Fairfax Financial is an insurance holding company that has followed a path to success similar to Berkshire Hathaway. When investing in Fairfax, you are really investing in CEO Prem Watsa’s abilities to allocate capital (the insurance float) into investments that are profitable. It is precisely Watsa’s ability to do this that has generated such above-average returns for shareholders over the past 25 years. Fairfax's insurance business has had little to do with the company's success other than providing the temporary capital with which to make its investments. I say “temporary” because that is exactly what Fairfax’s float has been. On average, Fairfax’s insurance business actually costs it 2% of float a year. But Watsa’s ability to seek out above-average returns has allowed for this 2% to be covered and still provide superior returns.

This cost of float is a substantial difference between Berkshire Hathaway and Fairfax. Berkshire has prided itself on being built upon high-quality insurance companies, where Fairfax's insurance portfolio has been mediocre over the years. Despite Fairfax’s mediocre underwriting history, there is reason to believe that insurance will play a more critical role in Fairfax’s returns in the near-future. One reason for this is the recent acquisition spree with purchases of high-quality insurers and taking many investments at equity private. If Fairfax can bring its average underwriting up a few notches, it can grow float at no cost (a goal of Watsa’s) and then investors can expect to add, on average, an additional 2% of float onto their returns on book value. This may not be substantial but that additional 2% can turn into wonders in Watsa’s hands if he continues compounding it at 20-25%. With a company that is worth only $8 billion and that pays a dividend/repurchases shares that consistently reduces capital, it should be a little easier