.3

Management's Discussion and Analysis of Financial Condition and Results of Operations
(as of March 9, 2018)

(Figures and amounts are in US$ and $ millions except per share amounts and as otherwise indicated. Figures may not add due to rounding.)

Notes to Management's Discussion and Analysis of Financial Condition and Results of Operations

(1)

Readers of the Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") should review the entire Annual Report for additional commentary and information. Additional information relating to the company, including its annual information form, can be found on SEDAR at www.sedar.com. Additional information can also be accessed from the company's website www.fairfax.ca.



(2)

Management analyzes and assesses the underlying insurance, reinsurance and run-off operations and the financial position of the consolidated group in various ways. Certain of the measures and ratios provided in this Annual Report, which have been used historically and disclosed regularly in Fairfax's Annual Reports and interim financial reporting, do not have a prescribed meaning under IFRS and may not be comparable to similar measures presented by other companies.



(3)

The company presents information on gross premiums written and net premiums written throughout this MD&A. These two measures are used in the insurance industry and by management in evaluating operating results. Gross premiums written represents the total premiums on policies issued during a specified period, irrespective of the portion earned, and is an indicator of the volume of new business generated by the company. Net premiums written represents gross premiums written less amounts ceded to reinsurers and is considered a measure of the insurance risk that the company has chosen to retain from the new business it has generated.



(4)

The combined ratio is the traditional performance measure of underwriting results of property and casualty companies and is calculated by the company as the sum of the loss ratio (claims losses and loss adjustment expenses expressed as a percentage of net premiums earned) and the expense ratio (commissions, premium acquisition costs and other underwriting expenses expressed as a percentage of net premiums earned). Other ratios used by the company include the commission expense ratio (commissions expressed as a percentage of net premiums earned) and the accident year combined ratio (calculated in the same manner as the combined ratio but excluding the net favourable or adverse development of reserves established for claims that occurred in previous accident years). These ratios are calculated from information disclosed in note 25 (Segmented Information) to the consolidated financial statements for the year ended December 31, 2017 and are used by management for comparisons to historical underwriting results and to the underwriting results of competitors and the broader property and casualty industry.



(5)

The company's long equity total return swaps allow the company to receive the total return on a notional amount of an equity index or individual equity instrument (including dividends and capital gains or losses) in exchange for the payment of a floating rate of interest on the notional amount. Conversely, short equity total return swaps allow the company to pay the total return on a notional amount of an equity index or individual equity instrument in exchange for the receipt of a floating rate of interest on the notional amount. Throughout this MD&A, the term "total return swap expense" refers to the net dividends and interest paid or received related to the company's long and short equity and equity index total return swaps. The company's consolidated interest and dividend income is shown net of total return swap expense.



(6)

The measures "pre-tax income before net gains (losses) on investments", "net realized gains (losses) on investments", and "net change in unrealized gains (losses) on investments" are each shown separately in this MD&A to present more meaningfully the results of the company's investment management strategies. The two measures "net realized gains (losses) on investments", and "net change in unrealized gains (losses) on investments" are derived from the details of net gains (losses) on investments as presented in note 5 (Cash and Investments) to the consolidated financial statements for the year ended December 31, 2017, and their sum is equal to "net gains (losses) on investments" as presented in the consolidated statement of earnings.



(7)

In this MD&A the term "equity hedges" refers to equity and equity-related short positions held in the company's investment portfolio as part of the company's economic hedging strategy that was discontinued

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in the fourth quarter of 2016; the term "short equity exposures" refers to equity and equity-related short positions held for investment purposes since discontinuing the economic hedging strategy.

(8)

Ratios included in the Capital Resources and Management section of this MD&A include: net debt divided by total equity, net debt divided by net total capital and total debt divided by total capital. Those performance measures are used by the company to assess the amount of leverage employed in its operations. The company also calculates an interest coverage ratio and an interest and preferred share dividend distribution coverage ratio as measures of its ability to service its debt and pay dividends to its preferred shareholders. These ratios are calculated using amounts presented in the company's consolidated financial statements for the year ended December 31, 2017 and are explained in detail in note 24 (Financial Risk Management, under the heading of Capital Management).



(9)

Average annual return on average equity is a performance measure calculated for a reporting segment as the cumulative net earnings for a specified period of time expressed as a percentage of average equity over the same period, using net earnings and equity amounts from segment operating results and segment balance sheets respectively.



(10)

Book value per basic share (also referred to as book value per share) is a performance measure calculated by the company as common shareholders' equity divided by the number of common shares outstanding.



(11)

Intercompany shareholdings of insurance and reinsurance affiliates are presented as "Investments in Fairfax insurance and reinsurance affiliates" and intercompany shareholdings of non-insurance affiliates are presented within "Portfolio investments" on the segmented balance sheets and carried at cost. Total intercompany shareholdings are presented as "Investments in Fairfax affiliates" within the "Capital" section of the segmented balance sheets.



(12)

References in this MD&A to the company's insurance and reinsurance operations do not include its run-off operations.

Overview of Consolidated Performance

The insurance and reinsurance operations produced an underwriting loss of $641.5 and a combined ratio of 106.6% in 2017 compared to an underwriting profit of $575.9 and a combined ratio of 92.5% in 2016. The underwriting loss in 2017 principally reflected the impact of higher current period catastrophe losses, lower net favourable prior year reserve development and an increase in non-catastrophe loss experience related to the current accident year. The insurance and reinsurance operations reported an operating loss (excluding net gains (losses) on investments) of $215.7 in 2017 compared to operating income of $1,039.2 in 2016 primarily as a result of the underwriting loss incurred in 2017, and lower share of profit of associates. Net premiums written by the insurance and reinsurance operations increased by 26.2% in 2017, principally reflecting the acquisition of Allied World on July 6, 2017, increased business volumes at OdysseyRe, and the consolidation of full year results for acquisitions made in 2016 (primarily Bryte Insurance, AMAG and Fairfirst Insurance).

Net investment gains of $1,467.5 in 2017 (compared to net investment losses of $1,203.6 in 2016) were principally due to the gain on the company's reduction of its equity accounted interest in ICICI Lombard, and net gains on net equity exposure, partially offset by net losses on CPI-linked derivatives and U.S. treasury bond forward contracts that reduce exposure to interest rate risk. Interest and dividends increased to $559.0 in 2017 from $555.2 in 2016, primarily reflecting lower total return swap expense, the consolidation of Allied World's interest and dividends of ($65.9) and increased interest income earned on cash equivalents and short term investments, partially offset by lower interest income earned as a result of sales of U.S. treasury and municipal bonds late in 2016 and in the first quarter of 2017. At December 31, 2017 subsidiary cash and short term investments of $17,545.0 (excluding Fairfax India and Fairfax Africa) accounted for 47.5% of portfolio investments.

Net earnings of $1,740.6 in 2017 (compared to a net loss of $512.5 in 2016) primarily reflected net investment gains (compared to net investment losses in 2016), a gain on the sale of the company's 97.7% interest in First Capital, and an increase in share of profit of associates, partially offset by underwriting losses due to current period catastrophe losses and an increased provision for income taxes primarily due to the impact of U.S. tax reform. The company's consolidated total debt to total capital ratio decreased to 25.8% at December 31, 2017 from 28.7% at December 31, 2016 primarily as a result of increased total capital, partially offset by increased total debt. The increase in total capital primarily reflected increases in common shareholders' equity (principally from the issuance of 5,075,894 subordinate voting shares pursuant to the acquisition of Allied World), non-controlling interests

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(principally from consolidating Allied World, Grivalia Properties and Fairfax Africa) and total debt (principally from consolidating the borrowings of Allied World, Grivalia Properties and Fairfax Africa, and increased borrowings by Fairfax India). Common shareholders' equity increased to $12,475.6 ($449.55 per basic share) at December 31, 2017 from $8,484.6 ($367.40 per basic share) at December 31, 2016 (an increase of 24.7%, adjusted for the $10.00 per common share dividend paid in the first quarter of 2017).

Maintaining its emphasis on financial soundness, the company held $2,368.4 of cash and investments at the holding company level ($2,356.9 net of $11.5 of holding company short sale and derivative obligations) at December 31, 2017 compared to $1,371.6 ($1,329.4 net of $42.2 of holding company short sale and derivative obligations) at December 31, 2016.

Business Developments

Acquisitions and Divestitures

The following narrative sets out the company's key business developments in 2017 and 2016 by reporting segment. Unless indicated otherwise, all completed acquisitions described in the following paragraphs resulted in a 100% ownership interest in the acquiree. For further details about these acquisitions and transactions (including definitions of terms set out in italics), refer to note 23 (Acquisitions and Divestitures) to the consolidated financial statements for the year ended December 31, 2017 or the Components of Net Earnings section of this MD&A under the relevant reporting segment heading.

Crum & Forster

On October 4, 2016 Crum & Forster acquired Trinity, which focuses on occupational accident insurance and produces approximately $26 of gross premiums written annually.

Allied World

On July 6, 2017 the company acquired 94.6% of Allied World AG. Contemporaneously with the closing of the acquisition of Allied World AG, OMERS, AIMCo and certain other third parties ("the co-investors") invested funds for an indirect equity interest in Allied World AG. The remaining 5.4% of Allied World AG was acquired on August 17, 2017 in a merger transaction under Swiss law pursuant to which Allied World became the surviving entity. This merger resulted in the co-investors holding an indirect ownership in Allied World of 32.6%. Allied World is a global property, casualty and specialty insurer and reinsurer with gross written premiums of approximately $3.1 billion in 2017 (inclusive of gross written premiums prior to the acquisition by Fairfax).

Fairfax Asia

On December 28, 2017 the company completed the sale of its 97.7% interest in First Capital to Mitsui Sumitomo.

On August 30, 2017 Pacific Insurance acquired Prudential Assurance Malaysia, a general insurer in Malaysia.

On July 6, 2017 the company sold a 12.2% equity interest in ICICI Lombard to private equity investors. On September 19, 2017 the company sold an additional 12.1% equity interest through participation in ICICI Lombard's initial public offering. The company's remaining 9.9% equity interest in ICICI Lombard was reclassified from the equity method of accounting to common stock at FVTPL (fair value of $549.0 at December 31, 2017). On March 31, 2016 the company increased its ownership interest in ICICI Lombard to 34.6% by acquiring an additional 9.0% of ICICI Lombard from ICICI Bank.

On October 10, 2016 the company acquired an 80.0% interest in AMAG, an established general insurer in Indonesia. On December 31, 2016 Fairfax Indonesia was merged into AMAG.

On October 3, 2016 Union Assurance acquired Fairfirst Insurance, a general insurer in Sri Lanka. On February 28, 2017 Union Assurance was merged into Fairfirst Insurance.

Insurance and Reinsurance – Other

During 2017 the company completed the acquisition of the business and renewal rights of the insurance operations of AIG in Hungary, Czech Republic and Slovakia (effective from April 30, 2017), Turkey (on May 2, 2017 and sold to Gulf Insurance on the same day), Bulgaria (effective from May 31, 2017), Poland (effective from June 30, 2017) and

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Romania (effective October 31, 2017). Further, the company completed the acquisition of the insurance operations of AIG in Chile and Colombia (effective from July 31, 2017), Argentina (effective from September 30, 2017) and Uruguay (effective January 31, 2018).

On December 7, 2016 the company acquired Bryte Insurance, a property and casualty insurer in South Africa and Botswana.

Other

Subsequent to December 31, 2017

On March 9, 2018 the company received a performance fee of $114.4 for the period January 30, 2015 to December 31, 2017 in the form of 7,663,685 newly issued Fairfax India subordinate voting shares, which increased the company's equity interest in Fairfax India to 33.6% from 30.2% at December 31, 2017.

On March 7, 2018 the company acquired the services business of Carillion, an infrastructure services company.

On February 22, 2018 the company sold its 51.0% ownership interest in The Keg to Cara for consideration of $74.6 (Cdn$94.7), comprised of cash consideration of $7.9 (Cdn$10.0) and 3,400,000 Cara subordinate voting shares. The transaction increased the company's equity interest in Cara to 43.2% from 40.2% at December 31, 2017.

On February 20, 2018 Fairfax India entered into an agreement to acquire a 51.0% equity interest in The Catholic Syrian Bank Ltd. ("CS Bank") for approximately $186 (12.1 billion Indian rupees). CS Bank, headquartered in Thrissur, Kerala, offers banking services across India.

Years ended December 31, 2017 and 2016

On December 27, 2017 Quess acquired the facility management and catering business of Manipal primarily through issuance of Quess common shares to Manipal shareholders and the reinvestment of Quess' existing holdings of Manipal preferred shares upon cancellation of those shares. In November of 2017 Thomas Cook India sold a 5.4% interest in Quess. On August 18, 2017 Quess completed a private placement of common shares with institutional investors. These transactions collectively reduced the company's indirect ownership of Quess from 42.1% to 33.1%.

On December 1, 2017 Cara acquired Pickle Barrel, which operates restaurants and provides catering services in the province of Ontario, Canada.

On July 4, 2017 the company acquired control of Grivalia Properties by increasing its equity interest to 52.6% through the purchase of an additional 10.3% equity interest from Eurobank Ergasias S.A. Accordingly, the company re-measured its equity accounted carrying value of Grivalia Properties to fair value and commenced consolidating Grivalia Properties.

On March 14, 2017 Fairchem and Privi Organics completed their previously announced merger, with the merged entity continuing under the Fairchem name. Subsequent to the merger, Fairfax India, which had acquired a 44.7% interest in Fairchem on February 8, 2016 and a 50.8% interest in Privi Organics on August 26, 2016, became the dominant shareholder in Fairchem with a 48.7% interest. Privi Organics is a supplier of aroma chemicals to the fragrances industry and Fairchem is a specialty chemical manufacturer of oleochemicals used in the paints, inks and adhesives industries, as well as intermediate nutraceutical and health products.

On February 17, 2017 the company acquired 98.8% of the voting rights and 64.2% of the equity interest in Fairfax Africa, which was established, with the support of Fairfax, to invest in public and private equity and debt instruments of African businesses or other businesses with customers, suppliers or business primarily conducted in, or dependent on, Africa.

On February 14, 2017 Fairfax India acquired a 51.0% interest in Saurashtra Freight, which operates a container freight station at the Mundra Port in the Indian state of Gujarat.

On January 26, 2017 the company invested in securities of Mosaic Capital through purchases of 6.00% senior preferred securities, 5.00% senior secured debentures and warrants entitling the company to acquire up to 17,026,106 common shares of Mosaic Capital at any time until January 26, 2024. The company's investment in Mosaic Capital warrants represents a potential voting interest of approximately 62%.

On January 13, 2017 the company acquired an additional 12,340,500 subordinate voting shares of Fairfax India for $145.0 in a private placement.

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On November 28, 2016 Cara acquired an 89.2% interest in Original Joe's, a Canadian multi-brand restaurant company. On September 2, 2016 Cara acquired St-Hubert, a Canadian full-service restaurant operator and fully integrated food manufacturer.

On October 31, 2016 the company acquired a 60.0% indirect interest in Golf Town, a Canadian specialty retailer of golf equipment, consumables, golf apparel and accessories.

Operating Environment

Insurance Environment

The property and casualty insurance and reinsurance industry is expected to report a moderate underwriting loss in 2017 driven by an active Atlantic hurricane season and wildfire activity on the U.S. west coast. This marks the first year of deteriorating underwriting results relative to the past several years, reflecting the above average catastrophe losses and the expectation that the benefit from prior year reserve releases may diminish somewhat, combined with the challenging market conditions that persist across many lines of business. The industry continues to feel the effects of low interest rates that negatively affect operating income, although investments results have been bolstered by strong equity markets throughout 2017. Despite interest rates having increased recently, the interest rates that currently prevail for reinvestment are still lower than those on maturing fixed income securities, with the gap narrowing as the 10-year anniversary of the financial crisis approaches. Strong performance in the equity markets, partially offset by the impact of underwriting losses, is expected to contribute to low single digit growth in capital for the industry. Insurance pricing on property and casualty lines of business shows signs of firming as catastrophe losses have focused attention on pricing across all segments, some of which were being subsidized by property lines of business that were benefiting from lower than average catastrophe losses in recent years.

The reinsurance sector remains well capitalized despite the significant catastrophe losses in 2017. Pricing on many reinsurance lines remains attractive: property catastrophe-exposed business has experienced significant rate increases for loss affected lines of business with non-loss affected lines of business experiencing low single digit price increases and non-catastrophe property and casualty reinsurance business experiencing flat or nominal price increases after several years of price decreases.

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Sources of Revenue

Revenue for the most recent three years is shown in the table that follows.

(1)

Allied World is included in the company's financial reporting with effect from July 6, 2017.

(2)

Other revenue comprises the revenue earned by the Other reporting segment, which primarily comprises the revenue earned by William Ashley, Sporting Life, Praktiker, The Keg, Thomas Cook India and its subsidiaries Quess and Sterling Resorts, Pethealth, Cara and its subsidiaries St-Hubert (acquired on September 2, 2016), Original Joe's (acquired on November 28, 2016) and Pickle Barrel (acquired on December 1, 2017), Boat Rocker, Golf Town (acquired on October 31, 2016), Mosaic Capital (consolidated on January 26, 2017), Grivalia Properties (consolidated on July 4, 2017), Fairfax Africa (since its initial public offering on February 17, 2017), and Fairfax India and its subsidiaries NCML, Fairchem (merged on March 14, 2017 with Privi Organics (acquired on August 26, 2016)) and Saurashtra Freight (acquired on February 14, 2017).

The increase in revenue to $16,224.6 in 2017 from $9,299.6 in 2016 principally reflected increased net gains on investments, a gain of $1,018.6 on the sale of the company's 97.7% interest in First Capital, higher net premiums earned (including the consolidation of the net premiums earned of Allied World of $1,028.7), higher other revenue and increased share of profit of associates. The increase in net gains on investments principally reflected the net gain of $930.1 related to the reduction in the company's shareholding in ICICI Lombard in 2017, higher net gains on common stocks and lower net losses on short equity exposures and equity hedges, partially offset by higher net losses on U.S. treasury bond forward contracts. Interest and dividends increased modestly to $559.0 in 2017 from $555.2 in 2016, primarily reflecting lower total return swap expense, the consolidation of the interest and dividends of Allied World ($65.9) and increased interest income earned on cash equivalents and short term investments, partially offset by lower interest income earned as a result of sales of U.S. treasury and municipal bonds late in 2016 and in the first quarter of 2017. Share of profit of associates of $200.5 in 2017 increased from $24.2 in 2016, primarily due to an increase at Eurolife in 2017 and a non-cash impairment charge of $100.4 recognized on Resolute in 2016.

The increase in net premiums earned by the company's insurance and reinsurance operations in 2017 reflected the consolidation of the net premiums earned by Allied World ($1,028.7), increases at Insurance and Reinsurance – Other ($353.4, 80.8% inclusive of the consolidation of the $241.1, $68.5 and $23.7 of net premiums earned by Bryte Insurance, Fairfax Latam and Colonnade Insurance related to the AIG branches in Central and Eastern Europe respectively), OdysseyRe ($259.3, 12.5%), Brit ($137.6, 9.8%), Northbridge ($110.9, 12.2% including the favourable effect of foreign currency translation), Crum & Forster ($83.3, 4.7%), Fairfax Asia ($25.1, 8.3% including the consolidation of year-over-year increases of $34.4 and $8.6 of net premiums earned by AMAG and Fairfirst Insurance) and Zenith National ($4.3, 0.5%). Net premiums earned at Run-off in 2016 principally reflected the

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impacts of the second quarter 2016 construction defect reinsurance transaction and the habitational casualty reinsurance transaction.

The decrease in revenue to $9,299.6 in 2016 from $9,580.4 in 2015 principally reflected increased net losses on investments and lower share of profit of associates, partially offset by higher net premiums earned, increased other revenue and higher interest and dividends. The increase in net losses on investments principally reflected net losses on equity and equity-related holdings after equity hedges (primarily realized losses) and CPI-linked derivatives, partially offset by net gains on bonds. Interest and dividends increased to $555.2 in 2016 from $512.2 in 2015 reflecting higher interest earned (primarily due to increased holdings of higher yielding government and corporate bonds for most of 2016, partially offset by lower holdings of U.S. state and municipal bonds), lower total return swap expense and lower interest on funds withheld expense. Share of profit of associates decreased to $24.2 in 2016 from $172.9 in 2015 primarily reflecting a non-cash impairment charge of $100.4 recognized on Resolute and lower share of profit from the KWF LPs (a Kennedy Wilson real estate partnership recognized a significant gain on disposition of its investment properties in 2015), partially offset by a higher share of profit of ICICI Lombard.

The increase in net premiums earned by the company's insurance and reinsurance operations in 2016 compared to 2015 reflected the consolidation of a full year of net premiums earned by Brit ($506.8 incremental increase year-over-year), increases at Crum & Forster ($247.5, 16.3%), Zenith National ($40.9, 5.3%), Northbridge ($34.1, 3.9% including the unfavourable effect of foreign currency translation) and Fairfax Asia ($15.5, 5.4%), partially offset by decreases at OdysseyRe ($130.0, 5.9%) and Insurance and Reinsurance – Other ($5.5, 1.2%). The decrease in net premiums earned at Run-off in 2016 principally reflected the impact of two significant reinsurance transactions in 2016 compared to the completion of four significant reinsurance transactions in 2015.

In order to better compare 2017 to 2016, the table which follows presents net premiums written by the company's insurance and reinsurance operations excluding the impact of the acquisition of Allied World (acquired July 6, 2017) and other smaller acquisitions as described in the footnotes.

(1)

Excludes AMAG (acquired October 10, 2016) and Fairfirst Insurance (acquired October 3, 2016).

(2)

Excludes Bryte Insurance (acquired December 7, 2016), Fairfax Latam (Chile and Colombia (effective from July 31, 2017) and Argentina (effective from September 30, 2017)) and the AIG branches in Central and Eastern Europe (Hungary, Czech Republic and Slovakia (effective from April 30, 2017), Bulgaria (effective from May 31, 2017), Poland (effective from June 30, 2017) and Romania (effective from October 31, 2017).

Northbridge's net premiums written increased by 13.0% in 2017 including the favourable effect of foreign currency translation. In Canadian dollar terms, Northbridge's net premiums written increased by 10.7% in 2017, primarily reflecting increased renewal and new business writings, and price increases across the group.

OdysseyRe's net premiums written increased by 18.8% in 2017, principally reflecting increases in the U.S. Insurance division (automobile, crop and liability package lines of business), North America division (property and casualty reinsurance lines of business), EuroAsia division (crop, commercial automobile and credit and bond reinsurance lines of business) and the London Market division (affinity and liability insurance lines of business).

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Crum & Forster's net premiums written increased by 3.5% in 2017, principally reflecting growth in the accident and health and commercial transportation lines of business, partially offset by decreases in excess and surplus and marine lines of business.

Zenith National's net premiums written increased by 2.2% in 2017, primarily reflecting increased exposure, partially offset by price decreases.

Brit's net premiums written increased by 3.4% in 2017, principally reflecting better than expected development on 2016 and prior underwriting years, inwards reinstatement premiums following the current period catastrophe losses, increased contribution from initiatives launched in recent years and measured growth in core lines of business, partially offset by modest price decreases and reductions in other lines of business through active portfolio management, the unfavourable impact of foreign currency translation and the impact of additional reinsurance purchased.

Net premiums written by Fairfax Asia decreased by 6.2% in 2017, principally reflecting lower writings in the commercial automobile, property and marine lines of business and the impact of lower premium retention (primarily at First Capital).

Net premiums written by the Insurance and Reinsurance – Other reporting segment increased by 4.9% in 2017, principally reflecting increases at Fairfax CEE (primarily at Colonnade Insurance), Advent and Fairfax Brasil, partially offset by decreases at Group Re.

Net gains (losses) on investments in 2017 and 2016 were comprised as shown in the following table:

(1)

During 2017 the company acquired control of Grivalia Properties by increasing its equity interest to 52.7% and commenced consolidating Grivalia Properties in the Other reporting segment. As a result, the company re-measured its equity accounted carrying value of Grivalia Properties to fair value and recorded a net realized gain of $51.3. Refer to note 6 (Investments in Associates) to the consolidated financial statements for the year ended December 31, 2017.

(2)

Other equity derivatives include long equity total return swaps, equity warrants and equity index call options.

(3)

During 2017 the company sold a 24.3% equity interest in ICICI Lombard for net proceeds of $908.5 and recorded a net realized gain of $595.6. The company's remaining 9.9% equity interest in ICICI Lombard was reclassified to common stock measured at FVTPL and re-measured to fair value for a net realized gain of $334.5. Refer to note 6 (Investments in Associates) to the consolidated financial statements for the year ended December 31, 2017.

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The company discontinued its economic equity hedging strategy in the fourth quarter of 2016 after giving consideration to the possible and actual outcome of the U.S. elections and the potential for fundamental changes that could improve U.S. economic growth and equity markets. During 2016 the company closed out $6,350.6 notional amount of short positions effected through equity index total return swaps (comprised of Russell 2000, S&P 500 and S&P/TSX 60 short equity index total return swaps) and recognized a net loss on investment of $955.2 (realized loss of $2,665.4 of which $1,710.2 had been recognized as unrealized losses in prior years). The company continues to hold short equity and equity index total return swaps for investment purposes, but no longer regards them as hedges of its equity and equity-related holdings.

During 2017 the company closed out $1,202.9 notional amount of short equity total return swaps and recognized a net loss on investment of $237.9 (realized loss of $553.1 of which $315.2 was recognized as unrealized losses in prior years). In the first quarter of 2018 the company closed out an additional $481.3 notional amount of short equity and equity index total return swaps and recognized a net loss on investment of $8.1 (realized loss of $199.0 of which $190.9 was recognized as unrealized losses in prior years), which reduced the notional amount of remaining short equity and equity index total return swaps to approximately $509. Refer to note 24 (Financial Risk Management) under the heading Market Price Fluctuations in the company's consolidated financial statements for the year ended December 31, 2017 for a tabular analysis followed by a discussion of the net effect of the company's equity and equity-related holdings (long exposures net of short exposures) and to the tabular analysis in the Investments section of this MD&A for further details about the components of net gains (losses) on investments.

Net gains on bonds of $44.9 in 2017 were primarily comprised of net gains on U.S. treasury bonds ($52.8) and U.S. state and municipal bonds ($67.3), partially offset by losses on Indian government bonds ($40.5) and corporate and other bonds ($46.6).

The company's CPI-linked derivative contracts produced net unrealized losses of $71.0 and $196.2 in 2017 and 2016 respectively. Net unrealized losses on CPI-linked derivative contracts typically reflect the market's expectation of increases in the values of the CPI indexes underlying those contracts at their respective maturities during the periods presented (those contracts are structured to benefit the company during periods of decreasing CPI index values).

The increase in other revenue to $3,257.6 in 2017 from $2,061.6 in 2016 principally reflected increases at Cara (reflecting the inclusion of the full year revenue of St-Hubert and Original Joe's, and the consolidation of Pickle Barrel on December 1, 2017), Thomas Cook India (reflecting increased business volumes at Quess), Fairfax India (reflecting the consolidation of Fairchem on March 14, 2017, the inclusion of the full year revenue of Privi Organics and increased business volumes at NCML), Golf Town (reflecting the inclusion of the full year revenue), and the consolidation of Mosaic Capital (on January 26, 2017) and Grivalia Properties (on July 4, 2017).

Net Premiums Earned by Geographic Region

As presented in note 25 (Segmented Information) to the consolidated financial statements for the year ended December 31, 2017, the United States, Canada, International and Asia accounted for 63.2%, 12.3%, 16.0% and 8.5% respectively, of net premiums earned by geographic region in 2017, compared to 65.5%, 13.4%, 12.4% and 8.7% respectively, in 2016.

United States

Net premiums earned in the United States geographic region increased by 19.3% from $5,152.8 in 2016 to $6,148.7 in 2017 primarily reflecting the consolidation of Allied World ($773.7 for the period July 6, 2017 to December 31, 2017) and increases at OdysseyRe (growth in the property and casualty reinsurance segments and the commercial automobile, casualty and crop insurance segments), Brit (organic growth and new initiatives) and Crum & Forster (growth in accident and health and commercial transportation lines of business), partially offset by lower net premiums earned at Run-off reflecting non-recurring transactions in 2016 involving the reinsurance of third party runoff portfolios.

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Canada

Net premiums earned in the Canada geographic region increased by 13.6% from $1,053.1 in 2016 to $1,196.8 in 2017 primarily reflecting increased net premiums earned at Northbridge (increased new business writings, modest price increases across the group and the favourable effect of the strengthening of the Canadian dollar relative to the U.S. dollar as measured by average annual rates of exchange) and the consolidation of Allied World ($20.5 for the period July 6, 2017 to December 31, 2017).

International

Net premiums earned in the International geographic region increased by 59.8% from $972.0 in 2016 to $1,553.2 in 2017 primarily reflecting the consolidation of Bryte Insurance ($241.1), Allied World ($146.3 for the period July 6, 2017 to December 31, 2017), and Fairfax Latam ($68.5), the impact of the expansion at Colonnade Insurance and modest increases in net premiums earned at Brit and OdysseyRe.

Asia

Net premiums earned in the Asia geographic region increased by 20.2% from $684.3 in 2016 to $822.7 in 2017 primarily as a result of the consolidation of Allied World ($88.2 for the period July 6, 2017 to December 31, 2017), year-over-year increases at AMAG and Fairfirst Insurance and modest increases in net premiums earned at Brit and OdysseyRe.

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Sources of Net Earnings

The following table presents the combined ratios and underwriting and operating results for each of the insurance and reinsurance operations and, as applicable, for run-off operations, as well as the earnings contributions from the Other reporting segment for the years ended December 31, 2017, 2016 and 2015. In that table, interest and dividends and share of profit (loss) of associates are presented separately as they relate to the insurance and reinsurance reporting segments, and included in Run-off, Corporate overhead and other, and Other as they relate to those segments. Pre-tax income before net gains (losses) on investments, net realized gains (losses) on investments, pre-tax income (loss) including net realized gains (losses) on investments, and net change in unrealized gains (losses) on investments are each shown separately to present more meaningfully the results of the company's investment management strategies.

(1)

Allied World is included in the company's financial reporting with effect from July 6, 2017.

133

The company's insurance and reinsurance operations produced an underwriting loss of $641.5 (combined ratio of 106.6%) in 2017 compared to an underwriting profit of $575.9 (combined ratio of 92.5%) in 2016. The increase in the combined ratio in 2017 principally reflected the impact of higher current period catastrophe losses, lower net favourable prior year reserve development and an increase in non-catastrophe loss experience related to the current accident year.

Net favourable prior year reserve development of $491.7 (5.1 combined ratio points) in 2017 decreased from $654.6 (8.5 combined ratio points) in 2016 and was comprised as follows:

(1)

Allied World is included in the company's financial reporting with effect from July 6, 2017.

Current period catastrophe losses of $1,330.4 (13.7 combined ratio points) in 2017 increased from $352.7 (4.6 combined ratio points) in 2016 and were comprised as follows:

(1)

Net of reinstatement premiums.

The following table presents the components of the company's combined ratios for the years ended December 31:

134

The commission expense ratio decreased to 16.9% in 2017 from 17.3% in 2016, primarily reflecting the consolidation of Allied World (non-recurring acquisition accounting adjustments reduced net premiums earned and commission expense in the period July 6, 2017 to December 31, 2017 and resulted in a commission expense ratio that was generally lower than Fairfax's other operating companies), partially offset by an increased commission expense ratio at Brit (primarily the impacts of non-recurring acquisition accounting adjustments which reduced net premiums earned and commission expense in 2016, partially offset by changes in the mix of business written, reinsurance purchased and higher net premiums earned in 2017).

The underwriting expense ratio increased to 17.4% in 2017 from 17.0% in 2016, primarily reflecting the consolidation of Allied World (Allied World's underwriting expense ratio of 21.1% for the period July 6, 2017 to December 31, 2017 was generally higher than Fairfax's other operating companies), partially offset by increased net premiums earned relative to underwriting expenses at OdysseyRe and Northbridge.

Underwriting expenses increased by 4.8% in 2017 (excluding the combined underwriting expenses of $310.2 of Allied World, Bryte Insurance and Fairfax Latam in 2017), primarily reflecting increases at Crum & Forster (primarily due to increased compensation costs related to new underwriting initiatives), Colonnade Insurance (primarily reflecting its start-up costs), Zenith National (primarily reflecting higher underwriting expenses attributable to ongoing investment in personnel) and Fairfax Asia (primarily reflecting the year-over-year impact of the consolidation of the underwriting expenses of AMAG and Fairfirst Insurance and increased compensation costs), partially offset by a decrease at Brit (primarily reflecting the favourable effect of foreign currency translation and increased fee income earned from the management of third party underwriting capital)

Operating expenses in the consolidated statements of earnings include only the operating expenses of the company's insurance and reinsurance and run-off operations and corporate overhead. Operating expenses increased to $2,049.5 in 2017 from $1,597.7 in 2016 primarily as a result of increased underwriting expenses of the insurance and reinsurance operations as described in the preceding paragraph and increased Fairfax and subsidiary holding companies' corporate overhead, partially offset by lower operating expenses at Run-off.

Other expenses increased to $3,024.6 in 2017 from $1,958.4 in 2016 primarily as a result of increases at Cara (reflecting the inclusion of the full year expenses of St-Hubert and Original Joe's, and the consolidation of Pickle Barrel on December 1, 2017), Thomas Cook India (reflecting increased business volumes at Quess), Fairfax India (reflecting the consolidation of Fairchem on March 14, 2017, the inclusion of the full year expenses of Privi Organics and increased business volume at NCML) and Golf Town (reflecting the inclusion of the full year expenses), and the consolidation of Mosaic Capital (on January 26, 2017) and Grivalia Properties (on July 4, 2017).

The company reported net earnings attributable to shareholders of Fairfax of $1,740.6 (net earnings of $66.74 per basic share and$64.98 per diluted share) in 2017 compared to a net loss attributable to shareholders of Fairfax of $512.5 (net loss of $24.18 per basic and diluted share) in 2016. The year-over-year increase in profitability primarily reflected increased net gains on investments and the gain on the sale of the company's 97.7% interest in First Capital, partially offset by a decrease in underwriting profit and increased provision for income taxes.

Common shareholders' equity increased from $8,484.6 at December 31, 2016 to $12,475.6 at December 31, 2017, primarily reflecting the issuance of 5,075,894 shares with a fair value of $2,191.6 pursuant to the acquisition of Allied World, net earnings attributable to shareholders of Fairfax of $1,740.6 and other comprehensive income of $283.8 (comprised of net unrealized foreign currency translation gains on foreign operations of $200.4 and the company's share of other comprehensive income of associates of $114.3, partially offset by net losses on defined benefit plans of $30.9), partially offset by dividends paid of $282.0 on the company's common and preferred shares. Common shareholders' equity per basic share at December 31, 2017 was $449.55 compared to $367.40 per basic share at December 31, 2016, representing an increase of 22.4% (without adjustment for the $10.00 per common share dividend paid in the first quarter of 2017, or an increase of 24.7% adjusted to include that dividend).

135

Net Earnings by Reporting Segment

The company's sources of net earnings (loss) shown by reporting segment are set out below for the years ended December 31, 2017 and 2016. The intercompany adjustment for gross premiums written eliminates premiums on reinsurance ceded within the group, primarily to OdysseyRe and Group Re.

Year ended December 31, 2017

Year ended December 31, 2016

(1)

Allied World is included in the company's financial reporting with effect from July 6, 2017.

136

Balance Sheets by Reporting Segment

The company's segmented balance sheets as at December 31, 2017 and 2016 present the assets and liabilities of, and the capital invested by the company in, each of the company's reporting segments. The segmented balance sheets have been prepared on the following basis:

(a)

The balance sheet for each reporting segment is on a legal entity basis for the subsidiaries within that segment, in accordance with Fairfax's IFRS accounting policies and includes, where applicable, acquisition accounting adjustments principally related to goodwill and intangible assets which arose on initial acquisition of the subsidiaries or on a subsequent step acquisition.



(b)

Certain of the company's subsidiaries held ownership interests in other Fairfax subsidiaries ("Fairfax affiliates") at December 31, 2017. These investments in Fairfax affiliates are carried at cost and are disclosed in the table below. Affiliated insurance and reinsurance balances, including premiums receivable (included in insurance contracts receivable), deferred premium acquisition costs, recoverable from reinsurers, funds withheld payable to reinsurers, provision for losses and loss adjustment expenses and provision for unearned premiums, are not shown separately but are eliminated in Corporate and Other.



(c)

Corporate and Other includes the Fairfax holding company and its subsidiary intermediate holding companies as well as the consolidating and eliminating entries required under IFRS to prepare consolidated financial statements. The most significant of those entries are derived from the elimination of intercompany reinsurance (primarily consisting of reinsurance provided by Group Re and reinsurance between OdysseyRe and the primary insurers), which affects recoverable from reinsurers, provision for losses and loss adjustment expenses and unearned premiums. Corporate and Other borrowings of $3,445.1 as at December 31, 2017 primarily consisted of Fairfax holding company debt of $3,475.1, partially offset by the elimination of intercompany debt. Corporate and Other borrowings of $3,479.6 as at December 31, 2016 primarily consisted of Fairfax holding company debt of $3,341.2 and purchase consideration payable of $129.2 (repaid in 2017) related to the TRG acquisition.

(1)

This table excludes subsidiaries where the company's equity interest is entirely held by the holding company including Northbridge, OdysseyRe, Crum & Forster, Brit, Allied World, Fairfax Asia, Fairfax Brasil, Fairfax Latam, Bryte Insurance and Polish Re.

(2)

Investments in insurance and reinsurance affiliates are reported in Investment in Fairfax insurance and reinsurance affiliates on the segmented balance sheet.

(3)

Investments in non-insurance affiliates are reported within Portfolio investments on the segmented balance sheet.