exv10w38



 






Exhibit 10.38




Amendment Number 1 to Investment Agreement



This Amendment Number 1 (“Amendment”) to the Investment Agreement (“Agreement”) dated as January 1,
2002, between Seneca Specialty Insurance Company and Hamblin Watsa Investment Counsel Ltd. and
Fairfax Financial Holdings Limited is effective as of January 1, 2005.





	 	1.	 	Capitalized terms used herein but not defined herein shall have the meanings ascribed
to them in the Agreement.
	 
	 	2.	 	Schedule A is hereby amended to read in its entirety as attached hereto.
	 
	 	3.	 	Unless specifically modified in this Amendment, all other terms and conditions
contained in the Agreement shall remain in full force and effect.




IN WITNESS WHEREOF, the parties hereto have caused their duly authorized officers to execute this
Amendment as of the date written below.




	 	 	 
	Hamblin Watsa Investment Counsel Ltd.
	 	Seneca Specialty Insurance Company
	 	 	 
	By: /s/ Paul Rivett
	 	By: /s/ Dennis J. Hammer
	 
	 	 
	Authorized Signature
 


Paul Rivett
	 	Authorized Signature
 


Dennis J. Hammer
	 
	 	 
	Printed Name
 


Vice President
	 	Printed Name
 


Vice President
	 
	 	 
	Title
	 	Title
	 	 	 
	Fairfax Financial Holdings Limited	 	 
	 	 	 
	By: /s/ Paul Rivett

 

Authorized Signature
 


Paul Rivett

 

Printed Name
 


Vice President

 

Title	 	 






 









 






SCHEDULE A




INVESTMENT GUIDELINES




FUNDAMENTAL OBJECTIVES





	1.	 	Invest on a long-term basis in accordance with applicable insurance regulatory guidelines.
	 
	2.	 	Ensure preservation of invested capital for policyholder protection, always providing
sufficient liquidity for the payment of claims and other policy obligations.





GUIDELINES





	1.	 	Approach
	 
	 	 	All investments are to be made using the long-term value investing approach by investing in
the securities of companies and other entities at prices below their underlying long-term
values to protect capital from loss and earn income over time and provide operating income
as needed.
	 
	 	 	With regard to equity securities, the investment manager will attempt to identify
financially sound companies and other entities with good potential profitability which are
selling at large discounts to their intrinsic value. Appropriate measures of low prices
may consist of some or all of the following characteristics: low price earnings ratios,
high dividend yields, significant discounts to book value and free cash flow. Downside
protection is obtained by seeking a margin of safety in terms of a sound financial position
and a low price in relation to intrinsic value. Appropriate measures of financial
integrity which are regularly monitored, include debt/equity ratios, financial leverage,
asset turnover, profit margin, return on equity and interest coverage.
	 
	 	 	As a result of this long-term value investing approach, it is anticipated that purchases
will be made when economic and issue-specific conditions are less than ideal and sentiment
is uncertain or negative. Conversely, it is expected that gains will be realized when
issue-specific factors are positive and sentiment is buoyant. The investment time horizon
is one business cycle (approximately 3-5 years).
	 
	 	 	With respect to fixed income securities, the long-term value investing approach is similar.
The investment manager will attempt to purchase attractively priced bonds offering yields
better than treasury bonds with maturities of 30 years or less that are of sound quality,
i.e. whose obligations are expected to be fully met as they come due. Rating services are
not regarded as an unimpeachable source for assessing credit quality any more than a
broker’s recommendation on a stock is necessarily correct. With any form of investment
research and evaluation, there is no substitute for the reasoned judgment of the investment
committee and the investment manager.
	 
	2.	 	Liquidity
	 
	 	 	An adequate cash flow shall be maintained to ensure that claims and operating expenses are
paid on a timely basis. An operating cash position is to be maintained at appropriate
levels and will be managed by the insurance company in accordance with an approved list of
liquid investments, as determined from time to time by the investment committee. These
securities will be managed by the insurance company as part of the treasury function and
are primarily restricted to treasury and agency securities of the U.S. government.
	 
	3.	 	Regulatory
	 
	 	 	All applicable insurance regulations will be complied with.





	4.	 	Diversification
	 
	 	 	The portfolio is to be invested in a wide range of securities of different issuers
operating in different industries and jurisdictions in order to diversify risk.
	 
	5.	 	Prudent Person Rule
	 
	 	 	Prudent investment standards are considered in the overall context of an investment
portfolio and how a prudent person would invest another person’s money without undue risk
of loss or impairment and with a reasonable expectation of fair return.
	 
	6.	 	Investment Committee
	 
	 	 	The board of directors of the insurance company shall appoint an investment committee of
the investment manager as the investment committee of the insurance company. The
investment committee shall meet at least once each quarter to review the investments and
loans of the insurance company.





 









 






STRATEGY





	1.	 	Maintain Adequate Liquidity
	 
	 	 	A detailed review of portfolio liquidity is undertaken on a periodic basis. This liquidity
analysis determines how much of each portfolio is in cash or can be converted into cash in
a given time period. The insurance company determines its near term liquidity requirements
and the liquidity of the portfolio will be modified from time to time to match such near
term requirement.
	 
	2.	 	Asset Allocation
	 
	 	 	The asset allocation will be determined by the investment manager and will include
short-term investments that will generate appropriate cash flows and long-term investments
such as stocks and bonds, both domestic and foreign, that generate investment gains. The
asset allocation will be monitored from time to time in order to comply with regulatory
guidelines and meet insurance policy liabilities.
	 
	3.	 	Foreign Exchange Risk
	 
	 	 	The investment manager shall use its discretion to hedge any foreign currency investments
and exposures. The investment manager may use a variety of methods to reduce such
exposures, including forward foreign exchange contracts, currency options and natural
hedging with foreign pay liabilities of the insurance company. Un-hedged foreign
investments will be limited to 15% of admitted assets at cost, subject to adjustment to
conform with applicable insurance regulatory requirements. Un-hedged exposure above this
amount must be approved by the investment committee.
	 
	4.	 	Interest Rate Risk
	 
	 	 	Interest rate risk will be minimized primarily through investment in a variety of term to
maturity fixed income securities with maturities less than thirty years. Maximum fixed
income portfolio duration is limited to the equivalent of a twenty year term to maturity
treasury security.





INVESTMENT CLASS EXPOSURE



The following exposure ranges established by the investment committee shall be monitored and
maintained by the investment manager for the stated asset classes:




	 	 	 	 	 	 	 
	Class	 	Range	 	 	 
	 	 	 	 	 	 
	Equities
	 	0-25%	 	 	 	 
	Fixed Income
	 	0-100%	 	 	 	 





Within the fixed income portfolio, the taxable/tax exempt mix will be determined relative to the
consolidated tax position of the insurance company and its affiliates and the relative investment
attractiveness of available tax exempt securities.



The investment committee will monitor the total asset class exposure and, if deemed appropriate,
will provide specific direction from time to time to the investment manager with respect to the
asset exposure ranges.




RETURN EXPECTATIONS



The foregoing asset class exposure is expected, on an annual basis, to result in returns better
than the Consumer Price Index plus 3% over a ten year period before the disbursement of investment
management fees. However, in any one year the annual return may be significantly above or below
this expectation.




INVESTMENT OBJECTIVES OF THE INVESTMENT MANAGER



The investment manager, subject to regulatory and insurance company imposed constraints mentioned
elsewhere, expects to provide additional returns to those returns that would be earned by the
alternative of passively managing a surrogate market index.



Measured over four year moving periods, performance of the investment manager is expected to result
in the following returns:




	 	 	 
	All Equities

	 	S&P 500 + 1% point
	 
	 	 
	Fixed Income:
	 	 
	Taxable Bonds

	 	Merrill Lynch Intermediate Treasury Index + 0.25%
	Tax-Advantaged Bonds

	 	Lehman Brothers 3 & 5 Year State GO Indexes





 









 






AGGREGATE INVESTMENT LIMITS, PERMITTED INVESTMENT CATEGORIES AND INDIVIDUAL INVESTMENT LIMITS




PERMITTED INVESTMENT CATEGORIES WITHIN ASSET CLASSES



The following are some examples of permitted investments within each asset class:




	 	 	 
	Equity

	 	Common shares, rights and warrants.
	 
	 	 
	Fixed Income

	 	Bonds, debentures, preferred shares, including those
convertible into common shares.
	 
	 	 
	Cash

	 	Cash on hand, demand deposits, treasury bills, short-term
notes and bankers’ acceptances, term deposits and guaranteed
investment certificates.





All of the above may be either U.S. domestic, Canadian or other foreign investments.



Convertible preferred securities will be classified as equities if the preferred dividend is not
being paid.



Private placement issues in public companies are allowed.




INVESTMENT CONSTRAINTS



All investments will be made in accordance with applicable insurance legislation as amended from
time to time.




INDIVIDUAL INVESTMENT LIMITS



Any combination of investments in any one corporate issuer will be limited to a maximum of 10% of
admitted assets.




QUALITY CONSTRAINTS



The investment manager may invest in permitted investment categories subject to the following
quality constraints:





	 	 	 	Investments in money market instruments (less than or equal to 1 year term) will be limited
to those included on the list approved by the insurance company. This list will include
money market instruments of the U.S. Treasury, agencies of the U.S. government, and as a
minimum commercial paper rated A1 or higher by Moody’s and rated P1 or higher by Standard &
Poor’s.	 
	 
	 	 	 	Investments in bonds and preferred securities will be limited by bond rating category as
follows:	 
	 
	 	 	 	LIMITS AS % OF ADMITTED ASSETS	 





	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 
	Bond Rating	 	% of Total	 	 	Min./Max.	 	 
	A or better
	 	 	50%	 	 	Min.	 
	BBB
	 	 	50%	 	 	Max.	 
	Less than BBB
	 	 	20%	 	 	Max.	 







	 	 	 	The above limits are subject to adjustment to conform with applicable insurance regulatory
requirements.
	 
	 	 	 	Limits are determined on a cost basis and include convertible securities.
	 
	 	 	 	Downgrades will be taken into account when making new investments but will not necessarily
result in the sale of existing positions.
	 
	 	 	 	Securities which are not rated by any public rating agency must be rated by the investment
manager and included as part of the categories above for the purposes of determining overall
exposure by bond rating category.
	 
	 	 	 	Any exceptions to the above must be approved by the investment committee.





PROHIBITED INVESTMENTS



In addition to any applicable insurance legislation prohibitions:





	(a)	 	No Real Estate will be purchased without investment committee approval.
	 
	(b)	 	No Mortgages on real estate will be purchased without investment committee approval. The
exceptions to this are obligations issued by an agency of the U.S. Government, or by U.S.
domiciled corporations that are issued as part of a registered public offering that also meet
the minimum quality tier requirements.





FOREIGN INVESTMENT LIMITS



Foreign securities may be purchased in compliance with applicable insurance legislation and with
the policy on foreign exchange risk outlined herein. Unless otherwise required by applicable
insurance legislation, Canadian securities shall not be considered foreign securities and
securities issued by U.S. domestic companies or other U.S. domestic entities that are denominated
in foreign currencies shall not constitute foreign securities.




OTHER



Derivative securities may be purchased up to 7.5% of the portfolios cost at book, subject to
adjustment to conform with applicable insurance regulatory requirements. Use of derivative
investments is infrequent and primarily for hedging purposes. The aforementioned limit on the
purchase of derivative securities shall not apply to traditional securities with limited embedded
derivative components such as convertible bonds and optional maturity date bonds.