Unsure Times for Insurer Fairfax Financial

Next, Fairfax must explain the role of obscure offshore subsidiaries. The fear among some investors is that the subs are being used to move cash from regulated U.S. companies to the Fairfax parent, where liquidity is getting tighter. Recall that Conseco, which recently filed for bankruptcy protection, consistently struggled to raise money from its insurance and finance units to meet parent company expenses and pay off its burdensome obligations.

At the root of Fairfax's problems, however, are the reserves for losses at its U.S. property and casualty subs, including TIG and Crum & Forster. These entities look deeply underserved, which could prompt regulatory action and thus deprive the parent company of cash it needs from its subs.

Bottom line? If things go badly for Watsa, Fairfax could face the mother of all liquidity crunches over the next 18 months.

Farifax declined to comment on a list of questions, saying: "We believe our annual report is the best forum to answer shareholder questions."

Fairfax stock rose $1.65 Wednesday to $78, leaving it 40% off its 52-week high. That steep drop has drawn in bargain hunters, who lick their lips at the fact that Fairfax's market worth of $1.1 billion is under half its book value of $2.3 billion at the end of the third quarter. (Dollar amounts are expressed here in U.S. currency, converted at the current exchange rate from Canadian dollars.)

Hanging in the Balance

The value investor's book value approach fails to hold up if Fairfax's assets are lower than the balance sheet indicates and liabilities are in fact higher. On the asset side, one item looks particularly doubtful: a deferred tax asset, which represents tax deductions Fairfax might be able to take on future profits. Notably, to utilize these deductions, Fairfax subs will actually have to show strong profits, which they didn't in the first nine months of 2002. For example, Fairfax's third-quarter numbers show the U.S. subs making an operating profit of just $5 million.