Odyssey Re Group. Secondary Contact: John Iten, New York (1) ; Factors Specific To Holding Company

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1 Primary Credit Analyst: Pablo A Feldman, ASA, New York (1) ; pablo_feldman@standardandpoors.com Secondary Contact: John Iten, New York (1) ; john_iten@standardandpoors.com Table Of Contents Major Rating Factors Rationale Factors Specific To Holding Company Outlook Competitive Position: A Diversified Reinsurance And Insurance Platform With Global Reach Management And Corporate Strategy: A Total Return Philosophy Enterprise Risk Management: Adequate Accounting Operating Performance: Strong, Disciplined Underwriting Combined With Value Investing Investments And Liquidity: A Strength To The Ratings Capitalization: Strong Financial Flexibility: Strong, Aligned With FFH DECEMBER 19,

2 Table Of Contents (cont.) Related Criteria And Research DECEMBER 19,

3 Major Rating Factors Strengths: Well-diversified, global footprint in reinsurance and specialty insurance. Strong operating performance. Strong capitalization. Core and largest member of Fairfax group of companies. Weaknesses: Susceptible to earnings volatility because of natural-peril and man-made catastrophes. Reserving risk due to long-tail casualty writings. High allocation to common stocks. Holding Company: Odyssey Re Holdings Corp. Counterparty Credit Rating Local Currency BBB-/Positive/-- Operating Companies Covered By This Report Financial Strength Rating Local Currency A-/Positive/-- Rationale The insurer financial strength ratings on Odyssey Re Holdings Corp.'s (ORH) operating reinsurance and insurance subsidiaries--odyssey Reinsurance Co. (ORC) and Hudson Specialty Insurance Co. (collectively referred to as Odyssey Re Group)--are based on their core position as wholly owned subsidiaries of Fairfax Financial Holdings Ltd. (FFH). The ratings are also based on the company's well-diversified global footprint in reinsurance and specialty insurance and strong operating performance supported by disciplined underwriting and successful value investing. Offsetting these positive factors are catastrophe exposure that can lead to earnings and capital volatility, high allocation to common stocks, and reserving risk due to long-tail casualty writings. However, these weaknesses are somewhat offset by the insurer's strong capitalization. Odyssey Re Group's competitive position is strong. Originally known as a casualty treaty reinsurer mostly in the U.S., Odyssey Re Group has gradually changed its business mix and geographic footprint since FFH's acquisition of its predecessor companies in 1996 and Specialty insurance writings currently represent about 35% of total writings, and reinsurance the remaining 65%. Geographically, about 43% of total writings are non-u.s., with the reinsurance segment more global and the insurance segment more U.S.-focused. Casualty writings account for 36%, property writings for 46%, and other lines for the remaining 18%. The reinsurance segment has shifted away from casualty lines of business toward property, surety, and other specialty lines. The focus of the insurance segment is specialty lines, such as tribal insurance, professional liability, health care, and crop. In 2011, the company wrote $2.4 billion gross written premiums (GWP) supported by an equity base of about $3.3 billion. We view Odyssey Re Group's operating performance as an important factor supporting the ratings. From 2007 to 2010, the group reported an average combined ratio of 98%, an average return on revenue (ROR) excluding realized gains and losses on investments of 13%, and annual return on average shareholder's equity (ROAE) of 16.5%. Performance in 2011 was substantially affected by a high level of property catastrophe losses during the year that resulted in a combined ratio of 117%, negative ROR, and negative ROAE. We see this deterioration in earnings as the DECEMBER 19,

4 result of a year of high catastrophe losses, and not as an indication of prospective deterioration in underwriting performance, as demonstrated by a combined ratio for the first nine months of 2012 of 86.5% and ROR of 19%. Odyssey Group's investments are managed by Hamblin-Watsa Investment Counsel (HWIC), a fully owned subsidiary of Fairfax. HWIC is an active investment manager, and the investment allocations at FFH and its subsidiaries are more dynamic than the asset portfolios of most other insurers. Furthermore, their portfolio allocation, can be, at times, more weighted toward equities than other property and casualty companies'. Odyssey Re Group allocated about 16% of its investments to common stock as of Sept. 30, The equity portfolio is currently hedged using total return swaps (TRS), which are positioned to protect the company's capital from a major downturn in equity markets, but may offer less protection when downward equity movements are less severe. While the intention of TRS strategy is to protect the company from downside equity risk, these instruments can also introduce additional risk to the company, somewhat diminishing the benefits. The residual equity risk retained by the company from this strategy relates to the fact that the portfolio Odyssey Re Group owns can behave differently than the equity index referenced by the TRS, also known as basis risk. In addition, the company also retains liquidity risk and counterparty credit risk relating to this equity portfolio (see section below on investments). Odyssey Re Group's strong capitalization benefits from low operational leverage (i.e. ratio of net premiums written to GAAP equity), negligible intangible assets, and high credit quality reinsurance recoverables. Even though the company still has exposure to pre-1999 liabilities, virtually all of its asbestos and environmental (A&E) liabilities were transferred to a Fairfax affiliate effective Jan. 1, A factor that partially offsets the company's capital adequacy position is uncertainty related to its substantial casualty reserves (about 67% of total reserves), which are usually medium- to long-tail. The group's exposure to natural-peril and man-made catastrophes also offsets its strong capital adequacy. Standard & Poor's considers Odyssey Re Group to be a core operation of FFH based on its contributions of about 35% of FFH's consolidated float and 40% of FFH's consolidated GWP. In the past five years, as the largest group in the FFH family (with 40% of total consolidated shareholders' equity), Odyssey Re Group has consistently contributed a strong earnings stream to FFH. Factors Specific To Holding Company The counterparty credit rating on ORH reflects Standard & Poor's standard notching for a U.S.-based insurance holding company to the financial strength ratings on its core insurance and reinsurance subsidiaries. The three-notch difference reflects the holding company's dependence on dividends from its operating subsidiaries to meet debt service and preferred dividend obligations. The payment of dividends to ORH by its operating insurance/reinsurance subsidiaries is subject to limitations imposed by law in Connecticut, Delaware, New York, and the U.K. ORH's assets primarily consist of the shares in ORC. The holding company depends on the available cash resources, liquid investments and dividends, or other distributions from ORC to make payments. ORH received $100 million in dividends from ORC in the first nine months of 2012, none in 2011, $512 million in 2010 ($225 million in cash plus a dividend payable of $287 million related to the transfer of Clearwater Insurance Co. (CIC)), $200 million in 2009, $410 million in 2008, $155 million in 2007, and $60 million in 2006). ORH used those amounts primarily to pay interest on DECEMBER 19,

5 its senior notes and dividends on its preferred stock, to buy back its common stock, to fund other corporate expenses, and to pay common stock dividends to outside shareholders (before October 2009) and to its ultimate parent, FFH. ORH repurchased approximately $43 million of its outstanding senior notes in the first six months of 2011 and $68 million of its outstanding preferred stock in the fourth quarter of There was no repurchase activity in As of June 30, 2012, the company's financial leverage was conservative for the rating level. Total debt plus hybrid securities to total capital was 12% and fixed-charge coverage was 15x. In 2011, the group's fixed-charge coverage ratios decreased substantially from historical levels, primarily because of high catastrophes. In 2011, interest and fixed coverage were negative as compared to averages of 9x and 6x, respectively, in the period We don't see this reduction as an indication of reduced prospective coverage ratios for the group but more as a reflection of lower earnings resulting from a year of high catastrophe losses, as demonstrated by the substantial increase in these measures for the first nine months of Outlook Our rating outlook on Odyssey Re Group is positive, reflecting the one-in-three likelihood of a one-notch upgrade on FFH's core insurance and reinsurance operating companies in the next 12 months. Because it is a core company of FFH, we expect to revise our outlook on Odyssey Re Group only along with a corresponding revision of our outlook on FFH. We expect Odyssey Re Group to remain a core member of Fairfax Group, because it is the largest contributor to consolidated profits and premiums. For the full year 2012 and incorporating in our expectations a normalized annual level of property catastrophe losses of $285 million, we expect Odyssey Re Group to generate a combined ratio of about 91%-95% and ROR of about 12%-16%. In the absence of major catastrophe losses in 2013 (annual catastrophes losses below $285 million), we expect the combined ratio to be in the range of 94%-98% and an ROR of 10%-13%. Although we expect the company to earn strong total return on its investments in a multi-year period, the company is not immune to investment losses or depressed investment returns in a single year. We expect premium growth of about 5%-10% in 2012 and 2013, mostly as a result of increases in crop insurance and property reinsurance writings as well as in reinsurance premiums writings in Canada and Latin America. We expect capital to remain redundant for the current rating level, and we do not expect any major reserve strengthening in either 2012 or 2013 (as defined by two and a half percentage points of prior year's ending net loss reserves). As a privately held company, ORH is not expected to issue additional debt, and financial leverage should remain in the range of 10%-15% and fixed charge coverage in the 3x-5x range. Competitive Position: A Diversified Reinsurance And Insurance Platform With Global Reach Odyssey Re has a strong competitive position in the global reinsurance and specialty insurance arenas. The company has a diversified franchise by product, geography, and sector and operates through four divisions (Americas, EuroAsia, London Market, and U.S. Insurance) and under three brands (Odyssey Re in global reinsurance, Newline in global DECEMBER 19,

6 specialty insurance, and Hudson in U.S. specialty insurance). Odyssey Re Group wrote $2.4 billion in gross premiums in 2011 supported by an equity base of about $3.3 billion. The group is diversified by sector. Currently, insurance constitutes about 35% of Odyssey Re Group's gross premiums written and reinsurance accounts for the remaining 65% (compared with a 16%/84% split in 2001). The improved diversification by sector has resulted mainly from growth in specialty insurance writings. Geographically, GWP are well diversified, with about 57% coming from the U.S. and the remainder from the rest of the world. Growth in Europe, Asia, and Latin America and the company's decision to decrease U.S. casualty reinsurance treaty writings have helped international diversification, somewhat offset by growth in U.S. specialty insurance. In 2011, the split between U.S. and non-u.s. writings was nearly even (52%/48%). The company's reinsurance business is more global, with the U.S. accounting for 39% and the rest of the world (Europe, Asia-Pacific, Latin America, Canada, Middle East, and other countries and regions) accounting for the remaining 61%. In contrast, the company's insurance business is still focused on the U.S., which accounted for 74% of total insurance writings in The breakdown between short- and long-tail classes has substantially changed since the inception of Odyssey Re, and currently property represents 46% of total writings, casualty 36%, and other 18%. The mix within casualty has also substantially changed. For example, U.S. casualty reinsurance accounted for 10% of GPW in 2011, substantially down from 32% in 2002, but has been somewhat compensated for by increases in casualty insurance written by Hudson and Newline, which account for 70% of all casualty writings. The shift by sector, geography, and class has been a strategic move. Odyssey Re Group reacted to substantial pricing and margin deterioration in the U.S. casualty reinsurance market by shifting its product offerings away from commoditized products and more toward specialty, where margins are higher, underwriting expertise is more recognized, and client relationships are stronger. The shifts in the portfolio are also reflected in the breakdown of GWP by operating division: Currently, the Americas accounts for 40% of GWP, U.S. Insurance for 26%, EuroAsia for 21%, and London Market for the remaining 12%. This compares with 68%, 5%, 13%, and 14%, respectively, in 2001, a shift that resulted from increases in EuroAsia and U.S. insurance divisions' writings and reduction in the Americas division writings (mostly U.S. casualty reinsurance). The broker channel is the main distribution channel of Odyssey Re Group. The company's reinsurance business is produced through brokers (85%) and direct relationships (15%). As of June 30, 2012, about 39%, 18%, and 11% of Odyssey Re's reinsurance units gross premiums written were generated from, or placed by, AON, Marsh, and Willis Re, respectively. The direct reinsurance business is mainly written through the EuroAsia division, which has a 70%/30% split between brokers and direct channels. Newline's writings are mainly sourced through brokers, with AON, Marsh, and Willis Re together accounting for about 30% of the business. However, these brokers account for less than 10% of the U.S. Insurance division writings. Americas Americas is the largest division within Odyssey Re Group, though its contribution has steadily declined because of growth from other divisions and the decision of the group to decrease U.S. casualty treaty writings during softening casualty market conditions. Not only has the company reduced casualty writings by almost 70% since 2003 (about $230 million in 2011, down from $762 million in 2003), but it has dramatically reduced the hit ratios (i.e. the ratio of DECEMBER 19,

7 programs bound to programs submitted) on new casualty programs submissions since 2009 to low single-percentage points. In 2011, the Americas division produced $793 million of GPW, or 33% of the total group, substantially down from $1.4 billion in writings (or 56% of the total group) at the peak of the insurance industry cycle in Geographically, business is sourced from the U.S. (76%), Latin America (15%), and Canada (9%). The division focuses solely on reinsurance and underwrites casualty lines (30% of total premiums in 2011), property (50%), and specialty (20%). About 90% of business is treaty business and the remainder facultative. Odyssey Re does not write property facultative in the U.S. The company participates in about 75% of the top traditional surety reinsurance programs in the U.S. and is a recognized casualty facultative underwriter with about 9,000 annual submissions from about 300 cedents. Business from Latin America and Canada will increase with expanded capacity in those markets and new offices recently opened in Montreal and Sao Paulo. EuroAsia The EuroAsia division, with writings from about 60 different countries, accounted for approximately $607 million, or 25% of total GPW, in This division is more property oriented than the Americas with two-thirds of the premiums coming from property catastrophe and other property lines (about 68%) and the remaining premiums distributed as follows: motor 11%, credit 9%, marine 5%, liability 3%, aerospace 3%, and accident and health 1%. Geographically, Odyssey Re maintains a strong market position in the region, particularly in France and Japan (mostly property related coverages), which account for about 24% and 11% of the division's volume, respectively. Business is further complemented by premium production in the rest of Europe, the Middle East, and a growing presence in Asia. We expect Odyssey Re to remain well positioned in Europe and Asia even though the division's premium is expected to remain flat because of severe competition and the company's decision to write higher excess layers. London Market The London Market division produced $360 million, or 15%, of total GPW in 2011 and gives the group access to the insurance and reinsurance distribution channels available in the London market. It operates through three platforms: the London branch of ORC, Newline Insurance Co. Ltd. (NICL), and Lloyd's Syndicate This division generates insurance and reinsurance business through brokers. NICL and Lloyd's Syndicate 1218 comprise the insurance operations of the division and are branded as Newline Group, focused primarily on non-u.s. liability insurance. In 2011, insurance writings amounted to about two-thirds of the division's written premiums while the balance came from reinsurance through ORC's London branch. Newline focuses on international specialty casualty insurance (64% of total division writings) such as professional indemnity, medical malpractice, directors and officers (D&O), crime, products liability, and employers' liability. Even though Newline operates in a coinsurance market, it leads the vast majority of the business that it writes (i.e. it leads underwriting, pricing, and claims management of the majority of this portfolio). ORC's London branch underwrites worldwide treaty reinsurance, consisting of property (23% of total division writings), marine and aerospace (11% of total division writings), and international casualty (2% of total division writings). The London branch of ORC has refocused its business since 2006 away from U.S. catastrophe treaties to focus its property underwriting activity on the attractive property catastrophe retrocession market--mostly U.S. exposures retroceded by non-u.s. insurers. The branch does not write U.S. primary catastrophe treaty business. The London Market division is highly opportunistic, and the absolute premium volume and relative business mix between DECEMBER 19,

8 Newline and the ORC branch is expected to fluctuate according to market conditions. U.S. Insurance The U.S. Insurance division generated $660 million, or 27% of total GPW, in The division writes specialty lines on an admitted (80%; Hudson Insurance Co.) and nonadmitted (20%; Hudson Specialty Insurance Co.) basis through its primary operating companies. About two-thirds of the admitted business has significant rate and form flexibility. This division writes mainly casualty lines of specialty insurance with crop representing 23% of GWP in 2011, professional liability 23%, specialty liability 20%, medical malpractice 14%, commercial auto 11%, property and package 8%, and personal auto 1%. Within this division, Odyssey Re Group has been migrating to in-house underwriting from program administrator underwriting in order to have greater control over the business written, and currently 69% of the portfolio is underwritten in house compared with 31% in 2006 and 0% in The focus of this division is on market niches that require highly specialized underwriting capabilities (either product-based niches or geographic niches) such as (1) tribal insurance covering about 70% of the federally recognized tribes in the U.S., (2) crop insurance, (3) professional liability, and (4) health care liability with a focus on tort reform states. Prospective We expect Odyssey Re Group to remain a core member of Fairfax Group because Odyssey Re Group is its largest contributor to consolidated profits and premiums. Standard & Poor's expects the company to maintain its strong competitive position, remain very selective in its new business acquisition, and not write business that does not meet its profitability thresholds. We expect premium growth of about 5%-10% in 2012 and 2013, mostly as a result of increases in crop insurance writings, property reinsurance writings, and also reinsurance premiums writings from Canada and Latin America. Management And Corporate Strategy: A Total Return Philosophy We view Odyssey Re Group's management and corporate strategy as marginally positive and a strength to the ratings. The management team has been successful in converting several reinsurance companies acquired by FFH in the 1990s into a consistent global provider of reinsurance and specialty insurance based on a well-thought-out total return philosophy combining disciplined underwriting with value investing. We view the management team as experienced and stable, and its strategy is in line with that of the FFH group of companies. As soft market conditions continue to erode potential underwriting profitability, the company remains selective in new business acquisition, which we view favorably. Operational management Odyssey Re Group operates through four strategic operating divisions (Americas, EuroAsia, London Market, and U.S. Insurance) and 30 underwriting units. The reinsurance segment has a network of 12 offices around the world. The U.S. insurance segment has 10 offices in the United States, and the international insurance segment, based in London, has a network of four offices. The underwriting operations of each division are managed on a decentralized basis (but with centralized IT platforms and controls), while reserving, catastrophe exposure management, investments, and enterprise risk management activities are managed centrally at the corporate level. DECEMBER 19,

9 Financial management Odyssey Re Group targets book value growth of 15% on average and a combined ratio in the mid-90s throughout the underwriting cycle. Standard & Poor's views Odyssey Re Group's underlying insurance risk tolerance as relatively low, though its stated peak-zone catastrophe loss tolerance is relatively high, as measured by an after-tax loss of about 25% of statutory surplus of ORC per one-in-250-year event. Also, the company has a high allocation to common stocks. Enterprise Risk Management: Adequate Standard & Poor's views Odyssey Re as a core entity within FFH, so we do not assess Odyssey Re's enterprise risk management (ERM) processes on a stand-alone basis. Rather, we assess the ERM process of the entire FFH group (Fairfax). Standard & Poor's considers FFH's ERM to be adequate. Our overall score is consistent with our opinion of 'adequate' for all the components of our ERM evaluation. Standard & Poor's considers ERM to be highly important to the overall assessment of the financial strength ratings on Fairfax's operating insurance and reinsurance companies given the group's size, complexity, and exposure to a variety of risks. Risk management culture at Fairfax and its core insurance and reinsurance subsidiaries is considered adequate given appropriate risk governance structures at the holding company and subsidiary level, an independent ERM function that has a direct line to the CEO and board of directors, and a multi-level function across the entire organization. Fairfax's ERM governance and the overall function have been improved in terms of influence in recent years--this is also consistent with our opinion of improving corporate governance structures. The group is enhancing communications and actively looks to leverage expertise across its business units and disciplines. However, many of these improvements are recent in nature. While we view the overall ERM framework as adequate, we do note some of the business units (in particular Odyssey Re Group) stand out as having better vetted ERM frameworks and risk controls. We view investment risk controls as adequate. Investments for the Fairfax Group are managed by HWIC, a fully owned subsidiary and the investment arm of Fairfax. Corporate ERM is highly involved in investment risk controls and monitoring as the CRO is part of the executive committee where investments issues are broadly discussed. HWIC's track record clearly shows that the company has managed to withstand multiple business cycles without exhibiting undue downside volatility. The track record is complemented by an infrastructure that tracks all transactions and checks that allocation are within tolerances and in compliance with the broad regulatory bodies that supervise the subsidiaries across the globe. Partially offsetting our positive views about HWIC's track record is that some of the market risk controls appear to be less structured compared to peers. In addition, the exposure to the equity markets and the hedges introduce basis risk and a certain amount of accounting volatility. We view property/casualty insurance underwriting risk controls as adequate. The subsidiaries have corporate support to implement cycle management strategies and reduce writings during soft market cycles without any pressure on top line growth. While the cycle management in terms of loss ratio containment is viewed positively, we would continue to look for defined prospective plans to improving the underwriting performance and results. Reserve/claims risk controls are adequate as evidenced by multiple loss reserve reviews at the different levels of the DECEMBER 19,

10 organization, robust reserve controls at the operating company levels, and consistent reserve releases from ongoing operations in the last five years. The actuaries of the major subsidiaries, including those of the runoff segment, are responsible for individual subsidiaries' reserve assessments, which are further reviewed for consistency by the actuaries in the corporate ERM department at the holding company level. We view catastrophe risk controls as strong. Fairfax manages its consolidated one-in-250 aftertax PML to no more than 15% of consolidated shareholders' equity (about 23% pre-tax). It is noteworthy that the group has moved the majority of its catastrophe exposure to its main reinsurance subsidiary, namely Odyssey Re Group, and has drastically reduced the catastrophe exposure to $25MM-$30MM at each of its primary subsidiaries to prevent accumulation of losses. Counterparty credit risk is viewed as adequate as it is aggregated and viewed at the corporate level to minimize any potential credit risk or overdependence on any one reinsurer. However, there is not yet a formal corporate-wide limit set for any one reinsurer. In addition, Fairfax's operational risk controls are considered adequate. Emerging risk management is considered adequate. Emerging risks are discussed regularly in global risk committee meetings. Fairfax's management of emerging risks is evidenced by its stable and very strong historical investment performance over economic cycles, particularly in 2008 during the financial markets turmoil. The insurance-related emerging risk identification, monitoring, and mitigation are still evolving in terms of maturity compared to some of its peers. We view risk models at Fairfax as adequate. The (re)insurance subsidiaries use a wide variety of models for underwriting, pricing, catastrophe management, and capital modeling, whereas the holding company is more focused on consolidated capital modeling and catastrophe modeling. Fairfax utilizes rating agencies and regulatory capital models, and uses an enterprisewide deterministic capital model to aid in scenario and stress testing. Odyssey Re Group, for its part, built up a stochastic economic capital model and is able to quantify exposure to major risk sources on a quarterly basis. Fairfax is looking to expand its economic capital model from its use in Odyssey Re Group to a corporatewide level, but this is still very much in the beginning stages. A score of adequate for strategic risk management is driven positively by the management's focus on minimizing downside. However, it is our opinion that the processes for evaluating risk reward trade-offs on an enterprise wide basis are not evolved. However, the group plans to adopt the economic capital model already in place at Odyssey Re and utilize it across the organization. We do recognize the advancements and plans that the group has made in its ERM framework and the level of sophistication that the operating companies have achieved, and hence we consider that some of the ERM component scores may be revised upward over the next 24 months if Fairfax maintains this momentum and enhances its controls in accordance with its risk profile. Accounting Because Odyssey Re has been a private company since 2009, its U.S. GAAP consolidated financial statements are DECEMBER 19,

11 Standard & Poor's primary source of its accounting, as well as the individual statutory regulatory filings of its operating subsidiaries. On Jan. 1, 2011, Odyssey Re transferred the ownership of CIC to TIG Insurance Group, which holds other Fairfax runoff operations. As a result, approximately $460 million of net loss reserves, including about $280 million of A&E net loss reserves, were moved from Odyssey Re Group to FFH's runoff segment. The transaction ultimately has transferred potential adverse reserve development risk from loss reserves related to A&E claims--which are highly correlated with uncertain legal outcomes. Notwithstanding the benefits to Odyssey Re Group, the economics of the transaction have resulted in lower investment income as well as a reduction in the group's capital base. Operating Performance: Strong, Disciplined Underwriting Combined With Value Investing Standard & Poor's views Odyssey Re Group's underwriting and operating performance as strong. From 2007 to 2010, the group reported an average combined ratio of 98% (95% excluding A&E incurred losses), an average return on revenue (ROR) excluding realized gains and losses on investments of 13%, and annual return on average shareholders' equity (ROAE) of 16.5%. Performance in 2011 was substantially affected by a high level of property catastrophe losses during the year that resulted in a combined ratio of 117%, negative ROR, and negative ROAE. We see this deterioration in earnings as a result of a year of high catastrophe losses and not as an indication of prospective deterioration in underwriting performance, as demonstrated by a combined ratio for the first nine months of 2012 of 86.5% and ROR, excluding realized investment gains and losses, of 19%. Given the demonstrated and consistent strategy of HWIC to harvest capital gains, we also look at the operating performance of FFH and its subsidiaries, including a share of their realized capital gains and losses. From 2007 to 2011, the ROR including realized investments gains and losses but excluding gains on credit default swaps (CDS) was 20% (10% excluding all realized gains and losses). The strong investment performance during 2007 to 2011 (i.e. annual average net investment income of $300 million and annual average realized investment gains of $210 million excluding gains on CDS) has benefited operating performance in the period. Although HWIC has historically produced a high level of realized investment gains over the long term, results on an annual basis are volatile. In 2011, Odyssey Re Group generated a combined ratio of 116.8% (98.6% in 2010)--including 2.6% (0.2% in 2010) net favorable reserve development of prior years' reserves--and an underwriting loss of $339.2 million ($27.2 million gain in 2010). Catastrophe losses were $762.5 million and $222.2 million in 2011 and 2010, respectively, which contributed to 38 percentage points and 12 percentage points to the combined ratio in those years. The ROR excluding realized capital gains and losses on investments was negative 5% in 2011, down from 13% in The catastrophe losses in 2011 reflect the potential volatility of Odyssey Re Group's earnings. However, the company's 2011 pretax catastrophe loss as a percentage of shareholders' equity was better than that of some of its peers, as was also the case in 2005, 2008, and In the first nine months of 2012, Odyssey Re Group generated a combined ratio of 86.5% (including 1.8% net favorable reserve development of prior years' reserves mostly related to prior years' catastrophe losses), an ROR of 19%, and an DECEMBER 19,

12 underwriting gain of $230 million. This compares with a 114.6% combined ratio (including 0.4% net favorable reserve development of prior years' reserves), negative 3% ROR, and an underwriting loss of $216.0 million for the same period in The significant improvement in underwriting performance has been mainly driven by the reduction of catastrophe losses in the first nine months of 2012 to $97.7 million (5.8 percentage points of the combined ratio) from $453.2 million in the same period in 2011 (30.9 points of the combined ratio). Expense ratio for the first nine months of 2012 was 27%, in line with the same period in 2011, and pretax operating income was $325 million as compared to a loss of about $66 million in the same period in Prospective For the full year 2012 and incorporating into our expectations a normalized annual level of property catastrophe losses of $285 million, we expect Odyssey Re Group to generate a combined ratio of about 91%-95% and ROR of about 12%-16%. In the absence of major catastrophe losses in 2013 (less than $285 million), we expect the combined ratio to be in the range of 94%-98% and the ROR to be 10%-13%. Although we expect the company to earn strong total returns on its investments in a multi-year period, the company is not immune to investment losses or depressed investment returns in a single year. Investments And Liquidity: A Strength To The Ratings We view Odyssey Re Group's investments as very strong. Odyssey Re, through FFH, follows a long-term value-oriented investment philosophy that emphasizes total return while preserving capital and providing sufficient liquidity for the payment of policyholders' claims. The investment portfolio of Odyssey Re Group is fully managed by HWIC, a company that has a long track record of successful investing, with long-term average historical performance above equity and fixed income indexes for the past 25 years. HWIC is an active investment manager, and the asset allocation is subject to a greater amount of change than the allocation of investment portfolios of most other insurers. We analyze the investment performance of FFH's subsidiaries, including that of Odyssey Re Group, on a total return basis (i.e. investment income plus a share of realized capital gains and losses on investments). During the period 2007 to 2011, net investment income at Odyssey Re Group accounted for $1.5 billion and realized investment gains excluding CDS gains $1.0 billion (and $1.6 billion including CDS gains). Odyssey Re's $8.7 billion investment portfolio was well diversified as of Sept. 30, 2012, and included municipal bonds (34% or $3 billion), cash and short-term investments (27% or $2.4 billion), government securities (9% or $0.8 billion), equities (16% or $1.4 billion), preferred stock (3% or $0.3 billion), corporate bonds (6% or $0.5 billion), and other (5% or $0.4 billion). Securities rated 'A' or higher comprise approximately 87% of the fixed income portfolio. As of Sept. 30, 2012, the average duration of the fixed-income portfolio including cash and cash equivalents and short-term investments is approximately 4.5 years and the average duration of insurance liabilities is about 4.3 years. The equity allocation (i.e. common stocks, convertible preferred stocks, and convertible bonds) is hedged by TRS, which have been purchased over the past two and a half years to protect the company's capital from a major downturn in equity markets. The current hedging strategy introduces three risks to the group that somewhat diminish its benefits: (1) liquidity risk, (2) counterparty credit risk, and (3) basis risk. DECEMBER 19,

13 Liquidity risk on equity hedging: This risk stems from the fact that Odyssey Re Group owns an equity basket and at the same time shorts TRS. Consequently, the company would generally be required to deliver cash to the TRS counterparty as equity markets increase, but would likely not receive cash from the equity basket as its value increases unless the equities owned are sold (the opposite would be true as markets decline). Considering Odyssey Re's current cash position, the group has sufficient liquidity resources to fund these posting requirements. Counterparty credit risk on equity hedging: Since Odyssey Re's TRS positions are over-the-counter derivatives, the instruments are subject to counterparty credit risk. This risk refers to the possibility that a counterparty may fail to make required payments under the TRS agreement. The net counterparty exposure after settlement and collateral arrangements for Fairfax consolidated was $143.1 million as of June 30, The major counterparties to the equity hedge are well known U.S. financial institutions that are rated investment grade and the contracts are generally reset quarterly. Basis risk on equity hedging: These hedges are subject to basis risk vis-à-vis the equity investments, whereby the change in value of the indices underlying the derivative instruments may not move exactly in line with the change in value of the company's equity portfolio. The basis risk could introduce negative investment performance to Odyssey Re Group under the following two scenarios: 1) given that the company is net "short" the TRS contracts, if the markets perform better than Odyssey Re Group's equity positions, this can result in a net economic loss position, and 2) in the case of a potential negative correlation between the long equity basket and short TRS (e.g., equity markets increase and Fairfax's equity portfolio decreases), an economic loss would comprise both a loss on the TRS positions and a loss on the equity portfolio. Odyssey Re currently holds sufficient capital to cover any losses that are likely to materialize under our ratings commensurate to stress scenarios for this risk. Liquidity Odyssey Re's liquidity remains strong, with 27% of its investments in cash, cash equivalents, or short-term investments as of Sept. 30, 2012 (about $2.4 billion). This is enough to cover the company's pretax gross property catastrophe exposure (at a return period of 250 years). Operating cash flows (adjusted for taxes paid on realized gains) were $243 million in 2011, $355 million in 2010, and $225 million in 2009 (unadjusted figures were $217 million, $264 million, and negative $3 million, respectively). There is an immediate debt maturity of $183 million in 2013 (and after that $125 million in 2015 and $50 million in 2016), which in our opinion does not create a rating concern due to the liquidity resources at Odyssey Re Group and Fairfax. Prospective Standard & Poor's expects investment performance to remain very strong and liquidity to remain strong. Because of the total return approach, we expect the company to produce strong total investment returns on a multi-year period, but low returns or losses in single years are possible. We expect the investment allocation at FFH and its subsidiaries to be subject to a greater amount of change than the asset portfolios of most other insurers/reinsurers. Capitalization: Strong We view Odyssey Re Group's capitalization as strong, based on our capital model and our views of the company's reserves and reinsurance. Shareholders' equity remained flat at $3.3 billion as of year-end 2011 as compared to year-end 2010 pro forma excluding CIC and increased to $3.6 billion as of Sept. 30, Our stand-alone pro forma capital model of Odyssey Re Group as of year-end ) includes a one-in-250 after-tax net PML catastrophe charge and 2) excludes any affiliated investments/loans, on which we apply a 100% capital DECEMBER 19,

14 charge. Even though the equity hedge provides protection to the company's capital in case of a major downturn in the equity markets, the equity hedge does not completely eliminate the equity risk at Odyssey Re Group. Hence, Standard & Poor's is currently not ascribing any credit in the capitalization analysis of Odyssey Re Group as a result of the equity hedge. The group's exposure to natural-peril and man-made catastrophes are factors that somewhat offset its very strong capital adequacy. Reserves We view Odyssey Re Group's loss reserves as adequate. By transferring the ownership of CIC to TIG, Odyssey Re Group has removed virtually all of its A&E reserves from its balance sheet, and hence we do not expect any major A&E reserve strengthening in the future. However, we still consider that Odyssey Re faces potential reserve risk because a significant proportion of its booked loss reserves are casualty related. As of Sept. 30, 2012, net loss reserves were $4.7 billion, about 55% of which were incurred but not reported reserves. Overall, reserve development has been fairly favorable since 2008 (based on GAAP financials). About 67% of total reserves are long-tail and the remainder short-tail. The uncertainty related to the company's substantial casualty reserves is a factor that partially offsets its strong capital base. Reinsurance Reinsurance utilization remained relatively moderate at 14% as of Sept. 30, Odyssey Re is largely a gross writer in property and casualty treaty reinsurance, but substantially protects its insurance operations and facultative business by using third-party reinsurance. The company's objective is to limit its peak zone net after-tax one-in-250-year per occurrence PML, including reinstatement premiums, to a maximum of 25% of its statutory surplus of ORC. As of Sept. 30, 2012, gross reinsurance recoverables totaled about $975 million and constituted about 27% of shareholders' equity. Excluding unrated reinsurers (which are largely collaterized), almost 100% of recoverables are rated 'A-' or above. Prospective In the absence of any major catastrophe, we expect Odyssey Re's capital adequacy in 2012 and 2013 to remain strong, reflecting strong operating performance supporting the capital base. We do not expect any major reserve strengthening in 2012 and 2013 (as defined by two and a half percentage points of prior year's ending net loss reserves). Financial Flexibility: Strong, Aligned With FFH Odyssey Re Group's financial flexibility is strong. As the largest group (approximately 40% of GWP) within the FFH group, Odyssey Re Group's financial flexibility is linked to that of its parent. On a consolidated stand-alone basis (including intermediary holding company ORH), financial leverage was a modest 12% and fixed coverage was 15x as of June 30, There is an immediate debt maturity of $183 million in 2013 (and after that $125 million in 2015 and $50 million in 2016), which in our opinion does not create a rating concern due to the liquidity resources at Odyssey Re Group and at Fairfax. Odyssey Re's financial flexibility also benefits its low level of reinsurance utilization. Related Criteria And Research Analysis Of Nonlife Insurance Operating Performance, April 22, DECEMBER 19,

15 Interactive Ratings Methodology, April 22, 2009 Table 1 Odyssey Re Holdings Corp./Business Statistics (Mil. $) --Year ended Dec Gross premiums written , , , , ,282.7 Change in gross premiums written (%) 11.7 (1.3) (4.3) 0.5 (2.3) Net premiums written , , , , ,089.4 Change in net premiums written (%) 12.7 (2.1) (6.7) (2.8) (3.3) Net premiums earned , , , , ,120.5 Change in net premiums earned (%) 6.8 (2.2) (7.2) (2.1) (4.7) Reinsurance utilization (%) Clearwater Insurance Co. transferred Jan. 1, Table 2 Odyssey Re Holdings Corp./Operating Statistics (Mil. $) --Year ended Dec Total revenue , , , , ,450.0 EBIT 2010 (58.1) EBIT adjusted 2010 (120.7) EBITDA 2010 (58.1) EBITDA adjusted 2010 (120.7) Net income (attributable to all shareholders) 2010 (66.0) Return on revenue (%) (5.3) Return on revenue (including realized capital gains/losses) (%) (2.3) Return on shareholders' equity (%) (1.9) Return on capital (%) (2.6) P/C: net commissions expense ratio (%) P/C: net expense ratio (%) P/C: net loss ratio (%) P/C: net combined ratio (%) P/C: net (favorable)/unfavorable prior year loss ratio (%) (2.6) (0.2) (0.6) (0.5) 1.9 P/C: net accident year loss ratio (%) P/C: net accident year combined ratio (%) Clearwater Insurance Co. transferred Jan. 1, Table 3 Odyssey Re Holdings Corp./Investment & Liquidity Statistics (Mil. $) --Year ended Dec Total invested assets , , , , ,779.4 Change in invested assets (%) (6.8) Total invested assets adjusted , , , , , DECEMBER 19,

16 Table 3 Odyssey Re Holdings Corp./Investment & Liquidity Statistics (Mil. $) (cont.) Net investment income Net investment yield (%) Net investment yield including realized capital gains/(losses) (%) Net investment yield including all gains/(losses) (%) Portfolio composition (% of general account invested assets) Cash and short-term investments (%) Bonds (%) Equity investments (%) Investments in partnerships, joint venture and other alternatives investments (%) Other investments (%) Clearwater Insurance Co. transferred Jan. 1, Table 4 Odyssey Re Holdings Corp./Capitalization Statistics (Mil. $) --Year ended Dec Total assets as reported , , , , ,501.0 Adjusted total assets , , , , ,713.8 Common equity , , , , ,557.2 Change in common equity (%) (8.9) Total adjusted capital , , , , ,536.8 Change in total adjusted capital (%) (13.2) (1.8) 15.6 Reinsurance and reserves Reinsurance utilization (%) Reinsurance recoverables to shareholders' equity (%) P/C: loss reserves to total shareholders' equity (%) P/C: loss reserves/net premiums written (%) Liquid assets/loss and unearned premium reserves (%) Clearwater Insurance Co. transferred Jan. 1, Table 5 Odyssey Re Holdings Corp./Financial Flexibility Statistics --Year ended Dec EBITDA interest coverage (x) (3.8) EBITDA fixed-charge coverage (x) (3.3) Debt leverage (%) Debt leverage including pension deficit as debt (%) Financial leverage (%) Financial leverage including pension deficit as debt (%) Qualifying hybrid leverage (HEC+IEC) ratio (%) DECEMBER 19,

17 Table 5 Odyssey Re Holdings Corp./Financial Flexibility Statistics (cont.) Clearwater Insurance Co. transferred Jan. 1, Ratings Detail (As Of December 19, 2012) Holding Company: Odyssey Re Holdings Corp. Issuer Credit Rating Local Currency Preferred Stock Senior Unsecured Operating Companies Covered By This Report Hudson Specialty Insurance Co. Financial Strength Rating Local Currency Counterparty Credit Rating Local Currency Odyssey Reinsurance Co. Financial Strength Rating Local Currency Issuer Credit Rating Local Currency Domicile BBB-/Positive/-- BB BBB- A-/Positive/-- A-/Positive/-- A-/Positive/-- A-/Positive/-- New York *Unless otherwise noted, all ratings in this report are global scale ratings. Standard & Poor's credit ratings on the global scale are comparable across countries. Standard & Poor's credit ratings on a national scale are relative to obligors or obligations within that specific country. DECEMBER 19,

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