**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-K**

**x**                              ANNUALREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**For the fiscal yearended December 31, 2006**

**OR**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

 

**For the transitionperiod from          to         **

**Commission filenumber 1-33128**

**ONEBEACON INSURANCE GROUP,LTD.**

(Exact name of Registrant as specified in its charter)

| **Bermuda**                                                     |   | **98-0503315**                        |
|-----------------------------------------------------------------|--------|---------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |   | (I.R.S. Employer  Identification No.) |
| **601 Carlson Parkway**                                         |   | ** **                            |
| **Minnetonka, Minnesota**                                       |   | **55305**                             |
| (Address of principal executive offices)                        |   | (Zip Code)                            |

 

Registrant’s telephone number, including area code: **(952) 852-2431**

Securities registered pursuant to Section 12(b) ofthe Act:

| **Title of each class**                              |   | **Name of each exchange on which registered** |
|------------------------------------------------------|--------|-----------------------------------------------|
| Class A Common Shares, par value $0.1 per share |   | New York Stock Exchange                       |

 

Securitiesregistered pursuant to Section 12(g) of the Act:

**None**

Indicate by check mark if the Registrant is awell-known seasoned issuer, as defined in Rule 405 of the Act.Yes   o    No   x

Indicate by check mark if the Registrant is notrequired to file reports pursuant to Section 13 or Section 15(d) ofthe Exchange Act. Yes   o    No   x

Indicate by check mark whether the Registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theExchange Act during the preceding 12 months (or for such shorter period thatthe Registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days. Yes   x    No   o

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K is not containedherein, and will not be contained, to the best of the Registrant’s knowledge,in definitive proxy or information statements incorporated by reference in Part IIIof this Form 10-K or any amendment to this Form 10-K.  x

Indicate by check markwhether the Registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of accelerated filer and largeaccelerated filer in Rule 12b-2 of the Exchange Act.

| Large accelerated filer  o |   | Accelerated Filer  o |   | Non-accelerated filer  x |
|--------------------------------------|--------|--------------------------------|--------|------------------------------------|

 

Indicate by check mark whether the Registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act).Yes   o    No   x

The aggregate market value of voting shares (based onthe closing price of Class A common shares listed on the New York StockExchange and the consideration received for those shares not listed on anational or regional exchange) held by non-affiliates of the Registrant as of December 31,2006, was $771,804,880.

As of February 27, 2007, 27,613,292 Class A commonshares, par value of $0.01 per share, and 72,400,000 Class B common shares, parvalue $0.01 per share, were outstanding.

**DOCUMENTS INCORPORATED BY REFERENCE**

Portions of the Registrant’sDefinitive Proxy Statement to be filed with the Securities and ExchangeCommission (“SEC”) pursuant to Regulation 14A under the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”), relating to theRegistrant’s Annual General Meeting of Members scheduled to be held May 22,2007 are incorporated by reference into Part III of this Form 10-K.With the exception of the portions of the Proxy Statement specificallyincorporated herein by reference, the Proxy Statement is not deemed to be filedas part of this Form 10-K.

** **

 

----

|                                      | ** ** | **PART I**                                                                                                                 |   |   |   |
|--------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|
| ITEM 1.                              |       | Business                                                                                                                        |   | 1      |   |
|                                 |       | General                                                                                                                         |   | 1      |   |
|                                 |       | Primary  Insurance Operations                                                                                                   |   | 2      |   |
|                                 |       | Affiliate Quota Shares                                                                                                          |   | 18     |   |
|                                 |       | Other Operations                                                                                                                |   | 19     |   |
|                                 |       | Investments                                                                                                                     |   | 20     |   |
|                                 |       | Regulatory Matters                                                                                                              |   | 22     |   |
|                                 |       | Ratings                                                                                                                         |   | 27     |   |
|                                 |       | Employees                                                                                                                       |   | 28     |   |
|                                 |       | Available Information                                                                                                           |   | 28     |   |
| ITEM  1A.                            |       | Risk  Factors                                                                                                                   |   | 28     |   |
| ITEM 1B.                             |       | Unresolved Staff Comments                                                                                                       |   | 41     |   |
| ITEM 2.                              |       | Properties                                                                                                                      |   | 41     |   |
| ITEM  3.                             |       | Legal  Proceedings                                                                                                              |   | 41     |   |
| ITEM 4.                              |       | Submission of Matters to a Vote of Security Holders                                                                             |   | 42     |   |
| Executive Officers of the Registrant |       | 42                                                                                                                              |   |
|                                 | ** ** | **PART II**                                                                                                                |   |   |   |
| ITEM 5.                              |       | Market for the Company’s Common Equity, Related  Shareholder Matters and Issuer Purchase of Equity Securities              |   | 44     |   |
| ITEM  6.                             |       | Selected  Financial Data                                                                                                        |   | 45     |   |
| ITEM 7.                              |       | Managements’ Discussion and Analysis of Financial  Condition and Results of Operations       |   | 48     |   |
|                                 |       | Liquidity and Capital Resources                                                                                                 |   | 68     |   |
|                                 |       | Critical  Accounting Estimates                                                                                                  |   | 76     |   |
|                                 |       | Forward  Looking Statements                                                                                                     |   | 94     |   |
| ITEM 7A.                             |       | Quantitative and Qualitative Disclosures About Market  Risk                                                                     |   | 95     |   |
| ITEM 8.                              |       | Financial Statements and Supplementary Data                                                                                     |   | 96     |   |
| ITEM 9.                              |       | Changes in Disagreements With Accountants on  Accounting and Financial Disclosure                                               |   | 97     |   |
| ITEM 9A.                             |       | Controls and Procedures                                                                                                         |   | 97     |   |
| ITEM  9B.                            |       | Other  Information                                                                                                              |   | 97     |   |
|                                 | ** ** | **PART III**                                                                                                               |   |   |   |
| ITEM 10.                             |       | Directors, Executive Officers, and Corporate  Governance                                                                        |   | 98     |   |
| ITEM 11.                             |       | Executive Compensation                                                                                                          |   | 98     |   |
| ITEM 12.                             |       | Security Ownership of Certain Beneficial Owners and  Management and Related Shareholder Matters                  |   | 98     |   |
| ITEM 13.                             |       | Certain Relationships, Related Transactions, and  Director Independence                                                         |   | 98     |   |
| ITEM 14.                             |       | Principal Accountant Fees and Services                                                                                          |   | 98     |   |
|                                 | ** ** | **PART IV**                                                                                                                |   |   |   |
| ITEM 15.                             |       | Exhibits and Financial Statement Schedules                                                                                      |   | 99     |   |
|                                 |       | CERTIFICATIONS                                                                                                                  |   |   |   |

 

----

**ITEM 1.**                BUSINESS

**Overview**

OneBeacon Insurance Group, Ltd., an exemptedBermuda company, and its subsidiaries (collectively, “OneBeacon,” the “Company,”“we,” “us,” or “our” ) is a property and casualty insurance writer thatprovides a range of specialty insurance products as well as a variety ofsegmented commercial and personal insurance products. With roots dating back to1831, we have been operating for more than 175 years and have manylong-standing relationships with independent agencies, which constitute ourprimary distribution channel. OneBeacon was acquired by White MountainsInsurance Group, Ltd. (“White Mountains”) from Aviva plc (“Aviva”,formerly CGNU) in 2001 (the “OneBeacon Acquisition”). White Mountains is aholding company whose businesses provide property and casualty insurance,reinsurance and certain other products. During the fourth quarter of 2006,White Mountains sold 27.6 million or 27.6% of the Company’s common shares in aninitial public offering. Prior to the initial public offering, OneBeacon was awholly-owned subsidiary of White Mountains.

Our headquarters are located at the Bank ofButterfield Building, 42 Reid Street, 6th Floor, Hamilton HM 12,Bermuda. Our U.S. headquarters are located at 1 Beacon Lane, Canton,Massachusetts 02021, our principal executive office is located at 601 CarlsonParkway, Minnetonka, Minnesota 55305 and our registered office is located atClarendon House, 2 Church Street, Hamilton HM 11, Bermuda. We alsomaintain our former U.S. headquarters located at 1 Beacon Street, BostonMassachusetts, 02108 which will be vacated in the first quarter of 2007 as wecomplete the transition to our new U.S. headquarters in Canton, Massachusetts.

Our reportable segments are Primary InsuranceOperations, Affiliate Quota Shares and Other Operations. We manage our PrimaryInsurance Operations segment through three major underwriting units: specialtylines, commercial lines and personal lines. Our Affiliate Quota Shares segmentreflects the results of two quota share reinsurance agreements we entered intowith subsidiaries of White Mountains primarily for White Mountains’ capitalmanagement purposes. These agreements were commuted in the fourth quarter of2006 in connection with our initial public offering. Certain other activitiesare conducted through our top holding company, OneBeacon InsuranceGroup, Ltd. and our intermediate subsidiaries and are included in ourOther Operations segment.

Our specialty lines businesses are national in scope,while our commercial and personal lines businesses have been concentratedprimarily in the Northeastern United States. We have added, and expect tocontinue to add, new specialty businesses both organically and throughacquisition. With licenses in 50 states and the District of Columbia, we havebegun to selectively expand geographically into attractive new markets in ourpersonal lines business and into new territories in our commercial linesbusiness that align well with our targeted approach to specific customersegments. In this expansion, we are guided by our focus on profitable growthwhile prudently managing underwriting risk.

In 2006, our net writtenpremiums totaled approximately $2.0 billion and we had total assets ofapproximately $9.9 billion and total common shareholders’ equity ofapproximately $1.8 billion at December 31, 2006.

**Our OperatingPrinciples**

We strive to operate within the spirit of fouroperating principles. These are:

**UnderwritingComes First.**   An insurance enterprise mustrespect the fundamentals of insurance. There must be a realistic expectation ofunderwriting profit on all business written, and demonstrated fulfillment ofthat expectation over time, with focused attention to the loss ratio and to allthe professional insurance disciplines of pricing, underwriting and claimsmanagement.

1

----

**Maintaina Disciplined Balance Sheet.**   The first concernhere is that insurance liabilities must always be fully recognized. Lossreserves and expense reserves must be solid before any other aspect of thebusiness can be solid. Pricing, marketing and underwriting all depend oninformed judgment of ultimate loss costs and that can be managed effectivelyonly with a disciplined balance sheet.

**Investfor Total Return.**   Historical insuranceaccounting tends to hide unrealized gains and losses in the investmentportfolio and over-reward reported investment income (interest and dividends).Regardless of the accounting, OneBeacon must invest for the best growth inafter-tax value over time. In addition to investing our bond portfolios fortotal after-tax return, that will also mean prudent investment in a balancedportfolio consistent with leverage and insurance risk considerations.

**Think Like Owners.**   Thinkinglike owners has a value all its own. There are stakeholders in a businessenterprise and doing good work requires more than this quarter’s profit. Butthinking like an owner embraces all that without losing the touchstone of acapitalist enterprise.

**Primary Insurance Operations**

Our Primary Insurance Operations segment providesspecialty lines insurance products, a variety of segmented commercial linesinsurance products for businesses and personal lines insurance products forindividuals. The Primary Insurance Operations segment also includes run-offbusiness which primarily consists of national accounts, certain specialtyprograms and regional agency business transferred to Liberty Mutual InsuranceGroup (“Liberty Mutual”) effective November 1, 2001. See “Business—Run-off”.

In the fourth quarter of 2006, we began to includeOneBeacon Specialty Property (OBSP) within commercial lines and AutoOneInsurance (AutoOne) within personal lines. Both OBSP and AutoOne were formerlyreported in specialty lines. The reporting change was undertaken to betteralign the reported results of our underwriting units with their product andmanagement structure. Prior periods have been reclassified to conform to thecurrent presentation.

Forthe twelve months ended December 31, 2004, 2005 and 2006, our net writtenpremiums by line of business were as follows:

| ** ** | ** ** | **Year ended December 31,** | ** ** |
|------------|------------|--------------------------------------------|------------|
| ** ** | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** ** | ** ** | **($ in millions)**              | ** ** |
| Specialty  |       | $                                          | 387.2      |   | $ | 416.3 |   | $ | 437.6 |   |
| Commercial |       | 826.8                                      |       | 654.4 |   | 718.3 |   |
| Personal   |       | 1,063.3                                    |       | 910.2 |   | 800.6 |   |
| Total(1)   |       | $                                          | 2,280.6    |   | $ | 1,988.6 |   | $ | 1,957.6 |   |

----

(1)          Includesrun-off business. See “Business—Run-off.”

***Specialty lines***

Our specialty linesunderwriting unit is a collection of niche businesses that focus on solving theunique needs of particular customer groups on a national scale. We providedistinct products and offer tailored coverages and services, managed byseasoned teams of market specialists. Our specialty businesses currentlyinclude:

·       *OneBeacon Professional Partners* (OBPP): Formed in 2002, OBPPis a provider of specialty liability products primarily focused on thehealth-care industry. Additional products include media liability and lawyers’professional liability insurance. Our health-care products include hospitalprofessional liability, or HPL, HMO reinsurance, providers excess insurance andmanaged care errors and 

2

----

omissions, or MCE&O.These products protect against claims arising from direct patient treatment,such as diagnoses, rendering opinions or referrals, and coverage forprofessional committee activities. In 2005, OBPP broadened its capabilitiesthrough two acquisitions and the formation of a new business. First Media Insurance Specialists wasacquired to distribute OBPP’s new product line of primary and excess medialiability coverages targeting small-to-midsized media companies (thatinclude publishers, broadcasters and authors). OBPP also acquired the renewalrights to the HPL and MCE&O business of Chubb Specialty Insurance.Additional net written premiums from both transactions totaled $38.0 millionin 2006. In November 2005, OBPP began offering lawyers’ professionalliability coverage targeting law firms employing fewer than 150 attorneys.

·       *International Marine Underwriters* (IMU): A leading providerof marine insurance, this business traces its roots back to the early 1900s.The IMU acquisition from Crum & Forster in the early 1990s doubled thecompany’s book of marine business. IMU coverages include physical damage orloss, and general liability for cargo and commercial hull, both at primary andexcess levels, marinas, including a “package” product (comprehensive propertyand liability coverage) and yachts (the offerings for which were strengthenedby IMU’s recent acquisition of yacht-specialist National MarineUnderwriters, Inc., a yacht insurance managing general agency in October 2006).IMU does not offer offshore energy products. Target customers include ferryoperators and charter boats (hull), marina operators and boat dealers (packageproduct) and private-pleasure yachts with hull values of less than$1 million.

·       *A.W.G. Dewar* (Dewar): A provider of tuition reimbursementinsurance since 1930, Dewar’s product protects both schools and parents fromthe financial consequences of a student’s withdrawal or dismissal from school.The tuition refund plan reimburses parents up to 100 percent of tuition,room and board fees when a student is obliged to leave school due to coveredreasons, such as medical or expulsion. Dewar provides customized policies toindependent schools and colleges in North America.

·       *Community Banking Professional Liability*: Formed in November 2005,this group provides professional liability coverages for community banks withassets of $3 billion or less. Its full array of management andprofessional liability coverages includes employment practices liability,fiduciary liability, lender’s liability, bankers professional liability, trusterrors and omissions, and directors and officers liability. This group alsooffers community banking customers access to commercial package products,thereby providing comprehensive insurance solutions to this customer group.Community Banking Professional Liability is augmented by strategicallypositioned underwriting specialists in markets such as the Northeast and theMid-West.

·       *Specialty Accident and Health (A&H):* Formed in November 2006, this groupprovides accident insurance coverages principally to large employers (generallyFortune 1000) on a group basis. The full array of anticipated product coverageswill include corporate accident, travel accident and occupational accidentcoverage primarily targeted to the trucking industry. This group conductsbusiness through independent agents and brokers and will selectively marketdirectly to customers.

Each of these businesses maintains stand-aloneoperations and distribution channels targeting their specific customer groups.Our specialty lines include several businesses focused on smaller property-casualtyinsurance segments where particular expertise and relationships with similarlyfocused distribution partners has resulted historically in strong operatingresults from our businesses. These businesses maintain their competitiveadvantage through a deep knowledge of their respective customers andmarketplace.

3

----

Forthe years ended December 31, 2004, 2005 and 2006, our specialty lines netwritten premiums were as follows:
|                           | ** ** | **Year ended December 31,(1)** | ** ** |
|---------------------------|------------|-----------------------------------------------|------------|
| ** **                | ** ** | **2004**                                      | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                | ** ** | **($ in millions)**                 | ** ** |
| OBPP                      |       | $                                             | 119.5      |   | $ | 149.5 |   | $ | 179.3 |   |
| IMU                       |       | 136.5                                         |       | 133.6 |   | 139.9 |   |
| Other specialty  lines(2) |       | 131.2                                         |       | 133.2 |   | 118.4 |   |
| Total specialty lines     |       | $                                             | 387.2      |   | $ | 416.3 |   | $ | 437.6 |   |

----

(1)          In the fourth quarter of2006, we began to include OBSP within commercial lines and AutoOne withinpersonal lines. Both OBSP and AutoOne were formerly reported in specialtylines. The reporting change was undertaken to better align the reported resultsof our underwriting units with their product and management structure. Priorperiods have been reclassified to conform to the current presentation.

(2)          IncludesAgri which was sold to a third party on September 29, 2006. Net writtenpremiums for Agri were $83.6 million, $84.0 million and $64.7 million for theyears ended December 31, 2004, 2005 and 2006, respectively. See “Management’sDiscussion and Analysis of Financial Condition and Results of Operations—OtherAcquisitions and Dispositions”.

***Commercial lines***

We provide insurance solutions for middle market andsmall businesses through products that target particular industry groups withcustomized coverages and services. Our targeted industry focus has resulted infavorable loss ratios and strong customer retention levels. In late 2004, ourcommercial lines underwriting unit was separated into middle market and smallbusiness divisions to enable a specialized focus in each market and torecognize the difference in product needs, customers and service requirements.

Our middle market accounts typically produceannualized gross premiums ranging from $25,000 to $1,000,000 and principallypurchase “package” property policies (combination policies offering propertyand liability coverage). We target 13 distinct customer groups includingtechnology, financial institutions, professional services, wholesalers,metalworkers and commercial real estate, among others. We also provide somestandard commercial business that is not targeted to a specific industry group.By partnering with our specialty lines businesses, our middle market commerciallines business can deliver a seamless, comprehensive OneBeacon solution, whichis a competitive advantage for us and for our agents. We have also formedstrategic partnerships with specialized insurance agencies to offer OneBeaconcoverage to targeted customer groups such as technology companies and communitybanks.

Included in the middle market division is OBSP. Formedin 2004, OBSP provides excess property coverage against certain damages overand above those covered by primary policies or a large self-insured retention.Target classes include apartments and condominiums, commercial real estate, small-to-mediummanufacturing, retail/wholesale and public entity and educational institutions.Its excess property solutions are provided primarily through surplus lineswholesalers in all 50 states and the District of Columbia.

We also market package, auto, workers compensation andumbrella coverage to small businesses which typically generate annualizedpremiums ranging from $500 to $25,000. We target 14 general industry groups aswell as some association and group businesses that provide a highly competitivesolution for select agents. Our small-business growth strategy istargeting insurance networks of typically suburban and rural agents thatrepresent a strong customer base in those areas. Our proprietary web platformthat expedites underwriting at the point of sale has enabled such growth in newterritories while limiting the 

4

----

need for much incrementalinfrastructure. In the first quarter of 2006 we introduced a small businessservice center to handle customer administration for enrolled agents.

Our commerciallines products across all customer accounts include:

·       *Multi-peril*: consists of a package policy sold tosmall to mid-sized insureds or to members of trade associations or other groupsthat includes general liability insurance and commercial property insurance.

·       *Automobile*: consists of physical damage and liabilitycoverage. Automobile physical damage insurance covers loss or damage tovehicles from collision, vandalism, fire, theft or other causes. Automobileliability insurance covers bodily injury of others, damage to their propertyand costs of legal defense resulting from a collision caused by the insured.

·       *Workers compensation*: covers an employer’s liability forinjuries, disability or death of employees, without regard to fault, asprescribed by state workers compensation law and other statutes.

·       *General liability*: covers businesses for any liabilityresulting from bodily injury and property damage arising from its generalbusiness operations, accidents on its premises and the products it manufacturesor sells.

·       *Umbrella*: supplements existing insurance policies bycovering losses from a broad range of insurance risks in excess of coverageprovided by the primary insurance policy up to a specified limit.

·       *Property*: covers losses to a business’ premises, inventoryand equipment as a result of weather, fire, theft and other causes.

·       *Excess and surplus property*: provides excess propertycoverage against certain damages over and above those covered by primarypolicies or a large self-insured retention.

·       *Inland marine*: covers property that may be in transit orheld by a bailee at a fixed location, movable goods that are often stored atdifferent locations or property with an unusual antique or collector’s value.

·       *Package*: consists of combination policies offering propertyand liability coverage.

Forthe years ended December 31, 2004, 2005 and 2006, commercial lines netwritten premiums were as follows:
|                               | ** ** | **Year ended December 31,(1)** | ** ** |
|-------------------------------|------------|-----------------------------------------------|------------|
| ** **                    | ** ** | **2004(2)**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                    | ** ** | **($ in millions)**                 | ** ** |
| Middle market  excluding OBSP |       | $                                             | 699.3      |   | $ | 531.6 |   | $ | 564.8 |   |
| OBSP                          |       | 19.7                                          |       | 43.6 |   | 51.2 |   |
| Total middle market           |       | 719.0                                         |       | 575.2 |   | 616.0 |   |
| Small business                |       | 107.8                                         |       | 79.2 |   | 102.3 |   |
| Total commercial lines        |       | $                                             | 826.8      |   | $ | 654.4 |   | $ | 718.3 |   |

----

(1)          In the fourth quarter of2006, we began to include OBSP, formerly a specialty lines business in the themiddle market division of commercial lines to better align the product andmanagement structure of our underwriting units. Prior periods have beenreclassified to conform to the current presentation.

(2)          2004includes approximately $404 million of net written premiums related to theacquisition of Atlantic Specialty Insurance Company, a subsidiary of AtlanticMutual Insurance Company, and the renewal rights to Atlantic Mutual’s segmentedcommercial insurance business.

5

----

***Personal lines***

Our personal lines underwriting unit provideshomeowners insurance, segmented private passenger automobile and packagepolicies (package products are combination policies offering home andautomobile coverage with optional umbrella, boatowners and other coverages)sold through select independent agents. We refer to this business astraditional personal lines.

To maintain a high degree of flexibility, in 2004 wecreated a highly segmented product suite, called OneChoice, under which we areable to offer the appropriate risk-adjusted product and pricing to ourcustomers. OneChoice is a multi-tiered product suite that enables us tooffer a broader range of coverages to a full spectrum of customers through moresophisticated pricing models that have a greater statistical correlationbetween historical loss experience and price than traditional pricing models.This product suite offers both automobile and homeowners coverages as well aspackage policies. OneChoice products rely on multiple, objective pricing tiersand rules-based underwriting that enable agents to offer OneBeaconsolutions to a broad array of their customers and increase OneBeacon’spenetration in existing and new markets. We regularly refine our productfeatures and rating plans to optimize target market production. Ease of use isa critical aspect of this business. We offer an integrated Web-based platformavailable either through our dedicated agent portal or through real-timecomparative rating engines.

Within our personal lines underwriting unit, weprovide management services for a fee to three reciprocal insurance exchanges,which we refer to as reciprocals that we have created and capitalized bylending them money in exchange for surplus notes. Reciprocals arenot-for-profit, policyholder-owned insurance carriers organized asunincorporated associations. We have no ownership interest in these reciprocals.As required by GAAP, our consolidated financial statements reflect theconsolidation of these reciprocals.

In 2002, we formed New Jersey Skylands Management LLCto provide management services for a fee to New Jersey Skylands InsuranceAssociation, a reciprocal, and its wholly-owned subsidiary New Jersey SkylandsInsurance Company, which we refer to together as New Jersey Skylands Insurance.New Jersey Skylands Insurance began writing personal automobile coverage fornew customers in August 2002. We formed Houston General InsuranceManagement Company in 2004 to provide management services for a fee to anotherreciprocal, Houston General Insurance Exchange. Houston General InsuranceExchange commenced writing business in Arizona, South Carolina and Texas in November 2005,June 2006 and October 2006, respectively, using the full suite ofOneChoice products (auto, home and package). In 2006, Adirondack AIF, LLC, oneof our wholly-owned subsidiaries entered into an agreement to providemanagement services for a fee to Adirondack Insurance Exchange. AdirondackInsurance Exchange was approved to write business in New York in 2006.

We utilize reciprocal structures to pursue long-termopportunities. In the long term, as the reciprocals produce positive operatingresults and/or as third party capital is invested, we expect to derive valuefrom reduced volatility in our year-to-year underwriting results, thegeneration of steady fee income for the various management services we provideto these associations and repayment of principal and interest on the surplusnotes.

Our personal linesproducts include:

·       *Automobile*: consists of physical damage and liabilitycoverage. Automobile physical damage insurance covers loss or damage tovehicles from collision, vandalism, fire, theft or other causes. Automobileliability insurance covers bodily injury of others, damage to their propertyand costs of legal defense resulting from a collision caused by the insured.

6

----

·       *Homeowners*: covers losses to an insured’s home, includingits contents, as a result of weather, fire, theft and other causes and lossesresulting from liability for acts of negligence by the insured or the insured’simmediate family. OneBeacon also offers identity theft resolution assistanceand identity theft expense reimbursement coverage as part of its homeownerspolicies.

·       *Package*: consists of customized combination policiesoffering home and automobile coverage with optional umbrella and boatowners coverage.

Also included in our personallines underwriting unit is AutoOne. Formed in 2001, AutoOne is a marketleader in “assigned risk” business in New York. Assigned risk plans provideautomobile insurance for individuals unable to secure coverage in the voluntarymarket. Insurance carriers are obliged to accept future assignments from stateassigned risk pools as a condition of maintaining a license to write automobilebusiness in the state. However, carriers may satisfy their assigned riskobligation by transferring their assignments to another insurer or by utilizingvarious “credits” (i.e. take-out, territorial and youthful driver credits).AutoOne offers services known as Limited Assigned Distribution, or LAD, andCommercial Limited Assigned Distribution, or CLAD, and credit programs toinsurance carriers. While AutoOne was able to expand its product offerings toan additional 12 states in the first quarter of 2006, the volume of businessdecreased due to a larger voluntary market in New York and New Jersey, wherethe majority of AutoOne’s assigned risk business is generated. AutoOne nowprovides 28 LAD and CLAD programs in 22 states where assigned risk obligationsmay be assumed by a servicing carrier under a negotiated fee arrangement.

AutoOne also writes “voluntary take-out business”(policies “taken out” of the assigned risk pool and written in the voluntarymarket) by selecting policies from the assigned risk business it manages forits clients and from select insurance brokers that replace their clientsassigned risk policy with an AutoOne policy. AutoOne receives credits for allpolicies taken out of the assigned risk plan which it can use either to reduceits future assigned risk obligations, or to sell to other carriers that can usethe credits to reduce their own quota obligations. In 2006, AutoOne wrote moretake-out business than all other carriers in New York combined and all of itstake-out credits were sold to other carriers or used internally to reduceOneBeacon’s own assigned risk quota obligation.

Forthe years ended December 31, 2004, 2005 and 2006, our personal lines netwritten premiums were as follows:
|                                                   | ** ** | **Year ended December 31,(1)** | ** ** |
|---------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                        | ** ** | **2004**                                      | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                        | ** ** | **($ in millions)**                 | ** ** |
| Traditional  personal lines excluding reciprocals |       | $                                             | 724.7      |   | $ | 618.8 |   | $ | 492.7 |   |
| Reciprocals(2)                                    |       | 75.5                                          |       | 43.5 |   | 93.2 |   |
| Traditional personal lines                        |       | 800.2                                         |       | 662.3 |   | $ | 585.9 |   |
| AutoOne                                           |       | 275.3                                         |       | 248.8 |   | 222.6 |   |
| Total personal lines(3)                           |       | $                                             | 1,063.3    |   | $ | 910.2 |   | $ | 800.6 |   |

----

(1)          In the fourth quarter of2006, we began to include AutoOne, formerly a specialty lines business inpersonal lines to better align the product and management structure of ourunderwriting units. Prior periods have been reclassified to conform to thecurrent presentation.

(2)          As a result of a changein accounting standards, we began consolidating the results of reciprocals on March 31,2004.

(3)          Includeselimination between traditional personal lines and AutoOne.

7

----

***Run-off***

Run-offprimarily consists of national accounts, certain specialty programs andregional agency business transferred to Liberty Mutual effective November 1,2001. Beginning in 2001, national accounts and certain specialty programs werediscontinued. On November 1, 2001, we transferred our regional agencybusiness, agents and operations in 42 states and the District of Columbia toLiberty Mutual pursuant to a renewal rights agreement (the “Liberty Agreement”).The operating results and cash flows of policies renewed from November 1,2001 through October 31, 2003 pursuant to the Liberty Agreement wereshared between Liberty Mutual and OneBeacon. The Liberty Agreement pro-ratedresults so that OneBeacon assumed approximately two-thirds of the operatingresults from renewals through October 31, 2002 and approximately one-thirdof the operating results from renewals through October 31, 2003. Therenewal rights under the Liberty Agreement expired on October 31, 2003. Asa result, we did not write any new premiums in 2004 or 2005 under the LibertyAgreement, but recorded earned premium in 2004 from policies written under theLiberty Agreement in 2003. We continue to manage claims from the discontinuednational accounts and specialty programs business as well as the claims relatedto the business that was subject to the Liberty Agreement.

**GeographicConcentration**

Our net written premiums are derived solely frombusiness produced in the United States.

Businessfrom specialty lines was produced in the following states:
|               | ** ** | **Year ended December 31,** | ** ** |
|---------------|------------|--------------------------------------------|------------|
| ** **    | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| California    |       | 13.9                                       | %          | 14.0 | % | 13.7 | % |
| Florida       |       | 7.6                                        |       | 7.9 |   | 8.8 |   |
| New York      |       | 7.7                                        |       | 7.7 |   | 7.3 |   |
| Texas         |       | 7.9                                        |       | 7.1 |   | 7.0 |   |
| Massachusetts |       | 7.0                                        |       | 6.4 |   | 5.2 |   |
| Pennsylvania  |       | 2.4                                        |       | 3.5 |   | 3.9 |   |
| Illinois      |       | 2.6                                        |       | 2.7 |   | 3.4 |   |
| Washington    |       | 5.2                                        |       | 4.5 |   | 3.2 |   |
| New Jersey    |       | 4.1                                        |       | 3.4 |   | 3.2 |   |
| Connecticut   |       | 3.5                                        |       | 3.3 |   | 3.1 |   |
| Other(1)      |       | 38.1                                       |       | 39.5 |   | 41.2 |   |
| Total         |       | 100.0                                      | %          | 100.0 | % | 100.0 | % |

----

(1)          No individual state wasgreater than 3% of net written premiums for specialty lines.

8

----

Businessfrom commercial lines was produced in the following states:
|               | ** ** | **Year ended December 31,** | ** ** |
|---------------|------------|--------------------------------------------|------------|
| ** **    | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| Massachusetts |       | 16.2                                       | %          | 19.0 | % | 17.7 | % |
| New York      |       | 24.8                                       |       | 13.7 |   | 13.6 |   |
| California    |       | 9.8                                        |       | 11.4 |   | 13.1 |   |
| Maine         |       | 7.9                                        |       | 9.0 |   | 7.8 |   |
| New Jersey    |       | 8.2                                        |       | 7.5 |   | 7.1 |   |
| Connecticut   |       | 6.8                                        |       | 7.5 |   | 6.5 |   |
| New Hampshire |       | 3.1                                        |       | 3.4 |   | 2.9 |   |
| Other(1)      |       | 23.2                                       |       | 28.5 |   | 31.3 |   |
| Total         |       | 100.0                                      | %          | 100.0 | % | 100.0 | % |

----

(1)          Noindividual state was greater than 3% of net written premiums for commerciallines.

Business from personallines was produced in the following states:
|               | ** ** | **Year ended December 31,** | ** ** |
|---------------|------------|--------------------------------------------|------------|
| ** **    | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| New York      |       | 40.5                                       | %          | 46.5 | % | 46.6 | % |
| Massachusetts |       | 23.4                                       |       | 22.1 |   | 21.7 |   |
| New Jersey    |       | 19.4                                       |       | 14.0 |   | 11.4 |   |
| Maine         |       | 7.2                                        |       | 7.2 |   | 7.3 |   |
| Connecticut   |       | 4.5                                        |       | 4.1 |   | 4.6 |   |
| Rhode Island  |       | 2.8                                        |       | 2.7 |   | 3.0 |   |
| Other(1)      |       | 2.2                                        |       | 3.4 |   | 5.4 |   |
| Total         |       | 100.0                                      | %          | 100.0 | % | 100.0 | % |

----

(1)          Noindividual state was greater than 3% of net written premiums for personallines.

**Marketing**

We offer our products through a network comprised ofindependent agents, regional and national brokers and wholesalers. OneBeacon’sdistribution relationships consist of approximately 2,800 select agencies andbrokers. No agency or broker produced more than 3% of our direct writtenpremiums during 2006.

Our specialty lines businesses are managed fromlocations logistically appropriate to their target markets. OBPP is based inAvon, Connecticut and distributes its products through select national andregional brokers and agents. IMU is headquartered in New York City and operatesthrough nine branch locations throughout the United States. Its products aredistributed through a network of select agents that specialize in marinebusiness. Dewar’s affiliate, A.W.G. Dewar Agency, distributes tuition refundproducts to independent schools and colleges throughout North America.

The majority of our commercial and personal linesproducts are distributed through select independent insurance agents. OneBeaconprotects the integrity of its franchise value by selectively appointing agentsin those areas where we conduct business. We believe that independent insuranceagents provide more complete assessments of their clients’ needs, which resultsin more appropriate coverages and prudent risk management. We also believe thatindependent agents will continue to be a significant force in overall industrypremium production as well as facilitate the cross-selling of specialty,commercial and personal business products. In addition to the use ofindependent agents, the commercial lines middle market business, OBSP, providesits excess property solutions primarily through surplus lines wholesalers. 

9

----

In New York, AutoOne, apersonal lines business generates take-out credits by writing policies fromselect insurance brokers that were previously in the New York Automobile InsurancePlan, or NYAIP, and sells these credits to insurance companies subject to NYAIPassignments. AutoOne markets its LAD and CLAD services and New York take-outcredits directly to insurance carriers seeking assigned risk solutions.

In addition, our top performingagencies have been designated as our Lighthouse Partners, a program designed tostrengthen these priority relationships and build those books of business. Thisprogram was introduced in the second quarter of 2006 and provides enhancedbenefits such as priority handling of accounts, access to our entire franchiseof products, preferred profit-sharing opportunities, and priority accessto our producer development school and co-op advertising. There were 98agencies with this designation in 2006. These agencies represent fewer thanfive percent of our overall agency plant but write approximately22 percent of our business and over 25 percent of our new business.We believe our Lighthouse Partners are the core of our distribution and marketingsystem and that this deeper mutual commitment will benefit both these agenciesand OneBeacon, and ultimately our policyholders and shareholders.

**Underwriting andPricing**

We believe there must be a realistic expectation ofattaining an underwriting profit on all the business we write, as well as ademonstrated fulfillment of that expectation over time. Consistent with our “underwritingcomes first” operating principle, adequate pricing is a critical component forachieving an underwriting profit. We underwrite our book with a disciplinedapproach towards pricing our insurance products and are willing to forgo abusiness opportunity if we believe it is not priced appropriately to theexposure.

Specialization—or a heightened focus on certaincustomer groups and/or geographies through products, pricing and expertise—is akey driver of our success in specialty lines and is being extended into ourcommercial and personal businesses. The proprietary knowledge we developregarding the industry, class and risk characteristics provides us with acompetitive edge for our terms and conditions on individual accounts. Webelieve specialization will result in superior returns as compared to a more “generalist”underwriting approach.

We have used tiered rating plans since 2003 in bothour commercial and personal lines that permit us to offer more tailored pricequotes to our customers based on underwriting criteria applicable to each tier.As a result, we now have the flexibility to renew expiring policies into theappropriate tier rather than being forced to choose to either renew the policyat the same base rate or cancel the policy. The enhanced accuracy and precisionof our rate plans enables us to more confidently price our products to theexposure, and thereby permits our agency partners to deliver solutions to abroader range of customers.

We also monitor pricingactivity on a weekly basis and regularly measure usage of tiers, credits,debits and limits. In addition, we regularly update base rates to achievetargeted returns on surplus and attempt to shift writings away from lines andclasses where pricing is inadequate. To the extent changes in premium rates,policy forms or other matters are subject to regulatory approval (see “RiskFactors—Regulation may restrict our ability to operate” and “Regulatory Matters—General”),we proactively monitor our pending regulatory filings to facilitate, to theextent possible, their prompt processing and approval. Lastly, we expendconsiderable effort to measure and verify exposures and insured values.

**Claims Management**

Effective claims management is a critical factor inachieving satisfactory underwriting results. We maintain an experienced staffof appraisers, medical specialists, managers, staff attorneys and fieldadjusters strategically located throughout our operating territories. We alsomaintain a special investigative 

10

----

unit designed to detectinsurance fraud and abuse, and support efforts by regulatory bodies and tradeassociations to curtail fraud.

Claims are separately organized by specialty,commercial, personal and run-off operations. This approach allows us to betteridentify and manage claims handling costs. In addition, a shared service unitmanages costs related to both staff and vendors. We also adopted a total claimscost management approach that gives equal importance to controlling claimshandling expenses, legal expenses and claims payments, enabling us to lower thesum of the three. This approach requires the utilization of approximately fiftymetrics to monitor the effectiveness of various programs implemented to lowertotal loss cost. The metrics are designed to guard against our implementing anexpense containment program that will cost us more than we expect to save. Asan example, an internal legal bill audit team has contributed to savings byreducing legal invoices submitted by outside counsel.

Our claims department utilizes a modern claimsworkstation that records reserves, payments and adjuster activity and assistseach claim handler in evaluating bodily injury claims, determining liabilityand identifying fraud. Our commitment and performance in fighting insurancefraud has reduced claim costs and aided law enforcement investigations. Underour staff counsel program, our in-house attorneys defend the majority of new lawsuits,which has resulted in savings when compared to the cost of using outsidecounsel. In addition, our internal legal bill audit team has contributed tosavings by reducing the amounts paid to our outside counsel.

Calendar year reported claims in our run-offoperations were 1,700 in 2006 compared to 3,400 in 2005, a 50% reduction, inpart due to the lapse of time and the nature of run-off operations. Theselevels of reported claims are down from 202,000 in 2002, 64,800 in 2003 and5,900 in 2004. Total open claims for run-off operations were 7,300 at December 31,2006 compared to 10,200 at December 31, 2005, a 28% reduction, whichreflects the success of our focus on settling claims from our run-offoperations. Total open claims for run-off operations were 33,000 in 2003,14,600 in 2004. These numbers included all of the claims that were previouslyhandled by Liberty Mutual as a Third Party Administrator, or TPA. Most of ourclaims for run-off operations are handled by in-house adjusters.

In connection with thepurchase of OneBeacon by White Mountains in 2001, to help protect againstpotential asbestos and environmental claims relating to the pre-acquisitionperiod, we purchased a reinsurance contract from the National Indemnity Company(NICO). See “Business—Reinsurance Protection and Catastrophe Management”. NICOhas retained a TPA, Resolute New England (“Resolute”), formerly Cavell USA, tomanage the claims processing for asbestos and environmental claims reinsuredunder the NICO Cover. Our claims department personnel are consulted by NICO andResolute on major claims. As with all TPAs, claims department personnel performclaim audits on Resolute to ensure their controls, processes and settlementsare appropriate. See “Management’s Discussion and Analysis of FinancialCondition and Results of Operations—Critical Accounting Estimates—Asbestos andEnvironmental Reserves.”

**ReinsuranceProtection and Catastrophe Management**

In the ordinary course of our business, we purchasereinsurance from high-quality, highly rated, third party reinsurers in order tominimize loss from large risks or catastrophic events.

The timing and size of catastrophe losses areunpredictable and the level of losses experienced in any year could be materialto our operating results and financial position. Examples of catastrophesinclude losses caused by earthquakes, wildfires, hurricanes and other types ofstorms and terrorist acts. The extent of losses caused by catastrophes is botha function of the amount and type of insured exposure in an area affected bythe event and the severity of the event. We use models (primarily AIR V.8) toestimate losses our exposures would generate under various scenarios as well asthe probability of those losses occurring. We use this model output in conjunctionwith other data to manage our exposure to catastrophe losses 

11

----

through individual riskselection and by limiting our concentration of insurance written in catastrophe-proneareas, such as coastal regions. In addition, we impose wind deductibles onexisting coastal windstorm exposures. We believe that our largest single eventnatural catastrophe exposures are Northeastern United States windstorms andCalifornia earthquakes.

We seek to further reduce our potential loss fromcatastrophe exposures through the purchase of catastrophe reinsurance.Effective July 1, 2006, we renewed our property catastrophe reinsuranceprogram through June 30, 2007. Under that cover, the first$200 million of losses resulting from any single catastrophe are retainedby us and losses from a single event in excess of $200 million and up to$850 million are reinsured for 100% of the loss. We anticipate this$850 million limit is sufficient to cover Northeast windstorm losses witha 0.4%-0.5% probability of occurrence (1-in-250-year eventto 1-in-200-year event). In the event of a catastrophe, ourproperty catastrophe reinsurance program can be reinstated for the remainder ofthe original contract term by paying a reinstatement premium that is based onthe percentage of coverage reinstated and the original property catastrophecoverage premium.

Our property catastrophe reinsurance program does notcover personal or commercial property losses resulting from nuclear, biologicalor chemical terrorist attacks. The program covers personal property lossesresulting from “certified” events as defined under the Terrorism Act, such asforeign terrorism, provided such losses were not caused by nuclear, biologicalor chemical means. The program also covers personal and commercial propertylosses resulting from “non-certified” events as defined under theTerrorism Act, such as domestic terrorist attacks, provided such losses werenot caused by nuclear, biological or chemical means.

We also purchase individual property reinsurancecoverage for certain risks to reduce large loss volatility. Theproperty-per-risk reinsurance program reinsures losses in excess of$5 million up to $75 million. Individual risk facultative reinsurancemay be purchased above $75 million where we deem it appropriate. The property-per-risktreaty also provides one limit of reinsurance protection for losses in excessof $10 million up to $75 million on an individual risk basis forterrorism losses. However, nuclear, biological and chemical events are notcovered.

We also maintain a casualty reinsurance program thatprovides protection for individual risk or catastrophe losses involving workerscompensation, general liability, automobile liability or umbrella liability inexcess of $6 million up to $81 million. This program providescoverage for either “certified” or “non-certified” terrorism losses but doesnot provide coverage for losses resulting from nuclear, biological or chemicalattacks.

In 2001, we purchased reinsurance contracts with tworeinsurance companies rated “AAA” (“Extremely Strong”, the highest oftwenty-one ratings) by Standard & Poor’s and “A++” (“Superior”, thehighest of fifteen ratings) by A.M. Best. One is a reinsurance cover withNICO which entitles us to recover up to $2.5 billion in ultimate loss andLAE incurred related primarily to A&E claims arising from business writtenby our predecessor prior to 1992 and 1987, respectively. As of December 31,2006, we have ceded estimated incurred losses of approximately$2.1 billion to the NICO Cover. The other contract is a reinsurance coverwith General Reinsurance Corporation, or GRC, for up to $570 million ofadditional losses on all claims arising from accident years 2000 and prior. Asof December 31, 2006, we have ceded estimated incurred losses of$550 million to the GRC Cover. Pursuant to the GRC Cover, we are notentitled to recover losses to the full contract limit if such losses arereimbursed by GRC more quickly than anticipated at the time the contract wassigned. We intend to only seek reimbursement from GRC for claims which resultin payment patterns similar to those supporting our recoverables recordedpursuant to the GRC Cover. The economic cost of not submitting certain othereligible claims to GRC is primarily the investment spread between the rate creditedby GRC and the rate achieved by us on our own investments. This cost, if any,is expected to be small.

12

----

Reinsurance contracts donot relieve us of our obligation to our policyholders. Therefore,collectibility of balances due from reinsurers is critical to our financialstrength.

**Terrorism**

Since the terrorist attacks of September 11,2001, OneBeacon has sought to mitigate the risk associated with any futureterrorist attacks by limiting the aggregate insured value of policies ingeographic areas with exposure to losses from terrorist attacks. This isaccomplished by either limiting the total insured values exposed, or, whereapplicable, through the use of terrorism exclusions.

On December 22, 2005, the United Statesgovernment extended the Terrorism Act, which was set to expire on December 31,2005, for two more years. The Terrorism Act, originally enacted on November 26,2002 establishes a Federal “backstop” for commercial property and casualtylosses, including workers compensation, resulting from acts of terrorism by oron behalf of any foreign person or foreign interest. The law limits theindustry’s aggregate liability by requiring the Federal government to share 85%of certified losses in 2007 once a company meets a specific retention ordeductible as determined by its prior year’s direct written premiums and limitsthe aggregate liability to be paid by the government and industry withoutfurther action by Congress at $100.0 billion. In exchange for this “back-stop,”primary insurers are required to make coverage available to commercial insuredsfor losses from acts of non-domestic terrorism as specified in the TerrorismAct. The following types of coverage are excluded from the program: commercialautomobile, burglary and theft, surety, farmowners multi-peril and allprofessional liability coverage except directors and officers coverage.

We estimate our individual retention level forcommercial policies subject to the Terrorism Act to be approximately$162 million in 2007. The aggregate industry retention level is$27.5 billion for 2007. The Federal government will pay 85% of coveredterrorism losses that exceed OneBeacon’s or the industry’s retention levels in2007, up to a total of $100 billion.

Our current property and casualty catastrophe reinsuranceprograms provide coverage for “non-certified” events as defined under theTerrorism Act provided such losses are not the result of a nuclear, biologicalor chemical attack. See “Business—Reinsurance Protection and CatastropheManagement.”

We closely monitor and manage our concentration ofrisk by geographic area. Our strategy is to control our exposures so that ourtotal Maximum Expected Loss from a likely terrorism event within any half-mileradius in a metropolitan area or around a target risk will not exceed$200 million, or $300 million in all other areas. Reports monitoringour terrorism exposures are generated quarterly, and the exposure of potentialnew business located in areas of existing concentration or that individuallypresent significant exposure is evaluated during the underwriting process. As aresult, we believe that we have taken appropriate actions to limit our exposureto losses from terrorist attacks and will continue to monitor our terrorismexposure in the future. Nonetheless, risks insured by us, including thosecovered by the Terrorism Act, remain exposed to terrorist attacks and thepossibility remains that losses resulting from future terrorist attacks couldprove to be material to us.

**Loss and LAEReserves**

Weestablish loss and LAE reserves that are estimates of amounts needed to payclaims and related expenses in the future for insured events that have alreadyoccurred. The process of estimating reserves involves a considerable degree ofjudgment by management and, as of any given date, is inherently uncertain. See“Management’s Discussion and Analysis of Financial Condition and Results ofOperations—Critical Accounting Estimates.”

13

----

Thefollowing tables summarize our loss and LAE reserve activities for the yearsended December 31, 2004, 2005 and 2006:
| Year ended December 31, 2004                                       | ** ** | ** ** | ** ** | **Primary  Insurance  Operations** | ** ** | **Affiliate  Quota Shares** | ** ** | **Other  Operations** | ** ** | **Consolidated** | ** ** |
|----------------------------------------------------------------------------------------|------------|------------|------------|------------------------------------|------------|----------------------------------|------------|-----------------------|------------|------------------|------------|
| Gross beginning  balance                                                               |       | $          | 6,109.0    |                               |       | $                                | —     |                  |       |             | $          | (413.1 | ) |   |   | $ | 5,695.9 |   |   |
| Less beginning  reinsurance recoverable on unpaid losses           |       | (2,954.8   | )          |                               | —     |                             |       |                  | 297.5      |             |       |   | (2,657.3 | ) |   |
| Net loss and LAE  reserves                                                             |       | 3,154.2    |       |                               | —     |                             |       |                  | (115.6     | )                |       |   | 3,038.6 |   |   |
| Loss and LAE reserves  sold—Traders & Pacific Insurance Company, or TPIC |       | —     |       |                               | —     |                             |       |                  | —     |             |       |   | — |   |   |
| Loss and LAE  reserves consolidated—New Jersey Skylands                      |       | 62.1       |       |                               | —     |                             |       |                  | —     |             |       |   | 62.1 |   |   |
| Loss and LAE incurred  relating to:                                                    |       |       |       |                               |       |                             |       |                  |       |             |       |   |   |   |   |
| Current year  losses                                                                   |       | 1,348.8    |       |                               | (62.7      | )                                |       |                  | —     |             |       |   | 1,286.1 |   |   |
| Prior year losses                                                                      |       | 99.3       |       |                               | —     |                             |       |                  | —     |             |       |   | 99.3 |   |   |
| Total incurred  loss and LAE                                                           |       | 1,448.1    |       |                               | (62.7      | )                                |       |                  | —     |             |       |   | 1,385.4 |   |   |
| Accretion of fair  value adjustment to net loss and LAE reserves                       |       | —     |       |                               | —     |                             |       |                  | 33.2       |             |       |   | 33.2 |   |   |
| Loss and LAE paid  relating to:                                                        |       |       |       |                               |       |                             |       |                  |       |             |       |   |   |   |   |
| Current year  losses                                                                   |       | (565.5     | )          |                               | 18.2       |                             |       |                  | —     |             |       |   | (547.3 | ) |   |
| Prior year losses                                                                      |       | (1,441.6   | )          |                               | —     |                             |       |                  | —     |             |       |   | (1,441.6 | ) |   |
| Total loss and  LAE payments                                                           |       | (2,007.1   | )          |                               | 18.2       |                             |       |                  | —     |             |       |   | (1,988.9 | ) |   |
| Net ending  balance                                                                    |       | 2,657.3    |       |                               | (44.5      | )                                |       |                  | (82.4      | )                |       |   | 2,530.4 |   |   |
| Plus ending  reinsurance recoverable on unpaid losses                                  |       | 2,670.9    |       |                               | —     |                             |       |                  | (279.1     | )                |       |   | 2,391.8 |   |   |
| Gross ending balance                                                                   |       | $          | 5,328.2    |                               |       | $                                | (44.5      | )                     |       |             | $          | (361.5 | ) |   |   | $ | 4,922.2 |   |   |

 

14

----

 
| Year ended December 31, 2005                                 | ** ** | ** ** | ** ** | **Primary  Insurance  Operations** | ** ** | **Affiliate  Quota Shares** | ** ** | **Other  Operations** | ** ** | **Consolidated** | ** ** |
|----------------------------------------------------------------------------------|------------|------------|------------|------------------------------------|------------|----------------------------------|------------|-----------------------|------------|------------------|------------|
| Gross beginning  balance                                                         |       | $          | 5,328.2    |                               |       | $                                | (44.5      | )                     |       |             | $          | (361.5 | ) |   |   | $ | 4,922.2 |   |   |
| Less beginning  reinsurance recoverable on unpaid losses     |       | (2,670.9   | )          |                               | —     |                             |       |                  | 279.1      |             |       |   | (2,391.8 | ) |   |
| Net loss and LAE  reserves                                                       |       | 2,657.3    |       |                               | (44.5      | )                                |       |                  | (82.4      | )                |       |   | 2,530.4 |   |   |
| Loss and LAE  reserves sold—TPIC                                            |       | (11.8      | )          |                               | —     |                             |       |                  | —     |             |       |   | (11.8 | ) |   |
| Loss and LAE  reserves consolidated—New Jersey Skylands                |       | —     |       |                               | —     |                             |       |                  | —     |             |       |   | — |   |   |
| Loss and LAE incurred  relating to:                                              |       |       |       |                               |       |                             |       |                  |       |             |       |   |   |   |   |
| Current year  losses                                                             |       | 1,229.7    |       |                               | 61.7       |                             |       |                  | —     |             |       |   | 1,291.4 |   |   |
| Prior year losses                                                                |       | 105.9      |       |                               | (6.9       | )                                |       |                  | —     |             |       |   | 99.0 |   |   |
| Total incurred  loss and LAE                                                     |       | 1,335.6    |       |                               | 54.8       |                             |       |                  | —     |             |       |   | 1,390.4 |   |   |
| Accretion of fair  value adjustment to net loss and LAE reserves                 |       | —     |       |                               | —     |                             |       |                  | 26.0       |             |       |   | 26.0 |   |   |
| Loss and LAE paid  relating to:                                                  |       |       |       |                               |       |                             |       |                  |       |             |       |   |   |   |   |
| Current year  losses                                                             |       | (421.0     | )          |                               | (76.8      | )                                |       |                  | —     |             |       |   | (497.8 | ) |   |
| Prior year losses                                                                |       | (1,228.7   | )          |                               | 24.9       |                             |       |                  | —     |             |       |   | (1,203.8 | ) |   |
| Total loss and  LAE payments                                                     |       | (1,649.7   | )          |                               | (51.9      | )                                |       |                  | —     |             |       |   | (1,701.6 | ) |   |
| Net ending  balance                                                              |       | 2,331.4    |       |                               | (41.6      | )                                |       |                  | (56.4      | )                |       |   | 2,233.4 |   |   |
| Plus ending  reinsurance recoverable on unpaid losses                            |       | 3,382.0    |       |                               | —     |                             |       |                  | (261.1     | )                |       |   | 3,120.9 |   |   |
| Gross ending balance                                                             |       | $          | 5,713.4    |                               |       | $                                | (41.6      | )                     |       |             | $          | (317.5 | ) |   |   | $ | 5,354.3 |   |   |

 
| Year ended December 31, 2006                                 | ** ** | ** ** | ** ** | **Primary  Insurance  Operations** | ** ** | **Affiliate  Quota Shares** | ** ** | **Other  Operations** | ** ** | **Consolidated** | ** ** |
|----------------------------------------------------------------------------------|------------|------------|------------|------------------------------------|------------|----------------------------------|------------|-----------------------|------------|------------------|------------|
| Gross beginning  balance                                                         |       | $          | 5,713.4    |                               |       | $                                | (41.6      | )                     |       |             | $          | (317.5 | ) |   |   | $ | 5,354.3 |   |   |
| Less beginning  reinsurance recoverable on unpaid losses     |       | (3,382.0   | )          |                               | —     |                             |       |                  | 261.1      |             |       |   | (3,120.9 | ) |   |
| Net loss and LAE  reserves                                                       |       | 2,331.4    |       |                               | (41.6      | )                                |       |                  | (56.4      | )                |       |   | 2,233.4 |   |   |
| Loss and LAE  reserves sold—TPIC                                            |       | —     |       |                               | —     |                             |       |                  | —     |             |       |   | — |   |   |
| Loss and LAE  reserves consolidated—New Jersey Skylands                |       | —     |       |                               | —     |                             |       |                  | —     |             |       |   | — |   |   |
| Loss and LAE incurred  relating to:                                              |       |       |       |                               |       |                             |       |                  |       |             |       |   |   |   |   |
| Current year  losses                                                             |       | 1,157.4    |       |                               | 114.9      |                             |       |                  | —     |             |       |   | 1,272.3 |   |   |
| Prior year losses                                                                |       | 22.9       |       |                               | (11.6      | )                                |       |                  | —     |             |       |   | 11.3 |   |   |
| Total incurred  loss and LAE                                                     |       | 1,180.3    |       |                               | 103.3      |                             |       |                  | —     |             |       |   | 1,283.6 |   |   |
| Accretion of fair  value adjustment to net loss and LAE reserves                 |       | —     |       |                               | —     |                             |       |                  | 23.0       |             |       |   | 23.0 |   |   |
| Loss and LAE paid relating  to:                                                  |       |       |       |                               |       |                             |       |                  |       |             |       |   |   |   |   |
| Current year  losses                                                             |       | (474.6     | )          |                               | (114.9     | )                                |       |                  | —     |             |       |   | (589.5 | ) |   |
| Prior year losses                                                                |       | (1,008.6   | )          |                               | 53.2       |                             |       |                  | —     |             |       |   | (955.4 | ) |   |
| Total loss and  LAE payments                                                     |       | (1,483.2   | )          |                               | (61.7      | )                                |       |                  | —     |             |       |   | (1,544.9 | ) |   |
| Net ending  balance                                                              |       | 2,028.5    |       |                               | —     |                             |       |                  | (33.4      | )                |       |   | 1,995.1 |   |   |
| Plus ending  reinsurance recoverable on unpaid losses                            |       | 3,079.7    |       |                               | —     |                             |       |                  | (237.1     | )                |       |   | 2,842.6 |   |   |
| Gross ending balance                                                             |       | $          | 5,108.2    |                               |       | $                                | —     |                  |       |             | $          | (270.5 | ) |   |   | $ | 4,837.7 |   |   |

 

15

----

The following information presents (1) ourreserve development over the preceding 10 years and (2) a reconciliationof reserves in accordance with accounting principles and practices prescribedor permitted by insurance authorities (“Statutory” basis) to such reservesdetermined in accordance with GAAP, each as prescribed by Securities ActIndustry Guide No. 6.

Section I of the 10 year table shows theestimated liability that was recorded at the end of each of the indicated yearsfor all current and prior accident year unpaid loss and LAE. The liabilityrepresents the estimated amount of loss and LAE for claims that were unpaid atthe balance sheet date, including incurred but not reported, or IBNR, reserves.In accordance with GAAP, the liability for unpaid loss and LAE is recorded inthe balance sheet gross of the effects of reinsurance with an estimate ofreinsurance recoverables arising from reinsurance contracts reported separatelyas an asset. The net balance represents the estimated amount of unpaid loss andLAE outstanding as of the balance sheet date, reduced by estimates of amountsrecoverable under reinsurance contracts.

Section II shows the cumulative amount of netloss and LAE paid relating to recorded liabilities as of the end of eachsucceeding year. Section III shows the re-estimated amount of thepreviously recorded net liability as of the end of each succeeding year.Estimates of the liability for unpaid loss and LAE are increased or decreasedas payments are made and more information regarding individual claims andtrends, such as overall frequency and severity patterns, becomes known. Section IVshows the cumulative net (deficiency)/redundancy representing the aggregatechange in the liability from original balance sheet dates and the re-estimatedliability through December 31, 2006. Section V shows the re-estimatedgross liability and re-estimated reinsurance recoverables through December 31,2006. Section VI shows the cumulative gross (deficiency)/redundancyrepresenting the aggregate change in the liability from original balance sheetdates and the re-estimated liability through December 31, 2006.

16

----

 
|                                                                                                                    | ** ** | **Primary Insurance Operations Loss and LAE (1), (2), (4)  Year ended December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                                         | ** ** | **1996**                                                                                                                                    | ** ** | **1997** | ** ** | **1998(3)** | ** ** | **1999** | ** ** | **2000** | ** ** | **2001** | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                                                                                         | ** ** | **($ in millions)**                                                                                                               | ** ** |
| I. Liability for unpaid  loss and LAE:                                                                             |       |                                                                                                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Gross balance                                                                                                      |       | $                                                                                                                                           | 5,804.4    |   | $ | 5,655.9 |   | $ | 6,869.5 |   | $ | 6,276.0 |   | $ | 6,875.4 |   | $ | 8,320.2 |   | $ | 7,507.0 |   | $ | 6,109.0 |   | $ | 5,328.2 |   | $ | 5,713.4 |   | $ | 5,108.2 |   |
| Less reinsurance  recoverable on  unpaid                                                                           |       | (1,260.4                                                                                                                                    | )          | (1,159.2 | ) | (1,641.0 | ) | (1,262.7 | ) | (1,252.1 | ) | (3,591.5 | ) | (3,534.4 | ) | (2,954.8 | ) | (2,670.9 | ) | (3,382.0 | ) | (3,079.7 | ) |
| Net balance                                                                                                        |       | $                                                                                                                                           | 4,544.0    |   | $ | 4,496.7 |   | $ | 5,228.5 |   | $ | 5,013.3 |   | $ | 5,623.3 |   | $ | 4,728.7 |   | $ | 3,972.6 |   | $ | 3,154.2 |   | $ | 2,657.3 |   | $ | 2,331.4 |   | $ | 2,028.5 |   |
| II. Cumulative amount of net liability paid through:                                                               |       |                                                                                                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| 1 year later                                                                                                       |       | 1,594.8                                                                                                                                     |       | 1,684.3 |   | 1,784.3 |   | 1,938.1 |   | 1,965.3 |   | 1,851.6 |   | 1,610.2 |   | 1,421.1 |   | 1,146.7 |   | 1,004.6 |   |   |   |
| 2 years later                                                                                                      |       | 2,621.3                                                                                                                                     |       | 2,732.5 |   | 2,908.5 |   | 3,065.1 |   | 3,153.0 |   | 3,039.5 |   | 2,764.2 |   | 2,274.5 |   | 1,833.5 |   |   |   |   |   |
| 3 years later                                                                                                      |       | 3,331.1                                                                                                                                     |       | 3,515.0 |   | 3,643.7 |   | 3,824.9 |   | 3,984.7 |   | 3,963.6 |   | 3,489.6 |   | 2,809.9 |   |   |   |   |   |   |   |
| 4 years later                                                                                                      |       | 3,872.2                                                                                                                                     |       | 4,028.8 |   | 4,061.7 |   | 4,330.3 |   | 4,596.8 |   | 4,529.5 |   | 3,941.0 |   |   |   |   |   |   |   |   |   |
| 5 years later                                                                                                      |       | 4,225.0                                                                                                                                     |       | 4,282.8 |   | 4,353.7 |   | 4,666.9 |   | 4,957.3 |   | 4,876.0 |   |   |   |   |   |   |   |   |   |   |   |
| 6 years later                                                                                                      |       | 4,398.1                                                                                                                                     |       | 4,464.4 |   | 4,555.9 |   | 4,887.2 |   | 5,194.4 |   |   |   |   |   |   |   |   |   |   |   |   |   |
| 7 years later                                                                                                      |       | 4,516.6                                                                                                                                     |       | 4,584.6 |   | 4,701.7 |   | 5,044.7 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| 8 years later                                                                                                      |       | 4,609.4                                                                                                                                     |       | 4,694.6 |   | 4,801.6 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| 9 years later                                                                                                      |       | 4,691.3                                                                                                                                     |       | 4,767.3 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| 10 years later                                                                                                     |       | 4,743.9                                                                                                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| III. Net Liability re-estimated as of:                                                                             |       |                                                                                                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| 1 year later                                                                                                       |       | 4,627.8                                                                                                                                     |       | 5,370.1 |   | 5,237.1 |   | 5,829.0 |   | 4,730.8 |   | 4,781.3 |   | 4,110.3 |   | 3,253.4 |   | 2,763.2 |   | 2,354.3 |   |   |   |
| 2 years later                                                                                                      |       | 5,476.0                                                                                                                                     |       | 5,424.7 |   | 5,916.1 |   | 4,942.0 |   | 4,824.2 |   | 5,059.4 |   | 4,227.0 |   | 3,380.4 |   | 2,765.5 |   |   |   |   |   |
| 3 years later                                                                                                      |       | 5,549.0                                                                                                                                     |       | 5,965.0 |   | 4,929.6 |   | 4,927.0 |   | 5,294.3 |   | 5,143.8 |   | 4,344.8 |   | 3,396.2 |   |   |   |   |   |   |   |
| 4 years later                                                                                                      |       | 5,924.8                                                                                                                                     |       | 4,980.5 |   | 4,857.5 |   | 5,221.8 |   | 5,336.0 |   | 5,222.8 |   | 4,365.1 |   |   |   |   |   |   |   |   |   |
| 5 years later                                                                                                      |       | 4,948.0                                                                                                                                     |       | 4,911.8 |   | 5,042.9 |   | 5,165.8 |   | 5,383.6 |   | 5,244.3 |   |   |   |   |   |   |   |   |   |   |   |
| 6 years later                                                                                                      |       | 4,900.4                                                                                                                                     |       | 5,069.3 |   | 4,929.1 |   | 5,197.2 |   | 5,385.8 |   |   |   |   |   |   |   |   |   |   |   |   |   |
| 7 years later                                                                                                      |       | 5,028.9                                                                                                                                     |       | 4,902.3 |   | 4,936.5 |   | 5,169.2 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| 8 years later                                                                                                      |       | 4,867.4                                                                                                                                     |       | 4,910.2 |   | 4,902.9 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| 9 years later                                                                                                      |       | 4,868.0                                                                                                                                     |       | 4,881.2 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| 10 years later                                                                                                     |       | 4,836.4                                                                                                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| IV. Cumulative net  (deficiency)/  redundancy(5)                                                                   |       | $                                                                                                                                           | (292.4     | ) | $ | (384.5 | ) | $ | 325.6 |   | $ | (155.9 | ) | $ | 237.5 |   | $ | (515.6 | ) | $ | (392.5 | ) | $ | (242.0 | ) | $ | (108.2 | ) | $ | (22.9 | ) |   |   |
| Percent  (deficient)/  redundant                                                                                   |       | (6.4                                                                                                                                        | )%         | (8.6 | )% | 6.2 | % | (3.1 | )% | 4.2 | % | (10.9 | )% | (9.9 | )% | (7.7 | )% | (4.1 | )% | (1.0 | )% |   |   |
| V. Reconciliation of net liability re-estimated  as of the end of the latest re-estimation period (see III above): |       |                                                                                                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Gross unpaid loss  and LAE latest  re-estimate                                                                     |       | $                                                                                                                                           | 8,926.8    |   | $ | 8,891.2 |   | $ | 9,385.1 |   | $ | 9,376.8 |   | $ | 9,560.0 |   | $ | 9,852.4 |   | $ | 8,918.1 |   | $ | 7,266.3 |   | $ | 6,269.1 |   | $ | 5,756.8 |   |   |   |
| Reinsurance  recoverable latest re-estimate                                                                        |       | (4,090.4                                                                                                                                    | )          | (4,010.0 | ) | (4,482.2 | ) | (4,207.6 | ) | (4,174.2 | ) | (4,608.1 | ) | (4,553.0 | ) | (3,870.1 | ) | (3,503.6 | ) | (3,402.5 | ) |   |   |
| Net unpaid loss  and LAE latest re-estimate                                                                        |       | $                                                                                                                                           | 4,836.4    |   | $ | 4,881.2 |   | $ | 4,902.9 |   | $ | 5,169.2 |   | $ | 5,385.8 |   | $ | 5,244.3 |   | $ | 4,365.1 |   | $ | 3,396.2 |   | $ | 2,765.5 |   | $ | 2,354.3 |   |   |   |
| VI. Cumulative  Gross deficiency                                                                                   |       | $                                                                                                                                           | (3,122.4   | ) | $ | (3,235.4 | ) | $ | (2,515.6 | ) | $ | (3,100.8 | ) | $ | (2,684.6 | ) | $ | (1,532.2 | ) | $ | (1,411.1 | ) | $ | (1,157.3 | ) | $ | (940.9 | ) | $ | (43.4 | ) |   |   |
| Percent deficient                                                                                                  |       | (53.8                                                                                                                                       | )%         | (57.2 | )% | (36.6 | )% | (49.4 | )% | (39.0 | )% | (18.4 | )% | (18.8 | )% | (18.9 | )% | (17.7 | )% | (0.8 | )% |   |   |

----

(1)          In 1998, CommercialGeneral Union or CGU, the predecessor company to OneBeacon, was formed as aresult of a pooling of interests between Commercial Union Corporation andGeneral Accident Corporation of America. All historical balances have beenrestated as though the companies had been merged throughout the periodspresented.

17

----

(2)          This table reflects theeffects of the NICO Cover and the GRC Cover as if they had been in effect forall periods presented.

(3)          CGU acquired HoustonGeneral Insurance Company or HGIC, in 1998. In 2005, OneBeacon contributed HGICto Houston General Insurance Exchange in 2005. All liabilities related to thisentity have been shown from 1998 forward in this table as it is stillconsolidated by OneBeacon.

(4)          The 10-year tableis reflective of activity related to our loss and LAE reserves from our PrimaryInsurance Operations segment and does not include the effect of any reserveactivity from the affiliate quota share agreements or other operations.

(5)          Our December 31,2005 net liability for unpaid loss and LAE for our Primary Insurance Operationssegment re-estimated as of one year later resulted in a net deficiency of$22.9 million.

The cumulative net (deficiency)/redundancy in thetable above reflects reinsurance recoverables recorded under the NICO Cover andthe GRC Cover. These covers apply to losses incurred in 2000 and prior years.As a result, they have the effect of significantly increasing our reinsurancerecoverables in 2001 and reducing our net reserve deficiency for each of theyears presented prior to 2001 by the amount of the gross reserves ceded at thetime these covers were purchased. See “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations—Critical Accounting Estimates.”In addition, in June 2005, we completed an internal study of our A&Eexposures. Based on the study, we increased our best estimate of our incurredlosses ceded to NICO, net of underlying reinsurance, by $353.0 million($841.0 million gross) to $2.1 billion, which is within the$2.5 billion coverage provided by the NICO Cover. This had the effect ofsignificantly increasing our reinsurance recoverables in 2005 and reducing ournet reserve deficiency for each of the years presented prior to 2001 by the amountof the gross reserves ceded to NICO upon completion of this study. See “Management’sDiscussion and Analysis of Financial Condition and Results of Operations—CriticalAccounting Estimates.”

Thefollowing table reconciles loss and LAE reserves for our Primary InsuranceOperations determined on a statutory basis to loss and LAE reserves determinedin accordance with GAAP at December 31, as follows:
|                                              | ** ** | **December 31,**         | ** ** |
|----------------------------------------------|------------|-------------------------------|------------|
| ** **                                   | ** ** | **2004**                      | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                   | ** ** | **($ in millions)** | ** ** |
| Statutory  reserves                          |       | $                             | 4,309.9    |   | $ | 4,253.4 |   | $ | 3,863.9 |   |
| Reinsurance  recoverable on unpaid losses(1) |       | 1,002.9                       |       | 1,455.2 |   | 1,280.5 |   |
| Reserves  allocated from other segments, net |       | 44.5                          |       | 41.6 |   | — |   |
| Other(2)                                     |       | (29.1                         | )          | (36.8 | ) | (36.2 | ) |
| GAAP reserves                                |       | $                             | 5,328.2    |   | $ | 5,713.4 |   | $ | 5,108.2 |   |

----

(1)          Representsadjustments made to add back reinsurance recoverables on unpaid losses includedwith the presentation of reserves under GAAP.

(2)          Primarilyrepresents long-term workers compensation loss and LAE reserve discountrecorded of $36.1 million, $36.8 million and $36.2 million in 2004,2005 and 2006 in excess of statutorily defined discount.

**Affiliate Quota Shares**

Our consolidated financialstatements reflect two quota share reinsurance agreements we entered into withsubsidiaries of White Mountains. Under the Esurance Quota Share, which waseffective on January 1, 2005, OneBeacon assumed approximately 85% ofbusiness written by Esurance Insurance Company, which includes business writtenby its wholly-owned subsidiary. Under the Sirius Quota Share, OneBeacon ceded 

18

----

between6% and 12% of business written, effective April 1, 2004, to SiriusInternational Insurance Corporation.

The affiliate quota shareswere entered into primarily for White Mountains’ capital management purposesand therefore, financial information reflected in Primary Insurance Operationsare prior to the quota share reinsurance agreements consistent with howmanagement measures our financial performance. Further, the affiliate quotashares were commuted during the fourth quarter of 2006 in connection with ourinitial public offering.

**Other Operations**

Our Other Operationssegment consists of the activities of OneBeacon Insurance Group, Ltd. andour intermediate subsidiary holding companies. Our Other Operations segmentprimarily consists of financing activities, purchase accounting adjustmentsrelating to the OneBeacon Acquisition and other assets and general andadministrative expenses incurred at the holding company level.

In May 2003, FundAmerican Companies, Inc. (“Fund American”), our wholly-owned subsidiary,issued $700.0 million face value of senior unsecured debt (the SeniorNotes) through a public offering, at an issue price of 99.7%. The Senior Notesbear an annual interest rate of 5.875%, payable semi-annually in arrears on May 15and November 15, until maturity on May 15, 2013, and are fully andunconditionally guaranteed as to the payment of principal and interest by WhiteMountains. White Mountains currently provides an irrevocable and unconditionalguarantee as to the payment of principal and interest (the Guarantee) on theSenior Notes. In consideration of this Guarantee, we have agreed to pay aspecified fee to White Mountains in the amount of 25 basis points per annum onthe outstanding principal amount of the Senior Notes. We have further agreedthat if White Mountains’ voting interest in us ceases to represent more than50% of all our voting securities, we will redeem, exchange or otherwise modifythe Senior Notes in order to fully and permanently eliminate White Mountains’obligations under the Guarantee. See “Management’s Discussion of FinancialCondition and Results of Operations—Financing”.

As part of the financingfor the OneBeacon Acquisition, Berkshire Hathaway Inc, or Berkshire, invested atotal of $300 million in cash, of which (1) $225 million was forthe purchase of cumulative non-voting preferred stock of Fund American (the “BerkshirePreferred Stock”), which has a $300 million redemption value; and (2) $75 millionwas for the purchase of warrants to acquire 1,724,200 common shares of WhiteMountains. The Berkshire Preferred Stock is entitled to a dividend of no lessthan 2.35% per quarter and is mandatorily redeemable on May 31, 2008.

Also in connection withthe OneBeacon Acquisition, Zenith Insurance Company, or Zenith, purchased$20.0 million in cumulative non-voting preferred stock of a subsidiary ofthe Company (the “Zenith Preferred Stock”). The Zenith Preferred Stock isentitled to a dividend of no less than a 2.5% per quarter through June 30,2007 and a dividend of no less than 3.5% per quarter thereafter and ismandatorily redeemable on May 31, 2011. At the Company’s option, theZenith Preferred Stock may be redeemed on June 30, 2007.

In connection with theinitial public offering and as part of the reorganization, OneBeacon createdtwo irrevocable grantor trusts and funded them with assets sufficient to makethe remaining dividend and redemption payments for the $20 million ZenithPreferred Stock that will be redeemed in 2007 and the $300 million BerkshirePreferred Stock that will be redeemed in May of 2008. The creation andfunding of the trusts does not legally defease the preferred stock or createany additional rights for the holders of the preferred stock, although theassets in the trusts remain segregated from OneBeacon’s other general assetsand are not available for any use other than the payment of the ZenithPreferred Stock and the Berkshire Preferred Stock. The assets held in trustremain subject to the claims of Fund American’s and Fund American Enterprises’creditors, respectively, in the event that either Fund American or FundAmerican Enterprises becomes insolvent. See “Management’s Discussion ofFinancial Condition and Results of Operations—Economic Defeasance”.

19

----

In connection with ourinitial public offering, Fund American established a $75 million revolvingcredit facility that matures in November 2011 (the Bank Facility). As ofDecember 31, 2006, the Bank Facility was undrawn.

*Investment Results*

At December 31 2006, approximately 94% of ourfixed maturity investments held an investment grade rating fromStandard & Poor’s or from Moody’s if a given security is unrated byStandard & Poor’s. Standard & Poor’s and Moody’s are twoleading independent rating agencies that assess the credit quality of companiesthat have publicly issued debt. An investment grade rating, which is indicativeof a strong credit profile of an issuer, is defined as “BBB-” (“Adequate”, thetenth highest of twenty-two ratings) or better by Standard & Poor’sand “Baa3” (“Moderate Risk”, the tenth highest of twenty-one ratings) or betterby Moody’s. We expect to continue to invest primarily in high quality fixedmaturity investments. Nearly all the fixed maturity investments currently heldby us are publicly traded, and as such we consider them to be liquid.

Thefollowing table presents the composition of our investment portfolio as of December 31,2005 and 2006:

| ** **                                 | ** ** | **As of December 31,** | ** ** |
|--------------------------------------------|------------|---------------------------------------|------------|
| ** **                                 | ** ** | **2005**                              | ** ** | **2006** | ** ** |
| **Type of Investment**           | ** ** | ** **                            | ** ** | **$ in  millions** | ** ** | **% of  total** | ** ** | **$ in  millions** | ** ** | **% of  total** | ** ** |
| Available-for-sale  investments:           |       |                                  |       |   |   |   |   |   |   |
| Fixed maturity investments                 |       | $                                     | 3,690.4    |   | 77.5 | % | $ | 3,539.7 |   | 67.9 | % |
| Short-term investments                     |       | 207.6                                 |       | 4.3 |   | 319.0 |   | 6.1 |   |
| Montpelier Re Holding Ltd. common stock(1) |       | 115.7                                 |       | 2.4 |   | — |   | — |   |
| Common stock, excluding Montpelier         |       | 475.6                                 |       | 10.0 |   | 737.1 |   | 14.1 |   |
| Held-to-maturity  investments:(2)          |       |                                  |       |   |   |   |   |   |   |
| Fixed maturity investments                 |       | —                                |       | — |   | 305.0 |   | 5.9 |   |
| Short-term investments                     |       | —                                |       | — |   | 33.8 |   | 0.6 |   |
| Other investments                          |       | 275.2                                 |       | 5.8 |   | 278.1 |   | 5.4 |   |
| Total                                      |       | $                                     | 4,764.5    |   | 100.0 | % | $ | 5,212.7 |   | 100 | % |
|                                            |            |                                       |            |  |  |  |  |  |  |  |  |  |  |

----

(1)          OnAugust 24, 2006, OneBeacon exchanged its investment in the common sharesof Montpelier Re Holdings Ltd., or Montpelier, for an agreed-upon portfolio ofcommon equity and fixed maturity securities of equal value that was owned byWhite Mountains. See “Management’s Discussion of Financial Condition andResults of Operations—Montpelier Investment”.

(2)          Representsassets held in trust to economically defease our preferred stock subject tomandatory redemption. See “Management’s Discussion of Financial Condition andResults of Operations—Economic Defeasance”.

20

----

Thefollowing table presents the total GAAP pre-tax rate of return for ourinvestment portfolio for the years ended December 31, 2004, 2005 and 2006:

| ** **                       | ** ** | **Year ended  December 31,** | ** ** |
|----------------------------------|------------|----------------------------------------|------------|
| **Type of Investment** | ** ** | ** **                             | ** ** | **2004** | ** ** | **2005** | ** ** | **2006(1)** | ** ** |
| Fixed maturity  investments      |       | 4.7                                    | %          | 1.7 | % |   | 5.8 | % |   |
| Short-term  investments          |       | 0.8                                    |       | 3.0 |   |   | 4.4 |   |   |
| Montpelier common  stock(2)      |       | 46.1                                   |       | (44.1 | ) |   | (7.6 | ) |   |
| Core common stock(3)             |       | 29.0                                   |       | 20.6 |   |   | 26.6 |   |   |
| Other investments                |       | 17.7                                   |       | 16.9 |   |   | 15.0 |   |   |
| Total                            |       | 8.5                                    | %          | 2.6 | % |   | 8.8 | % |   |
|                                  |            |                                        |            |  |  |  |  |  |  |  |  |

----

(1)          Includes $2.2 million ofnet investment income for assets held in trust.

(2)          OnAugust 24, 2006, OneBeacon exchanged its investment in the common sharesof Montpelier Re Holdings Ltd., or Montpelier, for an agreed-upon portfolio ofcommon equity and fixed maturity securities of equal value that was owned byWhite Mountains. See “Management’s Discussion of Financial Condition andResults of Operations—Montpelier Investment”.

(3)          Represents all commonstock holdings other than Montpelier.

Thebreakdown of our fixed maturity available-for-sale and held-to-maturityportfolios at December 31, 2006 by credit class, based upon issue creditratings provided by Standard & Poor’s, or if unrated by Standard &Poor’s, long-term obligation ratings provided by Moody’s, is as follows:

| **Ratings**                                           | ** ** | ** **                    | ** ** | **Cost or  Amortized Cost** | ** ** | **% of Total** | ** ** |
|-------------------------------------------------------|------------|-------------------------------|------------|---------------------------------------|------------|--------------------------|------------|
| ** **                                            | ** ** | **($ in millions)** | ** ** |
| U.S. government  and government-sponsored enterprises |       |                          | $          | 1,182.5                               |       |                     |       | 31.1 | % |   |
| AAA/Aaa                                               |       |                          | 997.0      |                                  |       |                     | 26.2       |   |   |
| AA/Aa                                                 |       |                          | 110.2      |                                  |       |                     | 2.9        |   |   |
| A/A                                                   |       |                          | 567.4      |                                  |       |                     | 14.9       |   |   |
| BBB/Baa                                               |       |                          | 713.2      |                                  |       |                     | 18.7       |   |   |
| Other/not rated                                       |       |                          | 236.2      |                                  |       |                     | 6.2        |   |   |
| Total                                                 |       |                          | $          | 3,806.5                               |       |                     |       | 100 | % |   |

 

Theweighted average duration of our fixed maturity portfolio at December 31,2006 is two years. The maturity distribution for fixed maturityavailable-for-sale investments held at December 31, 2006 is as follows:

| **Maturity**                      | ** ** | ** **                    | ** ** | **Amortized Cost** | ** ** | **Carrying  Value** | ** ** |
|-----------------------------------|------------|-------------------------------|------------|-------------------------|------------|---------------------|------------|
| ** **                        | ** ** | **($ in millions)** | ** ** |
| Due within one  year              |       |                          | $          | 178.5                   |       |                | $          | 178.3 |   |
| Due after one  through five years |       |                          | 1,020.8    |                    |       | 1,023.5             |       |
| Due after five  through ten years |       |                          | 753.6      |                    |       | 757.0               |       |
| Due after ten  years              |       |                          | 346.3      |                    |       | 348.4               |       |
| Asset-backed  securities          |       |                          | 1,091.4    |                    |       | 1,097.0             |       |
| Preferred stocks                  |       |                          | 110.9      |                    |       | 135.5               |       |
| Total                             |       |                          | $          | 3,501.5                 |       |                | $          | 3,539.7 |   |

 

21

----

Thematurity distribution for fixed maturity held-to-maturity investments held at December 31,2006 is as follows:

| **Maturity**                      | ** ** | ** **                    | ** ** | **Carrying  Value** | ** ** | **Estimated Fair  Value** | ** ** |
|-----------------------------------|------------|-------------------------------|------------|---------------------|------------|--------------------------------|------------|
| ** **                        | ** ** | **($ in millions)** | ** ** |
| Due within one  year              |       |                          | $          | 13.3                |       |                           |       | $ | 13.2 |   |   |
| Due after one  through five years |       |                          | 291.7      |                |       |                           | 290.8      |   |   |
| Due after five  through ten years |       |                          | —     |                |       |                           | —     |   |   |
| Due after ten  years              |       |                          | —     |                |       |                           | —     |   |   |
| Total                             |       |                          | $          | 305.0               |       |                           |       | $ | 304.0 |   |   |

 

Ourtotal GAAP pre-tax net investment results for the twelve months ended December 31,2006, was as follows:

| ** **                                | ** ** | **Total**                     | ** ** |
|-------------------------------------------|------------|-------------------------------|------------|
| ** **                                | ** ** | **($ in millions)** | ** ** |
| Gross investment  income                  |       |                          | $          | 205.5 |   |   |
| Net realized  investment gains            |       |                          | 163.6      |   |   |
| Net change in  unrealized gains           |       |                          | 47.8       |   |   |
| Total GAAP pre-tax  net investment return |       |                          | $          | 416.9 |   |   |

 

We regularly review ourentire portfolio, practice active security selection and perform frequent sectorselection analyses. As a general matter, we do not emphasize active asset-liabilitymatching as a portfolio management strategy.

**Investment inUnconsolidated Affiliate**

*MainStreet America Holdings, Inc., or MSA.**  *On October 31, 2006, wereceived a $70 million cash dividend from MSA, a subsidiary of Main StreetAmerica Group Mutual Holdings, Inc., or Main Street Group, a Florida-domiciledmutual property and casualty insurance holding company, which insures risks locatedprimarily in New York, Massachusetts, Connecticut, Pennsylvania, New Hampshire,Virginia and Florida. Following this transaction, we sold our 50% common stockinvestment in MSA to Main Street America Group, Inc., or Group, for (i) $70.0 millionin 9.0% non-voting cumulative perpetual preferred stock of Group and (ii) 4.9%of the common stock of Group. These transactions resulted in a net after-taxrealized gain of $8.5 million.

Prior to the exchange ofour common stock investment in MSA, we accounted for this investment using theequity method of accounting. MSA’s net written premiums for the years ended December 31,2004 and 2005 and the ten months ended October 31, 2006 totaled$454.5 million, $481.6 million and $424.2 million, respectively, andits net income totaled $30.3 million, $16.1 million and$32.3 million, respectively. As of December 31, 2005, our totalinvestment in MSA was $168.0 million.

**Regulatory Matters**

*General*

Our insurance operationsare subject to regulation and supervision in each of the jurisdictions wherethey are domiciled and licensed to conduct business. Generally, regulatoryauthorities have broad supervisory and administrative powers over such mattersas licenses, standards of solvency, premium rates, policy forms, investments,security deposits, methods of accounting, form and content of the consolidatedfinancial statements, reserves for unpaid loss and LAE, reinsurance, minimumcapital and surplus requirements, dividends and other distributions toshareholders, periodic examinations and annual and 

22

----

otherreport filings. In general, such regulation is for the protection ofpolicyholders rather than shareholders. Loss ratio trends in property andcasualty insurance underwriting may be improved by, among other things,changing the kinds of coverages provided by policies, providing loss preventionand risk management services, increasing premium rates, purchasing reinsuranceor by a combination of these factors. The ability of our insurance subsidiariesto meet emerging adverse loss ratio trends may be delayed, from time to time,by the effects of laws which require prior approval by insurance regulatoryauthorities of changes in policy forms and premium rates. We believe that weare in compliance with all applicable laws and regulations applicable to ourbusiness that would have a material effect on our financial position in theevent of non-compliance.

*State Accreditationand Monitoring*

Over the last several years most states haveimplemented laws that establish standards for current, as well as continued,state accreditation. In addition, the National Association of InsuranceCommissioners, or NAIC, has adopted risk-based capital, or RBC, standards forproperty and casualty companies, which are designed to determine minimum capitalrequirements and to raise the level of protection that statutory surplusprovides for policyholder obligations. The RBC formula for property andcasualty insurance companies measures three major areas of risk facing propertyand casualty insurers: underwriting, which encompasses the risk of adverse lossdevelopments and inadequate pricing; declines in asset values arising frommarket and/or credit risk; and off-balance sheet risk arising from adverseexperience from non-controlled assets, guarantees for affiliates or othercontingent liabilities and excessive premium growth. Under laws adopted byindividual states, insurers having less total adjusted capital than thatrequired by the RBC calculation will be subject to varying degrees ofregulatory action, depending on the level of capital inadequacy. Our currentRBC ratios are satisfactory and such ratios are not expected to result in anyadverse regulatory action. We are not aware of any current recommendations byregulatory authorities that would be expected to have a material effect on ourresults of operations or liquidity.

The NAIC has developed a set of financialrelationships or tests known as the Insurance Regulatory Information System toassist state regulators in monitoring the financial condition of insurancecompanies and identifying companies that require special attention or action byinsurance regulatory authorities. Insurance companies generally submit dataannually to the NAIC, which in turn analyzes the data using prescribedfinancial data ratios, each with defined “usual ranges.” Generally, regulatorswill begin to investigate or monitor an insurance company if its ratios falloutside the usual ranges for four or more of the ratios. If an insurancecompany has insufficient capital, regulators may act to reduce the amount ofinsurance it can issue. We are not aware that any of our insurance companiesare currently subject to regulatory investigation based on these ratios.

State insurance laws require us to analyze theadequacy of our reserves annually. Our actuaries must submit an opinion thatour reserves, when considered in light of the assets we hold with respect tothose reserves, make adequate provision for our contractual obligations andrelated expenses.

Many states have laws andregulations that limit an insurer’s ability to exit a market. For example,certain states limit a private passenger automobile insurer’s ability to cancelor renew policies. Furthermore, certain states prohibit an insurer fromwithdrawing from one or more lines of insurance business in the state withoutthe state regulator’s approval. State regulators may refuse to approvewithdrawal plans on the grounds that they could lead to market disruption. Suchlaws and regulations may restrict our ability to exit unprofitable markets.

*Mandatory SharedMarket Mechanisms*

As a condition of our license to do business incertain states, we are required to participate in mandatory shared marketmechanisms. Each state dictates the types of insurance and the level ofcoverage 

23

----

that must be provided. Themost common type of shared market mechanism in which we are required toparticipate is an assigned risk plan. Many states operate assigned risk plans.The NYAIP and New Jersey commercial automobile insurance plans are two suchshared market mechanisms in which we are required to participate. The totalnumber of such policies an insurer is required to accept is based on its marketshare of voluntary business in the state. Underwriting results related toassigned risk plans are typically adverse. Accordingly, we may be required tounderwrite policies with a higher risk of loss than we would otherwise accept.

Reinsurance facilities areanother type of shared market mechanism. Reinsurance facilities require aninsurance company to accept all applications submitted by certain statedesignated agents. The reinsurance facility then allows the insurer to cedesome of its business to the reinsurance facility so that the facility willreimburse the insurer for claims paid on ceded business. Typically, however,reinsurance facilities operate at a deficit, which is funded throughassessments against the same insurers. The Massachusetts CommonwealthAutomobile Reinsurers is one such reinsurance facility in which we are requiredto participate.

*GuarantyAssociations*

The insurance laws of manystates generally provide that property and casualty insurers doing business inthose states belong to a statutory property and casualty guaranty association.The purpose of these guaranty associations is to protect policyholders byrequiring that solvent property and casualty insurers pay certain insuranceclaims of insolvent insurers. These guaranty associations generally pay theseclaims by assessing solvent insurers proportionately based on the insurer’sshare of voluntary written premiums in the state. While most guarantyassociations provide for recovery of assessments through rate increases,surcharges or premium tax credits, there is no assurance that insurers willultimately recover these assessments. At December 31, 2006, our aggregatereserve for such assessments totaled $17.3 million.

*Pricing, Investmentand Dividends*

Nearly all states have insurance laws requiringproperty and casualty insurers to file price schedules, policy or coverageforms, and other information with the state’s regulatory authority. In mostcases, such price schedules and/or policy forms must be approved prior to use.While pricing laws vary from state to state, their objectives are generally toensure that prices are adequate, not excessive and not discriminatory. Forexample, Massachusetts, a state where we have a sizable presence, setsvirtually all aspects of automobile insurance rates, including agentcommissions. Such regulations often challenge an insurer’s ability toadequately price its product, which often leads to unsatisfactory underwritingresults.

We are subject to state laws and regulations thatrequire investment portfolio diversification and that limit the amount ofinvestment in certain categories. Non-compliance may cause non-conforminginvestments to be non-admitted in measuring statutory surplus and, in someinstances, may require divestiture.

One of the primary sourcesof cash inflows for us and certain of our intermediary holding companies isdividends received from our operating subsidiaries. Under the insurance laws ofthe jurisdictions under which our insurance subsidiaries are domiciled, aninsurer is restricted with respect to the timing or the amount of dividends itmay pay without prior approval by regulatory authorities. Accordingly, there isno assurance regarding the amount of such dividends that may be paid by suchsubsidiaries in the future. During 2006, our first-tier insurance subsidiariesdeclared and paid $90.1million in cash and non-cash dividends to OneBeaconInsurance Group LLC. Our first tier insurance subsidiaries have the ability topay dividends of approximately $234 million to their parent, in 2007without approval of regulatory authorities.

24

----

*Holding CompanyStructure*

We are subject toregulation under certain state insurance holding company acts. Theseregulations contain reporting requirements relating to our capital structure,ownership, financial condition and general business operations. Theseregulations also contain special reporting and prior approval requirements withrespect to certain transactions among affiliates. Since we are an insuranceholding company, the domiciliary states of our insurance subsidiaries imposeregulatory application and approval requirements on acquisitions of commonshares which may be deemed to confer control over those subsidiaries, as thatconcept is defined under the applicable state laws. Acquisition of as little as10% of our common shares may be deemed to confer control under the insurancelaws of some jurisdictions, and the application process for approval can beextensive and time consuming.

*Terrorism*

While the Federalgovernment does not directly regulate the insurance business, Federallegislation and administrative policies affect the insurance industry. On December 22,2005, the United States government extended the Terrorism Act, which was set toexpire on December 31, 2005, for two more years. The Terrorism Act,originally enacted on November 26, 2002 establishes a Federal “backstop”for commercial property and casualty losses, including workers compensation,resulting from acts of terrorism by or on behalf of any foreign person orforeign interest. The law limits the industry’s aggregate liability byrequiring the Federal government to share 85% of certified losses in 2007 oncea company meets a specific retention or deductible as determined by its prioryear’s direct written premiums and limits the aggregate liability to be paid bythe government and industry without further action by Congress at $100.0 billion.In exchange for this “back-stop,” primary insurers are required to makecoverage available to commercial insureds for losses from acts of non-domesticterrorism as specified in the Terrorism Act. The following types of coverageare excluded from the program: commercial automobile, burglary and theft,surety, farmowners multi-peril and all professional liability coverageexcept directors and officers coverage. We are actively complying with therequirements of the Terrorism Act in order to ensure our ability to bereimbursed by the Federal government for any losses we may incur as a result offuture terrorist acts.

*Legislation*

In addition, legislationhas been introduced in recent years that, if enacted, could result in the stateand Federal government assuming a more direct role in the regulation of theinsurance industry. Furthermore, a number of additional enacted and pendingstate and Federal legislative measures could lead to increased consolidationand increased competition for business and for capital in the financialservices industry. We cannot predict whether any state or Federal measures willbe adopted to change the nature or scope of the regulation of the insurancebusiness or what effect such measures may have on our insurance and reinsuranceoperations.

*Environmental*

Both Federal and statelaws and regulations govern the environmental cleanup of contaminated sites by,or for the account of, potentially responsible parties (“PRPs”). Superfund andcomparable state statutes can impose liability for the entire cost of clean-upupon any responsible party, regardless of fault. The insurance industry ingeneral is involved in extensive litigation regarding coverage issues arisingout of the cleanup of such sites by insured PRPs and as a result has disputedmany such claims. From time to time, comprehensive Superfund reform proposalsare introduced in Congress, but none has yet been enacted. At this time, itremains unclear as to whether Superfund reform legislation will be enacted orthat any such legislation will provide for a fair, effective and cost-efficientsystem for settlement of Superfund related claims. The NICO Cover includescoverage for such exposures at our company, however, there can 

25

----

be noassurance that the coverage provided under the NICO Cover will ultimately proveto be adequate for our incurred environmental losses.

*Certain OtherBermuda Law Considerations*

We are an exemptedcompany organized under the Companies Act. As a result, we will need to complywith the provisions of the Companies Act regulating the payment of dividendsand making of distributions from contributed surplus. A company is prohibitedfrom declaring or paying a dividend, or making a distribution out ofcontributed surplus, if there are reasonable grounds for believing that:

·       thecompany is, or would after the payment be, unable to pay its liabilities asthey become due; or

·       therealizable value of the company’s assets would thereby be less than theaggregate of its liabilities and its issued share capital and share premiumaccounts.

Under our bye-laws, each common share is entitled todividends if, and when, dividends are declared by our board of directors,subject to any preferred dividend right of the holders of any preferenceshares. Issued share capital is the aggregate par value of the company’s issuedshares, and the share premium account is the aggregate amount paid for issuedshares over and above their par value. Share premium accounts may be reduced incertain limited circumstances. In addition, the Companies Act regulates returnof capital, reduction of capital and any purchase or redemption of shares byOneBeacon.

Although we are incorporated in Bermuda, we have beendesignated as non-resident of Bermuda for exchange control purposes by theBermuda Monetary Authority, or the BMA. Pursuant to our non-resident status, wemay hold any currency other than Bermuda dollars and convert that currency intoany other currency, other than Bermuda dollars, without restriction.

Shares may be offered or sold in Bermuda only incompliance with the provisions of the Investment Business Act of 2003 and theExchange Control Act 1972, and related regulations of Bermuda which regulatethe sale of securities in Bermuda. In addition, specific permission is requiredfrom the BMA pursuant to the provisions of the Exchange Control Act 1972 andrelated regulations, for all issuances and transfers of securities of Bermudacompanies, other than in cases where the BMA has granted a general permission.The BMA in its policy dated June 1, 2005 provides that where any equitysecurities, including our common shares, of a Bermuda company are listed on anappointed stock exchange, general permission is given for the issue andsubsequent transfer of any securities of a company from and/or to anon-resident, for as long as any equities securities of such company remain solisted. The New York Stock Exchange is deemed to be an appointed stock exchangeunder Bermuda law. Notwithstanding the above general permission, the BMA hasgranted us permission to, subject to our common shares being listed on anappointed stock exchange, (a) issue and transfer our shares, up to theamount of our authorized capital from time to time, to persons resident andnon-resident of Bermuda for exchange control purposes; (b) issue andtransfer our options, warrants, depositary receipts, rights, and othersecurities; and (c) issue and transfer our loan notes and other debtinstruments and options, warrants, receipts, rights over loan notes and otherdebt instruments to persons resident and non-resident of Bermuda for exchangecontrol purposes.

In accordance with Bermuda law, share certificates areissued only in the names of corporations or individuals. In the case of anapplicant acting in a special capacity, for example, as an executor or trustee,certificates may, at the request of the applicant, record the capacity in whichthe applicant is acting. Notwithstanding the recording of any such specialcapacity, we are not bound to investigate or incur any responsibility inrespect of the proper administration of any such estate or trust. We will takeno notice of any trust applicable to any of our common shares whether or not wehave notice of such trust.

Under Bermuda law,exempted companies are companies formed for the purpose of conducting businessoutside Bermuda from a principal place in Bermuda. As exempted companies, wemay not, 

26

----

withoutthe express authorization of the Bermuda legislature or under a license grantedby the Bermuda Minister of Finance, participate in various specified businesstransactions, including:

·       theacquisition or holding of land in Bermuda, except land held by way of lease ortenancy agreement which is required for our business and held for a term notexceeding 50 years, or which is used to provide accommodation orrecreational facilities for our officers and employees and held with theconsent of the Bermuda Minister of Finance, for a term not exceeding21 years;

·       thetaking of mortgages on land in Bermuda in excess of $50,000;

·       theacquisition of any bonds or debentures secured by any land in Bermuda, otherthan certain types of Bermuda government or public authority securities; or

·       subjectto some exceptions, the carrying on of business of any kind in Bermuda forwhich we are not licensed in Bermuda.

Under Bermuda law,non-Bermudians (other than spouses of Bermudians) may not engage in any gainfuloccupation in Bermuda without an appropriate governmental work permit. Workpermits may be granted or extended by the Bermuda government upon showing that,after proper public advertisement in most cases, no Bermudian (or spouse of aBermudian) is available who meets the minimum standard requirements for theadvertised position. In 2001, the Bermuda government announced a new policylimiting the duration of work permits to six years, with certain exemptions forkey employees. In addition, exempted companies, such as us, must comply withBermuda resident representation provisions under the Companies Act whichrequire that a minimum number of offices must be filled by persons who areordinarily resident in Bermuda. We do not believe that such compliance willresult in any material expense to us.

**Competition**

Property and casualtyinsurance is highly competitive. In specialty lines, OneBeacon competes withnumerous regional and national insurance companies, most notably The ChubbCorporation, American International Group, The St. Paul Travelers Companies andCNA Financial Corporation. In commercial and personal lines, the Companycompetes with numerous regional and national insurance companies, most notablyThe St. Paul Travelers Companies, Inc., Zurich Financial Services Group,CNA Financial Corporation, Hartford Financial Services Group, Inc., TheHanover Insurance Group, Inc., W.R. Berkley Corporation, The ChubbCorporation, The Progressive Corporation, Allstate Insurance Company andLiberty Mutual Insurance Company. The more significant competitive factors formost insurance products the Company offers are price, product terms and claimsservice. OneBeacon’s underwriting principles and dedication to independentagency distribution are unlikely to make it the low-cost provider in mostmarkets. However, while it is often difficult for insurance companies todifferentiate their products to consumers, OneBeacon believes that itsdedication to providing superior product offerings, expertise and local talent,claims service and disciplined underwriting provide a competitive advantageover typical low-cost providers. However, as the emergence and growth of competitorsthat have lower cost structures, such as direct writers, continues, OneBeaconwill face greater pressure on its pricing which may impact its ability tocompete.

**Ratings**

Insurance companies areevaluated by various rating agencies in order to measure each company’sfinancial strength. Higher ratings generally indicate financial stability and astronger ability to pay claims. OneBeacon currently has an “A” rating with astable outlook from A.M. Best (“Excellent”, the third highest of 15ratings), “A” rating with a stable outlook from Standard & Poor’s (“Strong”,the sixth highest of 21 ratings), “A2” rating with a stable outlook by Moody’s(“Good”, the sixth highest of 21 ratings), and 

27

----

“A”rating with a stable outlook by Fitch (“Strong”, the sixth highest of 24ratings). The Company believes that strong ratings are an important factor inthe marketing of insurance products to agents and consumers. These financialstrength ratings do not refer to its ability to meet non-insuranceobligations and are not a recommendation to purchase or discontinue any policyor contract issued by the Company or to buy, hold, or sell its securities.

**Employees**

As of December 31,2006, OneBeacon employed approximately 3,200 persons. The Company believes thatit has satisfactory relations with its employees.

**AVAILABLEINFORMATION**

OneBeacon is subject to the informational reportingrequirements of the Securities Exchange Act of 1934. In accordance therewith,the Company files reports, proxy statements and other information with theSecurities and Exchange Commission (SEC). These documents are available free ofcharge at www.onebeacon.com as soon as reasonably practicable after suchmaterial is electronically filed with or furnished to the SEC. In addition, theCompany’s Code of Business Conduct as well as the charters of our BoardCommittees are available free of charge at www.onebeacon.com.

The Company will provideto any shareholder, upon request and without charge, copies of these documents(excluding any applicable exhibits unless specifically requested). Written ortelephone requests should be directed to Investor Relations, OneBeaconInsurance Group, Ltd., 1 Beacon Lane, Canton, MA 02021, telephone number (877)248-8765. Additionally, all such documents are physically available atthe Company’s registered office at Clarendon House, 2 Church Street, Hamilton,HM 11 Bermuda.

**ITEM 1A. RISKFACTORS**

The information containedin this report may contain “forward-looking statements” within the meaning of Section 27Aof the Securities Act of 1933 and Section 21E of the Securities ExchangeAct of 1934. *See***“FORWARD-LOOKINGSTATEMENTS”** (page 94) *forspecific important factors that could cause actual results to differ materiallyfrom those contained in forward-looking statements.* The Company’s actual future results and trendsmay differ materially depending on a variety of factors including, but notlimited to, the risks and uncertainties discussed below.

**Risks Relating toOur Business**

***Our loss and loss adjustment expense reserves may be inadequateto cover our ultimate liability for losses and as a result any inadequacy couldmaterially adversely affect our financial condition and results of operations.***

We are required to maintain adequate reserves to coverour estimated ultimate liabilities for loss and loss adjustment expenses, orLAE. Loss and LAE reserves are typically comprised of (1) case reservesfor claims reported and (2) reserves for losses that have occurred but forwhich claims have not yet been reported, referred to as incurred but notreported, or IBNR, reserves, which include a provision for expected futuredevelopment on case reserves. These reserves are estimates based on actuarialand statistical projections of what we believe the settlement andadministration of claims will cost based on facts and circumstances then knownto us. Because of the uncertainties that surround estimating loss and LAEreserves, we cannot be certain that our reserves are adequate and actual claimsand claim expenses paid might exceed our reserves. For example, we have had alarge number of construction defect claims arising from our general liabilityand multiple peril lines of business. Construction defect is a highly uncertainexposure due to issues concerning whether coverage exists, the definition of anoccurrence, the determination of ultimate damages and the allocation of suchdamages to financially responsible parties.

28

----

We had established gross loss and LAE reserves of$5,354.3 million and $4,837.7 million as of December 31, 2005and 2006, respectively. For the years ended December 31, 2004, 2005 and2006, we incurred $99.3 million, $99.0 million and $11.3 million oflosses, respectively, net of reinsurance, related to the re-estimation ofpreviously established reserves.

If in the future we determine that our reserves areinsufficient to cover our actual loss and LAE, we would have to strengthen ourreserves, which could have a material adverse effect on our financial conditionand results of operations.

For additional information relating to loss and LAEreserve requirements, see “Regulatory Matters.” For additional informationrelating to how we estimate our loss and LAE reserves, including our asbestosand environmental reserves, see “Business—Loss and LAE Reserves” and “Management’sDiscussion and Analysis of Financial Condition and Results of Operations—CriticalAccounting Estimates.”

***Exposure to asbestos or environmental claims couldmaterially adversely affect our financial condition and results of operations.***

Estimating our exposure to asbestos and environmentalclaims is subject to a particularly high degree of uncertainty. If we have notestablished adequate loss and LAE reserves to cover future claims, ourfinancial condition and results of operations could be materially adverselyaffected.

In connection with the OneBeacon Acquisition, to helpprotect against potential asbestos and environmental claims relating to thepre-acquisition period, we purchased a reinsurance contract from NICO, rated “AAA”by Standard & Poor’s and “A++” by A.M. Best. We refer to thisreinsurance contract as the NICO Cover. Under the NICO Cover we are entitled torecover up to $2.5 billion from NICO for (1) all asbestos claimsarising from business written by us in 1992 and prior, (2) allenvironmental claims arising from business written by us in 1987 and prior, and(3) certain other latent exposures. As of December 31, 2006, weestimate that on an incurred basis we have ceded losses of approximately$2.1 billion to the NICO Cover, leaving remaining protection under theNICO Cover of $404.0 million. Due to exclusions in policy language andchanges in coverages provided, we do not believe that we have significantexposure to asbestos claims arising from business we wrote after 1992 or toenvironmental claims arising from business we wrote after 1987.

As of December 31, 2006, we had established grossloss and LAE reserves for asbestos claims of $1,227.6 million. Approximately99% of these loss and LAE reserves are covered under reinsurance arrangements.Our net loss and LAE reserves for asbestos claims after giving effect to thirdparty reinsurance other than the NICO Cover was $766.6 million at December 31,2006. Our net loss and LAE reserves for asbestos claims after giving effect toboth third party reinsurance and the NICO Cover was $6.8 million at December 31,2006.

Estimating ourfuture exposure to asbestos claims is subject to considerable uncertainty dueto tort liability reform in various states, the difficulty of predicting juryawards in such matters and diverging legal interpretations and rules indifferent jurisdictions. These uncertainties also include, among other things:

·       theextent of coverage under insurance policies;

·       whetheror not particular claims are subject to an aggregate limit;

·       thenumber of occurrences involved in particular claims; and

·       newtheories of insured and insurer liability.

The ultimate liability for our asbestos claims remainsuncertain and could exceed the coverage under our reinsurance arrangements andour net loss and LAE reserves.

29

----

Insurers, including us, experienced an increase in thenumber of new asbestos-related claims in recent years, in particular in2002 and 2003. We experienced a 12% increase in the number of accounts withasbestos-related claims reported during 2002 as compared to 2001 andanother 51% increase in the number reported in 2003 from the level reported in2002. We believe this increase was attributable to, among other things, moreintensive advertising by lawyers seeking asbestos claimants, the increasingfocus by plaintiffs on new and previously peripheral defendants, anacceleration of claims prior to the potential enactment of Federal asbestoslegislation, and an increase in the number of entities seeking bankruptcyprotection as a result of asbestos-related liabilities. During 2004, westarted to experience a decrease in the number of accounts with asbestos-relatedclaims reported with a 37% decrease from the level reported in 2003; however,the number of accounts with asbestos-related claims reported in 2004 wasstill above levels reported in 1999, 2000 and 2001. During 2005, we experienceda 6% decrease in the number of accounts with asbestos-related claimsreported when compared to the average of the prior three-year period. During2006, we experienced a 13% decrease in the number of accounts with asbestos-relatedclaims reported when compared to the average of the prior three-year period. Itis uncertain whether the number of new annual claims and filings will continueto decrease, remain stable or increase when compared to prior annual periods.Also, in addition to adding new claims, bankruptcy proceedings may have theeffect of significantly accelerating and increasing loss payments by insurers,including us.

Increasingly, policyholders have been asserting thattheir claims for asbestos-related insurance are not subject to aggregatelimits on coverage and that each individual bodily injury claim should betreated as a separate occurrence under a policy. Some policyholders whopreviously sought payment from us for asbestos claims under their productsliability coverages, which were subject to aggregate limits, have increasinglysought payment from us for asbestos claims under the premises and operationscoverages of their liability policies, which may not be subject to similaraggregate limits. We expect this trend to continue. To the extent either issueis resolved in favor of policyholders, our coverage obligations under therelevant policies would be materially increased and capped only by theapplicable per occurrence limits and the number of asbestos bodily injuryclaims against the policyholders. Claims in these instances may varysignificantly and policyholders may seek large amounts, although such claimsfrequently settle for a fraction of the initial alleged amount. Accordingly, itis difficult to predict the ultimate size of the claims for coverage notsubject to aggregate limits.

From time to time in recent years, the United StatesCongress has given consideration to legislative proposals that would addressvarious issues connected with asbestos liability. While it is unclear whetherany such proposals will be passed into law at any time in the near future, ifat all, we cannot predict what impact, if any, such adopted legislation wouldhave on our ultimate asbestos liability or on the NICO Cover.

As of December 31, 2006, we had established grossloss and LAE reserves for environmental claims of $678.0 million. Approximately99% of these loss and LAE reserves are covered under reinsurance arrangements.Our net reserves for environmental claims after giving effect to third partyreinsurance, other than the NICO Cover was $394.6 million at December 31,2006. Our net loss and LAE reserves for environmental claims after givingeffect to both third party reinsurance and the NICO Cover aggregated$10.6 million as of December 31, 2006. Future exposure fromenvironmental claims is uncertain, in part, for reasons similar to thosedescribed above for asbestos claims.

30

----

As a result ofvarious state and Federal laws and regulations relating to environmentalremediation, particularly the Comprehensive Environmental Response,Compensation, and Liability Act of 1980, which is commonly referred to asSuperfund, and related damages claims, the insurance industry continues to beinvolved in litigation involving policy coverage and liability issues. Inaddition to regulatory pressures, the results of court decisions affecting theindustry’s coverage positions continue to be inconsistent and have expandedcoverage beyond the industry’s original expectations. Accordingly, the ultimateliability for environmental costs remain uncertain and could exceed thecoverage of our reinsurance arrangements.

***We may not be able tosuccessfully alleviate risk through reinsurance arrangements. Additionally, wemay be unable to collect all amounts due from our reinsurers under our existingreinsurance arrangements.***

We attempt to limit our risk of loss throughreinsurance arrangements. The availability and cost of reinsurance protectionis subject to market conditions, which are outside of our control. In addition,the coverage under our reinsurance contracts may be inadequate to cover ourfuture liabilities. As a result, we may not be able to successfully alleviaterisk through these arrangements, which could have a material adverse effect onour financial condition and results of operations.

We are not relievedof our obligation to our policyholders by purchasing reinsurance. Accordingly,we are subject to credit risk with respect to our reinsurance in the event thata reinsurer is unable to pay amounts owed to us as a result of a deteriorationin its financial condition or if it simply is unwilling to pay due to a disputeor other factors beyond our control. A number of reinsurers in the industryexperienced such a deterioration in the aftermath of the 2001 terrorist attacksand the active 2005 hurricane season. While several of our reinsurers wereadversely affected by these events, and in some cases ceased writing newreinsurance coverages, the impact on our operations from these events has beennegligible. In the future, it is possible that one or more of our reinsurers willbe significantly adversely affected by significant loss events, causing them tobe unable to pay amounts owed to us.

***Unpredictable catastrophic eventscould adversely affect our financial condition or results of operations.***

Our insurance operations expose us to claims arisingout of unpredictable natural and other catastrophic events, such as hurricanes,windstorms, severe winter weather, earthquakes, floods, fires and explosions.In recent years, the frequency of major weather-related catastrophes hasincreased. Our exposure to catastrophic windstorm damage in the NortheasternUnited States is the largest single natural catastrophe risk to our business.

The extent of losses from a catastrophe is a functionof both the total amount of insured exposure in the area affected by the eventand the severity of the event. Increases in the value and concentrations ofinsured property, the effects of inflation and changes in cyclical weatherpatterns may increase the severity of claims from catastrophic events in thefuture. Claims from catastrophic events could reduce our earnings and causesubstantial volatility in our results of operations for any fiscal quarter oryear and adversely affect our financial condition. Our ability to write newinsurance policies could also be impacted as a result of correspondingreductions in our surplus levels.

We manage our exposure to catastrophic losses bylimiting the aggregate insured value of policies in geographic areas withexposure to catastrophic events, by estimating a probable maximum loss, whichwe refer to as PML, for many different catastrophe scenarios and by buyingreinsurance. To manage and analyze aggregate insured values and PML, we use avariety of tools, including catastrophe modeling software. Our estimates of PMLare dependent on many variables, including assumptions about the demand surgeand storm surge, loss adjustment expenses, insurance-to-value andstorm intensity in the aftermath of weather-related catastrophes utilizedto model the event and the relationship of the actual event to the modeledevent. Accordingly, if our assumptions about these variables are incorrect, thelosses we might incur from an actual catastrophe could be materially higherthan our expectation of losses 

31

----

generated from modeled catastrophescenarios, and our financial condition and results of operations could bematerially adversely affected.

For example, in2005, standard industry models for forecasting the losses resulting fromhurricanes Katrina, Rita and Wilma proved to be inadequate. We had losses of$69.1 million in 2005 resulting from those hurricanes, which exceeded ourinternal expectations by approximately $24 million. The total industryloss from 2005 catastrophes was over $80 billion with approximately$58 billion related to hurricanes Katrina, Rita and Wilma, whichmaterially exceeded industry models. During the year ended December 31,2006, we increased our estimates of ultimate incurred loss and LAE relating tohurricanes Katrina, Rita and Wilma by $19.9 million.

***Future insurance and reinsurancecoverage for terrorist acts is uncertain, and we may in the future havesubstantial exposure to such acts.***

We are unable to predict the extent to which ourfuture insurance contracts will cover terrorist acts. We also are unsure howterrorist acts will be defined in our future contracts. The Terrorism RiskInsurance Act of 2002, or the Terrorism Act, which has been extended throughthe end of 2007, requires primary commercial insurers to make terrorismcoverage available and provides Federal protection for certain losses aboveboth individual company retention and industry retention levels. While we knowof no reason that the Terrorism Act will not be extended for an additionalperiod of time, there is no assurance that it will be extended or of the termsof any such extension. The following types of coverage are excluded from theprogram: commercial automobile, burglary and theft, surety, farmowners, multi-periland all professional liability coverages except directors and officerscoverage. Our current property and casualty catastrophe reinsurance programsprovide coverage for us for “non-certified” events as defined under theTerrorism Act, provided such losses are not the result of a nuclear, biologicalor chemical attack. Nonetheless, risks insured by us, including those coveredby the Terrorism Act, remain exposed to terrorist attacks and the possibilityremains that losses resulting from future terrorist attacks could prove to bematerial to our results of operations and financial condition.

***Our investment portfolio may suffer reduced returns orlosses which could adversely affect our results of operations and financialcondition. Any increase in interest rates or volatility in the equity and debtmarkets could result in significant losses in the fair value of our investmentportfolio.***

Our investment portfolio consists of fixed maturitysecurities, short-term investments, common equity securities and otherinvestments such as hedge funds, limited partnerships and private equities. Ourinvestment selections are designed to maximize after-tax, total risk-adjustedreturn over the long term; however, investing entails substantial risks. Wecannot assure you that we will achieve our investment objectives, and ourinvestment performance may vary substantially over time.

Investment returns are an important part of our growthin book value, and fluctuations in the fixed income or equity markets couldimpair our results of operations or financial condition. A significant periodof time normally elapses between the receipt of insurance premiums and thedisbursement of insurance claims. During this time, we generate investmentincome, consisting primarily of interest earned on fixed maturity investmentsand dividends earned on equity securities, by investing our capital as well asinsurance premiums allocated to support unpaid loss and LAE reserves. We alsorecognize unrealized investment gains and losses on the securities we hold inour investment portfolio and we generate investment gains and losses from salesof securities from our investment portfolio.

The investment income and fair market value of ourinvestment portfolio are affected by general economic and market conditions,including fluctuations in interest rates and volatility in the stock market.Interest rates are highly sensitive to many factors, including governmentalmonetary policies, domestic and international economic and political conditionsand other factors beyond our control. Although we attempt to manage the risksof investing in a changing interest rate environment, we may not be able toeffectively 

32

----

mitigate interest ratesensitivity. In particular, a significant increase in interest rates couldresult in significant losses, realized or unrealized, in the fair value of our investmentportfolio and, consequently, could have an adverse affect on our results ofoperations. In addition, we are exposed to changes in the level or volatilityof equity prices that affect the value of securities or instruments that derivetheir value from a particular equity security, a basket of equity securities ora stock index. These conditions are outside of our control and could adverselyaffect the value of our investments and our results of operations and financialcondition.

We are highly dependent on White Mountains Advisors,LLC (WM Advisors) and Prospector Partners, LLC (Prospector) in connection withthe management of our investment portfolio. Subsequent to the initial publicoffering, under agreements dated as of November 14, 2006, WM Advisorssupervises and directs the fixed income and alternative investment portion ofOneBeacon’s investment portfolio and Prospector supervises and directs thepublicly-traded common equity and convertible securities portion ofOneBeacon’s investment portfolio. The agreements both provide for an initialfixed term of three years, which will be extendible by us for an additionalyear (a fourth year) at or prior to the end of the second year of the term, andif so extended, for a second additional year (a fifth year) at or prior to theend of the third year of the term. If we lose our investment relationship withWM Advisors or with Prospector, we may not be able to secure an investmentadvisor or advisors who will produce returns on our investments similar to theseproduced by WM Advisors and Prospector in the past, or any positive returns atall.

***Wemay not maintain favorable financial strength ratings, which could adverselyaffect our ability to conduct business.***

We may not maintainfavorable financial strength ratings, which could adversely affect our abilityto conduct business. Third party rating agencies assess and rate the financialstrength, including claims-paying ability, of insurers and reinsurers.These ratings are based upon criteria established by the rating agencies andare subject to revision at any time at the sole discretion of the agencies.Some of the criteria relate to general economic conditions and othercircumstances outside the rated company’s control. These financial strengthratings are used by policyholders, agents and brokers as an important means ofassessing the suitability of insurers as business counterparties and havebecome an increasingly important factor in establishing the competitiveposition of insurance companies. These financial strength ratings do not referto our ability to meet non-insurance obligations and are not a recommendationto purchase or discontinue any policy or contract issued by us or to buy, holdor sell our securities. Our current financial strength ratings are “A” (“Excellent,”third highest of 15 ratings) by A. M. Best Company, Inc., “A” (“Strong,”sixth highest of 19 ratings) by Standard & Poor’s Rating Service, “A2”(“Good,” sixth highest of 21 ratings) by Moody’s Investors Service, Inc.and “A” (“Strong,” sixth highest of 24 ratings) by Fitch, Inc.Periodically, the rating agencies evaluate us to confirm that we continue tomeet the criteria of the ratings previously assigned to us. A downgrade orwithdrawal of our financial strength ratings could limit or prevent ourinsurance subsidiaries from writing new insurance policies or renewing existinginsurance policies, which would have a material adverse affect on our financialcondition and results of operations.

***Our debt, preferred stock andrelated service obligations could adversely affect our financial condition andresults of operations.***

As of December 31, 2006, we had $759.5 millionface value of indebtedness and $320.0 million face value of mandatorilyredeemable preferred stock outstanding. We have established and funded truststhat are solely dedicated to the payment of dividends and redemption amounts ofour outstanding mandatorily redeemable preferred stock with the deposit of U.S.government securities.

Our ability to meet our debt and related serviceobligations, as well as our ability to pay a dividend on our common shares,will depend on our future performance, which will be affected by financial,business, economic and other factors. We will not be able to control many ofthese factors, such as economic conditions and governmental regulation. Wecannot be certain that our earnings will be sufficient to allow 

33

----

us to pay the principaland interest on our debt and meet our other obligations. If we do not haveenough cash, we may be required to refinance all or part of our existing debt,sell assets, borrow more cash or sell equity. We cannot assure you that we willbe able to accomplish any of these alternatives on terms acceptable to us, ifat all.

We could incuradditional indebtedness and issue additional preferred stock in the future. Tothe extent new debt, new preferred stock and other obligations are added to ourand our subsidiaries’ current debt and preferred stock levels, the risksdescribed in the previous paragraph would increase.

***We are a holding company with nodirect operations, and our insurance subsidiaries’ ability to pay dividends tous is restricted by law.***

As a holdingcompany with no direct operations and whose only significant assets are thecapital stock of our subsidiaries, we rely on net investment income anddividends and other permitted payments from our subsidiaries to pay ourexpenses. Our subsidiaries may not be able to generate cash flow sufficient topay a dividend or distribute funds to us. In addition, applicable state lawsthat regulate the payment of dividends by our insurance subsidiaries couldprohibit such dividends or distributions. Under the insurance laws of thejurisdictions in which our insurance subsidiaries are domiciled, an insurer isrestricted with respect to the timing or the amount of dividends it may paywithout prior approval by regulatory authorities. Generally, our regulatedoperating subsidiaries have the ability to pay dividends during any 12-monthperiod, without having to obtain the prior approval of regulatory authorities,in an amount equal to the greater of statutory net income for the precedingyear or 10% of statutory surplus as of the end of the preceding year, subjectto the availability of unassigned funds. As a result, based on 2006 statutorynet income, our top tier regulated operating subsidiaries have the ability topay an aggregate of approximately $234 million of dividends during 2007without having to obtain prior approval of regulatory authorities, subject tothe availability of unassigned funds. As of December 31, 2006, our toptier regulated operating subsidiaries had $1.6 billion of unassigned fundsavailable for dividend distribution. Management believes that our cashbalances, cash flows from operations and cash flows from investments areadequate to meet expected cash requirements for the foreseeable future on botha holding company and operating subsidiary level. However, if our insurancesubsidiaries cannot pay dividends in future periods, beginning in 2008, we mayhave difficulty servicing our debt, paying dividends on our common shares andmeeting our holding company expenses. For additional information relating toinsurance regulations governing our operations, see “Regulatory Matters.”

***The property and casualtyinsurance industry is highly competitive and we may not be able to competeeffectively in the future.***

The property and casualty insurance industry is highlycompetitive and has, from time to time, experienced severe price competition.Competition in the personal auto insurance business line, for example, isintensifying and rate pressures in the auto industry are expected to continue.We compete with numerous regional and national insurance companies, includingThe St. Paul Travelers Companies, Inc., Zurich Financial Services Group,CNA Financial Corporation, Hartford Financial Services Group, Inc., TheHanover Insurance Group, Inc., W.R. Berkley Corporation, The ChubbCorporation, The Progressive Corporation, Allstate Insurance Company, LibertyMutual Insurance Company and American International Group, Inc. Many ofthese competitors have greater financial, marketing and management resourcesthan we do and have established long-term and continuing business relationshipsthroughout the insurance industry, which can be a significant competitiveadvantage for them.

34

----

In addition, theagents whom we rely upon compete with direct writers of insurance, who areoften able to offer substantial discounts in pricing as compared to ourinsurance products. If our agents experience increased competition from directwriters of insurance, we in turn could be adversely affected if they are unableto maintain a competitive position in their respective markets. If we areunable to maintain our competitive position, our financial condition andresults of operations may be adversely affected.

***We may suffer losses fromunfavorable outcomes from litigation and other legal proceedings.***

In the ordinary course of business, we are subject tolitigation and other legal proceedings as part of the claims process, theoutcomes of which are uncertain. We maintain reserves for these legalproceedings as part of our loss and LAE reserves. We also maintain separatereserves for legal proceedings that are not related to the claims process. Inthe event of an unfavorable outcome in one or more legal matters, our ultimateliability may be in excess of amounts we have currently reserved for and suchadditional amounts may be material to our results of operations and financialcondition. For a description of our material legal proceedings, see “Business—LegalProceedings.”

As industrypractices and legal, judicial, social and other conditions change, unexpectedand unintended issues related to claims and coverage may emerge. These issuesmay adversely affect our financial condition and results of operations byeither extending coverage beyond our underwriting intent or by increasing thenumber and size of claims. In some instances, these changes may not becomeapparent until some time after we have issued insurance contracts that areaffected by the changes.

***Our profitability may beadversely impacted by inflation and legislative actions and judicial decisions.***

The effects of inflation could cause claim costs torise in the future. In addition, judicial decisions and legislative actionscontinue to broaden liability and policy definitions and to increase theseverity of claim payments, such as described above with respect to asbestosand environmental claims. To the extent inflation and these legislative actionsand judicial decisions cause claim costs to increase above reserves establishedfor these claims, we will be required to increase our loss and LAE reserveswith a corresponding reduction in our net income in the period in which thedeficiency is identified.

***Regulationmay restrict our ability to operate.***

The insurance industry is subject to extensiveregulation under U.S. and state laws. Governmental agencies have broadadministrative power to regulate many aspects of the insurance business, whichinclude premium rates, marketing practices, advertising, policy forms andcapital adequacy. These governmental agencies are concerned primarily with theprotection of policyholders rather than shareholders. Insurance laws andregulations impose restrictions on the amount and type of investments,prescribe solvency standards that must be met and maintained and require themaintenance of reserves. Premium rate regulation is common across all of ourlines of business and may make it difficult for us to increase premiums to adequatelyreflect the cost of providing insurance coverage to our policyholders. In ourunderwriting, we rely heavily upon information gathered from third parties suchas credit report agencies and other data aggregators. The use of thisinformation is also highly regulated and any changes to the current regulatorystructure could materially affect how we underwrite and price premiums.

Changes in the lawsand regulations may restrict our ability to operate and/or have an adverseeffect upon the profitability of our business within a given jurisdiction. Forexample, legislation has been recently passed in Florida that significantlychanges reinsurance protection provided by the Florida Hurricane Catastrophefund to companies that write business in Florida. The new legislation alsocontains a provision that will disallow insurers to write automobile insurancein Florida and write homeowners insurance elsewhere in the U.S. unless theybegin to write homeowners insurance in Florida. We cannot determine what the impactof the new legislation will be upon our business in Florida, and the impactcould be adverse, depending on how this provision is interpreted and howregulations are promulgated. In addition, 

35

----

stateand Federal legislation has been proposed on catastrophe funds and underwritingin coastal areas which could impact our business.

***Government authorities arecontinuing to investigate the insurance industry, which may adversely affectour business.***

Recently, theinsurance industry has been heavily scrutinized by various regulatory bodies,including State Attorneys General and state insurance departments, for allegedillegal conduct surrounding a number of topics, including producer compensationarrangements and the sale and use of finite reinsurance. For example, during2004 and 2005, we received subpoenas from the Attorneys General ofMassachusetts, New York and Connecticut requesting documents and seekinginformation relating to the conduct of business between us and insurancebrokers. We have cooperated with all of these subpoenas and informationrequests. These investigations of the insurance industry, whether involving ourcompany specifically or not, together with any legal or regulatory proceedingsrelated settlement, or industry reforms, may materially adversely affect ourbusiness and future prospects.

***We may be unable to collectamounts utilized to capitalize reciprocals.***

Since 2002, we have capitalized three member-owned,not-for-profit insurance associations, which we refer to as reciprocals, byloaning money to them in exchange for surplus notes. As of December 31,2006, we have loaned an aggregate of $125.9 million, including$0.2 million loaned in the form of a security deposit, to the threereciprocals. These three associations are currently consolidated in ourconsolidated financial statements. As a result, the surplus notes and thesecurity deposit have been eliminated in consolidation. In the future,depending on their financial success, these associations could bedeconsolidated. At such time, the surplus notes would be reflected as notesreceivable on our balance sheet. Amounts utilized to capitalize reciprocals canbe difficult to extract as repayment of principal and interest is subject toregulatory approval. If any reciprocal is unable to cover its ultimateliability for loss and LAE or is unable to obtain insurance regulatory approvalto repay us, we would be unable to collect amounts owed under the relatedsurplus note. In addition, while we have no legal obligation to loan furtherfunds to these reciprocals, even in the event their capital becomes depleted,we may decide that it is in our best interest to provide the reciprocal withadditional capital, thereby increasing our loss exposure.

***Afailure to attract and retain key personnel could reduce our revenues andoperational effectiveness.***

Our performancesubstantially depends on the efforts and abilities of our management team andother key employees. Furthermore, much of our competitive advantage is based onthe expertise, experience and know-how of our key management personnel. We donot have fixed term employment agreements with any of these key employees norkey man life insurance and the loss of one or more of these key employees couldadversely affect our business, results of operations and financial condition.Our success also depends on the ability to hire and retain additional keypersonnel such as experienced underwriters. Difficulty in hiring or retainingkey personnel could adversely affect our results of operation and financial condition.

***We have no experience operatingas a stand-alone company and we may not be successful operating as astand-alone company.***

Prior to our initial public offering, OneBeacon was awholly-owned subsidiary of White Mountains. As a wholly-owned subsidiary,OneBeacon relied on White Mountains personnel for expertise in certain areas,including capital management, internal auditing and investor relations. Nowthat we are a stand-alone public company, we must provide these servicesinternally or through outsourcing, and we may not be able to do sosuccessfully.

In addition, wehave benefited from being a subsidiary of a well-financed, publicly-tradedcompany. Following the initial public offering, we continue to be a significantsubsidiary of White Mountains, 

36

----

howeverwe may gradually lose the benefit of being part of the White Mountains group,especially to the extent White Mountains elects to further sell down itsposition in our common shares. Accordingly, customers, agents, rating agenciesand investors will assess our strengths and weaknesses independently, and thismay have a negative effect upon our ability to attract new business and raiseadditional capital.

***We will incur increased costs asa result of being a public company.***

As a newly publiccompany, we are and we will incur significant levels of legal, accounting andother expenses that we did not incur as a wholly-owned subsidiary of WhiteMountains. The U.S. Sarbanes-Oxley Act of 2002, particularly Section 404,and related rules of the U.S. Securities and Exchange Commission and theNew York Stock Exchange, regulate corporate governance practices of publiccompanies. We expect that compliance with these public company requirementswill increase our costs and make some activities more time-consuming than theyhave been in the past when we were wholly-owned by White Mountains. While wehave spent considerable time and resources assisting our public parent incomplying with public company regulations, we will incur all expenses ourselvesgoing forward. Furthermore, the cost of compliance, while not material to WhiteMountains on a consolidated basis, could be material to us because of oursmaller size and scale of operations.

***Our written premiums are heavilyconcentrated in the Northeastern United States.***

Our revenues andprofitability for the foreseeable future will be substantially impacted byprevailing regulatory, economic, demographic, competitive, weather and otherconditions in the Northeastern United States. Changes in any of theseconditions could make it more costly or more difficult to conduct our business.We are particularly exposed to Northeast windstorm risks. In 2006, 63% of ournet written premiums were derived from our Primary Insurance Operations in NewYork, Massachusetts, New Jersey, Maine and Connecticut.

***Mandated market mechanisms mayrequire us to underwrite policies with a higher risk of loss and assessmentsand other surcharges for guaranty funds and second-injury funds mayreduce our profitability.***

We are often required to participate directly orindirectly in mandatory shared market mechanisms as a condition of our licensesto do business in certain states. These markets, which are commonly referred toas “residual” or “involuntary” markets, generally consist of risks considered tobe undesirable from a standard or routine underwriting perspective. In 2006,approximately 2% of our net written premiums related to our participation inmandatory shared market mechanisms. Underwriting performance related toassigned risk plans, a form of mandated market mechanism, is typically adverseand, as a result, we are required to underwrite some policies with a higherrisk of loss than we would normally accept.

Each state dictates the level of insurance coveragethat is mandatorily assigned to participating insurers within these markets.Our participation in mandatory shared market mechanisms is principallyconcentrated in the States of Massachusetts, New Jersey and New York. Incertain states, such as New York, the amount of involuntary policies we areobligated to write in a given year is based on our historical market share ofall voluntary policies written within that state. The share of involuntarywritten premium for policies assigned by the New York Automobile InsurancePlan, or NYAIP, a residual insurance plan that obtains personal automobileinsurance for individuals who cannot otherwise obtain insurance in thevoluntary insurance market, to a particular insurer in a given year is based onthe proportion of the total voluntary writings in New York two years earlier.We estimate the cost of discharging our obligation for our NYAIP assignments asof December 31, 2006 to be $13.0 million and we have recorded thisestimate as a liability in our consolidated financial statements. Ourparticipation in assigned risk plans may result in greater liabilities than weanticipate and could materially adversely affect our financial condition andresults of operations.

37

----

In addition, virtually all states require insurerslicensed to do business in their state to bear a portion of the loss sufferedby some insureds as the result of impaired or insolvent insurance companies.These guaranty funds are funded by assessments that are expected to increase inthe future as a result of recent insolvencies. Many states also have laws thatestablished second-injury funds to provide compensation to injuredemployees for aggravation of a prior condition or injury which are funded byeither assessments based on paid losses or premium surcharge mechanisms. Theeffect of these assessments and surcharges or changes in them could reduce ourprofitability in any given period or limit our ability to grow our business.

***Cyclicality of the property andcasualty insurance industry may cause fluctuations in our results of operationsand financial condition.***

The property and casualty insurance business,especially the commercial lines business, has been historically characterizedby periods of intense price competition, which could have an adverse effect onour results of operations and financial condition. Periods of intense pricecompetition historically have alternated with periods when shortages ofunderwriting capacity have permitted attractive premium levels. Any significantdecrease in the rates we can charge for property and casualty insurance wouldadversely affect our results. In the late 1990s, the property and casualtyinsurance industry experienced a prolonged period of downward pressure onprices caused by excess underwriting capacity and intense competition. Althoughpremium rates we achieved during 2004 and 2005 were significantly improved overthose achieved in prior years, an increase in competitive factors resultingfrom additional capital entering the property and casualty insurance market maycause current favorable pricing trends to reverse.

Our personal lines business is particularly affectedby the cyclicality of loss cost trends. Factors that affect loss cost trends inautomobile underwriting include inflation in the cost of automobile repairs,medical care, litigation of liability claims, improved automobile safetyfeatures, legislative changes and general economic conditions. Factors thataffect loss costs trends in homeowners underwriting include inflation in thecost of building materials and labor costs and demand caused by weather-relatedcatastrophes. Personal lines insurers, including us, are generally unable toincrease premium rates until some time after the costs associated with thecoverage have increased, primarily as a result of state insurance regulationlaws. Therefore, in a period of increasing loss costs, profit margins decline.

We expect to continue to experience the effects ofthis cyclicality which, during down periods, could materially adversely affectour financial condition and results of operations.

***We may need additional capital inthe future, which may not be available to us or available to us on favorableterms. Raising additional capital could dilute your ownership in our companyand may cause the market price of our common shares to fall.***

We may need toraise additional funds through public or private debt or equity financings inorder to:

·       fundliquidity needs;

·       replacecapital lost in the event of a catastrophe or adverse reserve development;

·       refinance$700 million aggregate principal amount of our senior notes;

·       satisfyletter of credit or guarantee bond requirements that may be imposed by ourclients or by regulators;

·       acquirenew businesses or invest in existing businesses;

·       expandour business into new regions and countries; or

·       otherwiserespond to competitive pressures.

Any additional capitalraised through the sale of equity will dilute your ownership percentage in ourcompany and may decrease the market price of our common shares. Furthermore,the securities may have 

38

----

rights,preferences and privileges that are senior or otherwise superior to those ofour common shares. Any additional financing we may need may not be available onterms favorable to us, or at all.

**Risks Relating toOur Relationship with White Mountains**

***Control of us by White Mountains and the holding ofWhite Mountains shares by some of our directors and officers may result inconflicts of interest.***

White Mountains beneficially owns all of our Class Bcommon shares, representing 96.3% of the voting power of our voting securitiesand 72.4% of our total equity. As long as White Mountains owns shares of ourcommon shares representing more than 50% of the voting power of our outstandingvoting securities, White Mountains will generally be able to determine theoutcome of all corporate actions requiring shareholder approval, including theelection of directors. Furthermore, we are relying on the “controlled company”exemption under the rules of the New York Stock Exchange, and aretherefore not required to have a majority of independent directors on ourboard. Of the ten directors that we have on our Board, six are current orformer employees, directors or officers of White Mountains. White Mountainsalso has control over the adoption or amendment of provisions in our memorandumof association or bye-laws and the approval of amalgamations, mergers, andother significant corporate transactions. Furthermore, White Mountains will continueto be able to exercise this control as long as their economic equity ownershipin us is at least 20%. These factors also may delay or prevent a change in themanagement or voting control of us.

Also, at some time in the future, White Mountains maysell all or a portion of its ownership interest in us or may make a tax-freedistribution to its shareholders of all or a portion of that interest.

Questions relating to conflicts of interest may arisebetween us and White Mountains in a number of areas relating to our past andongoing relationships. Certain of our directors and a number of our executiveofficers may own substantial amounts of White Mountains stock and may also bedirectors or officers of White Mountains from time to time. Their ownership of WhiteMountains stock and these other relationships could create, or appear tocreate, potential conflicts of interest when these individuals are faced withdecisions that could have different implications for us and White Mountains.These potential conflicts could arise, for example, over matters such as thedesirability of an acquisition opportunity, employee retention or recruiting,or our dividend policy.

***White Mountains may compete with us and theinvolvement of those individuals who are directors and officers of WhiteMountains and directors of ours in resolving matters relating to suchcompetition will not constitute a breach of fiduciary duty to us.***

Our bye-lawsprovide that White Mountains will have no obligation to refrain from:

·       engagingin the same or similar business activities or lines of business as we do; or

·       doingbusiness with any of our clients or customers.

Because White Mountains may currently or in the futureengage in the same activities in which we engage, we may be in direct competitionwith White Mountains. While White Mountains has indicated to us that itscurrent expectation is to manage its activities such that opportunities toacquire specialty businesses will be pursued through OneBeacon, White Mountainsis not legally obligated to do so and could in the future manage its activitiesin a different way. Due to the resources of White Mountains, includingfinancial resources, name recognition and knowledge of our strengths,weaknesses and business practices, White Mountains could have a competitiveadvantage over us should it decide to engage in the type of business weconduct, which may have a material adverse effect on our operations andfinancial condition. The corporate opportunity policy included in our bye-lawsaddresses potential conflicts of interest between us, on the one hand, andWhite Mountains and its officers and directors who are also our 

39

----

directors, on the otherhand. These provisions are designed to resolve conflicts between us and WhiteMountains.  Under our bye-laws, it is nota breach of fiduciary duty on the part of any of our officers and directors byreason of their participation in any of the above described activities.

***Transitional and other arrangements with WhiteMountains may not be on arm’s length terms.***

In connection with the initial public offering, wehave entered into certain contractual arrangements with White Mountains and itsaffiliates. These agreements were made in the context of a parent-subsidiaryrelationship. For example, some of our investments are managed pursuant to aninvestment management agreement on a discretionary basis by a registeredinvestment adviser which is owned by White Mountains. In connection with theoffering, we have secured a new multi-year investment management contractwith this adviser. While we are satisfied with the terms of such arrangement,we cannot confirm that such terms are as favorable to us as they might havebeen had we contracted with an independent advisor. On the other hand, afterthe expiration of this agreement, we may not be able to replace theseinvestment services in a timely manner or on terms and conditions, includingcost, that are comparable to those we receive from White Mountains, and we mayhave to pay higher prices for similar services from unaffiliated third parties.

***Refinancing of our senior notes may occur onunfavorable terms.***

In connection with theinitial public offering, we have entered into an agreement with White Mountainspursuant to which White Mountains will continue to guarantee the senior notesof our subsidiary, Fund American, for a specified fee in the amount of 25 basispoints per annum on the outstanding principal amount of the senior notes. Wehave further agreed that if White Mountains’ voting interest in our commonshares ceases to represent more than 50% of all our voting securities, we willseek to redeem, exchange or otherwise modify the senior notes in order to fullyand permanently eliminate White Mountains’ obligations under its guarantee.White Mountains and its subsidiaries beneficially own all of our outstanding Class Bcommon shares, representing 96.3% of the voting power of our voting securities.If we have not successfully eliminated the guarantee within 180 days uponnotice of the triggering of the voting interest condition, the guarantee feewill increase by 200 basis points. The guarantee fee will further increase by100 basis points for each subsequent 90 day period thereafter, up to amaximum guarantee fee of 425 basis points, until White Mountains’ obligationsunder its guarantee have been extinguished. This arrangement could require usto devote significant time and expense trying to refinance the senior notes andwe may not be able to do so on commercially reasonable terms or at all. Formore information on these and other arrangements with White Mountains, see  Note 18 to the Company’s financialstatements.

**Risks That Relateto Taxes**

***We may become subject to taxes in Bermuda after 2016.***

We may become subject to taxes in Bermuda after 2016.We have received a standard assurance from the Bermuda Minister of Finance,under Bermuda’s Exempted Undertakings Tax Protection Act 1966, that if anylegislation is enacted in Bermuda that would impose tax computed on profits orincome, or computed on any capital asset, gain or appreciation, or any tax inthe nature of estate duty or inheritance tax, then the imposition of any suchtax will not be applicable to us or to any of our operations or our shares,debentures or other obligations until March 28, 2016. Given the limited durationof the Minister of Finance’s assurance, we cannot be certain that we will notbe subject to any Bermuda tax after March 28, 2016. In the event that webecome subject to any Bermuda tax after such date, it would have a materialadverse effect on our financial condition and results of operations.

40

----

***Changes in tax lawsor tax treaties may cause more of the income of certain non-U.S. companies inour group to become subject to taxes in the United States.***

Thetaxable income of our U.S. subsidiaries is subject to U.S. Federal, state andlocal income tax and other taxes. The income of the non-U.S. companies in ourgroup is generally not subject to tax in the United States other thanwithholding taxes on interest and dividends. Certain of our non-U.S.companies are eligible for the benefits of tax treaties between the UnitedStates and other countries. We believe our non-U.S. companies willcontinue to be eligible for treaty benefits. However, it is possible thatfactual changes or changes to U.S. tax laws or changes to tax treaties thatpresently apply to our non-U.S. companies could impact income subject totax in the United States. Similarly, changes to the applicable tax laws,treaties or regulations of other countries could subject the income of membersof our group to higher rates of tax outside the United States.

**ITEM 1B.**       UNRESOLVEDSTAFF COMMENTS

As of the date of thisreport, the Company had no unresolved written comments from the Commissionstaff regarding its periodic or current reports under the Exchange Act.

**ITEM 2.**                PROPERTIES

Our headquarters arelocated at the Bank of Butterfield Building, 42 Reid Street,6th Floor, Hamilton HM 12, Bermuda. Our U.S. headquarters are locatedat 1 Beacon Lane, Canton, Massachusetts 02021, our principal executiveoffice is located at 601 Carlson Parkway, Minnetonka, Minnesota 55305 and ourregistered office is located at Clarendon House, 2 Church Street, HamiltonHM 11, Bermuda. We also maintain our former U.S. headquarters located at 1Beacon Street, Boston Massachusetts, 02108 which will be vacated in the firstquarter of 2007 as we complete the transition to our new U.S. headquarters inCanton, Massachusetts. We also maintain branch offices in various citiesthroughout the United States. Our U.S. headquarters is owned by us. Ourheadquarters, principal executive office, former U.S. headquarters  and our branch offices are leased. Managementconsiders our office facilities suitable and adequate for our current level ofoperations.

**ITEM 3.**                LEGALPROCEEDINGS

OneBeacon, and the insurance industry in general, issubject to litigation and arbitration in the normal course of business. Otherthan those items listed below, we are not a party to any material litigation orarbitration other than as routinely encountered in claims activity, none ofwhich is expected by management to have a material adverse effect on ourfinancial condition and/or cash flows.

OneBeacon is in a dispute with Liberty Mutual overcertain costs Liberty Mutual claims it incurred in connection with the LibertyAgreement. Liberty Mutual asserts that these costs are part of unallocated lossadjustment expenses, or ULAE, due Liberty Mutual under the Liberty Agreement.Liberty Mutual further asserts that ULAE on charges previously billed to andsettled by OneBeacon since the inception of the Liberty Agreement should beretroactively recast in addition to changing the calculation of ULAE chargesfor the period not yet settled. OneBeacon believes that the recast charges,which are significantly higher than prior ULAE calculations, and thecalculation of ULAE charges for the period not yet settled are inconsistentwith the terms of the Liberty Agreement and with standard industry definitionsof ULAE. The amount of additional ULAE Liberty Mutual claims that it incurredunder the Liberty Agreement totals approximately $68 million. LibertyMutual has netted amounts billed under the ULAE dispute against amountsotherwise payable to OneBeacon. As of December 31, 2006, OneBeacon hasrecorded in its loss and LAE reserves an estimate of ULAE expenses due LibertyMutual on a basis that it believes is consistent with the terms of the LibertyAgreement and with standard industry definitions of ULAE. In January 2006,Liberty Mutual initiated an arbitration proceeding against OneBeacon withrespect to this 

41

----

dispute, the ULAEArbitration. The initial organizational meeting on the ULAE Arbitration washeld in February 2007 and the final hearing is scheduled for April 2008.

In September 2006, OneBeacon initiated anarbitration against Liberty Mutual (and Peerless Insurance Company) seekingpayment of approximately $57 million relating to reinsurance premiums,ceding commissions, recoveries and commutations due to OneBeacon from LibertyMutual pursuant to the terms and conditions of the rewritten indemnityreinsurance agreement. To date, Liberty Mutual has refused to pay, assertingthat it is entitled to an offset against the ULAE amounts disputed by OneBeaconand subject to the ULAE Arbitration. In January 2007, this arbitration wasconsolidated into the ULAE Arbitration.

Our subsidiaries OneBeacon Insurance Group LLC andOneBeacon Insurance Company, or OBIC, also have asserted claims against LibertyMutual (and Peerless Insurance Company) in the Court of Common Pleas forPhiladelphia County, Pennsylvania, or the Court, in which they assert thatLiberty Mutual (and Peerless Insurance Company) breached the Pre-ClosingAdministrative Services Agreement, handled claims files negligently, breachedfiduciary duties and were unjustly enriched. The Court has stayed those claimspending the resolution of the arbitration between OBIC and Liberty Mutual forbreach of contract. The arbitration hearing commenced in November 2006 andwill continue in May 2007.

As of December 31,2006, we believe that our loss and LAE reserves are sufficient to coverreasonably anticipated outcomes of all related disputes with Liberty Mutual.

**ITEM 4.**                SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS

There were no matterssubmitted to a vote of the Company’s shareholders during the fourth quarter of2006.

**Executive Officers of the Registrant and itsSubsidiaries as of February 28, 2007:**

| **Name**                | ** ** | ** ** | ** ** | **Age**                                             | ** ** | **Position(s)** |
|-------------------------|------------|------------|------------|-----------------------------------------------------|------------|-----------------|
| T. Michael Miller       |       | 48         |       | Director, President and  Chief Executive Officer    |
| Paul H. McDonough       |       | 42         |       | Chief Financial Officer                             |
| Ann Marie Andrews       |       | 34         |       | Chief Accounting Officer                            |
| Alexander C. Archimedes |       | 55         |       | Senior Vice President,  OneBeacon Insurance Company |
| Andrew C. Carnase       |       | 42         |       | Senior Vice President,  OneBeacon Insurance Company |
| Kevin J. Rehnberg       |       | 43         |       | Senior Vice President,  OneBeacon Insurance Company |
| Thomas L. Forsyth       |       | 51         |       | Secretary                                           |

 

Set forth below is information concerning ourdirectors and executive officers as of the date of this filing:

T. Michael Miller became a director and President andCEO of OneBeacon in August 2006 and was appointed President and CEO ofOneBeacon Insurance Group LLC, or OBIG, in July 2005 and joined OBIG asits Chief Operating Officer in April 2005. Prior to joining OneBeacon, Mr. Millerspent 10 years at St. Paul Travelers, most recently as Co-Chief OperatingOfficer. Prior to joining St. Paul Travelers, Mr. Miller spent14 years with The Chubb Corporation.

Paul H. McDonough was appointed CFO of OneBeacon in August 2006and was appointed CFO of OBIG in December 2005. Mr. McDonough previouslyserved as Executive Vice President and CFO for BJ’s Wholesale Club in 2005, andserved as Treasurer for St. Paul Travelers, where he worked from 1999-2004.Prior to joining St. Paul Travelers, Mr. McDonough served in finance roleswith Sears and with Chevron.

42

----

Ann Marie Andrews became Chief Accounting Officer ofOneBeacon in October 2006. Prior to this appointment, Ms. Andrewsserved in various financial roles of increasing responsibility at OneBeacon,most recently as controller of OBIG. Prior to joining OneBeacon in July 2002,she was with Arthur Andersen LLP.

Alexander C. Archimedes became Senior Vice Presidentof OneBeacon Insurance Company in September 2002 after joining OneBeaconInsurance Company in January 2002. Mr. Archimedes was previously employedby Fireman’s Fund Insurance Company for 16 years and most recently served asPresident and CEO of Parkway Insurance Company (a Fireman’s Fund subsidiary)from 1993 to 2001. Prior to joining Fireman’s Fund, Mr. Archimedes spent 9years at Colonial Penn Insurance Company in various field and operationalroles.

Andrew C. Carnase became Senior Vice President ofOneBeacon Insurance Company in 2002. Mr. Carnase previously served asSenior Vice President at The Chubb Corporation where he worked in various underwritingmanagement positions from 1987 to 2002.

Kevin J. Rehnberg became Senior Vice President ofOneBeacon Insurance Company in 2005. Mr. Rehnberg previously served asSenior Vice President, Specialty Commercial at St. Paul Travelers where heworked from 1997-2005. Prior to joining The St. Paul Companies Mr. Rehnbergserved in underwriting management roles for 2 years with Liberty MutualInsurance Company and for 9 years with The Chubb Corporation.

Thomas L. Forsyth became General Counsel of OBIG in January 2006.Mr. Forsyth previously served as General Counsel of Swiss ReinsuranceAmerica Corporation from 1994 to 2005. Prior to joining Swiss Re, he was amember of the law department of the Travelers Insurance Companies andassociated with the law firm of Barger & Wolen.

43

----

**PART II**

**ITEM 5. MARKET FOR THECOMPANY’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASE OFEQUITY SECURITIES**

The common shares of OneBeacon are listed and traded on the New YorkStock Exchange (Symbol: OB). Our Class A common shares began trading on November 9,2006. Prior to such date, there was no established public trading market forour common shares. We also have Class B common shares that are not listedfor trading, all of which are held by White Mountains. There is no publicmarket for this class of securities. The closing price per share of the Class Acommon shares on the New York Stock Exchange on February 27, 2007 was $26.99.As of February 27, 2007, the 27,613,292 outstanding Class A commonshares were held by 6 holders of record. We have not paid any dividendssince our shares began to trade publicly on November 9, 2006. On February21, 2007, our Board of Directors declared a dividend of $0.21 per common share,payable on March 28, 2007 to shareholders of record on March 19, 2007.See “Management’s Discussion and Analysis of Financial Condition and Results ofOperations—Dividend Capacity”. Subject to the approval of the Board ofDirectors, the Company anticipates paying a quarterly dividend of $0.21 percommon share.

The following tablepresents the range of share prices for our Class A common shares for the periodfrom November 9, 2006, the date our Class A common shares commencedtrading on the New York Stock Exchange, through December 31, 2006:

| **Period from:**                                 | ** ** | ** ** | ** ** | **High** | ** ** | **Low** | ** ** |
|-------------------------------------------------------|------------|------------|------------|----------|------------|---------|------------|
| November 9, 2006  through December 31, 2006 |       | $          | 28.15      |     | $          | 26.01   |       |
|                                                       |            |            |            |          |            |         |            |  |  |

 

No repurchases of common shares were made by or onbehalf of the Company during the fourth quarter of 2006.

OneBeacon was acquired by White Mountains from Avivain 2001. White Mountains is a holding company whose businesses provide propertyand casualty insurance, reinsurance and certain other products. During thefourth quarter of 2006, White Mountains sold 27.6 million or 27.6% of theCompany’s Class A common shares in an initial public offering. Prior to theinitial public offering, OneBeacon was a wholly-owned subsidiary of WhiteMountains.

For information on securities authorized for issuanceunder the Company's equity compensation plans, see “Item 12—SecurityOwnership of Certain Beneficial Owners and Management and Related ShareholderMatters.”

**Stock PerformanceGraph**

The following chartcompares the total return on a cumulative basis of $100 invested in our Class Acommon shares on November 9, 2006, the date our shares commenced tradingon the New York Stock Exchange, to the Standard & Poor’s 500 StockIndex and the Standard & Poor’s Property and Casualty Insurance Index.

44

----

**ITEM 6. SELECTEDFINANCIAL DATA**

Thefollowing tables set forth our selected consolidated financial information forthe dates indicated. We have derived the selected consolidated financialinformation presented below as of and for the years ended December 31,2002, 2003, 2004, 2005 and 2006 from our consolidated financial statements,which have been prepared in accordance with GAAP. The consolidated financialstatements as of December 31, 2005 and 2006 and for the years ended December 31,2004, 2005 and 2006 have been audited by PricewaterhouseCoopersLLP, an independent registered public accounting firm. The consolidatedfinancial statements as of December 31, 2002 and 2003 and for theyear ended December 31, 2002 are unaudited. 

| ** **                                                              | ** ** | **Year ended December 31,**                                                      | ** ** |
|-------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------|------------|
| ** **                                                              | ** ** | **2002**                                                                                        | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                                              | ** ** | **($ in millions, except share and per share amounts)** | ** ** |
| **Summary Income Statement Data:**                                      | ** ** | ** **                                                                                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net written premiums                                                    |       | $                                                                                               | 2,357.3    |   | $ | 1,803.5 |   | $ | 2,164.7 |   | $ | 2,095.6 |   | $ | 2,007.0 |   |
| Earned premiums                                                         |       | $                                                                                               | 2,704.1    |   | $ | 1,992.4 |   | $ | 2,087.1 |   | $ | 2,012.7 |   | $ | 2,075.9 |   |
| Net investment income                                                   |       | 282.0                                                                                           |       | 210.9 |   | 209.6 |   | 236.8 |   | 191.8 |   |
| Net realized investment  gains                                          |       | 60.2                                                                                            |       | 115.9 |   | 128.8 |   | 123.2 |   | 163.6 |   |
| Net other revenues                                                      |       | 41.9                                                                                            |       | 98.7 |   | 59.5 |   | 24.1 |   | 38.8 |   |
| Total revenues                                                          |       | 3,088.2                                                                                         |       | 2,417.9 |   | 2,485.0 |   | 2,396.8 |   | 2,470.1 |   |
| Loss and LAE                                                            |       | 2,013.6                                                                                         |       | 1,364.2 |   | 1,385.4 |   | 1,390.4 |   | 1,283.6 |   |
| Policy acquisition  expenses and other underwriting expenses            |       | 906.2                                                                                           |       | 596.8 |   | 709.8 |   | 612.7 |   | 740.0 |   |
| General and  administrative expenses                                    |       | 29.0                                                                                            |       | 37.7 |   | 81.9 |   | 8.4 |   | 15.3 |   |
| Accretion of fair value  adjustment to loss and LAE reserves(1)         |       | 79.8                                                                                            |       | 48.6 |   | 33.2 |   | 26.0 |   | 23.0 |   |
| Interest expense(2)                                                     |       | 69.3                                                                                            |       | 68.9 |   | 92.6 |   | 96.5 |   | 104.1 |   |
| Total expenses                                                          |       | 3,097.9                                                                                         |       | 2,116.2 |   | 2,302.9 |   | 2,134.0 |   | 2,166.0 |   |
| Pre-tax income  (loss)                                                  |       | (9.7                                                                                            | )          | 301.7 |   | 182.1 |   | 262.8 |   | 304.1 |   |
| Income tax (provision)  benefit                                         |       | 0.4                                                                                             |       | (103.3 | ) | (49.4 | ) | (82.1 | ) | (68.9 | ) |
| Dividends and accretion  on subsidiary preferred stock to face value(2) |       | (40.9                                                                                           | )          | (21.5 | ) | — |   | — |   | — |   |
| Equity in earnings of  unconsolidated affiliates                        |       | 14.0                                                                                            |       | 57.5 |   | 27.4 |   | 5.6 |   | 10.3 |   |
| Income (loss) from  continuing operations                               |       | (36.2                                                                                           | )          | 234.4 |   | 160.1 |   | 186.3 |   | 245.5 |   |
| Cumulative effect of  changes in accounting principles                  |       | 625.1                                                                                           | (7)        | — |   | — |   | — |   | — |   |
| Income (loss) from  discontinued operations                             |       | 66.7                                                                                            |       | 19.2 |   | (24.1 | ) | 25.2 |   | 1.2 |   |
| Gain from sale of discontinued  operations, net of tax             |       | —                                                                                          |       | — |   | — |   | 21.1 |   | — |   |
| Net income                                                              |       | 655.6                                                                                           |       | 253.6 |   | 136.0 |   | 232.6 |   | 246.7 |   |
| Other comprehensive  income (loss)                                      |       | 202.1                                                                                           |       | 73.6 |   | 84.3 |   | (144.8 | ) | 29.0 |   |
| Comprehensive net income                                                |       | $                                                                                               | 857.7      |   | $ | 327.2 |   | $ | 220.3 |   | $ | 87.8 |   | $ | 275.7 |   |
| Earnings per share:                                                     |       |                                                                                            |       |   |   |   |   |   |   |   |   |
| Income (loss) from  continuing operations                               |       |                                                                                            |       |   |   |   |   |   |   |   |   |
| Basic                                                                   |       | $                                                                                               | (0.36      | ) | $ | 2.34 |   | $ | 1.60 |   | $ | 1.86 |   | $ | 2.46 |   |
| Diluted                                                                 |       | (0.36                                                                                           | )          | 2.32 |   | 1.60 |   | 1.86 |   | 2.46 |   |
| Net income                                                              |       |                                                                                            |       |   |   |   |   |   |   |   |   |
| Basic                                                                   |       | 6.56                                                                                            |       | 2.54 |   | 1.36 |   | 2.33 |   | 2.47 |   |
| Diluted                                                                 |       | 6.56                                                                                            |       | 2.51 |   | 1.36 |   | 2.33 |   | 2.47 |   |
| Weighted average number  of shares outstanding (in millions)            |       | 100.0                                                                                           |       | 100.0 |   | 100.0 |   | 100.0 |   | 100.0 |   |

45

----

 

| **Selected  Ratios (Based on GAAP Income Statement Data):** | ** **   | ** **   | ** **   | ** **   | ** **   | ** **   | ** **   | ** **   | ** **   | ** **   | ** **   |
|-------------------------------------------------------------|--------------|--------------|--------------|--------------|--------------|--------------|--------------|--------------|--------------|--------------|--------------|
| ***Consolidated***                                          | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** |
| Loss and LAE  ratio(3)                                      |         | 74.5         | %            | 68.5         | %            | 66.4         | %            | 69.1         | %            | 61.8         | %            |
| Expense ratio(4)                                            |         | 33.5         |         | 30.0         |         | 34.0         |         | 30.4         |         | 35.6         |         |
| Combined ratio(5)                                           |         | 108.0        | %            | 98.5         | %            | 100.4        | %            | 99.5         | %            | 97.4         | %            |
| ***Primary Insurance Operations***                          | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** |
| Loss and LAE  ratio(3)                                      |         | 74.5         | %            | 68.5         | %            | 65.7         | %            | 67.2         | %            | 60.7         | %            |
| Expense ratio(4)                                            |         | 33.5         |         | 30.0         |         | 34.2         |         | 31.4         |         | 35.6         |         |
| Combined ratio(6)                                           |         | 108.0        | %            | 98.5         | %            | 99.9         | %            | 98.6         | %            | 96.3         | %            |
| **Summary Balance Sheet Data:**                             |         |         |         |         |         |         |         |         |         |         |         |
| Total cash and  investments                                 |         | $            | 6,638.3      |         | $            | 5,395.5      |         | $            | 5,209.6      |         | $            | 4,808.6 |   | $ | 5,254.2 |   |
| Total assets                                                |         | 15,601.4     |         | 15,233.9     |         | 9,954.0      |         | 10,252.7     |         | 9,869.4      |         |
| Loss and LAE  reserves                                      |         | 7,025.9      |         | 5,695.9      |         | 4,922.2      |         | 5,354.3      |         | 4,837.7      |         |
| Unearned premiums                                           |         | 1,207.9      |         | 941.0        |         | 1,001.4      |         | 1,042.8      |         | 985.2        |         |
| Debt                                                        |         | 746.4        |         | 706.1        |         | 726.3        |         | 744.9        |         | 759.5        |         |
| Intercompany debt  payable                                  |         | 3.3          |         | —       |         | 1,000.0      | (8)          | —       |         | —       |         |
| Preferred stock  subject to mandatory redemption            |         | 181.0        |         | 194.5        |         | 211.9        |         | 234.0        |         | 262.3        |         |
| Common shareholders’  equity                           |         | 2,416.9      | (7)          | 2,804.1      | (8)          | 417.5        | (8)          | 1,560.0      | (8)          | 1,777.2      |         |
|                                                             |              |              |              |              |              |              |              |              |              |              |              |  |  |  |  |  |

 

----

(1)          In connection withpurchase accounting for our acquisition by White Mountains, which we refer toas the OneBeacon Acquisition, we were required to adjust to fair value our lossand LAE reserves and the related reinsurance recoverables by$646.9 million and $346.9 million, respectively, on our balance sheetas of June 1, 2001. This net charge to loss and LAE reserves of$300.0 million is being accreted through an income statement chargeratably with and over the period the claims are settled.

(2)          In accordance with ouradoption of Statement of Financial Accounting Standards No. 150, “Accountingfor Certain Financial Instruments with Characteristics of both Liabilities andEquity” or SFAS 150, beginning in the third quarter of 2003, we beganpresenting all accretion and dividends on preferred stock subject to mandatoryredemption as interest expense.

(3)          The loss and LAE ratiois calculated by dividing loss and LAE, which includes long-termcompensation expense, by earned premiums.

(4)          The expense ratio iscalculated by dividing policy acquisition expenses and other underwritingexpenses, which includes long-term compensation expense, by earnedpremiums.

(5)          The combined ratio isthe sum of the loss and LAE ratio and the expense ratio, including long-termincentive compensation expense. Long-term incentive compensation expenseincreased our consolidated combined ratio by 1.7 points, 4.2 points,5.3 points, 1.8 points and 2.1 points for the years ended December 31,2002, 2003, 2004, 2005 and 2006, respectively.

(6)          Includes our long-termincentive compensation expense. Long-term incentive compensation expense increasedour combined ratio for the Primary Insurance Operations by 1.7 points,4.2 points, 5.0 points, 1.8 points and 2.3 points for the yearsended December 31, 2002, 2003, 2004, 2005 and 2006, respectively.

46

----

(7)          In accordance with ouradoption of  SFAS No. 141, “BusinessCombinations” or SFAS 141, we recognized all of our outstanding deferredcredits on January 1, 2002.

(8)          As part of a corporatereorganization at White Mountains during 2004, we distributed our interest inseveral wholly owned subsidiaries to White Mountains. The distribution ofFolksamerica Holdings, Inc. and its subsidiaries, as well as$270.0 million in intercompany notes receivable from another affiliate ofWhite Mountains, resulted in a $1.3 billion reduction in commonshareholders’ equity. In addition, the distribution of WM Asset Management(Barbados) Ltd., which held, among other things, $1.0 billion ofnotes receivable from OneBeacon, resulted in a $1.1 billion reduction inshareholders’ equity in December 2004. During the first quarter of 2005,White Mountains contributed the $1.0 billion of intercompany notesreceivable back to OneBeacon, resulting in a $1.0 billion increase tocommon shareholders’ equity in 2005.

47

----

**ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS**

*The following discussion contains “forward-lookingstatements.” Statements that are not historical in nature are forward-lookingstatements. OneBeacon cannot promise that our expectations in such forward-lookingstatements will turn out to be correct. OneBeacon’s actual results could bematerially different from and worse than our expectations. See “Forward-LookingStatements” on page 94 for specific important factors that could causeactual results to differ materially from those contained in forward-lookingstatements.*

**Overview**

OneBeacon is a propertyand casualty insurance writer that provides a range of specialty insuranceproducts as well as a variety of segmented commercial and personal insuranceproducts. With roots dating back to 1831, we have been operating for more than175 years and have many long-standing relationships with independentagencies, which constitute our primary distribution channel. We consist of agroup of operating companies which are U.S.-based property and casualtyinsurance writers, substantially all of which operate in a multi-companypool. Pooling arrangements permit the participating companies to rely on thecapacity of the entire pool’s capital and surplus rather than just on its owncapital and surplus. Under such arrangements, the members share substantiallyall insurance business that is written, and allocate the combined premiums,losses and expenses. In 2006, our net written premiums totaled$2.0 billion and we had total assets of $9.9 billion and total commonshareholders’ equity of $1.8 billion at December 31, 2006.

***Our Historical Consolidated Financial Information***

Prior to our initialpublic offering, we consolidated certain other businesses for GAAP financialreporting and U.S. tax purposes that are no longer held by us, (the “InternalReorganization”). These other businesses are therefore reflected in ourhistorical consolidated financial statements in this report as discontinuedoperations. Furthermore, on August 24, 2006, we exchanged our investmentin the common shares of Montpelier, for an agreed-upon portfolio ofcommon equity and fixed maturity securities of equal value owned by WhiteMountains (See “Montpelier Investment”) and, in the fourth quarter of 2006, wecommuted our two quota share reinsurance arrangements with other subsidiariesof White Mountains.

***Our Segments***

OneBeacon’s reportable segments are Primary InsuranceOperations, Affiliate Quota Shares and Other Operations.

*PrimaryInsurance Operations.*   Our Primary InsuranceOperations segment includes the results of substantially all of our insuranceoperations, with the exception of certain quota share arrangements withaffiliates of White Mountains as described below. Our Primary InsuranceOperations segment also includes run-off business which primarilyconsists of national accounts, certain specialty programs and regional agencybusiness transferred to Liberty Mutual effective November 1, 2001. See “Business—Run-off”.

In the fourth quarter of 2006, we began to includeOBSP within commercial lines and AutoOne within personal lines. Both OBSP andAutoOne were formerly reported in specialty lines. The reporting change wasundertaken to better align the reported results of our underwriting units withtheir product and management structure. Prior periods have been reclassified toconform to the current presentation.

*AffiliateQuota Shares.**  *During2004 and 2005, we entered into two quota share reinsurance arrangements withother subsidiaries of White Mountains, primarily for White Mountains’ capitalmanagement purposes. Under the Sirius Quota Share, we ceded between 6% and 12%of business written, 

48

----

effective April 1,2004, to Sirius International Insurance Corporation. Under the Esurance QuotaShare, which was effective on January 1, 2005, we assumed approximately85% of business written by Esurance Insurance Company, which includes businesswritten by its wholly owned subsidiary. These agreements were commuted in thefourth quarter of 2006 in connection with our initial public offering.

*Other Operations.**  *Our Other Operations segmentconsists of the activities of our top holding company, OneBeacon InsuranceGroup, Ltd. and our intermediate holding and finance companies.

***Revenues***

We account for insurancepolicies that we write in accordance with Statement of Financial AccountingStandards (SFAS) No. 60, “Accounting and Reporting by InsuranceEnterprises,” or SFAS 60. Premiums written are recognized as revenues and areearned ratably over the term of the related policy. Unearned premiums representthe portion of premiums written that are applicable to future insurancecoverage provided by policies. AutoOne, one of our subsidiaries, which acts asa limited assigned distribution, or LAD, servicing carrier, enters intocontractual arrangements with insurance companies to assume private passengerand commercial automobile assigned risk exposures in 22 states. AutoOnereceives LAD and commercial limited assigned distribution, or CLAD, servicingfees from these other companies for assuming these risks. In addition, AutoOnechooses to write certain policies voluntarily by taking risks out of the NewYork Automobile Insurance Plan, or NYAIP. These policies generate takeoutcredits which can be sold for fees, which we refer to as take-out fees, toother carriers. These other carriers in turn can use such credits to reducetheir obligations to write assigned risk business. AutoOne’s LAD and CLADservicing and take-out fees are recorded as written premium when billed and areearned ratably over the term of the related policy to which the fee relates.

***Deferred Acquisition Costs***

Deferred acquisition costsrepresent commissions, premium taxes, brokerage expenses and other costs thatare directly attributable to and vary with the production of new business.These costs are deferred and amortized over the applicable premium recognitionperiod. Deferred acquisition costs are limited to the amount expected to berecovered from future earned premiums and anticipated investment income.

***Loss and Loss Adjustment Expenses***

Loss and loss adjustmentexpenses, or LAE, are charged against income as incurred. Unpaid loss and LAEreserves are based on estimates (generally determined by claims adjusters,legal counsel and actuarial staff) of the ultimate costs of settling claims,including the effects of inflation and other societal and economic factors.Unpaid loss and LAE reserves represent management’s best estimate of ultimateloss and LAE, net of estimated salvage and subrogation recoveries, ifapplicable. Such estimates are reviewed and updated on a quarterly basis andany adjustments resulting therefrom are reflected in current operations. Theprocess of estimating loss and LAE involves a considerable degree of judgmentby management and the ultimate amount of expense to be incurred could beconsiderably greater than or less than the amounts currently reflected in theconsolidated financial statements.

***Reinsurance***

Our insurance subsidiaries enter into ceded reinsurancecontracts from time to time to protect their businesses from losses due toconcentration of risk and to limit losses arising from catastrophic events. Themajority of such reinsurance contracts are executed through excess-of-losstreaties and catastrophe contracts under which a third party reinsurerindemnifies our insurance subsidiaries for a specified part or all of certaintypes of losses over stipulated amounts arising from any one occurrence orevent. We also have entered into quota share treaties with reinsurers underwhich all risks meeting prescribed criteria are 

49

----

ceded to third partyreinsurers on a pro rata basis. The amount of each risk ceded by us is subjectto maximum limits that vary by line of business and type of coverage. Amounts relatedto reinsurance contracts are recorded in our consolidated financial statementsin accordance with SFAS No. 113, “Accounting and Reporting for Reinsuranceof Short-Duration and Long-Duration Contracts,” or SFAS 113, andEmerging Issues Task Force Topic No. D-54, as applicable.

Amounts recoverable from reinsurers are estimated in amanner consistent with the claim liability associated with the reinsuredpolicies. Our ability to collect our reinsurance recoverables is subject to thesolvency of the reinsurers with whom we have entered into reinsurancecontracts. We are selective in regard to our reinsurers, principally placingreinsurance with those reinsurers with strong financial condition, industryratings and underwriting ability. Management monitors the financial conditionand ratings of our reinsurers on an ongoing basis.

Reinsurance premiums,commissions, expense reimbursements and reserves related to reinsured businessare accounted for on a basis consistent with those used in accounting for the originalpolicies issued and the terms of the reinsurance contracts. Premiums ceded toother companies are reported as a reduction of premiums written. Expenseallowances received in connection with reinsurance ceded have been accountedfor as a reduction of the related policy acquisition costs.

***Mandatorily Redeemable Preferred Stock***

OneBeacon has two classesof mandatorily redeemable preferred stock of subsidiaries. These instrumentsare classified as liabilities and are carried at their historical carryingvalues. All dividends and accretion on OneBeacon’s mandatorily redeemablepreferred stock have been recorded as interest expense. See Note 11. “MandatorilyRedeemable Preferred Stock of Subsidiaries” of the accompanying consolidatedfinancial statements.

***Share-Based Compensation***

*CompensationPhilosophy*

Our executive compensation policies are designed withone goal in mind, namely, the maximization of shareholder value over longperiods of time. We believe that this goal is best pursued by utilizing a pay-for-performanceprogram that serves to attract and retain superior executive talent and providemanagement with performance-based incentives to maximize shareholdervalue. Through this compensation program, we seek to maximize shareholder valueby aligning closely the financial interests of management with those of ourshareholders. The cost of all incentive compensation is fully accrued andexpensed.

Compensation of our seniormanagement team, including our named executive officers, consists primarily ofthree components: base salary, annual bonus and long-term incentive awards.Base salaries have been capped at $400,000. Annual bonus targets for all seniorexecutives are 50% of base salary. Long-term incentives for senior executiveshave in the past been comprised of performance shares and/or performance units.Under these instruments, payouts are explicitly tied to White Mountains’ orOneBeacon’s performance over a three-year period and are highly variable (theactual number of shares/units paid out at the end of the cycle will range from0% to 200% of target depending on performance against established goals). SeeNote 10, “Employee Share-Based Compensation Plans.”

*Share-BasedCompensation—Primary Insurance Operations*

**2002-2004performance cycle and prior**

For these cycles, thelong-term incentives for employees of our Primary Insurance Operations segmentwere comprised solely of White Mountains performance shares, with performanceobjectives tied to both White Mountains and OneBeacon. Accordingly, incentivecompensation expense in 2004 and prior 

50

----

yearsfor these operations was heavily dependent on the market price of WhiteMountains common shares, which rose by 41% in 2004. In the 2002-2004performance cycle, a total of 246,325 White Mountains performance shares wereearned by employees of our Primary Insurance Operations segment based on payoutlevels ranging from 113% to 200% of target.

**2003-2005through 2006-2008 performance cycles**

For these cycles,OneBeacon revised the design of its long-term incentive plans principally touse OneBeacon performance units instead of White Mountains performance shares,with performance targets primarily tied to OneBeacon’s adjusted combined ratio.Each unit is initially valued at $100 and compounds in value over the performanceperiod by the underwriting return on capital achieved by OneBeacon. In the caseof senior officers of our Primary Insurance Operations segment, a portion oftheir long-term incentive compensation in these periods has been denominated inWhite Mountains performance shares. As a result of the shift from WhiteMountains performance shares to OneBeacon performance units, OneBeacon’sincentive compensation expense associated with these performance cycles is nolonger significantly impacted by changes in the market price of White Mountainscommon shares. In the 2003-2005 performance cycle, no White Mountainsperformance shares were earned by employees of our Primary Insurance Operationssegment and, as of December 31, 2006, 4,400, 5,350 and 6,720 target White Mountainsperformance shares were outstanding for employees of our Primary InsuranceOperations segment with respect to the 2004-2006, 2005-2007 and 2006-2008performance cycles, respectively.

*Compensation—OtherOperations*

In connection with theInternal Reorganization, on August 3, 2006, all employees of our OtherOperations segment became employees of White Mountains. Therefore, we will nolonger incur significant compensation expense in our Other Operations segment.

*Share-BasedCompensation Recognition*

Our share-basedcompensation plans consist of performance shares which are typically settled incash and stock options which were granted in connection with our initial publicoffering. Effective January 1, 2006, we account for these share-basedcompensation plans in accordance with SFAS No. 123 R, “Share-BasedPayment” or SFAS 123R. Compensation cost is measured and recognized based onthe current market price of the underlying common shares and on the number ofshares that are expected to vest. Prior to adoption of SFAS 123R, we accountedfor these plans in accordance with Accounting Principles Board Opinion No. 25,“Accounting for Stock Issued to Employees,” or APB 25, whereby werecognized compensation cost based on the current market price of the underlyingcommon shares and on the assumption that all shares awarded would vest.Compensation cost gave effect only to actual rather than assumed forfeituresprior to adoption of SFAS 123R.

***Purchase Accounting***

In connection withpurchase accounting for our acquisition by White Mountains in 2001, which werefer to as the OneBeacon Acquisition, we were required to adjust to fair valueour loss and LAE reserves and the related reinsurance recoverables by$646.9 million and $346.9 million, respectively, on our balance sheetas of June 1, 2001. This net change to loss and LAE reserves of$300.0 million is being accreted through an income statement chargeratably with and over the period the claims are settled. Accordingly, werecognized $33.2 million, $26.0 million and $23.0 million of suchcharges, recorded as loss and LAE, during 2004, 2005 and 2006, respectively. Asof December 31, 2006, the outstanding pre-tax unaccreted adjustmentwas $33.4 million.

51

----

***Income taxes***

The income tax provisionrelated to pre-tax earnings from continuing operations for 2004, 2005 and 2006represented an effective tax rate of 27.1%, 31.2% and 22.7%, respectively. Oureffective tax rate for 2004 was lower than the U.S. statutory rate of 35%primarily due to the recognition of foreign tax credits and income generated injurisdictions other than the United States, which have lower tax rates,partially offset by non-deductible dividends and accretion on preferred stocksubject to mandatory redemption, which we report as interest expense for financialstatement purposes. Our effective tax rates for 2005 and 2006 were lower thanthe U.S. statutory rate of 35% primarily due to income generated injurisdictions other than the United States, partially offset by non-deductibledividends and accretion on preferred stock subject to mandatory redemption. Inaddition, our effective tax rate for 2006 was lower than the U.S. statutoryrate of 35% due to the settlement of the Federal income tax audits related totax years prior to 2003 and tax benefits recognized on the exchange of ourinvestment in MSA.

**DiscontinuedOperations**

In 2004 and 2006, we distributed or sold certainconsolidated subsidiaries to White Mountains at GAAP book value. We did notrecognize a gain or a loss on these distributions or sales. These subsidiariesare included in discontinued operations and comprise the following entities:

***Distributed in2004:***

·       FolksamericaHolding Company, including its wholly owned subsidiary, FolksamericaReinsurance Company—a reinsurance company that is now part of White MountainsRe Holdings Inc., or White Mountains Re, a wholly owned subsidiary ofWhite Mountains;

·       EsuranceInc. and Esurance Insurance Services Inc.—a holding company parent and aninsurance agency / services company.

***Sold in 2004:***

·       EsuranceInsurance Company and Esurance Property and Casualty Company—two property-casualtyinsurance companies.

***Sold in 2006:***

·       Aspart of the Internal Reorganization, we sold certain other consolidatedsubsidiaries to White Mountains on August 3, 2006 as follows:

·        WhiteMountains Advisors, LLC (WM Advisors)—an investment management subsidiary;

·        WhiteMountains Management Company, Inc. and White Mountains Capital, Inc.—bothservice companies;

·        WhiteMountains Services Holdings, Inc. and White Mountains Services, LLC—thesecompanies contain the remainder of mortgage banking run-off assets followingthe sale of substantially all the mortgage banking assets of White MountainsServices Corporation (formerly Source One Mortgage Services Corporation) toCitibank Mortgage, Inc. in 1999;

·        TuckermanCapital, L.P. and Tuckerman Capital II, L.P.—both private equity fundinvestments; and

·        InternationalAmerican Group—primarily consists of American Centennial Insurance Company andBritish Insurance Company of Cayman, two run-off insurance companies.

On September 30, 2005, we sold NFU to QBEInsurance Group, Ltd., or QBE, for $138.3 million in cash. NFU is includedin discontinued operations for all periods presented through the date of itssale. We 

52

----

recognized a gain of$26.2 million ($21.1 million after-tax) on the sale which is includedin gain on sale of discontinued operations and is presented net of tax in thestatements of consolidated income and comprehensive income.

Our income from continuing operations excludes the resultsof operations for the above entities for all periods presented. Net income orloss from discontinued operations has been presented separately and is shownnet of related income taxes.

Cash flows associated with the operating, financingand investing activities of discontinued operations are aggregated andpresented under separate captions in our consolidated statements of cash flows.

Assetsand liabilities of entities classified as discontinued operations have beenaggregated and are presented under separate captions on our consolidatedbalance sheets. See Note 2—”Discontinued Operations” of the accompanyingconsolidated financial statements. The following sets forth the assets andliabilities summarized under those captions:

| ** **                                         | ** ** | **As of December 31,** | ** ** |
|----------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                         | ** ** | **2005**                              | ** ** |
| ** **                                         | ** ** | **($ in millions)**         | ** ** |
| Cash                                               |       |                                  | $          | 0.3 |   |   |
| Total investments                                  |       |                                  | 111.8      |   |   |
| Reinsurance  recoverable on unpaid and paid losses |       |                                  | 26.3       |   |   |
| Other assets                                       |       |                                  | 134.0      |   |   |
| Total assets of  discontinued operations           |       |                                  | $          | 272.4 |   |   |
| Loss and LAE reserves                              |       |                                  | $          | 61.1 |   |   |
| Ceded reinsurance  payable                         |       |                                  | 4.1        |   |   |
| Funds held under  reinsurance                      |       |                                  | 0.1        |   |   |
| Other liabilities                                  |       |                                  | 136.9      |   |   |
| Total liabilities of  discontinued operations      |       |                                  | $          | 202.2 |   |   |

 

**Other Acquisitionsand Dispositions**

On March 31, 2004, we acquired Atlantic SpecialtyInsurance Company, or Atlantic Specialty, a subsidiary of Atlantic MutualInsurance Company, or Atlantic Mutual, and the renewal rights to AtlanticMutual’s segmented commercial insurance business, including the unearnedpremiums on the acquired book. We refer to this transaction as the AtlanticSpecialty Transaction. In connection with our acquisition of AtlanticSpecialty, we paid $30.1 million in cash and issued a $20.0 millionnote to the seller, which is recorded as debt on our balance sheet. Our 2004 resultsof operations include $404.0 million of net written premiums related tothe Atlantic Specialty Transaction. Under the terms of the agreement, we paidAtlantic Mutual a renewal commission on the premiums renewed during the 12months following the Atlantic Specialty Transaction.

During the first quarter of 2004, we sold4.5 million common shares of Montpelier to third parties for net proceedsof $155.3 million. As a result of this sale, as well as changes to thecomposition of the boards of directors of both Montpelier and White Mountains,we changed the method of accounting for our remaining common share investmentin Montpelier as of March 31, 2004 from an equity method investment in anunconsolidated affiliate to a common equity security classified as available forsale and carried at fair value. On August 24, 2006, OneBeacon exchangedits investment in the common shares of Montpelier for an agreed-upon portfolioof common equity and fixed maturity securities of equal value that was owned byWhite Mountains. At the time of the exchange, OneBeacon’s investment in thecommon shares of Montpelier was in an unrealized loss position of $6.9 million.This loss was deferred at the time of the exchange as sales of investmentsbetween OneBeacon and entities under White Mountains’ common 

53

----

control are deferred. Subsequentto the exchange, White Mountains sold 5.4 million common shares of Montpeliertriggering the recognition of $5.8 million in realized investment losses. As ofDecember 31, 2006, OneBeacon’s remaining deferred loss on the exchangetotaled $1.1 million.

During the third quarter of 2004, we entered into anagreement to sell the renewal rights to most of our pre-Atlantic Mutual NewYork commercial business to Tower Insurance Group. The transaction waseffective with December 1, 2004 renewals. The gross written premium inforce at the time of this transaction for the book of business totaledapproximately $110 million. We retained the commercial business acquiredfrom Atlantic Mutual.

During the fourth quarter of 2004, we sold two of ourinactive licensed subsidiaries, Potomac Insurance Company of Illinois andWestern States Insurance Company, for $25.3 million, as well as our boilerinspection service business, for $11.5 million, and recognized combined gainson the sales of $22.1 million through net other revenues.

On August 2, 2005, we sold one of our inactivelicensed subsidiaries, TPIC, to Endurance Reinsurance for $23.4 million incash and recognized a gain of $8.0 million ($5.2 million after-tax)on the sale through net other revenues in 2005.

During the second quarter of 2006, we sold one of ourinactive licenses subsidiaries, Homeland Central Insurance Company, or HCIC, toa subsidiary of White Mountains. In connection with the sale of HCIC, OneBeaconrecorded a $6.0 million gain as additional paid in capital.

On September 29, 2006 we sold certain assets andthe right to renew existing policies of Agri, a division of OneBeacon thatprovides commercial farm and ranch and commercial agricultural insuranceproducts, for $32.0 million in cash to QBE, and recorded a pre-tax gain of$30.4 million in the third quarter. In connection with this sale, we haveentered into agreements under which, at the option of QBE, we will write thepolicies of Agri on a direct basis and cede 100% of this business to QBE.

On October 31, 2006, OneBeacon restructured itsinvestment in Main Street America Holdings, Inc., or MSA. OneBeaconreceived a $70 million cash dividend from MSA following which OneBeacon soldits 50% common stock investment in MSA to Main Street America Group, Inc.,the MSA Group for (i) $70.0 million in 9.0% non-voting cumulativeperpetual preferred stock of the MSA Group and (ii) 4.9% of the commonstock of the MSA Group. (See “Note 3—Acquisitions and Dispositions”). EffectiveOctober 31, 2006, OneBeacon accounts for its remaining investment in theMSA Group in accordance with FAS 115. Prior to the sale, OneBeacon owned 50% ofthe total common shares outstanding of MSA and accounted for this investmentusing the equity method of accounting. These transactions resulted in a netafter-tax realized gain of $8.5 million.

54

----

**Results ofOperations**

*Review ofConsolidated Results*

Asummary of our consolidated financial results for the years ended December 31,2004, 2005 and 2006 is as follows:

| ** **                                                                                        | ** ** | **Year ended December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                        | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                                                                        | ** ** | **($ in millions)**              | ** ** |
| Net written  premiums                                                                             |       | $                                          | 2,164.7    |   | $ | 2,095.6 |   | $ | 2,007.0 |   |
| **Revenues**                                                                                      | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Earned premiums                                                                                   |       | $                                          | 2,087.1    |   | $ | 2,012.7 |   | $ | 2,075.9 |   |
| Net investment income                                                                             |       | 209.6                                      |       | 236.8 |   | 191.8 |   |
| Net realized investment gains                                                                     |       | 128.8                                      |       | 123.2 |   | 163.6 |   |
| Net other revenues                                                                                |       | 59.5                                       |       | 24.1 |   | 38.8 |   |
| Total revenues                                                                                    |       | 2,485.0                                    |       | 2,396.8 |   | 2,470.1 |   |
| **Expenses**                                                                                      | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Loss and LAE                                                                                      |       | 1,385.4                                    |       | 1,390.4 |   | 1,283.6 |   |
| Policy acquisition expenses                                                                       |       | 359.8                                      |       | 349.3 |   | 379.9 |   |
| Other underwriting expenses                                                                       |       | 350.0                                      |       | 263.4 |   | 360.1 |   |
| General and administrative expenses                                                               |       | 81.9                                       |       | 8.4 |   | 15.3 |   |
| Accretion of fair value adjustment to loss and LAE  reserves                                      |       | 33.2                                       |       | 26.0 |   | 23.0 |   |
| Interest expense on debt                                                                          |       | 45.0                                       |       | 44.1 |   | 45.5 |   |
| Interest expense—dividends and accretion on  preferred stock subject to mandatory redemption |       | 47.6                                       |       | 52.4 |   | 58.6 |   |
| Total expenses                                                                                    |       | 2,302.9                                    |       | 2,134.0 |   | 2,166.0 |   |
| **Pre-tax  earnings from continuing operations**                                                  |       | 182.1                                      |       | 262.8 |   | 304.1 |   |
| Income tax provision                                                                              |       | (49.4                                      | )          | (82.1 | ) | (68.9 | ) |
| **Income  from continuing operations before equity in earnings of unconsolidated  affiliates**    |       | 132.7                                      |       | 180.7 |   | 235.2 |   |
| Equity in earnings of unconsolidated affiliates                                                   |       | 27.4                                       |       | 5.6 |   | 10.3 |   |
| **Income  from continuing operations**                                                            |       | 160.1                                      |       | 186.3 |   | 245.5 |   |
| Income (loss) from discontinued operations                                                        |       | (24.1                                      | )          | 25.2 |   | 1.2 |   |
| Gain from sale of discontinued operations                                                         |       | —                                     |       | 21.1 |   | — |   |
| **Net income**                                                                                    |       | 136.0                                      |       | 232.6 |   | 246.7 |   |
| Other comprehensive income (loss)                                                                 |       | 84.3                                       |       | (144.8 | ) | 29.0 |   |
| **Comprehensive net income**                                                                      |       | $                                          | 220.3      |   | $ | 87.8 |   | $ | 275.7 |   |

 

**ConsolidatedResults—Year ended December 31, 2006 versus year ended December 31,2005**

Our pre-tax income from continuing operations for 2006was $304.1 million, compared to pre-tax income from continuing operations of$262.8 million for 2005 and our GAAP combined ratio was 97.4% for 2006,compared to 99.5% for 2005.

Our 2006 results included $29.1 million incurrent accident year catastrophe losses, which impacted the combined ratio by1.4 points, a decrease of $52.1 million from 2005, which included $69.1million in current accident year catastrophe losses related to HurricanesKatrina, Rita and Wilma. Adverse development on prior accident years was$11.3 million in 2006, which impacted the combined ratio by 0.5 points, adecrease of $87.7 million, compared with 2005, which included $99.0 million inadverse development primarily relating to 2002 and prior accident years.Offsetting these decreases was $81.8 million of incentive compensation expense,which impacted the combined ratio by 3.9 points, an increase 

55

----

of $17.7 million, comparedto 2005 and $19.5 million of expenses associated with actions taken to optimizelong-term occupancy costs, including our move to our new U.S. headquarters inCanton, Massachusetts, which added 1.0 point to the combined ratio. Inaddition, 2005 included a $53.6 million gain from the settlement of ourretiree medical plan as described below in “Consolidated Results—Year ended December 31,2005 versus year ended December 31, 2004”, which reduced the 2005 combinedratio by a total of 2.7 points. In addition, during 2005, we recorded a$23.9 million reclassification between liability accounts which resultedin a decrease in other underwriting expenses and a corresponding increase inloss and LAE. This reclassification decreased the 2005 expense ratio by 1.2points and increased the loss and LAE ratio by 1.2 points.

Our total revenues increased 3.1% in 2006 to$2,470.1 million, compared to $2,396.8 million in 2005, dueprincipally to a 3.1% increase in earned premiums in 2006. The increase inearned premiums was due to an increase in business assumed from the affiliatequota share agreement with Esurance, prior to the commutation of the quotashare agreement in the fourth quarter of 2006. Net realized investment gainsincreased to $163.6 million in 2006, compared with $123.2 million in 2005. The2005 period included a realized loss of $54.6 million due to another-than-temporary impairment with respect to our investment in Montpeliercommon shares, as further described below in “Consolidated Results—Year ended December 31,2005 versus year ended December 31, 2004”. The impairment chargerepresented the difference between our GAAP cost of $170.3 million and theinvestment’s fair value of $115.7 million at December 31, 2005. Partiallyoffsetting the increase in net realized investment gains was a $45.0 milliondecrease in net investment income primarily due to a $34.7 million specialdividend on Montpelier common stock in the first quarter of 2005.

Net other revenues increased 61.0% in 2006 to $38.8million, compared to $24.1 million in 2005, primarily due to the sale of ourrenewal rights to the Agri business which resulted in a pre-tax gain of $30.4million. Partially offsetting the Agri gain was a $12.6 million pre-tax loss onthe sale of our investment in MSA. This pre-tax loss was offset by tax benefitsrecognized on the exchange of our investment in MSA described below. Inaddition, net other revenues in 2005 included an $8.0 million gain fromthe sale of Traders and Pacific Insurance Company.

During 2005, as a result of an actuarial reviewcompleted in the fourth quarter we reallocated a portion of our IBNR reservesfrom some of our ongoing lines of business to run-off as described below in “ConsolidatedResults—Year ended December 31, 2005 versus year ended December 31,2004”. This adjustment had no impact on our 2005 combined ratio.

The income tax provision related to pre-tax incomefrom continuing operations for the years ended December 31, 2006 and 2005represented effective tax rates of 22.7% and 31.2%, respectively, which werelower than the U.S. statutory rate of 35%. The effective tax rate is lower foreach of the years ended December 31, 2006 and 2005 due to income generatedin jurisdictions other than the United States, partially offset bynon-deductible dividends and accretion on the Berkshire Preferred Stock andZenith Preferred Stock. Also contributing to the lower effective tax rate in2006 was a $26.3 million tax benefit recognized in the second quarter of 2006related to settlements of U.S. Federal income tax audits for the years prior to2003 as well as tax benefits recognized on the exchange of our investment inMSA which yielded a tax benefit of $16.7 million.

**ConsolidatedResults—Year ended December 31, 2005 versus year ended December 31,2004**

Our pre-tax income from continuing operations for 2005was $262.8 million, compared to pre-tax income from continuing operationsof $182.1 million for 2004 and our GAAP combined ratio was 99.5% for 2005,compared to 100.4% for 2004.

Our 2005 results included $69.1 million in lossesrelated to Hurricanes Katrina, Rita and Wilma, which impacted the combinedratio by 3.4 points, and $99.0 million in adverse development, primarily 

56

----

relating to 2002 and prioraccident years, which impacted the combined ratio by 4.9 points. Offsettingthese items was a $53.6 million gain from the settlement of our retireemedical plan, which reduced the combined ratio by a total of 2.7 points. Theretiree medical plan, which had been frozen in 2002, was terminated and anindependent trust was established and funded to provide benefits to coveredparticipants. These actions relieved us of our future retiree medicalobligations and triggered recognition of the gain. The majority of the gain wasrecorded as a reduction of other underwriting expenses with a portion of thegain reflected in the loss and LAE as a portion of the expense of the retireemedical program was allocated to the claims department. In addition, incentivecompensation expenses, which were historically heavily dependent upon themarket price of White Mountains common shares, were lower in 2005 compared to 2004.During 2005, White Mountains’ share price decreased 14%, compared to a 41%increase in 2004.

Our 2004 pre-tax income from continuingoperations included $99.3 million in adverse development, primarilyrelating to 2002 and prior accident years, which impacted our loss and LAEratio by 4.8 points. The 2004 adverse development was partially offset by arelease of $19.9 million of the liability attributable to New Yorkassigned risk obligations due to the shrinking of the New York assigned riskpool. Our 2004 results also included $45.9 million of catastrophe losses,$22.8 million of which related to four hurricanes in the southeasternUnited States, which increased our loss and LAE ratio by 2.2 points.

Our total revenues decreased 3.5% in 2005 to$2,396.8 million, compared to $2,485.0 million in 2004, dueprincipally to a 3.6% decline in earned premiums in 2005. The decrease inearned premiums was due to lower commercial lines premiums resulting from thesale of the renewal rights on most of our non-Atlantic Mutual New Yorkcommercial lines business to Tower Insurance Group late in 2004. As a result ofthis transaction, $110 million of premiums written in 2004 were subject tothis renewal rights agreement and were not written by OneBeacon during 2005.Our commercial lines also had a one-time premiums written increase of$134.6 million in 2004 from the assumption of unearned premium from theAtlantic Specialty Transaction. In addition, personal lines earned premiumdecreased in 2005 due to lower volumes in Massachusetts and New York. NewJersey Skylands Insurance, one of the reciprocals which we manage, also hadlower earned premiums in 2005 as compared to 2004. Partially offsetting thedeclines in earned premium from commercial and personal lines were premiumsassumed under the Esurance quota share, which was entered into in 2005.

Net realized investment gains in 2005 included arealized loss of $54.6 million due to an other-than-temporary impairmentwith respect to our investment in Montpelier common shares, compared to$35.2 million in realized gains in 2004 from our sale of Montpelier commonshares. During 2005, the market value of Montpelier common shares decreasedfrom $38.45 per share to $18.90 per share. Our original cost of this investmentin 2001 was $105.0 million, which was subsequently increased by$65.3 million in equity in earnings recorded from 2001 to March 2004,the period in which we accounted for the investment under the equity method ofaccounting. The impairment charge represented the difference between our GAAPcost of $170.3 million and the investment’s fair value of$115.7 million at December 31, 2005. During the first quarter of2004, we sold 4.5 million common shares of Montpelier to third parties,which resulted in a $35.2 million realized gain. As a result of this sale,as well as changes to the composition of the board of directors of bothMontpelier and White Mountains, we changed the method of accounting for ourremaining common share investment in Montpelier as of March 31, 2004 froman equity method investment in an unconsolidated affiliate to a common equitysecurity classified as available for sale and carried at fair value. Inaddition, excluding the Montpelier investment, our net realized gains in 2005were higher than in 2004 as a result of the sale of several highly appreciatedcommon stocks within the energy and utility industries in order to repositionour equity portfolio into securities with more attractive risk/rewardcharacteristics.

Net other revenues for 2005 included $8.0 millionin gains from the sale of Traders and Pacific Insurance Company. During 2004,we sold two of our inactive licensed subsidiaries, Potomac Insurance 

57

----

Company of Illinois andWestern States Insurance Company, as well as our boiler inspection servicebusiness, for a total gain of $22.1 million that was recognized in netother revenues.

During 2005, we also realized a $21.1 millionafter-tax gain on the sale of our subsidiary, NFU, which has been presented asa gain on the sale of its discontinued operations.

As a result of anactuarial review completed in the fourth quarter of 2005, we reallocated aportion of our IBNR reserves from some of our ongoing lines of business torun-off. This shifted $34.4 million of our IBNR reserves from specialtylines ($10.9 million), commercial lines ($11.5 million) and personal lines($12.0 million) to our run-off. This adjustment had no impact on our 2005combined ratio.

***Summary of Operations By Segment***

Our segments consist ofthe following: (1) Primary Insurance Operations, (2) Affiliate QuotaShares and (3) Other Operations. In the fourth quarter of 2006, within ourPrimary Insurance Operations segment, we began to include OBSP withincommercial lines and AutoOne within personal lines. Both OBSP and AutoOne wereformerly reported in specialty lines. The reporting change was undertaken tobetter align the reported results of our underwriting units with their productand management structure. Prior periods have been reclassified to conform tothe current presentation. The affiliate quota share agreements were commuted inthe fourth quarter of 2006 in connection with our initial public offering. Allof our investments are managed by our affiliate, WM Advisors, and by ProspectorPartners, LLC (Prospector). A discussion of our consolidated investmentoperations is included after the discussion of operations by segment. Oursegment information is presented in Note 14—”Segment Information” to ourconsolidated financial statements.

*Primary InsuranceOperations*

Financialresults for our Primary Insurance Operations segment for the years ended December 31,2004, 2005 and 2006, were as follows:

| ** **                           | ** ** | **Year ended December 31,** | ** ** |
|--------------------------------------|------------|--------------------------------------------|------------|
| ** **                           | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                           | ** ** | **($ in millions)**              | ** ** |
| Net written  premiums                |       | $                                          | 2,280.6    |   | $ | 1,988.6 |   | $ | 1,957.6 |   |
| Earned premiums                      |       | 2,203.0                                    |       | 1,988.2 |   | 1,944.0 |   |
| Net investment  income               |       | 211.1                                      |       | 232.5 |   | 182.3 |   |
| Net realized  investment gains       |       | 129.0                                      |       | 124.2 |   | 165.3 |   |
| Net other  revenues                  |       | 48.7                                       |       | 14.7 |   | 21.8 |   |
| Total revenues                       |       | 2,591.8                                    |       | 2,359.6 |   | 2,313.4 |   |
| Loss and LAE                         |       | 1,448.1                                    |       | 1,335.6 |   | 1,180.3 |   |
| Policy  acquisition expenses         |       | 403.3                                      |       | 360.5 |   | 332.3 |   |
| Other  underwriting expenses         |       | 350.0                                      |       | 263.4 |   | 360.1 |   |
| General and  administrative expenses |       | 30.4                                       |       | 1.1 |   | 3.3 |   |
| Interest expense  on debt            |       | 1.0                                        |       | 1.4 |   | 2.9 |   |
| Total expenses                       |       | 2,232.8                                    |       | 1,962.0 |   | 1,878.9 |   |
| Pre-tax income                       |       | $                                          | 359.0      |   | $ | 397.6 |   | $ | 434.5 |   |

 

58

----

Thefollowing tables provide GAAP ratios, net written premiums and earned premiumsby underwriting units for the years ended December 31, 2004, 2005 and2006:

| ** **                  | ** ** | **Year ended December 31, 2004** | ** ** |
|-----------------------------|------------|------------------------------------------------------|------------|
| ** **                  | ** ** | **Specialty**                                        | ** ** | **Commercial** | ** ** | **Personal** | ** ** | **Total(2)** | ** ** |
| ** **                  | ** ** | **($ in millions)**                        | ** ** |
| *GAAP Ratios: (1)(3)(4)(5)* |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Loss and LAE                |       |                                                 | 58.5       | % |   |   | 56.0 | % |   | 62.9 | % | 65.7 | % |
| Expense                     |       |                                                 | 32.6       |   |   |   | 41.6 |   |   | 28.5 |   | 34.2 |   |
| Total Combined              |       |                                                 | 91.1       | % |   |   | 97.6 | % |   | 91.4 | % | 99.9 | % |
| Net written  premiums       |       |                                                 | $          | 387.2 |   |   |   | $ | 826.8 |   |   | $ | 1,063.3 |   | $ | 2,280.6 |   |
| Earned premiums             |       |                                                 | 363.5      |   |   |   | 710.3 |   |   | 1,070.9 |   | 2,203.0 |   |
|                             |            |                                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

| ** **                  | ** ** | **Year ended December 31, 2005** | ** ** |
|-----------------------------|------------|------------------------------------------------------|------------|
| ** **                  | ** ** | **Specialty**                                        | ** ** | **Commercial** | ** ** | **Personal** | ** ** | **Total(2)** | ** ** |
| ** **                  | ** ** | **($ in millions)**                        | ** ** |
| *GAAP Ratios: (1)(3)(4)(5)* |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Loss and LAE                |       |                                                 | 55.1       | % |   |   | 58.9 | % |   |   | 62.0 | % |   | 67.2 | % |
| Expense                     |       |                                                 | 29.8       |   |   |   | 38.4 |   |   |   | 28.8 |   |   | 31.4 |   |
| Total Combined              |       |                                                 | 84.9       | % |   |   | 97.3 | % |   |   | 90.8 | % |   | 98.6 | % |
| Net written  premiums       |       |                                                 | $          | 416.3 |   |   |   | $ | 654.4 |   |   |   | $ | 910.2 |   |   | $ | 1,988.6 |   |
| Earned premiums             |       |                                                 | 391.7      |   |   |   | 654.7 |   |   |   | 933.7 |   |   | 1,988.2 |   |
|                             |            |                                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

| ** **                  | ** ** | **Year ended December 31, 2006** | ** ** |
|-----------------------------|------------|------------------------------------------------------|------------|
| ** **                  | ** ** | **Specialty**                                        | ** ** | **Commercial** | ** ** | **Personal** | ** ** | **Total**(2) | ** ** |
| ** **                  | ** ** | **($ in millions)**                        | ** ** |
| *GAAP Ratios: (1)(3)(4)(5)* | * *   |                                                 | * *   | * * |   |   | * * | * * |   |   | * * | * * |   | * * | * * |
| Loss and LAE                |       |                                                 | 54.7       | *%* |   |   | 56.0 | *%* |   |   | 63.5 | *%* |   | 60.7 | % |
| Expense                     |       |                                                 | 34.3       | * * |   |   | 39.0 | * * |   |   | 32.4 | * * |   | 35.6 |   |
| Total Combined              |       |                                                 | 89.0       | *%* |   |   | 95.0 | *%* |   |   | 95.9 | *%* |   | 96.3 | % |
| Net written  premiums       |       |                                                 | $          | 437.6 | * * |   |   | $ | 718.3 | * * |   |   | $ | 800.6 | * * |   | $ | 1,957.6 |   |
| Earned premiums             |       |                                                 | 432.3      | * * |   |   | 689.3 | * * |   |   | 822.3 | * * |   | 1,944.0 |   |
|                             |            |                                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

----

(1)          In the fourth quarter of2006, we began to include OBSP within commercial lines and AutoOne withinpersonal lines. Both OBSP and AutoOne were formerly reported in specialtylines. The reporting change was undertaken to better align the reported resultsof our underwriting units with their product and management structure. Priorperiods have been reclassified to conform to the current presentation.

(2)          Includes results fromrun-off. For the years ended December 31, 2004, 2005 and 2006, includesnet written premiums of $3.3 million, $7.7 million and $1.1 million,respectively, from run-off and earned premiums of $58.3 million,$8.1 million and $0.1 million, respectively, from run-off.

(3)          Includes our long-termincentive compensation expense. For the years ended December 31, 2004,2005 and 2006, long-term incentive compensation expense increased our totalGAAP combined ratio by 5.0 points, 1.8 points and 2.3 points, respectively.

(4)          Includes loss and LAErelating to catastrophes. For the years ended December 31, 2004, 2005 and2006, total calendar year incurred loss and LAE relating to catastrophesincreased our loss and LAE and total combined ratios by 2.1 points, 4.2points and 2.8 points, respectively, including development on prior accidentyear catastrophes which increased our loss and LAE and total combined ratios by0.1 points, 0.1 points and 1.3 points, respectively.

59

----

(5)          Prior accident yeardevelopment, including development on catastrophes, for the years ended December 31,2004, 2005 and 2006 increased our loss and LAE and total combined ratios by 4.5points, 5.3 points and 1.2 points, respectively.

**Primary InsuranceOperations—Year ended December 31, 2006 versus year ended December 31,2005**

*Specialtylines.**  *Netwritten premiums for specialty lines increased by 5.1% to $437.6 millionin 2006 as compared to $416.3 million in 2005. The increase was mainly dueto a $29.8 million increase in net written premiums in specialty liabilityproducts at OBPP to $179.3 million principally driven by our long-termcare and lawyers professional liability products.   During the third quarter of 2006, we sold therenewal rights to the Agri business. Excluding the Agri business, net writtenpremiums increased by 12%, compared to 2005.

The specialty lines combined ratio for 2006 was 89.0%,compared to 84.9% for 2005 due primarily to increases in the expense ratio. Theexpense ratio increased 4.5 points in 2006 to 34.3%, compared with 29.8% in2005 primarily due to a 1.1 point increase in incentive compensation expense in2006. In addition, 2005 included the favorable impact of the settlement of theretiree medical plan which lowered the expense ratio by 1.5 points. The lossand LAE ratio for 2006 was essentially flat when compared to 2005. Excludingthe favorable impact of the reallocation of some IBNR reserves to run-off in2005 (2.8 points), the loss and LAE ratio improved in 2006.

*Commerciallines.**  *Netwritten premiums for commercial lines increased by 9.8% to $718.3 millionin 2006, compared to $654.4 million in 2005 with increases in both themiddle market and the small business divisions. The increase in net writtenpremiums in the middle market division were in our property and inland marineproducts as well as at OBSP. The increase in small business was in our smallbusiness package products.

The commercial lines combined ratio for 2006 was95.0%, compared to 97.3% for 2005 due to a decreased loss and LAE ratio. The2006 loss and LAE ratio decreased to 56.0% compared to 58.9% in 2005, primarilydue to lower catastrophe losses in 2006 (4.4 points) as compared to 2005 (9.7points). Included in 2005 was $56.1 million, or 8.6 points, in losses incurredfrom Hurricanes Katrina, Rita and Wilma. Partially offsetting the impact ofthis decrease was the favorable impact of 1.1 points related to the settlementof the retiree medical plan in 2005 and 1.8 points related to the reallocationof some IBNR reserves to run-off. The expense ratio for 2006 increased slightlyto 39.0%, compared to 38.4% in 2005.  Included in 2006 were 1.3 points related toactions taken to optimize long-term occupancy costs and a 1.0 point increase inincentive compensation expense compared to 2005. The 2005 expense ratioincluded a 1.7 point decrease from the settlement of the retiree medical plan.

*Personallines.**  *Netwritten premiums for personal lines decreased by 12.0% to $800.6 millionin 2006, compared to $910.2 million in 2005. The decrease was attributableto reduced writings at AutoOne due to significant declines in New York’sassigned risk pool, and in traditional personal lines, premium decreased due toan increasingly competitive auto market and also Massachusetts state-mandatedrate decreases. With respect to the New York assigned risk pool, market trends indicate that assigned riskvolumes are expected to decline to approximately $200 million in 2007,down from $240 million in 2006, $383 million in 2005 and $629 millionin 2004. Assigned risk volumes in New Jersey are also expected to decline in2007. Market trends indicate that the assigned risk pool in New Jersey isexpected to decline to approximately $140 million in 2007, down from$175 million in 2006, $275 million in 2005 and $375 million in2004. The Company expects a reduction in AutoOne’s premium volume reflective ofthese trends.

The personal lines combined ratio for 2006 was 95.9%,compared to 90.8% for 2005. The decrease in the combined ratio was primarilydue to increases in both the loss and LAE ratio and the expense ratio. The lossand LAE ratio increased to 63.5%, compared to 62.0% in 2005, primarily due toone-time favorable items in 2005 including the settlement of the retireemedical plan (1.0 points) and the favorable 

60

----

impact of the reallocationof IBNR reserves to run-off (1.3 points). The expense ratio increased to 32.4%,compared with 28.8% in the prior year. The increase in the expense ratio in2006 was mainly due to other underwriting expenses, including 1.0 point relatedto actions taken to optimize long-term occupancy costs and 0.6 points ofincreased incentive compensation expense in 2006 and the inclusion of thesettlement of the retiree medical plan in 2005, which decreased the 2005 expenseratio by 1.5 points. In addition, the 2006 expense ratio was higher than the2005 expense ratio as expense reductions were not proportional to reductions inearned premiums.

*Run-off.**  *For 2006, run-off generated an underwritingloss of $44.1 million, compared to an underwriting loss of$133.4 million in 2005. The variance was primarily due to higher loss andLAE in the 2005 period. 2005 included $106.7 million in adverse development, mainlyfrom 2002 and prior accident years, which was primarily due to higher thananticipated defense costs and higher damages from liability assessments ingeneral liability and multiple peril lines. As described above, 2005 alsoincluded a reallocation of $34.4 million of IBNR reserves from some of ourongoing lines of business to run-off. In addition, during 2005, we recorded a$23.9 million reclassification between liability accounts which resultedin a decrease in other underwriting expenses and a corresponding increase inloss and LAE. This reclassification decreased the primary insurance operations’2005 expense ratio by 1.2 points and increased the loss and LAE ratio by 1.2points. Excluding the impact of the IBNR reserves reallocated to run-off and thereclassification between liability accounts, incurred loss and LAE in 2006 was$60.8 million lower than in the 2005 period.

**Primary InsuranceOperations—Year ended December 31, 2005 versus year ended December 31,2004**

*Specialtylines.**  *Netwritten premiums for specialty lines increased by 7.5% to $416.3 millionin 2005 as compared to $387.2 million in 2004. The increase was mainly dueto a $30.0 million increase in net written premiums in specialty liabilityproducts at OBPP to $149.5 million, which was principally from$28.1 million of net written premium from a renewal rights agreement withChubb Specialty that took effect during the third quarter of 2005.

The specialty lines combined ratio for 2005 was 84.9%,compared to 91.1% for 2004 due to decreases in both the loss and LAE ratio andthe expense ratio. The loss and LAE ratio decreased 3.4 points to 55.1%,compared to 58.5% in 2004 mainly due to the reallocation of a portion of IBNRreserves to run-off and the settlement of the retiree medical plan, whichreduced the loss and LAE ratio by a total of 3.8 points. Partially offsettingthese decreases was $13.0 million of losses related to Hurricanes Katrina,Rita and Wilma. These losses were incurred at IMU ($8.6 million), and Agri($4.4 million). In 2004, the combined ratio for specialty lines wasadversely impacted by $6.1 million (0.9 points) from the four hurricanesin the southeastern United States. The expense ratio decreased 2.8 points in2005 to 29.8%, compared with 32.6% in 2004 primarily due to the settlement ofthe retiree medical plan which reduced the 2005 expense ratio by 1.5 points.

*Commerciallines.**  *Netwritten premiums for commercial lines decreased to $654.4 million in 2005,compared to $826.8 million in 2004 with decreases in both the middle-marketand the small business divisions. The decrease, as compared to the prior year,was due in part to the sale of the renewal rights on $110.0 million oflegacy New York commercial lines business in late 2004 to Tower Insurance Group.The decrease in net written premiums in the middle-market division wasalso due to a one-time premium increase of $134.6 million in 2004 from theassumption of unearned premiums from the Atlantic Specialty Transaction.Excluding the impact of business subject to the renewal rights agreement withTower Insurance Group and the one-time premium increase of unearned premiumsfrom the Atlantic Specialty Transaction, net written premiums in the middle-marketdivision increased $100.8 million from the prior year due primarily togrowth in inland marine products and also net written premiums from the WestCoast region, which was acquired in connection with the Atlantic SpecialtyTransaction and completed its first full year of operation in 2005 as well as a$24.4 million increase in net written premiums at OBSP, an 

61

----

excess and surplusproperty provider which completed its first full year of operation in 2005 .Excluding the impact of the renewal rights agreement with Tower InsuranceGroup, net written premiums for the small business division were up$2.1 million when compared with the prior year.

The commercial lines combined ratio for 2005 was97.3%, compared to 97.6% for 2004 due to a decreased expense ratio. The 2005expense ratio decreased to 38.4% compared to 41.6% in 2004, primarily due to a1.7 point favorable impact from the settlement of the retiree medical plan anda decrease in incentive compensation expense compared to 2004. The 2005 lossand LAE ratio was 58.9%, compared to 56.0% in 2004, mainly due to catastrophelosses incurred from Hurricanes Katrina, Rita and Wilma, which impactedcommercial lines by $56.1 million, or 8.6 points. These losses were mainlyincurred by OBSP ($43.0 million). Partially offsetting these losses was thefavorable impact of the reallocation of a portion of IBNR reserves to run-offof 1.8 points and the settlement of the retiree medical plan of 1.1 points. The2004 period included $16.0 million in storm losses, an impact of 2.3points.

*Personallines.**  *Netwritten premiums for personal lines decreased to $910.2 million in 2005,compared to $1,063.3 million in 2004, primarily due to lower premiums atAutoOne due to changes in the fee structure of LAD and take-out business in NewYork, which we record in net written premiums, as well as decreased premiumvolume in Massachusetts and New York in traditional personal lines. Alsocontributing to the decrease in net written premiums were lower premiums at NewJersey Skylands driven by increased competition in New Jersey from the entranceof new providers.

The personal lines combined ratio for 2005 was 90.8%,compared to 91.4% for 2004. The decrease in the combined ratio was primarilydue to a decreased loss and LAE ratio. The loss and LAE ratio decreased to62.0%, compared to 62.9% in 2004, due to strong homeowners results resultingfrom a relatively mild winter, aided by favorable catastrophe experience due toa lack of northeast wind events, as well as lower loss frequencies in our autobusiness. Also contributing to the decrease in the loss and LAE ratio was thesettlement of the retiree medical plan (1.0 points) and the favorable impact ofthe reallocation of IBNR reserves to run-off (1.3 points). The expense ratiofor 2005 was essentially flat compared to 2004.

*Run-off.**  *For 2005, run-off generated anunderwriting loss of $133.4 million compared to an underwriting loss of$140.2 million in 2004. 2005 included $106.7 million in adversedevelopment, mainly from 2002 and prior accident years, which was primarily dueto higher than anticipated defense costs and higher damages from liabilityassessments in general liability and multiple peril lines. In addition, during2005, we reallocated $34.4 million of IBNR reserves from some of ourongoing lines of business to our run-off. The 2004 period included adversedevelopment related to run-off of $123.6 million, relating primarily to2000 and prior accident years resulting from higher defense costs and higherdamages from liability assessments and national account and program claimsadministered by third parties.

*Affiliate QuotaShares*

During 2004 and 2005, we entered into two quota sharereinsurance arrangements with other subsidiaries of White Mountains. Under theEsurance Quota Share, which was effective on January 1, 2005, we assumedapproximately 85% of business written by Esurance Insurance Company, whichincludes business written by its wholly owned subsidiary. Under the SiriusQuota Share, we ceded between 6% and 12% of business written, effective April 1,2004, to Sirius International Insurance Corporation.

The affiliate quota shares were entered into primarilyfor White Mountains’ capital management purposes and were therefore excludedfrom the information used by White Mountains’ Board of Directors to measure ourfinancial performance. The affiliate quota share agreements were commuted inthe fourth quarter of 2006 in connection with our initial public offering.

62

----

Asummary of results from our Affiliate Quota Shares segment for the years ended December 31,2004, 2005 and 2006 is as follows:

| ** **                   | ** ** | **Year ended December 31,** | ** ** |
|------------------------------|------------|--------------------------------------------|------------|
| ** **                   | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                   | ** ** | **Sirius  Quota  Share**                   | ** ** | **Esurance  Quota  Share** | ** ** | **Sirius  Quota  Share** | ** ** | **Esurance  Quota  Share** | ** ** | **Sirius  Quota  Share** | ** ** |
| ** **                   | ** ** | **($ in millions)**              | ** ** |
| Net written  premiums        |       | $                                          | (115.9     | ) |   | $ | 336.9 |   |   | $ | (229.9 | ) |   | $ | 227.4 |   |   | $ | (178.0 | ) |
| Earned premiums              |       | (115.9                                     | )          |   | 254.4 |   |   | (229.9 | ) |   | 309.9 |   |   | (178.0 | ) |
| Total revenues               |       | (115.9                                     | )          |   | 254.4 |   |   | (229.9 | ) |   | 309.9 |   |   | (178.0 | ) |
| Loss and LAE                 |       | (62.7                                      | )          |   | 177.1 |   |   | (122.3 | ) |   | 195.5 |   |   | (92.2 | ) |
| Policy  acquisition expenses |       | (43.5                                      | )          |   | 75.0 |   |   | (86.2 | ) |   | 114.4 |   |   | (66.8 | ) |
| Total expenses               |       | (106.2                                     | )          |   | 252.1 |   |   | (208.5 | ) |   | 309.9 |   |   | (159.0 | ) |
| Pre-tax income  (loss)       |       | $                                          | (9.7       | ) |   | $ | 2.3 |   |   | $ | (21.4 | ) |   | $ | — |   |   | $ | (19.0 | ) |

 

*Other Operations*

Our Other Operations segment consists of OneBeaconInsurance Group, Ltd. and our intermediate subsidiary holding companies.Our Other Operations segment primarily consists of financing activities,purchase accounting adjustments relating to our acquisition by White Mountainsin 2001 and other assets and general and administrative expenses incurred atthe holding company level. This segment also includes entities that prior tothe initial public offering employed persons associated with White Mountains’holding company operations. Accordingly, in 2004, 2005 and 2006, OtherOperations incentive compensation expense included $41.4 million,$1.9 million and $2.5 million associated with these personstransferred to White Mountains from these entities.

The purchase accounting adjustments relating to theOneBeacon Acquisition were made to reflect the estimated fair value of ourassets acquired and liabilities assumed on the date of the acquisition. Thepurchase accounting adjustments are primarily comprised of an adjustment to ourloss and LAE reserves and related reinsurance recoverables to record them atfair value, an adjustment to record the cost of our investments at fair valueand an allocation of the excess of acquired net assets over the purchase priceto our non-current, non-financial assets, primarily its property, plant andequipment.

The Other Operations segment results are affected bypurchase accounting over time as the fair value adjustments made at ouracquisition unwind. Accordingly, net investment income and/or net realizedinvestment gains and losses are affected as the difference between theamortized cost and the fair value of our investment portfolio is amortized intoinvestment income, or recorded as net realized investment gains and losses asthe investments are sold; the fair value adjustment to net loss and LAEreserves is expensed through income as our net loss and LAE reserves at thetime of the OneBeacon Acquisition are settled; and the portion of the carryingvalue of property, plant and equipment that was written off in purchaseaccounting is recorded as net other revenues when it is sold to third parties.

63

----

Asummary of results from our Other Operations segment for the years ended December 31,2004, 2005 and 2006 are as follows:

| ** **                                                        | ** ** | **Year ended December 31,** | ** ** |
|-------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                        | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                                        | ** ** | **($ in millions)**              | ** ** |
| Net investment  income                                            |       | $                                          | (1.5       | ) | $ | 4.3 |   | $ | 9.5 |   |
| Net realized  investment gains (loss)                             |       | (0.2                                       | )          | (1.0 | ) | (1.7 | ) |
| Net other  revenues                                               |       | 10.8                                       |       | 9.4 |   | 17.0 |   |
| Total revenues                                                    |       | 9.1                                        |       | 12.7 |   | 24.8 |   |
| General and  administrative expenses                              |       | 51.5                                       |       | 7.3 |   | 12.0 |   |
| Accretion of fair  value adjustment to loss and LAE reserves      |       | 33.2                                       |       | 26.0 |   | 23.0 |   |
| Interest expense  on debt                                         |       | 44.0                                       |       | 42.7 |   | 42.6 |   |
| Interest  expense—dividends and accretion on preferred stock |       | 47.6                                       |       | 52.4 |   | 58.6 |   |
| Total expenses                                                    |       | 176.3                                      |       | 128.4 |   | 136.2 |   |
| Pre-tax loss                                                      |       | $                                          | (167.2     | ) | $ | (115.7 | ) | $ | (111.4 | ) |

 

**Other OperationsResults—Year ended December 31, 2006 versus year ended December 31,2005**

Our Other Operations segment reported a pre-tax lossof $111.4 million for 2006, essentially flat compared to a pre-tax loss of$115.7 million for 2005. Fluctuations in revenues and expenses between2006 and 2005 essentially offset.

**Other OperationsResults—Year ended December 31, 2005 versus year ended December 31,2004**

Our Other Operationssegment reported a pre-tax loss of $115.7 million for 2005, compared to apre-tax loss of $167.2 million for 2004. The reduced pre-tax loss in 2005compared to 2004 was primarily attributable to a $38.0 million decrease inincentive compensation expense in 2005 compared to 2004 because of the changeof securities underlying the compensation plan from that of White Mountains’publicly traded common shares to units of OneBeacon. Additionally, there was a$5.8 million increase in net investment income from 2004 to 2005 as aresult of higher levels of invested assets in the holding companies.

**Summary ofInvestment Results**

***Investment Philosophy***

*Overview*

Our investment portfoliosare managed under agreements with White Mountains Advisors, LLC, a registeredinvestment adviser that is owned by White Mountains, and Prospector, aregistered investment adviser. See “Note 18.—Related Party Disclosures.” Ourinvestment philosophy is to maximize our after-tax total risk-adjustedreturn over the long term. Under this approach, each dollar of after-taxinvestment income and realized and unrealized gains and losses is valuedequally. Our investment portfolio mix as of December 31, 2006 consisted inlarge part of high quality, fixed maturity securities and short-terminvestments, as well as a smaller allocation to common equity securities andother investments, such as hedge funds, limited partnerships and privateequities. Our management believes that prudent levels of investments in commonequity securities and other investments within our investment portfolio arelikely to enhance long term after-tax total returns without significantlyincreasing the risk profile of the portfolio.

*Fixed income*

WM Advisors manages ourfixed income portfolio. WM Advisors’ overall fixed maturity investment strategyis to purchase securities that are attractively priced in relation to creditrisks. WM Advisors 

64

----

generallymanages the interest rate risk associated with holding fixed maturityinvestments by actively maintaining the average duration of the portfolio toachieve an adequate after-tax total return without subjecting theportfolio to an unreasonable level of interest rate risk.

*Equities*

Prospector manages our equity portfolio. Prospector’sinvestment strategy is to maximize absolute total return through investments ina variety of equity and equity-related instruments. Using a valueorientation, Prospector invests in relatively concentrated positions in theUnited States and other developed markets. Prospector’s philosophy is to investfor total risk-adjusted return using a bottom-up, value discipline.Preservation of capital is of the utmost importance.

For purposes of discussing rates of return, allpercentages are presented gross of management fees and trading expenses inorder to produce a more relevant comparison to benchmark returns.

Thefollowing table presents the composition of our investment portfolio as of December 31,2005 and 2006:

| ** **                            | ** ** | **As of December 31,** | ** ** |
|---------------------------------------|------------|---------------------------------------|------------|
| ** **                            | ** ** | **2005**                              | ** ** | **2006** | ** ** |
| **Type of Investment**      | ** ** | ** **                            | ** ** | **$ in  millions** | ** ** | **% of  total** | ** ** | **$ in  millions** | ** ** | **% of  total** | ** ** |
| Available-for-sale  investments:      |       |                                  |       |   |   |   |   |   |   |
| Fixed maturity investments            |       | $                                     | 3,690.4    |   | 77.5 | % | $ | 3,539.7 |   | 67.9 | % |
| Short-term investments                |       | 207.6                                 |       | 4.3 |   | 319.0 |   | 6.1 |   |
| Montpelier common stock               |       | 115.7                                 |       | 2.4 |   | — |   | — |   |
| Common stock, excluding Montpelier(1) |       | 475.6                                 |       | 10.0 |   | 737.1 |   | 14.1 |   |
| Held-to-maturity  investments:        |       |                                  |       |   |   |   |   |   |   |
| Fixed maturity investments            |       | —                                |       | — |   | 305.0 |   | 5.9 |   |
| Short-term investments                |       | —                                |       | — |   | 33.8 |   | 0.6 |   |
| Other  investments(2)                 |       | 275.2                                 |       | 5.8 |   | 278.1 |   | 5.4 |   |
| Total                                 |       | $                                     | 4,764.5    |   | 100.0 | % | $ | 5,212.7 |   | 100.0 | % |
|                                       |            |                                       |            |  |  |  |  |  |  |  |  |  |  |

----

(1)          On August 24, 2006,OneBeacon exchanged its investment in the common shares of Montpelier ReHoldings Ltd., or Montpelier, for an agreed-upon portfolio of common equity andfixed maturity securities of equal value that was owned by White Mountains. See“Management’s Discussion of Financial Condition and Results of Operations—MontpelierInvestment”.

(2)          Includesinvestments such as hedge funds, limited partnerships and private equities.

***Investment Returns***

Asummary of our consolidated pre-tax investment results for the yearsended December 31, 2004, 2005 and 2006 is as follows:

| ** **                                              | ** ** | **Year ended December 31,** | ** ** |
|---------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                              | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                              | ** ** | **($ in millions)**              | ** ** |
| Gross investment  income                                |       | $                                          | 223.5      |   | $ | 251.2 |   | $ | 205.5 |   |
| Net realized  investment gains                          |       | 128.8                                      |       | 123.2 |   | 163.6 |   |
| Net change in  unrealized gains (losses) on investments |       | 129.7                                      |       | (246.3 | ) | 47.8 |   |
| Total GAAP pre-tax  investment results                  |       | $                                          | 482.0      |   | $ | 128.1 |   | $ | 416.9 |   |

 

65

----

Grossinvestment returns versus typical benchmarks for the years ended December 31,2004 and 2005 and 2006 are as follows:

| ** **                       | ** ** | **Year ended December 31,** | ** ** |
|----------------------------------|------------|--------------------------------------------|------------|
| ** **                       | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006(1)** | ** ** |
| Fixed maturity  investments      |       | 4.7                                        | %          | 1.7 | % |   | 5.8 | % |   |
| Short-term  investments          |       | 0.8                                        |       | 3.0 |   |   | 4.4 |   |   |
| Total fixed income               |       | 4.3                                        |       | 1.8 |   |   | 5.7 |   |   |
| Lehman U.S. Aggregate Index      |       | 4.3                                        |       | 2.4 |   |   | 4.3 |   |   |
| Montpelier common  stock         |       | 46.1                                       |       | (44.1 | ) |   | (7.6 | ) |   |
| Core common stock(2)             |       | 29.0                                       |       | 20.6 |   |   | 26.6 |   |   |
| Total common stock               |       | 42.1                                       |       | 3.3 |   |   | 23.7 |   |   |
| Other investments                |       | 17.7                                       |       | 16.9 |   |   | 15.0 |   |   |
| Total equities                   |       | 37.0                                       |       | 6.5 |   |   | 21.3 |   |   |
| S&P 500 Index (total return) |       | 10.9                                       |       | 4.9 |   |   | 15.8 |   |   |
| Total  consolidated portfolio    |       | 8.5                                        | %          | 2.6 | % |   | 8.8 | % |   |

----

(1)          Includes $2.2 million ofnet investment income for assets held in trust.

(2)          Representsall common stock holdings other than Montpelier, which was transferred to WhiteMountains on August 24, 2006, in exchange for an agreed-uponportfolio of common equity and fixed maturity securities with an equal value.

*Investment Returns—Yearended December 31, 2006 versus year ended December 31, 2005*

**Overview**

Our total pre-taxinvestment results were $416.9 million, a return of 8.8% for the yearended December 31, 2006 versus $128.1 million, a return of 2.6% forthe year ended December 31, 2005. Gross investment income in 2006 of$205.5 million was down 18% from $251.2 million during 2005, dueprimarily to the receipt in 2005 of a $34.7 million special dividend onthe Montpelier investment. Net realized investment gains of $163.6 millionin 2006 were up by 33% from 2005, mainly due to recording another-than-temporary impairment in 2005 of $54.6 million on the Montpelierinvestment. Excluding this write-down, realized investment gains were down 8%.Net unrealized investment gains of $47.8 million during 2006 reflected theportfolios low duration as well as the effect of the weakening dollar againstour foreign-denominated securities, mostly in British pounds andAustralian dollars.

**Fixed income**

Our fixed income portfolioreturned 5.7% in 2006 versus 1.8% in 2005. During 2006, we maintained a highquality fixed maturity portfolio with a relatively short duration ofapproximately 4 years which performed consistent with its characteristicsand outperformed the longer-duration Lehman U.S. Aggregate Indexbenchmark by 140 basis points.

**Equities**

Our equity portfolioreturned 21.3% in 2006 versus 6.5% in 2005. Our 6.5% return in 2005 was drivenprimarily by excellent returns across the portfolio offset by a significantdecline in our largest equity position, Montpelier. Our core common stockportfolio returned 26.6% during 2006 and 20.6% in 2005, or 10.8 and15.7 percentage points better than the S&P 500 benchmark,respectively, as we benefited from our investments in the energy, commoditiesand utility sectors.

66

----

*Investment Returns—Yearended December 31, 2005 versus year ended December 31, 2004*

**Overview**

Our total pre-taxinvestment results were $128.1 million, a return of 2.6%, for the yearended December 31, 2005 versus $482.0 million, a return of 8.5%, forthe year ended December 31, 2004. Net investment income in 2005 of$251.2 million was up 13% from $223.5 million during 2004, dueprimarily to the receipt of a $34.7 million special dividend on theMontpelier investment and higher-short term interest rates more thanoffsetting reduced investment income reflective of a decrease in the size ofthe portfolio. Net realized investment gains of $123.2 million in 2005were down by only 4% from 2004, despite recording an other-than-temporaryimpairment of $54.6 million on the Montpelier investment. Excluding thiswrite-down, realized investment gains were up 38%, partially reflectingincreased sales activity as we decreased our positions in certain successfulcore equity holdings. Net unrealized investment losses of $246.3 millionduring 2005 reflected the effect of rising interest rates on the fixed maturityportfolio, losses from the Montpelier investment and the effect of thestrengthening dollar against our foreign-denominated securities, mostlyin British pounds and Australian dollars.

**Fixed income**

Our fixed income portfolioreturned 1.8% in 2005 versus 4.3% in 2004. During 2005, we maintained a highquality fixed maturity portfolio with a relatively short duration ofapproximately 3 years which performed consistent with its characteristicsbut lagged the longer-duration Lehman U.S. Aggregate Index benchmark by60 basis points.

**Equities**

Our equity portfolioreturned 6.5% in 2005 versus 37.0% in 2004. Our 6.5% return in 2005 was drivenprimarily by excellent returns across the portfolio offset by a significantdecline in our largest equity position, Montpelier. Our core common stockportfolio returned 20.6% during 2005 and 29.0% in 2004, or 15.7 and18.1 percentage points better than the S&P 500 benchmark,respectively, as we benefited from our investments in the energy, commoditiesand utility sectors.

***Montpelier Investment***

Inorder to reduce our exposure to certain insurance risks outside of our ownunderwriting competencies, on August 24, 2006, we exchanged our investmentin the common shares of Montpelier, a global property catastrophe reinsurer,for an agreed-upon portfolio of common equity and fixed maturitysecurities of equal value that was owned by White Mountains. As a result,Montpelier is no longer included in our investment results. The following tabledetails the book value effect of our total investment in Montpelier for theyears ended December 31, 2004, 2005 and 2006.

| ** **                                                     | ** ** | **Year ended December 31,** | ** ** |
|----------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                     | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                                     | ** ** | **($ in millions)**              | ** ** |
| Net investment  income, pre-tax                                |       | $                                          | 8.6        |   | $ | 41.9 |   | $ | 1.0 |   |
| Net realized  investment gains (losses), pre-tax               |       | 35.2                                       |       | (54.6 | ) | (5.8 | ) |
| Total revenues  (losses), pre-tax                              |       | 43.8                                       |       | (12.7 | ) | (4.8 | ) |
| Tax (expense)  benefit on total revenues                       |       | (15.3                                      | )          | 4.4 |   | 1.7 |   |
| Total revenues  (losses), after-tax                            |       | 28.5                                       |       | (8.3 | ) | (3.1 | ) |
| Change in net  unrealized investment gains (losses), after-tax |       | 42.0                                       |       | (42.0 | ) | (0.7 | ) |
| Equity in  earnings of Montpelier, after-tax                   |       | 10.8                                       |       | — |   | — |   |
| Equity in  unrealized gains of Montpelier, after-tax           |       | 2.6                                        |       | — |   | — |   |
| Net after-tax  change in book value from Montpelier investment |       | $                                          | 83.9       |   | $ | (50.3 | ) | $ | (3.8 | ) |

 

67

----

On August 24, 2006, OneBeacon exchanged itsinvestment in the common shares of Montpelier for an agreed-upon portfolio ofcommon equity and fixed maturity securities of equal value that was owned byWhite Mountains. At the time of the exchange, OneBeacon’s investment in thecommon shares of Montpelier was in an unrealized loss position of $6.9 million.This loss was deferred at the time of the exchange as sales of investmentsbetween OneBeacon and entities under White Mountains’ common control aredeferred. Subsequent to the exchange, White Mountains sold 5.4 million commonshares of Montpelier triggering the recognition of $5.8 million in realizedinvestment losses. As of December 31, 2006, OneBeacon’s remaining deferredloss on the exchange totaled $1.1 million.

During 2005, we realized $12.7 million of pre-taxlosses, net of dividends received, on our investment in Montpelier. Montpelier’scommon share price decreased from $38.45 per share at December 31, 2004 to$18.90 per share at December 31, 2005, primarily due to losses Montpelierincurred as a result of Hurricanes Katrina, Rita and Wilma. We recorded a$54.6 million pre-tax other-than-temporary impairment charge (reported asa realized investment loss) and a $64.6 million pre-tax change inunrealized investment loss on our Montpelier common share investment during2005. Our original cost of our existing Montpelier common share investment was$105.0 million, which was subsequently increased by equity in earningsrepresenting our proportionate share of Montpelier’s net income from 2001 untilMarch 2004, the period in which we accounted for the investment under theequity method of accounting. The impairment charge represented the differencebetween our GAAP book value of $170.3 million and the investment’s fairvalue of $115.7 million at December 31, 2005.

During 2005, we recorded $41.9 million in pre-taxdividends from Montpelier in net investment income. During the first quarter of2005, Montpelier declared a special dividend of $5.50 per share, payable toholders of its common shares. we recorded pre-tax investment income of$34.7 million in the first quarter for this special dividend, which wasincluded in net investment income from common equity securities. For the yearsended December 31, 2004, 2005 and 2006, we also recorded an aggregate of$8.6 million, $7.2 million and $1.0 million in pre-tax investment incomefrom Montpelier’s regular quarterly dividends.

We sold a portion of ourinvestment in Montpelier common shares during the first quarter of 2004resulting in a $35.2 million pre-tax realized gain. As a result of thissale, as well as changes to the composition of the boards of directors of bothMontpelier and White Mountains, we changed the method of accounting for ourremaining Montpelier common shares to the fair value method, resulting in a$50.1 million increase in pre-tax unrealized gains in the firstquarter of 2004.

**Impairment**

See Note 6—”Investment Securities” of theaccompanying consolidated financial statements for our analysis of impairmentlosses on investment securities.

**Liquidity and Capital Resources**

***Operating cash and short-term investments***

Our sources and uses of cash are as follows:

*Holdingcompany level.**  *Theprimary sources of cash for OneBeacon Insurance Group, Ltd. and certain ofour intermediate holding companies are expected to be dividends and tax sharingpayments received from our insurance operating subsidiaries and net investmentincome and proceeds from sales and maturities of holding company investments.The primary uses of cash are expected to be interest payments on our debtobligations, dividend payments on our preferred shares and our common shares,purchases of investments, payments made to tax authorities and holding companyoperating expenses.

68

----

*Operatingsubsidiary level.**  *Theprimary sources of cash for our operating subsidiaries are expected to bepremium collections, net investment income and proceeds from sales andmaturities of investments. The primary uses of cash are expected to be claimpayments, policy acquisition costs, debt obligations, operating expenses, thepurchase of investments and dividends and tax sharing payments made to parentholding companies.

Insurance companies typically collect premiums onpolicies that they write prior to paying claims made under those policies. Duringperiods of premium growth, insurance companies typically experience positivecash flow from operations, as premium receipts typically exceed claim payments.When this happens, positive cash flow from operations is usually offset by negativecash flow from investing activities, as the positive operating cash flow isused to purchase investments. Conversely, during periods of premium decline,insurance companies typically experience negative cash flow from operations,even during periods in which they report GAAP net income, as the claims thatthey pay exceed the premiums that they collect. When this happens, negativecash flow from operations is typically offset by positive cash flow frominvesting activities, as invested assets are sold to fund current claimpayments.

Since White Mountains acquired us in 2001, our writtenpremiums have decreased substantially. This was primarily due to a renewalrights agreement executed in November 2001 through which we transferredour regional agency business, agents and operations in 42 states and theDistrict of Columbia to Liberty Mutual Insurance Group. This transfer amountedto approximately 45% of our prior year annual written premiums in force at thetime of the transfer, or approximately $1.5 billion in annual premiums. Asa result, we have experienced negative cash flow from operations for each ofthe years ended December 31, 2004 and 2005, as we paid claims on run-offreserves related to the business that was transferred to Liberty Mutual.

Both internal and external forces influence ourfinancial condition, results of operations and cash flows. Claim settlements,premium levels and investment returns may be impacted by changing rates ofinflation and other economic conditions. In many cases, significant periods oftime, ranging up to several years or more, may lapse between the occurrence ofan insured loss, the reporting of the loss to us and the settlement of theliability for that loss. The exact timing of the payment of claims and benefitscannot be predicted with certainty. Our operating subsidiaries maintainportfolios of invested assets with varying maturities and a substantial amountof short-term investments to provide adequate liquidity for the payment ofclaims.

Management believes thatour cash balances, cash flows from operations and cash flows from investmentsare adequate to meet expected cash requirements for the foreseeable future onboth a holding company and operating subsidiary level.

***Dividend Capacity***

Under the insurance laws of the states andjurisdictions under which our operating subsidiaries are domiciled, an insureris restricted with respect to the timing or the amount of dividends it may paywithout prior approval by regulatory authorities. Accordingly, there can be no assuranceregarding the amount of such dividends that may be paid by such subsidiaries inthe future.

Generally, our regulated insurance operatingsubsidiaries have the ability to pay dividends during any 12-month periodwithout the prior approval of regulatory authorities in an amount equal to thegreater of prior year statutory net income or 10% of prior year end statutorysurplus, subject to the availability of unassigned funds. As a result, based on2006 statutory net income, our top tier regulated insurance operatingsubsidiaries have the ability to pay an aggregate of approximately $234 millionof dividends during 2007 without prior approval of regulatory authorities,subject to the availability of unassigned funds. As of December 31, 2006,OneBeacon’s top tier regulated insurance operating subsidiaries had$1.6 billion of unassigned funds.

69

----

In addition, as of December 31, 2006, we hadapproximately $31 million of unrestricted cash and fixed maturity investments outsideof our regulated insurance operating subsidiaries and we had an additional $66 million of unrestricted cash and fixedmaturity investments at OneBeacon Insurance Group, Ltd. and its intermediateholding companies. During 2006, OneBeacon LLC, the direct parent of ouroperating insurance subsidiaries, paid $90.1 million of dividends to FundAmerican, its parent.

In addition, FundAmerican’s ability to declare or pay dividends is limited by the terms of the Series APreferred Stock issued to Berkshire. Fund American may not, in certaincircumstances, declare or pay any dividend or distribution to any other classor series of stock without the consent of the holders of a majority ofoutstanding shares of the Berkshire Preferred Stock. Under the terms of aKeep-Well Agreement dated November 30, 2004 between White Mountains andFund American (the “Keep-Well”), White Mountains has agreed to return to FundAmerican up to approximately $1.1 billion if some or all of that amount isrequired by Fund American to meet its obligations under the terms of theBerkshire Preferred Stock. Under the Keep-Well, White Mountains must make anyrequired contributions to Fund American prior to making any distributions toits shareholders. The aggregate amount of distributions that White Mountainsmay make to its shareholders is limited; the limit increases or decreases by anamount equal to White Mountains’ consolidated net income or loss over the remaininglife of the Keep-Well. The Keep-Well will expire when all obligations of theBerkshire Preferred Stock, which is redeemable in May 2008, have beensatisfied. See “Management’s Discussion of Financial Condition and Results ofOperations—Economic Defeasance” for a discussion of the creation and funding ofan irrevocable grantor trust to economically defease the Berkshire PreferredStock.

**Economic Defeasance**

In connection with ourinitial public offering, two of our subsidiaries, Fund American and FundAmerican Enterprises, each established an irrevocable grantor trust. The assetsof each trust are solely dedicated to the satisfaction of the payment ofdividends and redemption amounts on, respectively, $300 millionliquidation preference of Fund American’s Berkshire Preferred Stock, and$20 million liquidation preference of Fund American Enterprises’ ZenithPreferred Stock. Fund American and Fund American Enterprises funded theirrespective trust with cash and purchased a portfolio of fixed maturity securitiesissued by the U.S. government and government-sponsored enterprises, thescheduled interest and principal payments are sufficient to pay when due allamounts required under the terms of the Berkshire Preferred Stock and theZenith Preferred Stock, respectively (including the mandatory redemption of theBerkshire Preferred Stock in May 2008 and the optional redemption of theZenith Preferred Stock in June 2007, which we will exercise). The creationand funding of the trusts does not legally defease the preferred stock norcreate any additional rights for the holders of the Berkshire Preferred Stockand the Zenith Preferred Stock either in the trusts or otherwise, although theassets in the trusts remain segregated from Fund American’s and Fund AmericanEnterprises’ other general assets and are not available to Fund American orFund American Enterprises for any use other than the payment of the BerkshirePreferred Stock and the Zenith Preferred Stock, respectively. The assets ofeach trust remain subject to the claims of Fund American’s and Fund AmericanEnterprises’ creditors, respectively, in the event that either Fund American orFund American Enterprises becomes insolvent. White Mountains Capital, Inc.,a subsidiary of White Mountains, serves as the trustee for both irrevocablegrantor trusts. The assets held in the trust as of December 31, 2006include $305.0 million of fixed maturity investment and $33.8 million ofshort-term investments. Pre-tax net investment income earned on theseinvestments totaled $2.2 million for the twelve months ended December 31,2006.

70

----

**Financing**

Thefollowing table summarizes our capital structure as of December 31, 2005and 2006:

|                                                                                      | ** ** | **As of  December 31,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                | ** ** | **2005**                          | ** ** | **2006** | ** ** |
| ** **                                                                                | ** ** | **($ in millions)**     | ** ** |
| Senior Notes,  carrying value                                                             |       | $                                 | 698.5      |   | $ | 698.7 |   |
| Other debt(1)                                                                             |       | 46.4                              |       | 60.8 |   |
| Total debt                                                                                |       | 744.9                             |       | 759.5 |   |
| Preferred stock  subject to mandatory redemption(2)                                       |       | 234.0                             |       | — |   |
| Total common  shareholders’ equity                                                   |       | 1,560.0                           |       | 1,777.2 |   |
| Total capital                                                                             |       | $                                 | 2,538.9    |   | $ | 2,536.7 |   |
| Ratio of debt to  total capital excluding preferred stock subject to mandatory redemption |       | 32.3                              | %          | 29.9 | % |
| Ratio of debt and  preferred stock subject to mandatory redemption to total capital(2)    |       | 38.6                              | %          | 29.9 | % |

 

----

(1)          See Note 7—“Debt”of the accompanying notes to consolidated financial statements.

(2)          The preferred stocksubject to mandatory redemption, having a carrying value of $262.3 million atDecember 31 2006, was not included in total capital at December 31,2006 because it was economically defeased in connection with our initial publicoffering.

We believe that our strong financial position providesus with the flexibility and capacity to obtain funds externally as neededthrough debt or equity financing on both a short-term and long-term basis.

The 5.875% Senior Notes due 2013 of our subsidiaryFund American, which we refer to as the Senior Notes, are currently rated “Baa2”(“Medium Grade”, the ninth highest of twenty-one ratings) with a stable outlookby Moody’s, “BBB” (“Adequate”, the ninth highest of twenty-two ratings) with astable outlook by Standard & Poor’s, “bbb” (“Very Good”, the ninthhighest of twenty-two ratings) with a stable outlook by A.M. Best and “BBB”(“Good”, the ninth highest of twenty-three ratings) with a stable outlookby Fitch.

In connection with our purchase of land and an officebuilding in Canton, Massachusetts, which is now our U.S. headquarters, weentered into a $40.8 million mortgage note to fund renovations. As ofDecember 31, 2006, we have fully drawn on the facility.

White Mountains currently provides an irrevocable andunconditional guarantee as to the payment of principal and interest (theGuarantee) on the Senior Notes. In consideration of this Guarantee, we haveagreed to pay a specified fee to White Mountains in the amount of 25 basispoints per annum on the outstanding principal amount of the Senior Notes. Wehave further agreed that if White Mountains’ voting interest in us ceases torepresent more than 50% of all our voting securities, we will redeem, exchangeor otherwise modify the Senior Notes in order to fully and permanentlyeliminate White Mountains’ obligations under the Guarantee (the GuaranteeElimination). White Mountains has agreed to provide written notice to us whenits voting interest in us has been reduced below 50%. We will have180 days from the receipt of such notification to complete the GuaranteeElimination. If the Guarantee Elimination is not completed within the initial180-day period, the Guarantee fee shall increase by 200 basispoints. The Guarantee fee shall further increase by 100 basis points for eachsubsequent 90-day period thereafter, up to a maximum Guarantee fee of 425basis points, until the Guarantee Elimination has been completed.

71

----

The Senior Notes were issued under an indenture whichcontains restrictive covenants that, among other things, limit the ability ofWhite Mountains, Fund American and their respective subsidiaries, whichincludes us, as a subsidiary of White Mountains, to create liens and enter intosale and leaseback transactions and substantially limits the ability of FundAmerican and its respective subsidiaries to consolidate, merge or transfertheir properties and assets. The indenture does not contain any financialratios or specified levels of net worth or liquidity to which White Mountainsor Fund American must adhere. At December 31, 2006, Fund American was incompliance with all of the covenants under the Senior Notes.

In connection with theinitial public offering, White Mountains and Fund American terminated theirexisting $400 million credit facility, under which they were both permittedborrowers. In November 2006, Fund American established a $75 millionrevolving credit facility that matures in November 2011. As of December 31,2006, the Bank Facility was undrawn. The Bank Facility contains variousaffirmative, negative and financial covenants which we consider to be customaryfor such borrowings and include maintaining certain minimum net worth andmaximum debt to capitalization standards. Failure to meet one or more of thesecovenants could result in an event of default, which ultimately could eliminateavailability under these facilities and result in acceleration of principalrepayment on any amounts outstanding. At December 31, 2006, we were incompliance with all of the covenants under the Bank Facility, and anticipate wewill continue to remain in compliance with these covenants for the foreseeablefuture.

**Off-Balance SheetArrangement**

*Galileo Guarantees*

Beginning in February 2006,one of our subsidiaries, OneBeacon Insurance Company, or OBIC, agreed toprovide guarantees of the obligations of Galileo Weather RiskManagement Ltd., or Galileo, to Galileo’s counterparty in certain weather-relatedproduct transactions. Galileo is a subsidiary of White Mountains. Theguarantees require OBIC to pay the full amount of Galileo’s obligations to thecounterparty in the event of Galileo’s failure to pay these obligations. In theevent of a payment, OBIC would be eligible to exercise all of the rights of thecounterparty against Galileo. As of December 31, 2006, OneBeacon hadexecuted sixteen guarantees of Galileo transactions, the total principal amountof which was approximately $158 million. In the event that the totalguaranteed principal amount exceeds the lesser of 5% of OBIC’s admitted assetsof $3.8 billion at December 31, 2006 or 25% of OBIC’s statutorysurplus of $1.7 billion at December 31, 2006, OBIC would require theapproval of the Pennsylvania Department of Insurance in order to make anyfurther guarantees. OBIC has agreed, at White Mountains’ option, to continue tomake these guarantees available until October 2008 and will receive fromGalileo an annual fee of 25 basis points of the value at risk for providing theguarantees. Pursuant to a separation agreement we entered into with WhiteMountains in connection with the initial public offering, White Mountains hasagreed that it will take appropriate steps to ensure that OBIC will not be calledon to make payment on these guarantees.

72

----

**ContractualObligations and Commitments**

Belowis a schedule of our material contractual obligations and commitments as of December 31,2006:

| ** **                                                                         | ** ** | **Due in  One Year  or Less** | ** ** | **Due in  Two to Three  Years** | ** ** | **Due in  Four to Five  Years** | ** ** | **Due After  Five  Years** | ** ** | **Total** | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|------------------------------------------------|------------|------------------------------------------------|------------|---------------------------------|------------|-----------|------------|
| ** **                                                                         | ** ** | **($ in millions)**                | ** ** |
| Debt                                                                               |       | $                                            | 2.0        |                                           |       | $                                              | 4.8        |                            |       |      | $          | 5.6 |   |   | $ | 748.4 |   | $ | 760.8 |   |
| Mandatorily  redeemable preferred stock(1)                                         |       | 20.0                                         |       |                                           | 300.0      |                                           |       |                            | —     |      |       | — |   | 320.0 |   |
| Loss and LAE  reserves(2)                                                          |       | 1,174.9                                      |       |                                           | 1,277.1    |                                           |       |                            | 766.2      |      |       | 1,890.0 |   | 5,108.2 |   |
| Interest on debt  and dividends on preferred stock subject to mandatory redemption |       | 71.3                                         |       |                                           | 93.5       |                                           |       |                            | 88.1       |      |       | 93.5 |   | 346.4 |   |
| Long-term  incentive compensation                                                  |       | 61.6                                         |       |                                           | 49.2       |                                           |       |                            | 6.9        |      |       | 29.9 |   | 147.6 |   |
| Pension and other  benefit plan obligations(3)                                     |       | 19.7                                         |       |                                           | 2.8        |                                           |       |                            | 3.5        |      |       | 12.7 |   | 38.7 |   |
| Operating leases                                                                   |       | 28.7                                         |       |                                           | 31.5       |                                           |       |                            | 10.1       |      |       | 11.4 |   | 81.7 |   |
| Total contractual  obligations                                                     |       | $                                            | 1,378.2    |                                           |       | $                                              | 1,758.9    |                            |       |      | $          | 880.4 |   |   | $ | 2,785.9 |   | $ | 6,803.4 |   |

----

(1)          The Berkshire PreferredStock and Zenith Preferred Stock are economically defeased. See “Management’sDiscussion of Financial Condition and Results of Operations—EconomicDefeasance.”

(2)          Represents expectedfuture cash outflows resulting from loss and LAE payments. Accordingly, thesebalances add back the discount on our workers compensation loss and LAEreserves of $190.7 million and the remaining purchase accounting fairvalue adjustment of $270.5 million related to the OneBeacon Acquisition asthey are non-cash items. Further, the amounts presented are gross ofreinsurance recoverables on unpaid losses of $2,842.6 million as of December 31,2006. See “Business—Loss and LAE Reserves.”

(3)          Represents expectedfuture cash outflows under our qualified and non-qualified,non-contributory, defined benefit pension plans and also our employee stockownership plan. Our pension plans were curtailed during the fourth quarter of2002. As a result, new participants are no longer added and benefits forexisting participants are not increased. Non-vested participants continueto vest during their employment.

Our loss and LAE reserves do not have contractualmaturity dates. However, based on historical payment patterns, the precedingtable includes an estimate of when management expects our loss and LAE reservesto be paid. The timing of claim payments is subject to significant uncertainty.We maintain a portfolio of marketable investments with varying maturities and asubstantial amount of short-term investments to provide adequate cash flows forthe payment of claims.

The balances included in the table above regarding ourlong-term incentive compensation plans include amounts payable for performanceshares and units, as well as deferred compensation balances. Exact amounts tobe paid cannot be predicted, for performance shares, with certainty, as the ultimateamounts of these liabilities are based on future performance. The estimatedpayments reflected in the table are based on current accrual factors (commonshare price and pay-out percentage) and assume that all outstanding balanceswere 100% vested as of December 31, 2006.

There are no provisions within our leasing agreementsthat would trigger acceleration of future lease payments. We do not finance ouroperations through the securitization of trade receivables, through specialpurpose entities or through synthetic leases. Further, we have not entered intoany material arrangement requiring us to guarantee payment of third party debt,lease payments or to fund losses of an unconsolidated special purpose entity.

73

----

We also have futurebinding commitments to fund certain limited partnership investments. Thesecommitments, which total $47.5 million as of December 31, 2006, donot have fixed funding dates and are therefore excluded from the table above.

**Cash Flows**

Detailed information concerning our cash flows duringthe years ended 2006, 2005 and 2004 follows:

***For the year ended December 31,2006***

*Financing and OtherCapital Activities*

During 2006, we declared and paid cash dividends of$28.3 million and $2.0 million to holders of the Berkshire PreferredStock and the Zenith Preferred Stock, respectively.

During 2006, we paid a total of $41.1 million ininterest under the Senior Notes.

During 2006, we drew down the remaining$22.4 million on an 18-year mortgage note that we entered into inconnection with our purchase of land and home office building. As of December 31,2006, we have drawn the full $40.8 million limit on the mortgage note.

During 2006, OneBeacon Insurance Group LLC declaredand paid dividends in cash and securities of $90.1 million to Fund American.

During 2006, White Mountains settled$303.8 million of intercompany debt owed to us.

During the fourth quarterof 2006, we fully repaid our $8 million loan with Dowling & PartnersConnecticut Fund III, LP.

*Acquisitions andDispositions*

On September 29,2006, we sold certain assets and the right to renew existing policies of Agri,a division of OneBeacon, for $32.0 million in cash to a third party.

*Other Liquidity andCapital Resource Activities*

During 2006, we reported net decreases in our loss andLAE reserves and reinsurance recoverables on paid and unpaid losses, primarilydue to claim payments (and related collections of reinsurance recoverables)related to run-off reserves.

On August 24, 2006, we exchanged our investmentin Montpelier common shares for an agreed-upon portfolio of common equityand fixed maturity securities of an equal value owned by White Mountains,resulting in a pre-tax realized loss of $5.8 million.

During the first quarter of 2006, we made payments inrespect of the 2003-2005 performance cycle totaling $13.4 million,in cash or by deferral into certain of our non-qualified compensation plans, toparticipants in our long-term incentive compensation plans. These payments weremade with respect to 12,600 performance shares based on a payout level of 142%of target.

***For the year ended December 31,2005***

*Financing and OtherCapital Activities*

During 2005, we declared and paid cash dividends of$28.3 million and $2.0 million to holders of the Berkshire PreferredStock and the Zenith Preferred Stock, respectively.

During 2005, we paid a total of $41.1 million ininterest under the Senior Notes.

74

----

During 2005, we drew down $18.4 million on an 18-yearmortgage note that we entered into in connection with our purchase of land andhome office building.

During 2005, WhiteMountains contributed $1.0 billion in intercompany notes receivable to us.These notes had been distributed by us to White Mountains in November 2004as part of a realignment of White Mountains’ business segments.

*Acquisitions andDispositions*

During 2005, we sold two of our insurancesubsidiaries, NFU and TPIC, to third parties for a total of $161.7 millionin cash.

On April 29, 2005, wepurchased a 284,000 square foot facility located in Canton, Massachusetts for$23.0 million.

*Other Liquidity andCapital Resource Activities*

During 2005, we reported an increase in loss and LAEreserves of $841.0 million resulting from an internal study of our A&Ereserves performed in 2005 and gross losses incurred as a result of HurricanesKatrina, Rita and Wilma. We also reported a corresponding increase inreinsurance recoverables of $841.0 million. Both of these increases werenon-cash items for the period, and were partially offset by claimpayments (and related collections of reinsurance recoverables) related to run-offreserves.

During the first quarter of 2005, we received a$34.7 million special dividend related to our common stock investment inMontpelier. This dividend represented $5.50 per share and was in addition toMontpelier’s normal quarterly dividend of $0.36 per share.

During the first quarter of 2005, we made payments inrespect of the 2002-2004 performance cycle totaling $180.3 million,in cash or by deferral into certain of our non-qualified compensation plans, toparticipants in our long-term incentive compensation plans. These payments weremade with respect to 287,285 performance shares based on payout levels rangingfrom 135% to 200% of target.

***For the year ended December 31,2004***

*Financing and OtherCapital Activities*

During 2004, we made cash distributions of$115.2 million to White Mountains.

During 2004, we declared and paid dividends of$28.3 million and $2.0 million to holders of the Berkshire PreferredStock and the Zenith Preferred Stock, respectively.

During 2004, we paid a total of $41.1 million ininterest under the Senior Notes.

During November and December of 2004, wetransferred (1) White Mountains Re and its subsidiaries, includingFolksamerica Reinsurance Company, (2) WM Asset Management (Barbados) Ltd.,including its $1.0 billion interest in notes receivable from us and (3) Esurance, Inc.,Esurance Insurance Services, Esurance Insurance Company and Esurance Propertyand Casualty Company to White Mountains as part of a realignment of WhiteMountains’ business segments.

During the first quarterof 2004, White Mountains issued 27,772 common shares to our employees inconnection with our employee stock ownership plan. We paid $13.2 millionto White Mountains in consideration for these common shares.

*Acquisitions and Dispositions*

During 2004, we acquired Atlantic Specialty for$30.1 million in cash and a $20.0 million note.

75

----

During 2004, we sold twoof our inactive licensed subsidiaries, Potomac Insurance Company of Illinoisand Western States Insurance Company for $25.3 million, as well as ourboiler inspection service business, for $11.5 million.

*Other Liquidity andCapital Resource Activities*

During 2004, we reported net decreases in our loss andLAE reserves and reinsurance recoverables on paid and unpaid losses, primarilydue to claim payments (and related collections of reinsurance recoverables)related to run-off reserves.

During the first quarter of 2004, we sold4.5 million common shares of Montpelier to third parties for net proceedsof $155.3 million.

During the first quarterof 2004, we made payments amounting to $92.5 million, in cash or bydeferral into certain of our non-qualified compensation plans, to participantsin our long-term incentive compensation plans. These payments were made withrespect to 197,924 performance shares based on payout levels ranging from 93%to 200% of target.

**Related Party Disclosures**

See “Note 18—Related PartyDisclosures”.

**Critical AccountingEstimates**

Management’s Discussion and Analysis of FinancialCondition and Results of Operations discusses our consolidated financialstatements, which have been prepared in accordance with GAAP. The consolidatedfinancial statements presented herein include all adjustments considerednecessary by management to fairly present our financial position, results ofoperations and cash flows. The preparation of financial statements inconformity with GAAP requires management to make estimates and assumptions thataffect the reported amounts of assets and liabilities as of the date of the historicalconsolidated financial statements and the reported amounts of revenues andexpenses during the reporting period.

In the current year presentation of financialinformation, certain amounts in the prior period historical consolidatedfinancial statements have been reclassified to conform with the currentpresentation. We have completed numerous significant transactions during theperiods presented that have affected the comparability of the historicalconsolidated financial statement information presented herein.

On an ongoing basis, management evaluates itsestimates, including those related to loss and LAE reserves, reinsurancetransactions and purchase accounting. Management bases its estimates onhistorical experience and on various other factors that are believed to bereasonable under the circumstances, the results of which form the basis formaking judgments about the carrying values of assets and liabilities that arenot readily apparent from other sources.

Management believes that its critical accountingpolicies affect its more significant estimates used in the preparation of itshistorical consolidated financial statements. The descriptions below aresummarized and have been simplified for clarity.

***1. Loss and LAE***

*Reserves other thanAsbestos and Environmental Reserves and Construction Defect Claim Reserves*

We establish loss and LAE reserves that are estimatesof amounts needed to pay claims and related expenses in the future for insuredevents that have already occurred. The process of estimating reserves 

76

----

involves a considerabledegree of judgment by management and, as of any given date, is inherentlyuncertain.

Loss and LAE reserves are typically comprised of (1) casereserves for claims reported and (2) reserves for losses that have occurredbut for which claims have not yet been reported, referred to as IBNR reserves,which include a provision for expected future development on case reserves.Case reserves are estimated based on the experience and knowledge of claimsstaff regarding the nature and potential cost of each claim and are adjusted asadditional information becomes known or payments are made. IBNR reserves arederived by subtracting paid loss and LAE and case reserves from estimates ofultimate loss and LAE. Actuaries estimate ultimate loss and LAE using variousgenerally accepted actuarial methods applied to known losses and other relevantinformation. Like case reserves, IBNR reserves are adjusted as additionalinformation becomes known or payments are made.

Ultimate loss and LAE are generally determined byextrapolation of claim emergence and settlement patterns observed in the pastthat can reasonably be expected to persist into the future. In forecastingultimate loss and LAE with respect to any line of business, past experiencewith respect to that line of business is the primary resource, but cannot berelied upon in isolation. Our own experience, particularly claims developmentexperience, such as trends in case reserves, payments on and closings ofclaims, as well as changes in business mix and coverage limits, is the mostimportant information for estimating our reserves. External data, availablefrom organizations such as statistical bureaus, consulting firms andreinsurance companies, is sometimes used to supplement or corroborate our ownexperience, and can be especially useful for estimating costs of new business.For some lines of business, such as “long-tail” coverages discussed below,claims data reported in the most recent accident year is often too limited toprovide a meaningful basis for analysis due to the typical delay in reportingof claims. For this type of business, we use a selected loss ratio method forthe initial accident year or years. This is a standard and accepted actuarialreserve estimation method in these circumstances in which the loss ratio isselected based upon information used in pricing policies for that line ofbusiness, as well as any publicly available industry data, such as industrypricing, experience and trends, for that line of business.

Uncertainties in estimating ultimate loss and LAE aremagnified by the time lag between when a claim actually occurs and when it isreported and settled. This time lag is sometimes referred to as the “claim-tail”.The claim-tail for most property coverages is typically short (usually a fewdays up to a few months). The claim-tail for liability/casualty coverages, suchas automobile liability, general liability, products liability, multiple perilcoverage, and workers compensation, can be especially long as claims are oftenreported and ultimately paid or settled years, even decades, after the relatedloss events occur. During the long claims reporting and settlement period,additional facts regarding coverages written in prior accident years, as wellas about actual claims and trends may become known and, as a result, we mayadjust our reserves. If management determines that an adjustment isappropriate, the adjustment is booked in the accounting period in which suchdetermination is made in accordance with GAAP. Accordingly, should reservesneed to be increased or decreased in the future from amounts currentlyestablished, future results of operations would be negatively or positivelyimpacted, respectively.

In determining ultimate loss and LAE, the cost to indemnifyclaimants, provide needed legal defense and other services for insureds andadminister the investigation and adjustment of claims are considered. Theseclaim costs are influenced by many factors that change over time, such asexpanded coverage definitions as a result of new court decisions, inflation incosts to repair or replace damaged property, inflation in the cost of medicalservices and legislated changes in statutory benefits, as well as by theparticular, unique facts that pertain to each claim. As a result, the rate atwhich claims arose in the past and the costs to settle them may not always berepresentative of what will occur in the future. The factors influencingchanges in claim costs are often difficult to isolate or quantify and developmentsin paid and incurred losses from historical trends are frequently subject tomultiple and conflicting interpretations. Changes in coverage terms or claimshandling practices may also cause future experience and/or 

77

----

development patterns tovary from the past. A key objective of actuaries in developing estimates ofultimate loss and LAE, and resulting IBNR reserves, is to identify aberrationsand systemic changes occurring within historical experience and accuratelyadjust for them so that the future can be projected reliably. Because of thefactors previously discussed, this process requires the use of informedjudgment and is inherently uncertain.

Our actuaries useseveral generally accepted actuarial methods to evaluate our loss and LAEreserves, each of which has its own strengths and weaknesses. We place more orless reliance on a particular method based on the facts and circumstances atthe time the reserve estimates are made. These methods generally fall into oneof the following categories or are hybrids of one or more of the followingcategories:

·       *Historical paid loss development methods*:These methods use historical loss payments over discrete periods of time toestimate future losses. Historical paid loss development methods assume thatthe ratio of losses paid in one period to losses paid in an earlier period willremain constant. These methods necessarily assume that factors that haveaffected paid losses in the past, such as inflation or the effects oflitigation, will remain constant in the future. Because historical paid lossdevelopment methods do not use case reserves to estimate ultimate losses, theycan be more reliable than the other methods discussed below that look to casereserves (such as actuarial methods that use incurred losses) in situationswhere there are significant changes in how case reserves are established by acompany’s claims adjusters. However, historical paid loss development methodsare more leveraged (meaning that small changes in payments have a larger impacton estimates of ultimate losses) than actuarial methods that use incurredlosses because cumulative loss payments take much longer to equal the expectedultimate losses than cumulative incurred amounts. In addition, and for similarreasons, historical paid loss development methods are often slow to react tosituations when new or different factors arise than those that have affectedpaid losses in the past.

·       *Historical incurred loss development methods*:These methods, like historical paid loss development methods, assume that theratio of losses in one period to losses in an earlier period will remainconstant in the future. However, instead of using paid losses, these methodsuse incurred losses (i.e., the sum of cumulative historical loss payments plusoutstanding case reserves) over discrete periods of time to estimate futurelosses. Historical incurred loss development methods can be preferable tohistorical paid loss development methods because they explicitly take intoaccount open cases and the claims adjusters’ evaluations of the cost to settleall known claims. However, historical incurred loss development methodsnecessarily assume that case reserving practices are consistently applied overtime. Therefore, when there have been significant changes in how case reservesare established, using incurred loss data to project ultimate losses can beless reliable than other methods.

·       *Expected loss ratio methods*: These methodsare based on the assumption that ultimate losses vary proportionately withpremiums. Expected loss ratios are typically developed based upon theinformation used in pricing, and are multiplied by the total amount of premiumswritten to calculate ultimate losses. Expected loss ratio methods are usefulfor estimating ultimate losses in the early years of long-tailed lines ofbusiness, when little or no paid or incurred loss information is available.

·       *Adjusted historical paid and incurred lossdevelopment methods*: These methods take traditional historical paidand incurred loss development methods and adjust them for the estimated impactof changes from the past in factors such as inflation, the speed of claimpayments or the adequacy of case reserves. Adjusted historical paid andincurred loss development methods are often more reliable methods of predictingultimate losses in periods of significant change, provided the actuaries candevelop methods to reasonably quantify the impact of changes.

78

----

We perform an actuarial review of our recordedreserves each quarter. Our actuaries compare the previous quarter’s estimatesof paid loss and LAE, case reserves and IBNR to amounts indicated by actualexperience. Differences between previous estimates and actual experience areevaluated to determine whether a given actuarial method for estimating loss andLAE should be relied upon to a greater or lesser extent than it had been in thepast. While some variance is expected each quarter due to the inherent uncertaintyin loss and LAE, persistent or large variances would indicate that priorassumptions and/or reliance on certain reserving methods may need to be revisedgoing forward.

In its selection of recorded reserves, our managementhistorically gave greater weight to adjusted paid loss development methods,which are not dependent on the consistency of case reserving practices, overmethods that rely on incurred losses. In recent years, the amount of weightgiven to methods based on incurred losses has increased with management’sconfidence that our case reserving practices have been more consistentlyapplied.

Upon completion of eachquarterly review, our actuaries select indicated reserve levels based on theresults of the actuarial methods described previously, which are the primaryconsideration in determining management’s best estimate of required reserves.At December 31, 2005 and 2006, the differences between our total heldreserves, which represents management’s best estimate of required reserves, andthe actuarially indicated reserve level were insignificant. However, in makingits best estimate, management also considers other qualitative factors that maylead to a difference between held reserves and actuarially recommended levelsin the future. Typically, these factors exist when management and our actuariesconclude that there is insufficient historical incurred and paid lossinformation or that trends included in the historical incurred and paid lossinformation are unlikely to repeat in the future. Such factors include, amongothers, recent entry into new markets or new products, improvements in theclaims department that are expected to lessen future ultimate loss costs andlegal and regulatory developments.

*Construction DefectClaims Reserves*

Construction defect claims are a non-A&Eexposure that has proven to have a greater degree of uncertainty whenestimating loss and LAE using generally accepted actuarial methods. Our generalliability and multiple peril lines of business have been significantly impactedby a large number of construction defect claims. Construction defect is aliability allegation relating to defective work performed in the constructionof structures such as apartments, condominiums, single family dwellings orother housing, as well as the sale of defective building materials. Such claimsseek recovery due to damage caused by alleged deficient construction techniquesor workmanship. Much of the recent claims activity has been generated byplaintiffs’ lawyers who approach new homeowners, and in many cases homeownerassociations with large numbers of homeowners in multi-residentialcomplexes, about defects or other flaws in their homes. Claims for constructiondefects began with claims relating to exposures in California. Then, as plaintiffs’lawyers organized suits in other states with high levels of multi-residentialconstruction, construction defect claims were reported in nearby westernstates, such as Colorado and Nevada, and eventually throughout the country. Thereporting of such claims can be quite delayed as the statute of limitations canbe up to ten years. Court decisions have expanded insurers’ exposure toconstruction defect claims as well. For example, in 1995 California courtsadopted a “continuous trigger” theory in which all companies that had everinsured a property that was alleged to have been damaged must respond to theclaimant, even if evidence of the alleged damage did not appear until after theinsurance period had expired. As a result, construction defect claims may bereported more than ten years after a project has been completed as litigationcan proceed for several years before an insurance company is identified as apotential contributor. Claims have also emerged from parties claimingadditional insured status on policies issued to other parties (e.g., such ascontractors seeking coverage on a sub-contractor’s policy). Further, inreserving for these claims, there is additional uncertainty due to thepotential for further unfavorable judicial rulings and regulatory actions. Theprimary actuarial methods that are used to estimate loss and 

79

----

LAE reserves forconstruction defect claims are frequency and severity methods. These methodsseparately project the frequency of future reported claims and the average costor severity of individual claims. The reserve is the product of the projectednumber of reported claims and the severity.

A large number ofconstruction defect claims have been identified relating to coverages that wehad written in the past through Commercial Union Corporation and GeneralAccident Corporation of America, which we refer to as our legacy companies, andtheir subsidiaries in California, Colorado, Nevada, Washington and Oregon.Management has sought to mitigate future construction defect risks in allstates by no longer providing insurance to certain residential generalcontractors and sub-contractors involved in multi-habitational projects.Mitigating actions also included initiating the withdrawal from problematicsub-segments within our construction book of business, such as street and roadconstruction, water, sewer and pipeline construction. As a result of theseactions, management believes that the number of reported construction defectclaims relating to coverages written in the past peaked in 2004 and willcontinue to decline.

*Asbestos andEnvironmental Reserves*

Our reserves include provisions made for claims thatassert damages from asbestos and environmental, or A&E, related exposures.Asbestos claims relate primarily to injuries asserted by those who allegedlycame in contact with asbestos or products containing asbestos. Environmentalclaims relate primarily to pollution and related clean-up cost obligations,particularly as mandated by Federal and state environmental protection agencies.In addition to the factors described above under “Non-Asbestos andEnvironmental Reserves” regarding the reserving process, we estimate ourA&E reserves based upon, among other factors, facts surrounding reportedcases and exposures to claims, such as policy limits and deductibles, currentlaw, past and projected claim activity and past settlement values for similarclaims, as well as analysis of industry studies and events, such as recentsettlements and asbestos-related bankruptcies. The cost of administeringA&E claims, which is an important factor in estimating loss and LAEreserves, tends to be higher than in the case of non-A&E claims due to thehigher legal costs typically associated with A&E claims.

A large portion of our A&E losses resulted fromthe operations of the Employers Group, an entity acquired by one of the legacycompanies in 1971. These operations, including business of Employers SurplusLines Insurance Company and Employers Liability Assurance Corporation, providedprimary and excess liability insurance for commercial insureds, includingFortune 500-sized accounts, some of whom subsequently experienced claimsfor A&E losses. We stopped writing such coverage in 1984.

Our liabilities for A&E losses from businessunderwritten in the recent past are substantially limited by the application ofexclusionary clauses in the policy language that eliminated coverage for suchclaims. After 1987 for pollution and 1992 for asbestos, most liability policiescontained industry-standard absolute exclusions of such claims. Inearlier years, various exclusions were also applied, but the wording of thoseexclusions was less strict and subsequent court rulings have reduced theireffectiveness.

We also incurred A&E losses via our participationin industry pools and associations. The most significant of these pools wasExcess Casualty Reinsurance Association, or ECRA, which provided excessliability reinsurance to U.S. insurers from 1950 until the early 1980s. ECRAincurred significant liabilities for A&E, of which we bear approximately a4.7% share, or $64.5 million at both December 31, 2005 and 2006,which is fully reflected in our loss and LAE reserves.

More recently, since the 1990s, we have experienced aninflux of claims from commercial insureds, including many non-Fortune 500-sizedaccounts written during the 1970s and 1980s, who are named as defendants inasbestos lawsuits. As a number of large well-known manufacturers of asbestosand asbestos-containing products have gone into bankruptcy, plaintiffshave sought recoveries from peripheral defendants, such as installers,transporters or sellers of such products, or from owners of premises on 

80

----

which the plaintiffs’exposure to asbestos allegedly occurred. At December 31, 2006, 520policyholders had asbestos-related claims against us. In 2006, 121 newinsureds with such peripheral involvement presented asbestos claims under priorpolicies we had written.

Historically, most asbestos claims have been assertedas product liability claims. Recently, insureds who have exhausted theavailable products liability limits of their insurance policies have soughtfrom insurers such as us payment for asbestos claims under the premises andoperations coverage of their liability policies, which may not be subject tosimilar aggregate limits. We expect this trend to continue. However, to datethere have been fewer of these premises and operations coverage claims thanproduct liability coverage claims. This may be due to a variety of factors,including that it may be more difficult for underlying plaintiffs to establishlosses as stemming from premises and operations exposures, which requires proofof the defendant’s negligence, rather than products liability under whichstrict legal liability applies. Premises and operations claims may varysignificantly and policyholders may seek large amounts, although such claimsfrequently settle for a fraction of the initial alleged amount. Accordingly,there is a great deal of variation in damages awarded for the actual injuries.As of December 31, 2006, there were approximately 323 active claims byinsureds against us without product liability coverage asserting operations orpremises coverage, which may not be subject to aggregate limits under thepolicies.

Immediately preceding the purchase of us by WhiteMountains in 2001, we purchased a reinsurance contract with NICO under which weare entitled to recover from NICO up to $2.5 billion in the future forasbestos claims arising from business written by us in 1992 and prior,environmental claims arising from business written by us in 1987 and prior, andcertain other exposures. Under the terms of the NICO Cover, NICO receives theeconomic benefit of reinsurance recoverables from certain of our third partyreinsurers in existence at the time the NICO Cover was executed, or Third PartyRecoverables. As a result, the Third Party Recoverables serve to protect the$2.5 billion limit of NICO coverage for the benefit of us. Any amountsuncollectible from third party reinsurers due to dispute or the reinsurers’financial inability to pay are covered by NICO under its agreement with us.Third Party Recoverables are typically for the amount of loss in excess of astated level each year. Of claim payments from 1995 through 2006, approximately50% of asbestos and environmental losses have been recovered under thehistorical third party reinsurance.

In June 2005, we completed an internal study ofour A&E exposures. This study considered, among other items, (1) facts,such as policy limits, deductibles and available third party reinsurance,related to reported claims; (2) current law; (3) past and projectedclaim activity and past settlement values for similar claims; (4) industrystudies and events, such as recent settlements and asbestos-relatedbankruptcies; and (5) collectibility of third-party reinsurance.Based on the study, we increased our best estimate of our incurred losses cededto NICO, net of underlying reinsurance, by $353.0 million($841.0 million gross) to $2.1 billion, which is within the$2.5 billion coverage provided by the NICO Cover. Based on the study, weestimated that the range of reasonable outcomes around our best estimate was$1.7 billion to $2.4 billion, versus a range of $1.5 billion to$2.4 billion from our previous study that was conducted in 2003. Due tothe NICO Cover, there was no impact to income or equity from the change inestimate.

The increase in the estimate of incurred A&Elosses was principally driven by raised projections for claims related toasbestos (particularly from assumed reinsurance business), and for mass tortsother than asbestos and environmental, particularly lead poisoning and sexualmolestation. The increase was partially offset by reduced projections ofultimate hazardous waste losses.

As part of our previously described actuarial reviewprocess, we review A&E activity each quarter and compare that activity towhat was assumed in the original internal study. As of December 31, 2006,we estimated that the range of reasonable outcomes around our best estimate was$1.7 billion to $2.4 billion.

As noted above, we estimate that on an incurred basiswe have ceded estimated incurred losses of approximately $2.1 billion tothe NICO Cover at December 31, 2006. Since entering into the NICO Cover,$29.2 million of the $2.1 billion of utilized coverage relates touncollected amounts from third party 

81

----

reinsurers through December 31,2006. Net losses paid totaled $847 million as of December 31, 2006,with $146 million paid in 2006. Asbestos payments during 2006 reflectpayments resulting from intensified efforts by claimants to resolve asbestosclaims prior to the potential enactment of Federal asbestos legislation. To theextent that our estimate of ultimate A&E losses as well as the estimate andcollectibility of Third Party Recoverables differs from actual experience, theremaining protection under the NICO Cover may be more or less than theapproximate $404.0 million that we estimate remained at December 31,2006.

Our reserves for A&E losses, net of Third PartyRecoverables but prior to NICO recoveries, were $1.2 billion at December 31,2006. An industry benchmark of reserve adequacy is the “survival ratio”,computed as a company’s reserves divided by its historical average yearly losspayments. This ratio indicates approximately how many more years of paymentsthe reserves can support, assuming future yearly payments are equal tohistorical levels. Our survival ratio was 16.6 at December 31, 2006. Thiswas computed as the ratio of A&E reserves, net of Third Party Recoverablesprior to the NICO Cover of $1.2 billion plus the remaining unused portionof the NICO Cover of $404.0 million, to the average A&E loss paymentsover the three-year period ended December 31, 2006, net of ThirdParty Recoverables. Our survival ratio was 18.6 at December 31, 2005. Webelieve that as a result of the NICO Cover and our historical third partyreinsurance programs, we should not experience material financial loss fromA&E exposures under current coverage interpretations and that our survivalratio compares favorably to industry survival ratios. However, the survivalratio is a simplistic measure estimating the number of years it would be beforethe current ending loss reserves for these claims would be paid using recentannual average payments. Many factors, such as aggressive settlementprocedures, mix of business and coverage provided, have a significant effect onthe amount of A&E reserves and payments and the resultant survival ratio.Thus, caution should be exercised in attempting to determine reserve adequacyfor these claims based simply on this survival ratio.

Our reserves for A&Elosses at December 31, 2006 represent management’s best estimate of itsultimate liability based on information currently available. Based on thisestimate, we believe the NICO Cover will be adequate to cover all of ourA&E obligations. However, as case law expands, medical and clean-up costsincrease and industry settlement practices change, we may be subject to A&Elosses beyond currently estimated amounts. Therefore, we cannot guarantee thatour A&E loss and LAE reserves, plus the remaining coverage under the NICOCover, will be sufficient to cover additional liability arising from any suchunfavorable developments. See Note 4—“Reserves for Unpaid Loss and LAE—Asbestosand environmental loss and LAE reserve activity” of the accompanyingconsolidated financial statements for more information regarding our A&Ereserves.

82

----

*Primary InsuranceOperations A&E Claims Activity*

OurA&E claims activity, which is all in our Primary Insurance Operationssegment, for the last two years is illustrated in the table below:

| ** **                                                          | ** ** | **Year ended  December 31,** | ** ** |
|---------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                          | ** ** | **2005**                               | ** ** | **2006** | ** ** |
| **Asbestos**                                                        |       |                                   |       |   |   |
| Accounts with  asbestos claims at the beginning of the year         |       | 664                                    |       | 592 |   |
| Accounts  reporting asbestos claims during the year                 |       | 128                                    |       | 121 |   |
| Accounts on which  asbestos claims were closed during the year      |       | (200                                   | )          | (193 | ) |
| Accounts with  asbestos claims at the end of the year               |       | 592                                    |       | 520 |   |
| **Environmental**                                                   |       |                                   |       |   |   |
| Accounts with  environmental claims at the beginning of the year    |       | 644                                    |       | 495 |   |
| Accounts  reporting environmental claims during the year            |       | 180                                    |       | 130 |   |
| Accounts on which  environmental claims were closed during the year |       | (329                                   | )          | (203 | ) |
| Accounts with  environmental claims at the end of the year          |       | 495                                    |       | 422 |   |
| **Total**                                                           |       |                                   |       |   |   |
| Total accounts  with A&E claims at the beginning of the year    |       | 1,308                                  |       | 1,087 |   |
| Accounts  reporting A&E claims during the year                  |       | 308                                    |       | 251 |   |
| Accounts on which  A&E claims were closed during the year       |       | (529                                   | )          | (396 | ) |
| Total accounts  with A&E claims at the end of the year          |       | 1,087                                  |       | 942 |   |

 

*Primary InsuranceOperations Reserve Estimation by Line of Business*

The process of establishing loss reserves is complexand imprecise as it must take into consideration many variables that aresubject to the outcome of future events. As a result, informed subjectiveestimates and judgments as to our ultimate exposure to losses are an integralcomponent of our loss reserving process. We, like other insurance companies,categorize and track our insurance reserves by “line of business”, such as autoliability, multiple peril package business, and workers compensation.Furthermore, we regularly review the appropriateness of reserve levels at theline of business level, taking into consideration the variety of trends thatimpact the ultimate settlement of claims for the subsets of claims in eachparticular line of business.

For loss andallocated loss adjustment expense reserves, excluding asbestos andenvironmental, the key assumption as of December 31, 2006 was that theimpact of the various reserving factors, as described below, on future paidlosses would be similar to the impact of those factors on the historical lossdata with the following exceptions:

·       Recentincreases in paid loss trends were inflated due to changes in claim handlingprocedure that decreased the settlement time for claims. This resulted in someincreases in paid loss activity that we believe will not continue into thefuture.

·       Increasesin case reserve adequacy over the 2001-2004 calendar periods haveresulted in trends in case incurred activity that we believe will not continueinto the future. Case incurred activity can be the result of underlying changesin expected claim costs or changes in the adequacy of the case reservesrelative to the underlying expected claim cost. If the activity is the resultof underlying changes in expected costs, it is more likely to repeat in thefuture, and would likely result in prior year reserve development, as thechange in ultimate claim costs would not have been considered when making theprevious selection of IBNR reserves. If the activity is the result of changesin case 

83

----

reserve adequacy, it wouldnot indicate any change in the ultimate claim costs and would not be expectedto repeat in the future. In these cases, it is unlikely that prior year reservedevelopment would occur, as the change in case reserves would be offset by acorresponding change in IBNR reserves (i.e., deficiency or redundancy in casereserves was implicitly captured when making the previous selection of IBNR reserves).

·       In2004, we established a separate claim group to manage run-off claims. Due tothe recent nature of this event, we do not believe that the impacts of thisgroup on future losses have been reflected in historical losses. Therefore, wehave given considerable weight to the most recent loss experience for thissegment.

The major causes ofmaterial uncertainty (“reserving factors”) generally will vary for each productline, as well as for each separately analyzed component of the product line.The following section details reserving factors by product line. There could beother reserving factors that may impact ultimate claim costs. Each reservingfactor presented will have a different impact on estimated reserves. Also,reserving factors can have offsetting or compounding effects on estimatedreserves. For example, in workers compensation, the use of expensive medicalprocedures that result in medical cost inflation may enable workers to returnto work faster, thereby lowering indemnity costs. Thus, in almost all cases, itis impossible to discretely measure the effect of a single reserving factor andconstruct a meaningful sensitivity expectation. Actual results will likely varyfrom expectations for each of these assumptions, resulting in an ultimate claimliability that is different from that being estimated currently.

*Workerscompensation*

Workers compensation is generally considered a longtail coverage, as it takes a relatively long period of time to finalize claimsfrom a given accident year. While certain payments such as initial medicaltreatment or temporary wage replacement for the injured worker are madequickly, some other payments are made over the course of several years, such asawards for permanent partial injuries. In addition, some payments can run aslong as the injured worker’s life, such as permanent disability benefits andongoing medical care. Despite the possibility of long payment tails, thereporting lags are generally short, settlements are generally not complex, andmost of the liability can be considered high frequency with moderate severity.The largest reserve risk generally comes from the low frequency, high severityclaims providing lifetime coverage for medical expense arising from a worker’sinjury.

Examples of common reservingfactors that can change and, thus, affect the estimated workers compensationreserves include:

*General workerscompensation reserving factors*

·       Mortalitytrends of injured workers with lifetime benefits and medical treatment ordependents entitled to survivor benefits

·       Degreeof cost shifting between workers compensation and health insurance

·       Changes in claim handlingphilosophies (e.g., case reserving standards)

*Indemnity reservingfactors*

·       Timerequired to recover from the injury

·       Degreeof available transitional jobs

·       Degreeof legal involvement

84

----

·       Changesin the interpretations and processes of various workers compensation bureaus’oversight of claims

·       Futurewage inflation for states that index benefits

·       Changesin the administrative policies of second injury funds

·       Re-marriage rate forspouse in instances of death

*Medical reservingfactors*

·       Changesin the cost of medical treatments, including prescription drugs, and underlyingfee schedules

·       Frequencyof visits to health providers

·       Numberof medical procedures given during visits to health providers

·       Typesof health providers used

·       Typeof medical treatments received

·       Useof preferred provider networks and other medical cost containment practices

·       Availabilityof new medical processes and equipment

·       Changesin the use of pharmaceutical drugs

·       Degree of patientresponsiveness to treatment

*Workerscompensation book of business reserving factors*

·       Productmix

·       Injurytype mix

·       Changes in underwritingstandards

*Personal automobileliability*

The personal automobile product line is a mix ofproperty and liability coverages and, therefore, includes both short and longtail coverages. The payments that are made quickly typically pertain to autophysical damage (property) claims and property damage (liability) claims. Thepayments that take longer to finalize and are more difficult to estimate relateto bodily injury claims. Personal automobile reserves are typically analyzed inthree components: bodily injury liability, property damage liability, andcollision/comprehensive claims. This last component has minimum reserve riskand fast payouts and, accordingly, separate factors are not presented.Reporting lags are relatively short and the claim settlement process forpersonal automobile liability generally is the least complex of the liabilityproducts. It is generally viewed as a high frequency, low to moderate severityproduct line.

Examples of commonreserving factors that can change and, thus, affect the estimated personalautomobile liability reserves include:

*Personal automobileliability reserving factors*

·       Trendsin jury awards

·       Changesin the underlying court system and its philosophy

85

----

·       Changesin case law

·       Litigationtrends

·       Frequencyof claims with payment capped by policy limits

·       Changein average severity of accidents, or proportion of severe accidents

·       Subrogationopportunities

·       Degreeof patient responsiveness to treatment

·       Changes in claim handlingphilosophies (e.g., case reserving standards)

*Personal automobileliability book of business reserving factors*

·       Changesin policy provisions (e.g., deductibles, policy limits, or endorsements)

·       Changes in underwritingstandards

*Multiple peril*

Commercial multiple peril provides a combination ofproperty and liability coverage typically for small businesses and, therefore,includes both short and long tail coverages. For property coverage, itgenerally takes a relatively short period of time to close claims, while forthe other coverages, generally for the liability coverages, it takes a longerperiod of time to close claims. The reserving risk for this line is dominatedby the liability coverage portion of this product, except occasionally in theevent of catastrophic or large single losses.

Multiple peril liability reserves here are generallyanalyzed as two components: bodily injury and property damage. Bodily injurypayments reimburse the claimant for damages pertaining to physical injury as aresult of the policyholder’s legal obligation arising from non-intentional actssuch as negligence, subject to the insurance policy provisions. In some casesthe damages can include future wage loss (which is a function of futureearnings power and wage inflation) and future medical treatment costs. Propertydamage payments result from damages to the claimant’s private property arisingfrom the policyholder’s legal obligation for non-intentional acts. In mostcases, property damage losses are a function of costs as of the loss date, orsoon thereafter. Defense costs are also a part of the insured costs covered byliability policies and can be significant, sometimes greater than the cost ofthe actual paid claims, though for some products this risk is mitigated bypolicy language such that the insured portion of defense costs erodes the amountof policy limit available to pay the claim.

Multiple peril liability is generally considered along tail line, as it takes a relatively long period of time to finalize andsettle claims from a given accident year. The speed of claim reporting and claimsettlement is a function of the specific coverage provided and thejurisdiction, among other factors. There are numerous components underlying themultiple peril liability product line. Some of these have relatively moderatepayment patterns (with most of the claims for a given accident year closedwithin 5 to 7 years), while others can have extreme lags in both reportingand payment of claims (e.g., a reporting lag of a decade for “constructiondefect” claims).

Examples of commonreserving factors that can change and, thus, affect the estimated multipleperil liability reserves include:

*Multiple perilliability reserving factors*

·       Changesin claim handling philosophies (e.g., case reserving standards)

·       Changesin policy provisions or court interpretations of such provisions

86

----

·       Newtheories of liability

·       Trendsin jury awards

·       Changesin the propensity to sue, in general with specificity to particular issues

·       Changesin statutes of limitations

·       Changesin the underlying court system

·       Distortionsfrom losses resulting from large single accounts or single issues

·       Changesin tort law

·       Shiftsin law suit mix between federal and state courts

·       Changes in settlementpatterns

*Multiple perilliability book of business reserving factors*

·       Changesin policy provisions (e.g., deductibles, policy limits, or endorsements)

·       Changesin underwriting standards

·       Product mix (e.g., size ofaccount, industries insured, or jurisdiction mix)

*Commercialautomobile liability*

The commercial automobile product line is a mix ofproperty and liability coverages and, therefore, includes both short and longtail coverages. The payments that are made quickly typically pertain to autophysical damage (property) claims and property damage (liability) claims. Thepayments that take longer to finalize and are more difficult to estimate relateto bodily injury claims. Commercial automobile reserves are typically analyzedin three components; bodily injury liability, property damage liability, andcollision/comprehensive claims. This last component has minimum reserve riskand fast payouts and, accordingly, separate reserving factors are notpresented. In general, claim reporting lags are minor, claim complexity is nota major issue, and the line is viewed as high frequency, low to moderateseverity.

Examples of commonreserving factors that can change and, thus, affect the estimated commercialautomobile liability reserves include:

*Bodily injury andproperty damage liability reserving factors*

·       Trendsin jury awards

·       Changesin the underlying court system

·       Changesin case law

·       Litigationtrends

·       Frequencyof claims with payment capped by policy limits

·       Changein average severity of accidents, or proportion of severe accidents

·       Subrogationopportunities

·       Changesin claim handling philosophies (e.g., case reserving standards)

·       Frequencyof visits to health providers

·       Numberof medical procedures given during visits to health providers

87

----

·       Typesof health providers used

·       Typesof medical treatments received

·       Changesin cost of medical treatments

·       Degree of patientresponsiveness to treatment

*Commercialautomobile liability book of business reserving factors*

·       Changesin policy provisions (e.g., deductibles, policy limits, or endorsements)

·       Changesin mix of insured vehicles (e.g., long-haul trucks versus local and smallervehicles, or fleet risks versus non-fleet risks)

·       Changes in underwritingstandards

*General liability*

See the above discussionsunder the liability product lines with regard to reserving factors for multipleperil.

*Homeowners/Farmowners*

Homeowners/Farmowners is generally considered a shorttail coverage. Most payments are related to the property portion of the policy,where the claim reporting and settlement process is generally restricted to theinsured and the insurer. Claims on property coverage are typically reportedsoon after the actual damage occurs, although delays of several months are notunusual. The resulting settlement process is typically fairly short term,although exceptions do exist. The liability portion of thehomeowners/farmowners policy generates claims which take longer to pay due tothe involvement of litigation and negotiation, but with generally smallreporting lags. Overall, the line is generally high frequency, low to moderateseverity (except for catastrophes), with simple to moderate claim complexity.

Examples of commonreserving factors that can change and, thus, affect the estimatedhomeowners/farmowners reserves include:

*Non-catastrophereserving factors*

·       Salvageopportunities

·       Amountof time to return property to residential use

·       Changesin weather patterns

·       Localbuilding codes

·       Litigationtrends

·       Trends in jury awards

*Catastrophereserving factors*

·       Physicalconcentration of policyholders

·       Availabilityand cost of local contractors

·       Localbuilding codes

·       Qualityof construction of damaged homes

88

----

·       Amountof time to return property to residential use

·       For the more severecatastrophic events, “demand surge” inflation, whereby the greatly increaseddemand for building materials such as plywood far surpasses the immediatesupply, leading to short-term material increases in building material costs

*Homeowners/Farmownersbook of business reserving factors*

·       Policyprovisions mix (e.g., deductibles, policy limits, or endorsements)

·       Degreeof concentration of policyholders

·       Changes in underwritingstandards

*Primary InsuranceOperations Loss and LAE Development*

*Loss and LAEdevelopment—2004*

We experienced $99.3 million of net unfavorabledevelopment on prior accident year loss and LAE reserves during 2004, relatingprimarily to 2002 and prior accident years. The net unfavorable developmentrelated primarily to personal auto liability, general liability and multipleperil reserves due in part to emerging trends in claims experienced in ourrun-off operations, including national account and program claims administeredby third parties. These claim trends principally included higher defense costsand higher damages from liability assessments.

Prior to 2004, we had madeassumptions that case reserving standards and settlement practices in therun-off operations would be consistent with the standards and practices thatwere observed in the ongoing operations. During 2004, multiple peril liabilityand general liability case incurred loss and LAE for run-off claims was doublethat for ongoing claims. As a result, management increased the overall level ofreserves for run-off during 2004. In addition, management undertook a more indepth review of the standards and practices as they applied to run-off claimsand formed a separate run-off claims unit.

*Loss and LAE development—2005*

In 2005, we experienced $99.0 million ofunfavorable development on prior accident year loss reserves, primarily due tohigher than anticipated defense costs and higher damages from liabilityassessments in general liability and multiple peril reserves in our run-offoperations.

Specifically, managementhad implicitly assumed at December 31, 2004 that the IBNR and known casedevelopment would be approximately 26% of actual case reserves for the 2001 andprior accident years for multiple peril and general liability. During 2005,case incurred loss and LAE was 72% of the entire future expected developmentwhich was unusually large for these long tail lines of business. As a result,management increased IBNR reserves for these lines so that as of year end 2005the IBNR was approximately 40% relative to the remaining case reserves.

*Loss and LAEdevelopment—2006*

In 2006, we experienced $11.3 million ofunfavorable development on prior accident year loss reserves, primarily due todevelopment on losses related to hurricane events impacting our excess propertypolicies.

Specifically atDecember 31, 2005, management had reviewed all known losses related tohurricane events impacting our excess property policies. Based on informationat that time, management established reserves for those losses which wereexpected to reach our coverage layers. During 2006, several individual claimsexperienced adverse development resulting in more losses penetrating ourcoverage layers. As a 

89

----

result,management increased held reserves as of December 31, 2006 to reflect theactual adverse claim development as well as a provision for future adversedevelopment on these claims.

*Primary InsuranceOperations Case and IBNR Reserves by Line of Business*

Lossand LAE reserves, net of reinsurance recoverables on unpaid losses, by line ofbusiness at December 31, 2005 and 2006 for our Primary InsuranceOperations were as follows:

| ** **                       | ** ** | **December 31, 2005** | ** ** | **December 31, 2006** | ** ** |
|----------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                       | ** ** | **Case**                        | ** ** | **IBNR**                        | ** ** | **Total** | ** ** | **Case** | ** ** | **IBNR** | ** ** | **Total** | ** ** |
| ** **                       | ** ** | **($ in millions)**   | ** ** |
| Workers  compensation(1)         |       | $                               | 195.2      |                            | $          | 132.6 |   | $ | 327.8 |   | $ | 82.0 |   | $ | 136.3 |   | $ | 218.3 |   |
| Personal  automobile liability   |       | 445.5                           |       | 174.7                           |       | 620.2 |   | 378.6 |   | 187.5 |   | 566.1 |   |
| Multiple  peril(1)(2)            |       | 310.4                           |       | 236.0                           |       | 546.4 |   | 237.9 |   | 193.0 |   | 430.9 |   |
| Commercial  automobile liability |       | 140.2                           |       | 65.6                            |       | 205.8 |   | 110.2 |   | 66.2 |   | 176.4 |   |
| General  liability(2)            |       | 106.1                           |       | 227.2                           |       | 333.3 |   | 77.0 |   | 281.1 |   | 358.1 |   |
| Homeowners/Farmowners            |       | 81.1                            |       | 41.4                            |       | 122.5 |   | 72.7 |   | 33.4 |   | 106.1 |   |
| Other(1)                         |       | 115.5                           |       | 59.9                            |       | 175.4 |   | 105.2 |   | 67.4 |   | 172.6 |   |
| Total                            |       | $                               | 1,394.0    |                            | $          | 937.4 |   | $ | 2,331.4 |   | $ | 1,063.6 |   | $ | 964.9 |   | $ | 2,028.5 |   |

----

(1)          Includes loss and LAEreserves related to A&E.

(2)          Includesloss and LAE reserves related to construction defect claims.

*Primary InsuranceOperations Range of Reserves by Line of Business*

Ourrange of reserve estimates at December 31, 2006 was evaluated to considerthe strengths and weaknesses of the actuarial methods applied against ourhistorical claims experience data. The following table shows the recordedreserves and the high and low ends of our range of reasonable loss and LAEreserve estimates at December 31, 2006. The high and low ends of our rangeof reserve estimates in the table below are based on the results of variousactuarial methods described above.

| ** **                       | ** ** | **December 31, 2006** | ** ** |
|----------------------------------|------------|---------------------------------|------------|
| ** **                       | ** ** | **Low**                         | ** ** | **Recorded** | ** ** | **High** | ** ** |
| ** **                       | ** ** | **($ in millions)**   | ** ** |
| Workers  compensation            |       | $                               | 183        |   | $ | 218.3 |   | $ | 304 |   |
| Personal  automobile liability   |       | 502                             |       | 566.1 |   | 582 |   |
| Multiple peril                   |       | 401                             |       | 430.9 |   | 526 |   |
| Commercial  automobile liability |       | 169                             |       | 176.4 |   | 190 |   |
| General liability                |       | 283                             |       | 358.1 |   | 382 |   |
| Homeowners/Farmowners            |       | 93                              |       | 106.1 |   | 107 |   |
| Other                            |       | 159                             |       | 172.6 |   | 174 |   |
| Total                            |       | $                               | 1,790      |   | $ | 2,028.5 |   | $ | 2,265 |   |

 

The recorded reserves represent management’s bestestimate of unpaid loss and LAE by line of business. We use the results ofseveral different actuarial methods to develop our estimate of ultimatereserves. While we have not determined the statistical probability of actualultimate paid losses falling within the range, management believes that it isreasonably likely that actual ultimate paid losses will fall within the rangesnoted above because the ranges were developed by using several differentgenerally accepted actuarial methods.

The probability that ultimate losses will fall outsideof the ranges of estimates by line of business is higher for each line ofbusiness individually than it is for the sum of the estimates for all linestaken 

90

----

together due to theeffects of diversification. The diversification effects result from the factthat losses across our different lines of business are not completelycorrelated. Although management believes our reserves are reasonably stated,ultimate losses may deviate, perhaps materially, from the recorded reserveamounts and could be above the high end of the range of actuarial projections.This is because ranges are developed based on known events as of the valuationdate, whereas the ultimate disposition of losses is subject to the outcome ofevents and circumstances that may be unknown as of the valuation date.

The percentages shown in the following table representthe linear interpolation of where our recorded loss and LAE reserves are withinthe range of reserves estimates by line of business at December 31, 2005and 2006, where the low end of the range equals zero, the middle of the rangeequals 50% and the high end of the range equals 100%.

| ** **                       | ** ** | **December 31,**                                              | ** ** |
|----------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                       | ** ** | **2005**                                                           | ** ** | **2006** | ** ** |
| ** **                       | ** ** | **(expressed as a  percentage of  the range)** | ** ** |
| Workers  compensation            |       |                                                               | 39         | % |   |   | 29 | % |   |
| Personal  automobile liability   |       |                                                               | 61         |   |   |   | 81 |   |   |
| Multiple peril                   |       |                                                               | 30         |   |   |   | 24 |   |   |
| Commercial  automobile liability |       |                                                               | 37         |   |   |   | 33 |   |   |
| General liability                |       |                                                               | 57         |   |   |   | 75 |   |   |
| Homeowners/Farmowners            |       |                                                               | 83         |   |   |   | 93 |   |   |
| Other                            |       |                                                               | 78         |   |   |   | 91 |   |   |
| Total                            |       |                                                               | 46         | % |   |   | 50 | % |   |

 

For some types of claims, such as workerscompensation, management used forecasting models that consider the unique lossdevelopment characteristics of these types of claims. As a result of the trendssuggested by these models, management chose a point estimate that was at alower point in the range at December 31, 2006 as compared to the prioryear. Management also selected a point estimate higher in the range for newerand/or growing segments of business, in part based on their view that actuarialmethods that rely on historical loss and LAE patterns may have a higher degreeof uncertainty for these businesses. As these segments accumulate more historicaldata, management’s selections place greater reliance on the emergingexperience. For personal automobile liability, this resulted in our recordingreserves at the higher end of the range in 2006, reflecting a more conservativeview of recently emerging favorable loss experience. Management has alsoselected a point estimate higher in the range for general liability as thereserves in this line are increasingly related to our growing professionalliability businesses. For homeowners and “other” (principally shorter tailedlines of business such as ocean and inland marine insurance) recorded reservesremain at the high end of their respective ranges, as management’s selectionsreflect a conservative approach to recognition of recent favorable incurredloss development patterns.

*SensitivityAnalysis*

The followingdiscussion includes disclosure of possible variations from current estimates ofloss reserves due to a change in certain key assumptions. Each of the impactsdescribed below is estimated individually, without consideration for anycorrelation among key assumptions or among lines of business. Therefore, itwould be inappropriate to take each of the amounts described below and add themtogether in an attempt to estimate volatility for our reserves in total. It isimportant to note that the variations discussed are not meant to be aworst-case scenario, and therefore, it is possible that future variations maybe more than amounts discussed below.

·       *Workers compensation*: Recorded reservesfor workers compensation were $218.3 million at December 31, 2006.The two most important assumptions for workers compensation reserves are lossdevelopment factors and loss cost trends, particularly medical cost inflation.Loss development 

91

----

patterns are dependent onmedical cost inflation. Approximately half of the workers compensation netreserves are related to future medical costs. Across the entire reserve base, a0.5 point change in calendar year medical inflation would have changed theestimated net reserve by $54 million at December 31, 2006, in eitherdirection.

·       *Personal automobile liability*: Recordedreserves for personal auto liability were $566.1 million across all linesat December 31, 2006. Personal auto liability reserves are shorter-tailedthan other lines of business (such as workers compensation) and, therefore,less volatile. However, the size of the reserve base means that future changesin estimate could be material to our results of operations in any given period.A key assumption for personal auto liability is the implicit loss cost trend,particularly the severity trend component of loss costs. A 2.0 point change inassumed annual severity for the two most recent accident years would havechanged the estimated net reserve by $15.7 million at December 31,2006, in either direction. Assumed annual severity for accident years prior tothe two most recent accident years is likely to have minimal variability.

·       *Multiple peril liability and general liability*: Recordedreserves for multiple peril and general liability combined were $789.0 millionat December 31, 2006. Reported loss development patterns are a keyassumption for these lines of business, particularly for more mature accidentyears. Historically, assumptions on reported loss development patterns havebeen impacted by, among other things, emergence of new types of claims (e.g.construction defect claims) or a shift in the mixture between smaller, moreroutine claims and larger, more complex claims. If the severity trend forconstruction defect claims changed by 3.0 points this would have changed theestimated net reserve by $10.9 million at December 31, 2006, ineither direction. Separately, if case reserve adequacy for non constructiondefect claims changed by 10.0 points this would have changed the estimated netreserve by $22.9 million at December 31, 2006, in either direction.

***2. Reinsurance Transactions***

Our insurance subsidiaries purchase reinsurance fromtime to time to protect their businesses from losses due to exposureaggregation, to manage their operating leverage ratios and to limit ultimatelosses arising from catastrophic events. Amounts recoverable from reinsurersare estimated in a manner consistent with the claim liability associated withthe reinsured policies. Amounts related to reinsurance contracts are recordedin accordance with SFAS 113.

In connection with the OneBeacon Acquisition, wepurchased reinsurance contracts with two reinsurance companies rated “AAA” (“ExtremelyStrong”, the highest of twenty-one ratings) by Standard & Poor’s and “A++”(“Superior”, the highest of fifteen ratings) by A.M. Best. One is areinsurance cover with NICO which entitles us to recover up to$2.5 billion in ultimate loss and LAE incurred related to A&E claimsarising from business written by our predecessor prior to 1992 and 1987,respectively. As of December 31, 2006, we have ceded estimated incurredlosses of approximately $2.1 billion to NICO under the NICO Cover. Theother contract is a reinsurance cover with General Reinsurance Corporation, orGRC, for up to $570 million of additional losses on all claims arisingfrom accident years 2000 and prior, which we refer to as the GRC Cover. As of December 31,2006, we have ceded estimated incurred losses of $550.0 million to GRCunder the GRC Cover. The NICO Cover and GRC Cover, which were contingent on andoccurred contemporaneously with the OneBeacon Acquisition, were put in place inlieu of a seller guarantee of loss and LAE reserves and are therefore accountedfor as prospective reinsurance under GAAP in accordance with Emerging IssuesTask Force Topic No. D-54, or EITF Topic D-54.

The collectibility ofreinsurance recoverables is subject to the solvency and willingness to pay ofthe reinsurer. We are selective in choosing our reinsurers, placing reinsuranceprincipally with those reinsurers with a strong financial condition, industryratings and underwriting ability. Management monitors the 

92

----

financialcondition and ratings of our reinsurers on an ongoing basis. See Note 5—“Reinsurance”of the accompanying consolidated financial statements for additionalinformation on our reinsurance programs.

***3. Purchase Accounting***

When we acquire another company, our management mustestimate the fair values of the assets and liabilities acquired, as prescribedby SFAS No. 141, “Business Combinations.” Certain assets and liabilitiesrequire little judgment to estimate their fair values, particularly those thatare quoted on a market exchange, such as publicly-traded investmentsecurities. Other assets and liabilities, however, require a substantial amountof judgment to estimate their fair values. The most significant of these is theestimation required to fair value loss and LAE reserves. We estimate the fairvalue of loss and LAE reserves obtained in an acquisition following theprinciples contained within Financial Accounting Standards Board (“FASB”)Statement of Financial Accounting Concepts No. 7: “Using Cash FlowInformation and Present Value in Accounting Measurements”, or CON 7. Under CON7, the fair value of a particular asset or liability essentially contains fiveelements: (1) an estimate of the future cash flows; (2) expectationsabout possible variations in the amount or timing of those cash flows; (3) thetime value of money, represented by the risk-free rate of interest; (4) theprice for bearing the uncertainty inherent in the asset or liability; and (5) other,sometimes unidentifiable, factors including illiquidity and marketimperfections.

Our actuaries estimate the fair value of loss and LAEreserves obtained in an acquisition by taking the acquired company’s recordedreserves and discounting them based on expected reserve payout patterns usingthe current risk-free rate of interest. Then, our actuaries develop additionalcash flow scenarios that use different payout and ultimate reserve assumptionsdeemed to be reasonably possible based upon the inherent uncertainties presentin determining the amount and timing of payment of such reserves. In eachscenario, the risk-free rate of interest is used to discount future cash flows.These scenarios are put in a statistical model that assigns a probability toeach cash flow scenario. Our actuaries then choose the scenario that bestrepresents the price for bearing the uncertainty inherent within the acquiredcompany’s recorded reserves. The “price” for bearing the uncertainty inherentwithin the acquired company’s reserves is measured as the difference betweenthe selected cash flow scenario and the expected cash flow scenario. Thescenario selected has typically been between 1.5 and 2 standard deviations fromthe expected cash flow outcome. The fair value of the acquired company’s lossand LAE reserves is determined to be the sum of the expected cash flow scenario(i.e., the acquired company’s discounted loss and LAE reserves) and theuncertainty “price.”

The difference between anacquired company’s loss and LAE reserves and our best estimate of the fairvalue of such reserves at the acquisition date is amortized ratably over thepayout period of the acquired loss and LAE reserves. Historically, the fairvalue of an acquired company’s loss and LAE reserves has been less than itsnominal reserves at acquisition. Accordingly, the amortization has been andwill continue to be recorded as an expense on our income statement until fullyamortized. The outstanding pre-tax unaccreted adjustment as of December 31,2006 was $33.4 million.

93

----

**FORWARD-LOOKINGSTATEMENTS**

The informationcontained in this report may contain “forward-looking statements” withinthe meaning of Section 27A of the Securities Act of 1933 and Section 21Eof the Securities Exchange Act of 1934. All statements, other than statementsof historical facts, included or referenced in this report that addressactivities, events or developments which we expect or anticipate will or mayoccur in the future are forward-looking statements. The words “will,” “believe,”“intend,” “expect,” “anticipate,” “project,” “estimate,” “predict” and similarexpressions are also intended to identify forward-looking statements.These forward-looking statements include, among others, statements withrespect to our:

·       growthin book value per share or return on equity;

·       businessstrategy;

·       financialand operating targets or plans;

·       incurredloss and loss adjustment expenses and the adequacy of its loss and lossadjustment expense reserves and related reinsurance;

·       projectionsof revenues, income (or loss), earnings (or loss) per share, dividends, marketshare or other financial forecasts;

·       expansionand growth of its business and operations; and

·       futurecapital expenditures.

These statementsare based on certain assumptions and analyses made by us in light of ourexperience and perception of historical trends, current conditions and expectedfuture developments, as well as other factors believed to be appropriate in thecircumstances. However, whether actual results and developments will conformwith its expectations and predictions is subject to a number of risks anduncertainties that could cause actual results to differ materially fromexpectations, including:

·       therisks discussed beginning on page 28 of this Form 10-K;

·       recordedloss and loss adjustment expense reserves subsequently proving to have beeninadequate;

·       claimsarising from catastrophic events, such as hurricanes, earthquakes, floods orterrorist attacks;

·       competitiveforces, including the conduct of other property and casualty insurers andreinsurers;

·       changesin domestic or foreign laws or regulations, or their interpretation, applicableto us, our competitors or our clients;

·       thecontinued availability of capital and financing;

·       generaleconomic, market or business conditions;

·       aneconomic downturn or other economic conditions adversely affecting ourfinancial position;

·       businessopportunities (or lack thereof) that may be presented to us and pursued; and

·       otherfactors, most of which are beyond our control.

Consequently, all of the forward-lookingstatements made in this report are qualified by these cautionary statements,and there can be no assurance that the actual results or developmentsanticipated by us will be realized or, even if substantially realized, thatthey will have the expected consequences to, or effects on, us or our businessor operations. We assume no obligation to update publicly any such forward-lookingstatements, whether as a result of new information, future events or otherwise.

94

----

**ITEM 7A.**        QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our consolidated balancesheet includes a substantial amount of assets and liabilities whose fair valuesare subject to market risk. The term market risk refers to the risk of lossarising from adverse changes in interest rates and other relevant market ratesand prices. Due to our sizable balances of interest rate sensitive instruments,market risk can have a significant effect on OneBeacon’s consolidated financialposition.

***Interest Rate Risk***

*Fixed Maturity Portfolio*. In connection with our consolidated insurancesubsidiaries, we invest in interest rate sensitive securities, primarily debtsecurities. Our strategy is to purchase fixed maturity investments that areattractively priced in relation to perceived credit risks. Our fixed maturityinvestments are held as available for sale in accordance with SFAS No. 115,“Accounting for Certain Investments in Debt and Equity Securities,” orSFAS 115, whereby these investments are carried at fair value on thebalance sheet with net unrealized gains or losses reported net of tax in aseparate component of common shareholders’ equity. We generally manage ourinterest rate risk associated with our portfolio of fixed maturity investmentsby monitoring the average duration of the portfolio, which allows us to achievean adequate yield without subjecting the portfolio to an unreasonable level ofinterest rate risk. Our fixed maturity portfolio is comprised of primarilyinvestment grade corporate securities, U.S. government and agency securities,municipal obligations and mortgage-backed securities (e.g., thosereceiving an investment grade rating from Standard & Poor’s or Moody’s).

Increases and decreases in prevailing interest ratesgenerally translate into decreases and increases in fair values of fixedmaturity investments, respectively. Additionally, fair values of interest ratesensitive instruments may be affected by the creditworthiness of the issuer,prepayment options, relative values of alternative investments, the liquidityof the instrument and other general market conditions.

Thetable below summarizes the estimated effects of hypothetical increases anddecreases in market interest rates on our fixed maturity investments andpension fixed maturity investments:

| ** **                          | ** ** | **Fair value at  December 31,  2006** | ** ** | **Assumed change  in relevant  interest rate** | ** ** | **Estimated fair value  after change in  interest rate** | ** **      | **After-tax increase  (decrease) in  carrying value** | ** ** |
|-------------------------------------|------------|------------------------------------------------------|------------|----------------------------------------------------------|------------|-----------------------------------------------------------------------------------|-----------------|----------------------------------------------------------------------|------------|
| ** **                          | ** ** | **($ in millions)**                        | ** ** |
| Fixed maturity  investments         |       |                                                 | $          | 3,843.7                                                  |       |                                                                              | 100 bp decrease |                                                                 |       | $ | 3,922.2 |   |   |   | $ | 51.0 |   |   |
|                                |       |                                                 |       |                                                     |       | 50 bp decrease                                                                    |            |                                                                 | 3,883.6    |   |   |   | 25.9 |   |   |
|                                |       |                                                 |       |                                                     |       | 50 bp increase                                                                    |            |                                                                 | 3,803.7    |   |   |   | (26.0 | ) |   |
|                                |       |                                                 |       |                                                     |       | 100 bp increase                                                                   |            |                                                                 | 3,762.9    |   |   |   | (52.5 | ) |   |
| Pension fixed  maturity investments |       |                                                 | $          | 286.9                                                    |       |                                                                              | 100 bp decrease |                                                                 |       | $ | 295.3 |   |   |   | $ | 5.5 |   |   |
|                                |       |                                                 |       |                                                     |       | 50 bp decrease                                                                    |            |                                                                 | 291.1      |   |   |   | 2.7 |   |   |
|                                |       |                                                 |       |                                                     |       | 50 bp increase                                                                    |            |                                                                 | 282.6      |   |   |   | (2.8 | ) |   |
|                                |       |                                                 |       |                                                     |       | 100 bp increase                                                                   |            |                                                                 | 278.5      |   |   |   | (5.5 | ) |   |

 

*Long-term obligations.*As of December 31, 2006, our interest anddividend bearing long-term obligations consisted primarily of the Senior Notes,the Berkshire Preferred Stock and the Zenith Preferred Stock obligations, whichhave fixed interest and dividend rates. As a result, our exposure to interestrate risk resulting from variable interest rate obligations is insignificant.

The Senior Notes were issued in 2003 and mature on May 15,2013. At December 31, 2006, the fair value of the Senior Notes was$705.4 million, which compared to a carrying value of $698.7 million.The Berkshire Preferred Stock and Zenith Preferred Stock obligations wereissued in 2001 and mature on May 31, 2008 and May 31, 2011,respectively. At the Company’s option, the Zenith Preferred Stock may beredeemed on June 30, 2007. At December 31, 2006, the fair values ofthe Berkshire Preferred Stock and 

95

----

Zenith Preferred Stockobligations were $331.5 million and $21.6 million, respectively,which compared to carrying values of $242.3 million and$20.0 million, respectively.

The fair values of these obligations were estimated bydiscounting future cash flows using current market rates for similarobligations or using quoted market prices.

*Equity Price Risk.*The carrying values of our common equity securitiesand our other investments are based on quoted market prices or management’sestimates of fair value (which is based, in part, on quoted market prices) asof the balance sheet date. Market prices of common equity securities, ingeneral, are subject to fluctuations which could cause the amount to berealized upon sale or exercise of the instruments to differ significantly fromthe current reported value. The fluctuations may result from perceived changesin the underlying economic characteristics of the investee, the relative priceof alternative investments, general market conditions and supply and demandimbalances for a particular security.

*Foreign Currency ExchangeRates.*Our investments denominated inforeign currencies are valued using period-end exchange rates and our netinvestment income on foreign-denominated securities are valued usingaverage exchange rates. Foreign currency exchange rate risk is the risk that wewill incur losses on a U.S. dollar basis due to adverse changes in foreigncurrency exchange rates.

At December 31, 2006, we held $258.5 millionin bonds denominated in foreign currencies, mostly in British pounds andAustralian dollars. Assuming a hypothetical 10% increase or decrease in therate of exchange from the British pound and Australian dollar to the U.S.dollar as of December 31, 2006, the carrying value of our foreign currency-denominatedbond portfolio would have respectively decreased or increased by$25.9 million.

*Mortgage Note on RealEstate Owned.*In connection with our purchaseof land and an office building in 2005 that became our U.S. headquarters in thefourth quarter of 2006, we entered into a $40.8 million, 18-yearmortgage note which has a variable interest rate based upon the lender’s30 day LIBOR rate. As of December 31, 2006, we had fully drawn on themortgage note. Repayment will commence in January 2009.

*Cash Flow Hedge.*Concurrentwith entering into the mortgage note in 2005, we also entered into an interestrate swap to hedge our exposure to the variability in the interest rate on themortgage note. The notional amount of the swap is equal to the debt outstandingon the mortgage note and will be adjusted to match the drawdowns and repaymentson the mortgage note so that the principal amount of the mortgage note and thenotional amount of the swap are equal at all times. Under the terms of theswap, we pay a fixed interest rate of approximately 6% and receive a variableinterest rate based on the same LIBOR index used for the mortgage note.Interest paid or received on the swap is reported in interest expense. Inaccordance with SFAS No. 133, “Accounting for Derivative Instruments andHedging Activities”, or SFAS 133, we have accounted for the swap as a cashflow hedge and have recorded the interest rate swap at fair value on thebalance sheet in other assets. Changes in the fair value of the interest rateswap, which was a $0.6 million gain, after-tax, for the year ended December 31,2006, is reported as a component of other comprehensive income. We monitorcontinued effectiveness of the hedge by monitoring the changes in the terms ofthe instruments as described above as compared to the actual changes inprincipal and notional amount in the mortgage note and interest rate swap,respectively.

**ITEM 8.**                FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA

The financial statementsand supplementary data have been filed as a part of this Annual Report on Form 10-Kas indicated in the Index to Consolidated Financial Statements and FinancialStatement Schedules appearing on page F-1 of this report.

96

----

**ITEM 9.**                CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

**ITEM 9A.**        CONTROLSAND PROCEDURES

The Company is not anaccelerated filer and therefore is not required to include the assessment andreports required under this item until its annual report on Form 10-Kis filed for the fiscal year ended December 31, 2007.

**ITEM 9B.**    OTHERINFORMATION

None.

97

----

**PART III**

**ITEM 10.**      DIRECTORS,EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE

**a.     Directors**

Reported under thecaption “The Board of Directors” in the Company’s 2007 Proxy Statement andincorporated herein by reference.

**b.     ExecutiveOfficers**

Reported in Part Ipursuant to General Instruction G to Form 10-K.

**c.      AuditCommittee Financial Expert**

Reported under thecaption “Corporate Governance—Committees of the Board—Audit Committee” of theCompany’s 2007 Proxy Statement and incorporated herein by reference.

**d.     Compliancewith Section 16(a) of the Exchange Act**

Reported under thecaption “Compliance with Section 16(a) of the Exchange Act” of theCompany’s 2007 Proxy Statement, and incorporated herein by reference.

**e.      Codeof Ethics**

The Company’s Codeof Business Conduct, which applies to all directors, officers and employees incarrying out their responsibilities to and on behalf of the Company, is postedon the Company’s website at www.onebeacon.com.

**f.      NominatingCommittee**

There have been nomaterial changes to the procedure by which shareholders may recommend nomineesto the Company’s Board of Directors. The procedures for shareholders tonominate directors may be found in the Company’s 2007 Proxy Statement.

**ITEM 11.**         EXECUTIVECOMPENSATION

Reported under the captions“Compensation of Executive Officers”, “Report of the Compensation Committee onExecutive Compensation” and “Member Performance Graph” of the Company’s 2007Proxy Statement, and incorporated herein by reference.

**ITEM 12.**         SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDERMATTERS

Reported under thecaptions “Voting Securities and Principal Holders Thereof” and “EquityCompensation Plan Information” of the Company’s 2007 Proxy Statement, andincorporated herein by reference.

**ITEM 13.**         CERTAINRELATIONSHIPS, RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE

Reported under the caption“Certain Relationships, Related Transactions and Director Independence” of theCompany’s 2007 Proxy Statement, and incorporated herein by reference.

**ITEM 14.**         PRINCIPALACCOUNTANT FEES AND SERVICES

Reported under the caption “Independent RegisteredPublic Accountant Fees and Services” of the Company’s 2007 Proxy Statement, andincorporated herein by reference.

98

----

**PART IV**

**ITEM15.**         EXHIBITS AND FINANCIALSTATEMENT SCHEDULES

**a.     DocumentsFiled as Part of the Report**

The financialstatements and financial statement schedules and reports of independentauditors have been filed as part of this Annual Report on Form 10-Kas indicated in the Index to Consolidated Financial Statements and FinancialStatement Schedules appearing on page F-1 of this report. A listing ofexhibits filed as part of the report appears on pages 99 through 100 ofthis report.

**b.     Exhibits**
| Exhibit  No.        | ** ** | **Description**                                                                                                                                                                                |
|---------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   1.1**   |       | Form of  Underwriting Agreement.                                                                                                                                                          |
|   2.1**   |       | Form of Separation  Agreement between White Mountains Insurance Group, Ltd. and OneBeacon  Insurance Group, Ltd.                                                                          |
|   3.1**   |       | Memorandum of  Association of OneBeacon Insurance Group, Ltd.                                                                                                                                  |
|   3.1.1** |       | Certificate of Deposit  of Memorandum of Increase of Share Capital dated October 31, 2006.                                                                                                |
|   3.2**   |       | Bye-laws of  OneBeacon Insurance Group, Ltd.                                                                                                                                                   |
|   4.1**   |       | Specimen Class A  common share certificate.                                                                                                                                               |
|   4.3**   |       | Form of  Registration Rights Agreement between OneBeacon Insurance Group, Ltd. and  White Mountains Insurance Group, Ltd.                                                                 |
| 10.1**              |       | Form of Separation  Agreement between White Mountains Insurance Group, Ltd. and OneBeacon  Insurance Group, Ltd. (filed as Exhibit 2.1).                                             |
| 10.2.1**            |       | Form of Existing  Investment Management Agreement with White Mountains Advisors LLC (formerly  known as OneBeacon Asset Management, Inc.).                                           |
| 10.2.2**            |       | Form of Side-by-Side  Investment Management Agreement between White Mountains Advisors LLC and  OneBeacon Insurance Group, Ltd.                                                           |
| 10.2.3*             |       | Investment Management  Agreement with White Mountains Advisors LLC, dated as of November 14,  2006.                                                                                       |
| 10.3.1**            |       | Form of Investment  Management Agreement with Prospector Partners, LLC.                                                                                                                   |
| 10.4.1**            |       | OneBeacon Performance  Unit Plan (as amended).                                                                                                                                                 |
| 10.4.2**            |       | OneBeacon Phantom White  Mountains Share Plan.                                                                                                                                                 |
| 10.4.3**            |       | OneBeacon Long-Term  Incentive Plan.                                                                                                                                                           |
| 10.4.4**            |       | White Mountains Long-Term  Incentive Plan.                                                                                                                                                     |
| 10.4.5**            |       | OneBeacon 2006  Management Incentive Plan.                                                                                                                                                     |
| 10.4.6**            |       | OneBeacon Deferred  Compensation Plan.                                                                                                                                                         |
| 10.4.7**            |       | OneBeacon Insurance  Group, Ltd. Non-Qualified Stock Option Agreement.                                                                                                                         |
| 10.5.1**            |       | Senior Indenture dated  as of May 19, 2003, among Fund American Companies, Inc., White  Mountains Insurance Group, Ltd. and Bank One, National Association, as  Trustee.             |
| 10.5.2**            |       | First Supplemental  Indenture dated as of May 19, 2003, among Fund American  Companies, Inc., White Mountains Insurance Group, Ltd. and Bank One, National  Association, as Trustee. |

99

----

 
| 10.6.1.1** |   | Adverse Development  Agreement of Reinsurance No. 8888 between Potomac Insurance Company  (“PIC”) and General Re Corporation dated April 13, 2001.                                                                                                                |
|------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.6.1.2** |   | Adverse Development  Agreement of Reinsurance between CGU Insurance Company (and certain of its  affiliates) and PIC dated April 13, 2001.                                                                                                                                       |
| 10.6.2.1** |   | Aggregate Loss Portfolio  Reinsurance Agreement between PIC and NICO dated March 15, 2001.                                                                                                                                                                                       |
| 10.6.2.2** |   | Aggregate Loss Portfolio  Reinsurance Agreement between CGU Insurance Company and PIC dated  March 15, 2001.                                                                                                                                                                     |
| 10.7.1*    |   | Trust Agreement between  Fund American Companies, Inc. and White Mountains Capital, Inc.  dated as of November 14, 2006.                                                                                                                                               |
| 10.7.2*    |   | Trust Agreement between  Fund American Enterprises Holdings, Inc. and White Mountains  Capital, Inc. dated as of November 14, 2006.                                                                                                                                    |
| 10.8*      |   | Credit Agreement dated  as of November 14, 2006 among Fund American Companies, Inc.,  OneBeacon Insurance Group Ltd., the Lenders from time to time party  thereto and Bank of America, N.A., as Administrative Agent, Swing Line  Lender and the Issuing Lender. |
| 10.9**     |   | Guaranty Services  Agreement between OneBeacon Insurance Company and Galileo Weather Risk  Management Ltd.                                                                                                                                                                            |
| 10.10**    |   | Construction Loan  Agreement between OneBeacon Insurance Company and Citizens Bank of  Massachusetts dated December 16, 2005.                                                                                                                                                    |
| 10.11**    |   | Amended and Restated  Certificate of Designation of Series A Preferred Stock of Fund American  Companies, Inc.                                                                                                                                                              |
| 12.1*      |   | Statement of Computation  of Earnings to Fixed Charges.                                                                                                                                                                                                                               |
| 21.1*      |   | List of Subsidiaries.                                                                                                                                                                                                                                                                 |
| 23.1*      |   | Consent of  PricewaterhouseCoopers LLP.                                                                                                                                                                                                                                          |
| 24.1*      |   | Power of Attorney  (included on signature page to the Registration Statement).                                                                                                                                                                                                   |
| 31.1*      |   | Certification  of T. Michael Miller pursuant to Section 302 of the Sarbanes-Oxley Act  of 2002.                                                                                                                                                                                  |
| 31.2*      |   | Certification of Paul H.  McDonough pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                   |
| 32.1***    |   | Certification of T.  Michael Miller pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                              |
| 32.2***    |   | Certification of Paul H.  McDonough pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                              |

----

*       FiledHerewith

**    Previouslyfiled

***  Furnished Herewith

**c.      FinancialStatement Schedules**

The financial statement schedules and report ofindependent registered public accounting firm have been filed as part ofthis Annual Report on Form 10-K as indicated in the Index toConsolidated Financial Statements and Financial Statement Schedules appearingon page F-1 of this report.

100

----

**SIGNATURES**

Pursuantto the requirements of the Securities Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned, thereto dulyauthorized.

|                              | ** ** | **OneBeacon Insurance Group, Ltd.** |
|------------------------------|------------|------------------------------------------|
|                         | ** ** | ** **                               |
|                         | By:        | **/s/**T. MICHAEL MILLER                 |
|                         |       | T. Michael Miller                        |
| Date: February 28, 2007 |       | President and Chief Executive  Officer   |

 

POWER OF ATTORNEY

**KNOW ALL MEN** by these presents, that the undersigned does herebymake, constitute and appoint T. Michael Miller and Paul H. McDonough, and eachof them, as true and lawful attorney-in-fact and agent of the undersigned, withfull power of substitution, resubstitution and revocation, for and in the name,place and stead of the undersigned, to execute and deliver the Annual Report onForm 10-K, and any and all amendments thereto; such Form 10-Kand each such amendment to be in such form and to contain such terms andprovisions as said attorney or substitute shall deem necessary or desirable;giving and granting unto said attorney, or to such person or persons as in anycase may be appointed pursuant to the power of substitution herein given, fullpower and authority to do and perform any and every act and thing whatsoeverrequisite, necessary or, in the opinion of said attorney or substitute, able tobe done in and about the premises as fully and to all intents and purposes asthe undersigned might or could do if personally present, hereby ratifying andconfirming all that said attorney or such substitute shall lawfully do or causeto be done by virtue hereof.

**IN WITNESS WHEREOF,** the undersigned has duly executed these presentsthis 28th day of February, 2007.

Pursuantto the requirements of the Securities Act of 1934, this report has been signedby the following persons in the capacities and on the date indicated.

| Signature              | ** ** | **Title**                                      | ** ** | **Date**               |
|------------------------|------------|------------------------------------------------|------------|------------------------|
| /s/  T. MICHAEL MILLER | ** ** | President and Chief  Executive Officer         | ** ** | ** **             |
| T. Michael Miller      |       | (Principal Executive Officer) and Director     |       | February 28, 2007 |
|                   |       |                                           |       |                   |
| /s/ PAUL H. MCDONOUGH  |       | Chief Financial Officer (Principal             |       |                   |
| Paul H. McDonough      |       | Financial Officer)                             |       | February 28, 2007 |
|                   |       |                                           |       |                   |
| /s/ ANN MARIE ANDREWS  |       | Chief Accounting Officer (Principal Accounting |       |                   |
| Ann Marie Andrews      |       | Officer)                                       |       | February 28, 2007 |
|                   |       |                                           |       |                   |
| *                      |       | Director, Chairman of the Board                |       |                   |
| Lowndes A. Smith       |       |                                           |       | February 28, 2007 |
|                   |       |                                           |       |                   |
| *                      |       | Director                                       |       |                   |
| Reid T. Campbell       |       |                                           |       | February 28, 2007 |
|                   |       |                                           |       |                   |
| *                      |       | Director                                       |       |                   |
| Morgan W. Davis        |       |                                           |       | February 28, 2007 |
|                   |       |                                           |       |                   |

101

----

 

| *            |   | Director |   |                   |
|--------------|--------|----------|--------|------------------------|
| David T. Foy |   |     |   | February 28, 2007 |

 

| *                          |   | Director         |   |                   |
|----------------------------|--------|------------------|--------|------------------------|
| Lois W. Grady              |   |             |   | February 28, 2007 |
|                       |   |             |   |                   |
| *                          |   | Director         |   |                   |
| Richard P. Howard          |   |             |   | February 28, 2007 |
|                       |   |             |   |                   |
| *                          |   | Director         |   |                   |
| Robert R. Lusardi          |   |             |   | February 28, 2007 |
|                       |   |             |   |                   |
| *                          |   | Director         |   |                   |
| Kent D. Urness             |   |             |   | February 28, 2007 |
|                       |   |             |   |                   |
| *                          |   | Director         |   |                   |
| Allan L. Waters            |   |             |   | February 28, 2007 |
|                       |   |             |   |                   |
| *By: /s/ PAUL H. MCDONOUGH |   | Attorney-in-fact |   |                   |
| Paul H. McDonough          |   |             |   | February 28, 2007 |

 

102

----

**ONEBEACONINSURANCE GROUP, LTD.INDEX TO CONSOLIDATED FINANCIAL STATEMENTS**

|                                                                                                        | ** ** | **Form 10-K** |
|--------------------------------------------------------------------------------------------------------|------------|--------------------|
| ** **                                                                                             | ** ** | **Pages**          |
| **Audited Consolidated Financial  Statements**                                                         |       |               |
| Consolidated  Balance Sheets:                                                                          |       |               |
| As  of December 31, 2005 and 2006                                                                 |       | F-2                |
| Consolidated Statements of Income and Comprehensive  Income:                                           |       |               |
| For the years ended December 31, 2004, 2005 and  2006                                             |       | F-3                |
| Consolidated Statements of Common Shareholders’  Equity:                                          |       |               |
| For the years ended December 31, 2004, 2005 and  2006                                             |       | F-4                |
| Consolidated Statements of Cash Flows:                                                                 |       |               |
| For the years ended December 31, 2004, 2005 and  2006                                             |       | F-5                |
| Notes to Consolidated Financial Statements                                                             |       | F-6                |
| **Other  Financial Information:**                                                                      |       |               |
| Report of Independent Registered Public Accounting  Firm                                               |       | F-59               |
| Selected Quarterly Financial Data (Unaudited)                                                          |       | F-60               |
| **Financial  Statement Schedules:**                                                                    |       |               |
| I.     Summary  of investments—other than investments in related parties |       | S-1                |
| II.   Condensed  financial information of the Registrant                                |       | S-2                |
| III.  Supplementary  insurance information                                                   |       | S-3                |
| IV.  Reinsurance                                                                             |       | S-4                |
| V.   Valuation  and qualifying accounts                                                 |       | S-5                |
| VI.  Supplemental information for property  and casualty insurance underwriters              |       | S-6                |

 

F-1

----

**CONSOLIDATEDBALANCE SHEETS**

| ** **                                                                                                                             | ** ** | **December 31,**                                                                   | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------|------------|
| ** **                                                                                                                             | ** ** | **2005**                                                                                | ** ** | **2006** | ** ** |
| ** **                                                                                                                             | ** ** | **($ in millions, except  share and per share  amounts)** | ** ** |
| **Assets**                                                                                                                             |       |                                                                                    |       |   |   |
| Available-for-sale investments:                                                                                                        |       |                                                                                    |       |   |   |
| Fixed maturity  investments, at fair value (amortized cost $3,650.6 and $3,501.5)                                                      |       | $                                                                                       | 3,690.4    |   | $ | 3,539.7 |   |
| Common equity  securities, at fair value (cost $459.3 and $568.9)                                                                      |       | 591.3                                                                                   |       | 737.1 |   |
| Short-term  investments, at amortized cost (which approximates fair value)                                                             |       | 207.6                                                                                   |       | 319.0 |   |
| Held-to-maturity investments (assets held in trust):                                                                                   |       |                                                                                    |       |   |   |
| Fixed maturity  investments, at amortized cost (estimated fair value $0 and $304.0)                                                    |       | —                                                                                  |       | 305.0 |   |
| Short-term  investments, at amortized cost (which approximates fair value)                                                             |       | —                                                                                  |       | 33.8 |   |
| Other investments (cost  $240.4 and $229.5)                                                                                            |       | 275.2                                                                                   |       | 278.1 |   |
| Total investments                                                                                                                      |       | 4,764.5                                                                                 |       | 5,212.7 |   |
| Cash                                                                                                                                   |       | 44.1                                                                                    |       | 41.5 |   |
| Reinsurance recoverable  on unpaid losses                                                                                              |       | 1,171.6                                                                                 |       | 1,032.6 |   |
| Reinsurance recoverable  on unpaid losses—Berkshire Hathaway, Inc.                                                           |       | 1,949.3                                                                                 |       | 1,810.0 |   |
| Reinsurance recoverable  on paid losses                                                                                                |       | 24.3                                                                                    |       | 32.4 |   |
| Premiums receivable                                                                                                                    |       | 605.1                                                                                   |       | 517.1 |   |
| Securities lending  collateral                                                                                                         |       | 447.1                                                                                   |       | 528.8 |   |
| Deferred acquisition  costs                                                                                                            |       | 204.4                                                                                   |       | 183.8 |   |
| Investment in  unconsolidated affiliate                                                                                                |       | 168.0                                                                                   |       | — |   |
| Deferred tax asset                                                                                                                     |       | 108.5                                                                                   |       | 61.2 |   |
| Intercompany debt  receivable                                                                                                          |       | 76.6                                                                                    |       | — |   |
| Investment income  accrued                                                                                                             |       | 46.2                                                                                    |       | 34.8 |   |
| Ceded unearned premiums                                                                                                                |       | 28.0                                                                                    |       | 38.2 |   |
| Accounts receivable on  unsettled investment sales                                                                                     |       | 2.9                                                                                     |       | 6.7 |   |
| Other assets                                                                                                                           |       | 339.7                                                                                   |       | 369.6 |   |
| Assets of discontinued  operations                                                                                                     |       | 272.4                                                                                   |       | — |   |
| Total assets                                                                                                                           |       | $                                                                                       | 10,252.7   |   | $ | 9,869.4 |   |
| **Liabilities**                                                                                                                        |       |                                                                                    |       |   |   |
| Loss and LAE reserves                                                                                                                  |       | $                                                                                       | 5,354.3    |   | $ | 4,837.7 |   |
| Unearned premiums                                                                                                                      |       | 1,042.8                                                                                 |       | 985.2 |   |
| Debt                                                                                                                                   |       | 744.9                                                                                   |       | 759.5 |   |
| Securities lending  payable                                                                                                            |       | 447.1                                                                                   |       | 528.8 |   |
| Preferred stock subject  to mandatory redemption:                                                                                      |       |                                                                                    |       |   |   |
| Held by Berkshire  Hathaway Inc. (redemption value $300.0)                                                                             |       | 214.0                                                                                   |       | 242.3 |   |
| Held by others  (redemption value $20.0)                                                                                               |       | 20.0                                                                                    |       | 20.0 |   |
| Ceded reinsurance  payable                                                                                                             |       | 77.1                                                                                    |       | 71.9 |   |
| Accounts payable on  unsettled investment purchases                                                                                    |       | 1.9                                                                                     |       | 11.5 |   |
| Other liabilities                                                                                                                      |       | 588.4                                                                                   |       | 635.3 |   |
| Liabilities of  discontinued operations                                                                                                |       | 202.2                                                                                   |       | — |   |
| Total liabilities                                                                                                                      |       | 8,692.7                                                                                 |       | 8,092.2 |   |
| **Common shareholders’ equity**                                                                                                   |       |                                                                                    |       |   |   |
| Common shares and paid-in  surplus (par value $0.01; authorized, 200,000,000 shares; issued and  outstanding, 100,013,292 shares) |       | 1,169.8                                                                                 |       | 1,115.9 |   |
| Retained earnings                                                                                                                      |       | 232.6                                                                                   |       | 474.4 |   |
| Accumulated other  comprehensive income, after-tax:                                                                                    |       |                                                                                    |       |   |   |
| Net unrealized gains on  investments                                                                                                   |       | 163.1                                                                                   |       | 173.1 |   |
| Net unrealized foreign  currency translation (losses) gains                                                                            |       | (1.6                                                                                    | )          | 11.8 |   |
| Other comprehensive  (loss) income items                                                                                               |       | (3.9                                                                                    | )          | 2.0 |   |
| Total common  shareholders’ equity                                                                                                |       | 1,560.0                                                                                 |       | 1,777.2 |   |
| Total liabilities and common shareholders’ equity                                                                                 |       | $                                                                                       | 10,252.7   |   | $ | 9,869.4 |   |

 

See Notes to Consolidated Financial Statements including Note 19—“Commitments and Contingencies.”

F-2

----

**CONSOLIDATEDSTATEMENTS OF INCOME AND COMPREHENSIVE INCOME**

 

| ** **                                                                                    | ** ** | **Year ended December 31,**                                  | ** ** |
|-----------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|
| ** **                                                                                    | ** ** | **2004**                                                                    | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                                                                    | ** ** | **($ in millions, except per share amounts)** | ** ** |
| **Revenues**                                                                                  |       |                                                                        |       |   |   |   |   |
| Earned premiums                                                                               |       | $                                                                           | 2,087.1    |   | $ | 2,012.7 |   | $ | 2,075.9 |   |
| Net investment income                                                                         |       | 209.6                                                                       |       | 236.8 |   | 191.8 |   |
| Net realized investment  gains                                                                |       | 128.8                                                                       |       | 123.2 |   | 163.6 |   |
| Net other revenues                                                                            |       | 59.5                                                                        |       | 24.1 |   | 38.8 |   |
| Total revenues                                                                                |       | 2,485.0                                                                     |       | 2,396.8 |   | 2,470.1 |   |
| **Expenses**                                                                                  |       |                                                                        |       |   |   |   |   |
| Loss and LAE                                                                                  |       | 1,385.4                                                                     |       | 1,390.4 |   | 1,283.6 |   |
| Policy acquisition  expenses                                                                  |       | 359.8                                                                       |       | 349.3 |   | 379.9 |   |
| Other underwriting  expenses                                                                  |       | 350.0                                                                       |       | 263.4 |   | 360.1 |   |
| General and  administrative expenses                                                          |       | 81.9                                                                        |       | 8.4 |   | 15.3 |   |
| Accretion of fair value  adjustment to loss and LAE reserves                                  |       | 33.2                                                                        |       | 26.0 |   | 23.0 |   |
| Interest expense on debt                                                                      |       | 45.0                                                                        |       | 44.1 |   | 45.5 |   |
| Interest expense—dividends  on preferred stock subject to mandatory redemption           |       | 30.3                                                                        |       | 30.3 |   | 30.3 |   |
| Interest  expense—accretion on preferred stock subject to mandatory redemption           |       | 17.3                                                                        |       | 22.1 |   | 28.3 |   |
| Total expenses                                                                                |       | 2,302.9                                                                     |       | 2,134.0 |   | 2,166.0 |   |
| **Pre-tax income**                                                                            |       | 182.1                                                                       |       | 262.8 |   | 304.1 |   |
| Income tax provision                                                                          |       | (49.4                                                                       | )          | (82.1 | ) | (68.9 | ) |
| **Income from continuing  operations before equity in earnings of unconsolidated affiliates** |       | 132.7                                                                       |       | 180.7 |   | 235.2 |   |
| Equity in earnings of  unconsolidated affiliates                                              |       | 27.4                                                                        |       | 5.6 |   | 10.3 |   |
| **Income from continuing  operations**                                                        |       | 160.1                                                                       |       | 186.3 |   | 245.5 |   |
| (Loss) income from  discontinued operations                                                   |       | (24.1                                                                       | )          | 25.2 |   | 1.2 |   |
| Gain from sale of  discontinued operations, net of tax                                        |       | —                                                                      |       | 21.1 |   | — |   |
| **Net income**                                                                                |       | 136.0                                                                       |       | 232.6 |   | 246.7 |   |
| Change in net unrealized  gains and losses for investments held                               |       | 136.9                                                                       |       | (57.5 | ) | 100.4 |   |
| Recognition of net  unrealized gains and losses for investments sold                          |       | (69.3                                                                       | )          | (60.4 | ) | (84.9 | ) |
| Change in foreign  currency translation                                                       |       | 16.7                                                                        |       | (25.2 | ) | 13.2 |   |
| Change in other  comprehensive income (loss) items                                            |       | —                                                                      |       | (1.7 | ) | 0.3 |   |
| **Comprehensive net income**                                                                  |       | $                                                                           | 220.3      |   | $ | 87.8 |   | $ | 275.7 |   |
| **Basic and diluted earnings per share**                                                      |       |                                                                        |       |   |   |   |   |
| Basic:                                                                                        |       |                                                                        |       |   |   |   |   |
| Income from continuing  operations                                                            |       | $                                                                           | 1.60       |   | $ | 1.86 |   | $ | 2.46 |   |
| (Loss) income from  discontinued operations                                                   |       | (0.24                                                                       | )          | 0.25 |   | 0.01 |   |
| Gain from sale of  discontinued operations, net of tax                                        |       | —                                                                      |       | 0.21 |   | — |   |
| Net income available to  common shareholders                                                  |       | $                                                                           | 1.36       |   | $ | 2.33 |   | $ | 2.47 |   |
| Diluted:                                                                                      |       |                                                                        |       |   |   |   |   |
| Income from continuing  operations                                                            |       | $                                                                           | 1.60       |   | $ | 1.86 |   | $ | 2.46 |   |
| (Loss) income from  discontinued operations                                                   |       | (0.24                                                                       | )          | 0.25 |   | 0.01 |   |
| Gain from sale of  discontinued operations, net of tax                                        |       | —                                                                      |       | 0.21 |   | — |   |
| Net income available to common shareholders                                                   |       | $                                                                           | 1.36       |   | $ | 2.33 |   | $ | 2.47 |   |
|                                                                                               |            |                                                                             |            |  |  |  |  |  |  |  |  |  |  |  |

 

See Notes to Consolidated Financial Statements.

F-3

----

**CONSOLIDATEDSTATEMENTS OF COMMON SHAREHOLDERS’ EQUITY**

| ** **                                                          | ** ** | **Common  shareholders’  equity** | ** ** | **Common  shares and  paid-in  surplus** | ** ** | **Retained  earnings** | ** ** | **Accum. other  comprehensive  income,  after-tax** | ** ** |
|---------------------------------------------------------------------|------------|----------------------------------------|------------|-----------------------------------------------|------------|------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                          | ** ** | **($ in millions)**          | ** ** |
| Balances at  January 1, 2004                                   |       |                                   | $          | 2,804.1                                       |       |                   | $          | 1,884.8                                                  |       | $ | 637.2 |   |   | $ | 282.1 |   |   |
| Net income                                                          |       |                                   | 136.0      |                                          |       | —                 |       | 136.0                                                    |       |   | — |   |   |
| Other  comprehensive income, after-tax                              |       |                                   | 84.3       |                                          |       | —                 |       | —                                                   |       |   | 84.3 |   |   |
| Dividends to  White Mountains                                       |       |                                   | (773.2     | )                                             |       | —                 |       | (773.2                                                   | )          |   | — |   |   |
| Distributions of  capital to White Mountains                        |       |                                   | (1,833.7   | )                                             |       | (1,769.8               | )          | —                                                   |       |   | (63.9 | ) |   |
| Balances at  December 31, 2004                                 |       |                                   | 417.5      |                                          |       | 115.0                  |       | —                                                   |       |   | 302.5 |   |   |
| Net income                                                          |       |                                   | 232.6      |                                          |       | —                 |       | 232.6                                                    |       |   | — |   |   |
| Other  comprehensive loss, after-tax                                |       |                                   | (144.9     | )                                             |       | —                 |       | —                                                   |       |   | (144.9 | ) |   |
| Contributions of  capital from White Mountains                      |       |                                   | 1,054.8    |                                          |       | 1,054.8                |       | —                                                   |       |   | — |   |   |
| Balances at  December 31, 2005                                 |       |                                   | 1,560.0    |                                          |       | 1,169.8                |       | 232.6                                                    |       |   | 157.6 |   |   |
| Adjustment to adopt SFAS No. 155, after-tax                    |       |                                   | —     |                                          |       | —                 |       | 7.1                                                      |       |   | (7.1 | ) |   |
| Net income                                                          |       |                                   | 246.7      |                                          |       | —                 |       | 246.7                                                    |       |   | — |   |   |
| Other  comprehensive income, after-tax                              |       |                                   | 29.0       |                                          |       | —                 |       | —                                                   |       |   | 29.0 |   |   |
| Dividends to White  Mountains                                       |       |                                   | (12.0      | )                                             |       | —                 |       | (12.0                                                    | )          |   | — |   |   |
| (Distributions)  contributions of capital (to) from White Mountains |       |                                   | (52.7      | )                                             |       | (54.4                  | )          | —                                                   |       |   | 1.7 |   |   |
| Issuance of  common shares                                          |       |                                   | 0.3        |                                          |       | 0.3                    |       | —                                                   |       |   | — |   |   |
| Accrued stock  option expense                                       |       |                                   | 0.2        |                                          |       | 0.2                    |       | —                                                   |       |   | — |   |   |
| Adjustment to adopt  SFAS No. 158, after-tax                   |       |                                   | 5.7        |                                          |       | —                 |       | —                                                   |       |   | 5.7 |   |   |
| Balances at  December 31, 2006                                 |       |                                   | $          | 1,777.2                                       |       |                   | $          | 1,115.9                                                  |       | $ | 474.4 |   |   | $ | 186.9 |   |   |

 

See Notes to Consolidated Financial Statements.

F-4

----

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

| ** **                                                                         | ** ** | **Year ended December 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                         | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                                                         | ** ** | **($ in millions)**              | ** ** |
| Cash flows from operations:                                                        |       |                                       |       |   |   |   |   |
| Net income                                                                         |       | $                                          | 136.0      |   | $ | 232.6 |   | $ | 246.7 |   |
| Charges (credits) to reconcile net income to cash  flows used for operations:      |       |                                       |       |   |   |   |   |
| Loss (income) from  discontinued operations                                        |       | 24.1                                       |       | (25.2 | ) | (1.2 | ) |
| Gain from sale of  discontinued operations                                         |       | —                                     |       | (21.1 | ) | — |   |
| Net realized investment  gains                                                     |       | (128.8                                     | )          | (123.2 | ) | (163.6 | ) |
| Other operating items:                                                             |       |                                       |       |   |   |   |   |
| Net change in loss and  LAE reserves                                               |       | (868.0                                     | )          | 443.8 |   | (516.6 | ) |
| Net change in unearned  premiums                                                   |       | —                                     |       | 41.4 |   | (57.6 | ) |
| Net change in premiums  receivable                                                 |       | (94.8                                      | )          | (81.4 | ) | 88.0 |   |
| Net change in reinsurance  recoverable on paid and unpaid losses                   |       | 312.2                                      |       | (710.9 | ) | 270.2 |   |
| Net change in other  assets and liabilities                                        |       | (173.8                                     | )          | (185.7 | ) | 193.1 |   |
| Net cash (used for)  provided from operating activities of continuing operations   |       | (793.1                                     | )          | (429.7 | ) | 59.0 |   |
| Net cash provided from  (used for) operating activities of discontinued operations |       | 109.6                                      |       | 84.9 |   | (22.0 | ) |
| Net cash (used  for) provided from operations                                      |       | (683.5                                     | )          | (344.8 | ) | 37.0 |   |
| Cash flows from investing activities:                                              |       |                                       |       |   |   |   |   |
| Net change in short-term  investments available-for-sale                           |       | 140.9                                      |       | 159.8 |   | (117.3 | ) |
| Net change in short-term  investments held-to-maturity                             |       | —                                     |       | — |   | (33.8 | ) |
| Sales of fixed maturity  investments                                               |       | 3,792.1                                    |       | 2,974.9 |   | 1,833.3 |   |
| Maturities of fixed  maturity investments                                          |       | 666.4                                      |       | 48.5 |   | 480.2 |   |
| Sales of common equity  securities                                                 |       | 202.0                                      |       | 389.4 |   | 433.5 |   |
| Sales of other  investments                                                        |       | 26.7                                       |       | 16.9 |   | 17.8 |   |
| Sales of consolidated and  unconsolidated affiliate, net of cash sold              |       | 192.0                                      |       | 23.4 |   | 11.1 |   |
| Sale of renewal rights                                                             |       | —                                     |       | — |   | 32.0 |   |
| Sale of discontinued  operations                                                   |       | —                                     |       | 138.2 |   | 95.7 |   |
| Purchase of consolidated  affiliate, net of cash acquired                          |       | (30.0                                      | )          | — |   | — |   |
| Purchases of fixed  maturity investments available-for-sale                        |       | (3,834.5                                   | )          | (2,904.8 | ) | (2,135.5 | ) |
| Purchases of common  equity securities                                             |       | (100.9                                     | )          | (291.4 | ) | (413.4 | ) |
| Purchases of other  investments                                                    |       | (80.6                                      | )          | (115.5 | ) | (72.0 | ) |
| Purchases of fixed  maturity investments held-to-maturity                          |       | —                                     |       | — |   | (303.3 | ) |
| Net change in unsettled  investment purchases and sales                            |       | (60.2                                      | )          | (0.4 | ) | 5.8 |   |
| Net acquisitions of  property and equipment                                        |       | (4.2                                       | )          | (31.9 | ) | (8.0 | ) |
| Net cash provided  from (used for) investing activities of continuing operations   |       | 909.7                                      |       | 407.1 |   | (173.9 | ) |
| Net cash (used  for) provided from investing activities of discontinued operations |       | (61.5                                      | )          | (12.5 | ) | 19.8 |   |
| Net cash provided  from (used for) investing activities                            |       | 848.2                                      |       | 394.6 |   | (154.1 | ) |
| Cash flows from financing activities:                                              |       |                                       |       |   |   |   |   |
| Proceeds from issuances  of debt                                                   |       | —                                     |       | 18.4 |   | 22.4 |   |
| Repayment of debt                                                                  |       | —                                     |       | — |   | (8.0 | ) |
| Repayment of loans by  affiliates                                                  |       | —                                     |       | — |   | 303.8 |   |
| Loans to affiliates                                                                |       | —                                     |       | (34.0 | ) | (102.6 | ) |
| Distributions and  dividends to White Mountains                                    |       | (115.2                                     | )          | — |   | (70.8 | ) |
| Dividends paid on  mandatorily redeemable preferred stock of subsidiaries          |       | (30.3                                      | )          | (30.3 | ) | (30.3 | ) |
| Contributions of capital  from White Mountains                                     |       | —                                     |       | 0.1 |   | — |   |
| Net cash (used  for) provided from financing activities of continuing operations   |       | (145.5                                     | )          | (45.8 | ) | 114.5 |   |
| Net cash used for  financing activities of discontinued operations                 |       | (9.1                                       | )          | — |   | — |   |
| Net cash (used  for) provided from financing activities                            |       | (154.6                                     | )          | (45.8 | ) | 114.5 |   |
| Net increase  (decrease) in cash during year                                       |       | 10.1                                       |       | 4.0 |   | (2.6 | ) |
| Cash balance at  beginning of year                                                 |       | 30.0                                       |       | 40.1 |   | 44.1 |   |
| Cash balance at  end of year                                                       |       | $                                          | 40.1       |   | $ | 44.1 |   | $ | 41.5 |   |

 

See Notes to Consolidated Financial Statements.

F-5

----

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

**NOTE 1. Nature ofOperations and Summary of Significant Accounting Policies**

The accompanying consolidated financial statementsinclude the accounts of OneBeacon Insurance Group, Ltd. (the “Company” orthe “Registrant”) and its subsidiaries (collectively, “OneBeacon”) and havebeen prepared in accordance with generally accepted accounting principles inthe United States of America (“GAAP”). The OneBeacon operating companies areU.S.-based property and casualty insurance writers, substantially all ofwhich operate in a multi-company pool. OneBeacon offers a wide range ofspecialty, commercial and personal products and services sold primarily throughselect independent agencies and brokers.

OneBeacon was acquired by White MountainsGroup, Ltd. (“White Mountains”) from Aviva plc (“Aviva”, formerly CGNU) in2001 (the “OneBeacon Acquisition”). White Mountains is a holding company whosebusinesses provide property and casualty insurance, reinsurance and certainother products. During the fourth quarter of 2006, White Mountains sold 27.6million or 27.6% of the Company’s common shares in an initial public offering.Prior to the initial public offering, OneBeacon was a wholly-owned subsidiaryof White Mountains. Within this report, the term “OneBeacon” is used to referto one or more entities within the consolidated organization, as the contextrequires. The Company is a Bermuda exempted limited company with itsheadquarters located at the Bank of Butterfield Building, 42 Reid Street,6th Floor, Hamilton HM 12, Bermuda. The Company’s U.S. headquartersare located at 1 Beacon Lane, Canton, Massachusetts 02021, its principalexecutive office is located at 601 Carlson Parkway, Minnetonka, Minnesota 55305and its registered office is located at Clarendon House, 2 Church Street,Hamilton HM 11, Bermuda. OneBeacon also maintains its former U.S.headquarters located at 1 Beacon Street, Boston Massachusetts, 02108 which willbe vacated in the first quarter of 2007 as it completes the transition to itsnew U.S. headquarters in Canton, Massachusetts. OneBeacon’s reportable segmentsare Primary Insurance Operations, Affiliate Quota Shares, and Other Operations,as defined below.

OneBeacon’s Primary Insurance Operations segmentincludes the results of substantially all of its insurance operations, with theexception of certain quota share arrangements with affiliates of WhiteMountains as described below.

During 2004 and 2005, OneBeacon entered into two quotashare reinsurance arrangements with other subsidiaries of White Mountains.Under the Sirius Quota Share, OneBeacon ceded between 6% and 12% of businesswritten, effective April 1, 2004, to Sirius International InsuranceCorporation. Under the Esurance Quota Share, which was effective on January 1,2005, OneBeacon assumed approximately 85% of business written by EsuranceInsurance Company, which includes business written by its wholly-ownedsubsidiary, Esurance Property and Casualty Insurance Company. These quota shareagreements were commuted during the fourth quarter of 2006 in connection withthe Company’s initial public offering.

OneBeacon’s Other Operations segment consists of theCompany and its intermediate holding companies.

All significant intercompany transactions have beeneliminated in consolidation. The preparation of financial statements inconformity with GAAP requires management to make estimates and assumptions thataffect the reported amounts of assets and liabilities as of the date of thefinancial statements and the reported amounts of revenues and expenses duringthe reporting period. Actual results could differ from those estimates.

As discussed in furtherdetail in Note 2, “Discontinued Operations,” in 2004 and 2006, OneBeacondistributed or sold certain consolidated subsidiaries to White Mountains. Aspart of a reorganization immediately preceding the initial public offering,OneBeacon sold certain other consolidated subsidiaries to White Mountains on August 3,2006 at GAAP book value. In addition, OneBeacon sold National 

F-6

----

FarmersUnion Property and Casualty Company (“NFU”), its wholly-owned subsidiary, in September 2005.The distributed or sold subsidiaries, including those that were sold in August 2006,and NFU have been classified as discontinued operations. Accordingly, theresults of operations for the distributed or sold subsidiaries and NFU arepresented net of tax, as income or loss from discontinued operations in theconsolidated statements of income and comprehensive income. The assets andliabilities of the distributed or sold subsidiaries and NFU were aggregated andpresented under separate captions on the consolidated balance sheets. NFU’sresults of operations are included in discontinued operations through the dateof its sale. The gain on sale of NFU is included in gain from discontinuedoperations, net of tax, in 2005. Cash flows associated with the operating,financing and investing activities of discontinued operations are aggregatedand presented under separate captions in the consolidated statements of cashflows.

***Basis of presentation***

*Investmentsecurities*

The majority of OneBeacon’s fixed maturity investmentsare classified as available-for-sale and are reported at fair value as of thebalance sheet date as determined by quoted market prices. The basis ofpresentation for OneBeacon’s portfolio of fixed maturity investments that isnot classified as available-for-sale is described below. OneBeacon’s portfolioof common equity securities is classified as available-for-sale and is reportedat fair value as of the balance sheet date as determined by quoted marketprices. Net unrealized investment gains and losses on available-for-salesecurities are reported net, after-tax, as a separate component of commonshareholders’ equity. Changes in net unrealized investment gains and losses,after-tax, are reported as a component of other comprehensive income.Investment securities are regularly reviewed for impairment based on criteriathat include the extent to which cost exceeds market value, the duration of themarket decline, the financial health of and specific prospects for the issuerand the ability and intent to hold the investment to recovery. Investmentlosses that are determined to be other-than-temporary are recognized inearnings. Realized gains and losses resulting from sales of investmentsecurities are accounted for using the weighted average method. Premiums anddiscounts on fixed maturity investments are accreted to income over theanticipated life of the investment.

OneBeacon owns convertible bonds with embeddedderivatives. Prior to January 1, 2006, in accordance with FinancialAccounting Standards Board (“FASB”) Statement of Financial Accounting Standards(“SFAS”) No. 133, “Accounting for Derivative Instruments and HedgingActivities” (“SFAS 133”), OneBeacon bifurcated all equity option derivativesthat are embedded in its convertible bonds. The original host instruments werereported, at fair value, in fixed maturity investments and the embeddedderivatives were reported, at fair value, in other investments. Changes in fairvalues of the equity options were included in realized investment gains andlosses. Effective January 1, 2006, OneBeacon adopted SFAS No. 155, “Accountingfor Certain Hybrid Instruments, an amendment to Statements No. 133 and 140”(“SFAS 155”). SFAS 155 eliminated the requirement to bifurcate financialinstruments with embedded derivatives if the holder of the instrument elects toaccount for the entire instrument on a fair value basis with changes in fairvalue of the entire instrument recorded through income as realized investmentgains or losses. Prior to adoption of SFAS 155, OneBeacon had recorded $143.6million related to the host instrument in fixed maturity investments and $73.6million for the equity conversion option in other investments. Upon adoption ofSFAS 155, OneBeacon recorded an adjustment of $7.1 million to reclassify netunrealized gains on investments (gross gains of $7.1 million and gross lossesof $0 million) to opening retained earnings to reflect the cumulative effect ofadoption. At December 31, 2006, OneBeacon had $379.7 million ofconvertible bonds recorded in fixed maturity investments.

Short-term investments consist of money market funds,certificates of deposit and other securities which, at the time of purchase,mature or become available for use within one year. Short-term 

F-7

----

investments are carried atamortized cost, which approximated fair value as of December 31, 2005 and2006.

In connection with the initial public offering and aspart of the reorganization described above, OneBeacon created two irrevocablegrantor trusts and funded them with assets sufficient to make the remainingdividend and redemption payments for $20 million of preferred stock that willbe redeemed in 2007 and $300 million of preferred stock that will be redeemedin May of 2008. See *Mandatorily Redeemable Preferred Stock* section of this noteand Note 11 for further discussion of preferred stock subject to mandatoryredemption. The cash contributed to fund these trusts was used to purchase aportfolio of fixed maturity securities. This portfolio of fixed maturityinvestments is classified as held-to-maturity and is reported at amortizedcost. The creation and funding of the trusts does not legally defease thepreferred stock or create any additional rights for the holders of preferredstock, although the assets in the trusts remain segregated from OneBeacon’sother general assets. OneBeacon has the ability and intent to hold theinvestments in this portfolio to maturity. Certain of the investments purchasedto fund the trusts mature within one year and are therefore reflected asshort-term investments. Consistent with the basis of presentation describedabove, these short-term investments are carried at amortized cost, whichapproximated fair value as of December 31, 2006. These investments arereferred to herein as “assets held in trust”.

Other investments include limited partnership, hedgefunds and private equity interests. Changes in OneBeacon’s interest in otherinvestments accounted for using the equity method are included in realizedinvestment gains or losses. Changes in OneBeacon’s interest in otherinvestments not accounted for under the equity method are reported, net of tax,as a component of common shareholders’ equity with changes therein reported,after-tax, as a component of other comprehensive income.

OneBeacon participates ina securities lending program as a mechanism for generating additionalinvestment income on its fixed maturity portfolio. Under the security lendingarrangements, certain of its fixed maturity investments are loaned to otherinstitutions for short periods of time through a lending agent. OneBeaconmaintains control over the securities it lends, retains the earnings and cashflows associated with the loaned securities and receives a fee from theborrower for the temporary use of the asset. Collateral, in the form of cashand United States government securities, is required at a rate of 102% of thefair value of the loaned securities, is controlled by the lending agent and maynot be sold or re-pledged. The fair value of the securities lending collateralis recorded as both an asset and liability on the balance sheet, however, otherthan in the event of default by the borrower, this collateral is not availableto OneBeacon and will be remitted to the borrower by the lending agent upon thereturn of the loaned securities. Because of these restrictions, OneBeaconconsiders its securities lending activities to be non cash transactions. Anindemnification agreement with the lending agent protects OneBeacon in theevent a borrower becomes insolvent or fails to return any of the securities onloan.

*Cash Flow Hedge*

Contemporaneously withentering into a variable rate mortgage note during 2005, as further describedin Note 7, OneBeacon entered into an interest rate swap agreement under whichit pays a fixed rate and receives a variable rate to hedge its exposure tointerest rate fluctuations. The notional amount of the swap is equal to theoutstanding principal of the mortgage note it hedges and is adjusted at thesame time as the mortgage note principal changes for drawdowns and repayments.The underlying index used to determine the variable interest paid under theswap is the same as that used for OneBeacon’s variable rate mortgage note. Inaccordance with SFAS 133, OneBeacon has accounted for the swap as a cashflow hedge and has recorded the interest rate swap at fair value on the balancesheet in other assets. Changes in the fair value of the interest rate swap,after tax, are reported as a component of other comprehensive income. OneBeaconmonitors continued effectiveness of the hedge by monitoring the changes in theterms of the 

F-8

----

instrumentsas described above as compared to the actual changes in principal and notionalamount in the mortgage note and interest rate swap, respectively.

*Cash*

Cash includes amounts onhand and demand deposits with banks and other financial institutions. Amountspresented in the statement of cash flows are shown net of balances acquired andsold in the purchase or sale of the Company’s consolidated subsidiaries.

*Insuranceoperations*

OneBeacon accounts for insurance policies that itwrites in accordance with SFAS No. 60, “Accounting and Reporting byInsurance Enterprises” (“SFAS 60”). Premiums written are recognized as revenuesand are earned ratably over the term of the related policy. Unearned premiumsrepresent the portion of premiums written that are applicable to futureinsurance coverage provided by policies. AutoOne, which acts as a limitedassigned distribution (“LAD”) servicing carrier, enters into contractualarrangements with insurance companies to assume private passenger andcommercial automobile assigned risk exposures in 22 states. AutoOnereceives LAD and commercial limited assigned distribution (“CLAD”) servicingfees from these other companies for assuming these risks. LAD and CLADservicing fees are typically a percentage of the total premiums that AutoOnemust write to fulfill the obligation of the transferor company. In addition,LAD servicing carriers may choose to write certain policies voluntarily bytaking risks out of the New York Automobile Insurance Plan (“NYAIP”). Thesepolicies generate takeout credits which can be “sold” for fees (“takeout fees”)to other carriers. These other carriers in turn can use such credits to reducetheir obligations to write assigned risk business. AutoOne’s LAD and CLADservicing and takeout fees are recorded as written premium when billed and areearned ratably over the term of the related policy to which the fee relates.

Deferred acquisition costs represent commissions,premium taxes, brokerage expenses and other costs which are directlyattributable to and vary with the production of new business. These costs aredeferred and amortized over the applicable premium recognition period as policyacquisition expenses. Deferred acquisition costs are limited to the amountexpected to be recovered from future earned premiums and anticipated investmentincome. This limitation is referred to as a premium deficiency. A premiumdeficiency is recognized if the sum of expected loss and loss adjustmentexpenses (“LAE”), unamortized acquisition costs, and maintenance costs exceedsrelated unearned premiums. A premium deficiency is recognized by charging anyunamortized acquisition costs to expense to the extent required in order toeliminate the deficiency. If the premium deficiency exceeds unamortizedacquisition costs then a liability is accrued for the excess deficiency. Forthe years ended December 31, 2004, 2005 and 2006, no deferredacquisition costs were charged to expense based on the determination of apremium deficiency.

Loss and LAE are charged against income as incurred.Unpaid insurance loss and LAE are based on estimates (generally determined byclaims adjusters, legal counsel and actuarial staff) of the ultimate costs ofsettling claims, including the effects of inflation and other societal andeconomic factors. Unpaid reinsurance loss and LAE are based primarily onreports received from ceding companies and actuarial projections. Unpaid lossand LAE reserves represent management’s best estimate of ultimate loss and LAE,net of estimated salvage and subrogation recoveries, if applicable. Suchestimates are regularly reviewed and updated and any adjustments resultingtherefrom are reflected in current operations. The process of estimating lossand LAE involves a considerable degree of judgment by management and theultimate amount of expense to be incurred could be considerably greater than orless than the amounts currently reflected in the financial statements.

OneBeacon discounts certain of its long term workerscompensation loss and LAE reserves when such liabilities constitute unpaid butsettled claims under which the payment pattern and ultimate costs are fixed 

F-9

----

and determinable on anindividual claim basis. OneBeacon discounts these reserves using an averagediscount rate which is determined based on the facts and circumstancesapplicable at the time the claims are settled (5.0% and 5.3% at December 31,2005 and 2006, respectively). As of December 31, 2005 and 2006, thediscount on OneBeacon’s workers compensation loss and LAE reserves amounted to$214.3 million and $190.7 million, respectively.

In connection with purchase accounting for the OneBeaconAcquisition, OneBeacon was required to adjust to fair value its loss and LAEreserves and the related reinsurance recoverables by $646.9 million and$346.9 million, respectively, on the acquired balance sheet as of June 1,2001. This net reduction to loss and LAE reserves of $300.0 million isbeing accreted through an income statement charge ratably with and over theperiod the claims are settled. See Note 4.

OneBeacon’s insurance subsidiaries enter into cededreinsurance contracts from time to time to protect their businesses from lossesdue to concentration of risk, to manage their operating leverage ratios and tolimit losses arising from catastrophic events. The majority of such reinsurancecontracts are executed through excess of loss treaties and catastrophecontracts under which the reinsurer indemnifies for a specified part or all ofcertain types of losses over stipulated amounts arising from any one occurrenceor event. OneBeacon has also entered into quota share treaties with reinsurersunder which all risks meeting prescribed criteria are covered on a pro ratabasis. The amount of each risk ceded by OneBeacon is subject to maximum limitswhich vary by line of business and type of coverage. Amounts related toreinsurance contracts are recorded in accordance with SFAS No. 113, “Accountingand Reporting for Reinsurance of Short-Duration and Long-Duration Contracts” (“SFAS113”) and Emerging Issues Task Force (“EITF”) Topic No. D-54 (“EITFTopic D-54”) as applicable.

Amounts recoverable from reinsurers are estimated in amanner consistent with the claim liability associated with the reinsuredpolicies. The collectibility of reinsurance recoverables is subject to thesolvency of the reinsurers. OneBeacon is selective in regard to its reinsurers,principally placing reinsurance with those reinsurers with strong financialcondition, industry ratings and underwriting ability. Management monitors thefinancial condition and ratings of its reinsurers on an ongoing basis.

Reinsurance premiums,commissions, expense reimbursements and reserves related to reinsured businessare accounted for on a basis consistent with those used in accounting for theoriginal policies issued and the terms of the reinsurance contracts. Premiumsceded to other companies are reported as a reduction of premiums written.Expense allowances received in connection with reinsurance ceded have beenaccounted for as a reduction of the related policy acquisition costs and aredeferred and amortized accordingly. Funds held under reinsurance treatiesrepresent contractual payments due to the reinsurer that OneBeacon has retainedto secure obligations of the reinsurer. Such amounts are recorded asliabilities in the consolidated financial statements.

*Accounting forMandatory Shared Market Mechanisms*

As a condition to its licenses to do business incertain states, OneBeacon’s insurance operations must participate in variousmandatory shared market mechanisms commonly referred to as “residual” or “involuntary”markets. These markets generally consist of risks considered to be undesirablefrom a standard or routine underwriting perspective. Each state dictates thelevels of insurance coverage that is mandatorily assigned to participatinginsurers within these markets. The total amount of such business an insurermust accept in a particular state is generally based on that insurer’s marketshare of voluntary business written within that state. In certain cases,OneBeacon is obligated to write business from shared market mechanisms at afuture date based on its historical market share of all voluntary policieswritten within that state. Involuntary business generated from mandatory sharedmarket mechanisms is accounted for in accordance with SFAS 60 or as assumedreinsurance under SFAS 113, depending upon the structure of the mechanism.

F-10

----

OneBeacon’s marketassignments are typically required to be written in the current period,although, in certain cases OneBeacon is required to accept policy assignmentsat a future date. OneBeacon’s residual market assignments to be written in thefuture primarily relate to private passenger automobile assigned risk exposureswithin the State of New York where several of OneBeacon’s insurancesubsidiaries write voluntary automobile insurance. The share of involuntary writtenpremium for policies assigned by the NYAIP to a particular insurer in a givenyear is based on the proportion of the total voluntary writings in New York twoyears prior. Anticipated losses associated with future market assignments arerecognized in accordance with SFAS No. 5, “Accounting for Contingencies”,when the amount of such anticipated losses is determined to be probable and canbe reasonably estimated.

*Accounting forInsurance Related Assessments*

Under existing guarantyfund laws in all states, insurers licensed to do business in those states canbe assessed for certain obligations of insolvent insurance companies topolicyholders and claimants. In accordance with Statement of Position (“SOP”) 97-3,“Accounting by Insurance and Other Enterprises for Insurance RelatedAssessments” (“SOP 97-3”), OneBeacon’s insurance subsidiaries recordguaranty fund assessments when such assessments are billed by the respectiveguaranty funds. In addition, each insurance subsidiary’s policy is to accruefor any significant insolvencies when the loss is probable and the assessmentamount can be reasonably estimated.

*Deferred SoftwareCosts*

OneBeacon capitalizescosts related to computer software developed for internal use during theapplication development stage of software development projects in accordancewith SOP 98-1, “Accounting for the Costs of Computer SoftwareDeveloped or Obtained for Internal Use”. These costs generally consist ofcertain external, payroll and payroll related costs. OneBeacon begins amortizationof these costs once the project is completed and ready for its intended use.Amortization is on a straight line basis and over a useful life of three tofive years. At December 31, 2005 and 2006, OneBeacon had deferred softwarecosts of $44.0 million and $35.1 million, respectively.

*Federal and foreignincome taxes*

The majority of the Company’s subsidiaries fileconsolidated tax returns in the United States. Income earned or lossesgenerated by companies outside the United States are generally subject to anoverall effective tax rate lower than that imposed by the United States.

Deferred tax assets andliabilities are recorded when a difference between the carrying amounts ofassets and liabilities for financial reporting purposes and the amounts for taxpurposes exists, and for other temporary differences as defined by SFAS No. 109,“Accounting for Income Taxes” (“SFAS 109”). The deferred tax asset or liabilityis recorded based on tax rates expected to be in effect when the differencereverses. The deferred tax asset is recognized when it is more likely than notthat it will be realized.

*Foreign currencyexchange*

The U.S. dollar is thefunctional currency for all of OneBeacon’s businesses. OneBeacon is subject toforeign currency fluctuations associated with its foreign investmentsecurities. Assets recorded in foreign currencies are translated into U.S.dollars at exchange rates in effect at the balance sheet date. Net foreignexchange gains and losses arising from the translation are generally reportedin common shareholders’ equity, in accumulated other comprehensive income orloss, net of tax. As of December 31, 2005 and 2006, OneBeacon had anafter-tax unrealized foreign currency translation (losses) gains of$(1.5) million and $12.0 million, respectively, recorded on itsconsolidated balance sheets.

F-11

----

*Variable InterestEntities*

In December 2003, theFASB issued Interpretation No. 46(R), “Consolidation of Variable InterestEntities” (“FIN 46R”), which addresses consolidation issues surroundingspecial purpose entities and certain other entities, collectively termedvariable interest entities (“VIE”), to which previous accounting guidance onconsolidation does not apply. A VIE is an entity in which the equity investorsdo not have the characteristics of a controlling interest or do not havesufficient equity at risk for the entity to finance its activities withoutadditional subordinated financial support from other parties. UnderFIN 46R, the primary beneficiary of a VIE is required to consolidate theVIE in its financial statements. The primary beneficiary is an entity that hasa variable interest that will absorb the majority of the VIE’s expected lossesif they occur, receive a majority of the entity’s expected residual returns ifthey occur, or both. OneBeacon adopted the disclosure provisions of FIN 46Rbeginning with its December 31, 2002 consolidated financial statements andits consolidation provisions as of March 31, 2004. See Note 16.

*MandatorilyRedeemable Preferred Stock*

OneBeacon has two classesof mandatorily redeemable preferred stock which are considered noncontrollinginterests and have been recorded as liabilities at their historical carryingvalues in accordance with SFAS No. 150, “Accounting for Certain FinancialInstruments With Characteristics of Both Liability and Equity”. Dividends andaccretion on OneBeacon’s mandatorily redeemable preferred stock have beenrecorded as interest expense. See Note 11.

***Recently Adopted Changes in Accounting Principles***

*Share-BasedCompensation*

OneBeacon’s share-based compensation plansconsist of performance shares and also stock options granted in connection withthe initial public offering. OneBeacon’s share-based compensation plansare designed to maximize shareholder value over long periods of time byaligning the financial interests of its management with those of its owners.Performance shares are payable only upon achievement of pre-defined businessgoals and are valued based on the market value of White Mountains’ commonshares at the time awards are earned. Performance shares are typically paid incash, though they may be paid in White Mountains’ common shares at the electionof the Board of Directors, or may be deferred in accordance with the terms ofthe Company’s deferred compensation plans. OneBeacon expenses the full cost ofall its share-based compensation. See Note 10.

In December 2004, the FASB issued SFASNo. 123(R), “Share-Based Payment” (“SFAS 123R”), which is arevision to SFAS No. 123, “Accounting for Stock Based Compensation”(“SFAS 123”) and supersedes Accounting Principles Board Opinion (“APB”)No. 25, “Accounting for Stock Issued to Employees” (“APB 25”). EffectiveJanuary 1, 2006, OneBeacon adopted SFAS 123R to account for its share-basedcompensation under the modified prospective method of adoption. Under thismethod of adoption, SFAS 123R applies to new grants of share-basedawards, awards modified after the effective date and the remaining portion ofthe fair value of the unvested awards at the adoption date. The unvestedportion of OneBeacon performance share awards, as well as new awards, such asthe stock options granted in connection with the initial public offering, aresubject to the fair value measurement and recognition requirements ofSFAS 123R.

Prior to adoption of SFAS 123R, OneBeaconaccounted for its share-based compensation plans under the recognition andmeasurement principles of APB 25, and related interpretations, and thedisclosure provisions of SFAS 123. The accounting treatment forOneBeacon’s performance share awards under APB 25 was identical to the methodprescribed by SFAS 123, whereby the liability for performance share awardswas measured each period based upon the current market price of the underlyingcommon shares. Under APB 25, the liability for the compensation cost forperformance share awards was measured each period 

F-12

----

based upon the currentmarket price of the underlying common shares. Forfeitures were recognized asthey occurred. Upon adoption of SFAS 123R an estimate of futureforfeitures was incorporated into the determination of the compensation costfor performance shares. The effect of this change was immaterial.

During 2004, 2005 and2006, OneBeacon recorded compensation charges (credits) of $132.1 million,$(5.2) million and $8.0 million, respectively, for outstandingperformance shares.

**Performance Shares**

Thefollowing summarizes performance share activity for the years endedDecember 31, 2005 and 2006:

| ** **                    | ** ** | **Year Ended December 31,**   | ** ** |
|-------------------------------|------------|----------------------------------------------|------------|
| ** **                    | ** ** | **2005**                                     | ** ** | **2006** | ** ** |
| ** **                    | ** ** | **Target  performance  shares  outstanding** | ** ** | **Accrued  expense** | ** ** | **Target  performance  shares  outstanding** | ** ** | **Accrued  expense** | ** ** |
| ** **                    | ** ** | **(in millions)**                       | ** ** |
| Beginning of year             |       |                                         | 199,710    |   |   | $ | 210.2 |   |   | 44,700 |   |   |   | $ | 24.8 |   |   |
| Payments and deferrals(1)(2)  |       |                                         | (163,375   | ) |   | (180.3 | ) |   | (12,600 | ) |   |   | (13.4 | ) |   |
| Forfeitures and cancellations |       |                                         | (15,735    | ) |   | (10.2 | ) |   | (412 | ) |   |   | (0.1 | ) |   |
| New awards                    |       |                                         | 24,100     |   |   | — |   |   | 20,235 |   |   |   | - |   |   |
| Transfers(3)                  |       |                                         | —     |   |   | — |   |   | (35,865 | ) |   |   | (10.3 | ) |   |
| Expense recognized            |       |                                         | —     |   |   | 5.1 |   |   | — |   |   |   | 6.8 |   |   |
| End of year                   |       |                                         | 44,700     |   |   | $ | 24.8 |   |   | 16,058 |   |   |   | $ | 7.8 |   |   |

----

(1)          Performance sharepayments in 2005 for the 2002-2004 performance cycle ranged from 135% to200% of target.

(2)          Performance sharepayments in 2006 for the 2003-2005 performance cycle were made at 142% oftarget.

(3)          Represents the transferof employee liabilities associated with business formerly held by OneBeaconthat were unrelated to its ongoing operations.

Thefollowing summarizes performance shares outstanding and accrued performanceshare expense at December 31, 2006 for each performance cycle:

| ** **                       | ** ** | **Target  performance  shares  outstanding** | ** ** | **Accrued  expense** | ** ** |
|----------------------------------|------------|----------------------------------------------|------------|----------------------|------------|
| ** **                       | ** ** | **(in millions)**                       | ** ** |
| Performance cycle:               |       |                                         |       |                 |       |   |   |   |   |
| 2004—2006                   |       |                                         | 4,400      |                 |       |   | $ | 3.7 |   |   |
| 2005—2007                   |       |                                         | 5,350      |                 |       |   | 2.1 |   |   |
| 2006—2008                   |       |                                         | 6,720      |                 |       |   | 2.1 |   |   |
| Sub-total                        |       |                                         | 16,470     |                 |       |   | 7.9 |   |   |
| Assumed forfeitures              |       |                                         | (412       | )                    |       |   | (0.1 | ) |   |
| Total at  December 31, 2006 |       |                                         | 16,058     |                 |       |   | $ | 7.8 |   |   |

 

If 100% of the outstanding performance shares had beenvested on December 31, 2006, the total additional compensation cost to berecognized would have been $4.4 million, based on current accrual factors(common share price and payout assumptions).

F-13

----

All performance sharesearned for the 2002-2004 and the 2003-2005 performance cycles weresettled in cash or by deferral into certain non-qualified deferred compensationplans of the Company’s subsidiaries.

**Stock Options**

Asdescribed above, in connection with the initial public offering, OneBeaconissued 1,420,000 options to acquire common shares of the Company to certainmembers of its management. The following summarizes option activity for theyear ended December 31, 2006:

| ** **         | ** ** | **2006**                         | ** ** |
|--------------------|------------|----------------------------------|------------|
| ** **         | ** ** | **Target  options  outstanding** | ** ** | **Accrued  expense** | ** ** |
| ** **         | ** ** | **(in millions)**           | ** ** |
| Beginning of year  |       |                             | —     |   |   |   | $ | — |   |   |
| New awards         |       |                             | 1,420      |   |   |   | — |   |   |
| Payments           |       |                             | —     |   |   |   | — |   |   |
| Forfeitures        |       |                             | —     |   |   |   | — |   |   |
| Expense recognized |       |                             | —     |   |   |   | 0.2 |   |   |
| End of year        |       |                             | 1,420      |   |   |   | $ | 0.2 |   |   |

 

*Hybrid FinancialInstruments*

In February 2006, the FASB issued SFAS 155.The Statement eliminates the requirement to bifurcate financial instrumentswith embedded derivatives if the holder of the instrument elects to account forthe entire instrument on a fair value basis. Changes in fair value are recordedas realized gains. The fair value election may be applied upon adoption of theStatement for hybrid instruments that had been bifurcated under SFAS 133prior to adoption. The Statement is effective for fiscal years commencing afterSeptember 15, 2006 with early adoption permitted as of the beginning of anentity’s fiscal year.

OneBeacon adoptedSFAS 155 effective January 1, 2006. See *Investmentsecurities*section of this note for a discussion of effect ofadoption.

*Defined BenefitPostretirement Plans*

In September 2006, the FASB issued SFAS No. 158,“Employers’ Accounting for Defined Benefit Pension and Other PostretirementPlans, an amendment to Statements No. 87, 88, 106 and 132R” (“SFAS 158”). TheStatement requires an employer that sponsors a defined benefit plan torecognize the funded status of a benefit plan, measured as the differencebetween plan assets at fair value and the projected benefit obligation (fordefined benefit pension plans) or the accumulated benefit obligation (for otherpostretirement benefit plans) in its statement of financial position. TheStatement also requires recognition of amounts previously deferred andamortized under SFAS 87 and SFAS 106 in other comprehensive income inthe period in which they occur. Under the new Statement, plan assets and obligationsmust be measured as of the fiscal year end. The Statement is effective forOneBeacon for fiscal years ending after December 15, 2006.

OneBeacon adopted SFAS 158effective December 31, 2006. As a result, OneBeacon recognized theover-funded status of its projected benefit obligation related to its qualifiedpension plan increasing the asset on its balance sheet by $8.8 million andrecognizing a $5.7 million after-tax adjustment to accumulated othercomprehensive income at December 31, 2006. See Note 9.

F-14

----

***Recent Accounting Pronouncements***

*Income Taxes*

In July 2006, theFASB issued FASB Interpretation No. 48, “Accounting for Uncertainty inIncome Taxes” (“FIN 48”). FIN 48 is an interpretation of SFAS 109. Theinterpretation prescribes a recognition threshold and measurement attribute forthe financial statement recognition and measurement of a tax position taken orexpected to be taken in a tax return. Under the new guidance, recognition isbased upon whether or not a company determines that it is more likely than notthat a tax position will be sustained upon examination based upon the technicalmerits of the position. In evaluating the more-likely-than-not recognitionthreshold, a company should presume the tax position will be subject toexamination by a taxing authority with full knowledge of all relevantinformation. If the recognition threshold is met, then the tax position ismeasured at the largest amount of benefit that is more than 50% likely of beingrealized upon ultimate settlement. FIN 48 also provides guidance onderecognition, classification, interest and penalties, accounting in interimperiods, disclosure and transition. The interpretation is effective for fiscalyears beginning after December 15, 2006. OneBeacon expects the effect ofadoption to be modest and to consist of reclassification of certain income taxrelated assets and liabilities in our statement of financial position and animmaterial effect on the balance of retained earnings. OneBeacon does notexpect the adoption to have a material effect on its results of operations orcash flows.

*Fair ValueMeasurements*

In September 2006,the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”).The Statement provides a revised definition of fair value and guidance on themethods used to measure fair value. The Statement also expands financialstatement disclosure requirements for fair value information. The Statementestablishes a fair value hierarchy that distinguishes between assumptions basedon market data from independent sources (“observable inputs”) and a reportingentity’s internal assumptions based upon the best information available whenexternal market data is limited or unavailable (“unobservable inputs”). Thefair value hierarchy in SFAS 157 prioritizes inputs within three levels.Quoted prices in active markets have the highest priority (Level 1)followed by observable inputs other than quoted prices (Level 2) andunobservable inputs having the lowest priority (Level 3). The Statement iseffective for financial statements issued for fiscal years beginning after November 15,2007, with earlier application allowed for entities that have not issuedfinancial statements in the fiscal year of adoption. OneBeacon has not yetdetermined the effect of adoption on its financial condition, results ofoperations or cash flows.

**NOTE 2.Discontinued Operations**

In 2004 and 2006,OneBeacon distributed or sold certain consolidated subsidiaries at GAAP bookvalue to White Mountains. These subsidiaries are included in discontinuedoperations and comprise the following entities:

***Distributed in 2004:***

·       FolksamericaHolding Company, including its wholly-owned subsidiary, FolksamericaReinsurance Company—a reinsurance company that is now part of White MountainsRe Group, Ltd.;

·       Esurance Inc. and EsuranceInsurance Services Inc.—a holding company parent and an insuranceagency/services company;

***Sold in 2004:***

·       Esurance Insurance Companyand Esurance Property and Casualty Company—two property-casualtyinsurance companies.

F-15

----

***Sold in 2006:***

·       WhiteMountains Advisors LLC—an investment management subsidiary;

·       WhiteMountains Management Company, Inc. and White Mountains Capital, Inc.—bothservice companies;

·       WhiteMountains Services Holdings and White Mountains Services, LLC—these companiescontain the remainder of mortgage banking run-off assets from the sale ofsubstantially all the mortgage banking assets of White Mountains ServicesCorporation (formerly Source One Mortgage Services Corporation) to CitibankMortgage, Inc. in 1999;

·       TuckermanCapital, L.P. and Tuckerman Capital II, L.P.—both private equity fundinvestments;

·       InternationalAmerican Group—primarily consists of American Centennial Insurance Company andBritish Insurance Company of Cayman, two run-off insurance companies.

On September 30, 2005, OneBeacon sold NFU to QBEInsurance Group, Ltd. (“QBE”) for $138.3 million in cash. NFU isincluded in discontinued operations for all periods presented through the dateof its sale. OneBeacon recognized a gain of approximately $26.2 million($21.1 million after-tax) on the sale which is included in gain from saleof discontinued operations and is presented net of tax on the statements ofconsolidated income and comprehensive income.

OneBeacon’s net income from continuing operationsexcludes the results of operations for the above entities for all periodspresented. Income or loss from discontinued operations has been presentedseparately and is shown net of related income taxes.

Assetsand liabilities of entities classified as discontinued operations have beenaggregated and are presented under separate captions on the consolidatedbalance sheets. The following details the assets and liabilities summarizedunder those captions:

| ** **                                         | ** ** | **December 31,**         | ** ** |
|----------------------------------------------------|------------|-------------------------------|------------|
| **Selected Balance Sheet Data**     | ** ** | ** **                    | ** ** | **2005** | ** ** |
| ** **                                         | ** ** | **($ in millions)** | ** ** |
| Cash                                               |       |                          | $          | 0.3 |   |   |
| Total investments                                  |       |                          | 111.8      |   |   |
| Reinsurance  recoverable on paid and unpaid losses |       |                          | 26.3       |   |   |
| Other assets                                       |       |                          | 134.0      |   |   |
| Total assets of  discontinued operations           |       |                          | $          | 272.4 |   |   |
| Loss and LAE reserves                              |       |                          | $          | 61.1 |   |   |
| Ceded reinsurance  payable                         |       |                          | 4.1        |   |   |
| Funds held under  reinsurance                      |       |                          | 0.1        |   |   |
| Other liabilities                                  |       |                          | 136.9      |   |   |
| Total liabilities of  discontinued operations      |       |                          | $          | 202.2 |   |   |
|                                                    |            |                               |            |  |  |  |  |  |

 

**NOTE 3. Acquisitions and Dispositions**

During the first quarterof 2004, OneBeacon sold 4.5 million common shares of MontpelierRe Holdings, Ltd., or Montpelier, to third parties for net proceeds of$155.3 million. As a result of this sale, as well as changes to thecomposition of the Board of Directors of both Montpelier and White Mountains,OneBeacon changed the method of accounting for its remaining common shareinvestment in Montpelier as of March 31, 2004 from an equity methodinvestment in an unconsolidated affiliate to a common equity securityclassified as available-for-sale and carried at fair value. See Note 6.

F-16

----

On March 31, 2004,OneBeacon acquired Atlantic Specialty Insurance Company (“Atlantic Specialty”),a subsidiary of Atlantic Mutual Insurance Company (“Atlantic Mutual”), and therenewal rights to Atlantic Mutual’s segmented commercial insurance business,including the unearned premiums on the acquired book (the “Atlantic SpecialtyTransaction”). In connection with its acquisition of Atlantic Specialty,OneBeacon paid $30.1 million in cash and issued a $20.0 million noteto the seller. See Note 7. OneBeacon’s 2004 results of operations include$404.0 million of net written premiums related to the Atlantic SpecialtyTransaction. Under the terms of the agreement, OneBeacon paid Atlantic Mutual arenewal commission on the premiums renewed during the twelve months followingthe Atlantic Specialty Transaction.

During the third quarterof 2004, OneBeacon entered into an agreement to sell the renewal rights to mostof its pre-Atlantic Mutual New York commercial business to TowerInsurance Group. The transaction was effective with December 1, 2004renewals. The gross written premium in force at the time of this transactionfor the book of business totaled approximately $110.0 million. OneBeaconretained the commercial business acquired from Atlantic Mutual.

During the fourth quarterof 2004, OneBeacon sold two of its inactive licensed subsidiaries, PotomacInsurance Company of Illinois and Western States Insurance Company for$25.3 million, as well as its boiler inspection service business, for$11.5 million and recognized combined pre-tax gains on the sales of$22.1 million through net other revenues. The sales were all made to thirdparties.

On August 2, 2005,OneBeacon sold one of its inactive licensed subsidiaries, Traders and PacificInsurance Company (“TPIC”), to Endurance Reinsurance for $23.4 million incash and recognized a pre-tax gain of $8.0 million on the sale through netother revenues.

During the second quarterof 2006, OneBeacon sold one of its inactive licenses subsidiaries, HomelandCentral Insurance Company (“HCIC”) to a subsidiary of White Mountains. Inconnection with the sale of HCIC, OneBeacon recorded a $6.0 million gainassociated with the sale as additional paid in capital.

On September 29,2006, OneBeacon sold certain assets and the right to renew existing policies ofAgri, a division of OneBeacon that provided commercial farm and ranch andcommercial agricultural insurance products, for $32.0 million in cash toQBE and recorded a pre-tax gain of $30.4 million through net otherrevenues. In connection with this sale, OneBeacon entered into agreements underwhich, at the option of QBE, it will write the policies of Agri on a directbasis and cede 100% of this business to QBE.

On October 31, 2006,OneBeacon restructured its investment in Main Street America Holdings, Inc.(“MSA”). OneBeacon received a $70 million cash dividend from MSA followingwhich OneBeacon sold its 50% common stock investment in MSA to Main StreetAmerica Group, Inc. (“the MSA Group”) for (i) $70.0 million in 9.0%non-voting cumulative perpetual preferred stock of the MSA Group and (ii) 4.9%of the common stock of the MSA Group. Effective October 31, 2006,OneBeacon accounts for its remaining investment in the MSA Group in accordancewith SFAS No. 115, “Accounting for Certain Investments in Debt and EquitySecurities.” See Note 1 for a discussion of OneBeacon’s accounting forinvestment securities. Prior to the sale, OneBeacon owned 50% of the totalcommon shares outstanding of MSA and accounted for this investment using theequity method of accounting. These transactions resulted in a net after-taxrealized gain of $8.5 million. See Note 15.

**NOTE 4. Reserves for Unpaid Loss and LAE**

OneBeacon’s insurancesubsidiaries establish loss and LAE reserves that are estimates of amountsneeded to pay claims and related expenses in the future for insured events thathave already occurred. The process of estimating reserves involves aconsiderable degree of judgment by management and, as of any given date, isinherently uncertain.

F-17

----

Reserves are typicallycomprised of (1) case reserves for claims reported and (2) reservesfor losses that have occurred but for which claims have not yet been reported,referred to as incurred but not reported (“IBNR”) reserves, which include aprovision for expected future development on case reserves. Case reserves areestimated based on the experience and knowledge of claims staff regarding thenature and potential cost of each claim and are adjusted as additionalinformation becomes known or payments are made. IBNR reserves are derived bysubtracting paid loss and LAE and case reserves from estimates of ultimate lossand LAE. Actuaries estimate ultimate loss and LAE using various generallyaccepted actuarial methods applied to known losses and other relevantinformation. Like case reserves, IBNR reserves are adjusted as additionalinformation becomes known or payments are made.

Ultimate loss and LAE aregenerally determined by extrapolation of claim emergence and settlementpatterns observed in the past that can reasonably be expected to persist intothe future. In forecasting ultimate loss and LAE with respect to any line ofbusiness, past experience with respect to that line of business is the primaryresource, but cannot be relied upon in isolation. OneBeacon’s own experience,particularly claims development experience, such as trends in case reserves,payments on and closings of claims, as well as changes in business mix andcoverage limits, is the most important information for estimating its reserves.External data, available from organizations such as statistical bureaus,consulting firms and reinsurance companies, is sometimes used to supplement orcorroborate OneBeacon’s own experience, and can be especially useful forestimating costs of new business. For some lines of business, such as“long-tail” coverages discussed below, claims data reported in the most recentaccident year is often too limited to provide a meaningful basis for analysisdue to the typical delay in reporting of claims. For this type of business,OneBeacon uses a selected loss ratio method for the initial accident year oryears. This is a standard and accepted actuarial reserve estimation method inthese circumstances in which the loss ratio is selected based upon informationused in pricing policies for that line of business, as well as any publiclyavailable industry data, such as industry pricing, experience and trends, forthat line of business.

Uncertainties inestimating ultimate loss and LAE are magnified by the time lag between when aclaim actually occurs and when it is reported and settled. This time lag issometimes referred to as the “claim-tail”. The claim-tail for most propertycoverages is typically short (usually a few days up to a few months). Theclaim-tail for liability/casualty coverages, such as automobile liability,general liability, products liability, multiple peril coverage, and workerscompensation, can be especially long as claims are often reported andultimately paid or settled years, even decades, after the related loss eventsoccur. During the long claims reporting and settlement period, additional factsregarding coverages written in prior accident years, as well as about actualclaims and trends may become known and, as a result, OneBeacon may adjust itsreserves. If management determines that an adjustment is appropriate, theadjustment is booked in the accounting period in which such determination ismade in accordance with GAAP. Accordingly, should reserves need to be increasedor decreased in the future from amounts currently established, future resultsof operations would be negatively or positively impacted, respectively.

In determining ultimateloss and LAE, the cost to indemnify claimants, provide needed legal defense andother services for insureds and administer the investigation and adjustment ofclaims are considered. These claim costs are influenced by many factors thatchange over time, such as expanded coverage definitions as a result of newcourt decisions, inflation in costs to repair or replace damaged property,inflation in the cost of medical services and legislated changes in statutorybenefits, as well as by the particular, unique facts that pertain to eachclaim. As a result, the rate at which claims arose in the past and the costs tosettle them may not always be representative of what will occur in the future.The factors influencing changes in claim costs are often difficult to isolateor quantify and developments in paid and incurred losses from historical trendsare frequently subject to multiple and conflicting interpretations. Changes incoverage terms or claims handling practices may also cause future experienceand/or development patterns to vary from the past. A key objective of actuariesin developing estimates of ultimate loss and LAE, and resulting IBNR reserves,is to identify aberrations and systemic changes 

F-18

----

occurringwithin historical experience and accurately adjust for them so that the futurecan be projected reliably. Because of the factors previously discussed, thisprocess requires the use of informed judgment and is inherently uncertain.

***Loss and LAE reserve summary***

Thefollowing table summarizes the loss and LAE reserve activities of OneBeacon’sinsurance subsidiaries for the years ended December 31, 2004, 2005 and2006:

| ** **                                                       | ** ** | **Year ended December 31,** | ** ** |
|------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                       | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                                       | ** ** | **($ in millions)**              | ** ** |
| Gross beginning  balance                                         |       | $                                          | 5,695.9    |   | $ | 4,922.2 |   | $ | 5,354.3 |   |
| Less beginning reinsurance recoverable on unpaid  losses         |       | (2,657.3                                   | )          | (2,391.8 | ) | (3,120.9 | ) |
| Net loss and LAE  reserves                                       |       | 3,038.6                                    |       | 2,530.4 |   | 2,233.4 |   |
| Loss and LAE  reserves sold—TPIC                            |       | —                                     |       | (11.8 | ) | — |   |
| Loss and LAE  reserves consolidated—New Jersey Skylands     |       | 62.1                                       |       | — |   | — |   |
| Loss and LAE incurred  relating to:                              |       |                                       |       |   |   |   |   |
| Current year losses                                              |       | 1,286.1                                    |       | 1,291.4 |   | 1,272.3 |   |
| Prior year losses                                                |       | 99.3                                       |       | 99.0 |   | 11.3 |   |
| Total incurred  loss and LAE                                     |       | 1,385.4                                    |       | 1,390.4 |   | 1,283.6 |   |
| Accretion of fair  value adjustment to net loss and LAE reserves |       | 33.2                                       |       | 26.0 |   | 23.0 |   |
| Loss and LAE paid  relating to:                                  |       |                                       |       |   |   |   |   |
| Current year losses                                              |       | (547.3                                     | )          | (497.8 | ) | (589.5 | ) |
| Prior year losses                                                |       | (1,441.6                                   | )          | (1,203.8 | ) | (955.4 | ) |
| Total loss and  LAE payments                                     |       | (1,988.9                                   | )          | (1,701.6 | ) | (1,544.9 | ) |
| Net ending  balance                                              |       | 2,530.4                                    |       | 2,233.4 |   | 1,995.1 |   |
| Plus ending reinsurance recoverable on unpaid losses             |       | 2,391.8                                    |       | 3,120.9 |   | 2,842.6 |   |
| Gross ending balance                                             |       | $                                          | 4,922.2    |   | $ | 5,354.3 |   | $ | 4,837.7 |   |

 

*Loss and LAEdevelopment—2004*

OneBeacon experienced $99.3 million of netunfavorable development on prior accident year loss and LAE reserves during2004, relating primarily to 2002 and prior accident years. The net unfavorabledevelopment related primarily to personal auto liability, general liability andmultiple peril reserves due in part to emerging trends in claims experienced inOneBeacon’s run-off operations, as well as national account and program claimsadministered by third parties. These claim trends principally included higherdefense costs and higher damages from liability assessments.

Prior to 2004, OneBeaconhad made assumptions that case reserving standards and settlement practices inthe run-off operations would be consistent with the standards and practicesthat were observed in the ongoing operations. During 2004, multiple perilliability and general liability case incurred loss and LAE for run-off claimswas double that for ongoing claims. As a result, management increased theoverall level of reserves for run-off during 2004. In addition, managementundertook a more in depth review of the standards and practices as they appliedto run-off claims and formed a separate run-off claims unit.

*Loss and LAEdevelopment—2005*

In 2005, OneBeacon experienced $99.0 million ofnet unfavorable development on prior accident year loss reserves, primarily dueto higher than anticipated defense costs and higher damages from liabilityassessments in general liability and multiple peril reserves in OneBeacon’srun-off operations.

F-19

----

Specifically, managementhad implicitly assumed at December 31, 2004 that the IBNR and known casedevelopment would be approximately 26% of actual case reserves for the 2001 andprior accident years for multiple peril and general liability. During 2005,case incurred loss and LAE was 72% of the entire future expected developmentwhich was unusually large for these long tail lines of business. As a result,management increased IBNR reserves for these lines so that as of year end 2005the IBNR was approximately 40% relative to the remaining case reserves.

*Loss and LAEdevelopment—2006*

In 2006, OneBeacon experienced $11.3 million ofunfavorable development on prior accident year loss reserves, primarily due todevelopment on losses related to hurricane events impacting OneBeacon’s excessproperty policies.

Specifically at December 31,2005, management had reviewed all known losses related to hurricane eventsimpacting its excess property policies. Based on information at that time,management established reserves for those losses which were expected to reachthe coverage layers. During 2006, several individual claims experienced adversedevelopment resulting in more losses penetrating the coverage layers. As aresult, management increased held reserves as of December 31, 2006 toreflect the actual adverse claim development as well as a provision for futureadverse development on these claims.

*Fair valueadjustment*

In connection with purchase accounting for theOneBeacon Acquisition, OneBeacon was required to adjust to fair value OneBeacon’sloss and LAE reserves and the related reinsurance recoverables by$646.9 million and $346.9 million, respectively, on OneBeacon’sacquired balance sheet as of June 1, 2001. This net reduction to loss andLAE reserves of $300.0 million is being accreted through an incomestatement charge ratably with and over the period the claims are settled.Accordingly, OneBeacon recognized $33.2 million, $26.0 million and $23.0 millionof such charges, recorded as loss and LAE during 2004, 2005 and 2006,respectively.

The fair values ofOneBeacon’s loss and LAE reserves and related reinsurance recoverables acquiredon June 1, 2001 were based on the present value of their expected cashflows with consideration for the uncertainty inherent in both the timing of,and the ultimate amount of, future payments for losses and receipts of amountsrecoverable from reinsurers. In estimating fair value, management adjusted thenominal loss reserves of OneBeacon (net of the effects of reinsurance obtainedfrom the NICO Cover, as defined below, and the GRC Cover, as defined inNote 5) and discounted them to their present value using an applicablerisk-free discount rate. The series of future cash flows related to such losspayments and reinsurance recoveries were developed using OneBeacon’s historicalloss data. The resulting discount was reduced by the “price” for bearing theuncertainty inherent in OneBeacon’s net loss reserves in order to estimate fairvalue. This was approximately 11% of the present value of the expectedunderlying cash flows of the loss reserves and reinsurance recoverables ofOneBeacon, which is believed to be reflective of the cost OneBeacon would incurif they had attempted to reinsure the full amount of its net loss and LAEreserves with a third party reinsurer.

***Asbestos and environmental loss and LAE reserveactivity***

OneBeacon’s reserves include provisions made forclaims that assert damages from A&E related exposures. Asbestos claimsrelate primarily to injuries asserted by those who came in contact withasbestos or products containing asbestos. Environmental claims relate primarilyto pollution and related clean-up costs obligations, particularly as mandatedby Federal and state environmental protection agencies. In addition to thefactors described above regarding the reserving process, OneBeacon estimatesits A&E reserves based upon, among other factors, facts surroundingreported cases and exposures to claims, such 

F-20

----

as policy limits anddeductibles, current law, past and projected claim activity and past settlementvalues for similar claims, as well as analysis of industry studies and events,such as recent settlements and asbestos-related bankruptcies. The cost ofadministering A&E claims, which is an important factor in estimating lossreserves, tends to be higher than in the case of non-A&E claims due to thehigher legal costs typically associated with A&E claims.

In connection with the OneBeacon Acquisition, Avivacaused OneBeacon to purchase a reinsurance contract with National IndemnityCompany (“NICO”) under which OneBeacon is entitled to recover from NICO up to$2.5 billion in the future for asbestos claims arising from businesswritten by OneBeacon in 1992 and prior, environmental claims arising frombusiness written by OneBeacon in 1987 and prior, and certain other exposures(the “NICO Cover”). Under the terms of the NICO Cover, NICO receives theeconomic benefit of reinsurance recoverables from certain of OneBeacon’s thirdparty reinsurers in existence at the time the NICO Cover was executed (“ThirdParty Recoverables”). As a result, the Third Party Recoverables serve toprotect the $2.5 billion limit of NICO coverage for the benefit ofOneBeacon. Any amounts uncollectible from third party reinsurers due to disputeor the reinsurers’ financial inability to pay are covered by NICO under itsagreement with OneBeacon. Third Party Recoverables are typically for the amountof loss in excess of a stated level each year. Of claim payments in the past11 years, approximately 50% of A&E losses have been recovered underthe historical third party reinsurance.

In June 2005, OneBeacon completed an internalstudy of its A&E exposures. This study considered, among other items: (1) facts,such as policy limits, deductibles and available third party reinsurance,related to reported claims; (2) current law; (3) past and projectedclaim activity and past settlement values for similar claims; (4) industrystudies and events, such as recent settlements and asbestos relatedbankruptcies; and (5) collectibility of third party reinsurance. Based onthe study, OneBeacon increased its best estimate of its incurred losses cededto NICO, net of underlying reinsurance, by $353 million ($841 milliongross) to $2.1 billion, which is within the $2.5 billion coverageprovided by the NICO Cover. OneBeacon estimated that the range of reasonableoutcomes around its best estimate was $1.7 billion to $2.4 billion. Dueto the NICO Cover, there was no impact to income or equity from the change inestimate.

The increase in the estimate of incurred A&Elosses was principally driven by raised projections for claims related toasbestos (particularly from assumed reinsurance business), and for mass tortsother than asbestos and environmental, particularly lead poisoning and sexualmolestation. This increase was partially offset by reduced projections ofultimate hazardous waste losses.

As part of OneBeacon’s actuarial review process,OneBeacon’s actuaries review A&E activity each quarter and compare thatactivity to what was assumed in the original study. As of December 31,2006, OneBeacon estimated that the range of reasonable outcomes around its bestestimate was $1.7 billion to $2.4 billion.

As noted above, OneBeacon estimates that on anincurred basis it has used approximately $2.1 billion of the coverageprovided by NICO at December 31, 2006. Since entering into the NICO Cover,$29.2 million of the $2.1 billion of utilized coverage relates touncollected amounts from third party reinsurers through December 31, 2006.Net losses paid totaled approximately $847.0 million as of December 31,2006, with $146.0 million paid in 2006. Asbestos payments during 2006reflect payments resulting from intensified efforts by claimants to resolveasbestos claims prior to enactment of potential Federal asbestos legislation.To the extent that OneBeacon’s estimate of ultimate A&E losses as well asthe estimate and collectibility of Third Party Recoverables differs from actualexperience, the remaining protection under the NICO Cover may be more or lessthan the approximate $404.0 million that OneBeacon estimates remained at December 31,2006.

OneBeacon’s reserves for A&E losses at December 31,2006 represent management’s best estimate of its ultimate liability based oninformation currently available. However, as case law expands, medical andclean up costs increase and industry settlement practices change, OneBeacon maybe subject to A&E 

F-21

----

losses beyond currentlyestimated amounts. OneBeacon cannot reasonably estimate at the present timeloss reserve additions arising from any such future unfavorable developmentsand cannot be sure that allocated loss reserves, plus the remaining capacityunder the NICO Cover and other reinsurance contracts, will be sufficient tocover additional liability arising from any such unfavorable developments.

Thefollowing tables summarize reported A&E loss and LAE reserve activities(gross and net of reinsurance) for OneBeacon for the years ended December 31,2004, 2005 and 2006, respectively.

| ** **                            | ** ** | **Year ended December 31,** | ** ** |
|---------------------------------------|------------|--------------------------------------------|------------|
| ** **                            | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                            | ** ** | **Gross**                                  | ** ** | **Pre-NICO  Net(1)** | ** ** | **Net** | ** ** | **Gross** | ** ** | **Pre-NICO  Net(1)** | ** ** | **Net** | ** ** | **Gross** | ** ** | **Pre-NICO  Net(1)** | ** ** | **Net** | ** ** |
| ** **                            | ** ** | **($ in millions)**              | ** ** |
| **Asbestos:**                         |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Beginning balance                     |       | $                                          | 969.5      |   |   | $ | 641.6 |   |   | $ | 4.2 |   | $ | 868.9 |   |   | $ | 599.2 |   |   | $ | 8.5 |   | $ | 1,323.4 |   |   | $ | 845.9 |   |   | $ | 7.4 |   |
| Incurred loss and LAE                 |       | 6.7                                        |       |   | 1.5 |   |   | 5.9 |   | 544.8 |   |   | 307.5 |   |   | — |   | (4.0 | ) |   | (1.6 | ) |   | — |   |
| Paid loss and LAE                     |       | (107.3                                     | )          |   | (43.9 | ) |   | (1.6 | ) | (90.3 | ) |   | (60.8 | ) |   | (1.1 | ) | (91.8 | ) |   | (77.7 | ) |   | (0.6 | ) |
| Ending balance                        |       | 868.9                                      |       |   | 599.2 |   |   | 8.5 |   | 1,323.4 |   |   | 845.9 |   |   | 7.4 |   | 1,227.6 |   |   | 766.6 |   |   | 6.8 |   |
| **Environmental:**                    |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Beginning balance                     |       | 559.8                                      |       |   | 454.8 |   |   | 8.6 |   | 513.0 |   |   | 408.4 |   |   | 10.2 |   | 729.7 |   |   | 421.5 |   |   | 6.5 |   |
| Incurred loss and LAE                 |       | 9.6                                        |       |   | 4.7 |   |   | 6.7 |   | 265.7 |   |   | 42.7 |   |   | 2.0 |   | (8.6 | ) |   | (7.8 | ) |   | — |   |
| Paid loss and LAE                     |       | (56.4                                      | )          |   | (51.1 | ) |   | (5.1 | ) | (49.0 | ) |   | (29.6 | ) |   | (5.7 | ) | (43.1 | ) |   | (19.1 | ) |   | 4.1 |   |
| Ending balance                        |       | 513.0                                      |       |   | 408.4 |   |   | 10.2 |   | 729.7 |   |   | 421.5 |   |   | 6.5 |   | 678.0 |   |   | 394.6 |   |   | 10.6 |   |
| **Total asbestos and environmental:** |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Beginning balance                     |       | 1,529.3                                    |       |   | 1,096.4 |   |   | 12.8 |   | 1,381.9 |   |   | 1,007.6 |   |   | 18.7 |   | 2,053.1 |   |   | 1,267.4 |   |   | 13.9 |   |
| Incurred loss and LAE                 |       | 16.3                                       |       |   | 6.2 |   |   | 12.6 |   | 810.5 |   |   | 350.2 |   |   | 2.0 |   | (12.6 | ) |   | (9.4 | ) |   | — |   |
| Paid loss and LAE                     |       | (163.7                                     | )          |   | (95.0 | ) |   | (6.7 | ) | (139.3 | ) |   | (90.4 | ) |   | (6.8 | ) | (134.9 | ) |   | (96.8 | ) |   | 3.5 |   |
| Ending  balance                       |       | $                                          | 1,381.9    |   |   | $ | 1,007.6 |   |   | $ | 18.7 |   | $ | 2,053.1 |   |   | $ | 1,267.4 |   |   | $ | 13.9 |   | $ | 1,905.6 |   |   | $ | 1,161.2 |   |   | $ | 17.4 |   |

----

(1)           RepresentsA&E reserve activity, net of third party reinsurance, but prior to the NICOCover.

F-22

----

**NOTE 5. Reinsurance**

In thenormal course of business, OneBeacon’s insurance subsidiaries seek to limitlosses that may arise from catastrophes or other events by reinsuring withthird party reinsurers. OneBeacon remains liable for risks reinsured even ifthe reinsurer does not honor its obligations under reinsurance contracts. Theeffects of reinsurance (including the quota share reinsurance agreements withaffiliates) on OneBeacon’s insurance subsidiaries’ written and earned premiumsand on loss and LAE were as follows:

| ** **            | ** ** | **Year ended December 31,** | ** ** |
|-----------------------|------------|--------------------------------------------|------------|
| ** **            | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **            | ** ** | **($ in millions)**              | ** ** |
| **Written premiums:** |       |                                       |       |   |   |   |   |
| Direct                |       | $                                          | 2,115.2    |   | $ | 2,042.4 |   | $ | 2,028.0 |   |
| Assumed               |       | 289.6                                      |       | 426.5 |   | 287.8 |   |
| Ceded                 |       | (240.1                                     | )          | (373.3 | ) | (308.8 | ) |
| Net written  premiums |       | $                                          | 2,164.7    |   | $ | 2,095.6 |   | $ | 2,007.0 |   |
| **Earned premiums:**  |       |                                       |       |   |   |   |   |
| Direct                |       | $                                          | 1,996.4    |   | $ | 2,043.5 |   | $ | 2,007.5 |   |
| Assumed(1)            |       | 331.1                                      |       | 357.1 |   | 375.3 |   |
| Ceded                 |       | (240.4                                     | )          | (387.9 | ) | (306.9 | ) |
| Net earned  premiums  |       | $                                          | 2,087.1    |   | $ | 2,012.7 |   | $ | 2,075.9 |   |
| **Loss and LAE:**     |       |                                       |       |   |   |   |   |
| Direct                |       | $                                          | 1,441.8    |   | $ | 2,157.4 |   | $ | 1,245.1 |   |
| Assumed(1)            |       | 681.3                                      |       | 360.1 |   | 249.5 |   |
| Ceded                 |       | (737.7                                     | )          | (1,127.1 | ) | (211.0 | ) |
| Net loss and LAE      |       | $                                          | 1,385.4    |   | $ | 1,390.4 |   | $ | 1,283.6 |   |

----

(1)          On November 1,2001, OneBeacon transferred its regional agency business, agents and operationsin 42 states and the District of Columbia to Liberty Mutual pursuant to arenewal rights agreement (the “Liberty Agreement”). The Liberty Agreementpro-rated results from renewals through October 31, 2003, at which timethe renewal rights expired. Assumed amounts in 2004 principally relate tobusiness assumed under the Liberty Agreement.

Through the quota share with Esurance, in 2005 and2006 OneBeacon assumed premiums of $336.9 million and $227.4 million, lossand LAE of $177.1 million and $195.5 million, and expenses of$99.4 million and $114.4 million, respectively. At December 31, 2005,OneBeacon had assumed unearned premiums of $82.5 million and loss and LAEreserves of $62.3 million from Esurance. The quota share agreement withEsurance was commuted during the fourth quarter of 2006 in connection with theCompany’s initial public offering. At commutation cash and investments wereused to settle the assets and liabilities assumed under this agreement.

Consistent with the terms of the quota share agreementwith Sirius, OneBeacon’s cession to Sirius increased from 6% to 12% over thecourse of 2004. OneBeacon’s cession to Sirius was 12% for 2005 and 2006.OneBeacon ceded premiums of $115.9 million, $230.0 million and$178.0, loss and LAE of $62.7 million, $122.3 million and $92.2million and expenses of $43.5 million, $86.2 million and $66.8million for the years ended December 31, 2004, 2005 and 2006,respectively. At December 31, 2005, OneBeacon had ceded loss and LAEreserves of $103.8 million to Sirius. The quota share agreement withSirius was commuted during the fourth quarter of 2006 in connection with theCompany’s initial public offering. At commutation a cash and investments wereused to settle the assets and liabilities ceded under this agreement.

F-23

----

In the ordinary course of its business, OneBeaconpurchases reinsurance from high-quality, highly rated third party reinsurers inorder to minimize loss from large risks or catastrophic events.

The timing and size of catastrophe losses areunpredictable and the level of losses experienced in any year could be materialto OneBeacon’s operating results and financial position. Examples ofcatastrophes include losses caused by earthquakes, wildfires, hurricanes andother types of storms and terrorist acts. The extent of losses caused bycatastrophes is both a function of the amount and type of insured exposure inan area affected by the event and the severity of the event. OneBeaconcontinually assesses and implements programs to manage its exposure to catastrophelosses through individual risk selection and by limiting its concentration ofinsurance written in catastrophe-prone areas, such as coastal regions. Inaddition, OneBeacon imposes wind deductibles on existing coastal windstormexposures. OneBeacon’s largest single event natural catastrophe exposures areNortheastern windstorms and California earthquakes.

OneBeacon seeks to further reduce its exposure tocatastrophe losses through the purchase of catastrophe reinsurance. OneBeaconuses probable maximum loss (“PML”) forecasting to quantify its exposure tocatastrophic losses. PML is a statistical modeling technique that measures acompany’s catastrophic exposure as the maximum probable loss in a given timeperiod.

Since the terrorist attacks of September 11,2001, OneBeacon has sought to mitigate the risk associated with any futureterrorist attacks by reducing the insured value of policies written ingeographic areas with a high concentration of exposure to losses from terroristattacks or by seeking to exclude coverage for such losses from their policies.

On December 22, 2005, the United Statesgovernment extended the Terrorism Act, which was set to expire on December 31,2005, for two more years. The Terrorism Act, originally enacted on November 26,2002 establishes a Federal “backstop” for commercial property and casualtylosses, including workers compensation, resulting from acts of terrorism by oron behalf of any foreign person or foreign interest. The law limits theindustry’s aggregate liability by requiring the Federal government to share 85%of certified losses in 2007 once a company meets a specific retention ordeductible as determined by its prior year’s direct written premiums and limitsthe aggregate liability to be paid by the government and industry withoutfurther action by Congress at $100.0 billion. In exchange for this “back-stop,”primary insurers are required to make coverage available to commercial insuredsfor losses from acts of non-domestic terrorism as specified in the Terrorism Act.The following types of coverage are excluded from the program: commercialautomobile, burglary and theft, surety, farmowners multi-peril and allprofessional liability coverage except directors and officers coverage.

OneBeacon estimates its individual retention level forcommercial policies subject to the Terrorism Act to be approximately$162 million in 2007. The aggregate industry retention level is$27.5 billion for 2007. The Federal government will pay 85% of coveredterrorism losses that exceed OneBeacon’s or the industry’s retention levels in2007, up to a total of $100 billion.

OneBeacon seeks to further reduce its potential lossfrom catastrophe exposures through the purchase of catastrophe reinsurance.Effective July 1, 2006, OneBeacon renewed its property catastrophereinsurance program through June 30, 2007. Under that cover, the first$200 million of losses resulting from any single catastrophe are retainedby the Company and losses from a single event in excess of $200 millionand up to $850 million are reinsured for 100% of the loss. OneBeaconanticipates this $850 million limit is sufficient to cover Northeastwindstorm losses with a 0.4%-0.5% probability of occurrence (1-in-250-yearevent to 1-in-200-year event). In the event of a catastrophe,OneBeacon’s property catastrophe reinsurance program can be reinstated for theremainder of the original contract term by paying a reinstatement premium thatis based on the percentage of coverage reinstated and the original propertycatastrophe coverage premium.

F-24

----

OneBeacon’s property catastrophe reinsurance programdoes not cover personal or commercial property losses resulting from nuclear,biological or chemical terrorist attacks. The program covers personal propertylosses resulting from “certified” events as defined under the Terrorism Act,such as foreign terrorism, provided such losses were not caused by nuclearbiological or chemical means. The program also covers personal and commercialproperty losses resulting from “non-certified” events as defined underthe Terrorism Act, such as domestic terrorist attacks, provided such losseswere not caused by nuclear, biological or chemical means.

OneBeacon also purchased individual propertyreinsurance coverage for certain risks to reduce large loss volatility. Theproperty-per-risk reinsurance program reinsures losses in excess of$5 million up to $75 million. Individual risk facultative reinsurancemay be purchased above $75 million where OneBeacon deems it appropriate.The property-per-risk treaty also provides one limit of reinsurance protectionfor losses in excess of $10 million up to $75 million on anindividual risk basis for terrorism losses. However, nuclear, biological andchemical events are not covered.

OneBeacon also maintains a casualty reinsuranceprogram that provides protection for individual risk or catastrophe lossesinvolving workers compensation, general liability, automobile liability orumbrella liability in excess of $6 million up to $81 million. Thisprogram provides coverage for either “certified” or “non-certified” terrorismlosses but does not provide coverage for losses resulting from nuclear,biological or chemical attacks.

In connection with the OneBeacon Acquisition, Avivacaused OneBeacon to purchase two reinsurance contracts: the NICO Cover, areinsurance contract from NICO for up to $2.5 billion in old A&Eclaims and certain other exposures and an adverse development cover fromGeneral Reinsurance Corporation (“GRC”) for up to $570.0 million,comprised of $400.0 million of adverse development on losses occurring inyears 2000 and prior (the “GRC Cover”) in addition to $170.0 million ofreserves ceded as of the date of the OneBeacon Acquisition. The NICO Cover andGRC Cover, which were contingent on and occurred contemporaneously with theOneBeacon Acquisition, were put in place in lieu of a seller guarantee of lossand LAE reserves and are therefore accounted for as prospective reinsuranceunder GAAP in accordance with EITF Topic D-54.

Pursuant to the GRC Cover, OneBeacon is not entitledto recover losses to the full contract limit if such losses are reimbursed byGRC more quickly than anticipated at the time the contract was signed.OneBeacon intends to only seek reimbursement from GRC for claims which resultin payment patterns similar to those supporting its recoverables recordedpursuant to the GRC Cover. The economic cost of not submitting certain othereligible claims to GRC is primarily the investment spread between the ratecredited by GRC and the rate achieved by OneBeacon on its own investments. Thiscost, if any, is expected to be small.

F-25

----

Reinsurancecontracts do not relieve OneBeacon of its obligation to its insureds.Therefore, collectibility of balances due from its reinsurers is critical toOneBeacon’s financial strength. The following table provides a listing ofOneBeacon’s top reinsurers for its primary insurance operations, excludingindustry pools and associations and affiliates of OneBeacon, based uponrecoverable amounts, the percentage of total reinsurance recoverables and thereinsurer’s A.M. Best rating.

| ** **                                                         | ** ** | **Balance at  December 31, 2006** | ** ** | **% of total** | ** ** | **A.M. Best  Rating(1)** | ** ** |
|--------------------------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------|------------|-------------------------------|------------|
| **($ in millions)**                                      | ** ** | ** **                                       | ** ** |
| Subsidiaries of  Berkshire (NICO and GRC)(2)                       |       |                                             | $          | 2,217.2                  |       |                          |       | 71 | % |   |   | A | ++ |   |
| Munich  Reinsurance America (formerly America Reinsurance Company) |       |                                             | 59.3       |                     |       |                          | 2          | % |   |   | A |   |   |
| Tokio Marine and Nichido  Fire                                     |       |                                             | 52.3       |                     |       |                          | 2          | % |   |   | A | ++ |   |
| Liberty Mutual  and subsidiaries(3)                                |       |                                             | 42.5       |                     |       |                          | 1          | % |   |   | A |   |   |
| Swiss Re                                                           |       |                                             | 22.7       |                     |       |                          | 1          | % |   |   | A | + |   |

----

(1)**         **A.M. Best ratings as detailed above are:“A++” (Superior, which is the highest of fifteen ratings), “A+” (Superior,which is the second highest of fifteen ratings) and “A” (Excellent, which isthe third highest of fifteen ratings).

(2)**         **Includes $404.0 million of ThirdParty Recoverables, which NICO would pay under the terms of the NICO Cover ifthey are unable to collect from third party reinsurers. OneBeacon also has anadditional $384.0 million of Third Party Recoverables from various reinsurers,the majority of which are rated “A” of better by A.M. Best.

(3)**         **At December 31, 2006, OneBeacon hadassumed balances payable and expenses payable of approximately$28.7 million under its renewal rights agreement with Liberty Mutual,which expired on October 31, 2003. In the event Liberty Mutual becomesinsolvent, OneBeacon has the right to offset these balances against its reinsurancerecoverable due from Liberty Mutual.

**NOTE 6. InvestmentSecurities**

OneBeacon’snet investment income is comprised primarily of interest income associated withOneBeacon’s fixed maturity investments, dividend income from its equityinvestments and interest income from its short-term investments. Net investmentincome for 2004, 2005 and 2006 consisted of the following:

| ** **                      | ** ** | **Year ended December 31,** | ** ** |
|---------------------------------|------------|--------------------------------------------|------------|
| ** **                      | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                      | ** ** | **($ in millions)**              | ** ** |
| **Investment income:**          |       |                                       |       |   |   |   |   |
| Fixed maturity investments      |       | $                                          | 196.4      |   | $ | 177.1 |   | $ | 165.5 |   |
| Short-term investments          |       | 3.4                                        |       | 9.6 |   | 14.2 |   |
| Common equity securities        |       | 16.7                                       |       | 49.3 |   | 20.4 |   |
| Other                           |       | 7.0                                        |       | 15.2 |   | 5.5 |   |
| Total investment  income        |       | 223.5                                      |       | 251.2 |   | 205.6 |   |
| Less investment expenses        |       | (13.9                                      | )          | (14.4 | ) | (13.8 | ) |
| Net investment  income, pre-tax |       | $                                          | 209.6      |   | $ | 236.8 |   | $ | 191.8 |   |

 

During the first quarter of 2005, Montpelier declareda special dividend of $5.50 per share, payable to holders of its common shares.OneBeacon recorded pre-tax investment income of $34.7 million in the firstquarter for this special dividend, which was included in net investment incomefrom common equity securities. For the years ended December 31, 2004, 2005and 2006, OneBeacon also recorded an aggregate 

F-26

----

of $8.6 million,$7.2 million and $1.0 million in pre-tax investment income from Montpelier’sregular quarterly dividends.

Thecomposition of net realized investment gains consisted of the following:

| ** **                                                         | ** ** | **Year ended December 31,** | ** ** |
|--------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                         | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                                         | ** ** | **($ in millions)**              | ** ** |
| Fixed maturity  investments                                        |       | $                                          | 23.3       |   | $ | 35.4 |   | $ | 39.2 |   |
| Common equity  securities                                          |       | 57.7                                       |       | 69.9 |   | 104.6 |   |
| Other investments                                                  |       | 47.8                                       |       | 17.9 |   | 19.8 |   |
| Net realized investment gains, pre-tax                             |       | 128.8                                      |       | 123.2 |   | 163.6 |   |
| Income taxes  attributable to realized investment gains and losses |       | (45.1                                      | )          | (43.1 | ) | (57.2 | ) |
| Net realized  investment gains, after-tax                          |       | $                                          | 83.7       |   | $ | 80.1 |   | $ | 106.4 |   |

 

OneBeacon recognized gross realized investment gainsof $143.7 million, $203.2 million and $199.9 million and grossrealized investment losses of $14.9 million, $80.0 million and$36.3 million on sales of investment securities during 2004, 2005 and2006, respectively. Of the $80.0 million in gross investment lossesrealized during 2005, $54.6 million related to an other-than-temporaryimpairment on OneBeacon’s investment in Montpelier common shares. The remainingbalance of $25.4 million primarily represented realized losses on sales offixed maturities, none of which individually exceeded $5.0 million.

During the first quarter of 2004, OneBeacon sold4.5 million shares of Montpelier to third parties for net proceeds of$155.3 million, resulting in a realized investment gain of$35.2 million.

As of December 31, 2005, OneBeacon owned6.3 million common shares of Montpelier, with a fair value of$115.7 million. On August 24, 2006, OneBeacon exchanged its investmentin the common shares of Montpelier for an agreed-upon portfolio of commonequity and fixed maturity securities of equal value that was owned by WhiteMountains. At the time of the exchange, OneBeacon’s investment in the commonshares of Montpelier was in an unrealized loss position of $6.9 million. Thisloss was deferred at the time of the exchange as sales of investments betweenOneBeacon and entities under White Mountains’ common control are deferred. Subsequentto the exchange, White Mountains sold 5.4 million common shares of Montpeliertriggering the recognition of $5.8 million in realized investment losses. As ofDecember 31, 2006, OneBeacon’s remaining deferred loss on the exchangetotaled $1.1 million.

As of December 31, 2005 and 2006, OneBeaconreported $1.9 million and $11.5 million, respectively, in accountspayable on unsettled investment purchases and $2.9 million and $6.7million, respectively, in accounts receivable on unsettled investment sales.

F-27

----

Thecomponents of OneBeacon’s change in net unrealized investment gains (losses),after-tax, and net change in unrealized foreign currency gains (losses),after-tax, as recorded in the statements of income and comprehensive incomewere as follows:

| ** **                                                                                     | ** ** | **Year ended December 31,** | ** ** |
|------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                     | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                                                                     | ** ** | **($ in millions)**              | ** ** |
| Net change in pre-tax  unrealized gains (losses) for investment securities                     |       | $                                          | 222.9      |   | $ | (85.5 | ) | $ | 161.2 |   |
| Net change in pre-tax  unrealized gains (losses) from investments in unconsolidated affiliates |       | (7.9                                       | )          | (3.0 | ) | (6.7 | ) |
| Net change in pre-tax  unrealized investment gains (losses) for investments                    |       | 215.0                                      |       | (88.5 | ) | 154.5 |   |
| Income taxes  attributable to investments                                                      |       | (78.1                                      | )          | 31.0 |   | (54.1 | ) |
| Net change in  unrealized gains (losses) for investments, after-tax                            |       | 136.9                                      |       | (57.5 | ) | 100.4 |   |
| Recognition of  pre-tax net unrealized gains for investments sold                              |       | (106.7                                     | )          | (93.0 | ) | (130.6 | ) |
| Income taxes  attributable to investments sold                                                 |       | 37.4                                       |       | 32.6 |   | 45.7 |   |
| Recognition of  net unrealized gains for investments sold, after-tax                           |       | (69.3                                      | )          | (60.4 | ) | (84.9 | ) |
| Change in net unrealized  investment gains (losses), after-tax                                 |       | $                                          | 67.6       |   | $ | (117.9 | ) | $ | 15.5 |   |

 

| ** **                                                           | ** ** | **Year ended December 31,** | ** ** |
|----------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                           | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                                           | ** ** | **($ in millions)**              | ** ** |
| Net change in  unrealized foreign currency gains (losses)            |       | $                                          | 25.7       |   | $ | (38.8 | ) | $ | 20.3 |   |
| Income taxes  attributable to foreign currency gains (losses)        |       | (9.0                                       | )          | 13.6 |   | (7.1 | ) |
| Net change in unrealized  foreign currency gains (losses), after-tax |       | $                                          | 16.7       |   | $ | (25.2 | ) | $ | 13.2 |   |

 

The components of OneBeacon’s ending net unrealizedinvestment gains and losses on its investment portfolio and its investments inunconsolidated affiliate were as follows:

| ** **                                                                    | ** ** | **Year ended  December 31,** | ** ** |
|-------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                    | ** ** | **2005**                               | ** ** | **2006** | ** ** |
| ** **                                                                    | ** ** | **($ in millions)**          | ** ** |
| **Investment securities:(1)**                                                 |       |                                   |       |   |   |
| Gross unrealized investment gains                                             |       | $                                      | 235.0      |   | $ | 255.3 |   |
| Gross unrealized investment losses                                            |       | (26.6                                  | )          | (18.8 | ) |
| Net unrealized  gains from investment securities                              |       | 208.4                                  |       | 236.5 |   |
| Net unrealized  gains from investments in unconsolidated affiliate            |       | 6.7                                    |       | — |   |
| Total net unrealized investment gains from  continuing operations, before tax |       | 215.1                                  |       | 236.5 |   |
| Income taxes attributable to such gains                                       |       | (75.3                                  | )          | (82.8 | ) |
| Total net unrealized investment gains from  continuing operations, after-tax  |       | 139.8                                  |       | 153.7 |   |
| Net unrealized  gains from discontinued operations, after-tax                 |       | 2.1                                    |       | — |   |
| Total net unrealized  investment gains, after-tax                             |       | $                                      | 141.9      |   | $ | 153.7 |   |

----

(1)          Does not includedeferred gains and losses on sales of investments between OneBeacon andentities under White Mountains’ common control of $24.1 million and $18.7million, after-tax, as of December 31, 2005 and 2006, respectively.

Prior to the funding of the trusts to economicallydefease the preferred stock subject to mandatory redemption, OneBeacon did nothave any held-to-maturity investments. The carrying value, gross unrealizedinvestment gains and losses, and estimated market values of OneBeacon’s fixedmaturity held-to-maturity investments, carried at amortized cost, as of December 31,2006, were as follows:

F-28

----

 

| ** **                        | ** ** | **December 31, 2006** | ** ** |
|-----------------------------------|------------|---------------------------------|------------|
| ** **                        | ** ** | **Carrying  Value**             | ** ** | **Gross  unrealized  gains** | ** ** | **Gross  unrealized  losses** | ** ** | **Net foreign  currency  gains** | ** ** | **Estimated  Market  Value** | ** ** |
| ** **                        | ** ** | **($ in millions)**   | ** ** |
| U.S. Government  obligations      |       |                            | $          | 305.0 |   |   |   | $ | — |   |   |   | $ | (1.0 | ) |   |   | $ | — |   |   |   | $ | 304.0 |   |   |
| Total fixed  maturity investments |       |                            | $          | 305.0 |   |   |   | $ | — |   |   |   | $ | (1.0 | ) |   |   | $ | — |   |   |   | $ | 304.0 |   |   |

 

Thecost or amortized cost, gross unrealized investment gains and losses, andcarrying values of OneBeacon’s fixed maturity available-for-sale investments asof December 31, 2005 and 2006, were as follows:

| ** **                                         | ** ** | **December 31, 2005**   | ** ** |
|----------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                         | ** ** | **Cost or  amortized  cost** | ** ** | **Gross  unrealized  gains** | ** ** | **Gross  unrealized  losses** | ** ** | **Net foreign  currency  gains (losses)** | ** ** | **Carrying  value** | ** ** |
| ** **                                         | ** ** | **($ in millions)**     | ** ** |
| U.S. Government  obligations                       |       | $                                 | 691.6      |   |   | $ | 3.7 |   |   |   | $ | (2.5 | ) |   |   | $ | — |   |   | $ | 692.8 |   |
| Debt securities  issued by industrial corporations |       | 1,689.4                           |       |   | 37.0 |   |   |   | (8.3 | ) |   |   | (6.7 | ) |   | 1,711.4 |   |
| Municipal  obligations                             |       | 17.1                              |       |   | 0.6 |   |   |   | — |   |   |   | — |   |   | 17.7 |   |
| Asset-backed  securities                           |       | 1,082.7                           |       |   | 6.5 |   |   |   | (11.7 | ) |   |   | — |   |   | 1,077.5 |   |
| Foreign  government obligations                    |       | 129.1                             |       |   | 0.9 |   |   |   | (1.4 | ) |   |   | — |   |   | 128.6 |   |
| Preferred stocks                                   |       | 40.7                              |       |   | 17.7 |   |   |   | (0.2 | ) |   |   | 4.2 |   |   | 62.4 |   |
| Total fixed  maturity investments                  |       | $                                 | 3,650.6    |   |   | $ | 66.4 |   |   |   | $ | (24.1 | ) |   |   | $ | (2.5 | ) |   | $ | 3,690.4 |   |

 

| ** **                                         | ** ** | **December 31, 2006**   | ** ** |
|----------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                         | ** ** | **Cost or  amortized  cost** | ** ** | **Gross  unrealized  gains** | ** ** | **Gross  unrealized  losses** | ** ** | **Net foreign  currency  gains** | ** ** | **Carrying  value** | ** ** |
| ** **                                         | ** ** | **($ in millions)**     | ** ** |
| U.S. Government  obligations                       |       | $                                 | 806.7      |   |   | $ | 1.8 |   |   |   | $ | (4.2 | ) |   |   | $ | — |   |   | $ | 804.3 |   |
| Debt securities  issued by industrial corporations |       | 1,429.6                           |       |   | 8.2 |   |   |   | (8.4 | ) |   |   | 10.7 |   |   | 1,440.1 |   |
| Municipal  obligations                             |       | 8.2                               |       |   | 0.4 |   |   |   | — |   |   |   | — |   |   | 8.6 |   |
| Asset-backed  securities                           |       | 1,091.4                           |       |   | 9.4 |   |   |   | (3.7 | ) |   |   | — |   |   | 1,097.1 |   |
| Foreign  government obligations                    |       | 54.7                              |       |   | — |   |   |   | (0.6 | ) |   |   | — |   |   | 54.1 |   |
| Preferred stocks                                   |       | 110.9                             |       |   | 17.1 |   |   |   | (0.4 | ) |   |   | 7.9 |   |   | 135.5 |   |
| Total fixed  maturity investments                  |       | $                                 | 3,501.5    |   |   | $ | 36.9 |   |   |   | $ | (17.3 | ) |   |   | $ | 18.6 |   |   | $ | 3,539.7 |   |

 

F-29

----

Thecost or amortized cost and carrying value of OneBeacon’s fixed maturityavailable-for-sale investments at December 31, 2006 is presented below bycontractual maturity. Actual maturities could differ from contractualmaturities because borrowers may have the right to call or prepay certainobligations with or without call or prepayment penalties.

| ** **                              | ** ** | **December 31, 2006**   | ** ** |
|-----------------------------------------|------------|-----------------------------------|------------|
| ** **                              | ** ** | **Cost or  amortized  cost** | ** ** | **Carrying  value** | ** ** |
| ** **                              | ** ** | **($ in millions)**     | ** ** |
| Due in one year  or less                |       | $                                 | 178.5      |   | $ | 178.3 |   |
| Due after one  year through five years  |       | 1,020.8                           |       | 1,023.5 |   |
| Due after five  years through ten years |       | 753.6                             |       | 757.0 |   |
| Due after ten  years                    |       | 346.3                             |       | 348.4 |   |
| Asset-backed  securities                |       | 1,091.4                           |       | 1,097.0 |   |
| Preferred stocks                        |       | 110.9                             |       | 135.5 |   |
| Total                                   |       | $                                 | 3,501.5    |   | $ | 3,539.7 |   |

 

Thematurity distribution for fixed maturity held-to-maturity investments held at December 31,2006 is as follows:

| **Maturity**                      | ** ** | ** **                    | ** ** | **Carrying  Value** | ** ** | **Estimated  Fair Value** | ** ** |
|-----------------------------------|------------|-------------------------------|------------|---------------------|------------|--------------------------------|------------|
| ** **                        | ** ** | **($ in millions)** | ** ** |
| Due within one  year              |       |                          | $          | 13.3                |       |                           |       | $ | 13.2 |   |   |
| Due after one  through five years |       |                          | 291.7      |                |       |                           | 290.8      |   |   |
| Due after five  through ten years |       |                          | —     |                |       |                           | —     |   |   |
| Due after ten  years              |       |                          | —     |                |       |                           | —     |   |   |
| Total                             |       |                          | $          | 305.0               |       |                           |       | $ | 304.0 |   |   |

 

Thecost or amortized cost, gross unrealized investment gains and losses, andcarrying values of OneBeacon’s common equity securities and other investmentsas of December 31, 2005 and 2006, were as follows:

| ** **                | ** ** | **December 31, 2005**   | ** ** |
|---------------------------|------------|-----------------------------------|------------|
| ** **                | ** ** | **Cost or  amortized  cost** | ** ** | **Gross  unrealized  gains** | ** ** | **Gross  unrealized  losses** | ** ** | **Net foreign  currency  gains** | ** ** | **Carrying  value** | ** ** |
| ** **                | ** ** | **($ in millions)**     | ** ** |
| Common equity  securities |       |                              | $          | 459.3 |   |   |   | $ | 133.0 |   |   |   | $ | (1.7 | ) |   |   | $ | 0.7 |   |   |   | $ | 591.3 |   |   |
| Other investments         |       |                              | $          | 240.4 |   |   |   | $ | 35.6 |   |   |   | $ | (0.8 | ) |   |   | $ | — |   |   |   | $ | 275.2 |   |   |

 

| ** **                | ** ** | **December 31, 2006**   | ** ** |
|---------------------------|------------|-----------------------------------|------------|
| ** **                | ** ** | **Cost or  amortized  cost** | ** ** | **Gross  unrealized  gains** | ** ** | **Gross  unrealized  losses** | ** ** | **Net foreign  currency  losses** | ** ** | **Carrying  value** | ** ** |
| ** **                | ** ** | **($ in millions)**     | ** ** |
| Common equity  securities |       |                              | $          | 568.9 |   |   |   | $ | 169.2 |   |   |   | $ | (0.9 | ) |   |   | $ | (0.1 | ) |   |   | $ | 737.1 |   |   |
| Other investments         |       |                              | $          | 229.5 |   |   |   | $ | 49.2 |   |   |   | $ | (0.6 | ) |   |   | $ | — |   |   |   | $ | 278.1 |   |   |

 

Sales and maturities of available-for-saleinvestments, excluding short-term investments, totaled $4,687.2 million,$3,429.7 million and $5,981.6 million for the years ended December 31,2004, 2005 and 2006, respectively. There were no non-cash exchanges orinvoluntary sales of investment securities during 2004, 2005 or 2006.

F-30

----

OneBeacon’s consolidated insurance operations arerequired to maintain deposits with certain insurance regulatory agencies inorder to maintain their insurance licenses. The fair value of such depositstotaled $441.3 million and $323.6 million as of December 31,2005 and 2006, respectively.

OneBeacon participates ina securities lending program whereby it loans investment securities to otherinstitutions for short periods of time. OneBeacon receives a fee from theborrower in return for the use of its assets and its policy is to requirecollateral equal to approximately 102% of the fair value of the loanedsecurities, which is held by a third party. All securities loaned can beredeemed on short notice. The total market value of OneBeacon’s securities on loanat December 31, 2006 was $518.7 million with corresponding collateralof $528.8 million.

***Impairment***

OneBeacon’s portfolio of fixed maturity investments iscomprised primarily of investment grade corporate debt securities, U.S.government and agency securities and mortgage-backed securities that areclassified as available-for-sale. At December 31, 2006, approximately 94%of OneBeacon’s fixed maturity investments received an investment grade ratingfrom Standard & Poor’s or, if a given security was unrated by Standard &Poor’s, from Moody’s Investor Services. OneBeacon expects to continue to investprimarily in high quality, fixed maturity investments. Nearly all the fixedmaturity investments currently held by OneBeacon are publicly traded, and assuch are considered to be liquid.

Temporary losses on investment securities are recordedas unrealized losses. Temporary losses do not impact net income and earningsper share but serve to reduce comprehensive net income and common shareholders’equity. Unrealized losses subsequently identified as other-than-temporaryimpairments are recorded as realized losses. Other-than-temporary impairmentspreviously recorded as unrealized losses do not impact comprehensive net incomeand common shareholders’ equity but serve to reduce net income and earnings pershare.

OneBeacon’s methodology of assessingother-than-temporary impairments is based on security-specific facts andcircumstances as of the balance sheet date. As a result, subsequent adversechanges in an issuers’ credit quality or subsequent weakening of marketconditions that differ from expectations could result in additionalother-than-temporary impairments. In addition, the sale of a fixed maturitysecurity with a previously recorded unrealized loss would result in a realizedloss. Either of these situations would adversely impact net income and earningsper share but would not impact comprehensive net income and common shareholders’equity.

F-31

----

Thefollowing table presents an analysis of the continuous periods during whichOneBeacon has held investment positions which were carried at an unrealizedloss as of December 31, 2006 (excluding short-term investments):

| ** **                              | ** ** | **December 31, 2006** | ** ** |
|-----------------------------------------|------------|---------------------------------|------------|
| ** **                              | ** ** | **0-6  Months**                 | ** ** | **6-12  Months** | ** ** | **> 12  Months** | ** ** | **Total** | ** ** |
| ** **                              | ** ** | **(in millions)**          | ** ** |
| **Fixed maturity investments:**         |       |                            |       |   |   |   |   |   |   |   |   |
| Number of positions                     |       |                            | 72         |   |   | 20 |   | 89 |   | 181 |   |
| Market value                            |       |                            | $          | 958.8 |   |   | $ | 353.6 |   | $ | 595.2 |   | $ | 1,907.6 |   |
| Amortized cost                          |       |                            | $          | 961.4 |   |   | $ | 356.6 |   | $ | 606.9 |   | $ | 1,924.9 |   |
| Unrealized loss                         |       |                            | $          | (2.6 | ) |   | $ | (3.0 | ) | $ | (11.7 | ) | $ | (17.3 | ) |
| **Common equity securities:**           |       |                            |       |   |   |   |   |   |   |   |   |
| Number of positions                     |       |                            | 6          |   |   | — |   | — |   | 6 |   |
| Market value                            |       |                            | $          | 47.6 |   |   | $ | — |   | $ | — |   | $ | 47.6 |   |
| Amortized cost                          |       |                            | $          | 48.5 |   |   | $ | — |   | $ | — |   | $ | 48.5 |   |
| Unrealized loss                         |       |                            | $          | (0.9 | ) |   | $ | — |   | $ | — |   | $ | (0.9 | ) |
| **Other investments:**                  |       |                            |       |   |   |   |   |   |   |   |   |
| Number of positions                     |       |                            | 1          |   |   | 1 |   | 2 |   | 4 |   |
| Market value                            |       |                            | $          | 3.8 |   |   | $ | 14.1 |   | $ | 2.9 |   | $ | 20.8 |   |
| Amortized cost                          |       |                            | $          | 3.8 |   |   | $ | 14.1 |   | $ | 3.5 |   | $ | 21.4 |   |
| Unrealized loss                         |       |                            | $          | — |   |   | $ | — |   | $ | (0.6 | ) | $ | (0.6 | ) |
| **Total:**                              |       |                            |       |   |   |   |   |   |   |   |   |
| Number of positions                     |       |                            | 79         |   |   | 21 |   | 91 |   | 191 |   |
| Market value                            |       |                            | $          | 1,010.2 |   |   | $ | 367.7 |   | $ | 598.1 |   | $ | 1,976.0 |   |
| Amortized cost                          |       |                            | $          | 1,013.7 |   |   | $ | 370.7 |   | $ | 610.4 |   | $ | 1,994.8 |   |
| Unrealized loss                         |       |                            | $          | (3.5 | ) |   | $ | (3.0 | ) | $ | (12.3 | ) | $ | (18.8 | ) |
| **% of total gross unrealized  losses** |       |                            | 18.6       | % |   | 16.0 | % | 65.4 | % | 100.0 | % |

 

During the years ended December 31, 2004, 2005and 2006, OneBeacon recognized pre-tax other-than-temporary impairment chargesof $2.4 million, $58.0 million and $5.5 million, respectively.The charges taken in 2004 and 2006 did not include any positions which wereindividually significant. The charge taken in 2005 was primarily due toOneBeacon’s investment in Montpelier. During 2005, the market value ofMontpelier common shares decreased from $38.45 per share to $18.90 per share.OneBeacon’s original cost of this investment was $105.0 million which wassubsequently increased by $65.3 million in equity in earnings recorded byOneBeacon from 2001 to March 2004, the period in which it accounted forthe investment under the equity method of accounting. The impairment chargerepresented the difference between OneBeacon’s GAAP cost of $170.3 millionand the investment’s fair value of $115.7 million at December 31,2005.

OneBeacon believes thatthe gross unrealized losses relating to its fixed maturity investments at December 31,2006 resulted primarily from increases in market interest rates from the datesthat certain investments within that portfolio were acquired as opposed tofundamental changes in the credit quality of the issuers of such securities.OneBeacon views these decreases in value as being temporary because it has theintent and ability to retain such investments until recovery. However, shouldOneBeacon determine that it no longer has the intent and ability to hold afixed maturity investment that has an existing unrealized loss resulting froman increase in market interest rates until it recovers, this loss would berealized through the income statement at the time such determination is made.OneBeacon also believes that the gross unrealized losses recorded on its commonequity securities and its other investments at December 31, 2006 resultedprimarily from decreases in quoted market values from the dates that certain 

F-32

----

investmentssecurities within that portfolio were acquired as opposed to fundamentalchanges in the issuer’s financial performance and near term financialprospects. Therefore, these decreases are also viewed as being temporary.However, due to the inherent risk involved in investing in the equity markets,it is possible that the decrease in market value of these investments mayultimately prove to be other than temporary. At December 31, 2006,OneBeacon’s investment portfolio did not include any individual investmentsecurities with an after-tax unrealized loss of more than $3.0 million formore than a six-month period.

**NOTE 7. Debt**

**OneBeacon’sdebt outstanding as of December 31, 2005 and 2006 consisted of thefollowing:**

| ** **                                                        | ** ** | **December 31,**         | ** ** |
|-------------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                                        | ** ** | **2005**                      | ** ** | **2006** | ** ** |
| ** **                                                        | ** ** | **($ in millions)** | ** ** |
| Senior unsecured  notes (“Senior Notes”), at face value |       | $                             | 700.0      |   | $ | 700.0 |   |
| Unamortized original issue discount                               |       | (1.5                          | )          | (1.3 | ) |
| Senior Notes, carrying value                                      |       | 698.5                         |       | 698.7 |   |
| Bank Facility                                                     |       | —                        |       | — |   |
| Mortgage note on  real estate owned                               |       | 18.4                          |       | 40.8 |   |
| Atlantic  Specialty Note                                          |       | 20.0                          |       | 20.0 |   |
| Fund III Note                                                     |       | 8.0                           |       | — |   |
| Total debt                                                        |       | $                             | 744.9      |   | $ | 759.5 |   |

 

Aschedule of contractual repayments of OneBeacon’s debt as of December 31,2006 follows:

| ** **                 | ** ** | **December 31,  2006**   | ** ** |
|----------------------------|------------|-------------------------------|------------|
| ** **                 | ** ** | **($ in millions)** | ** ** |
| Due in one year  or less   |       |                          | $          | 2.0 |   |   |
| Due in two to  three years |       |                          | 4.8        |   |   |
| Due in four to  five years |       |                          | 5.6        |   |   |
| Due after five  years      |       |                          | 748.4      |   |   |
| Total                      |       |                          | $          | 760.8 |   |   |

 

***Senior Notes***

In May 2003, FundAmerican Companies, Inc. (“Fund American”), a wholly-owned subsidiary ofthe Company, issued $700.0 million face value of senior unsecured debtthrough a public offering, at an issue price of 99.7%. The Senior Notes bear anannual interest rate of 5.875%, payable semi-annually in arrears on May 15and November 15, until maturity on May 15, 2013, and are fully andunconditionally guaranteed as to the payment of principal and interest by WhiteMountains. Fund American incurred $7.3 million in expenses related to theissuance of the Senior Notes (including the $4.5 million underwritingdiscount), which have been deferred and are being recognized into interestexpense over the life of the Senior Notes. Taking into effect the amortizationof the original issue discount and all underwriting and issuance expenses, theSenior Notes have an effective yield to maturity of approximately 6.0% perannum.

***Bank Facility***

In connection with theinitial public offering, White Mountains and Fund American terminated theirexisting $400 million credit facility, under which they were both permittedborrowers. In November 2006, Fund American established a $75 millionrevolving credit facility that matures in November 2011 (“the BankFacility”). As of December 31, 2006, the Bank Facility was undrawn.

F-33

----

***Mortgage Note on Real Estate Owned***

In connection with its December 2005 purchase ofland and an office building that is now its U.S. headquarters, OneBeaconentered into a $40.8 million, 18-year mortgage note which has avariable interest rate based upon the lender’s 30 day LIBOR rate. As of December 31,2006, OneBeacon had drawn the full amount of $40.8 million on the mortgagenote. Repayment will commence in January 2009.

Concurrent with enteringinto the mortgage note, OneBeacon also entered into an interest rate swap tohedge its exposure to the variability in the interest rate on the mortgagenote. The notional amount of the swap is equal to the debt outstanding on themortgage note and will be adjusted to match the drawdowns and repayments on themortgage note so that the principal amount of the mortgage note and thenotional amount of the swap are equal at all times. Under the terms of theswap, OneBeacon pays a fixed interest rate of approximately 6% and receives avariable interest rate based on the same LIBOR index used for the mortgagenote. Interest paid or received on the swap is reported in interest expense.Changes in the fair value of the interest rate swap, which was a$0.6 million gain, after-tax, for the year ended December 31, 2006,is reported as a component of other comprehensive income.

***Other Debt of Operating Subsidiaries***

In connection with the Atlantic Specialty Transactionon March 31, 2004, OneBeacon issued a $20.0 million ten-year note tothe seller (the “Atlantic Specialty Note”). OneBeacon is required to repay$2.0 million of principal on the notes per year, commencing in January 2007.The note accrues interest at a rate of 5.2% except that the outstandingprincipal amount in excess of $15.0 million accrues interest at a rate of3.6%.

OneBeacon ProfessionalPartners (“OBPP”) borrowed $8.0 million from Dowling & PartnersConnecticut Fund III, LP (“Fund III”) in connection with an incentiveprogram sponsored by the State of Connecticut known as the ConnecticutInsurance Reinvestment Act (the “CIR Act”). The CIR Act provides forConnecticut tax credits to be granted for qualifying investments made byapproved fund managers. The loan made by Fund III to OBPP was a qualifyinginvestment and had the potential to generate up to $8.0 million of taxcredits that would be shared equally between Fund III on the one hand andOBPP on the other. This loan was repaid in November 2006.

***Interest***

Total interest expenseincurred by OneBeacon for its indebtedness was $45.0 million,$44.1 million and $45.5 million in 2004, 2005 and 2006, respectively.Total cash interest paid by OneBeacon for its indebtedness was$44.8 million, $44.1 million and $43.4 million in 2004, 2005 and2006, respectively.

**NOTE 8. IncomeTaxes**

OneBeacon is domiciled in Bermuda and has subsidiariesdomiciled in several countries. The majority of the Company’s worldwideoperations are taxed in the United States. Income earned or losses incurred bynon-U.S. companies will generally be subject to an overall effective tax ratelower than that imposed by the United States.

OneBeacon’s U.S. subsidiaries join in the filing of aFederal consolidated tax return. The consolidated parent is Fund AmericanFinancial Services, Inc. For all years, the companies included within theU.S. consolidated tax return are parties to a tax sharing agreement whichprovides that each company pays the amount of income taxes or estimated tax orreceives refunds that it would have to make or be entitled to if it filed itsown separate tax return. As a result, certain companies have made payments, andreceived refunds from the consolidated parent that are different than amountspayable to the Internal Revenue Service. In connection with the initial publicoffering, settlements of outstanding intercompany tax 

F-34

----

balances were made withcompanies which were transferred out of OneBeacon. The companies that aredomiciled outside of the United States file separate returns for theappropriate jurisdictions.

The total income tax provision for the years ended December 31,2004, 2005 and 2006 consisted of the following:

| ** **                              | ** ** | **Year ended December 31,** | ** ** |
|-----------------------------------------|------------|--------------------------------------------|------------|
| ** **                              | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                              | ** ** | **($ in millions)**              | ** ** |
| **Current tax provision  (benefit):**   |       |                                       |       |   |   |   |   |
| Federal                                 |       | $                                          | 118.5      |   | $ | (27.5 | ) | $ | 48.9 |   |
| State                                   |       | 0.1                                        |       | — |   | (0.2 | ) |
| Non-U.S.                                |       | 4.6                                        |       | 1.1 |   | 0.5 |   |
| Total current tax  provision (benefit)  |       | 123.2                                      |       | (26.4 | ) | 49.2 |   |
| **Deferred tax provision  (benefit):**  |       |                                       |       |   |   |   |   |
| Federal                                 |       | (73.8                                      | )          | 108.5 |   | 19.7 |   |
| State                                   |       | —                                     |       | — |   | — |   |
| Non-U.S.                                |       | —                                     |       | — |   | — |   |
| Total deferred  tax provision (benefit) |       | (73.8                                      | )          | 108.5 |   | 19.7 |   |
| Total income tax  provision             |       | $                                          | 49.4       |   | $ | 82.1 |   | $ | 68.9 |   |

 

F-35

----

Deferredincome taxes reflect the net tax effects of temporary differences between thecarrying amounts of assets and liabilities for financial reporting purposes andthe amounts for tax purposes. An outline of the significant components ofOneBeacon’s deferred tax assets and liabilities follows:

| ** **                                           | ** ** | **December 31,**         | ** ** |
|------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                           | ** ** | **2005**                      | ** ** | **2006** | ** ** |
| ** **                                           | ** ** | **($ in millions)** | ** ** |
| **Deferred income tax assets  related to:**          |       |                          |       |   |   |
| Unearned premiums                                    |       | $                             | 69.8       |   | $ | 65.3 |   |
| Compensation and bonus accruals                      |       | 49.5                          |       | 49.5 |   |
| Discounting of loss and LAE reserves                 |       | 60.9                          |       | 47.3 |   |
| U.S. net operating loss and tax credit carryforwards |       | 69.6                          |       | 37.1 |   |
| Deferred compensation plans                          |       | 26.6                          |       | 22.9 |   |
| Pension and benefit accruals                         |       | 20.1                          |       | 9.5 |   |
| Fixed assets                                         |       | 7.4                           |       | 8.7 |   |
| Involuntary pool and guaranty fund accruals          |       | 5.2                           |       | 4.5 |   |
| Allowance for doubtful accounts                      |       | 3.8                           |       | 2.8 |   |
| Other accrued compensation                           |       | 3.8                           |       | 2.8 |   |
| Foreign currency translation on investments          |       | 1.1                           |       | — |   |
| Other items                                          |       | 7.2                           |       | 7.4 |   |
| Total deferred  income tax assets                    |       | 325.0                         |       | 257.8 |   |
| **Deferred income tax liabilities  related to:**     |       |                          |       |   |   |
| Net unrealized investment gains                      |       | 90.8                          |       | 92.6 |   |
| Deferred acquisition costs                           |       | 71.3                          |       | 64.2 |   |
| Purchase accounting                                  |       | 18.1                          |       | 11.7 |   |
| Equity in unconsolidated affiliate                   |       | 15.5                          |       | — |   |
| Foreign currency translation on investments          |       | —                        |       | 6.4 |   |
| Other items                                          |       | 15.4                          |       | 8.7 |   |
| Total deferred  income tax liabilities               |       | 211.1                         |       | 183.6 |   |
| Net deferred tax  asset before valuation allowance   |       | 113.9                         |       | 74.2 |   |
| Valuation allowance                                  |       | (5.4                          | )          | (13.0 | ) |
| Net deferred tax asset                               |       | $                             | 108.5      |   | $ | 61.2 |   |

 

The total net deferred tax asset relates solely to theU.S. consolidated return group.

At December 31, 2005 and 2006, a valuationallowance of $5.4 million and $13.0 million, respectively, wasestablished for the net deferred tax assets of the consolidated insurancereciprocals which file separate consolidated returns. OneBeacon believes thatit is more likely than not that results of future operations will generatesufficient taxable income to realize the deferred tax asset balances (net ofvaluation allowance) carried at December 31, 2005 and 2006.

F-36

----

Areconciliation of taxes calculated using the 35% U.S. statutory rate (the taxrate at which the majority of OneBeacon’s worldwide operations are taxed) tothe income tax provision on pre-tax earnings follows:

| ** **                                              | ** ** | **Year ended December 31,** | ** ** |
|---------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                              | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                              | ** ** | **($ in millions)**              | ** ** |
| Tax provision at  the U.S. statutory rate               |       | $                                          | 63.7       |   | $ | 92.0 |   | $ | 106.4 |   |
| **Differences in taxes resulting  from:**               |       |                                       |       |   |   |   |   |
| Non-deductible preferred stock dividends and  accretion |       | 16.7                                       |       | 18.3 |   | 20.5 |   |
| Tax reserve adjustments                                 |       | 39.7                                       |       | (3.2 | ) | (18.0 | ) |
| Tax exempt interest and dividends                       |       | (3.1                                       | )          | (1.8 | ) | (19.7 | ) |
| Change in valuation allowance                           |       | 3.3                                        |       | 2.1 |   | 7.6 |   |
| Non-U.S. earnings, net of foreign taxes                 |       | (15.7                                      | )          | (30.9 | ) | (32.0 | ) |
| Realignment                                             |       | (13.0                                      | )          | — |   | — |   |
| Foreign tax credit                                      |       | (38.8                                      | )          | — |   | — |   |
| Other, net                                              |       | (3.4                                       | )          | 5.6 |   | 4.1 |   |
| Total income tax  provision on pre-tax earnings         |       | $                                          | 49.4       |   | $ | 82.1 |   | $ | 68.9 |   |

 

The non-U.S. component of pre-tax income was$57.9 million, $91.3 million and $92.8 million for the yearsended December 31, 2004, 2005 and 2006, respectively.

During 2004, as a result of the Company’sreorganization to align its legal organization with its main operatingbusinesses, certain subsidiaries were removed from the existing consolidatedFederal income tax group, resulting in $13.0 million tax benefit toOneBeacon.

At December 31, 2006, there were U.S. netoperating loss carryforwards of approximately $37.7 million availablewhich will begin to expire in 2011. Included in these tax losses are losses of$13.4 million subject to an annual limitation on utilization underInternal Revenue Code Section 382. Also included in these losses are netoperating losses of $22.7 million related to the insurance reciprocalswhich file  separate consolidated tax returns.

At December 31, 2006, there were alternativeminimum tax credit carryforwards available of approximately $6.1 million.The alternative minimum tax credit does not expire.

Subsequent to the passage of the Jobs Creation Act of2004, which extended the carryforward period for utilization of a foreign taxcredit, Fund American Financial Services, Inc. filed amended U.S. taxreturns to claim a credit rather than a deduction for foreign taxes paid. At December 31,2006, $18.2 million of the credit remained which will expire in 2010.

The U.S. Federal income tax returns of the U.S.companies are routinely audited by taxing authorities. For Federal income taxpurposes, years 2003 through 2004 are currently under examination. All yearsprior to 2003 have been settled. During 2006, OneBeacon recognized $26.3million in tax benefits related to the settlements of the U.S. Federal incometax audits for the years prior to 2003. In management’s opinion, adequate taxliabilities have been established for all open tax years. These liabilitiescould be revised in the future if estimates of OneBeacon’s ultimate liabilitychanges.

Cash payments for Federalincome taxes, net of tax refunds received, including those related to companiesincluded in discontinued operations, totaled $86.5 million in 2004, $(5.3)million in 2005 and $(4.2) million in 2006.

F-37

----

**NOTE 9. Retirementand Postretirement Plans**

OneBeacon sponsors a qualified and a non-qualified,non-contributory, defined benefit pension plan covering substantially allemployees who were employed as of December 31, 2001 and remain activelyemployed with OneBeacon.

OneBeacon’s pension plans were curtailed in the fourthquarter of 2002. The Plans no longer add new participants or increase benefitsfor existing participants. Non-vested plan participants continue to vest duringtheir employment with OneBeacon, which effectively causes the projected benefitobligation to equal the accumulated benefit obligation.

The benefits for the plans are based primarily onyears of service and employees’ pay through December 31, 2002.Participants generally vest after five years of continuous service. OneBeacon’sfunding policy is consistent with the funding requirements of Federal laws andregulations.

In addition to the defined benefit plans, OneBeaconhad a contributory postretirement benefit plan which provided medical and lifeinsurance benefits to pensioners and survivors. OneBeacon’s funding policy wasto make contributions to the plan that were necessary to cover its currentobligations.

In the fourth quarter of 2005, OneBeacon settled itspostretirement benefit obligation through the funding of an independent trustto provide benefits for covered participants in the amount of$31.2 million. Upon completing the funding of the independent trust,OneBeacon terminated the postretirement benefit plan. OneBeacon’s settlement ofits postretirement benefit obligation and termination of the plan resulted inrecognition of a $53.6 million gain.

Thefollowing tables set forth the obligations and funded status, assumptions, planassets and cash flows associated with the various pension plans andpostretirement benefits at December 31, 2005 and 2006:

| ** **                                                                     | ** ** | **Pension Benefits**     | ** ** | **Other  Postretirement  Benefits** | ** ** |
|--------------------------------------------------------------------------------|------------|-------------------------------|------------|-------------------------------------|------------|
| ** **                                                                     | ** ** | **2005**                      | ** ** | **2006**                            | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                                                     | ** ** | **($ in millions)** | ** ** |
| **Change in projected benefit  obligation:**                                   |       |                          |       |                                |       |   |   |   |   |   |   |   |   |
| Projected benefit  obligation at beginning of year                             |       |                          | $          | 497.0                               |       |   | $ | 507.3 |   | $ | 50.4 |   |   | $ | — |   |   |
| Service cost                                                                   |       |                          | 1.1        |                                |       | 2.6 |   | 0.1 |   |   | — |   |   |
| Interest cost                                                                  |       |                          | 28.5       |                                |       | 27.7 |   | 2.8 |   |   | — |   |   |
| Curtailment                                                                    |       |                          | —     |                                |       | — |   | (31.2 | ) |   | — |   |   |
| Special  termination benefit cost                                              |       |                          | 2.8        |                                |       | 1.6 |   | — |   |   | — |   |   |
| Assumption  changes                                                            |       |                          | 22.8       |                                |       | 36.9 |   | — |   |   | — |   |   |
| Actuarial (gain)  / loss                                                       |       |                          | 7.8        |                                |       | 3.3 |   | (14.0 | ) |   | — |   |   |
| Benefits and  expenses paid with plan assets, net of participant contributions |       |                          | (49.7      | )                                   |       | (42.2 | ) | (8.1 | ) |   | — |   |   |
| Benefits paid  directly by OneBeacon                                           |       |                          | (3.0       | )                                   |       | (3.1 | ) | — |   |   | — |   |   |
| **Projected  benefit obligation at end of year**                               |       |                          | $          | 507.3                               |       |   | $ | 534.1 |   | $ | — |   |   | $ | — |   |   |
| **Change in plan assets:**                                                     |       |                          |       |                                |       |   |   |   |   |   |   |   |   |
| Fair value of  plan assets at beginning of year                                |       |                          | $          | 471.4                               |       |   | $ | 488.0 |   | $ | — |   |   | $ | — |   |   |
| Actual return on  plan assets                                                  |       |                          | 66.3       |                                |       | 83.4 |   | — |   |   | — |   |   |
| Employer  contributions                                                        |       |                          | —     |                                |       | — |   | 39.3 |   |   | — |   |   |
| Benefits and  expenses paid, net of participant contributions                  |       |                          | (49.7      | )                                   |       | (42.2 | ) | (39.3 | ) |   | — |   |   |
| Other adjustments                                                              |       |                          | —     |                                |       | 3.5 |   | — |   |   | — |   |   |
| **Fair  value of plan assets at end of year**                                  |       |                          | $          | 488.0                               |       |   | $ | 532.7 |   | $ | — |   |   | $ | — |   |   |
| **Funded status at end of year**                                               |       |                          | $          | (19.3                               | )          |   | $ | (1.4 | ) | $ | — |   |   | $ | — |   |   |

 

F-38

----

The funded status of the consolidated pension plans atDecember 31, 2006 was $(1.4) million, which represents anover-funding of $27.4 million related to the qualified pension plan and anunder-funding of $28.8 million related to the non-qualified pension plan.The non-qualified plan, which is unfunded, does not hold any assets. OneBeaconhas set aside $20.1 million in irrevocable rabbi trusts for the benefit ofnon-qualified pension plan participants. In accordance with GAAP, the assetsheld in the rabbi trusts are not reflected in the funded status of theconsolidated pension plans as presented.

Amountsrecognized in the financial statements consist of:

| ** **                                             | ** ** | **Pension Benefits**     | ** ** | **Other  Postretirement  Benefits** | ** ** |
|--------------------------------------------------------|------------|-------------------------------|------------|-------------------------------------|------------|
| ** **                                             | ** ** | **2005**                      | ** ** | **2006**                            | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                             | ** ** | **($ in millions)** | ** ** |
| Prepaid benefit  cost recorded in other assets         |       | $                             | 14.9       |                                | $          | 27.4 |   |   | $ | — |   |   |   | $ | — |   |   |
| Accrued benefit  cost recorded in other liabilities    |       | (29.6                         | )          | (28.8                               | )          |   | — |   |   |   | — |   |   |
| **Net amount recognized in the financial  statements** |       | $                             | (14.7      | )                                   | $          | (1.4 | ) |   | $ | — |   |   |   | $ | — |   |   |

 

The accumulated benefit obligation for all definedbenefit pension plans was $507.3 million and $534.1 million at December 31,2005 and 2006, respectively.

Informationfor the OneBeacon non-qualified pension plan, which had accumulated benefitobligations in excess of plan assets, was as follows:

| ** **                      | ** ** | **December 31,**         | ** ** |
|---------------------------------|------------|-------------------------------|------------|
| ** **                      | ** ** | **2005**                      | ** ** | **2006** | ** ** |
| ** **                      | ** ** | **($ in millions)** | ** ** |
| Projected benefit  obligation   |       | $                             | 29.6       |   | $ | 28.8 |   |
| Accumulated  benefit obligation |       | $                             | 29.6       |   | $ | 28.8 |   |
| Fair value of plan  assets      |       | $                             | —     |   | $ | — |   |

 

Informationfor the OneBeacon qualified pension plan, which had accumulated benefitobligations less than plan assets, was as follows:

| ** **                      | ** ** | **December 31,**         | ** ** |
|---------------------------------|------------|-------------------------------|------------|
| ** **                      | ** ** | **2005**                      | ** ** | **2006** | ** ** |
| ** **                      | ** ** | **($ in millions)** | ** ** |
| Projected benefit  obligation   |       | $                             | 477.6      |   | $ | 505.3 |   |
| Accumulated  benefit obligation |       | $                             | 477.6      |   | $ | 505.3 |   |
| Fair value of plan  assets      |       | $                             | 488.0      |   | $ | 532.7 |   |

 

Theincremental effect of applying SFAS 158 on individual line items in thestatement of financial position, was as follows:

| ** **                                          | ** ** | **Before  Application of  SFAS 158** | ** ** | **Adjustments** | ** ** | **After  Application of  SFAS 158** | ** ** |
|-----------------------------------------------------|------------|------------------------------------------------|------------|-----------------|------------|-----------------------------------------------|------------|
| ** **                                          | ** ** | **($ in millions)**                  | ** ** |
| Prepaid benefit  cost recorded in other assets      |       |                                           | $          | 18.6            |       |                                          |       | $ | 8.8 |   |   |   | $ | 27.4 |   |   |
| Accrued benefit  cost recorded in other liabilities |       |                                           | 28.8       |            |       |                                          | —     |   |   |   | 28.8 |   |   |
| Deferred federal  income taxes                      |       |                                           | 64.3       |            |       |                                          | (3.1       | ) |   |   | 61.2 |   |   |
| Accumulated other  comprehensive income             |       |                                           | 181.2      |            |       |                                          | 5.7        |   |   |   | 186.9 |   |   |
| Total common  shareholders’ equity             |       |                                           | $          | 1,771.5         |       |                                          |       | $ | 5.7 |   |   |   | $ | 1,777.2 |   |   |

 

F-39

----

Thecomponents of net periodic benefit costs for the years ended December 31,2004, 2005 and 2006 were as follows:

| ** **                                                     | ** ** | **Pension Benefits**     | ** ** | **Other Postretirement Benefits** | ** ** |
|----------------------------------------------------------------|------------|-------------------------------|------------|---------------------------------------------|------------|
| ** **                                                     | ** ** | **2004**                      | ** ** | **2005**                                    | ** ** | **2006** | ** ** | **2004** | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                                     | ** ** | **($ in millions)** | ** ** |
| Service cost                                                   |       | $                             | 1.1        |                                        | $          | 1.1 |   | $ | 2.6 |   | $ | 0.1 |   | $ | 0.1 |   |   | $ | — |   |   |
| Interest cost                                                  |       | 29.1                          |       | 28.5                                        |       | 27.7 |   | 3.2 |   | 2.8 |   |   | — |   |   |
| Expected return  on plan assets                                |       | (30.9                         | )          | (30.6                                       | )          | (30.6 | ) | — |   | — |   |   | — |   |   |
| Amortization of  prior service benefit                         |       | —                        |       | —                                      |       | — |   | (4.1 | ) | (4.1 | ) |   | — |   |   |
| Amortization of  unrecognized loss                             |       | —                        |       | 0.1                                         |       | 0.3 |   | 0.1 |   | — |   |   | — |   |   |
| Net periodic  pension cost before special termination benefits |       | (0.7                          | )          | (0.9                                        | )          | — |   | (0.7 | ) | (1.2 | ) |   | — |   |   |
| Special  termination benefits expense(1)                       |       | 2.9                           |       | 2.8                                         |       | 1.6 |   | — |   | — |   |   | — |   |   |
| **Total net periodic benefit cost  (income)**                  |       | $                             | 2.2        |                                        | $          | 1.9 |   | $ | 1.6 |   | $ | (0.7 | ) | $ | (1.2 | ) |   | $ | — |   |   |

----

(1)          Specialtermination benefits are additional payments made from the pension plan when avested participant’s employment is terminated due to a reduction in force.

**Assumptions**

Theweighted average assumptions used to determine benefit obligations at December 31,2005 and 2006 were:

| ** **    | ** ** | **Pension Benefits** | ** ** | **Other  Postretirement  Benefits** | ** ** |
|---------------|------------|---------------------------|------------|-------------------------------------|------------|
| ** **    | ** ** | **2005**                  | ** ** | **2006**                            | ** ** | **2005** | ** ** | **2006** | ** ** |
| Discount rate |       | 5.500                     | %          | 5.027                               | %          |   | — |   |   |   | — |   |   |
|               |            |                           |            |                                     |            |  |  |  |  |  |  |  |  |

 

Theweighted average assumptions used to determine net periodic benefit cost forthe years ended December 31, 2005 and 2006 were:

| ** **                                        | ** ** | **Pension Benefits** | ** ** | **Other  Postretirement  Benefits** | ** ** |
|---------------------------------------------------|------------|---------------------------|------------|-------------------------------------|------------|
| ** **                                        | ** ** | **2005**                  | ** ** | **2006**                            | ** ** | **2005** | ** ** | **2006** | ** ** |
| Discount rate                                     |       | 5.875                     | %          | 5.500                               | %          |   | — |   |   |   | — |   |   |
| Expected long-term  rate of return on plan assets |       | 6.750                     | %          | 6.500                               | %          |   | — |   |   |   | — |   |   |

 

OneBeacon’s discount rate assumptions used to accountfor its qualified and non-qualified pension plans reflect the rates at whichthe benefit obligations could be effectively settled. These rates weredetermined based on consideration of published yields for high qualitylong-term corporate bonds and U.S. Treasuries, as well as settlement rates frominsurance company annuity contracts.

OneBeacon performed ananalysis of expected long-term rates of return based on the allocation of itspension plan assets at both December 31, 2005 and 2006 to develop expectedrates of return for each significant asset class or economic indicator. A rangeof returns was developed based both on forecasts and on broad-markethistorical benchmarks for expected return, correlation, and volatility for eachasset class. Although the expected investment return assumption is long-term innature, the range of reasonable returns had dropped over the past few years asa consequence of lower inflation and lower bond yields.

F-40

----

***Plan Assets***

OneBeacon’spension plans’ asset allocations at December 31, 2005 and 2006, by assetcategory were as follows:

| ** **                       | ** ** | **Plan Assets at  December 31,** | ** ** |
|----------------------------------|------------|-------------------------------------------------|------------|
| **Asset Category**          | ** ** | ** **                                      | ** ** | **2005** | ** ** | **2006** | ** ** |
| Equity securities                |       |                                            | 38         | % |   |   | 42 | % |   |
| Fixed maturity  securities       |       |                                            | 31         |   |   |   | 32 |   |   |
| Convertible  securities          |       |                                            | 22         |   |   |   | 20 |   |   |
| Cash and short-term  investments |       |                                            | 9          |   |   |   | 6 |   |   |
| Total                            |       |                                            | 100        | % |   |   | 100 | % |   |
|                                  |            |                                                 |            |  |  |  |  |  |  |  |  |

 

The majority of the plans’ assets are managed by WhiteMountains Advisors, LLC  (“WM Advisors”),a subsidiary of White Mountains, and Prospector Partners, LLC (“Prospector”),both related parties (see Note 18). The investment policy places an emphasis onpreserving invested assets through a diversified portfolio of high-qualityincome producing investments and equity investments.

The investment managementprocess integrates the risks and returns available in the investment arena withthe risks and returns available to the plan in establishing the properallocation of invested assets. The asset classes include fixed income, equity,convertible securities, and cash and cash equivalents. The factors examined inestablishing the appropriate investment mix include the outlook for risk andreturn in the various investment markets and sectors, and the long term needfor capital growth.

***Cash Flows***

OneBeacon does not expect to make a contribution toits pension plans in 2007. OneBeacon expects to pay $2.8 million of benefitpayments related to the non-qualified pension plan, for which OneBeacon hasestablished assets held in rabbi trusts.

Thefollowing benefit payments, which reflect expected future service, asappropriate, are expected to be paid:

| ** ** | ** ** | **Expected  Benefit  Payments** | ** ** |
|------------|------------|---------------------------------|------------|
| ** ** | ** ** | **($ in millions)**   | ** ** |
| 2007       |       |                            | $          | 37.7 |   |   |
| 2008       |       |                            | 37.1       |   |   |
| 2009       |       |                            | 36.3       |   |   |
| 2010       |       |                            | 35.9       |   |   |
| 2011       |       |                            | 35.5       |   |   |
| 2012-2016  |       |                            | 173.9      |   |   |

 

***Other Benefit Plans***

OneBeacon sponsors an employee savings plan (definedcontribution plan) covering the majority of employees. The contributory planprovides qualifying employees with matching contributions of up to six percentof salary (subject to Federal limits on allowable contributions in a givenyear). Total expense for the plan was $4.1 million, $4.7 million and$4.9 million in 2004, 2005 and 2006, respectively.

Following the curtailment of the OneBeacon PensionPlan and effective January 1, 2003, OneBeacon replaced its defined benefitpension plan with an employee stock ownership plan. See Note 10.

F-41

----

OneBeacon had apost-employment benefit liability of $13.2 million and $9.6 millionrelated to its long-term disability plan at December 31, 2005 and 2006,respectively.

**NOTE 10. Employee Share-BasedCompensation Plans**

OneBeacon’s share-basedcompensation programs, consisting primarily of performance shares, are designedto maximize shareholder value over long periods of time by aligning thefinancial interests of its management with those of  owners. OneBeacon’s board of directorsbelieves that share-based compensation for its key employees should bepayable in full only if OneBeacon achieves superior returns for its owners.OneBeacon expenses all its share-based compensation. As a result,OneBeacon’s calculation of such return includes the full expense of alloutstanding share-based compensation awards. See Note 1 for asummary of OneBeacon’s share-based compensation expense incurred for theyears ended December 31, 2004, 2005 and 2006.

***OneBeacon Long-Term Incentive Plan (the “IncentivePlan”)***

The Incentive Planprovides for granting various types of share-based incentive awards includingperformance shares, performance units, options, share appreciation rights andrestricted shares to certain key employees of OneBeacon. The Incentive Plan wasadopted by the Board in October 2006. Prior to adoption of the IncentivePlan, share-based awards were granted under the OneBeacon Phantom Share WTMPlan.

***Performance Shares & Phantom PerformanceShares***

Performance shares are conditional grants of aspecified maximum number of common shares or an equivalent amount of cash. Phantomshares are much like performance shares but settle only in cash. In general,grants are earned, subject to the attainment of pre-specified performancegoals, at the end of a three-year period or as otherwise determined by theCompensation Committee of the Board and are valued based on the market value ofcommon shares at the time awards are paid. Results that significantly exceedpre-specified targets can result in a performance share payout of up to 200% ofvalue whereas results significantly below target result in no payout. Through2006, the principal performance share goal has been White Mountains’ after-taxcorporate return on equity as measured by growth in its intrinsic value pershare (“ROE”). In determining intrinsic value per share White Mountains’Compensation Committee of its Board of Directors, has considered the WhiteMountains’ growth in economic value per share with some attention to growth intangible book value per share and growth in market value per share. Thisproprietary measure is viewed by White Mountains’ and OneBeacon’s management asbeing an objective and conservative measure of the value of White Mountains’stock and includes the cost of all outstanding compensation awards.

At December 31, 2006, 14,250, 11,300 and 6,720performance shares had been granted at target and remained outstanding underthe Incentive Plan for the three-year performance periods beginning 2004, 2005and 2006, respectively. During 2005, the Company cancelled 3,000 and 3,000target performance shares for the three-year performance periods beginning 2004and 2005, respectively. During 2004, 34,402 performance shares (relating to the2001-2003 performance period) were earned under the White Mountains’Long-Term Incentive Plan based on payout levels ranging from 93% to 147% oftarget, totaling $16.1 million. During 2005, 49,275 performance shares(relating to the 2002-2004 performance period) were earned under theWhite Mountains’ Long-Term Incentive Plan based on payout levels ranging from160% to 180% of target, totaling $31.0 million. During 2006,  no performance shares were earned under theWhite Mountains’ Long-Term Incentive Plan.

The targeted performance goal for full payment of theoutstanding performance shares granted during 2004, 2005 and 2006 under thePhantom Share Plan is the attainment of an ROE of 13%. At an 

F-42

----

ROE of 6% or less, noperformance shares would be earned and at an ROE of 20% or more, 200% ofperformance shares would be earned.

At December 31, 2006,there were 3,200, 3,350 and 3,420 phantom performance shares outstanding underthe Incentive Plan for the three-year performance periods beginning 2004, 2005and 2006, respectively. During 2004, 163,521 performance shares (relating tothe 2001-2003 performance period) were earned under the Incentive Planbased on payout levels ranging from 151% to 200% of target, totaling$76.4 million. During 2005, 238,010 performance shares (relating to the2002-2004 performance period) were earned under the Incentive Plan basedon payout levels ranging from 135% to 200% of target, totaling$149.3 million. During 2006, no performance shares were earned under theIncentive Plan.

***Stock Options***

At December 31, 2006,the Company had 1,420,000 options outstanding representing 1.4% of commonshares outstanding. These options which were issued in November 2006 inconnection with the initial public offering to certain key employees as aone-time incentive, vest in equal installments on each of the third, forth andfifth anniversaries of issuance. The term of the options is 5.5 years. Eachoption has a per share exercise price of $30.00. The fair value of each optionaward at grant date was estimated using a closed-form option model using anexpected volatility assumption of 30.0%, a risk-free interest rate assumptionof 4.6%, a forfeiture assumption of 5.0%, an expected dividend rate assumptionof 3.4% and an expected term assumption of 5.5 years. In 2006, the Companyrecognized compensation expense of $0.2 million in connection with theseoptions.

***Other Share-Based Compensation***

OneBeacon’s defined contribution plan (the “401(k) Plan”)offers participants the ability to invest their balances in several differentinvestment options, including the common shares of White Mountains andsubsequent to the initial public offering, common shares of the Company. As of December 31,2005 and 2006, the 401(k) Plan owned less than 1% of either of the totalWhite Mountains common shares outstanding and the total Company common sharesoutstanding.

Effective January 1, 2003, OneBeacon InsuranceCompany (“OBIC”), a wholly-owned subsidiary of the Company, adopted an employeestock ownership plan (“ESOP”), which is a OneBeacon-funded benefit plan.The ESOP provides all of its participants with an annual base contribution incommon shares (which historically have been common shares of White Mountainsbut subsequent to the initial public offering will now be in the common sharesof the Company) equal to 3% of their salary, up to the applicable SocialSecurity wage base (or $94,200 with respect to 2006). Additionally, thoseparticipants not otherwise eligible to receive certain other Company benefitscan earn a variable contribution up to an additional 6% of their salary, cappedat the annual covered compensation limits ($220,000 for 2006), contingent uponOneBeacon’s performance. The variable contribution amounts earned by eligibleparticipants constituted approximately 4.5%, 3.0% and 6.0% of salary for theyears ended 2004, 2005 and 2006, respectively. OneBeacon has recorded$13.3 million, $7.8 million and $15.5 million in compensationexpense to pay benefits and allocate common shares to participant’s accountsfor the years ended 2004, 2005 and 2006, respectively.

In connection with the initialpublic offering, four common shares of the Company’s common stock wereawarded to each employee and deposited into participant ESOP accounts. A totalof 13,292 shares were awarded and an expense of $0.3 million was recognized.

As of December 31,2006, the Company has no outstanding shareappreciation rights or restricted share awards.

F-43

----

**NOTE 11. MandatorilyRedeemable Preferred Stock of Subsidiaries**

***Mandatorily Redeemable Preferred Stock***

OneBeacon has two classesof mandatorily redeemable preferred stock of subsidiaries. These instrumentsare classified as liabilities and are carried at their historical carryingvalues. Dividends and accretion on OneBeacon’s mandatorily redeemable preferredstock have been recorded as interest expense. During the years ended December 31,2004, 2005 and 2006, OneBeacon recorded $47.6 million, $52.4 millionand $58.6 million, respectively, as interest expense on preferred stock (ofwhich $17.3 million, $22.1 million and $28.3 million,respectively, represented accretion of discount).

*Berkshire PreferredStock*

As part of the financing for the OneBeaconAcquisition, Berkshire invested a total of $300 million in cash, of which (1) $225 millionwas for the purchase of cumulative non-voting preferred stock of Fund American(the “Berkshire Preferred Stock”), which has a $300 million redemptionvalue; and (2) $75 million was for the purchase of warrants toacquire 1,724,200 common shares of White Mountains. The Berkshire PreferredStock is entitled to a dividend of no less than 2.35% per quarter and ismandatorily redeemable on May 31, 2008. The Berkshire Preferred Stock wasinitially recorded at $145.2 million, as the aggregate proceeds receivedfrom Berkshire of $300 million were allocated between the BerkshirePreferred Stock and the warrants, based on their relative fair values inaccordance with Accounting Principles Board Opinion No. 14, “Accountingfor Convertible Debt and Debt Issued with Stock Purchase Warrants”. Through December 31,2006, the carrying value of the Berkshire Preferred Stock had been accreted upto $242.3 million.

During each of the yearsended December 31, 2004, 2005 and 2006, OneBeacon declared and paiddividends of $28.2 million on the Berkshire Preferred Stock and recorded$17.3 million, $22.1 million and $28.3 million, respectively, ofrelated accretion charges.

*Zenith PreferredStock*

Also in connection with the financing for theOneBeacon Acquisition, Zenith Insurance Company (“Zenith”) purchased$20.0 million in cumulative non-voting preferred stock of a subsidiary ofthe Company (the “Zenith Preferred Stock”). The Zenith Preferred Stock isentitled to a dividend of no less than a 2.5% per quarter through June 30,2007 and a dividend of no less than 3.5% per quarter thereafter and ismandatorily redeemable on May 31, 2011. At the Company’s option, theZenith Preferred Stock may be redeemed on June 30, 2007. During the yearsended December 31, 2004, 2005 and 2006, OneBeacon declared and paiddividends of $2.0 million, $2.0 million and $2.0 million,respectively, on the Zenith Preferred Stock.

As described in Note 1, inconnection with the initial public offering and as part of the reorganization,OneBeacon created two irrevocable grantor trusts and funded them with assetssufficient to make the remaining dividend and redemption payments for the $20million Zenith Preferred Stock that will be redeemed in 2007 and the $300million Berkshire Preferred Stock that will be redeemed in May of 2008.The creation and funding of the trusts does not legally defease the preferredstock or create any additional rights for the holders of the preferred stock,although the assets in the trusts remain segregated from OneBeacon’s othergeneral assets and are not available for any use other than the payment of theZenith Preferred Stock and the Berkshire Preferred Stock. The assets held intrust remain subject to the claims of Fund American’s and Fund AmericanEnterprises’ creditors, respectively, in the event that either Fund American orFund American Enterprises becomes insolvent.

F-44

----

**NOTE 12. CommonShareholders’ Equity**

During 2004, OneBeacon made distributions to WhiteMountains totaling $215.2 million, $115.2 million of which was paid incash. The 2004 distributions were recorded as a $186.7 million return ofcapital and a $28.5 million dividend from retained earnings. OneBeacon didnot make any distributions to White Mountains during 2005. During 2006,OneBeacon made distributions to White Mountains totaling $72.4 million, ofwhich $58.8 million was paid in cash. The 2006 distributions were made prior tothe initial public offering and were recorded as a $60.4 million return ofcapital and a $12.0 million dividend from retained earnings.

During 2006, OneBeacon sold one of its inactivelicenses subsidiaries, HCIC, to a subsidiary of White Mountains. In connectionwith the sale of HCIC, OneBeacon recorded a $6.0 million gain as additionalpaid in capital.

As part of a corporatereorganization at White Mountains during 2004, OneBeacon distributed severalwholly-owned subsidiaries to White Mountains. The distribution of WM AssetManagement (Barbados) Ltd., which held, among other things, $1.0 billionof notes receivable from other intermediary holding company subsidiaries ofOneBeacon, resulted in a $1.1 billion reduction in common shareholders’equity. The distribution was recorded as a $744.7 million dividend, a$362.7 million return of capital and a $20.8 million distribution ofother comprehensive income. In addition, the distribution of FolksamericaHoldings, Inc. and its subsidiaries, as well as $270 million inintercompany notes receivable from another affiliate of White Mountains,resulted in a $1.3 billion reduction in common shareholders’ equity, ofwhich $1,220.4 million was recorded as a return of capital and$43.1 million was a distribution of other comprehensive income. During thefirst quarter of 2005, White Mountains contributed $1.0 billion ofintercompany notes receivable back to OneBeacon upon completing White Mountains’realignment of its business segments.

**NOTE 13. Statutory Capitaland Surplus**

OneBeacon’s insurance operations are subject toregulation and supervision in each of the jurisdictions where they aredomiciled and licensed to conduct business. Generally, regulatory authoritieshave broad supervisory and administrative powers over such matters as licenses,standards of solvency, premium rates, policy forms, investments, securitydeposits, methods of accounting, form and content of financial statements,reserves for unpaid loss and LAE, reinsurance, minimum capital and surplusrequirements, dividends and other distributions to shareholders, periodicexaminations and annual and other report filings. In general, such regulationis for the protection of policyholders rather than shareholders. Over the lastseveral years most states have implemented laws that establish standards forcurrent, as well as continued, state accreditation. In addition, the NationalAssociation of Insurance Commissioners uses risk-based capital (“RBC”)standards for property and casualty insurers as a means of monitoring certainaspects affecting the overall financial condition of insurance companies. At December 31,2006, OneBeacon’s active insurance operating subsidiaries met their respectiveRBC requirements.

OneBeacon’s combinedpolicyholders’ surplus as reported to various regulatory authorities as of December 31,2005 and 2006, was $1,675.9 million and $2,013.1 million, respectively.OneBeacon’s consolidated combined statutory net income for the years ended December 31,2004, 2005 and 2006 was $381.9 million, $212.7 million and$372.0 million, respectively. The principal differences between OneBeacon’scombined statutory amounts and the amounts reported in accordance with GAAPinclude deferred acquisition costs, deferred taxes, gains recognized underretroactive reinsurance contracts, market value adjustments for debt securitiesand recognition of pension plan curtailment gains. OneBeacon’s insurancesubsidiaries’ statutory policyholders’ surplus at December 31, 2006 was inexcess of the minimum requirements of relevant state insurance regulations.

F-45

----

***Dividend Capacity***

Under the insurance laws of the states andjurisdictions under which OneBeacon’s insurance operating subsidiaries aredomiciled, an insurer is restricted with respect to the timing or the amount ofdividends it may pay without prior approval by regulatory authorities.Accordingly, there can be no assurance regarding the amount of such dividendsthat may be paid by such subsidiaries in the future.

Generally, OneBeacon’s regulated insurance operatingsubsidiaries have the ability to pay dividends during any twelve month periodwithout the prior approval of regulatory authorities in an amount equal to thegreater of prior year statutory net income or 10% of prior year end statutorysurplus, subject to the availability of unassigned funds. As a result, basedupon 2006 statutory net income OneBeacon’s top tier regulated insuranceoperating subsidiaries have the ability to pay approximately $234 millionof dividends during 2007 without prior approval of regulatory authorities,subject to the availability of unassigned funds. At December 31, 2006,OneBeacon’s top tier regulated insurance operating subsidiaries hadapproximately $1.6 billion of unassigned funds available for dividenddistribution.

In addition, as of December 31, 2006, OneBeaconhad $30.7 million of unrestricted cash and fixed maturity investments outsideof its regulated insurance operating subsidiaries and OneBeacon had an additional $65.8million of unrestricted cash and investments at the Company and itsintermediate holding companies. During 2006, OneBeacon LLC, the directparent of OneBeacon’s operating subsidiaries, paid $90.1 million of dividendsto Fund American, its parent.

In addition, Fund American’s ability to declare or paydividends is limited by the terms of the Series A Preferred Stock issuedto Berkshire. Fund American may not, in certain circumstances, declare or payany dividend or distribution to any other class or series of stock without theconsent of the holders of a majority of outstanding shares of the BerkshirePreferred Stock. Under the terms of a Keep-Well Agreement datedNovember 30, 2004 between White Mountains and Fund American (the“Keep-Well”), White Mountains has agreed to return to Fund American up toapproximately $1.1 billion if some or all of that amount is required by FundAmerican to meet its obligations under the terms of the Berkshire PreferredStock. Under the Keep-Well, White Mountains must make any requiredcontributions to Fund American prior to making any distributions to itsshareholders. The aggregate amount of distributions that White Mountains maymake to its shareholders is limited; the limit increases or decreases by anamount equal to White Mountains’ consolidated net income or loss over theremaining life of the Keep-Well. The Keep-Well will expire when all obligationsof the Berkshire Preferred Stock, which is redeemable in May 2008, havebeen satisfied. See Note 1 and Note 11 for discussion of the creationand funding of an irrevocable grantor trust to economically defease theBerkshire Preferred Stock.

F-46

----

**NOTE 14. SegmentInformation**

OneBeacon’ssegments consist of the following: (1) Primary Insurance Operations, (2) AffiliateQuota Shares and (3) Other Operations. OneBeacon has made its segmentdetermination based on consideration of the following criteria: (i) thenature of the business activities of each of the Company’s subsidiaries andaffiliates; (ii) the manner in which the Company’s subsidiaries andaffiliates are organized; (iii) the existence of primary managersresponsible for specific subsidiaries and affiliates; and (iv) theorganization of information provided to the Board of Directors. Significantintercompany transactions among OneBeacon’s segments have been eliminatedherein. Financial information for OneBeacon’s segments follows:

| ** **                                                           | ** ** | **Primary  Insurance  Operations** | ** ** | **Affiliate  Quota  Shares**(1) | ** ** | **Other  Operations** | ** ** | **Total** | ** ** |
|----------------------------------------------------------------------|------------|------------------------------------|------------|---------------------------------|------------|-----------------------|------------|-----------|------------|
| **Year ended December 31, 2004**                 | ** ** | **($ in millions)**      | ** ** |
| Earned premiums                                                      |       |                               | $          | 2,203.0                         |       |                  |       | $         | (115.9     | ) |   |   | $ | — |   |   | $ | 2,087.1 |   |
| Net investment  income (loss)                                        |       |                               | 211.1      |                            |       |                  | —     |      |       |   | (1.5 | ) |   | 209.6 |   |
| Net realized  investment gains (losses)                              |       |                               | 129.0      |                            |       |                  | —     |      |       |   | (0.2 | ) |   | 128.8 |   |
| Net other  revenues                                                  |       |                               | 48.7       |                            |       |                  | —     |      |       |   | 10.8 |   |   | 59.5 |   |
| Total revenues                                                       |       |                               | 2,591.8    |                            |       |                  | (115.9     | )         |       |   | 9.1 |   |   | 2,485.0 |   |
| Loss and LAE                                                         |       |                               | 1,448.1    |                            |       |                  | (62.7      | )         |       |   | — |   |   | 1,385.4 |   |
| Policy  acquisition expenses                                         |       |                               | 403.3      |                            |       |                  | (43.5      | )         |       |   | — |   |   | 359.8 |   |
| Other  underwriting expenses                                         |       |                               | 350.0      |                            |       |                  | —     |      |       |   | — |   |   | 350.0 |   |
| General and  administrative expenses                                 |       |                               | 30.4       |                            |       |                  | —     |      |       |   | 51.5 |   |   | 81.9 |   |
| Accretion of fair  value adjustment to loss and LAE reserves         |       |                               | —     |                            |       |                  | —     |      |       |   | 33.2 |   |   | 33.2 |   |
| Interest expense  on debt                                            |       |                               | 1.0        |                            |       |                  | —     |      |       |   | 44.0 |   |   | 45.0 |   |
| Interest expense-on  preferred stock subject to mandatory redemption |       |                               | —     |                            |       |                  | —     |      |       |   | 47.6 |   |   | 47.6 |   |
| Total expenses                                                       |       |                               | 2,232.8    |                            |       |                  | (106.2     | )         |       |   | 176.3 |   |   | 2,302.9 |   |
| Pre-tax income  (loss)                                               |       |                               | $          | 359.0                           |       |                  |       | $         | (9.7       | ) |   |   | $ | (167.2 | ) |   | $ | 182.1 |   |

 

 

F-47

----

| ** **                                                           | ** ** | **Primary  Insurance  Operations** | ** ** | **Affiliate  Quota  Shares**(1) | ** ** | **Other  Operations** | ** ** | **Total** | ** ** |
|----------------------------------------------------------------------|------------|------------------------------------|------------|---------------------------------|------------|-----------------------|------------|-----------|------------|
| ** **                                                           | ** ** | **($ in millions)**      | ** ** |
| **Year ended December 31, 2005**                 |       |                               |       |                            |       |                  |       |      |       |   |   |   |   |   |   |
| Earned premiums                                                      |       |                               | $          | 1,988.2                         |       |                  |       | $         | 24.5       |   |   |   | $ | — |   |   | $ | 2,012.7 |   |
| Net investment  income                                               |       |                               | 232.5      |                            |       |                  | —     |      |       |   | 4.3 |   |   | 236.8 |   |
| Net realized  investment gains (losses)                              |       |                               | 124.2      |                            |       |                  | —     |      |       |   | (1.0 | ) |   | 123.2 |   |
| Net other revenues                                                   |       |                               | 14.7       |                            |       |                  | —     |      |       |   | 9.4 |   |   | 24.1 |   |
| Total revenues                                                       |       |                               | 2,359.6    |                            |       |                  | 24.5       |      |       |   | 12.7 |   |   | 2,396.8 |   |
| Loss and LAE                                                         |       |                               | 1,335.6    |                            |       |                  | 54.8       |      |       |   | — |   |   | 1,390.4 |   |
| Policy acquisition  expenses                                         |       |                               | 360.5      |                            |       |                  | (11.2      | )         |       |   | — |   |   | 349.3 |   |
| Other underwriting  expenses                                         |       |                               | 263.4      |                            |       |                  | —     |      |       |   | — |   |   | 263.4 |   |
| General and  administrative expenses                                 |       |                               | 1.1        |                            |       |                  | —     |      |       |   | 7.3 |   |   | 8.4 |   |
| Accretion of fair  value adjustment to loss and LAE reserves         |       |                               | —     |                            |       |                  | —     |      |       |   | 26.0 |   |   | 26.0 |   |
| Interest expense  on debt                                            |       |                               | 1.4        |                            |       |                  | —     |      |       |   | 42.7 |   |   | 44.1 |   |
| Interest expense-on  preferred stock subject to mandatory redemption |       |                               | —     |                            |       |                  | —     |      |       |   | 52.4 |   |   | 52.4 |   |
| Total expenses                                                       |       |                               | 1,962.0    |                            |       |                  | 43.6       |      |       |   | 128.4 |   |   | 2,134.0 |   |
| Pre-tax  income (loss)                                               |       |                               | $          | 397.6                           |       |                  |       | $         | (19.1      | ) |   |   | $ | (115.7 | ) |   | $ | 262.8 |   |
| **Year ended December 31,  2006**                               | ** ** |                               |       |                            |       |                  |       |      |       |   |   |   | ** ** | ** ** | ** ** |
| Earned premiums                                                      |       |                               | $          | 1,944.0                         |       |                  |       | $         | 131.9      |   |   |   | $ | — |   |   | $ | 2,075.9 |   |
| Net investment  income                                               |       |                               | 182.3      |                            |       |                  | —     |      |       |   | 9.5 |   |   | 191.8 |   |
| Net realized  investment gains (losses)                              |       |                               | 165.3      |                            |       |                  | —     |      |       |   | (1.7 | ) |   | 163.6 |   |
| Net other revenues                                                   |       |                               | 21.8       |                            |       |                  | —     |      |       |   | 17.0 |   |   | 38.8 |   |
| Total revenues                                                       |       |                               | 2,313.4    |                            |       |                  | 131.9      |      |       |   | 24.8 |   |   | 2,470.1 |   |
| Loss and LAE                                                         |       |                               | 1,180.3    |                            |       |                  | 103.3      |      |       |   | — |   |   | 1,283.6 |   |
| Policy acquisition  expenses                                         |       |                               | 332.3      |                            |       |                  | 47.6       |      |       |   | — |   |   | 379.9 |   |
| Other underwriting  expenses                                         |       |                               | 360.1      |                            |       |                  | —     |      |       |   | — |   |   | 360.1 |   |
| General and  administrative expenses                                 |       |                               | 3.3        |                            |       |                  | —     |      |       |   | 12.0 |   |   | 15.3 |   |
| Accretion of fair  value adjustment to loss and LAE reserves         |       |                               | —     |                            |       |                  | —     |      |       |   | 23.0 |   |   | 23.0 |   |
| Interest expense  on debt                                            |       |                               | 2.9        |                            |       |                  | —     |      |       |   | 42.6 |   |   | 45.5 |   |
| Interest expense-on  preferred stock subject to mandatory redemption |       |                               | —     |                            |       |                  | —     |      |       |   | 58.6 |   |   | 58.6 |   |
| Total expenses                                                       |       |                               | 1,878.9    |                            |       |                  | 150.9      |      |       |   | 136.2 |   |   | 2,166.0 |   |
| Pre-tax  income (loss)                                               |       |                               | $          | 434.5                           |       |                  |       | $         | (19.0      | ) |   |   | $ | (111.4 | ) |   | $ | 304.1 |   |
| **December 31, 2005**                                           | ** ** |                               |       |                            |       |                  |       |      |       |   |   |   | ** ** | ** ** | ** ** |
| Total investments                                                    |       |                               | $          | 4,488.9                         |       |                  |       | $         | —     |   |   |   | $ | 275.6 |   |   | $ | 4,764.5 |   |
| Reinsurance  recoverable on paid and unpaid losses                   |       |                               | 3,406.3    |                            |       |                  | —     |      |       |   | (261.1 | ) |   | 3,145.2 |   |
| Total assets                                                         |       |                               | 9,886.2    |                            |       |                  | 33.1       |      |       |   | 333.4 |   |   | 10,252.7 |   |
| Loss and LAE  reserves                                               |       |                               | 5,713.4    |                            |       |                  | (41.6      | )         |       |   | (317.5 | ) |   | 5,354.3 |   |
| Total liabilities                                                    |       |                               | 7,780.3    |                            |       |                  | 51.9       |      |       |   | 860.5 |   |   | 8,692.7 |   |
| Total equity                                                         |       |                               | 2,105.9    |                            |       |                  | (18.8      | )         |       |   | (527.1 | ) |   | 1,560.0 |   |
| **December 31, 2006**                                           | ** ** |                               |       |                            |       |                  |       |      |       |   |   |   | ** ** | ** ** | ** ** |
| Total investments                                                    |       |                               | $          | 4,806.9                         |       |                  |       | $         | —     |   |   |   | $ | 405.8 |   |   | $ | 5,212.7 |   |
| Reinsurance  recoverable on paid and unpaid losses                   |       |                               | 3,112.1    |                            |       |                  | —     |      |       |   | (237.1 | ) |   | 2,875.0 |   |
| Total assets                                                         |       |                               | 9,729.2    |                            |       |                  | —     |      |       |   | 140.2 |   |   | 9,869.4 |   |
| Loss and LAE  reserves                                               |       |                               | 5,108.2    |                            |       |                  | —     |      |       |   | (270.5 | ) |   | 4,837.7 |   |
| Total liabilities                                                    |       |                               | 7,382.3    |                            |       |                  | —     |      |       |   | 709.9 |   |   | 8,092.2 |   |
| Total equity                                                         |       |                               | 2,346.9    |                            |       |                  | —     |      |       |   | (569.7 | ) |   | 1,777.2 |   |

----

(1)          The affiliatequota share agreements were commuted during the fourth quarter of 2006.

F-48

----

Thefollowing tables provide net written premiums and earned insurance premiums forOneBeacon’s Primary Insurance Operations by major underwriting unit and intotal for the years ended December 31, 2004, 2005, and 2006:

| ** **                             | ** ** | **Specialty**                 | ** ** | **Commercial** | ** ** | **Personal** | ** ** | **Total(1)** | ** ** |
|----------------------------------------|------------|-------------------------------|------------|----------------|------------|--------------|------------|--------------|------------|
| ** **                             | ** ** | **($ in millions)** | ** ** |
| **Year  ended December 31, 2004** | ** ** |                          | ** ** | ** **     |       |         | ** ** | ** **   |       | ** ** | ** ** | ** ** | ** ** |
| Net written  premiums                  |       |                          | $          | 387.2          | ** ** |         |       | $            | 826.8      | ** ** |   | $ | 1,063.3 |   | $ | 2,280.6 |   |
| Earned premiums                        |       |                          | 363.5      | ** **     |       |         | 710.3      | ** **   |       | 1,070.9 |   | 2,203.0 |   |
| **Year  ended December 31, 2005** | ** ** |                          | ** ** | ** **     |       |         | ** ** | ** **   |       | ** ** | ** ** | ** ** | ** ** |
| Net written  premiums                  |       |                          | $          | 416.3          | ** ** |         |       | $            | 654.4      | ** ** |   | $ | 910.2 |   | $ | 1,988.6 |   |
| Earned premiums                        |       |                          | 391.7      | ** **     |       |         | 654.7      | ** **   |       | 933.7 |   | 1,988.2 |   |
| **Year  ended December 31, 2006** | ** ** |                          | ** ** | ** **     |       |         | ** ** | ** **   |       | ** ** | ** ** | ** ** | ** ** |
| Net written  premiums                  |       |                          | $          | 437.6          | ** ** |         |       | $            | 718.3      | ** ** |   | $ | 800.6 |   | $ | 1,957.6 |   |
| Earned premiums                        |       |                          | 432.3      | ** **     |       |         | 689.3      | ** **   |       | 822.3 |   | 1,944.0 |   |

----

(1)          Includesresults from run-off.

**NOTE 15. Investmentin Unconsolidated Affiliate**

OneBeacon’s investments in unconsolidated affiliatesrepresent operating investments in other companies in which OneBeacon has asignificant voting and economic interest but does not control the entity.

On October 31, 2006, OneBeacon’s investment inMSA was restructured. OneBeacon received a $70 million cash dividend from MSAfollowing which OneBeacon sold its 50% common stock investment in MSA to MainStreet America Group, Inc. (“the MSA Group”) for (i) $70.0 million in9.0% non-voting cumulative perpetual preferred stock of the MSA Group and (ii) 4.9%of the common stock of the MSA Group. (See “Note 3—Acquisitions andDispositions”). Effective October 31, 2006, OneBeacon accounts for itsremaining investment in the MSA Group in accordance with SFAS 115. Prior to thesale, OneBeacon owned 50% of the total common shares outstanding of MSA andaccounted for this investment using the equity method of accounting. Thesetransactions resulted in a net after-tax realized gain of $8.5 million.

Priorto the exchange of our common stock investment in MSA, we accounted for thisinvestment using the equity method of accounting. The following table provides summary financialamounts recorded by OneBeacon under the equity method relating to itsinvestment in MSA common stock.

| ** **                                                                              | ** ** | **2004**                      | ** ** | **2005** | ** ** | **2006** | ** ** |
|-----------------------------------------------------------------------------------------|------------|-------------------------------|------------|----------|------------|----------|------------|
| ** **                                                                              | ** ** | **($ in millions)** | ** ** |
| **Amounts  recorded by OneBeacon:**                                                     |       |                          |       |     |       |     |       |
| Investment in MSA  common stock.                                                        |       | $                             | 161.7      |     | $          | 168.0    |       | $ | — |   |
| Equity in  earnings from MSA common stock(1)                                            |       | 16.4                          |       | 5.6      |       | 10.3     |       |
| Equity in unrealized  investment gains (losses) from MSA’s investment portfolio(2) |       | 1.3                           |       | (4.0     | )          | 0.3      |       |
|                                                                                         |            |                               |            |          |            |          |            |  |  |  |

----

(1)          Equity in earningsamounts are net of taxes of $1.2 million, $3.0 million and $5.6 million for theyears ended December 31, 2004 and 2005 and the ten months ended October 31,2006, respectively.

(2)          Recordeddirectly to common shareholders’ equity (after-tax) as a component of othercomprehensive income.

F-49

----

**NOTE 16. VariableInterest Entities**

***Reciprocals***

Reciprocals are not-for-profit, policyholder-ownedinsurance carriers organized as unincorporated associations. Each policyholderinsured by the reciprocal shares risk with the other policyholders. Policyholdersshare profits and losses in the same proportion as the amount of insurancepurchased but are not subject to assessment for net losses of the reciprocal.

OneBeacon has capitalized three reciprocals by loaningmoney to them in exchange for surplus notes. In 2002, OneBeacon formed NewJersey Skylands Management LLC to provide management services for a fee to NewJersey Skylands Insurance Association, a reciprocal, and its wholly-ownedsubsidiary New Jersey Skylands Insurance Company (together, New Jersey SkylandsInsurance). New Jersey Skylands Insurance was capitalized with a$31.3 million surplus note issued to OneBeacon in 2002. New JerseySkylands Insurance began writing personal automobile coverage for new customersin August 2002. In 2004, OneBeacon formed Houston General ManagementCompany to provide management services for a fee to another reciprocal, HoustonGeneral Insurance Exchange. During 2004, OneBeacon contributed$2.0 million of capital to Houston General Insurance Exchange. In 2005,OneBeacon contributed one of its subsidiaries, Houston General InsuranceCompany with assets of $149.4 million and liabilities of$127.6 million, to Houston General Insurance Exchange (together “HoustonGeneral Insurance”). Subsequent to the contribution of Houston GeneralInsurance Company, Houston General Insurance Exchange issued a surplus note of$23.7 million to OneBeacon. In November 2005, Houston GeneralInsurance commenced writing personal automobile business in Arizona. In 2006,Adirondack AIF, LLC, a wholly-owned subsidiary of OneBeacon, entered into anagreement to provide management services for a fee to Adirondack InsuranceExchange (“Adirondack Insurance”), a reciprocal. Adirondack Insurance wascapitalized with a $70.7 million surplus note issued to OneBeacon in May 2006.Adirondack Insurance began writing personal automobile and homeowners businessin August 2006. Principal and interest on the surplus notes are repayableto OneBeacon only with regulatory approval. The obligation to repay principalon the notes is subordinated to all other liabilities including obligations topolicyholders and claimants for benefits under insurance policies. OneBeaconhas no ownership interest in New Jersey Skylands Insurance, Houston GeneralInsurance or Adirondack Insurance.

Under the provisions of FIN 46R, OneBeacon hasdetermined that each of the reciprocals qualifies as a VIE. Further, OneBeaconhas determined that it is the primary beneficiary and accordingly, consolidatesall three reciprocals. New Jersey Skylands Insurance was consolidated on March 31,2004 upon adoption of FIN 46R and Houston General Insurance Exchange andAdirondack Insurance were consolidated upon inception.

At December 31, 2005 and 2006, consolidatedamounts related to New Jersey Skylands Insurance included total assets of$105.6 million and $89.2 million, respectively, and total liabilitiesof $119.6 million and $113.7 million, respectively. At December 31,2006, the net amount of capital at risk is equal to the surplus note of$31.3 million less the accumulated losses as of December 31, 2006 of$24.5 million.

At December 31, 2005 and 2006, consolidatedamounts related to Houston General Insurance included total assets of$187.3 million and $167.2 million, respectively, and total liabilities of$165.3 million and $148.8 million, respectively. At December 31, 2006the net amount of capital at risk is equal to the surplus note of$23.7 million.

At December 31, 2006,amounts related to Adirondack Insurance included total assets of$124.8 million and total liabilities of $130.3 million. At December 31,2006 the net amount of capital at risk is equal to the surplus note of$70.7 million less the accumulated losses as of December 31, 2006 of$5.5 million.

F-50

----

**NOTE 17. Fair Valueof Financial Instruments**

SFAS No. 107, “Disclosure about Fair Value ofFinancial Instruments” (“SFAS 107”), requires disclosure of fair valueinformation of financial instruments. For certain financial instruments wherequoted market prices are not available, other independent valuation techniquesand assumptions are used. Because considerable judgment is used, theseestimates are not necessarily indicative of amounts that could be realized in acurrent market exchange. SFAS 107 excludes certain financial instrumentsfrom disclosure, including insurance contracts, other than financial guaranteesand investment contracts. OneBeacon carries its financial instruments on itsbalance sheet at fair value with the exception of its fixed-rate, long-termindebtedness and its mandatorily redeemable preferred stock.

At December 31, 2005 and 2006, the fair value ofOneBeacon’s Senior Notes (its fixed-rate, long-term indebtedness) was$705.4 million and $692.7 million, respectively, which compared to acarrying value of $698.5 million and $698.7 million, respectively.

At December 31, 2005, the fair values of theBerkshire Preferred Stock and the Zenith Preferred Stock were$331.5 million and $21.6 million, respectively, which compared tocarrying values of $214.0 million and $20.0 million, respectively. AtDecember 31, 2006, the fair values of the Berkshire Preferred Stock andthe Zenith Preferred Stock were $319.5 million and $20.6 million,respectively, which compared to carrying values of $242.3 million and$20.0 million, respectively.

The fair values of these obligations were estimated bydiscounting future cash flows using current market rates for similarobligations or using quoted market prices. Considerable judgment is required todevelop such estimates of fair value. Therefore, the estimate provided hereinis not necessarily indicative of the amounts that could be realized in acurrent market exchange.

In December 2005,OneBeacon entered into a mortgage note with a variable interest rate based on 30-dayLIBOR. At December 31, 2006, the carrying value of the note of$40.8 million was considered to approximate its fair value.

**NOTE 18.Related Party Disclosures**

***White Mountains***

During the fourth quarterof 2006, White Mountains sold 27.6 million or 27.6% of the Company’s commonshares in an initial public offering. Prior to the initial public offering,OneBeacon was a wholly-owned subsidiary of White Mountains. As ofDecember 31, 2006, White Mountains owned 72.4% of the Company’soutstanding common shares.

*SeparationAgreement*

In connection with the initial public offering, theCompany entered into a Separation Agreement with White Mountains to address anumber of operational, administrative and financial matters relating to thefact that OneBeacon would no longer be a wholly-owned subsidiary of WhiteMountains. These matters included, among others, the administration of payroll,employee benefits programs, deferred compensation and 401(k) plans,OneBeacon’s travel and logistics office, certain information technology assetsand functions and certain agreements with respect to finance and taxarrangements. Pursuant to the Separation Agreement, White Mountains has agreedto indemnify the Company and its subsidiaries, as well as their current andformer officers, directors and employees to the extent permitted by law, forany and all claims or actions resulting in losses, expenses or damages relatingto or arising out of the business, operation or ownership of any subsidiarycompany or business owned by the Company or its subsidiaries that, subsequentto OneBeacon’s ownership, was a subsidiary or business of White Mountains (butno longer a subsidiary or business of OneBeacon).

F-51

----

Prior to entering into the Separation Agreement, anumber of these matters were governed by informal arrangements betweenOneBeacon and White Mountains. For the years ended December 31, 2004, 2005and 2006, OneBeacon recorded expenses of $13.6 million, $12.3 millionand $10.0 million, respectively, for investment advisory services andother services of the type described in the Separation Agreement that wereprovided to OneBeacon by subsidiaries of White Mountains. For the years endedDecember 31, 2004, 2005 and 2006, OneBeacon recorded revenues of $1.7 million,$3.2 million and $4.5 million, respectively, for claims handlingservices and other services of the type described in the Separation Agreementthat OneBeacon provided to White Mountains and its subsidiaries.

*Registration RightsAgreement*

In connection with theinitial public offering, the Company entered into a registration rightsagreement with White Mountains that provides that White Mountains can demandthat the Company register the distribution of its common shares owned by WhiteMountains (“demand” registration rights). In addition, White Mountains has“piggyback” registration rights, which means that White Mountains may includeits shares in any future registrations of the Company’s common equitysecurities, whether or not that registration relates to a primary offering bythe Company or a secondary offering by or on behalf of any of the Company’sshareholders. These registration rights are transferable by White Mountains.The Company will pay all costs and expenses in connection with each suchregistration, except underwriting discounts and commissions applicable to thecommon shares sold by White Mountains. The registration rights agreementcontains customary terms and provisions with respect to, among other things,registration procedures and rights to indemnification in connection with theregistration of the common shares on behalf of White Mountains. The Companywill register sales of its common shares owned by employees and directors ofWhite Mountains pursuant to employee share or option plans, but only to theextent such registration is required for the shares to be freely tradable.

*InvestmentManagement Agreement with WM Advisors*

Prior to the initial public offering, WM Advisors, managed the majority ofOneBeacon’s investments, including the investments of the employee benefit planportfolios. Prospector served as a discretionary advisor with respect tocertain assets, specifically publicly-traded common equity andconvertible securities, through a sub-advisory agreement with WM Advisors.

Subsequent to the initial public offering, under anagreement dated as of November 14, 2006, WM Advisors supervises anddirects the fixed income and alternative investment portion of OneBeacon’sinvestment portfolio in accordance with the investment objectives, policies andrestrictions described in OneBeacon’s investment guidelines, as well as themajority of the investments of the employee benefit plan portfolios. Under theagreement, WM Advisors has full discretion and authority to make all investmentdecisions in respect of the fixed income and alternative investment portion ofOneBeacon’s investment portfolio as well as the portfolios of the employeebenefit plans on OneBeacon’s behalf and at OneBeacon’s sole risk, and to doanything which WM Advisors deems is required, appropriate or advisable inconnection with the foregoing. The assets of OneBeacon’s portfolio as well asthe portfolios of the employee benefit plans will be held in one or more separatelyidentifiable accounts in the custody of a bank or similar entity designated byOneBeacon and acceptable to WM Advisors. OneBeacon is responsible for custodialarrangements and the payment of all custodial charges and fees. Prospectorcontinues to serve as a discretionary advisor with respect to the publicly-tradedcommon equity and convertible securities of the employee benefit planportfolios, through a sub-advisory agreement with WM Advisors. During 2006,OneBeacon incurred $1.2 million in fees for investment management servicesprovided by WM Advisors under this investment management agreement.

F-52

----

OneBeaconhas agreed to pay annual investment management fees generally based on thequarter-end market values held under custody as set forth in the table below:

| **Assets Under Management**                   | ** ** | ** **         | ** ** | **Annual Fee** | ** ** |
|---------------------------------------------------------|------------|--------------------|------------|---------------------|------------|
| Investment Grade Fixed  Income:                         |       |               |       |
| —Up to $999  million                               |       | 10.0 basis points  |       |
|                                                    |       | (0.1% or 0.001)    |       |
| —Next $1—$1.999  billion                      |       | 8.5 basis points   |       |
| —Amounts over $2  billion                          |       | 7.5 basis points   |       |
| High Yield Fixed  Income                                |       | 25.0 basis points  |       |
| Hedge Funds, Limited  Partnerships and Private Equities |       | 100.0 basis points |       |

 

WM Advisors is paid a quarterly fee for treasurymanagement services computed at the annual rate of 1.75 basis points (0.0175%)of the aggregate value of net assets, not to exceed $500,000 in 2007, on anannual basis. For all years thereafter, the annual rate will be 1.75 basispoints of the aggregate value of net assets with no limit on the total annualcharge.

WM Advisors provides reports containing a detailedlisting of invested assets and transactions in OneBeacon’s investment portfolioat least quarterly. OneBeacon reviews periodically the performance of and thefees paid to WM Advisors under the agreement.

The agreement provides foran initial fixed term of three years, which will be extendible by us for anadditional year (a fourth year) at or prior to the end of the second year ofthe term, and if so extended, for a second additional year (a fifth year) at orprior to the end of the third year of the term. During such term, the WMAdvisors Agreement is terminable by us only (i) for cause (includingmaterial non-performance by WM Advisors), (ii) if there is a change incontrol of WM Advisors (for this purpose, a change in control represents 50% orgreater change in voting interest of WM Advisors), or (iii) if WhiteMountains’ voting interest in us falls below 50%. Following the end of theinitial term and any extensions, the WM Advisors Agreement may be terminated byeither party on 60 days written notice.

*Fund AmericanGuarantee*

White Mountains has provided and, pursuant to theSeparation Agreement, continues to provide anirrevocable and unconditional guarantee as to the payment of principal andinterest (the “Guarantee”) on the Fund American 5.875% Senior Notes due2013. See Note 7.

In consideration of thisGuarantee, OneBeacon has agreed to pay a specified fee to White Mountains inthe amount of 25 basis points per annum on the outstanding principal amount ofthe Senior Notes. Such payment will be made on a semi-annual basis in arrears.OneBeacon has further agreed that if White Mountains’ voting interest in theCompany falls below 50%, OneBeacon will redeem, exchange or otherwise modifythe Senior Notes in order to fully and permanently eliminate White Mountains’obligations under the Guarantee(the “Guarantee Elimination”). White Mountainshas agreed to provide written notice to OneBeacon when its voting interest inus has been reduced below 50%. OneBeacon shall have 180 days from thereceipt of such notification to complete the Guarantee Elimination. If theGuarantee Elimination is not completed within the initial 180-day period,the Guarantee fee shall increase by 200 basis points. The Guarantee fee shallfurther increase by 100 basis points for each subsequent 90-day periodthereafter, up to a maximum Guarantee fee of 425 basis points, until theGuarantee Elimination has been completed. All expenses associated with theelimination of the Guarantee will be borne by OneBeacon.

F-53

----

*Keep-Well*

Under the terms of the Keep-Well described in Note 13,White Mountains has agreed to return to Fund American up to approximately $1.1 billionif some or all of that amount is required by Fund American to meet itsobligations under the terms of the Berkshire Preferred Stock. Under theKeep-Well, White Mountains must make any required contributions to FundAmerican prior to making any distributions to its shareholders. The aggregateamount of distributions that White Mountains may make to its shareholders islimited; the limit increases or decreases by an amount equal to White Mountains’consolidated net income or loss over the remaining life of the Keep-Well. TheKeep-Well will expire when all obligations of the Berkshire Preferred Stock,which is redeemable in May 2008, have been satisfied.

*Irrevocable GrantorTrusts*

In connection with theinitial public offering, OneBeacon created two irrevocable grantor trusts andfunded them with assets sufficient to make the remaining dividend andredemption payments for $20 million of preferred stock that will be redeemed in2007 and $300 million of preferred stock that will be redeemed in May of2008. See Note1 and Note 11. White Mountains Capital, Inc. serves as the trusteefor both irrevocable grantor trusts.

*Galileo Guarantees*

Beginning in February 2006, OBIC agreed toprovide guarantees of the obligations of Galileo Weather RiskManagement Ltd. (“Galileo”) to Galileo’s counterparty in certain weather-relatedproduct transactions. See Note 19.

*Affiliate QuotaShares*

During 2005 and 2004,OneBeacon participated in two quota share reinsurance arrangements with othersubsidiaries of White Mountains. Under the Esurance Quota Share, which waseffective on January 1, 2005, OneBeacon assumed approximately 85% ofbusiness written by Esurance Insurance Company, which includes business writtenby its wholly owned subsidiary. Under the Sirius Quota Share, OneBeacon cededbetween 6% and 12% of business written, effective April 1, 2004, to SiriusInternational Insurance Corporation, a subsidiary of White Mountains Re. Theaffiliate quota shares were entered into primarily for White Mountains’ capitalmanagement purposes. These quota shareagreements were commuted during the fourth quarter of 2006 in connection withthe Company’s initial public offering.

***Prospector***

*InvestmentManagement Agreement with Prospector*

Prior to the initial public offering, Prospectormanaged most of the publicly-traded common equity and convertiblesecurities in OneBeacon’s portfolio, as well as the employee benefit planportfolios, through a sub-advisory agreement with WM Advisors.

In connection with the initial public offering of theCompany’s common stock, OneBeacon entered into an investment managementagreement with Prospector dated November 14, 2006, pursuant to whichProspector supervises and directs the publicly-traded common equity andconvertible securities portion of OneBeacon’s investment portfolio inaccordance with the investment objectives, policies and restrictions describedin OneBeacon’s investment guidelines,. Under the agreement, Prospector hasdiscretion and authority with respect to the portfolio it manages for OneBeaconthat is substantially similar to WM Advisors’ discretion and authority underits agreement. The assets of OneBeacon’s portfolio are held in one or moreseparately identifiable accounts in the custody of a bank or similar entitydesignated by us and acceptable to Prospector. OneBeacon is responsible forcustodial arrangements and the payment of all 

F-54

----

custodial charges andfees. As of December 31, 2006, Prospector earned $0.5 million in feeswith respect to OneBeacon’s portfolio.

Prospector continues to serve as a discretionaryadvisor to WM Advisors under the sub-advisory agreement with respect tospecified assets in OneBeacon’s employee benefit plan portfolios.

Under the agreement, OneBeacon pays annual managementfees to Prospector based on aggregate net assets under management according tothe following schedule: 1.00% on the first $200 million; 0.50% on the next$200 million; and 0.25% on amounts over $400 million.

The agreement has an initial fixed term of threeyears, which is extendible by us for an additional year (a fourth year) at orprior to the end of the second year of the term, and if so extended, for asecond additional year (a fifth year) at or prior to the end of the third yearof the term. The agreement is terminable by OneBeacon only (i) for cause(including material non-performance by Prospector), (ii) if eitherJohn D. Gillespie or Richard P. Howard are no longer affiliated withProspector, (iii) if there is a change in control of Prospector (for thispurpose, a change in control represents 50% or greater change in votinginterest of Prospector), or (iv) if White Mountains’ voting interest inthe Company falls below 50%. Following the end of the initial term and anyextensions, the Prospector Agreement may be terminated by either party on60 days written notice. OneBeacon reviews periodically the performance ofand the fees paid to Prospector under the agreement.

Richard P. Howard, amanaging member of Prospector, is a director of the Company.

*Prospector RevenueSharing Agreement*

Pursuant to a revenuesharing agreement established in connection with his historical employment byWhite Mountains, Mr. John Gillespie agreed to pay Fund American 33% ofcertain revenues of Prospector in return for Fund American agreeing to pay itsoperational expenses. For 2004, Fund American received total revenues of$4.2 million and paid total expenses of $2.8 million under the revenuesharing agreement. Effective August 1, 2005, Mr. Gillespie’srelationship with White Mountains was revised and the revenue sharing agreementbetween Prospector and Fund American was terminated. For 2005, Fund Americanreceived total revenues of $2.1 million and paid total expenses of$2.1 million under the revenue sharing agreement.

*Prospector ManagedLimited Partnerships*

At December 31, 2005 and 2006, OneBeacon had$33.9 million and $35.6 million, respectively, invested in limitedpartnerships managed by Prospector.

**NOTE 19.Commitments and Contingencies**

OneBeacon leases certainoffice space under noncancellable operating leases expiring at various datesthrough 2010. Rental expense for all of OneBeacon’s locations was approximately$34.1 million, $34.8 million and $34.0 million for the years ended December 31,2004, 2005 and 2006, respectively. OneBeacon also has various other leaseobligations which are immaterial in the aggregate.

OneBeacon’s future annualminimum rental payments required under noncancellable leases primarily foroffice space are $28.7 million, $20.6 million, $10.9 million,$5.8 million and $15.7 million for 2007, 2008, 2009, 2010 and 2011and thereafter, respectively.

***Assigned Risks***

As a condition ofOneBeacon’s license to do business in certain states, OneBeacon’s insuranceoperations are required to participate in mandatory shared market mechanisms.Each state dictates the types of insurance and the level of coverage that mustbe provided. The total amount of such business an insurer is required to acceptis based on its market share of voluntary business in the state. In certaincases, 

F-55

----

OneBeaconis obligated to write business from mandatory shared market mechanisms at sometime in the future based on the market share of voluntary policies it iscurrently writing. Underwriting results related to assigned risk plans aretypically adverse and are not subject to the predictability associated withOneBeacon’s voluntarily written business.

Under existing guarantyfund laws in all states, insurers licensed to do business in those states canbe assessed for certain obligations of insolvent insurance companies topolicyholders and claimants. In accordance with SOP 97-3, OneBeacon’sinsurance subsidiaries record guaranty fund assessments when such assessmentsare billed by the respective guaranty funds. In addition, each insurancesubsidiary’s policy is to accrue for any significant insolvencies when the lossis probable and the assessment amount can be reasonably estimated. The actualamount of such assessments will depend upon the final outcome of rehabilitationproceedings and will be paid over several years. At December 31, 2006, thereserve for such assessments at OneBeacon’s insurance subsidiaries totaled$17.3 million.

***Legal Contingencies***

OneBeacon, and theinsurance industry in general, are subject to litigation and arbitration in thenormal course of business. Other than those items listed below, OneBeacon isnot a party to any material litigation or arbitration other than as routinelyencountered in claims activity, none of which is expected by management to havea material adverse effect on OneBeacon’s financial condition and/or cash flows.

OneBeacon is in a disputewith Liberty Mutual over certain costs Liberty Mutual claims it incurred inconnection with the Liberty Agreement. Liberty Mutual asserts that these costsare part of unallocated loss adjustment expenses (“ULAE”) due Liberty Mutualunder the Liberty Agreement. Liberty Mutual further asserts that ULAE oncharges previously billed to and settled by OneBeacon since the inception ofthe Liberty Agreement should be retroactively recast in addition to changingthe calculation of ULAE charges for the period not yet settled. OneBeaconbelieves that the recast charges, which are significantly higher than priorULAE calculations, and the calculation of ULAE charges for the period not yetsettled are inconsistent with the terms of the Liberty Agreement and withstandard industry definitions of ULAE. The amount of additional ULAE LibertyMutual claims that it incurred under the Liberty Agreement totals$68.4 million. Liberty Mutual has netted amounts billed under the ULAEdispute against amounts otherwise payable to OneBeacon. As of December 31,2006, OneBeacon has recorded in its loss and LAE reserves an estimate of ULAEexpenses due Liberty Mutual on a basis that it believes is consistent with theterms of the Liberty Agreement and with standard industry definitions of ULAE. InJanuary 2006, Liberty Mutual initiated an arbitration proceeding againstOneBeacon with respect to this dispute (the “ULAE Arbitration”). The initialorganizational meeting on the ULAE Arbitration was held in February 2007and the final hearing is scheduled for April 2008.

In September 2006,OneBeacon initiated an arbitration against Liberty Mutual (and PeerlessInsurance Company) seeking payment of approximately $57 million relatingto reinsurance premiums, ceding commissions, recoveries and commutations due toOneBeacon from Liberty Mutual pursuant to the terms and conditions of therewritten indemnity reinsurance agreement. To date, Liberty Mutual has refusedto pay, asserting that it is entitled to an offset against the ULAE amountsdisputed by OneBeacon and subject to the ULAE Arbitration. In January 2007,this arbitration was consolidated into the ULAE Arbitration.

The Company’ssubsidiaries, OneBeacon Insurance Group LLC and OBIC, also have asserted claimsagainst Liberty Mutual (and Peerless Insurance Company) in the Court of CommonPleas for Philadelphia County, Pennsylvania, or the Court, in which they assertthat Liberty Mutual (and Peerless Insurance Company) breached the Pre-ClosingAdministrative Services Agreement, handled claims files negligently, breachedfiduciary duties and were unjustly enriched. The Court has stayed those claimspending the resolution of the arbitration between OBIC and Liberty Mutual forbreach of contract. The arbitration hearing commenced in November 2006 andwill continue in May 2007.

F-56

----

OneBeacon believes thatits loss and LAE reserves are sufficient to cover reasonably anticipatedoutcomes of all related disputes with Liberty Mutual as of December 31,2006.

***Guarantees***

Beginning in February 2006,OBIC agreed to provide guarantees of the obligations of Galileo to Galileo’scounterparty in certain weather-related product transactions. Galileo isa subsidiary of White Mountains. The guarantees require OBIC to pay the fullamount of Galileo’s obligations to the counterparty in the event of Galileo’sfailure to pay these obligations. In the event of a payment, OBIC would beeligible to exercise all of the rights of the counterparty against Galileo. Asof December 31, 2006, OneBeacon had executed sixteen guarantees of Galileotransactions, the total principal amount of which was approximately$158 million. In the event that the total guaranteed principal amountexceeds the lesser of 5% of OBIC’s admitted assets of $3.8 billion at December 31,2006 or 25% of OBIC’s statutory surplus of $1.7 billion at December 31,2006, OBIC would require the approval of the Pennsylvania Department ofInsurance in order to make any further guarantees. OBIC has agreed, at WhiteMountains’ option, to continue to make these guarantees available until October 2008and will receive from Galileo an annual fee of 25 basis points of the value atrisk for providing the guarantees. Pursuant to a separation agreement enteredinto by OneBeacon and White Mountains in connection with the initial publicoffering, White Mountains has agreed that it will take appropriate steps toensure that OBIC will not be called on to make payment on these guarantees.

F-57

----

**NOTE 20. Earnings perShare**

Basic and dilutedearnings per share amounts have been determined in accordance with SFAS No. 128,“*Earnings per Share*.” OneBeaconhas 100,013,292 shares issued and outstanding. On October 18, 2006,OneBeacon executed a stock split and recapitalization that increased the commonshares outstanding from 12,000 to 100,000,000 and reduced the par value from$1.00 to $0.01. The stock split and recapitalization have been reflectedretroactively in these financial statements for all periods presented. Inconnection with the initial public offering, four common shares of the Company’scommon stock were awarded to each employee and deposited into participant ESOPaccounts. A total of 13,292 shares were awarded. The earnings per share amountshave been determined assuming that the common shares were outstanding for allperiods presented.

| ** **                                               | ** ** | **2004** | ** ** | **2005** | ** ** | **2006** | ** ** |
|----------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| **Basic earnings per share numerators (in  millions):**  |       |     |       |     |       |     |       |
| Income from continuing  operations                       |       | $        | 160.1      |     | $          | 186.3    |       | $ | 245.5 |   |
| (Loss) income from  discontinued operations, net of tax  |       | (24.1    | )          | 25.2     |       | 1.2      |       |
| Gain from sale of  discontinued operations, net of tax   |       | —   |       | 21.1     |       | —   |       |
| Net income available to  common shareholders             |       | $        | 136.0      |     | $          | 232.6    |       | $ | 246.7 |   |
| **Diluted earnings per share numerators (in millions):** |       |     |       |     |       |     |       |
| Income from continuing  operations                       |       | $        | 160.1      |     | $          | 186.3    |       | $ | 245.5 |   |
| Other effects on diluted  earnings(1)                    |       | (0.1     | )          | —   |       | —   |       |
| (Loss) income from  discontinued operations, net of tax  |       | (24.1    | )          | 25.2     |       | 1.2      |       |
| Gain from sale of  discontinued operations, net of tax   |       | —   |       | 21.1     |       | —   |       |
| Net income available to  common shareholders             |       | $        | 135.9      |     | $          | 232.6    |       | $ | 246.7 |   |
| **Basic earnings per share (in dollars):**               |       |     |       |     |       |     |       |
| Net income from  continuing operations                   |       | $        | 1.60       |     | $          | 1.86     |       | $ | 2.46 |   |
| (Loss) income from  discontinued operations              |       | (0.24    | )          | 0.25     |       | 0.01     |       |
| Gain from sale of  discontinued operations, net of tax   |       | —   |       | 0.21     |       | —   |       |
| Net income available to  common shareholders             |       | $        | 1.36       |     | $          | 2.33     |       | $ | 2.47 |   |
| **Diluted earnings per share (in dollars):**             |       |     |       |     |       |     |       |
| Income from continuing  operations                       |       | $        | 1.60       |     | $          | 1.86     |       | $ | 2.46 |   |
| (Loss) income from  discontinued operations              |       | (0.24    | )          | 0.25     |       | 0.01     |       |
| Gain from sale of  discontinued operations, net of tax   |       | —   |       | 0.21     |       | —   |       |
| Net income available to common shareholders              |       | $        | 1.36       |     | $          | 2.33     |       | $ | 2.47 |   |

----

(1)          Thediluted earnings per share numerator for the year ended December 31, 2004has been adjusted to exclude a portion of OneBeacon’s equity in earnings ofunconsolidated affiliates, which is reflective of dilution in Montpelier’s earningsbrought about by outstanding warrants and options to acquire common shares ofMontpelier that were in-the-money. As of March 31, 2004,OneBeacon changed its method of accounting for its investment in Montpelierfrom equity accounting to fair value, therefore, this equity adjustments is notapplicable to periods beginning after such date.

**NOTE 21. Subsequent Events**

On February 21, 2007, the Board of Directorsdeclared a dividend of $0.21 per common share, payable on March 29, 2007to shareholders of record on March 19, 2007.

F-58

----

**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

To the Board of Directors and Shareholders ofOneBeacon Insurance Group, Ltd.:

In our opinion, the accompanying consolidatedfinancial statements listed in the accompanying index appearing on page F-1present fairly, in all material respects, the financial position of OneBeaconInsurance Group, Ltd. at December 31, 2005 and 2006, and the results oftheir operations and their cash flows for each of the three years in the periodended December 31, 2006 in conformity with accounting principles generallyaccepted in the United States of America. In addition, in our opinion, thefinancial statement schedules listed in the accompanying index present fairly,in all material respects, the information set forth therein when read inconjunction with the related consolidated financial statements. These financialstatements and financial statement schedules are the responsibility of theCompany’s management. Our responsibility is to express an opinion on thesefinancial statements and financial statement schedules based on our audits. Weconducted our audits of these statements in accordance with the standards ofthe Public Company Accounting Oversight Board (United States). Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement. An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements, assessing the accounting principlesused and significant estimates made by management, and evaluating the overallfinancial statement presentation. We believe that our audits provide areasonable basis for our opinion.

/s/ PricewaterhouseCoopers LLP

PricewaterhouseCoopers LLPBoston, MassachusettsFebruary 28, 2007

F-59

----

**SELECTED QUARTERLYFINANCIAL DATA**

**(Unaudited)**

Selectedquarterly financial data for 2005 and 2006 is shown in the following table. Thequarterly financial data includes, in the opinion of management, all recurringadjustments necessary for a fair presentation of the results of operations forthe interim periods.

| ** **                                                 | ** ** | **2005 Three Months Ended** | ** ** | **2006 Three Months Ended** | ** ** |
|------------------------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|
| **Millions, except per share amounts** | ** ** | **Mar. 31**                           | ** ** | **June 30**                           | ** ** | **Sept. 30** | ** ** | **Dec. 31** | ** ** | **Mar. 31** | ** ** | **June 30** | ** ** | **Sept. 30** | ** ** | **Dec. 31** | ** ** |
| Revenues                                                   |       | $                                          | 626.7      |                                       | $          | 590.7 |   | $ | 629.3 |   | $ | 550.1 |   | $ | 586.5 |   | $ | 632.8 |   | $ | 672.5 |   | $ | 578.3 |   |
| Expenses                                                   |       | 520.8                                      |       | 514.1                                      |       | 568.1 |   | 531.0 |   | 544.7 |   | 543.4 |   | 564.7 |   | 513.2 |   |
| Pre-tax earnings                                           |       | 105.9                                      |       | 76.6                                       |       | 61.2 |   | 19.1 |   | 41.8 |   | 89.4 |   | 107.8 |   | 65.1 |   |
| Tax provision                                              |       | (36.4                                      | )          | (24.2                                      | )          | (18.7 | ) | (2.8 | ) | (11.7 | ) | (8.7 | ) | (34.1 | ) | (14.4 | ) |
| Equity in  earnings of unconsolidated affiliate            |       | 2.8                                        |       | 1.7                                        |       | 2.7 |   | (1.6 | ) | 2.2 |   | 8.0 |   | (1.6 | ) | 1.7 |   |
| Net income from  continuing operations                     |       | $                                          | 72.3       |                                       | $          | 54.1 |   | $ | 45.2 |   | $ | 14.7 |   | $ | 32.3 |   | $ | 88.7 |   | $ | 72.1 |   | $ | 52.4 |   |
| Net income from  continuing operations per share:          |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic and diluted                                          |       | $                                          | 0.72       |                                       | $          | 0.54 |   | $ | 0.45 |   | $ | 0.15 |   | $ | 0.32 |   | $ | 0.89 |   | $ | 0.72 |   | $ | 0.52 |   |

 

F-60

----

**SCHEDULE I**

**ONEBEACON INSURANCE GROUP, LTD.**

**SUMMARYOF INVESTMENTS—OTHER THAN**

**INVESTMENTSIN RELATED PARTIES**

**At December 31,2006**

| ** **                                                  | ** ** | **Cost**                      | ** ** | **Fair  Value** | ** ** | **Carrying  Value** | ** ** |
|-------------------------------------------------------------|------------|-------------------------------|------------|-----------------|------------|---------------------|------------|
| ** **                                                  | ** ** | **($ in millions)** | ** ** |
| **Available-for-sale investments:**                         |       |                          |       |            |       |                |       |
| Fixed maturities:                                           |       |                          |       |            |       |                |       |
| Bonds:                                                      |       |                          |       |            |       |                |       |
| U.S. Government and government agencies and  authorities(1) |       | $                             | 950.0      |            | $          | 946.9               |       | $ | 946.9 |   |
| Corporate bonds and asset-backed securities                 |       | 1,998.0                       |       | 2,014.8         |       | 2,014.8             |       |
| States, municipalities and political subdivisions           |       | 8.2                           |       | 8.7             |       | 8.7                 |       |
| Convertibles and bonds with warrants attached               |       | 379.7                         |       | 379.7           |       | 379.7               |       |
| Foreign governments                                         |       | 54.7                          |       | 54.1            |       | 54.1                |       |
| Redeemable preferred stocks                                 |       | 110.9                         |       | 135.5           |       | 135.5               |       |
| Total fixed  maturities                                     |       | 3,501.5                       |       | 3,539.7         |       | 3,539.7             |       |
| Short-term  investments                                     |       | 319.0                         |       | 319.0           |       | 319.0               |       |
| Common equity  securities:                                  |       |                          |       |            |       |                |       |
| Banks, trust and insurance companies                        |       | 103.5                         |       | 119.9           |       | 119.9               |       |
| Public utilities                                            |       | 32.4                          |       | 61.4            |       | 61.4                |       |
| Industrial, miscellaneous and other                         |       | 433.0                         |       | 555.8           |       | 555.8               |       |
| Total common  equity securities                             |       | 568.9                         |       | 737.1           |       | 737.1               |       |
| **Held-to-maturity  investments:**                          |       |                          |       |            |       |                |       |
| Fixed maturities                                            |       | 303.3                         |       | 304.0           |       | 305.0               |       |
| Short term investments                                      |       | 33.8                          |       | 33.8            |       | 33.8                |       |
| Total  held-to-maturity investments                         |       | 337.1                         |       | 337.8           |       | 338.8               |       |
| Other investments                                           |       | 229.5                         |       | 278.1           |       | 278.1               |       |
| Total investments                                           |       | $                             | 4,956.0    |            | $          | 5,211.7             |       | $ | 5,212.7 |   |

----

(1)          Includes mortgage-backedsecurities issued by GNMA, FNMA and FHLMC.

S-1

----

**SCHEDULE II**

**ONEBEACON INSURANCEGROUP, LTD.(Registrant Only)**

**CONDENSEDBALANCE SHEETS**

| ** **                                                 | ** ** | **December 31,**         | ** ** |
|------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                                 | ** ** | **2005**                      | ** ** | **2006** | ** ** |
| ** **                                                 | ** ** | **($ in millions)** | ** ** |
| Assets:                                                    |       |                          |       |   |   |
| Investments in consolidated and unconsolidated  affiliates |       | $                             | 1,560.0    |   | $ | 1,776.5 |   |
| Total assets                                               |       | $                             | 1,560.0    |   | $ | 1,776.5 |   |
| Liabilities                                                |       | $                             | —     |   | $ | (0.7 | ) |
| Common  shareholders’ equity                          |       | $                             | 1,560.0    |   | $ | 1,777.2 |   |
| Total liabilities  and common shareholders’ equity    |       | $                             | 1,560.0    |   | $ | 1,776.5 |   |

 

**CONDENSEDSTATEMENTS OF INCOME AND COMPREHENSIVE INCOME**

| ** **                                                                           | ** ** | **Year ended December 31,** | ** ** |
|--------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                           | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                                                           | ** ** | **($ in millions)**              | ** ** |
| Revenues                                                                             |       | $                                          | —     |   | $ | — |   | $ | 0.1 |   |
| Expenses                                                                             |       | —                                     |       | — |   | 5.9 |   |
| Pre-tax  income (loss)                                                               |       | —                                     |       | — |   | (5.8 | ) |
| Income tax provision                                                                 |       | —                                     |       | — |   | — |   |
| Net income (loss)                                                                    |       | —                                     |       | — |   | (5.8 | ) |
| Equity in earnings from consolidated  affiliates—continuing operations          |       | 160.1                                      |       | 186.3 |   | 251.3 |   |
| Equity in earnings (loss) from consolidated  affiliates—discontinued operations |       | (24.1                                      | )          | 46.3 |   | 1.2 |   |
| Consolidated net  income                                                             |       | 136.0                                      |       | 232.6 |   | 246.7 |   |
| Other comprehensive net income (loss) items, after-tax                               |       | 84.3                                       |       | (144.8 | ) | 29.0 |   |
| Consolidated  comprehensive net income                                               |       | $                                          | 220.3      |   | $ | 87.8 |   | $ | 275.7 |   |

 

**CONDENSEDSTATEMENTS OF CASH FLOWS**

| ** **                                                                                 | ** ** | **Year ended December 31,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                 | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                                                                 | ** ** | **($ in millions)**              | ** ** |
| Net income                                                                                 |       | $                                          | 136.0      |   | $ | 232.6 |   | $ | 246.7 |   |
| Charges (credits) to  reconcile net income to net cash from operations:                    |       |                                       |       |   |   |   |   |
| Undistributed earnings from consolidated  subsidiaries—continuing operations          |       | (160.1                                     | )          | (186.3 | ) | (251.3 | ) |
| Undistributed (earnings) loss from consolidated  subsidiaries—discontinued operations |       | 24.1                                       |       | (46.3 | ) | (1.2 | ) |
| Net change in  other assets and liabilities                                                |       | —                                     |       | — |   | 5.4 |   |
| Net cash used for  operations                                                              |       | —                                     |       | — |   | (0.4 | ) |
| Net cash used for  investing activities                                                    |       | —                                     |       | — |   | (14.6 | ) |
| Net cash provided  from financing activities                                               |       | —                                     |       | — |   | 15.0 |   |
| Net change in  cash during the year                                                        |       | —                                     |       | — |   | — |   |
| Cash balance at  beginning of year                                                         |       | —                                     |       | — |   | — |   |
| Cash balance at end of  year                                                               |       | $                                          | —     |   | $ | — |   | $ | — |   |

 

S-2

----

**SCHEDULE III**

**ONEBEACONINSURANCE GROUP, LTD.SUPPLEMENTARY INSURANCE INFORMATION**

| **Column A** | ** ** | **Column B**             | ** ** | **Column C**                | ** ** | **Column D**                                                               | ** ** | **Column E**      | ** ** | **Column F**                                     | ** ** | **Column G**    | ** ** | **Column H**              | ** ** | **Column I**                                              | ** ** | **Column J**                                       | ** ** | **Column K**              | ** ** |
|-------------------|------------|-------------------------------|------------|----------------------------------|------------|---------------------------------------------------------------------------------|------------|------------------------|------------|-------------------------------------------------------|------------|----------------------|------------|--------------------------------|------------|----------------------------------------------------------------|------------|---------------------------------------------------------|------------|--------------------------------|------------|
| **Segment**       | ** ** | ** **                    | ** ** | **Deferred  acquisition  costs** | ** ** | **Future policy  benefits,  losses,  claims and  loss expenses** | ** ** | **Unearned  premiums** | ** ** | **Other  policy  claims and  benefits  payable** | ** ** | **Premiums  earned** | ** ** | **Net  investment  income(1)** | ** ** | **Benefits,  claims, losses,  and  settlement  expenses** | ** ** | **Amortization  of policy  acquisition  expenses** | ** ** | **Other  operating  expenses** | ** ** | **Premiums  written** | ** ** |
| ** **        | ** ** | **($ in millions)** | ** ** |                             |
|                   |            |                               |            |                                  |            |                                                                                 |            |                        |            |                                                       |            |                      |            |                                |            |                                                                |            |                                                         |            |                                |            |  |  |  |

| **Years ended:**            |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|-----------------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|
| **December 31, 2004:** |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |

| Primary Insurance Operations |   |   | $      | 187.3  |   |   |   | $      | 5,328.2 |   |   |   | $      | 1,001.4 |   |   |   | $      | — |   |   |   | $      | 2,203.0 |   |   |   | $      | 211.1  |   |   |   | $      | 1,448.1 |   |   |   | $      | 403.3  |   |   |   | $ | 350.0 |   |   |   | $ | 2,280.6 |   |   |
|------------------------------|--------|--------|--------|--------|--------|--------|--------|--------|---------|--------|--------|--------|--------|---------|--------|--------|--------|--------|--------|--------|--------|--------|--------|---------|--------|--------|--------|--------|--------|--------|--------|--------|--------|---------|--------|--------|--------|--------|--------|--------|--------|--------|---|-------|--------|--------|--------|---|---------|--------|--------|
| Affiliate Quota Shares       |   |   | — |   |   |   | (44.5  | )      |    |   | — |   |   |    | — |   |   |   | (115.9 | )      |   |   | — |    |   |   | (62.7  | )      |   |   | (43.5  | )      |   |    | — |   |   |   | (115.9 | )      |   |
| Other Operations             |   |   | — |   |   |   | (361.5 | )      |    |   | — |   |   |    | — |   |   |   | — |   |   |   | — |    |   |   | — |   |   |   | — |   |   |    | — |   |   |   | — |   |   |
| **December 31, 2005:**  |   |   |   |   |   |   |   |   |    |   |   |   |   |    |   |   |   |   |   |   |   |   |   |    |   |   |   |   |   |   |   |   |   |    |   |   |   |   |   |   |   |
| Primary Insurance Operations |   |   | $      | 180.1  |   |   |   | $      | 5,713.4 |   |   |   | $      | 960.3   |   |   |   | $      | — |   |   |   | $      | 1,988.2 |   |   |   | $      | 232.5  |   |   |   | $      | 1,335.6 |   |   |   | $      | 360.5  |   |   |   | $ | 263.4 |   |   |   | $ | 1,988.6 |   |   |
| Affiliate Quota Shares       |   |   | 24.3   |   |   |   | (41.6  | )      |    |   | 82.5   |   |   |    | — |   |   |   | 24.5   |   |   |   | — |    |   |   | 54.8   |   |   |   | (11.2  | )      |   |    | — |   |   |   | 107.0  |   |   |
| Other Operations             |   |   | — |   |   |   | (317.5 | )      |    |   | — |   |   |    | — |   |   |   | — |   |   |   | — |    |   |   | — |   |   |   | — |   |   |    | — |   |   |   | — |   |   |
| **December 31, 2006:**  |   |   |   |   |   |   |   |   |    |   |   |   |   |    |   |   |   |   |   |   |   |   |   |    |   |   |   |   |   |   |   |   |   |    |   |   |   |   |   |   |   |
| Primary Insurance Operations |   |   | $      | 183.8  |   |   |   | $      | 5,108.2 |   |   |   | $      | 985.2   |   |   |   | $      | — |   |   |   | $      | 1,944.0 |   |   |   | $      | 182.3  |   |   |   | $      | 1,180.3 |   |   |   | $      | 332.3  |   |   |   | $ | 360.1 |   |   |   | $ | 1,957.6 |   |   |
| Affiliate Quota Shares       |   |   | — |   |   |   | — |   |    |   | — |   |   |    | — |   |   |   | 131.9  |   |   |   | — |    |   |   | 103.3  |   |   |   | 47.6   |   |   |    | — |   |   |   | 49.4   |   |   |
| Other Operations             |   |   | — |   |   |   | (270.5 | )      |    |   | — |   |   |    | — |   |   |   | — |   |   |   | — |    |   |   | — |   |   |   | — |   |   |    | — |   |   |   | — |   |   |

----

(1)          Theamounts shown exclude net investment income (expense) relating to non-insuranceoperations of $(1.5) million, $4.3 million and $9.5 million forthe twelve months ended December 31, 2004, 2005 and 2006, respectively.

S-3

----

**SCHEDULE IV**

**ONEBEACONINSURANCE GROUP, LTD.REINSURANCE**

| ** **                   | **Column A**        | ** **                    | ** ** | **Column B** | ** ** | **Column C**                   | ** ** | **Column D**                   | ** ** | **Column E** | ** ** | **Column F**                                    | ** ** |
|------------------------------|--------------------------|-------------------------------|------------|-------------------|------------|-------------------------------------|------------|-------------------------------------|------------|-------------------|------------|------------------------------------------------------|------------|
| ** **                   | **Premiums earned** | ** **                    | ** ** | **Gross  amount** | ** ** | **Ceded to  other  companies** | ** ** | **Assumed  from  other  companies** | ** ** | **Net  amount**   | ** ** | **Percentage  of amount  assumed to  net** | ** ** |
| ** **                   | ** **               | **($ in millions)** | ** ** |
| **Years ended:**             |                     |                          |       |              |       |                                |       |                                |       |              |       |                                                 |       |   |   |   |   |   |   |
| **December 31, 2004:**  |                     |                          |       |              |       |                                |       |                                |       |              |       |                                                 |       |   |   |   |   |   |   |
| Primary Insurance Operations |                     |                          | $          | 1,996.4           |       |                                |       | $                                   | (124.5     | )                 |       |                                                 | $          | 331.1 |   |   | $ | 2,203.0 |   |   | 15.0 | % |   |
| Affiliate Quota Shares       |                     |                          | —     |              |       |                                | (115.9     | )                                   |       |              | —     |                                                 |       | (115.9 | ) |   | — |   |   |
| Other Operations             |                     |                          | —     |              |       |                                | —     |                                |       |              | —     |                                                 |       | — |   |   | — |   |   |
| **December 31,  2005:** |                     |                          |       |              |       |                                |       |                                |       |              |       |                                                 |       |   |   |   |   |   |   |
| Primary Insurance Operations |                     |                          | $          | 2,043.5           |       |                                |       | $                                   | (158.0     | )                 |       |                                                 | $          | 102.7 |   |   | $ | 1,988.2 |   |   | 5.2 | % |   |
| Affiliate Quota Shares       |                     |                          | —     |              |       |                                | (229.9     | )                                   |       |              | 254.4      |                                                 |       | 24.5 |   |   | 1,038.4 | % |   |
| Other Operations             |                     |                          | —     |              |       |                                | —     |                                |       |              | —     |                                                 |       | — |   |   | — |   |   |
| **December 31,  2006:** |                     |                          |       |              |       |                                |       |                                |       |              |       |                                                 |       |   |   |   |   |   |   |
| Primary Insurance Operations |                     |                          | $          | 2,007.5           |       |                                |       | $                                   | (128.9     | )                 |       |                                                 | $          | 65.4 |   |   | $ | 1,944.0 |   |   | 3.4 | % |   |
| Affiliate Quota Shares(1)    |                     |                          | —     |              |       |                                | (178.0     | )                                   |       |              | 309.9      |                                                 |       | 131.9 |   |   | 235.0 | % |   |
| Other Operations             |                     |                          | —     |              |       |                                | —     |                                |       |              | —     |                                                 |       | — |   |   | — |   |   |
|                              |                          |                               |            |                   |            |                                     |            |                                     |            |                   |            |                                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

----

(1)          The affiliate quotashare agreements were commuted during the fourth quarter of 2006.

S-4

----

**SCHEDULE V**

**ONEBEACONINSURANCE GROUP, LTD.VALUATION AND QUALIFYING ACCOUNTS**

| ** **                                          | ** ** | **Column A**                              | ** ** | **Column B**                                         | ** ** | **Column C**                    | ** ** | **Column D**            | ** ** | **Column E**                        | ** ** |
|-----------------------------------------------------|------------|------------------------------------------------|------------|-----------------------------------------------------------|------------|--------------------------------------|------------|------------------------------|------------|------------------------------------------|------------|
| ** **                                          | ** ** | **Additions (subtractions)**              | ** ** |
| ** **                                          | ** ** | **Balance at  beginning  of period** | ** ** | **Charged (Credited)  to costs  and  expenses** | ** ** | **Charged  to other  accounts** | ** ** | **Deductions  described(1)** | ** ** | **Balance at  end of  period** | ** ** |
| ** **                                          | ** ** | **($ in millions)**                  | ** ** |
| **Years ended:**                                    |       |                                           |       |                                                      |       |                                 |       |                         |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| **December 31, 2004:**                         |       |                                           |       |                                                      |       |                                 |       |                         |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Reinsurance  recoverable on paid and unpaid losses: |       |                                           |       |                                                      |       |                                 |       |                         |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Allowance for reinsurance balances                  |       |                                           | $          | 14.0                                                      |       |                                 |       | $                            | —     |                                     |       |   | $ | — |   |   |   | $ | (2.5 | ) |   |   | $ | 11.5 |   |   |
| Premiums  receivable:                               |       |                                           |       |                                                      |       |                                 |       |                         |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Allowance for uncollectible accounts                |       |                                           | 23.0       |                                                      |       |                                 | 11.5       |                         |       |                                     | —     |   |   |   | (12.9 | ) |   |   | 21.6 |   |   |
| **December 31,  2005:**                        |       |                                           |       |                                                      |       |                                 |       |                         |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Reinsurance  recoverable on paid and unpaid losses: |       |                                           |       |                                                      |       |                                 |       |                         |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Allowance for reinsurance balances                  |       |                                           | $          | 11.5                                                      |       |                                 |       | $                            | —     |                                     |       |   | $ | — |   |   |   | $ | 1.7 |   |   |   | $ | 13.2 |   |   |
| Premiums  receivable:                               |       |                                           |       |                                                      |       |                                 |       |                         |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Allowance for uncollectible accounts                |       |                                           | 21.6       |                                                      |       |                                 | (8.3       | )                            |       |                                     | —     |   |   |   | 0.3 |   |   |   | 13.6 |   |   |
| **December 31,  2006:**                        |       |                                           |       |                                                      |       |                                 |       |                         |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Reinsurance  recoverable on paid and unpaid losses: |       |                                           |       |                                                      |       |                                 |       |                         |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Allowance for reinsurance balances                  |       |                                           | $          | 13.2                                                      |       |                                 |       | $                            | —     |                                     |       |   | $ | — |   |   |   | $ | 0.2 |   |   |   | $ | 13.4 |   |   |
| Premiums  receivable:                               |       |                                           |       |                                                      |       |                                 |       |                         |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Allowance for  uncollectible accounts               |       |                                           | 13.6       |                                                      |       |                                 | (3.0       | )                            |       |                                     | —     |   |   |   | 6.2 |   |   |   | 16.8 |   |   |

----

(1)          Represents netreinstatements (charge-offs) of balances receivables.

S-5

----

**SCHEDULE VI**

**ONEBEACONINSURANCE GROUP, LTD.SUPPLEMENTAL INFORMATION FOR PROPERTY AND CASUALTY INSURANCE UNDERWRITERS**

| **Column A**                                           | ** ** | ** **               | ** **                | **Column B**                                      | ** ** | **Column C**                     | ** ** | **Column D**     | ** **                | **Column E**      | ** ** | **Column F**                           | ** ** | **Column G**                                                                    | ** **     | **Column H**                          | ** ** | **Column I**             | ** ** | **Column J**      | ** **                                  | **Column K**        | ** ** |
|-------------------------------------------------------------|------------|--------------------------|---------------------------|--------------------------------------------------------|------------|---------------------------------------|------------|-----------------------|---------------------------|------------------------|------------|---------------------------------------------|------------|--------------------------------------------------------------------------------------|----------------|--------------------------------------------|------------|-------------------------------|------------|------------------------|---------------------------------------------|--------------------------|------------|
| ** **                                                  | ** ** | **Deferred**             | ** **                | **Reserves  for Unpaid  Claims and  Claims** | ** ** | **Discount,  if any,  deducted** | ** ** | ** **            | ** **                | ** **             | ** ** | **Net**                                     | ** ** | **Claims and Claims  Adjustment  Expenses  Incurred Related to** | ** **     | **Amortization  of deferred  policy** | ** ** | **Paid  Claims  and  Claims** | ** ** | ** **             | ** **                                  |
| **Affiliation with registrant**                   | ** ** | ** **               | ** **                | **acquisition  costs**                                 | ** ** | **Adjustment  Expenses**              | ** ** | **in  Column C** | ** **                | **Unearned  Premiums** | ** ** | **Earned  Premiums**                        | ** ** | **investment  income(5)**                                                            | ** **     | **(1)  Current Year**                 | ** ** | **(2)  Prior Year**      | ** ** | **acquisition  costs** | ** **                                  | **Adjustment  Expenses** | ** ** | **Premiums  written** | ** ** |
| ** **                                                  | ** ** | **($ in millions)** | ** **                |
| **Primary  Insurance Operations:**                          |       |                     |                      |                                                   |       |                                  |       |                  |                      |                   |       |                                        |       |                                                                                 |           |                                       |       |                          |       |                   |                                        |                     |       |   |   |   |   |   |   |   |   |   |   |   |
| 2004                                                        |       |                     | $ 187.3              |                                                   |       | $ 5,328.2                        |       |                  | $ 259.4              | (3)                    |       | $ 1,001.4                              |       |                                                                                 | $ 2,203.0 |                                       |       | $ 211.1                  |       |                   | $ 1,342.0                              |                     |       | $ 106.1 |   |   | $ 403.3 |   |   | $ 2,007.1 |   |   | $ 2,280.6 |   |
| 2005                                                        |       |                     | 180.1                     |                                                   |       | 5,713.4                               |       |                  | 214.3                     | (3)                    |       | 960.3                                       |       |                                                                                 | 1,988.2        |                                       |       | 232.5                         |       |                   | 1,236.6                                     |                     |       | 99.0 |   |   | 360.5 |   |   | 1,664.4 |   |   | 1,988.6 |   |
| 2006                                                        |       |                     | 183.8                     |                                                   |       | 5,108.2                               |       |                  | 190.7                     | (3)                    |       | 985.2                                       |       |                                                                                 | 1,944.0        |                                       |       | 182.3                         |       |                   | 1,157.4                                     |                     |       | 22.9 |   |   | 332.3 |   |   | 1,483.2 |   |   | 1,957.6 |   |
| **Affiliate Quota Shares:(1)**                              |       |                     |                      |                                                   |       |                                  |       |                  |                      |                   |       |                                        |       |                                                                                 |           |                                       |       |                          |       |                   |                                        |                     |       |   |   |   |   |   |   |   |   |   |   |   |
| 2004                                                        |       |                     | $   — |                                                   |       | $ (44.5                          | )          |                  | $   — |                   |       | $      — |       |                                                                                 | $ (115.9  | )                                          |       | $   —     |       |                   | $ (55.9                                | )                        |       | (6.8 | ) |   | (43.5 | ) |   | (18.2 | ) |   | (115.9 | ) |
| 2005                                                        |       |                     | 24.3                      |                                                   |       | (41.6                                 | )          |                  | —                    |                   |       | 82.5                                        |       |                                                                                 | 24.5           |                                       |       | —                        |       |                   | 54.8                                        |                     |       | — |   |   | (11.2 | ) |   | 37.2 |   |   | 107.0 |   |
| 2006                                                        |       |                     | —                    |                                                   |       | —                                |       |                  | —                    |                   |       | —                                      |       |                                                                                 | 131.9          |                                       |       | —                        |       |                   | 114.9                                       |                     |       | (11.6 | ) |   | 47.6 |   |   | 61.7 |   |   | 49.4 |   |
| **Other Operations:**                                       |       |                     |                      |                                                   |       |                                  |       |                  |                      |                   |       |                                        |       |                                                                                 |           |                                       |       |                          |       |                   |                                        |                     |       |   |   |   |   |   |   |   |   |   |   |   |
| 2004                                                        |       |                     | $   — |                                                   |       | $ (361.5                         | )          |                  | $ 361.5              | (4)                    |       | $      — |       |                                                                                 | —         |                                       |       | $   —     |       |                   | $      — |                     |       | — |   |   | — |   |   | — |   |   | — |   |
| 2005                                                        |       |                     | —                    |                                                   |       | (317.5                                | )          |                  | 317.5                     | (4)                    |       | —                                      |       |                                                                                 | —         |                                       |       | —                        |       |                   | —                                      |                     |       | — |   |   | — |   |   | — |   |   | — |   |
| 2006                                                        |       |                     | —                    |                                                   |       | (270.5                                | )          |                  | 270.5                     | (4)                    |       | —                                      |       |                                                                                 | —         |                                       |       | —                        |       |                   | —                                      |                     |       | — |   |   | — |   |   | — |   |   | — |   |
| **50%-or-less owned  property and casualty  investees:(2)** |       |                     |                      |                                                   |       |                                  |       |                  |                      |                   |       |                                        |       |                                                                                 |           |                                       |       |                          |       |                   |                                        |                     |       |   |   |   |   |   |   |   |   |   |   |   |
| 2004                                                        |       |                     | $ 30.8               |                                                   |       | $ 162.8                          |       |                  | $   — |                   |       | $ 144.2                                |       |                                                                                 | $ 217.8   |                                       |       | $ 13.2                   |       |                   | 144.7                                       |                     |       | 4.7 |   |   | 60.0 |   |   | 132.7 |   |   | 227.3 |   |
| 2005                                                        |       |                     | 31.2                      |                                                   |       | 190.2                                 |       |                  | —                    |                   |       | 154.5                                       |       |                                                                                 | 233.8          |                                       |       | 13.6                          |       |                   | 149.3                                       |                     |       | 18.0 |   |   | 62.8 |   |   | 143.9 |   |   | 240.8 |   |
|                                                             |            |                          |                           |                                                        |            |                                       |            |                       |                           |                        |            |                                             |            |                                                                                      |                |                                            |            |                               |            |                        |                                             |                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

----

(1)             The affiliate quota share agreements were commutedduring the fourth quarter of 2006 in connection with the Company’s initialpublic offering.

(2)             The amounts shown represent OneBeacon’s share of MSA,its 50% owned unconsolidated property and casualty insurance affiliate. On October 31,2006, OneBeacon restructured its investment in MSA. See Note 3.

(3)             The amounts shown represent OneBeacon’s discount on itslong-term workers compensation loss and LAE reserves, as such liabilitiesconstitute unpaid but settled claims under which the payment pattern andultimate costs are fixed and determinable on an individual basis. OneBeacondiscounts these reserves using a discount rate which is determined based on thefacts and circumstances applicable at the time the claims are settled (4.7%,5.0% and 5.3% at December 31, 2004, 2005 and 2006).

(4)             The amounts shown exclude unamortized fair valueadjustments to reserves for unpaid claims and claims adjustment expenses madein purchase accounting as a result of Fund American’s purchase of OneBeacon forthe years ended December 31, 2004, 2005 and 2006, respectively.

(5)             The amounts shown exclude net investment income(expense) relating to non-insurance operations of $(1.5) million,$4.3 million and $9.5 million for the twelve months ended December 31,2004, 2005 and 2006, respectively.

S-6

----