2
195.2
–
52.4

1,307.1
783.8
200.6
–
79.8

1,206.0
303.2
205.5
136.0
79.8

Total debt

2,381.0

2,543.0

2,532.7

2,371.3

1,930.5

Net debt
Common shareholders’ equity
Preferred equity
Non-controlling interests

Total equity and non-controlling

interests

Net debt/equity and non-controlling

interests

Net debt/net total capital
Total debt/total capital
Interest coverage

1,613.6
2,720.3
136.6
1,292.9

1,984.0
2,507.6
136.6
751.4

1,965.9
2,665.1
136.6
579.5

1,961.1
2,327.3
136.6
432.0

1,602.8
1,760.4
136.6
315.8

4,149.8

3,395.6

3,381.2

2,895.9

2,212.8

38.9%
28.0%
36.5%
5.2x

58.4%
36.9%
42.8%
N/A

58.1%
36.8%
42.8%
2.6x

67.7%
40.4%
45.0%
4.5x

72.4%
42.0%
46.6%
5.1x

At  December  31,  2006,  Fairfax  had  $767.4  of  cash,  short  term  investments  and  marketable
securities at the holding company level. Net debt decreased to $1,613.6 at December 31, 2006
from $1,984.0 at December 31, 2005, and the above-noted leverage ratios improved primarily
due to 2006 net earnings, proceeds received on the secondary offering of OdysseyRe common
shares (which increased cash and the OdysseyRe non-controlling interest), the repayment of
Fairfax senior notes upon maturity and other opportunistic debt repurchases during the year.
This improvement was somewhat offset by $48.1 in net additional subsidiary debt, primarily
resulting from $44.0 of net additional long term debt issued by OdysseyRe.

Non-controlling interests increased in 2006 due primarily to the company’s secondary offering
of  OdysseyRe  common  shares  and  the  non-controlling  interest  share  of  Northbridge’s  and
OdysseyRe’s net earnings for the year.

Fairfax’s  common  shareholders’  equity  (excluding  other  paid  in  capital)  increased  from
$2,448.2 at December 31, 2005 to $2,662.4 at December 31, 2006, principally as a result of the
net  earnings  for  the  year.  Holding  company  liquidity  strengthened,  while  total  holding
company  debt  decreased  by  $210.1  during  2006  and  its  debt  maturity  proﬁle  remained
unchanged, with no signiﬁcant debt maturities until 2012.

121

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

The company has issued and repurchased common shares over the last ﬁve years as follows:

Date

2002 – repurchase of shares
2003 – repurchase of shares
2004 – issue of shares
2004 – repurchase of shares
2005 – issue of shares
2005 – repurchase of shares
2006 – repurchase of shares

Number of
subordinate
voting shares

Average
issue/repurchase
price per share

Net proceeds/
(repurchase cost)

(210,200)
(240,700)
2,406,741
(215,200)
1,843,318
(49,800)
(67,800)

79.32
127.13
124.65
146.38
162.75
148.59
113.57

(16.7)
(30.6)
299.7
(31.5)
299.8
(7.4)
(7.7)

Fairfax’s  indirect  ownership  of  its  own  shares  through  The  Sixty  Two  Investment  Company
Limited results in an effective reduction of shares outstanding by 799,230, and this reduction
has been reﬂected in the earnings per share and book value per share ﬁgures.

A common measure of capital adequacy in the property and casualty industry is the premiums
to  surplus  (or  common  shareholders’  equity)  ratio.  This  is  shown  for  the  insurance  and
reinsurance subsidiaries of Fairfax for the past ﬁve years in the following table:

Insurance

Northbridge (Canada)
Crum & Forster (U.S.)
Fairmont (U.S.)(1)
Fairfax Asia(2)
Reinsurance
OdysseyRe

Canadian insurance industry
U.S. insurance industry

Net Premiums Written to Surplus
(Common Shareholders’ Equity)

2006

2005

2004

2003

2002

1.0
1.0
n/a
0.4

1.1

1.0
0.9

1.1
0.9
0.9
0.5

1.5

1.1
1.0

1.3
0.9
1.0
0.6

1.6

1.2
1.1

1.5
0.8
1.5
2.2

1.7

1.6
1.2

1.5
0.7
1.1
2.1

1.6

1.4
1.3

(1) Fairmont  in  2003,  2004  and  2005;  only  Ranger  in  2002.  Fairmont  was  included  in  Crum  &

Forster in 2006.

(2) Fairfax Asia since 2004, only Falcon for prior years.

In Canada, property and casualty companies are regulated by the Ofﬁce of the Superintendent
of Financial Institutions on the basis of a minimum supervisory target of 150% of a minimum
capital test (MCT) formula. At December 31, 2006, Northbridge’s subsidiaries had a weighted
average MCT ratio of 250% of the minimum statutory capital required, compared to 237% at
December 31, 2005, well in excess of the 150% minimum supervisory target.

In  the  U.S.,  the  National  Association  of  Insurance  Commissioners  (NAIC)  has  developed  a
model law and risk-based capital (RBC) formula designed to help regulators identify property
and casualty insurers that may be inadequately capitalized. Under the NAIC’s requirements, an
insurer  must  maintain  total  capital  and  surplus  above  a  calculated  threshold  or  face  varying
levels of regulatory action. The threshold is based on a formula that attempts to quantify the
risk of a company’s insurance, investment and other business activities. At December 31, 2006,
the U.S. insurance, reinsurance and runoff subsidiaries had capital and surplus in excess of the
regulatory minimum requirement of two times the authorized control level – each subsidiary
had capital and surplus in excess of 4.1 times the authorized control level, except for TIG (2.6
times). As part of the TIG reorganization described in the Runoff and Other section, Fairfax has
guaranteed that TIG will have capital and surplus of at least two times the authorized control
level at each year-end.

122

Fairfax  and  its  insurance  and  reinsurance  subsidiaries  are  rated  as  follows  by  the  respective
rating agencies:

Fairfax
Commonwealth
Crum & Forster
Falcon
Federated
Lombard
Markel
OdysseyRe

Liquidity

A.M. Best

Standard
& Poor’s Moody’s

bb+
A–
A–
–
A–
A–
A–
A

BB
BBB
BBB
A–
BBB
BBB
BBB
A–

Ba3
–
Baa3
–
–
–
–
A3

DBRS

BB (high)
–
–
–
–
–
–
–

The  purpose  of  liquidity  management  is  to  ensure  that  there  is  sufﬁcient  cash  to  meet  all
ﬁnancial commitments and obligations as they fall due.

The company believes that its cash position, short term investments and marketable securities
provide  adequate  liquidity  to  meet  all  of  the  company’s  obligations  in  2007.  Besides  these
holding company resources, the holding company expects to continue to receive management
fees,  investment  income  on  its  holdings  of  cash,  short  term  investments  and  marketable
securities, tax sharing payments and dividends from its insurance and reinsurance subsidiaries.
Tax  sharing  payments  received  in  2007  may  decline  due  to  the  2006  deconsolidation  of
OdysseyRe from the U.S. consolidated tax group. For 2007, the holding company’s obligations
consist  of  the  repayment  of  $60.4  of  senior  debt  (paid  in  February  2007),  the  payment  of  a
$49.0 dividend on common shares (paid in February 2007) interest, overhead expenses and the
payment of approximately $30.5 purchase consideration payable.

Contractual Obligations

The  following  table  provides  a  payment  schedule  of  current  and  future  obligations  as  at
December 31, 2006:

Net claims liability
Long term debt

Total

Less than
1 year

1 – 3 years

3 – 5 years

More than
5 years

10,658.6

3,113.9

3,696.4

1,686.2

2,162.1

obligations – principal

2,115.7

60.4

174.9

–

1,880.4

Long term debt

obligations – interest

1,459.8

160.8

302.8

297.0

699.2

Operating leases –

obligations

Other long term liabilities –

principal

Other long term liabilities –

interest

384.5

77.6

114.8

197.1

177.8

4.5

16.9

10.3

32.7

74.2

12.2

30.8

117.9

170.1

97.4

14,993.5

3,434.1

4,331.9

2,100.4

5,127.1

For  further  detail  on  Fairfax’s  net  claims  liability,  long  term  debt  principal  and  interest
payments, other long term liability payments and operating lease payments, please see notes 5,
7, 8, 9 and 15, respectively, of the company’s consolidated ﬁnancial statements.

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SEC Subpoenas

On September 7, 2005, the company announced that it had received a subpoena from the U.S.
Securities  and  Exchange  Commission  (the  ‘‘SEC’’)  requesting  documents  regarding  any
nontraditional  insurance  or  reinsurance  product  transactions  entered  into  by  the  entities  in
the consolidated group and any non-traditional insurance or reinsurance products offered by
the  entities  in  that  group.  On  September  26,  2005,  the  company  announced  that  it  had
received a further subpoena from the SEC as part of its investigation into such loss mitigation
products,  requesting  documents  regarding  any  transactions  in  the  company’s  securities,  the
compensation for such transactions and the trading volume or share price of such securities.
Previously,  on  June  24,  2005,  the  company  announced  that  the  company’s  Fairmont
subsidiary  had  received  a  subpoena  from  the  SEC  requesting  documents  regarding  any
nontraditional  insurance  product  transactions  entered  into  by  Fairmont  with  General  Re
Corporation  or  afﬁliates  thereof.  The  U.S.  Attorney’s  ofﬁce  for  the  Southern  District  of  New
York is reviewing documents produced by the company to the SEC and is participating in the
investigation  of  these  matters.  The  company  is  cooperating  fully  with  these  requests.  The
company  has  prepared  presentations  and  provided  documents  to  the  SEC  and  the
U.S. Attorney’s ofﬁce, and its employees, including senior ofﬁcers, have attended or have been
requested to attend interviews conducted by the SEC and the U.S. Attorney’s ofﬁce.

The  company  and  Prem  Watsa,  the  company’s  Chief  Executive  Ofﬁcer,  received  subpoenas
from the SEC in connection with the answer to a question on the February 10, 2006 investor
conference call concerning the review of the company’s ﬁnite reinsurance contracts. In the fall
of 2005, Fairfax and its subsidiaries prepared and provided to the SEC a list intended to identify
certain  ﬁnite  contracts  and  contracts  with  other  non-traditional  features  of  all  Fairfax  group
companies.  As  part  of  the  2005  year-end  reporting  and  closing  process,  Fairfax  and  its
subsidiaries internally reviewed all of the contracts on the list provided to the SEC and some
additional contracts as deemed appropriate. That review led to the restatement by OdysseyRe.
That  review  also  led  to  some  changes  in  accounting  for  certain  contracts  at  nSpire  Re.
Subsequently,  during  2006  following  an  internal  review  of  the  company’s  consolidated
ﬁnancial  statements  and  accounting  records  that  was  undertaken  in  contemplation  of  the
commutation of the Swiss Re corporate insurance cover, the company also restated various of
its  previously  reported  consolidated  ﬁnancial  statements  and  related  disclosures.  That
restatement  included  a  restatement  of  the  accounting  for  certain  reinsurance  contracts  that
were commuted in 2004 to apply the deposit method of accounting rather than reinsurance
accounting.  All  of  the  above  noted  items  and  related  adjustments  are  reﬂected  in  the
company’s comparative results. The company continues to respond to requests for information
from the SEC and there can be no assurance that the SEC’s review of documents provided will
not give rise to further adjustments.

The company understands that the SEC has issued subpoenas to various third parties involved
in the matters which are the subject of the SEC subpoenas issued to the company, including
the  company’s  independent  auditors  (which  in  Canada  received  a  letter  requesting
cooperation  and  in  the  U.S.  received  a  subpoena)  and  a  shareholder  (that  has  previously
disclosed  receipt  of  a  subpoena).  In  addition,  it  is  possible  that  other  governmental  and
enforcement  agencies  will  seek  to  review  information  related  to  these  matters,  or  that  the
company,  or  other  parties  with  whom  it  interacts,  such  as  customers  or  shareholders,  may
become subject to direct requests for information or other inquiries by such agencies.

These  inquiries  are  ongoing  and  the  company  continues  to  comply  with  requests  for
information  from  the  SEC  and  the  U.S.  Attorney’s  ofﬁce.  At  the  present  time  the  company
cannot  predict  the  outcome  from  these  continuing  inquiries  or  the  ultimate  effect  on  its
business,  operations  or  ﬁnancial  condition,  which  effect  could  be  material  and  adverse.  The
ﬁnancial cost to the company to address these matters has been and is likely to continue to be
signiﬁcant.  The  company  expects  that  these  matters  will  continue  to  require  signiﬁcant

124

management attention, which could divert management’s attention away from the company’s
business. In addition, the company could be materially adversely affected by negative publicity
related to these inquiries or any similar proceedings. Any of the possible consequences noted
above, or the perception that any of them could occur, could have an adverse effect upon the
market price for the company’s securities.

Lawsuits

During 2006, several lawsuits seeking class action status were ﬁled against Fairfax and certain of
its ofﬁcers and directors in the United States District Court for the Southern District of New
York.  The  Court  made  an  order  consolidating  the  various  pending  lawsuits  and  granted  the
single  remaining  motion  for  appointment  as  lead  plaintiffs.  The  Court  also  issued  orders
approving  scheduling  stipulations  ﬁled  by  the  parties  to  the  consolidated  lawsuit.  On
February 8, 2007, the lead plaintiffs ﬁled an amended consolidated complaint (the ‘‘Amended
Consolidated Complaint’’), which states that the lead plaintiffs seek to represent a class of all
purchasers  and  acquirers  of  securities  of  Fairfax  between  May  21,  2003  and  March  22,  2006
inclusive.  The  Amended  Consolidated  Complaint  names  as  defendants  Fairfax,  certain  of  its
ofﬁcers  and  directors,  OdysseyRe  and  Fairfax’s  auditors.  The  Amended  Consolidated
Complaint alleges that the defendants violated U.S. federal securities laws by making material
misstatements  or  failing  to  disclose  certain  material  information  regarding,  among  other
things,  Fairfax’s  and  OdysseyRe’s  assets,  earnings,  losses,  ﬁnancial  condition,  and  internal
ﬁnancial  controls.  The  Amended  Consolidated  Complaint  seeks,  among  other  things,
certiﬁcation  of  the  putative  class;  unspeciﬁed  compensatory  damages  (including  interest);
unspeciﬁed monetary restitution; unspeciﬁed extraordinary, equitable and/or injunctive relief;
and costs (including reasonable attorneys’ fees). These claims are at a preliminary stage. The
court  has  scheduled  the  next  conference  for  April  5,  2007,  and  pursuant  to  the  scheduling
stipulations,  the  defendants  will  ﬁle  their  answers  or  motions  to  dismiss  the  Amended
Consolidated Complaint on or before May 10, 2007. The ultimate outcome of any litigation is
uncertain and should the consolidated lawsuit be successful, the defendants may be subject to
an  award  of  signiﬁcant  damages,  which  could  have  a  material  adverse  effect  on  Fairfax’s
business, results of operations and ﬁnancial condition. The consolidated lawsuit may require
signiﬁcant management attention, which could divert management’s attention away from the
company’s  business.  In  addition,  the  company  could  be  materially  adversely  affected  by
negative publicity related to this lawsuit. Any of the possible consequences noted above, or the
perception that any of them could occur, could have an adverse effect upon the market price
for the company’s securities. Fairfax, OdysseyRe and the named ofﬁcers and directors intend to
vigorously  defend  against  the  consolidated  lawsuit  and  the  company’s  ﬁnancial  statements
include no provision for loss.

On  July  26,  2006,  Fairfax  ﬁled  a  lawsuit  seeking  $6  billion  in  damages  from  a  number  of
defendants  who,  the  complaint  alleges,  participated  in  a  stock  market  manipulation  scheme
involving Fairfax shares. The complaint, ﬁled in Superior Court, Morris County, New Jersey,
alleges  violations  of  various  state  laws,  including  the  New  Jersey  Racketeer  Inﬂuenced  and
Corrupt  Organizations  Act  (RICO),  pursuant  to  which  treble  damages  may  be  available.  The
defendants have removed this lawsuit to the District Court for the District of New Jersey, and
Fairfax has ﬁled a motion to remand the lawsuit to Superior Court, Morris County, New Jersey.
The ultimate outcome of any litigation is uncertain.

Management’s Evaluation of Disclosure Controls and Procedures

As  disclosed  in  note  2  to  the  audited  consolidated  ﬁnancial  statements,  during  2006  the
company  restated  its  consolidated  ﬁnancial  statements  as  at  and  for  the  years  ended
December 31, 2001 through 2005 and all related disclosures. The restatement of the company’s
consolidated ﬁnancial statements followed an internal review of the company’s consolidated

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ﬁnancial  statements  and  accounting  records  that  was  undertaken  in  contemplation  of  the
commutation of the company’s $1 billion corporate insurance cover ultimately reinsured with
a Swiss Re subsidiary. That review identiﬁed an overstatement of the consolidated net assets of
the  company  and  errors  in  accounting  for  the  periodic  consolidated  earnings  statements.  In
connection  with  the  restatement,  the  company’s  management  identiﬁed  four  material
weaknesses in its internal control over ﬁnancial reporting as of December 31, 2005 relating to
ﬁnancial reporting organizational structure and personnel, head ofﬁce consolidation controls,
investment accounting in accordance with US GAAP and accounting for income taxes.

Upon  identiﬁcation  of  the  four  material  weaknesses  and  under  the  review  of  the  Audit
Committee  of  the  company’s  Board  of  Directors,  the  company  developed  a  comprehensive
plan  to  remediate  the  material  weaknesses.  The  status  of  remediation  of  each  material
weakness was reviewed with the Audit Committee and the Committee was advised of issues
encountered and key decisions reached by management relating to the remediation efforts.

As  of  December  31,  2006  and  as  described  under  Remediation  of  Material  Weaknesses  in
Internal  Control  Over  Financial  Reporting  below,  the  material  weaknesses  relating  to
investment  accounting  in  accordance  with  US  GAAP  and  accounting  for  income  taxes  were
remediated,  and  the  two  material  weaknesses  relating  to  a  sufﬁcient  complement  of
accounting  personnel  and  lines  of  communication  within  the  organization  and  head  ofﬁce
consolidation controls had not been remediated.

Under  the  supervision  and  with  the  participation  of  our  management,  including  the
company’s  CEO  and  CFO,  the  company  conducted  an  evaluation  of  the  effectiveness  of  its
disclosure  controls  and  procedures  as  required  by  Canadian  securities  legislation  as  of
December  31,  2006.  Disclosure  controls  and  procedures  are  designed  to  ensure  that  the
information required to be disclosed by the company in the reports it ﬁles or submits under
securities  legislation  is  recorded,  processed,  summarized  and  reported  on  a  timely  basis  and
that such information is accumulated and reported to management, including the company’s
CEO  and  CFO,  as  appropriate,  to  allow  required  disclosures  to  be  made  in  a  timely  fashion.
Based on their evaluation, the CEO and CFO have concluded that as of December 31, 2006, the
company’s  disclosure  controls  and  procedures  were  not  effective  because  of  the  material
weakness discussed below.

Notwithstanding  the  existence  of  two  remaining  material  weaknesses,  the  company’s
management has concluded that the ﬁnancial statements included herein fairly present, in all
material respects, the company’s ﬁnancial position, results of operations and cash ﬂows for the
periods presented in conformity with generally accepted accounting principles.

Management’s Report on Internal Control over Financial Reporting

The company’s management is responsible for establishing and maintaining adequate internal
control over ﬁnancial reporting (as deﬁned in Rule 13a-15(f) under the Securities Exchange Act
of  1934.  The  company’s  internal  control  over  ﬁnancial  reporting  is  a  process  designed  to
provide  reasonable  assurance  regarding  the  reliability  of  ﬁnancial  reporting  and  the
preparation  of  ﬁnancial  statements  for  external  purposes  in  accordance  with  generally
accepted accounting principles. A company’s internal control over ﬁnancial reporting includes
those policies and procedures that (i) pertain to the maintenance of records that, in reasonable
detail,  accurately  and  fairly  reﬂect  the  transactions  and  dispositions  of  the  assets  of  the
company;  (ii)  provide  reasonable  assurance  that  transactions  are  recorded  as  necessary  to
permit preparation of ﬁnancial statements in accordance with generally accepted accounting
principles,  and  that  receipts  and  expenditures  of  the  company  are  being  made  only  in
accordance  with  authorizations  of  management  and  directors  of  the  company;  and
(iii)  provide  reasonable  assurance  regarding  prevention  or  timely  detection  of  unauthorized

126

acquisition, use, or disposition of the company’s assets that could have a material effect on the
ﬁnancial statements.

Because of its inherent limitations, internal control over ﬁnancial reporting may not prevent or
detect misstatements. Also, projections of any evaluation of effectiveness to future periods are
subject to the risk that controls may become inadequate because of changes in conditions, or
that the degree of compliance with the policies or procedures may deteriorate.

The company’s management assessed the effectiveness of the company’s internal control over
ﬁnancial reporting as of December 31, 2006. In making this assessment, our management used
the  criteria  set  forth  by  the  Committee  of  Sponsoring  Organizations  of  the  Treadway
Commission (‘‘COSO’’) in Internal Control-Integrated Framework.

A material weakness is a control deﬁciency, or combination of control deﬁciencies, that results
in  more  than  a  remote  likelihood  that  a  material  misstatement  of  the  annual  or  interim
ﬁnancial  statements  will  not  be  prevented  or  detected.  The  company’s  management  has
concluded that, as of December 31, 2006, the following two material weaknesses in internal
control over ﬁnancial reporting existed:

1.

2.

The company did not maintain a sufﬁcient complement of accounting personnel to
support  the  activities  of  the  company  and  lines  of  communication  between  the
company’s operations and accounting and ﬁnance personnel at head ofﬁce and the
subsidiaries were not adequate to raise issues to the appropriate level of accounting
personnel.  Further,  the  company  did  not  maintain  personnel  with  an  appropriate
level  of  accounting  knowledge,  experience  and  training  to  support  the  size  and
complexity of the organization and its ﬁnancial reporting requirements. This control
deﬁciency contributed to the other material weakness identiﬁed.

The  company  did  not  maintain  effective  controls  over  the  completeness  and
accuracy  of  period-end  ﬁnancial  reporting  and  period-end  close  processes  at  the
Fairfax  head  ofﬁce  consolidation  level.  Speciﬁcally,  the  company  did  not  maintain
effective  review  and  monitoring  processes  and  documentation  relating  to  the
(i)  recording  of  recurring  and  non-recurring  journal  entries,  and  (ii)  translation  of
foreign currency transactions and subsidiary company results.

Each  of  these  control  deﬁciencies  could  result  in  misstatements  of  the  company’s  ﬁnancial
statement accounts and disclosures that would result in a material misstatement to the annual
or  interim  consolidated  ﬁnancial  statements  that  would  not  be  prevented  or  detected.
Accordingly,  the  company’s  management  has  concluded  that  these  control  deﬁciencies
constitute material weaknesses.

As  a  result  of  the  material  weaknesses  in  internal  control  over  ﬁnancial  reporting  described
above,  the  company’s  management,  including  the  CEO  and  CFO,  concluded  that,  as  of
December 31, 2006, the company’s internal control over ﬁnancial reporting was not effective
based on the criteria in Internal Control – Integrated Framework issued by COSO.

Management’s assessment of the effectiveness of the company’s internal control over ﬁnancial
reporting  as  of  December  31,  2006  has  been  audited  by  PricewaterhouseCoopers  LLP,  an
independent registered public accounting ﬁrm, as stated in their report which appears herein.

Remediation of Material Weaknesses in Internal Control Over Financial
Reporting

During the last half of 2006 and continuing into 2007, the company has been actively engaged
in the implementation of remediation efforts to address the material weaknesses in existence at
December  31,  2005.  These  remediation  efforts,  outlined  below,  are  speciﬁcally  designed  to
address  the  material  weaknesses  identiﬁed  by  the  company’s  management.  As  a  result  of  its

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assessment  of  the  effectiveness  of  internal  control  over  ﬁnancial  reporting,  the  company’s
management determined that as of December 31, 2006, two material weaknesses, relating to
investment  accounting  in  accordance  with  US  GAAP  and  accounting  for  income  taxes,  had
been  remediated,  and  two  material  weaknesses,  relating  to  a  sufﬁcient  complement  of
accounting  personnel  and  lines  of  communication  within  the  organization  and  head  ofﬁce
consolidation controls, had not been remediated.

Completed Remediation

(a)

Investment Accounting in Accordance with US GAAP

As of December 31, 2005, the company did not maintain effective controls over the accounting
for certain derivative instruments in accordance with FAS 133. Speciﬁcally, the company did
not maintain appropriate controls over the processes to account for convertible bond securities
and to identify embedded derivatives in other ﬁxed income securities in accordance with US
GAAP.  This  control  deﬁciency  resulted  in  the  restatement  of  the  company’s  US  GAAP  net
earnings (loss) with an offsetting amount in other comprehensive income for each of the three
years ended December 31, 2005, including interim periods therein.

The  company  has  taken  several  speciﬁc  actions  to  remediate  this  material  weakness  and  to
further  strengthen  controls  over  investment  accounting  in  accordance  with  US  GAAP,
including:

1.

2.

The company has implemented new control procedures designed to identify features
of  newly  purchased  investment  securities  in  order  to  determine  the  appropriate
investment  accounting  in  accordance  with  US  GAAP  and  Canadian  GAAP.
Investment  accounting  memoranda  are  prepared  at  inception  for  new  investment
positions in securities with unique or non-standard features for use by the head ofﬁce
and subsidiaries’ investment accounting teams.

The  company  has  established  the  Investment  Accounting  Working  Group,
comprising  members  of  the  head  ofﬁce  and  subsidiaries’  investment  accounting
teams, to assist in the preparation and review of investment accounting memoranda
and  to  research  and  analyze  the  impact  of  new  accounting  pronouncements.  The
Investment Accounting Working Group has improved communication between head
ofﬁce  investment  accounting  and  the  investment  accounting  teams  of  the
subsidiaries.

Based upon the speciﬁc actions taken, as listed above, and the testing and evaluation of the
effectiveness of the controls, the company’s management has concluded that remediation of
the  material  weakness  in  investment  accounting  in  accordance  with  US  GAAP  has  been
achieved as of December 31, 2006.

(b) Accounting for Income Taxes

As  of  December  31,  2005,  the  company  did  not  maintain  effective  controls  over  the
completeness  and  accuracy  of  the  calculation  and  review  of  income  taxes,  including  the
determination of income taxes payable, future income tax assets and liabilities and the related
income  tax  provision,  including  the  impact  on  US  GAAP  information.  Speciﬁcally,  the
company  did  not  maintain  appropriate  controls  over  tax  effecting  certain  permanent
differences,  temporary  differences  and  US  GAAP  reconciling  items.  This  control  deﬁciency
resulted in the restatement of the company’s consolidated ﬁnancial statements for the years
ended  December  31,  2001  through  2005  and  related  disclosures  including  interim  periods
therein.

128

The  company  has  taken  several  speciﬁc  actions  to  remediate  this  material  weakness  and  to
further strengthen controls over accounting for income taxes, including:

1.

2.

3.

The  company  has  implemented an  enhanced  collaborative  review  process  for  the
determination of income tax provisions, income taxes payable and future income tax
assets  and  liabilities  in  accordance  with  US  GAAP  and  Canadian  GAAP  by  both  its
U.S. and Canadian tax teams.

The company has strengthened its control procedures relating to its review of the tax
impact on recurring and non-recurring consolidation journal entries.

The company has strengthened its control procedures relating to its review both by
the U.S. and Canadian tax team of the tax impact of the US GAAP reconciling items.

Based upon the speciﬁc actions taken, as listed above, and the testing and evaluation of the
effectiveness of the controls, the company’s management has concluded that remediation of
the material weakness in accounting for income taxes has been achieved as of December 31,
2006.

Continuing Remediation

The  company  has  devoted  signiﬁcant  efforts  towards  remediation  of  the  two  remaining
material  weaknesses.  Speciﬁc  steps  have  been  taken  and  progress  achieved,  however,  the
remaining  two  material  weaknesses  were  not  yet  remediated  as  of  December  31,  2006.  The
company’s management continues to assign the highest priority to remediation efforts in these
areas, with the goal of remediating these two material weaknesses during the ﬁrst half of 2007.
However, due to the nature of the remediation process and the need to allow adequate time
after implementation to evaluate and test the effectiveness of the controls, no assurance can be
given as to the timing of the achievement of remediation.

The  company  has  taken  the  following  speciﬁc  remediation  steps  with  respect  to  its  two
remaining material weaknesses:

(a) Financial Reporting Organizational Structure and Personnel

As  of  December  31,  2005,  the  company  did  not  maintain  an  appropriate  accounting  and
ﬁnancial  reporting  organizational  structure  and  a  sufﬁcient  complement  of  accounting
personnel  to  support  the  activities  of  the  company.  Speciﬁcally,  lines  of  communication
between the company’s operations and accounting and ﬁnance personnel and the subsidiaries
were not adequate to raise issues to the appropriate level of accounting personnel. Further, the
company  did  not  maintain  personnel  with  an  appropriate  level  of  accounting  knowledge,
experience  and  training  to  support  the  size  and  complexity  of  the  organization  and  its
ﬁnancial reporting requirements.

The company has implemented the following measures:

1.

2.

3.

The Chief Financial Ofﬁcer has been appointed to the Executive Committee and the
Operations  Committee  and  the  accounting  and  ﬁnancial  reporting  organizational
structure has been redesigned to facilitate better communication and accountability.

The company has recently hired additional ﬁnancial accounting personnel at head
ofﬁce  with  the  requisite  training,  skills  and  experience  appropriate  to  the  job
requirements and the complexity of the organization.

The  company  has  established  committees  and  working  groups  comprised  of  head
ofﬁce and subsidiary accounting personnel to enhance communication.

The company continues to seek additional ﬁnancial accounting personnel for head ofﬁce, with
emphasis on US GAAP technical expertise, and additional testing will be required to evaluate

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the effectiveness of controls including the operation of the committees and working groups.
Accordingly,  the  company  believes  that  full  remediation  has  not  yet  been  achieved as  of
December 31, 2006.

(b) Head Ofﬁce Consolidation Controls

As  of  December  31,  2005,  the  company  did  not  maintain  effective  controls  over  the
completeness and accuracy of period-end ﬁnancial reporting and period-end close processes at
the Fairfax head ofﬁce consolidation level. Speciﬁcally, the company did not maintain effective
review and monitoring processes and documentation relating to the (i) recording of recurring
and  non-recurring  journal  entries,  (ii)  recording  of  intercompany  and  related  company
eliminations  and  reconciliations  and  (iii)  translation  of  foreign  currency  transactions  and
subsidiary company results.

The company has undertaken the following measures:

1.

2.

3.

The company is in the process of strengthening certain documentation and review
procedures relating to recurring and non-recurring consolidation journal entries.

The  company  implemented  control  procedures  designed  to  identify,  analyze  and
reconcile intercompany balances in a timely manner through increased collaboration
with the subsidiaries’ accounting teams during the third quarter and fourth quarter
close processes.

The  company  is  in  the  process  of  strengthening  its  control  procedures  over  the
currency translation adjustment accounting at the head ofﬁce and subsidiary levels.

Additional  testing  will  be  required  to  evaluate  the  effectiveness  of  the  new  and  enhanced
control  procedures  for  items  (1)  and  (3)  above.  Accordingly,  the  company believes  that
remediation has not yet been achieved as of December 31, 2006.

The two material weaknesses will be fully remediated when, in the opinion of the company’s
management, the revised control procedures and processes have been operating for a sufﬁcient
period of time to provide reasonable assurance as to their effectiveness. The remediation and
ultimate  resolution  of  the  company’s  material  weaknesses  will  be  reviewed  by  the  Audit
Committee  of  the  company’s  Board  of  Directors.  The  company  will  disclose  any  further
developments arising as a result of its remediation efforts in future ﬁlings.

Issues and Risks

The  following  issues  and  risks,  among  others,  should  also  be  considered  in  evaluating  the
outlook  of  the  company.  For  a  fuller  detailing  of  issues  and  risks  relating  to  the  company,
please  see  Risk  Factors  in  Fairfax’s  Supplemental  and  Base  Shelf  Prospectus  ﬁled  on
September 28, 2005 with the securities regulatory authorities in Canada and the United States,
which is available on SEDAR and EDGAR.

Claims Reserves

The major risk that all property and casualty insurance and reinsurance companies face is that
the  provision  for  claims  is  an  estimate  and  may  be  found  to  be  deﬁcient,  perhaps  very
signiﬁcantly, in the future as a result of unanticipated frequency or severity of claims or for a
variety of other reasons including unpredictable jury verdicts, expansion of insurance coverage
to include exposures not contemplated at the time of policy issue (e.g. asbestos and pollution)
and poor weather. Fairfax’s gross provision for claims was $15,502.3 at December 31, 2006.

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Latent Claims

The company has established loss reserves for asbestos, environmental and other latent claims
that represent its best estimate of ultimate claims and claims adjustment expenses based upon
known facts and current law. As a result of signiﬁcant issues surrounding liabilities of insurers,
risks  inherent  in  major  litigation  and  diverging  legal  interpretations  and  judgments  in
different jurisdictions, actual liability for these types of claims could exceed the loss reserves set
by  the  company  by  an  amount  that  could  be  material  to  its  operating  results  and  ﬁnancial
condition in future periods.

Reinsurance Recoverables

Most insurance and reinsurance companies reduce their liability for any individual claim by
reinsuring  amounts  in  excess  of  the  maximum  they  want  to  retain.  This  third  party
reinsurance does not relieve the company of its primary obligation to the insured. Reinsurance
recoverables can become an issue mainly due to solvency credit concerns, given the long time
period over which claims are paid and the resulting recoveries are received from the reinsurers,
or policy disputes. Fairfax had $5,506.5 recoverable from reinsurers as at December 31, 2006.

Catastrophe Exposure

Insurance  and  reinsurance  companies  are  subject  to  losses  from  catastrophes  such  as
earthquakes,  hurricanes  and  windstorms,  hailstorms  or  terrorist  attacks,  which  are
unpredictable and can be very signiﬁcant.

Prices

Prices  in  the  insurance  and  reinsurance  industry  are  cyclical  and  can  ﬂuctuate  quite
dramatically.  With  under-reserving,  competitors  can  price  below  underlying  costs  for  many
years and still survive. The property and casualty insurance and reinsurance industry is highly
competitive.

Foreign Exchange

The company has assets, liabilities, revenue and costs that are subject to currency ﬂuctuations.
These currency ﬂuctuations have been and can be very signiﬁcant and can affect the statement
of earnings or, through the currency translation account, shareholders’ equity.

Cost of Revenue

Unlike most businesses, the insurance and reinsurance business can have enormous costs that
can  signiﬁcantly  exceed  the  premiums  received  on  the  underlying  policies.  Similar  to  short
selling in the stock market (selling shares not owned), there is no limit to the losses that can
arise from most insurance policies, even though most contracts have policy limits.

Regulation

Insurance  and  reinsurance  companies  are  regulated  businesses  which  means  that  except  as
permitted  by  applicable  regulation,  Fairfax  does  not  have  access  to  its  insurance  and
reinsurance subsidiaries’ net income and shareholders’ capital without the requisite approval
of applicable insurance regulatory authorities.

Taxation

Realization of the company’s future income taxes asset is dependent upon the generation of
taxable income in those jurisdictions where the relevant tax losses and other timing differences
exist.  Capitalized  operating  and  capital  loss  carryforwards  are  a  major  component  of  the

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F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

company’s future income taxes asset. Failure to achieve projected levels of proﬁtability could
lead  to  a  writedown  in  this  future  income  taxes  asset  if  the  expected  recovery  period  for
capitalized loss carryforwards becomes longer than anticipated.

Bond and Common Stock Holdings

The  company  has  bonds  and  common  stocks  in  its  portfolio.  The  market  value  of  bonds
ﬂuctuates  with  changes  in  interest  rates  and  credit  outlook.  The  market  value  of  common
stocks is exposed to ﬂuctuations in the stock market.

Goodwill

The  majority  of  the  goodwill  on  the  balance  sheet  arises  from  Cunningham  Lindsey,
particularly  its  U.K.  operations.  Continued  proﬁtability  is  essential  for  there  to  be  no
impairment in the carrying value of the goodwill.

Ratings

The company has ﬁnancial strength or claims paying and issuer credit or debt ratings by the
major  rating  agencies  in  North  America.  As  ﬁnancial  stability  is  very  important  to  its
customers, the company is vulnerable to downgrades by the rating agencies.

Holding Company

Being a small holding company, Fairfax is very dependent on strong operating management,
which makes it vulnerable to management turnover.

Financial Strength

Fairfax strives to be soundly ﬁnanced. If the company requires additional capital or liquidity
but cannot obtain it at all or on reasonable terms, its business, operating results and ﬁnancial
condition would be materially adversely affected.

Cost of Reinsurance and Adequate Protection

The  availability  and  cost  of  reinsurance  are  subject  to  prevailing  market  conditions,  both  in
terms  of  price  and  available  capacity,  which  can  affect  the  company’s  business  volume  and
proﬁtability. Many reinsurance companies have begun to exclude certain coverages from the
policies  they  offer.  In  the  future,  alleviation  of  risk  through  reinsurance  arrangements  may
become increasingly difﬁcult.

Information Requests or Proceedings by Government Authorities

SEC Subpoenas

On  September  7,  2005,  the  company  announced  that  it  had  received  a  subpoena  from  the
U.S.  Securities  and  Exchange  Commission  (the  ‘‘SEC’’)  requesting  documents  regarding  any
nontraditional  insurance  or  reinsurance  product  transactions  entered  into  by  the  entities  in
the consolidated group and any non-traditional insurance or reinsurance products offered by
the  entities  in  that  group.  On  September  26,  2005,  the  company  announced  that  it  had
received a further subpoena from the SEC as part of its investigation into such loss mitigation
products,  requesting  documents  regarding  any  transactions  in  the  company’s  securities,  the
compensation for such transactions and the trading volume or share price of such securities.
Previously,  on  June  24,  2005,  the  company  announced  that  the  company’s  Fairmont
subsidiary  had  received  a  subpoena  from  the  SEC  requesting  documents  regarding  any
nontraditional  insurance  product  transactions  entered  into  by  Fairmont  with  General  Re
Corporation  or  afﬁliates  thereof.  The  U.S.  Attorney’s  ofﬁce  for  the  Southern  District  of  New

132

York is reviewing documents produced by the company to the SEC and is participating in the
investigation  of  these  matters.  The  company  is  cooperating  fully  with  these  requests.  The
company  has  prepared  presentations  and  provided  documents  to  the  SEC  and  the
U.S. Attorney’s ofﬁce, and its employees, including senior ofﬁcers, have attended or have been
requested to attend interviews conducted by the SEC and the U.S. Attorney’s ofﬁce.

The  company  and  Prem  Watsa,  the  company’s  Chief  Executive  Ofﬁcer,  received  subpoenas
from the SEC in connection with the answer to a question on the February 10, 2006 investor
conference call concerning the review of the company’s ﬁnite reinsurance contracts. In the fall
of 2005, Fairfax and its subsidiaries prepared and provided to the SEC a list intended to identify
certain  ﬁnite  contracts  and  contracts  with  other  non-traditional  features  of  all  Fairfax  group
companies.  As  part  of  the  2005  year-end  reporting  and  closing  process,  Fairfax  and  its
subsidiaries internally reviewed all of the contracts on the list provided to the SEC and some
additional contracts as deemed appropriate. That review led to the restatement by OdysseyRe.
That  review  also  led  to  some  changes  in  accounting  for  certain  contracts  at  nSpire  Re.
Subsequently,  during  2006  following  an  internal  review  of  the  company’s  consolidated
ﬁnancial  statements  and  accounting  records  that  was  undertaken  in  contemplation  of  the
commutation of the Swiss Re corporate insurance cover, the company also restated various of
its  previously  reported  consolidated  ﬁnancial  statements  and  related  disclosures. That
restatement  included  a  restatement  of  the  accounting  for  certain  reinsurance  contracts  that
were commuted in 2004 to apply the deposit method of accounting rather than reinsurance
accounting.  All  of  the  above  noted  items  and  related  adjustments  are  reﬂected  in  the
company’s comparative results. The company continues to respond to requests for information
from the SEC and there can be no assurance that the SEC’s review of documents provided will
not give rise to further adjustments.

The company understands that the SEC has issued subpoenas to various third parties involved
in the matters which are the subject of the SEC subpoenas issued to the company, including
the  company’s  independent  auditors  (which  in  Canada  received  a  letter  requesting
cooperation  and  in  the  U.S.  received  a  subpoena)  and  a  shareholder  (that  has  previously
disclosed  receipt  of  a  subpoena).  In  addition,  it  is  possible  that  other  governmental  and
enforcement  agencies  will  seek  to  review  information  related  to  these  matters,  or  that  the
company,  or  other  parties  with  whom  it  interacts,  such  as  customers  or  shareholders,  may
become subject to direct requests for information or other inquiries by such agencies.

These  inquiries  are  ongoing  and  the  company  continues  to  comply  with  requests  for
information  from  the  SEC  and  the  U.S.  Attorney’s  ofﬁce.  At  the  present  time  the  company
cannot  predict  the  outcome  from  these  continuing  inquiries  or  the  ultimate  effect  on  its
business,  operations  or  ﬁnancial  condition,  which  effect  could  be  material  and  adverse.  The
ﬁnancial cost to the company to address these matters has been and is likely to continue to be
signiﬁcant.  The  company  expects  that  these  matters  will  continue  to  require  signiﬁcant
management attention, which could divert management’s attention away from the company’s
business. In addition, the company could be materially adversely affected by negative publicity
related to these inquiries or any similar proceedings. Any of the possible consequences noted
above, or the perception that any of them could occur, could have an adverse effect upon the
market price for the company’s securities.

Lawsuit

During 2006, several lawsuits seeking class action status were ﬁled against Fairfax and certain of
its ofﬁcers and directors in the United States District Court for the Southern District of New
York.  The  Court  made  an  order  consolidating  the  various  pending  lawsuits  and  granted  the
single  remaining  motion  for  appointment  as  lead  plaintiffs.  The  Court  also  issued  orders
approving  scheduling  stipulations  ﬁled  by  the  parties  to  the  consolidated  lawsuit.  On
February 8, 2007, the lead plaintiffs ﬁled an amended consolidated complaint (the ‘‘Amended

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F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

Consolidated Complaint’’), which states that the lead plaintiffs seek to represent a class of all
purchasers  and  acquirers  of  securities  of  Fairfax  between  May  21,  2003  and  March  22,  2006
inclusive.  The  Amended  Consolidated  Complaint  names  as  defendants  Fairfax,  certain  of  its
ofﬁcers  and  directors,  OdysseyRe  and  Fairfax’s  auditors.  The  Amended  Consolidated
Complaint alleges that the defendants violated U.S. federal securities laws by making material
misstatements  or  failing  to  disclose  certain  material  information  regarding,  among  other
things,  Fairfax’s  and  OdysseyRe’s  assets,  earnings,  losses,  ﬁnancial  condition,  and  internal
ﬁnancial  controls.  The  Amended  Consolidated  Complaint  seeks,  among  other  things,
certiﬁcation  of  the  putative  class;  unspeciﬁed  compensatory  damages  (including  interest);
unspeciﬁed monetary restitution; unspeciﬁed extraordinary, equitable and/or injunctive relief;
and costs (including reasonable attorneys’ fees). These claims are at a preliminary stage. The
court  has  scheduled  the  next  conference  for  April  5,  2007,  and  pursuant  to  the  scheduling
stipulations,  the  defendants  will  ﬁle  their  answers  or  motions  to  dismiss  the  Amended
Consolidated Complaint on or before May 10, 2007. The ultimate outcome of any litigation is
uncertain and should the consolidated lawsuit be successful, the defendants may be subject to
an  award  of  signiﬁcant  damages,  which  could  have  a  material  adverse  effect  on  Fairfax’s
business, results of operations and ﬁnancial condition. The consolidated lawsuit may require
signiﬁcant management attention, which could divert management’s attention away from the
company’s  business.  In  addition,  the  company  could  be  materially  adversely  affected  by
negative publicity related to this lawsuit. Any of the possible consequences noted above, or the
perception that any of them could occur, could have an adverse effect upon the market price
for the company’s securities. Fairfax, OdysseyRe and the named ofﬁcers and directors intend to
vigorously  defend  against  the  consolidated  lawsuit  and  the  company’s  ﬁnancial  statements
include no provision for loss.

Critical Accounting Estimates and Judgments

In the preparation of the company’s consolidated ﬁnancial statements, management has made
a number of estimates and judgments, the more critical of which are discussed below.

Provision for Claims

For Fairfax’s reinsurance subsidiaries, provisions for claims are established based on reports and
individual  case  estimates  provided  by  the  ceding  companies.  For  Fairfax’s  subsidiaries  that
write direct insurance, provisions for claims are based on the case method as they are reported.
Case estimates are reviewed on a regular basis and are updated as new information is received.
An additional provision over and above those provisions established under the case method is
established for claims incurred but not yet reported, potential future development on known
claims  and  closed  claims  that  may  reopen  (IBNR  reserves).  The  actuaries  establish  the  IBNR
reserves  based  on  estimates  derived  from  reasonable  assumptions  and  appropriate  actuarial
methods. Typically, actuarial methods use historical experience to project the future; therefore
the actuary must use judgment and take into consideration potential changes, such as changes
in the underlying book of business, in law and in cost factors.

In  order  to  ensure  that  the  estimated  consolidated  provision  for  claims  included  in  the
company’s  ﬁnancial  statements  is  adequate,  the  provisions  at  the  company’s  insurance,
reinsurance  and  runoff  operations  are  subject  to  several  reviews,  including  by  one  or  more
independent  actuaries.  The  reserves  are  reviewed  separately  by,  and  must  be  acceptable  to,
internal actuaries at each operating company, the chief actuary at Fairfax’s head ofﬁce, and one
or  more  independent  actuaries,  including  an  independent  valuation  actuary  whose  report
appears in each Annual Report.

134

Provision for Uncollectible Reinsurance Recoverables

Fairfax establishes provisions for uncollectible reinsurance recoverables on a centralized basis,
which  are  based  on  a  detailed  review  of  the  credit  risk  of  each  underlying  reinsurer.
Considerations involved in establishing these provisions include the balance sheet strength of
the reinsurer, its liquidity (or ability to pay), its desire to pay (based on prior history), ratings as
determined  by  external  rating  agencies  and  speciﬁc  disputed  amounts  based  on  contract
interpretations which occur from time to time. The company monitors these provisions and
reassesses  them  on  a  quarterly  basis,  or  more  frequently  if  necessary,  updating  them  as  new
information becomes available.

Provision for Other than Temporary Impairment in the Value of Investments

Fairfax reviews its investments on a quarterly basis and focuses its attention on investments for
which  the  fair  value  has  been  below  cost  for  six  months  and  on  investments  which  have
experienced sharp declines in the market based on critical events, even if those investments
have  been  below  cost  for  less  than  a  six  month  period.  In  considering  whether  or  not  an
impairment is other than temporary, the company assesses the underlying intrinsic value of
the investment as of the review date as compared to the date of the original investment and
considers the impact of any changes in the underlying fundamentals of the investment. The
company also considers the issuer’s ﬁnancial strength and health, the company’s ability and
intent to hold the security to maturity for ﬁxed income investments, the issuer’s performance
as compared to its competitors, industry averages, views published by third party analysts and
the  company’s  expectations  for  recovery  in  value  in  a  reasonable  time  frame.  Provisions  are
reviewed on a regular basis and, if appropriate, are increased if additional negative information
becomes available; these provisions are only released on the sale of the security.

Valuation Allowance for Recovery of Future Income Taxes

In  determining  the  need  for  a  valuation  allowance  (which  is  based  on  management’s  best
estimate) for the recovery of future income taxes, management considers primarily current and
expected proﬁtability of the companies and their ability to utilize the losses fully within the
next  few  years.  Fairfax  reviews  the  recoverability  of  its  future  income  taxes  asset  and  the
valuation allowance on a quarterly basis, taking into consideration the underlying operation’s
performance as compared to plan, the outlook for the business going forward, changes to tax
law, the ability of the company to refresh tax losses and the expiry date of the tax losses.

Assessment of Goodwill for Potential Impairment

Goodwill on the company’s balance sheet arises primarily from Cunningham Lindsey and is
subject  to  impairment  tests  annually  or  when  signiﬁcant  changes  in  operating  expectations
occur.  Management  estimates  the  fair  value  of  each  of  the  company’s  operations  using
discounted expected future cash ﬂows, which requires the making of a number of estimates,
including  estimates  about  future  revenue,  net  earnings,  corporate  overhead  costs,  capital
expenditures,  cost  of  capital,  and  the  growth  rate  of  the  various  operations.  The  discounted
cash ﬂows supporting the goodwill in the reporting unit are compared to its book value. If the
discounted  cash  ﬂows  supporting  the  goodwill  in  the  reporting  unit  are  less  than  its  book
value, a goodwill impairment loss is recognized equal to the excess of the book value of the
goodwill  over  the  fair  value  of  the  goodwill.  Given  the  variability  of  the  future-oriented
ﬁnancial information, a sensitivity analysis of the goodwill impairment test is performed by
varying the discount and growth rates to enable management to conclude whether or not the
goodwill  balance  has  been  impaired.  As  at  December  31,  2006,  goodwill  in  the  amount  of
$150.4 arose from Cunningham Lindsey’s U.K. operations; this goodwill is sensitive to changes
in future proﬁtability as well as to the discount rates used in the assessment.

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Compliance with Corporate Governance Rules

Fairfax is a Canadian reporting issuer with securities listed on the Toronto Stock Exchange and
the New York Stock Exchange (the ‘‘NYSE’’). It has in place corporate governance practices that
comply with all applicable rules and substantially comply with all applicable guidelines and
policies  of  the  Canadian  Securities  Administrators  and  the  practices  set  out  therein.  In  the
context  of  its  listing  on  the  NYSE,  Fairfax  also  substantially  complies  with  the  corporate
governance standards prescribed by the NYSE even though, as a ‘‘foreign private issuer’’, it is
not required to comply with most of those standards. The only signiﬁcant difference between
Fairfax’s  corporate  governance  practices  and  the  standards  prescribed  by  the  NYSE  relates  to
shareholder approval of the company’s equity compensation plans, which would be required
by  NYSE  standards  but  is  not  required  under  applicable  Canadian  rules  as  the  plans  involve
only outstanding shares purchased in the market and do not involve newly issued securities.

In  2005,  Fairfax’s  Board  of  directors,  in  consultation  with  outside  experts  retained  by  the
Board, took a number of initiatives intended to retain and enhance its existing principles and
practices. The Board has adopted a set of Corporate Governance Guidelines (which include a
written  mandate  of  the  Board),  established  an  Audit  Committee,  a  Governance  and
Nominating Committee and a Compensation Committee, approved written charters for all of
its  committees,  approved  a  Code  of  Business  Conduct  and  Ethics  applicable  to  all  directors,
ofﬁcers  and  employees  of  the  company  and  established,  in  conjunction  with  the  Audit
Committee, a Whistleblower Policy. The company continues to monitor developments in the
area of corporate governance as well as its own procedures.

Forward-Looking Statements

Certain statements contained herein may constitute forward-looking statements and are made
pursuant  to  the  ‘‘safe  harbor’’  provisions  of  the  United  States  Private  Securities  Litigation
Reform  Act  of  1995.  The  words  ‘‘believe’’,  ‘‘anticipate’’,  ‘‘project’’,  ‘‘expect’’,  ‘‘intend’’,  ‘‘will
likely  result’’,  ‘‘will  seek  to’’,  or  ‘‘will  continue’’  and  similar  expressions  identify  forward-
looking statements which relate to, among other things, the company’s plans and objectives
for  future  operations  and  reﬂect  the  company’s  current  views  with  respect  to  future  results,
performance  and  achievements.  Such  forward-looking  statements  are  subject  to  known  and
unknown  risks,  uncertainties  and  other  factors  which  may  cause  the  actual  results,
performance  or  achievements  of  Fairfax  to  be  materially  different  from  any  future  results,
performance or achievements expressed or implied by such forward-looking statements.

Such  factors  include,  but  are  not  limited  to:  a  reduction  in  net  income  if  the  reserves  of  the
company’s subsidiaries (including reserves for asbestos, environmental and other latent claims)
are insufficient; underwriting losses on the risks these subsidiaries insure that are higher or lower
than expected; the lowering or loss of one of these subsidiaries’ financial or claims paying ability
ratings; an inability to realize the company’s investment objectives; exposure to credit risk in the
event the company’s subsidiaries’ reinsurers or insureds fail to make payments; a decrease in the
level of demand for these subsidiaries’ products, or increased competition; an inability to obtain
reinsurance coverage at reasonable prices or on terms that adequately protect these subsidiaries;
an  inability  to  obtain  required  levels  of  capital;  an  inability  to  access  cash  of  the  company’s
subsidiaries;  risks  associated  with  requests  for  information  from  the  Securities  and  Exchange
Commission or other regulatory bodies; risks associated with current government investigations
of,  and  class  action  litigation  related  to,  insurance  industry  practice;  the  passage  of  new
legislation; and the failure to realize future income tax assets. Additional risks and uncertainties
are  described  in  this  Annual  Report  under  the  heading  Issues  and  Risks  and  in  Fairfax’s
Supplemental and Base Shelf Prospectus (under ‘‘Risk Factors’’) filed on September 28, 2005 with
the  securities  regulatory  authorities  in  Canada  and  the  United  States,  which  is  available  on
SEDAR  and  EDGAR.  Fairfax  disclaims  any  intention  or  obligation  to  update  or  revise  any
forward-looking statements, except as otherwise required by law.

136

Quarterly Data (unaudited)

Years ended December 31

First

Fourth
Quarter Quarter Quarter Quarter

Second

Third

2006

Revenue
Net earnings (loss)
Net earnings (loss) per share
Net earnings (loss) per diluted share

2005

Revenue
Net earnings (loss)
Net earnings (loss) per share
Net earnings (loss) per diluted share

2004

Revenue
Net earnings (loss)
Net earnings (loss) per share
Net earnings (loss) per diluted share

1,714.5
198.4
10.99
10.51

1,480.1
47.2
2.80
2.74

1,492.8
50.1
3.46
3.33

1,935.6
229.2
12.73
12.14

1,513.2
22.9
1.29
1.29

1,435.5
43.2
2.97
2.88

1,515.1
(359.2)
(20.41)
(20.41)

1,547.5
(208.6)
(13.19)
(13.19)

1,453.1
(4.7)
(0.52)
(0.52)

1,638.5
159.1
8.81
8.45

1,359.7
(308.1)
(17.51)
(17.51)

1,448.3
(35.5)
(2.74)
(2.74)

Full
Year

6,803.7
227.5
12.17
11.92

5,900.5
(446.6)
(27.75)
(27.75)

5,829.7
53.1
3.11
3.11

Prior to giving effect to the 2005 hurricanes and the 2004 hurricanes, operating results at the
company’s insurance and reinsurance operations have been improving as a result of company
efforts,  although  they  have  been  affected  by  the  more  difﬁcult  insurance  environment
subsequent  to  the  ﬁrst  half  of  2004  (interrupted  temporarily  subsequent  to  the  2005
hurricanes).  Apart  from  reserve  strengthenings  which  have  occurred,  individual  quarterly
results have been (and may in the future be) affected by losses from signiﬁcant natural or other
catastrophes  and  by  commutations  or  settlements  by  the  runoff  group,  the  occurrence  of
which  is  not  predictable,  and  have  been  (and  are  expected  to  continue  to  be)  signiﬁcantly
impacted by changes in the fair value of investments, the timing of which is not predictable.

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Stock Prices and Share Information

As at March 9, 2007 Fairfax had 16,982,070 subordinate voting shares and 1,548,000 multiple
voting shares outstanding (an aggregate of 17,730,840 shares effectively outstanding after an
intercompany  holding).  Each  subordinate  voting  share  carries  one  vote  per  share  at  all
meetings  of  shareholders  except  for  separate  meetings  of  holders  of  another  class  of  shares.
Each multiple voting share carries ten votes per share at all meetings of shareholders except in
certain circumstances (which have not occurred) and except for separate meetings of holders of
another class of shares. The multiple voting shares are not publicly traded.

Below  are  the  Toronto  Stock  Exchange  high,  low  and  closing  prices  of  subordinate  voting
shares of Fairfax for each quarter of 2006, 2005 and 2004.

2006

High
Low
Close

2005

High
Low
Close

2004

High
Low
Close

First
Quarter

Second
Quarter

Third
Quarter

Fourth
Quarter

(Cdn $)

179.09
120.00
124.20

214.78
180.00
180.68

250.00
196.00
203.74

151.51
100.00
106.16

205.00
158.29
203.05

231.10
196.00
227.79

159.85
107.52
145.03

218.50
183.00
201.40

225.60
150.01
157.00

241.00
141.59
231.67

205.29
160.18
168.00

214.60
147.71
202.24

Below  are  the  New  York  Stock  Exchange  high,  low  and  closing  prices  of  subordinate  voting
shares of Fairfax for each quarter of 2006, 2005 and 2004.

2006

High
Low
Close

2005

High
Low
Close

2004

High
Low
Close

First
Quarter

Second
Quarter

Third
Quarter

Fourth
Quarter

156.00
102.50
107.21

171.12
148.35
149.50

187.20
147.57
155.21

130.00
88.87
95.03

168.28
126.73
166.00

174.15
141.12
170.46

142.50
94.99
130.11

179.90
158.00
173.90

170.90
116.00
124.85

209.00
126.91
198.50

175.00
137.38
143.36

177.75
120.50
168.50

138

APPENDIX A

GUIDING PRINCIPLES FOR FAIRFAX FINANCIAL HOLDINGS LIMITED

OBJECTIVES:

1) We expect to compound our mark-to-market book value per share over the long term by
15%  annually  by  running  Fairfax  and  its  subsidiaries  for  the  long  term  beneﬁt  of
customers, employees and shareholders – at the expense of short term proﬁts if necessary.

Our focus is long term growth in book value per share and not quarterly earnings. We plan
to grow through internal means as well as through friendly acquisitions.

2) We always want to be soundly ﬁnanced.

3) We provide complete disclosure annually to our shareholders.

STRUCTURE:

1) Our  companies  are  decentralized  and  run  by  the  presidents  except  for  performance
evaluation,  succession  planning,  acquisitions  and  ﬁnancing  which  are  done  by  or  with
Fairfax. Cooperation among companies is encouraged to the beneﬁt of Fairfax in total.

2) Complete  and  open  communication  between  Fairfax  and  subsidiaries  is  an  essential

requirement at Fairfax.

3)

4)

Share ownership and large incentives are encouraged across the Group.

Fairfax will always be a very small holding company and not an operating company.

VALUES:

1) Honesty and integrity are essential in all our relationships and will never be compromised.

2) We are results oriented – not political.

3) We  are  team  players  –  no  ‘‘egos’’.  A  confrontational  style  is  not  appropriate.  We  value

loyalty – to Fairfax and our colleagues.

4) We are hard working but not at the expense of our families.

5) We always look at opportunities but emphasize downside protection and look for ways to

minimize loss of capital.

6) We are entrepreneurial. We encourage calculated risk taking. It is all right to fail but we

should learn from our mistakes.

7) We will never bet the company on any project or acquisition.

8) We believe in having fun – at work!

139

F A I R F A X  F I N A N C I A L  H O L D I N G S  L I M I T E D

Consolidated Financial Summary
(in US$ millions except share and per share data and as otherwise indicated)(1)

Return on
average
common
shareholders’
equity

Per Share

Common
share-

Net
holders’ earnings –

equity

diluted Revenue

Earnings
before
income
taxes

Net
earnings

Total
assets(2)

Invest-
ments

Net
debt(3)

Common
share-
holders’

Shares
equity outstanding

Closing
share
price(4)

As at and for the years ended December 31:
(1.35)
0.98
1.72
1.63
1.87
2.42
3.34
1.44
4.19
3.41
7.15

–
25.2%
32.5%
22.8%
21.0%
23.0%
21.5%
7.7%
15.9%
11.4%
20.4%
21.9%
20.5%
24.1%
2.5%
3.3%
(23.4%)
14.5%
13.9%
1.8%
(18.1%)
8.5%

1.52
4.25
6.30
8.26
10.50
14.84
18.38
18.55
26.39
31.06
38.89
63.31
86.28
112.49
155.55
148.14
117.03
125.25
163.70
162.76
137.50
150.16

1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006

12.2
38.9
86.9
112.0
108.6
167.0
217.4
237.0
266.7
464.8
837.0
11.26 1,082.3
14.12 1,507.7
23.60 2,469.0
3.20 3,905.9
5.04 4,157.2
(31.93) 3,953.2
17.49 5,104.7
19.51 5,731.2
3.11 5,829.7
(27.75) 5,900.5
11.92 6,803.7

(0.6)
6.6
14.0
17.9
16.6
19.8
28.3
5.8
36.2
33.7
70.1
137.4
218.0
358.9
(72.2)
(66.7)
(695.1)
294.7
537.1
287.6
(466.5)
878.6

(0.6)
4.7
12.3
12.1
14.4
18.2
19.6
8.3
25.8
27.9
63.9
110.6
152.1
280.3
42.6
75.5

23.9
68.8
93.5
111.7
113.1
289.3
295.3
311.7
641.1
1,105.9
1,221.9
2,520.4
4,054.1
7,867.8

30.4
7.6
–
93.4
29.7
3.7
139.8
46.0
4.9
200.6
60.3
27.3
209.5
76.7
21.9
461.9
81.6
83.3
447.0
101.1
58.0
464.6
113.1
69.4
906.6
211.1
118.7
1,549.3
279.6
166.3
2,104.8
346.1
175.7
4,216.0
664.7
281.6
7,148.9
369.7
960.5
830.0 1,364.8
13,640.1
22,229.3 12,289.7 1,248.5 2,088.5
21,667.8 10,399.6 1,251.5 1,940.8
(406.5) 22,183.8 10,228.8 1,194.1 1,679.5
22,173.2 10,596.5 1,602.8 1,760.4
252.8
24,877.1 12,491.2 1,961.1 2,264.6
288.6
26,271.2 13,460.6(6) 1,965.9 2,605.7
53.1
(446.6) 27,542.0 14,869.4(6) 1,984.0 2,448.2
26,576.5 16,819.7(6) 1,613.6 2,662.4
227.5

5.0
7.0
7.3
7.3
7.3
5.5
5.5
6.1
8.0
9.0
8.9

3.25(5)
12.75
12.37
15.00
18.75
11.00
21.25
25.00
61.25
67.00
98.00
10.5 290.00
11.1 320.00
12.1 540.00
13.4 245.50
13.1 228.50
14.4 164.00
14.1 121.11
13.8 226.11
16.0 202.24
17.8 168.00
17.7 231.67

(1) All share references are to common shares; shares outstanding are in millions.

(2) Commencing in 1995, reﬂects a change in accounting policy for reinsurance recoverables.

(3) Total debt (beginning in 1994, net of cash in the holding company).

(4) Quoted in Canadian dollars.

(5) When current management took over in September 1985.

(6) Excludes  $539.5  in  2004,  $700.3  in  2005  and  $783.3  in  2006  of  cash  and  short  term  investments  arising  from  the

company’s economic hedges against a decline in the equity markets.

140

Directors of the Company
Frank B. Bennett (retiring as of April 2007)
President, Artesian Management, Inc.

Anthony F. Grifﬁths
Corporate Director

Robert J. Gunn (as of April 2007)
Corporate Director

Ofﬁcers of the Company
Trevor J. Ambridge
Vice President

David Bonham
Vice President, Financial Reporting

John Cassil
Vice President

David L. Johnston (as of April 2007)
President and Vice-Chancellor, University of Waterloo

Peter Clarke
Vice President and Chief Risk Ofﬁcer

Jean Cloutier
Vice President and Chief Actuary

Hank Edmiston
Vice President, Regulatory Affairs

Bradley P. Martin
Vice President, Chief Operating Ofﬁcer and
Corporate Secretary

Paul Rivett
Vice President and Chief Legal Ofﬁcer

Eric P. Salsberg
Vice President, Corporate Affairs

Ronald Schokking
Vice President and Treasurer

Greg Taylor
Vice President and Chief Financial Ofﬁcer

V. Prem Watsa
Chairman and Chief Executive Ofﬁcer

M. Jane Williamson
Vice President

Head Ofﬁce
95 Wellington Street West
Suite 800
Toronto, Canada M5J 2N7
Telephone (416) 367-4941
Website www.fairfax.ca

Auditors
PricewaterhouseCoopers LLP

General Counsel
Torys

Transfer Agents and Registrars
CIBC Mellon Trust Company, Toronto
Mellon Investor Services LLC, New York

Share Listings
Toronto and New York Stock Exchanges
Stock Symbol: FFH

Annual Meeting
The annual meeting of shareholders of Fairfax
Financial Holdings Limited will be held on
Wednesday, April 18, 2007 at 9:30 a.m.
(Toronto time) in the Glenn Gould Studio at
the Canadian Broadcasting Centre, 250 Front
Street West, Toronto, Canada

Paul L. Murray
President, Pinesmoke Investments

Brandon W. Sweitzer
Senior Fellow, U.S. Chamber of Commerce

V. Prem Watsa
Chairman and Chief Executive Ofﬁcer

Operating Management
Canadian Insurance – Northbridge
Mark J. Ram, President
Northbridge Financial Corporation

Craig Hurford, President
Commonwealth Insurance Company

John M. Paisley, President
Federated Insurance Company of Canada

Richard Patina, President
Lombard General Insurance Company of Canada

Silvy Wright, President
Markel Insurance Company of Canada

U.S. Insurance
Nikolas Antonopoulos, President
Crum & Forster Holdings Corp.

Asian Insurance – Fairfax Asia
James F. Dowd, Chairman and CEO
Fairfax Asia

Sammy Y. Chan, President
Fairfax Asia

Kenneth Kwok, President
Falcon Insurance Company (Hong Kong) Limited

Ramaswamy Athappan, Principal Ofﬁcer
First Capital Insurance Limited

Reinsurance – OdysseyRe
Andrew A. Barnard, President
Odyssey Re Holdings Corp.

Runoff
Dennis C. Gibbs, Chairman
TRG Holding Corporation

Other
Jan Christiansen, President
Cunningham Lindsey Group Inc.

Ray Roy, President
MFXchange Holdings Inc.

Roger Lace, President
Hamblin Watsa Investment Counsel Ltd.

141