Description

E-L Financial (ELF) is an investment holding company that trades at a substantial discount to the sum of its parts. ELF’s strategy is to accumulate wealth within each area of investment. ELF has investments in 3 areas:
1) an investment portfolio of publicly traded fixed income and equity securities, owned both directly and indirectly through a number of closed-end investment fund corporations and other investment companies
2) a 100% interest in the Dominion of Canada General Insurance Company, a property and casualty underwriter,
3) an 80% interest in the Empire Life Insurance Company, a life and health underwriter.

Investment portfolio
First, this investment portfolio is outside of and in addition to the investment portfolios of ELF’s two insurance companies. The following table summarizes the market values of the investment portfolio (pre-tax) at December 31
2001 2000
Short-term investments $57.3mm $31.1mm
Bonds and debentures 118.5mm 118.7mm
Common and preferred stock 439.4mm 406.7mm
Total $615.1mm $556.4mm

The investment portfolio is carried at market value on the balance sheet and the difference between cost and market value is recorded as unrealized appreciation of investments (net of taxes) in shareholders’ equity. As at September 30, 2002, the market value of the investment portfolio net of taxes was $572.9mm or $149 per share.

Dominion of Canada General Insurance Company
In existence since 1887, Dominion is a mid-sized Canadian property and casualty insurer offering both personal and commercial products, distributed solely through its network of approximately 600 independent brokers. Dominion participates in all major lines of business in the property and casualty marketplace. Business line and geographic mix have been relatively consistent over the past few years. Automobile insurance comprises 63% of the business; personal property is 21% and commercial property and casualty lines account for 16%. Approximately 69% of Dominion’s business in based in Ontario, 15% in Alberta, 9% in the Atlantic provinces and 7% in British Columbia. The following table (in Canadian $ millions) summarizes Dominion’s operations:

Auto Pers. Property Comm Prop&Cas Total
2001 2000 2001 2000 2001 2000 2001 2000
Gross written premium
$415 $396 $142 $139 $104 $94 $661 $629
Growth
4.8% 7.2% 2.2% 3.0% 10.8% 6.6% 5.1% 6.2%
Mix of business
63% 63% 22% 22% 15% 15% 100% 100%
Net earned premium
$403 $381 $133 $129 $90 $84 $626 $594
Net income $36.5 $32.7
Return on avg equity 10.2% 10.1%

Dominion’s combined ratio declined to 106.4% in 2001 from 109.9% in 2000. The company views this as unacceptable (who doesn’t) and is working to get the combined ratio down. Management is disciplined and should be able to get the ratio to slightly above 100% (102%-103%).

The following table (in Canadian $ millions) summarizes Dominion’s invested assets (at amortized cost for bonds; cost for other categories) as at December 31:
2001 2000
Cash and short-term investments $89.5 (8%) $54.6
Bonds and debentures 535.1 (49%) 572.0
Preferred stock 105.1 (10%) 97.2
Common stock 324.1 (30%) 252.2
Mortgages and commercial loans 33.8 (3%) 32.4
Rental properties 1.8 1.8
Total $1,089.4 $1,010.2

Data for the nine months ended September 30 is as follows:
2002 2001
Revenue $560.8mm $527.4mm

Net income before investment gains $14.2mm $8.7mm
Investment gains $6.6mm $10.6mm
Total $20.8mm $19.3mm

Dominion’s book value at September 30, 2002 was $393.4million. Assuming a 1.3x to 1.5x book value multiple, Dominion is worth approx $511 million to $590 million or $133 to $154 per ELF share.

Empire Life Insurance Company
In existence since 1923, Empire Life is a stock company and has both shareholders and participating policyholders. Each group participates in the earnings of the Company. Shareholders are entitled to all the earnings of the non-participating section of the business and ten percent of the distributed income of the participating section of the business. ELF has an 80% interest in Empire Life.

Empire provides a full range of life insurance, investment plans and annuities, employee benefit plans and financial services to meet the needs of individuals, professionals and businesses through a network of regional financial resource centers and group sales offices across Canada and through an independent national network of Managing General Agents and their brokers. In terms of assets, Empire ranks among the top 15 of Canadian life insurance companies.

In 2001, 58% of premium income came from Ontario, 23% from Quebec, 16% from Western Canada and the remainder from the rest of Canada. The company has strong capital ratios and an A rating from AM Best.

The following table sets out the 2001 revenue derived from major lines of business (in Canadian $ millions):
Premium Invest & Other
Income Income Total
Individual Life and Health $149.9 $43.7 $193.6
Employee Benefits 120.6 4.8 125.4
Investment Products 70.9 109.8 180.7
Other - 38.9 38.9
Total $341.4 $197.2 $538.6

The following tables summarizes the 2001 net income contribution from each of the business lines (in Canadian $ millions):
2001 2000
Segregated Funds $5.0mm $7.2mm(decline due to market depn)
Investment Products (4.3) 4.9 (decline to reserve adds. for
adverse mortality experience)
Employee Benefits 3.1 0.1 (strong growth)
Individual Insurance 3.2 3.2
Capital & Surplus 21.0 18.8 (investment income)
Total $28.0mm $34.2mm

Net profit contribution
To ELF after policy-
Holder adjustment,etc. $29.6mm $32.1mm

The majority of the investment portfolio is in bonds with the majority of bonds being governments and high-grade corporates.

Data for the nine months ended September 30 is as follows:
2002 2001
Revenue $415.7mm $375.4mm

Net income before investment gains $2.7mm $8.5mm
Investment gains $10.1mm $10.0mm
Total $12.7mm $18.5mm

Empire’s book value at September 30, 2002 was approx $297 million. Assuming a 1.3x to 1.5x book value multiple, Empire is worth approx $386 million to $446 million or $100 to $116 per ELF share.

Other
The Jackman family (Hal Jackman was former lieutenant governor of Ontario) owns 35.1% of ELF. Third Avenue is also a shareholder. The company is opportunistic both in terms of acquisitions and divestitures. During the Canadian bank merger mania, they sold their National Trust operations at a very good price. ELF has a strong balance sheet with no debt and almost no goodwill, ideal for acquisitions.

One of the main reasons for the low share price is the fact that not a single investment analyst covers ELF. Furthermore, ELF has made little effort to make itself accessible to the average investor (high share price a la Berkshire Hathaway).

Conclusion
Value per share
Investment portfolio $149
Dominion $133 to $154
Empire Life $100 to $116
Total $382 to $419 (midpoint = $400)

At a price of $230, ELF trades at a substantial discount to the $400 sum of the parts valuation.

Catalyst

Share split, dividend increase (annual dividend is currently $0.50 per share), share buyback and cheap valuation.