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Prem Watsa, Chairman and CEO of Fairfax FinancialCharla Jones/The Globe and Mail

Fairfax Financial Holdings Ltd. says its third-quarter profits plummeted more than 96 per cent as it faced losses on its equity hedges.

The Toronto-based financial services company said net earnings fell to $34.6-million (U.S.), or 90 cents per share, against $973.9-million, or $46.73 per share, a year earlier.

The insurance and investment giant says the decline was mostly from a lack of net investment gains in the period from hedging, as well as lower interest and dividend income.

Companies buy hedges – contracts that protect the future value of investments and other assets – during volatile stock markets. However, unexpected share price swings can lead to paper losses on the balance sheet, which must be accounted for.

Fairfax chairman and chief executive officer Prem Watsa was confident that the Toronto Stock Exchange, and other markets, were going to drop even further than they did during the 2008 market drop, so in 2010 he hedged the company's stock portfolio.

This year the TSX has moved higher, which led to a net loss on investments of $23.6-million in the quarter.

However, the underwriting business at the casualty and property insurer was profitable this quarter, delivering $73.7-million in gains compared to a loss of $105.3-million in the comparable period.

"Our underwriting results continued to improve on increased premiums and we produced a small investment loss due to our unrealized investment losses related to our defensive hedging strategy," Mr. Watsa said.

Net premiums written increased by 5.6 per cent to $1.51-billion from $1.43-billion in the 2011 quarter.

Fairfax, through its subsidiaries, is involved in property and casualty insurance and reinsurance and investment management.