The easiest way that is pretty much always doable (at least pre-EE, no idea about any changes) is to turn off XP sharing until you have a full party, reach level three in the Shield Maze*, give Lann a Divine Hunter level and pick the Leopard companion. Buff it with Camellia, send it to facetank the Water Elemental and win.
edit 2: To explain, with reaching level three on Lann, you can give him the Leopard and Boon Companion, pushing the Leopard to level three. That means it can have Doge and Diehard, making it possible to withstand more punishment from the Large Water Elemental. You can (well, should, I suppose) cast Enlarge Person on your party to make everything have reach and hit more easily and harder. Charge in, pull them out, charge back in, as charge gives a nice chunk of extra AB. Use Glaives and the Masterwork Greatsword for the 1.5 extra damage multiplier to get through the DR 5.
Other ways are kiting, because it is damned slow, or having a CHA to AC double dip MC - that way you can potentially push your armor class with buffs to a point where it's possible to withstand the attacks provided you can stomach reloading a couple of times. It has 'only' 17 attack bonus, but 37 AC is really hard to reach (more like impossible), so you need as many debuffs on it as you can make stick. Also, of course, do the entire Shield Maze before taking on the Elemental for all the scrolls and potions.
*One of the things that is very noticable on Unfair is how many more enemies there are in the game. Combined with hogging all the experience for yourself (it is pointless not to until you can get out of the prologue and add party members or mercenaries), it provides a much needed level boost. That is even more of a reason why simply increasing the difficulty to Unfair for boss fights is not indicative of how a full Unfair run plays.
That circular room in Blackwater that @Gorth had problems with - IIRC on Unfair that had three times the amount of demons. With much, much better stats.
edit: Ah, ninja'ed.